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, 2017

 

¨

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)

 

4 Orinda Way, Suite 125-A

Orinda, CA 94563

(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 ¨ No x   

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.: 

 

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer x

Smaller reporting company ¨

Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ¨

 

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. As of June 30, 2017, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of the registrant's equity held by non-affiliates of the registrant was approximately $43,613,782 based on net asset value per share of the registrant's common stock on such date.

 

The number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding as of November 5, 2018 was 6,511,714.

 

Documents Incorporated by Reference

 

None.

 

 

 

Forward Looking Statements

 

The following information contains statements that constitute forward-looking statements. 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-Optivist TM 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
	•	the risks, uncertainties and other factors we identify in “Risk Factors” and elsewhere in this annual report.

 

Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by our forward-looking statements. A description of some of the risks that could cause our actual results to differ appears under the section “Risk Factors” and elsewhere in this prospectus. Additional risks of which we are not currently aware or which we currently deem immaterial could also cause our actual results to differ.

 

In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements. These forward-looking statements are made as of the date of this prospectus. We undertake no obligation to publicly update or revise any forward-looking statements after the date of this prospectus, whether as a result of new information, future events or otherwise, except as required by law.

 

Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made, and we assume no duty to and do not undertake to update forward-looking statements. These forward-looking statements contained in this prospectus do not meet the safe harbor for forward-looking statements pursuant to Section 27A of the Securities Act. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2017

 

TABLE OF CONTENTS

 

	Page
PART I
Item 1. Business	4
Item 1A. Risk Factors	18
Item 1B. Unresolved Staff Comments	36
Item 2. Properties	36
Item 3. Legal Proceedings	36
Item 4. Mine Safety Disclosures	36
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	37
Item 6. Selected Financial Data	39
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 7A. Quantitative and Qualitative Disclosures About Market Risk	53
Item 8. Financial Statements and Supplementary Data	54
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	55
Item 9A. Controls and Procedures	55
Item 9B. Other Information	55
PART III
Item 10. Directors, Executive Officers and Corporate Governance	56
Item 11. Executive Compensation	60
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	62
Item 13. Certain Relationships and Related Transactions, and Director Independence	63
Item 14. Principal Accountant Fees and Services	64
PART IV
Item 15. Exhibits and Financial Statement Schedules	65
Item 16. Form 10-K Summary	66
Signatures	67

 

 

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 TM 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, or (the “1940 Act”).  

 

We are managed by VII Peaks Capital, LLC, or (the “Manager”), which is registered as an investment adviser with the Securities and Exchange Commission, or (the “SEC”). We have elected to be treated for federal income tax purposes as a regulated investment company, or (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”).

 

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 SEC on March 1, 2012. We achieved the minimum offering requirement on July 10, 2012 and commenced operations on such date. As of December 31, 2017, we issued 6.8 million shares of common stock for gross proceeds of $63.8 million, including $5.9 million under our distribution reinvestment plan (“DRIP”).

 

We invest in discounted corporate debt, senior secured term loan 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” or the “Manager”), 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. We also make opportunistic debt and preferred equity investments in private companies.

 

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. There can be no assurance that any of these objectives be achieved.

 

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 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 company’s 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 also invest directly in debt of private companies. We define a “redemption event” as a maturity event or a put event (where investors in the target company’s debt security can have a redemption right at a pre-determined price). We hold such debt an average of 24 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 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 $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 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 also make senior secured direct loan investments in companies with a minimum enterprise value of $5.0 million. For such senior secured direct loan investments, we may receive equity securities to boost overall returns. We expect our portfolio to be predominantly composed of senior secured term loans and high-yield 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 shareholders 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 making distributions on a monthly basis to our shareholders.

 

Between 2001 and 2008, corporate debt levels and the supply of leverage offered by banks and other investors began a steady increase. Since then, corporate debt has continued to increase, with the financing sources less available. We believe a significant amount of this debt will be subject to a redemption event prior to 2021. Many of the companies that have outstanding issues of such debt have not, or 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.

 

Conversion to Closed End Interval Fund

 

At our adjourned annual meeting of stockholders held on December 28, 2016, our stockholders (i) approved the withdrawal of our election to be treated as a business development company; (ii) approved our reorganization as a Delaware Statutory Trust; (iii) approved the amended and restated investment management agreement with our Manager, and (iv) approved of a fundamental policy whereby we would become an “interval fund”, under which we would make annual repurchase offers of our shares on or about November 1^st of each calendar year (collectively, the “Reorganization”). We will complete the Reorganization promptly after approval of an N-2 Registration Statement filed by VII Peaks Co-Optivist Income Fund, a Delaware Statutory Trust, which was formed on January 25, 2017.

 

Changes to Investment Advisory Agreement

 

Set forth below is a chart that summarizes the differences between our Manager’s current investment advisory agreement and the amended and restated investment management agreement approved by our shareholders:

 

	Current Investment Advisory Agreement		Proposed Amended and Restated Investment Advisory Agreement
Fees-Management	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. Fee is payable monthly in arrears.		2.00% if our gross assets are below $100 million; 1.75% if our gross assets are between $100 million and $250 million; and 1.50% if our gross assets are above $250 million. Fee is payable monthly in arrears.
Incentive Fee on Net Investment Income	20% of our net investment income above a hurdle rate of 8% per annum, paid quarterly.		No change.
Incentive Fee on Capital Gains	20% of our realized capital gains, less realized and unrealized capital losses.		Eliminated.
Future Offering Expenses	Incurred by our manager and reimbursed at the rate of 1.5% of gross offering proceeds.		Incurred and paid by us.
Past Offering Expenses paid by Manager	Only reimbursable to the extent of 1.5% of our gross offering proceeds.		No change.

 

Conversion to Interval Fund

 

In the event the Reorganization is consummated, our shareholders approved the adoption of a fundamental policy under which we would operate as an “interval fund” that makes periodic repurchase offers for our common stock. Set forth below is the fundamental policy approved by our shareholders:

 

(a) We will make offers to repurchase our shares at annual intervals pursuant to Rule 23c-3, as amended from time to time. Our Board of Directors may place such conditions and limitations on repurchases as may be permitted.

 

(b) November 1^st of each year, or the next business day if November 1^st is not a business day, will be the deadline (the “Repurchase Request Deadline”) by which we must receive repurchase requests submitted by our shareholders in response to the most recent repurchase offer.

 

  

(c) The date on which the repurchase price for shares is to be determined shall occur within fourteen (14) days after the Repurchase Request Deadline.

 

(d) Repurchase requests may be suspended or postponed under certain circumstances, as provided for in Rule 23c-3.

 

Fundamental Investment Policies and Restrictions

 

Following our withdrawal of our election to be treated as a business development company, we will no longer be required to invest at least 70% of our assets in eligible portfolio securities. Instead, we are required to adopt fundamental policies and restrictions that govern how we may invest our assets. The stated fundamental policies may only be changed by the affirmative vote of a majority of our outstanding voting securities. As defined by the Investment Company Act of 1940 (the “1940 Act”), the vote of a “majority of the outstanding voting securities of the company” means the vote, at an annual or special meeting of the company’s shareholders duly called, (a) of 66- 2 ⁄ 3% or more of the voting securities present at such meeting, if the holders of more than 50% of the outstanding voting securities of the company are present or represented by proxy; or (b) of more than 50% of the outstanding voting securities of the company, whichever is less.

 

Set forth below are the fundamental policies and restrictions that we expect to adopt upon consummation of the Reorganization: 

 

(1)

we may borrow money, except to the extent permitted by the 1940 Act, or any rules, exemptions or interpretations thereunder that may be adopted, granted or issued by the SEC.

 

(2)

we may not act as an underwriter of securities of other issuers, except to the extent we may be deemed to be an underwriter when disposing of our own securities.

 

(3)

we may not make loans if, as a result, more than 33-1/3% of our total assets would be lent to other persons, including other investment companies to the extent permitted by the 1940 Act or any rules, exemptions or interpretations thereunder that may be adopted, granted or issued by the SEC. This limitation does not apply to (1) the lending of portfolio securities, (2) the purchase of debt securities, other debt instruments, loan participations and/or engaging in direct corporate loans in accordance with our investment goals and policies, and (3) repurchase agreements to the extent the entry into a repurchase agreement is deemed to be a loan.

 

(4)

we may not purchase or sell real estate unless acquired as a result of ownership of securities or other instruments and provided that this restriction does not prevent us from (i) purchasing or selling securities or instruments secured by real estate or interests therein, securities or instruments representing interests in real estate or securities or instruments of issuers that invest, deal or otherwise engage in transactions in real estate or interests therein, and (ii) making, purchasing or selling real estate mortgage loans.

 

(5)

we may not purchase or sell physical commodities, unless acquired as a result of ownership of securities or other instruments, provided that this restriction does not prevent us from investing in commodities contracts for the purpose of hedging its investment portfolio, including currency futures, stock index futures, interest rate futures and options thereon.

 

(6)

we may not issue senior securities, except to the extent permitted by the 1940 Act or any rules, exemptions or interpretations thereunder that may be adopted, granted or issued by the SEC.

 

(7)

we may not invest more than 25% of our net assets in securities of issuers in any one industry (other than securities issued or guaranteed by the U.S. government or any of its agencies or instrumentalities or securities of other investment companies).

 

(8)

we will not be limited in the percentage of our assets that may be invested in the securities of any one issuer.

 

With respect to these investment restrictions (except our policy on borrowings set forth above), if a percentage restriction is adhered to at the time of our investment or transaction, a later change in percentage resulting from a change in the values of our investments or the value of our total assets, unless otherwise stated, will not constitute a violation of such restriction or policy.

 

The 1940 Act currently limits borrowing to no more than 33-1/3% of the value of our total net assets. In addition, the 1940 Act currently limits the issuance of a class of senior securities that is indebtedness to no more than 33-1/3% of the value of our total assets or, if the class of senior security is stock, to no more than 50% of the value of our total assets.

 

Our Manager

 

Our investment activities are managed by our Manager who is registered as an investment adviser under the Investment Advisers Act of 1940, as amended, or (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 of the Fund and Stephen Shea, a managing member 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 meets to discuss new and existing opportunities and developments on current investments. Our investment committee currently consists of Mr. Chandhoke, our Chief Executive Officer, and Mr. Milton Balbuena, Co-Chief Investment Officer.

 

Our Affiliates

 

Our Manager is owned and managed by Gurpreet (Gurprit) S. Chandhoke, our Chief Executive Officer, and Stephen F. Shea. Founded in April 2009 with principal offices in Orinda, California, our Manager also manages VII Peaks Co-Optivist B Fund I, LLC, VII Peaks Co-Optivist R Fund I, LLC and VII Peaks Co-Optivist B Fund II, LLC, and the VII Peaks Direct Lending Fund, which are private funds that were formed to conduct private placements of securities and which have substantially similar investment objectives as the Fund. As of December 31, 2017, VII Peaks Co-Optivist B Fund I, LLC, VII Peaks Co-Optivist R Fund I, LLC and VII Peaks Co-Optivist B Fund II, LLC had aggregate net assets of $3.3 million.

 

The investment objective, strategy and fee structure of the private funds are substantially similar to those of VII Peaks Co-Optivist Income BDC II, Inc. However, the performance of the private funds is not necessarily indicative of our future performance.

 

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. See below a chart compiled from S&P for Investment-grade and Speculative-grade USD Bonds maturing from 2017 to 2027. The charts below show over $4.6 trillion of U.S. based investment-grade bonds to mature between 2017 to 2027 and $445 billion in speculative grade bonds to mature between 2018 and 2022.

 

 

 

 

 

 

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 refinancing 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 an 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, senior secured term loan 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 Fund. 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 24 months. During this hold period we anticipate working co-operatively with target company management and other debt holders on a debt restructuring or exchange.

 

•

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

 

  Secondary Market Debt Securities

 

With respect to corporate debt, senior secured term loan and equity-linked debt securities that we acquire on the secondary market, 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 leveraged 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 Fund’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.

 

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.

 

 

Below is a summary of our investment and approval process:

 

 

Originated Investment Positions

 

We also expect to generate current income through debt and equity investments that we originate, in addition to investments that we acquire on the secondary market. A secondary objective is to generate long-term capital appreciation through such investments. We anticipate that during our offering period we will invest largely in over-the-counter debt securities and customized debt and equity investments in lower middle market companies. We have adopted the following business strategy to achieve our investment objective:

 

Focus on middle market companies with stable cash flow.   We believe that there are relatively few finance companies focused on transactions involving middle market companies, and this is one factor that allows us to negotiate favorable investment terms. Such favorable terms include higher debt yields and lower leverage levels, more significant covenant protection and greater equity participation than typical of transactions involving larger companies. We will generally invest in established companies with positive cash flow. We believe that established companies possess better risk-adjusted return profiles than newer companies that are building management or in early stages of building a revenue base. These middle market companies represent a significant portion of the U.S. economy and often require substantial capital investment to grow their businesses.

 

Employ disciplined underwriting policies and rigorous portfolio management.   We employ an extensive underwriting process that includes a review of the prospects, competitive position, financial performance and industry dynamics of each potential portfolio company. In addition, we perform substantial due diligence on potential investments and seek to invest with management teams and/or private equity sponsors who have proven capabilities in building value. Through our Manager, we offer managerial assistance to our portfolio companies, giving them access to our investment experience, direct industry expertise and contacts, and allowing us to continually monitor their progress. As part of the monitoring process, our Manager analyzes monthly and quarterly financial statements versus the previous periods and year, review financial projections, meet with management, attend board meetings and review all compliance certificates and covenants.

 

Focus on long-term credit performance and principal protection.   We will structure our customized loan investments on a conservative basis with high cash yields, first and/or second lien security interests where possible, cash origination fees, and lower relative leverage levels. Portfolio companies may pay fund manager due diligence fees to cover legal, due diligence, and loan structuring costs. We will seek strong deal protections for our customized debt investments, including default penalties, information rights, board observation rights, and affirmative, negative and financial covenants, such as lien protection and prohibitions against change of control. We believe these protections will reduce our risk of capital loss.

 

Diversification.   We seek to diversify our portfolio broadly among companies in a multitude of different industries and end markets, thereby reducing the concentration of credit risk in any one company or sector of the economy. We cannot guarantee that we will be successful in this effort.

 

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.

 

 

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.

 

The diagram below is illustrative of how we may use our position as an influential debt holder of a target company to restructure its indebtedness.  

 

 

 

 

Portfolio Monitoring

 

Valuation process. Each quarter, we value investments in our portfolio, and disclose such values 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, or a committee thereof, determines 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, or a committee thereof, deems worthy and relevant, including independent third-party valuation firms, if applicable.

 

Managerial assistance.  As a business development company, 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 Management and submitted to our Board of Directors, or a committee thereof for review. 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 a third-party valuation service annually for certain Level 3 investments.

 

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

 

	·	each portfolio company or investment is 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, or committee thereof 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, 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, 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 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 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.

  

Determinations in Connection With Offerings

 

We last sold our share in our continuous offering at a price of $8.75 per share: however, we have not sold shares in our continuous offering since April 30, 2015. 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 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 or losses 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.

 

 

Effective for the February 28, 2013 close and onwards, the Pricing Committee of our Board of Directors increased the share price for new investments from $10.00 to $10.15 per share due to an increase in our NAV generated from successful refinancings of portfolio companies. On August 8, 2014, the Pricing Committee of our Board of Directors decreased the share price for new investments from $10.15 to $10.00 per share, and on November 18, 2014 the Pricing Committee of our Board of Directors decreased the share price for new investments from $10.00 to $9.75 per share. On November 24, 2015, the Board of Directors of the Fund and the Pricing Committee of the Board made a decision to approve a price reduction from $9.75 to $9.25 per share effective for the Funds next closing date and next declared distribution date. On May 23, 2016, the Board of Directors of the Fund and the Pricing Committee of the Board made a final decision to approve a price reduction from $9.25 to $8.75 per share. The decreases in August and November 2014 and November 2015 were made as a result of reductions in the net asset value per share of the Fund’s common stock, which resulted from three factors: overall declines in the market prices of high yield debt instruments; declines in the market value of specific positions that have defaulted or which the market perceives will need to restructure or the ones that have already been restructured into 144A private placement equity positions for which real pricing is not available; and as a result of distributions made to date in excess of net investment income. The Fund has also not been able to raise any additional capital since May 2015 because the N-2 has not been made effective by the SEC. The Pricing Committee of our Board of Directors is required to reassess our offering price when there is a decrease in NAV per share of more than 5% below our current net offering price, and is required to reduce the offering price where the decrease in the NAV per share is the result of a non-temporary movement in the credit markets or in the value of our assets. Our board reviewed market data regarding movements in the credit markets, and the specific circumstances surrounding each of the positions in our portfolio which had experienced the greatest decline in value, including recent earnings announcements, collateral, priority in the capital structure, and current indications as to the terms of any restructuring.

 

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.

 

Taxation and Election of 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, 2017, 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 business development company 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 ended October 31^st 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.

 

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

 

•

executes, monitors and services the investments we make.

 

Under the investment advisory agreement, our Manager has a fiduciary responsibility for the safeguarding and use of our assets. Our 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 and clerical, bookkeeping 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, transfer agency and other service providers supervision and oversight, preparation and supervision of the financial records for which we are required to maintain for SEC reporting, stockholder reporting and other Fund needs, implementation and supervision of a robust compliance program and oversight and administration of the quarterly share repurchase program. In addition, our Manager assists us in activities which include, among other things, performance and supervision of investor relations, the Fund’s Board of Directors communication and reporting, determining and publishing our net asset value, overseeing the preparation and filing of our tax returns, the communication, printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and other events such as distributions, 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 overseeing and performing the compliance functions and our allocable portion of the compensation of our chief financial officer, chief compliance officer and any administrative support staff; however, to date, cost of the chief financial officer, fund administration accounting and the chief compliance officer are charged directly to the Fund. 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 also provides the reimbursement to the Fund by the Manager for the Manager’s share of the Directors and Officers insurance, which is paid by the Fund in full. Either party may terminate the administration agreement 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 Fund 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 Fund. 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 Fund, 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 business development company, 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.

 

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”.

 

Regulation

 

The election as a business development company under the 1940 Act contains prohibitions and restrictions relating to transactions between business development companies 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 business development company 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 business development company, 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 business development company, 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 business development company 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 Fund) 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

 

•

is controlled by a business development company or a group of companies including a business development company, the business development company actually exercises a controlling influence over the management or policies of the eligible portfolio company, and, as a result thereof, the business development company 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 business development company 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 business development company 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 business development company purchases such securities in conjunction with one or more other persons acting together, the business development company 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 business development company, 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. 

 

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

 

The Fund primarily invests in debt securities, therefore on a rare occasion would the Manager vote a proxy. If a proxy is received, 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.

Pine Grove Financial Center

4 Orinda Way, Bldg. A, Suite 125A

Orinda, CA 94563

 

  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.

 

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.

 

ITEM 1A. RISK FACTORS

 

An investment in shares of our common stock involves a high degree of risk. You should carefully read and consider all of the risks described below, together with all of the other information contained or referred to in this prospectus, before making a decision to invest in our shares. If any of the following events occur, our financial condition, business and results of operation, may be materially adversely affected. In that event, you could lose all or part of your investment. This prospectus also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of specific factors, including but not limited to the risks described below.

 

Risks Related to Our Business and Structure

 

We are a relatively new company and have a limited operating history, and are subject to the business risks and uncertainties associated with any new business, including the risk that we will not achieve our business objectives.

 

We were formed in 2011 and commenced operations in July 2012 when we raised an aggregate of $1.0 million from investors unaffiliated with us or our Manager. 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 compete for investments with other business development companies and investment funds (including private equity funds and mezzanine funds), as well as traditional financial services companies such as commercial banks and other sources of funding. Moreover, alternative investment vehicles, such as hedge funds, also make investments in middle market private U.S. companies. As a result, competition for investment opportunities in private U.S. companies may intensify. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we have. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than we are able to do. We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure. If we are forced to match our competitors’ pricing, terms and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss. A significant part of our competitive advantage stems from the fact that the market for investments in private U.S. companies is under served by traditional commercial banks and other financial sources. A significant increase in the number and/or the size of our competitors in this target market could force us to accept less attractive investment terms. Furthermore, many of our competitors may have greater experience operating under, or are not subject to, the regulatory restrictions under the 1940 Act that are imposed on us as a business development company.

   

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.

 

Price declines in the medium- and large-sized corporate leveraged loan market may adversely affect the fair value of our portfolio, reducing our net asset value through increased net unrealized depreciation.

 

Prior to the onset of the financial crisis that began in 2007, securitized investment vehicles, hedge funds and other highly leveraged non-bank financial institutions comprised the majority of the market for purchasing and holding senior and subordinated debt. As the trading price of the loans underlying these portfolios began to deteriorate beginning in the first quarter of 2007, we believe that many institutions were forced to raise cash by selling their interests in performing assets in order to satisfy margin requirements or the equivalent of margin requirements imposed by their lenders and/or, in the case of hedge funds and other investment vehicles, to satisfy widespread redemption requests. This resulted in a forced deleveraging cycle of price declines, compulsory sales, and further price declines, with falling underlying credit values, and other constraints resulting from the credit crisis generating further selling pressure.

 

Conditions in the medium and large-sized U.S. corporate debt market may experience similar disruption or deterioration in the future, which may cause pricing levels to similarly decline or be volatile. As a result, our net asset value could decline through an increase in unrealized depreciation and incurrence of realized losses in connection with the sale of our investments, which could have a material adverse impact on our business, financial condition and results of operations.

 

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 effect on your investment.

 

We expect to continue to authorize and declare distributions with record and payment dates distributions on a 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.

 

Our distributions may exceed our earnings. Therefore, portions of the distributions that we make may represent a return of capital to you for tax purposes that will lower your tax basis in your common stock and reduce the amount of funds we have for investment in targeted assets.

 

Since the Fall of 2013, our cash distributions to shareholders have been funded partly from capital contributed by shareholders. Prior to the Fall of 2013, a substantial portion of our distributions were funded by expense reimbursements from our then manager, which are subject to recoupment. In August 2013, we replaced our then manager with our current Manager, and our current Manager has not entered into an expense support agreement with us. As a consequence, we do not expect to generate net investment income sufficient to support our projected dividends unless our current Manager enters into an expense support agreement with us, our mix of interest and dividend paying assets increase, or until our expense ratio decreases, which we do not expect will happen until we have significantly more assets than we do at present.

 

 

Our ability to pay distributions might be adversely affected by, among other things, the impact of one or more of the risk factors described in this prospectus. All distributions are and will be paid at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our RIC status, compliance with applicable business development company regulations and such other factors as our Board of Directors may deem relevant from time to time. We cannot assure you that we will continue to pay distributions to our shareholders in the future. A return of capital is a return of your investment, rather than a return of earnings or gains derived from our investment activities. A shareholder will not be subject to immediate taxation on the amount of any distribution treated as a return of capital to the extent of the shareholder’s basis in its shares; however, the shareholder’s basis in its shares will be reduced (but not below zero) by the amount of the return of capital, which will result in the shareholder recognizing additional gain (or a lower loss) when the shares are sold. To the extent that the amount of the return of capital exceeds the shareholder’s basis in its shares, such excess amount will be treated as gain from the sale of the shareholder’s shares. Distributions from the proceeds of our public offering or from borrowings also could reduce the amount of capital we ultimately invest in our portfolio companies.

 

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.

 

Economic activity in the United States was impacted by the global financial crisis of 2008 and has yet to fully recover.

 

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.

 

Economic activity continued to be somewhat subdued because of declining annual job growth. As a result, corporate interest rate risk premiums, otherwise known as credit spreads, declined significantly throughout most of 2009 and 2010. However, credit spreads remain slightly above historical averages, particularly in the loan market. The improving economic and market conditions that have driven these declines in credit spreads may reverse themselves if uncertainty returns to the markets. Such a reversal could negatively impact credit spreads as well as our ability to obtain financing, particularly from the debt markets. As a result, corporate interest rate risk premiums, otherwise known as credit spreads, declined significantly throughout most of 2009 and 2010. However, credit spreads remain slightly above historical averages, particularly in the loan market. The improving economic and market conditions that have driven these declines in credit spreads may reverse themselves if uncertainty returns to the markets. Such a reversal could negatively impact credit spreads as well as our ability to obtain financing, particularly from the debt markets.

 

The tightening of the US monetary policy through the increase in Fed interest rate continued in 2017 with three rate increases. The increase in the Fed rate can have a negative effect on our investments by making it harder and more expensive to refinance capital structures or even obtain financing.

 

The tightening of US monetary policy through increases in the Fed interest rate happened for the first time in nine years in December of 2015. Per the Fed’s statement, it plans to raise interest rates at a slow (.25%) but steady pace so long as gauges of U.S. inflation and economic growth improve. The Fed made projections to raise the rate four times in 2016 but only increased the rate once in December 2016. After expecting three to four rate increases in 2017, the Fed raised rates three times in 2017 to settle between a range of 1.25% to 1.50%. Through September 2018 the Fed has raised rates an additional three times to 2.25%. The Fed commented that it will assess economic conditions relative to its objectives of maximum employment and 2% inflation when determining future adjustments to the target range of the federal funds rate. There can be no guarantee the Fed will raise rates at the pace they proposed, nor can there be any assurance that the Fed will make sound decisions as to when to raise rates. The increase in the Fed rate can have a negative effect on our investments by making it harder and more expensive to refinance capital structures or even obtain financing. Default rates in the US high-yield market currently stand around 1.6% for the trailing twelve months according to Fitch Ratings. The ratings company forecasts the U.S. high-yield default rate will finish 2018 at 2%, the lowest rate since 2013 and below the non-recessionary 2.3% average. The average yield on a U.S. junk bond is now around 5.8%, according to Bank of America Merrill Lynch indexes, below the mean of the last 10 years.

 

 

Positive global growth paired with hawkish banks and low volatility overall could have a material adverse effect on the companies we invest in.

 

Overall, for the year of 2017 volatility was the lowest it has been in decades, potentially leading to dangerous complacency amid a growing market. The Fed raised central bank rates three times in 2017, three times through September 2018 and signaled for more to come in 2018. This coincided with growth momentum in the U.S., in which GDP growth reached 3.3% annualized return in the third quarter while the stock market experienced strong performance and the oil industry ended on an uptrend as well. U.S. unemployment also dipped 0.6% below its lowest level since December 2000, 4.1%. Employers also added an average of 174,000 jobs per month for 2017. In the debt markets, the U.S. is set to sell the most debt in eight years by 2018, which is estimated at $1.3 trillion, more than double the 2017 issuance. Germany’s government stated the intended to sell more 30-year Bunds during 2018 while interest rates are low, causing the German yield curves to steepen. An ECB Governing Council member stated Europe may start using interest rates to regulate the economy rather than asset purchases. However, the fiscal stimulus created by the tax plan overhaul could accelerate overall growth and spur inflation. Within the High Yield markets, they generated between a 6% and 7% return for the year of 2017, depending on which index you benchmark. However, potential weakness resides in lowering LIBOR floors, the Fed’s 2% inflation goal and a faster pace of Fed rate hikes. Leveraged loan markets underperformed compared to High Yield for the year, mostly caused by large refinancing and repricings coupled with slow Fed rate hikes. The rising rate credit environment and strong global economic growth is potentially creating a dangerously complacent market. This could have a material adverse effect on the financial markets and economic conditions in the United States and the rest of the world. It could also limit our ability and the ability of our portfolio companies to obtain financing; it can also have an adverse material effect on the valuation of our portfolio companies. Overall, 2017 was a fairly positive year in the equity and bond markets, paving the way for a positive 2018.

 

A substantial portion of our investment portfolio may be recorded at fair value as determined in good faith by our Board of Directors, or a committee thereof, 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, and a committee thereof. 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, and a committee thereof.

 

To the extent that an investment is not traded, we determine the fair value of the investment by analyzing various fundamental factors, including 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 infrequently traded securities existed.

 

Where a security is traded on a market, including the over-the-counter secondary market for institutional investors described above, we normally value the security using only market data, even if the market data consists solely of bid and ask quotes rather than actual trades, and we disregard fundamental factors that may suggest a different value. The over the counter market for high yield securities has recently suffered distress due to investor redemptions from high yield debt funds as well as the forced liquidation of a major high yield debt fund, which has caused the fair value of many of our investments to deviate materially from the values that we estimate internally based on fundamental factors. Due to these uncertainties, 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.

 

Any unrealized losses we experience on our portfolio may be an indication of future realized losses, and any unrealized gains may not be realized, which could reduce our income available for distribution.

 

As a business development company, we are required to carry our investments at market value or, if no market value is ascertainable, at the fair value as determined in good faith by our Board of Directors. Decreases in the market values or fair values of our investments are recorded as unrealized depreciation. Any unrealized losses in our portfolio could be an indication of a portfolio company’s inability to meet its repayment obligations to us with respect to the affected investments. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods. In addition, decreases in the market value or fair value of our investments will reduce our net asset value.

 

Any unrealized gains may be reduced if any of our portfolio companies are unable to repay obligations to us within a timely period or if any portfolio companies experience potential slowdowns in their business.

 

Our ability to achieve our investment objective depends on our Manager’s ability to manage and support our investment process. If our Manager were to lose any members of its senior management team, our ability to achieve our investment objective could be significantly harmed.

 

We are externally managed and depend upon the investment expertise, diligence, skill and network of business contacts of our Manager. We also depend, to a significant extent, on our Manager’s access to the investment professionals and the information and deal flow generated by these investment professionals in the course of their investment and portfolio management activities. Our Manager will evaluate, negotiate, structure, close, monitor and service our investments. Our success depends to a significant extent on the continued service and coordination of our Manager, including its key professionals. The departure of a significant number of our Manager’s key professionals could have a materially adverse effect on our ability to achieve our investment objective. In addition, we can offer no assurance that our Manager will remain our investment adviser and sub-adviser or that we will continue to have access to their investment professionals or their information and deal flow.

 

 

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 certain provisions of the Sarbanes-Oxley Act and the related rules and regulations promulgated by the SEC. Our management is 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 are 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.

 

Management concluded it had material weaknesses resulting from the following:

 

The Fund has not been able to file its December 31, 2017 10-K report or its subsequent 2018 10-Q reports in a timely manner. The Fund had to wait for the financial statements from its privately held portfolio companies. Those companies are not required to file audited financial statements and therefore do not have the same reporting deadlines as the Fund. Once financial statements are received by the Fund, they are forwarded to a third-party to prepare independent valuations of the warrants issued by those companies. To avoid these delays in the future, management has concluded that it will use the financials from those privately held portfolio companies for the period ending September 30 to provide to its third-party valuation firm to prepare the December 31 valuations, if their December 31 financials are not available by January 30 of the following year. Management team has brought in additional outside resources to help with completing financial statements in a timely manner.

 

Subsequent to December 31, 2016, our Board of Directors elected to restate our financial statements for the three and six months ended June 30, 2016, and for the three and nine months ended September 30, 2016, in order to correct an error in the accounting for certain warrants received in connection with direct loans that we made. Specifically, we did not assign a cost to the warrants based upon their fair value on the date of receipt relative to the total fair value of the debt and warrants received. The difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the warrants is to be treated as original issue discount, and accreted into interest income over the life of the loan. The change will result in an increase in net investment income, and a decrease in unrealized appreciation in the same amount, in each period, and will have no impact on our net asset value per share, as previously reported. Management previously concluded that its disclosure controls were effective for those periods. In response, in 2017 we implemented additional controls whereby officers will seek outside guidance in regard to accounting for transactions that we have not historically engaged in and which present novel issues. We believe the material deficiency has been remediated by the additional controls and procedures that have been implemented.

 

We may in the future identify additional internal control deficiencies that could rise to the level of a material weakness or uncover errors in our financial reporting, and such material weaknesses could have a material adverse effect on the accuracy, timeliness and reliability of our financial reporting, which may have an adverse effect on our financial condition and results of operation as well as the price of our common stock.

 

We have a high concentration of our portfolio in direct loans

 

We have 42% of our assets invested in direct loans to privately held companies. Default of any of these direct loans could have an adverse effect on our portfolio. This would also have an adverse effect on cash flow and our ability to make distributions.

 

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.

 

 

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.

 

Risks Related to our Manager

 

Our Manager has limited prior experience managing a Business Development Company or a RIC.

 

Our Manager was formed in 2009, has only managed a business development company since 2012, and has limited prior experience managing a business development company 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 business development company 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 business development companies and RICs that do not apply to the other types of investment vehicles. For example, under the 1940 Act, business development companies 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 business development company or a RIC or could force us to pay unexpected taxes and penalties, which could be material. Our Manager has no experience managing a business development company 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.

 

 

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 performing services for other entities. As a result, there may be conflicts between us and our Manager, including members of its management team regarding the allocation of resources to the management of our day-to-day activities.

 

Further, our Manager’s officers 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.

 

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, including original issue discount, which may arise if we receive warrants in connection with the origination of a loan or possibly in other circumstances, or contractual payment-in-kind, or (“PIK”), interest, which represents contractual interest added to the loan balance and due at the end of the loan term. To the extent we do not distribute accrued PIK interest, the deferral of PIK interest has the simultaneous effects of increasing the assets under management and increasing the base management fee at a compounding rate, while generating investment income and increasing the incentive fee at a compounding rate. In addition, the deferral of PIK interest would also increase the loan-to-value ratio at a compounding rate if the issuer’s assets do not increase in value, and investments with a deferred interest feature, such as PIK interest, may represent a higher credit risk than loans on which interest must be paid in full in cash on a regular basis. 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 or PIK interest) 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

 

•

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 business development company’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 business development company’s pay their manager.

 

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 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 business development company.

 

As a business development company, 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 business development company, 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 business development company would reduce our operating flexibility.

 

If we do not remain a business development company, 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 business development company 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 business development company, 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.

 

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 Fund. 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.

 

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 uncertain of our sources for funding our future capital needs; if we cannot obtain debt or equity financing on acceptable terms, our sell our portfolio investments or collect our loan payments timely, our ability to acquire investments and to expand our operations will be adversely affected.

 

Our audited financial statements for the year ended December 31, 2017 have been prepared assuming we will continue to operate as a going concern. Due to the high annual fixed costs of running the Fund as a Business Development Company, any working capital reserves we maintain may not be sufficient for investment purposes, and we may require debt or equity financing to operate. Any loan defaults from portfolio companies, or our inability to sell such loans, will negatively impact our results of operations, reduce our overall liquidity and cash flows needed to continue as a going concern. Any defaults would also increase the difficulty in securing alternative sources of funding, and there can be no assurances that we will be able to obtain such funding on favorable terms or sell our portfolio investments or collect our loan payments timely. If we are unable to obtain sufficient financing, or sell our investments in a timely manner, we may be required to reduce, defer, or discontinue certain or all of our operations or we would be less able to create and maintain a broad portfolio of investments and achieve our investment objective, which may negatively impact our results of operations and reduce our ability to make distributions to our shareholders or we may not be able to continue as a going concern.

 

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.

 

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.

 

To the extent original issue discount constitutes a portion of our income, we will be exposed to risks associated with the deferred receipt of cash representing such income.

 

Our investments may include original issue discount instruments. To the extent original issue discount constitutes a portion of our income, we will be exposed to typical risks associated with such income being required to be included in taxable and accounting income prior to receipt of cash, including the following:

 

•

Original issue discount instruments may have unreliable valuations because the accruals require judgments about collectability.

 

•

Original issue discount instruments may create heightened credit risks because the inducement to trade higher rates for the deferral of cash payments typically represents, to some extent, speculation on the part of the borrower.

 

•

For accounting purposes, cash distributions to stockholders representing original issue discount income do not come from paid-in capital, although they may be paid from the offering proceeds. Thus, although a distribution of original issue discount income comes from the cash invested by the stockholders, the 1940 Act does not require that stockholders be given notice of this fact.

 

•

In the case of PIK, “toggle” debt, the PIK election has the simultaneous effects of increasing the assets under management, thus increasing the base management fee, and increasing the investment income, thus increasing the incentive fee.

 

•

Original issue discount creates risk of non-refundable cash payments to the Advisor based on non-cash accruals that may never be realized.

 

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.

 

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. As of December 31, 2017, we did not hold any variable rate securities in our portfolio. 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.

 

 

To the extent we borrow funds the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.

 

Borrowings, also known as leverage, magnify the potential for gain or loss on invested equity capital. To the extent we use leverage to partially finance our investments, you will experience increased risks associated with investing in our securities. We may borrow from banks and other lenders and may issue debt securities or enter into other types of borrowing arrangements in the future. Our loan agreements may contain financial and operating covenants that could restrict our business activities. Breach of any of those covenants could cause a default under those instruments. Such a default, if not cured or waived, could have a material adverse effect on us. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our income would cause our net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make distributions to our stockholders. Leverage is generally considered a speculative investment technique. While we have used leverage in the past, at December 31, 2017, we did not have any outstanding leverage, nor did we have a leverage facility available to us.

 

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 large 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;

 

•

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 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, or a committee thereof. 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. Privately-held companies are not required to file periodic reports with the SEC regarding their financial performance or material business developments nor or they subject to the same SEC regulatory oversight as publicly held companies. In addition, such companies may not be audited or have similar governance as publicly held companies. 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.

 

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.

 

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. We also invest in certain companies who issue us warrants for the shares of their equity which are not traded on the secondary market. The illiquidity of these investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. 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.

 

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 continued 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 1%. 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 has halted the quantitative easing program, after injection of $4.5 trillion over the period from 2008-2015. The program was introduced to steer the world’s largest economy through the financial crisis. It aided in keeping interest rates near an all-time low in the U.S. The long term unintended consequences remain concerning, including excessive risk-taking. As the Fed begins to decrease its debt holdings, it may have adverse effects on the credit markets.

 

•

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.

 

Revenue from our investments may not be guaranteed.

 

We generate investment income in the form of interest and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt and collateralized securities in our portfolio. The level of income we receive is directly related to the balance of collectible income producing investments multiplied by the weighted average yield of our investments. There is no guarantee that the companies we invest in will pay the coupon interest when due.

 

 

We may be subject to litigation claims from Relativity.

 

On July 30, 2015, Relativity Media, LLC (“Relativity”) filed a voluntary Chapter 11 case in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). At the time, we owned 855,079 shares of Series E Preferred Stock of Relativity. In October 2015, Relativity filed an adversary proceeding against our Manager in the Bankruptcy Court alleging that our Manager breached a commitment to provide $30 million of financing as part of a proposed reorganization of Relativity. We were not named as a defendant in the adversary proceeding. However, on October 20, 2015, Relativity sought and obtained from the Bankruptcy Court an ex parte temporary restraining order, or TRO, that barred our Manager and “its agents, servants, officers, employees and attorneys, and all persons in active concert or participation with them from transferring, assigning, encumbering, or taking any other action with respect to any and all funds” in our US Bank and Wells Fargo accounts. Neither we nor our Manager were provided with prior notice of the hearing on the TRO or were present at the hearing. The two accounts affected by the TRO contained substantially all of our assets at the time. The TRO was dissolved pursuant to a Stipulation and Agreed Order entered by the Bankruptcy Court on October 28, 2015, pursuant to which the parties agreed to engage in negotiations to resolve their dispute. (The negotiations did not result in a settlement). Following the dissolution of the TRO, our Manager filed a Motion for Summary Judgment in the adversary proceeding. The motion was fully briefed but never heard by the Court.

 

In April 2016, Relativity’s Plan of Reorganization was confirmed by the Court. The Plan provides, among other things, that most claims of the debtor are assigned to the Liquidating Trust that was established by the confirmed Plan. In 2016, our Manager reached a settlement with Relativity which settlement was conditioned upon approval by the Bankruptcy Court.  Prior to the time that the reorganized debtor’s motion for approval of the settlement was set for hearing, such motion was withdrawn by the reorganized debtor on January 25, 2017. At approximately the same time at the insistence of the Court, the pending Motion for Summary Judgment in the adversary proceeding was withdrawn without prejudice to the subsequent refilling of such summary judgment motion.

 

Given the uncertainty surrounding Relativity, it is not clear if the lawsuit that may involve us and against our Manager will be pursued or dropped. In the event the creditors trust or the reorganized debtor elects to pursue the case, our Manager intends to vigorously defend the case. Our Manager contends, among other things, that the parties never reached a binding agreement on the terms of an investment and that Relativity has suffered no harm since it has obtained alternative financing to replace the financing it contends that our Manager did not provide.

 

On February 8, 2017, the principal secured lender to Relativity and Relativity’s co-manager filed a joint motion to convert Relativity’s bankruptcy case to Chapter 7 liquidation proceeding, asserting an inability by Relativity to raise capital for its operations and significant defaults on its debts.  Such motion was withdrawn with prejudice on May 17, 2017. At the hearing, the then-pending motion to convert the bankruptcy case to chapter 7 liquidation was dismissed with prejudice by the petitioning creditors. The court did not discuss the adversary case related to the Fund's matter.

 

On May 3, 2018, the reorganized debtor itself filed a voluntary petition for relief under Chapter 11 of title 11 of the United Stated Bankruptcy Code and has filed a motion to approve the sale of the bulk of its remaining assets. The Bankruptcy Judge ultimately approved such sale. It is our understanding that such sale has now occurred. The US Trustee moved to dismiss and convert the 2015 bankruptcy proceeding by reason of the Reorganized Debtor’s failure to fulfill its obligations under the confirmed plan. After hearing and discussion, the Court concluded that at the present time neither dismissal nor conversion is in the best interest of any party and the Court denied the Motion without prejudice to bringing it again at a future date.

 

Given the uncertainty surrounding Relativity, it is not clear if the lawsuit against our Manager will be pursued or dropped. In the event the creditor or litigation trust elects to continue the case, our Manager intends to defend the case vigorously. Our Manager contends, among other things, that the parties never reached a binding agreement on the terms of an investment and that Relativity has suffered no harm since it has obtained alternative financing to replace the financing it contends that our Manager did not provide.

 

Risks Related to Our Continuous Offering and Our Shares

 

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, our expense ratio will be higher, and the value of your investment in us may be reduced in the event our assets under-perform.

 

Our continuous offering was being made on a best efforts basis by Arete Wealth Management, LLC ("Arete"), our managing broker/dealer and distributor of the Fund's shares, but that agreement was mutually terminated in October of 2017 since we have not been able to complete the comment review process with respect to the annual amendment to our Form N-2 registration statement for fiscal 2015, and therefore have not been able to issue any shares in our continuous offering since April 30, 2015. Our inability to obtain approval of our Form N-2 amendment in 2015 was partially due to issues that arose from a material weakness in our internal controls that we discovered in 2015, which has since been remedied, as well as uncertainties regarding the valuation of a material investment we made in Relativity Media, LLC in 2015. In the middle of 2016, the Board of Directors voted to withdraw our election to be treated as a business development company and convert the Fund into a closed end fund that elects to be an “interval fund” (the “Reorganization”). The Reorganization was approved by our shareholders at an adjourned shareholder meeting held on December 28, 2016. As a result of the Reorganization, we did not resubmit our Form N-2 to the SEC for approval in 2016. We expect to resume offering shares after the Form N-2 for the reorganized fund is approved by the SEC, and the Reorganization is completed.

 

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 pay a premium for their common stock if our Board of Directors does not decrease the offering price in the event of a decline in our net asset value, or (“NAV”) per share.

 

Prior to consummation of the Reorganization, our policy has been that the purchase price at which you purchase common stock will be determined at each monthly 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 common stock. In the event of a decrease to our net asset value per share, you could pay a premium of more than 5.0% for your common stock if our Board of Directors does not decrease the offering price. 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 our 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, our 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. If our Board of Directors determines that the decline in our net asset value per share is the result of a temporary movement in the credit markets or the value of our assets, investors will purchase common stock at an offering price per share, net of selling commissions and dealer manager fees, which represents a premium to the net asset value per share of greater than 5.0%.

 

In the fiscal year ended 2017, the net asset value of our common stock decreased to an amount more than 5% below our then current offering price. The decline resulted from three factors: overall declines in the market prices of high yield debt instruments; declines in the market value of specific positions that have defaulted or which the market perceives will need to restructure or the ones that have already been restructured into 144A private placement equity positions for which real pricing is not available; and as a result of distributions made to date in excess of net investment income. The Pricing Committee of our Board of Directors reviewed market data regarding movements in the credit markets, and the specific circumstances surrounding each of the positions in our portfolio which had experienced the greatest decline in value, including recent earnings announcements, collateral, priority in the capital structure, and current indications as to the terms of any restructuring. Based on that analysis, the Board of Directors determined that a reduction in our gross offering price to $9.25 per share in 2015 and then to $8.75 in 2016 accurately reflected the extent to which the decline was the result of non-temporary factors in the markets and specific positions. However, the current offering price of $8.75 is more than 5% greater than the net asset value per share of our common stock. Therefore, investors in our common stock will experience immediate dilution of their investments.

 

In the event the Reorganization is completed, our policy will be that the purchase price of our common stock in monthly closings will be offered at the Fund’s net asset value (“NAV”) per share, plus the sales load (as described below), as of the first business day of each month. The NAV per share is computed by dividing the Fund’s NAV by the total number of shares outstanding at the time the determination is made. A sales load, which includes selling commissions of 6% of the gross proceeds from sales made by selected dealers, which includes 2% for dealer manager fees, will be paid or charged on sales of shares. The sales load will be deducted from the proceeds paid to the Fund.

 

If we are unable to raise substantial funds in our continuous “best efforts” offering, our distributions may continue to constitute a return of capital or we may have to reduce our distribution rate.

 

Since we have commenced operations, we have implemented a policy of declaring monthly distributions at an annual distribution rate of 7.35% per annum of our offering price. Our distributions have not been based on our investment performance. Prior to September 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. We expect to continue paying distributions at the same distribution rate, and that a substantial part of those distributions will constitute a return of capital for the foreseeable future. Furthermore, our ability to generate net investment income sufficient to cover our monthly dividend has been hindered by the fact that we have a number of portfolio investments that are on non-accrual status, and because we hold more equity investments that do not generate regular interest or dividend income. Our distributions will continue to constitute a return of capital until our net investment income is sufficient to support our distribution rate, which will probably not occur until our Manager enters into an expense support agreement with us, our mix of interest and dividend paying assets increase, or our assets increase enough to lower our expense ratio, which we do not expect to occur until we have significantly more net assets than we do at present.

 

If our Board of Directors elects to maintain the same policy declaring monthly distributions at an annual distribution rate of 7.35% per annum of our offering price, our distributions may decrease as our offering price decreases.

 

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. When we initially elected to be treated as a business development corporation, our Board of Directors resolved that it would, within four years following the completion of our public offering or any subsequent follow-on offering, recommend that we pursue a liquidity event for our shareholders. However, there was no assurance that we would be able to 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 provided 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. However, we suspended our tender offer program in the third quarter of 2015 and have not determined when we will resume the tender offer program. Unless and until we resume the tender offer program, or effect another type of liquidity event, shareholders will not have any realistic options to liquidate their shares.

 

In mid-2016, our Board of Directors approved resolutions to withdraw our election to be treated as a business development company and convert the Fund into a closed end fund that elects to be an “interval fund” (the “Reorganization”). The Reorganization was approved by our shareholders at an adjourned shareholder meeting held on December 28, 2016. We expect to resume offering shares after the Form N-2 for the reorganized fund is approved by the SEC, and the Reorganization is completed. The Reorganization includes the adoption of a fundamental policy under which we would make annual tender offers of between 5% and 25% of our shares on an annual basis at our net asset value at the time, which will provide shareholders with some liquidity for their shares. Therefore, if the Reorganization is consummated, we no longer expect to complete an alternative liquidity event.

 

If the Reorganization is not completed for any reason, we may still seek to undertake an alternative liquidity event. 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.

 

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. However, we suspended our tender offer program in the third quarter of 2015, and have not determined when we will resume the tender offer program. 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. Once conversion of the Fund is complete, an annual tender offer will be available to shareholders.

 

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 our 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. We suspended our tender offer program in the third quarter of 2015. Once the conversion of the Fund is completed, we will resume a tender offer program on an annual basis. Unless and until we resume the tender offer program, or effect another type of liquidity event, shareholders will not have any realistic options to liquidate their shares.

 

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.

 

 

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

 

Shareholders do 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. After an investor purchases shares, our board may elect to sell additional shares in the future, issue equity interests in private offerings, or issue share-based awards to our independent directors or persons associated with the Advisor. 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, you may also experience dilution in the book value and fair value of your shares of common stock.

 

Under the 1940 Act, we generally are prohibited from issuing or selling our common stock at a price below net asset value per share, which may be a disadvantage as compared with certain public companies. We may, however, sell our common stock, or warrants, options, or rights to acquire our common stock, at a price below the current net asset value of our common stock if our Board of Directors and independent directors determine that such sale is in our best interests and the best interests of our stockholders, and our stockholders, including a majority of those stockholders 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 (less any distributing commission or discount). If we raise additional funds by issuing common stock or senior securities convertible into, or exchangeable for, our common stock, then the percentage ownership of our stockholders at that time will decrease and you will experience dilution.

 

Under the terms of our charter, our Board of Directors is authorized to issue shares of preferred stock with rights and privileges superior to common stockholders without common stockholder approval.

 

Under the terms of our charter, our Board of Directors is authorized to issue shares of preferred stock in one or more classes or series without stockholder approval. The board has discretion to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series of preferred stock. Every issuance of preferred stock will be required to comply with the requirements of the 1940 Act. The 1940 Act requires, among other things, that (1) immediately after issuance and before any distribution is made with respect to our common stock and before any purchase of common stock is made, such preferred stock together with all other senior securities must not exceed an amount equal to 50% of our total assets after deducting the amount of such distribution or purchase price, as the case may be, and (2) the holders of shares of preferred stock, if any are issued, must be entitled as a class to elect two directors at all times and to elect a majority of the directors if distributions on such preferred stock are in arrears by two years or more. Certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock.

 

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.

 

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.

 

Investing in our common stock involves a high degree of risk.

 

The investments we make in accordance with our investment objective may result in a higher amount of risk and volatility or loss of principal than alternative investment options. Our investments in portfolio companies may be highly speculative and aggressive and, therefore, an investment in our common stock may not be suitable for someone with lower risk tolerance.

 

The net asset value of our common stock may fluctuate significantly.

 

The net asset value and liquidity, if any, of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:

 

	•	significant volatility in the market price and trading volume of securities of business development companies or other companies in our sector, which are not necessarily related to the operating performance of the companies;
	•	changes in regulatory policies or tax guidelines, particularly with respect to RICs or business development companies;
	•	loss of RIC or business development company status;
	•	changes in earnings or variations in operating results;

 

 

	•	changes in the value of our portfolio of investments;
	•	changes in accounting guidelines governing valuation of our investments;
	•	any shortfall in revenue or net income or any increase in losses from levels expected by investors;
	•	departure of the Manager or certain of its respective key personnel;
	•	operating performance of companies comparable to us;
	•	general economic trends and other external factors; and
	•	loss of a major funding source.

 

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.

 

You may have current tax liability on distributions you elect to reinvest in shares of our common stock but would not receive cash from such distributions to pay such tax liability.

 

If you participate in our distribution reinvestment plan, you will be deemed to have received, and for U.S. federal income tax purposes will be taxed on, the amount reinvested in shares of our common stock to the extent the amount reinvested was not a tax-free return of capital. As a result, unless you are a tax-exempt entity, you may have to use funds from other sources to pay your tax liability on the value of our common stock received from the distribution.

 

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.

 

 

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 Pine Grove Financial Center, 4 Orinda Way, Bldg. A, Suite 125-A, Orinda, CA 94563. We believe that our current office facilities are adequate for our business as we intend to conduct it.

 

ITEM 3. LEGAL PROCEEDINGS

 

On July 30, 2015, Relativity Media, LLC (“Relativity”) filed a voluntary Chapter 11 case in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). At the time, we owned 855,079 shares of Series E Preferred Stock of Relativity. In October 2015, Relativity filed an adversary proceeding against our Manager in the Bankruptcy Court alleging that our Manager breached a commitment to provide $30 million of financing as part of a proposed reorganization of Relativity. We were not named as a defendant in the adversary proceeding. However, on October 20, 2015, Relativity sought and obtained from the Bankruptcy Court an ex parte temporary restraining order, or TRO, that barred our Manager and “its agents, servants, officers, employees and attorneys, and all persons in active concert or participation with them from transferring, assigning, encumbering, or taking any other action with respect to any and all funds” in our US Bank and Wells Fargo accounts. Neither we nor our Manager were provided with prior notice of the hearing on the TRO or were present at the hearing. The two accounts affected by the TRO contained substantially all of our assets at the time. The TRO was dissolved pursuant to a Stipulation and Agreed Order entered by the Bankruptcy Court on October 28, 2015, pursuant to which the parties agreed to engage in negotiations to resolve their dispute. (The negotiations did not result in a settlement). Following the dissolution of the TRO, our Manager filed a Motion for Summary Judgment in the adversary proceeding. The motion was fully briefed but never heard by the Court.

 

In April 2016, Relativity’s Plan of Reorganization was confirmed by the Court. The Plan provides, among other things, that most claims of the debtor are assigned to the Liquidating Trust that was established by the confirmed Plan. In 2016, our Manager reached a settlement with Relativity which settlement was conditioned upon approval by the Bankruptcy Court.  Prior to the time that the reorganized debtor’s motion for approval of the settlement was set for hearing, such motion was withdrawn by the reorganized debtor on January 25, 2017. At approximately the same time at the insistence of the Court, the pending Motion for Summary Judgment in the adversary proceeding was withdrawn without prejudice to the subsequent refilling of such summary judgment motion.

 

Given the uncertainty surrounding Relativity, it is not clear if the lawsuit that may involve us and against our Manager will be pursued or dropped. In the event the creditors trust or the reorganized debtor elects to pursue the case, our Manager intends to vigorously defend the case. Our Manager contends, among other things, that the parties never reached a binding agreement on the terms of an investment and that Relativity has suffered no harm since it has obtained alternative financing to replace the financing it contends that our Manager did not provide.

 

On February 8, 2017, the principal secured lender to Relativity and Relativity’s co-manager filed a joint motion to convert Relativity’s bankruptcy case to Chapter 7 liquidation proceeding, asserting an inability by Relativity to raise capital for its operations and significant defaults on its debts.  Such motion was withdrawn with prejudice on May 17, 2017. At the hearing, the then-pending motion to convert the bankruptcy case to chapter 7 liquidation was dismissed with prejudice by the petitioning creditors. The court did not discuss the adversary case related to the Fund's matter.

 

On May 3, 2018, the reorganized debtor itself filed a voluntary petition for relief under Chapter 11 of title 11 of the United Stated Bankruptcy Code and has filed a motion to approve the sale of the bulk of its remaining assets. The Bankruptcy Judge ultimately approved such sale. It is our understanding that such sale has now occurred. The US Trustee moved to dismiss and convert the 2015 bankruptcy proceeding by reason of the Reorganized Debtor’s failure to fulfill its obligations under the confirmed plan. After hearing and discussion, the Court concluded that at the present time neither dismissal nor conversion is in the best interest of any party and the Court denied the Motion without prejudice to bringing it again at a future date.

 

Given the uncertainty surrounding Relativity, it is not clear if the lawsuit against our Manager will be pursued or dropped. In the event the creditor or litigation trust elects to continue the case, our Manager intends to defend the case vigorously. Our Manager contends, among other things, that the parties never reached a binding agreement on the terms of an investment and that Relativity has suffered no harm since it has obtained alternative financing to replace the financing it contends that our Manager did not provide.

 

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 last sold our shares in our continuous offering at a price of $8.75 per share; however, we have not sold shares in our continuous offering since April 30, 2015. 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. Closings are typically monthly. For the year ended December 31, 2015, we had one price reduction. On November 24, 2015, the Board of Directors of the Fund and the Pricing Committee of the Board made a final decision to approve a price reduction from $9.75 to $9.25 per share effective for the Funds next closing date and next declared distribution date. For the year ended December 31, 2016, we had one price reduction. On May 23, 2016, the Board of Directors of the Fund and the Pricing Committee of the Board made a final decision to approve a price reduction from $9.25 to $8.75 per share. For the year ended December 31, 2017, we had no price reduction.

 

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.

 

In the fiscal years ended 2015 and 2016, the net asset value of our common stock decreased to an amount more than 5% below our then current offering price. The declines resulted from three factors: overall declines in the market prices of high yield debt instruments; declines in the market value of specific positions that have defaulted or which the market perceives will need to restructure or the ones that have already been restructured into 144A private placement equity positions for which real pricing is not available; and as a result of distributions made to date in excess of net investment income. The Pricing Committee of our Board of Directors reviewed market data regarding movements in the credit markets, and the specific circumstances surrounding each of the positions in our portfolio which had experienced the greatest decline in value, including recent earnings announcements, collateral, priority in the capital structure, and current indications as to the terms of any restructuring. Based on that analysis, the Board of Directors determined that a reduction in our gross offering price to $9.25 per share in 2015 and then to $8.75 in 2016 accurately reflected the extent to which the decline was the result of non-temporary factors in the markets and specific positions. However, the current offering price of $8.75 is more than 5% greater than the net asset value per share of our common stock. Therefore, investors in our common stock will experience immediate dilution of their investments.

 

Set forth below is a chart describing the classes of our securities outstanding as of December 31, 2017:

 

Title of Class		Amount Authorized				Amount Outstanding
Common Stock, par value $0.001 per share		$	200,000,000				6,477,563

 

During the three months ended December 31, 2017, we issued 34,354.67 shares of common stock for consideration of $285,573 under our dividend reinvestment program. As of December 31, 2017, we had 1,541 record holders of our common stock.

 

Distributions

 

Subject to our Board of Director’s discretion and applicable legal restrictions, we have historically declared and paid ordinary cash distributions at a rate equal to 7.35% of our latest offering price per share. Prior to the September 30, 2015, we paid distributions on a semi-monthly basis. We changed to paying distributions monthly in order to reduce costs. Any distributions to our shareholders will be declared out of assets legally available for distribution. We may fund our cash distributions to shareholders from any sources of funds available to us, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, and dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies. We have not established limits on the amount of funds we may use from available sources to make distributions.

 

 

Based upon our current level of operations, we estimate that approximately 55% of our distributions will constitute a return of capital. Our distributions historically have not been based on our investment performance. Prior to September 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities constitutes the return of capital previously paid to us for shares of our common stock.

 

The following table shows the percentage of our distributions, which have been funded from net investment income, realized capital gains and return of capital since January 2015:

  

Period		Per Share				Net Investment Income				Realized  Gain From  Investments				Return of Capital
January 1, 2015 - March 31, 2015			0.179154				15	%			5	%			80	%
April 1, 2015 - June 30, 2015			0.179154				63	%			15	%			22	%
July 1, 2015 - September 30, 2015			0.209015				19	%			11	%			70	%
October 1, 2015 - December 31, 2015 *			0.170315				—	%			6	%			94	%
January 1, 2016 – March 31, 2016 **			0.169969				1	%			—	%			99	%
April 1, 2016 – June 30, 2016***			0.107188				—	%			—	%			100	%
July 1, 2016 – September 30, 2016****			0.214372				23	%			—	%			77	%
October 1, 2016 – December 31, 2016			0.107186				24	%			11	%			65	%
January 1, 2017 – March 31, 2017			0.160779				22	%			4	%			74	%
April 1, 2017 - June 30, 2017			0.160779				35	%			6	%			59	%
July 1, 2017 – September 30, 2017*****			0.160779				55	%			—	%			45	%
October 1, 2017 – December 31, 2017******			0.160779				50	%			—	%			50	%

  

* For the period from October 31, 2015 to December 31, 2015, the Fund had a net investment loss of approximately $268 thousand. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

** For the period from January 1, 2016 to March 31, 2016, the Fund had a realized loss from investments of approximately $700 thousand. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

*** For the period from April 1, 2016 to June 30, 2016, the Fund had a net investment loss of approximately $4 thousand and a realized loss from investments of approximately $12.6 million. These amounts are reflected on the source of distributions table below in the distributions from paid in capital amount. The allocation of the distributions between net investment income and return of capital are different than previously reported as a result of the correction of an accounting error. For further detail, please see Item 9A Controls and Procedures.

 

**** For the period from July 1, 2016 to September 30, 2016, the Fund had a realized loss from investments of approximately $0.04 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount. The allocation of the distributions between net investment income and return of capital are different than previously reported as a result of the correction of an accounting error. For further detail, please see Item 9A Controls and Procedures.

 

***** For the period from July 1, 2017 to September 30, 2017, the Fund had a realized loss from investments of approximately $0.5 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

****** For the period from October 1, 2017 to December 31, 2017, the Fund had a realized loss from investments of approximately $3.5 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

  

We expect to continue making distributions as declared by our Board of Directors, based on the current offering price, 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 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.

 

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. We expect to continue paying distributions at the same distribution rate, based on the current offering price, and that a substantial part of those distributions will constitute a return of capital for the foreseeable future. Furthermore, our ability to generate net investment income sufficient to cover a dividend has been hindered by the fact that we have several investments that are on non-accrual status, and because we hold more equity investments that do not generate regular interest or dividend income. Our distributions will continue to constitute a return of capital until our net investment income is sufficient to support our distribution rate if, our mix of interest and dividend paying assets increase, or our assets increase enough to lower our expense ratio, which we do not expect to occur until we have significantly more net assets than we do at present. As a result, for the foreseeable future, a significant portion of the distributions we make will 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.

 

 

The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. The actual tax characteristics of distributions to shareholders are reported to shareholders annually on a Form 1099-DIV. 

 

We have elected to be treated, beginning with our taxable year ended December 31, 2013, 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 ended on October 31^st 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.

 

The following table reflects the sources of the cash distributions on a tax basis that the Fund has paid on its common stock (dollars in thousands) during the fiscal years ended December 31, 2017, 2016 and 2015:

 

Source of Distributions:		Year ended December 31, 2017								Year ended December 31, 2016								Year ended December 31, 2015
Distributions from net investment income		$	1,681				40.8	%		$	473				12.6	%		$	830				18.5	%
Distributions from realized gain on investments			98				2.4	%			78				2.1	%			425				9.5	%
Distributions from paid in capital			2,339				56.8	%			3,195				85.3	%			3,235				72.0	%
Total		$	4,118				100.0	%		$	3,746				100.0	%		$	4,490				100.0	%

 

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 is required on their part to do so. If shareholders elect to participate in the DRIP program, they are not charged selling commissions, dealer manager fees or other sales charges for the purchase of DRIP shares. The purchase price of the DRIP shares is 95% of the current offering price of the shares at the time of the distribution. Shares issued pursuant to our DRIP will have the same voting rights as our shares of common stock offered pursuant to our prospectus.

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following selected financial data as of and for the years ended December 31, 2017 and 2016 was derived from our financial statements, which has been audited by OUM & Co. LLP, our independent registered public accounting firm as stated in their report. The selected financial data as of and for the years ended December 31, 2015, 2014, and 2013 was derived from our financial statements, which was audited by BPM LLP. 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):

 

 

		As of and for the Year Ended December 31, 2017				As of and for the Year Ended December 31, 2016				As of and for the Year Ended December 31, 2015				As of and for the Year Ended December 31, 2014				As of and for the Year Ended December 31, 2013
Statement of operations data:
Total investment income		$	4,234			$	3,120			$	3,512			$	3,260			$	1,659
Operating expenses
Total operating expenses			2,553				2,651				2,682				2,441				1,637
Less: Expense waivers and reimbursements			-				-				-				-				(776	)
Net expenses			2,553				2,651				2,682				2,441				861
Net investment income			1,681				469				830				819				798
Realized and unrealized gain (loss), net			15,225				7,145				(14,189	)			(6,093	)			(101	)
Net increase (decrease) in net assets resulting from operations		$	16,906			$	7,614			$	(13,359	)		$	(5,274	)		$	697
Per share data - basic and diluted:
Net investment income		$	0.26			$	0.07			$	0.14			$	0.19			$	0.37
Net realized and unrealized gain (loss) on investments		$	2.38			$	1.15			$	(2.34	)		$	(1.42	)		$	(0.05	)
Net increase (decrease) in net assets resulting from operations		$	2.64			$	1.22			$	(2.20	)		$	(1.23	)		$	0.32
Distributions declared		$	(0.65	)		$	(0.60	)		$	(0.74	)		$	(0.73	)		$	(0.79	)
Balance sheet data:
Investments at fair value		$	47,495			$	40,345			$	26,722			$	37,428			$	23,154
Investments in money market funds – at fair value		$	18			$	157			$	6,210			$	3,104			$	1,644
Total assets		$	48,430			$	41,219			$	33,689			$	42,381			$	27,764
Total liabilities		$	797			$	7,537			$	5,199			$	1,693			$	340
Total net assets		$	47,633			$	33,682			$	28,490			$	40,688			$	27,424
Other data:
Total return			49.52	%			23.62	%			(32.37	)%			(8.88	)%			7.72	%
Number of portfolio company investments at period end			16				29				33				45				39
Total portfolio investments for the year		$	7,785			$	36,545			$	23,245			$	31,308			$	27,685
Investment sales and repayments for the year		$	17,343			$	30,593			$	19,688			$	11,765			$	10,314

  

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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”, “us,” “our” and the “Fund” refer to VII Peaks Co-Optivist Income BDC II, Inc., a Maryland corporation and, as required by context to VII Peaks Capital, 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, senior secured term loan 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. In addition, we also provide direct loans with equity warrant coverage to portfolio companies to help facilitate corporate expansion.

 

Our investment activities are managed by our Manager. 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 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.

 

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.  

 

Investments - Money Market

 

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

 

Investment Classification

 

The Fund classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which we own more than 25.0% of the voting securities or maintain greater than 50.0% of the board representation. Under the 1940 Act, “Affiliated Investments” are defined as those non-control investments in companies in which we own between 5.0% and 25.0% of the voting securities. Under the 1940 Act, “Non-affiliated Investments” are defined as investments that are neither Control Investments nor Affiliated Investments.

  

Valuation of Portfolio Investments

 

We have adopted Financial Accounting Standards Board (“FASB”), ASC Topic 820, Fair Value Measurements and Disclosures (“ASC Topic 820”), which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP 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. US Bank is the Fund custodian. Through US Bank, the Fund uses FT Interactive, a third-party valuation firm, to price the notes. The prices are reviewed by the CEO.

 

Level 3:

Unobservable inputs for the asset or liability.

 

The investment portfolio is recorded on a trade date basis. 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. Five of the forty-three investments were valued using the closing market price at year end December 31, 2017.

  

The following table presents investments that are not publicly traded or have no closing market price, as of December 31, 2017:

 

Portfolio Company		Asset Type			Investment Coupon Rate				Maturity Date
Ansgar Media, LLC - Class B Units		Equity – Preferred Stock				—			—
Ansgar Media, LLC		Senior Secured First Lien Debt				12.00	%		January 11, 2019
Ansgar Media, LLC		Senior Secured First Lien Debt				12.00	%		September 8, 2019
Ansgar Media, LLC (8)		Senior Secured First Lien Debt				12.00	%		October 24, 2018
Ansgar Media, LLC (8)		Senior Secured First Lien Debt				12.00	%		October 27, 2018
Aspect Software, Inc. (1)		Equity – Common Stock				—			—
Aspire Holdings (2)		Equity – Common Stock				—			—
Colt Defense, LLC (3)		Senior Unsecured Debt				8.00	%		July 12, 2021
Digital Golf Technologies, LLC		Senior Secured First Lien Debt				13.00	%		January 11, 2020
Digital Golf Technologies, LLC		Warrant				—			—
Education Management LLC		Equity – Common Stock				—			—
Education Management LLC		Warrant				—			—
GeoCommerce, Inc. (4)		Senior Secured First Lien Debt				12.00	%		April 27, 2018
GeoCommerce, Inc. (4)		Senior Secured First Lien Debt				12.00	%		May 15, 2018
GeoCommerce, Inc. (4)		Senior Secured First Lien Debt				12.00	%		October 14, 2018
GeoCommerce, Inc.		Senior Secured First Lien Debt				12.00	%		December 21, 2018
GeoCommerce, Inc.		Warrant				—			—
Logan's Roadhouse, Inc. (5)		Equity – Common Stock				—			—
Logan's Roadhouse, Inc. PIK Exit Facility Term Loan (5)		Senior Secured Second Lien Debt				9.50	%		November 23, 2020
Nima, LLC (6)		Senior Secured First Lien Debt				12.00	%		May 20, 2018
Nima, LLC (6)		Senior Secured First Lien Debt				12.00	%		August 11, 2018
Nima, LLC (6)		Senior Secured First Lien Debt				12.00	%		October 16, 2018
Nima, LLC		Senior Secured First Lien Debt				12.00	%		November 2, 2018
Nima, LLC		Senior Secured First Lien Debt				12.00	%		December 21, 2018
Nima, LLC		Senior Secured First Lien Debt				12.00	%		February 16, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		April 6, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		June 19, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		August 4, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		August 31, 2019
Nima, LLC		Warrant				—			—
UCI International, Inc. (7)		Equity – Common Stock				—			—
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		April 7, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		July 14, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		August 1, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		August 17, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		August 31, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		October 2, 2019
Vieste Group, LLC		Warrant				—			—

 

(1)

The original 10.63% senior secured second lien notes due on May 15, 2017 defaulted. As part of Aspect’s bankruptcy and planned reorganization process, the Fund participated in a rights offering to purchase a new 3.00% PIK senior unsecured convertible note maturing on May 23, 2023 in an effort to facilitate recovery of its previous investment in the senior secured lien notes in Aspect. On November 25, 2016, the 3.00% PIK senior unsecured convertible notes were exchanged out for mandatory conversion to shares of common stock of Aspect Software Parent, Inc. at a rate of 1/30 i.e. one common share per $30.00 in principal amount of notes outstanding.

	(2)	Converted from exchange of 12.00% Endeavour International Corp, senior secured first lien debt.
	(3)	On January 19, 2016, there was a mandatory exchange offer to exchange all of the 8.75% senior unsecured notes to 8.00% PIK third lien notes.
	(4)	GeoCommerce, Inc. has requested loan extensions for the loans in default.  We have sent those extensions along with our reservation of rights letters. However, GeoCommerce, Inc. has not taken any action on the loan extensions as they are working to secure third-party financing to repay the loans.
	(5)	The company filed for bankruptcy in Delaware on August 8, 2016. The Fund participated in DIP financing as part of the company’s restructuring process during bankruptcy and has received a PIK second lien exit facility T/L in exchange. On April 28, 2017, the remaining unexchanged bonds were converted to equity.
	(6)	Nima, LLC is currently in default of three of their loans. We are currently in discussion with Nima, LLC to either extend the loans or renegotiate the terms.
	(7)	On June 2, 2016, UCI International, LLC and certain of its affiliates filed voluntary petitions for relief under Chapter 11 Bankruptcy in the District of Delaware. As per the Plan of Reorganization and based on Rank contribution being reached, the Fund received 30,714 shares of the company on March 29, 2017.
	(8)	We expect to give loan extensions to Ansgar Media, LLC

 

 

Securities that are not publicly-traded are valued at fair value as determined in good faith by our Board of Directors, or a committee thereof. 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.

 

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

 

•

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

 

•

preliminary valuations are then documented and reviewed with the members of our Board of Directors, or a committee thereof  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, M&A comparables, the principal market and enterprise values, among other factors.

 

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

 

Securities transactions are accounted for on the trade date. We generate investment income in the form of interest, dividend and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt, senior unsecured convertible debt and collateralized securities in our portfolio. The level of income we receive is directly related to the balance of collectible income producing investments multiplied by the coupon rate of our investments. Coupon interest income is adjusted for the amortization of premiums and accretion of discounts. We record interest income on an accrual basis to the extent that we expect to collect such amounts. The Fund stops accruing when the invested company defaults in payment and has passed the 30-day grace period, files for bankruptcy or goes through reorganization converting bonds to equity. We expect the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases.

 

 

Dividend income is recognized on the ex-dividend date for common equity securities and on an accrual basis for preferred equity securities to the extent that such amounts are expected to be collected or realized. In determining the amount of dividend income to recognize, if any, from cash distributions on common equity securities, we will assess many factors including a portfolio company’s cumulative undistributed income and operating cash flow. Cash distributions from common equity securities received in excess of such undistributed amounts are recorded first as a reduction of our investment and then as a realized gain on investment. We stop accruing interest or dividends on our investments when it is determined that the interest or dividend is not collectible. We assess the collectability of the interest and dividends based on many factors including the portfolio company’s ability to service our loan based on current and projected cash flows as well as the current valuation of the portfolio company’s current total enterprise value. For investments with payment-in-kind (“PIK”) interest and cumulative dividends, we base income and dividend accruals on the valuation of the PIK notes or securities received from the borrower or the redemption value of the security. If the portfolio company valuation indicates a value of the PIK notes or securities or redemption value that is not sufficient to cover the contractual interest or dividend, we will not accrue interest or dividend income on the notes or securities and will record an allowance for any accrued interest or dividend receivable as a reduction of interest or dividend income in the period we determine it is not collectible.

 

In connection with our debt investments, we may receive warrants or similar equity-related securities ("Warrants"). We determine the cost basis of Warrants based upon their fair values on the date of receipt relative to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the Warrants is treated as original issue discount (“OID”), and accreted into interest income over the life of the debt investment using a method that approximates the effective interest method. Similarly, loan origination fees are capitalized and amortized as other income over the life of the loan.

 

For loans and debt securities with contractual 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. Dividend income, if any, is recognized on an accrual basis to the extent that we expect to collect such amount. We record prepayment premiums on loans and debt securities as interest income when we receive such amounts. In addition, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting fees and performance-based fees. Any such fees generated in connection with investments will be recognized when earned.

 

Loans and debt securities, including those that are individually identified as being impaired under ASC Topic 310 — Receivables (“ASC Topic 310”), are generally placed on non-accrual status immediately if, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the debt agreement, or when principal or interest is past due 90 days or more. Interest accrued but not collected at the date a loan or security is placed on non-accrual status is reversed against interest income. Interest income is recognized on non-accrual loans or debt securities only to the extent received in cash. However, where there is doubt regarding the ultimate collectability of principal, cash receipts, whether designated as principal or interest, are thereafter applied to reduce the carrying value of the loan or debt security. Loans or securities are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured.

 

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

 

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the weighted-average amortized cost 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 reflects 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.

 

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, or (“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.

 

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 initial cost of the organizational and offering expenses, but the Fund is obligated to reimburse the Manager for such costs to the extent of 1.5% of the gross offering proceeds in our continuous offering. The Fund also agreed to reimburse the Manager for organization and offering expenses incurred by a prior manager in consideration for the Manager’s agreement to pay $1.3 million owed to the Fund by the prior manager under an expense reimbursement agreement, which amount the Manager paid in full during the year ended December 31, 2014. 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 (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.

 

 

The Fund has evaluated the implications of ASC Topic 740, Accounting for Income Taxes, (“ASC Topic 740”) for all tax years and in all major tax jurisdictions, and determined that there is no material impact on the financial statements.

  

Portfolio and Investment Activity

 

During the year ended December 31, 2017, we made $7.8 million of investments in new and existing portfolio companies and had $17.3 million in aggregate amount of exits, maturities and repayments, resulting in net repayments of $9.5 million for the year. During the year ended December 31, 2016, we made $36.5 million of investments in new and existing portfolio companies and had $30.6 million in aggregate amount of exits, maturities and repayments, resulting in net investments of $5.9 million for the year. During the year ended December 31, 2015, we made $23.2 million of investments in new and existing portfolio companies and had $19.7 million in aggregate amount of exits, maturities and repayments, resulting in net investments of $3.5 million for the year.

 

As of December 31, 2017, we have invested an aggregate of approximately $29.5 million in forty-three investment positions in sixteen portfolio companies. On December 31, 2017, the fair value of our investment positions was $48.1 million (including money market investments of approximately $.02 million and the interest receivable of $0.6 million). As of such date, our estimated gross annual portfolio yield was 12.1% and gross annual portfolio yield to maturity was 12.1% (excluding equity investments and non-accrual investments) based on the purchase price of our investments. The average duration of our debt portfolio was approximately 1.0 year. During the year ended December 31, 2017, eight T-bills matured, we exited nine portfolio companies in full and two companies in partial, for aggregate sales proceeds of $17.3 million.

 

 As of December 31, 2016, we have invested an aggregate of approximately $41.6 million in forty-seven investment positions in twenty-nine portfolio companies. On December 31, 2016, the fair value of our investment positions was $40.9 million (including money market investments and the accrued interest of $0.4 million). As of such date, our estimated gross annual portfolio yield was 8.6% and gross annual portfolio yield to maturity was 8.6% (excluding equity investments and non-accrual investments) based on the purchase price of our investments. The average duration of our debt portfolio was approximately 1.6 years. During the year ended December 31, 2016, six T-bills matured, one T-bill was sold, and we exited eight portfolio companies in full, for aggregate sales proceeds of $30.6 million.

 

The following table presents one debt investment that had not paid coupon interest as due beyond the thirty-day grace period, as of December 31, 2017. Interest incurred on these investments was recorded through the date that the last coupon payment was received:

 

Portfolio Company		Asset Type		Investment Coupon Rate				Maturity Date
Gymboree Corp. (1)		Senior Unsecured Debt			9.13	%		December 1, 2018

  

(1)

On August 10, 2017, the Gymboree Corporation announced solicitation of consents from holders of its 9.125% senior unsecured notes due 2018 pertaining to the first amended joint chapter 11 plan of reorganization. The Fund has decided to accept the plan and submit its consent.

 

The following table presents twelve equity investments that are non-income producing, as of December 31, 2017:

 

Portfolio Company		Asset Type		Investment Coupon Rate				Maturity Date
Ansgar Media, LLC - Class B Units		Equity – Preferred Stock			—			—
Aspect Software, Inc. (1)		Equity – Common Stock			—			—
Aspire Holdings (2)		Equity – Common Stock			—			—
Digital Golf Technologies, LLC		Warrant			—			—
Education Management LLC (3)		Equity – Common Stock			—			—
Education Management LLC (3)		Warrant			—			—
GeoCommerce, Inc.		Warrant			—			—
Logan's Roadhouse, Inc. (4)		Equity – Common Stock			—			—
NII Holdings, Inc. (5)		Equity – Common Stock			—			—
Nima, LLC		Warrant			—			—
UCI International, Inc. (6)		Equity – Common Stock			—			—
Vieste Group, LLC		Warrant			—			—

 

	(1)	Converted from exchange of 3.00% PIK senior unsecured convertible notes.
	(2)	Converted from exchange of 12.00% Endeavour International Corp First Lien Bonds.
	(3)	Received in exchange of 15.00% Cash/PIK bonds.
	(4)	The company filed for bankruptcy in Delaware on August 8, 2016. The Fund participated in DIP financing as part of the company’s restructuring process during bankruptcy and has received a PIK Second Lien Exit Facility T/L in exchange. On April 28, 2017, the remaining unexchanged bonds were converted to equity.
	(5)	Received in exchange of 10.00% senior unsecured debt.
	(6)	Received in exchange of 8.625% senior unsecured notes.

 

 

The following table shows the weighted average yield of our portfolio composition based on fair value at December 31, 2017:

 

		At December 31, 2017
		Percentage of Total Portfolio				Weighted Average Current Coupon Yield
Investments – Money Market			—	%			—	%
Senior Secured First Lien Debt			43.0				12.1
Senior Secured Second Lien Debt			0.4				9.5
Senior Unsecured Debt			0.3				8.1
Equity Securities			56.3				n/a
Total			100.0	%			12.1	%*

 

* 12.1% yield is on non-defaulted, non-equity positions and excludes money market investments.

 

As of December 31, 2017, our non-defaulted, non-equity portfolio had a yield to maturity of 12.1%, and an average duration of 1.0 year.

 

The following table shows the weighted average yield of our portfolio composition based on fair value at December 31, 2016:

 

		At December 31, 2016
		Percentage of Total Portfolio				Weighted Average Current Coupon Yield
Investments – Money Market			0.4	%			—	%
U.S. Government Securities			17.7				0.7
Senior Secured First Lien Debt			42.1				11.4
Senior Secured Second Lien Debt			1.3				11.1
Senior Unsecured Debt			12.0				10.1
Senior Subordinated Debt			2.6				9.3
Equity Securities			23.9				n/a
Total			100.0	%			8.6	%*

 

* 8.6% yield is on non-defaulted, non-equity positions and excludes money market investments. 

 

As of December 31, 2016, our non-defaulted, non-equity portfolio had a yield to maturity of 8.6%, and an average duration of 1.60 years.

 

The following table shows the portfolio composition by industry grouping at fair value at December 31, 2017 (dollars in thousands):

 

		At December 31, 2017
		Investments at Fair Value				Percentage of Total Portfolio
Media: Broadcasting & Subscription		$	16,546				34.9	%
Technology			14,282				30.1
Consumer Electronics			11,694				24.6
Renewable Energy			2,624				5.5
Services: Consumer			1,100				2.3
Telecommunications			528				1.1
Beverage, Food & Tobacco			266				0.6
Automobile			255				0.5
Aerospace and Defense			152				0.3
Energy: Oil & Gas			39				0.1
Investments - Money Market			18				—
Retail			9				—
Total		$	47,513				100.0	%

 

 

The following table shows the portfolio composition by industry grouping at fair value at December 31, 2016 (dollars in thousands):

 

		At December 31, 2016
		Investments at Fair Value				Percentage of Total Portfolio
Media: Broadcasting & Subscription		$	10,418				25.7	%
Technology			7,684				19.0
U.S. Government			7,173				17.7
Consumer Electronics			6,500				16.0
Aerospace and Defense			2,124				5.3
Energy: Oil & Gas			1,460				3.6
Services: Consumer			1,428				3.5
Retail			1,084				2.7
Healthcare & Pharmaceuticals			1,050				2.6
Telecommunications			607				1.5
Environmental Industries			279				0.7
Beverage, Food & Tobacco			249				0.6
Automobile			238				0.6
Investments – Money Market			157				0.4
Media: Advertising, Printing & Publishing			51				0.1
Total		$	40,502				100.0	%

 

Our fair value of total investments was $47.5 million as of December 31, 2017 as compared to $40.5 million as of December 31, 2016. The increase in the fair value of our investments was attributable to two factors: a) warrants received in connection with additional loan investments in Vieste Group, LLC, and b) increase in the valuation estimate of Ansgar Media, LLC, GeoCommerce, Inc. and Nima, LLC warrants based on equity valuations of $10.5 million, $10.3 million and $4.9 million, respectively.

 

Discussion and Analysis of Results of Operations

 

Results of Operations

 

The results of operations are based on investment income less expenses, adjusted for the impact of the realized gain/loss and change in unrealized gain/loss on our investment portfolio. To the extent that it is expected to be received, investment income is recognized on an accrual basis. Income is earned as coupon interest adjusted for the amortization of premiums and accretion of discounts on the high-yield corporate debt investments. Expenses include professional services, management fees, administrative services, organizational and offering costs and other general and administrative. Realized gains (losses) are from investments sold, written off, or called at an advantageous price. The unrealized appreciation (depreciation) is the change in the market price on investments in the portfolio at period end, subject to significant fluctuation.

 

Operating results for the years ended December 31, 2017, 2016 and 2015 were as follows (in thousands): 

 

		For the Year Ended December 31, 2017				For the Year Ended December 31, 2016				For the Year Ended December 31, 2015
Total investment income		$	4,234			$	3,120			$	3,512
Total operating expenses			2,553				2,651				2,682
Net investment income			1,681				469				830
Net realized gain (loss) on non-controlled/non-affiliate investments			(3,897	)			(13,263	)			425
Net unrealized appreciation (depreciation) on non-controlled/non-affiliate investments			12,145				18,992				(16,716	)
Net unrealized appreciation on affiliate investments			6,977				1,416				2,102
Net increase (decrease) in net assets resulting from operations		$	16,906			$	7,614			$	(13,359	)

 

 

Investment Income

 

We generated investment income of $4.2 million for the year ended December 31, 2017, as compared to $3.1 million for the year ended December 31, 2016, and $3.5 million for the year ended December 31, 2015. Interest income was $4.0 million for the year ended December 31, 2017, as compared to $3.0 million for the year ended December 31, 2016, and $2.9 million for the year ended December 31, 2015. The increase in interest income in 2017 as compared to 2016 was attributable to higher yield earned on investments in senior secured notes of Ansgar Media, LLC, GeoCommerce, Inc., Nima, LLC, Vieste Group, LLC and Digital Golf Technologies, LLC, partially offset by an increase in debt investments placed on non-accrual status and restructuring of certain debt investments into equity investments. Fee income was $0.3 million for the year ended December 31, 2017, as compared to $0.1 million and $0.6 million for the years ended December 31, 2016 and 2015, respectively. Fee income is non-recurring in nature. The increase in fee income in 2017 as compared to 2016 was attributable to higher amount of investments in direct lending deals that earn 3% origination fee, which is being amortized over the term of the loan.

 

Interest from debt investments is in the form of interest and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt and collateralized securities in our debt portfolio. Our debt portfolio constituted approximately 43.7% of investment portfolio at December 31, 2017 (excluding money market investments). The level of interest income we receive is directly related to the balance of collectible income producing investments multiplied by the coupon rate of our investments, offset by debt investments held in non-accrual status. 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 debt portfolio during the year ended December 31, 2017 was lower than the year ended December 31, 2016, which was attributable to – 1) increase in debt investments placed on non-accrual status and restructuring of certain debt investments into equity investments; and 2) in the money warrants and/or other equity securities received while making direct lending investments in companies like Ansgar Media, LLC, Geocommerce, Inc., Nima, LLC, and Digital Golf Technologies, LLC. At December 31, 2017, the weighted average coupon yield of our debt investments was 12.1% as compared to 8.6% at December 31, 2016, and 7.6% at December 31, 2015. This coupon yield is for the non-defaulted and non-equity positions. Based on current and prior three quarters’ net assets, average net assets as of December 31, 2017 were $43.1 million, as compared to $31.8 million as of December 31, 2016, and $39.2 million for the year ended December 31, 2015.

 

Since becoming operational in the third quarter of 2012, we generate income primarily from the cash interest we collect on our debt investments and, to a lesser extent, from the early termination fees that many of our debt investments require the borrower to pay. Going forward, we may generate income in the form of commitment, origination or structuring fees. Any such fees will be generated in connection with our investments and recognized as earned.

 

Operating Expenses

 

The composition of our operating expenses for the years ended December 31, 2017, 2016 and 2015 was as follows (in thousands):

 

		For the Year Ended December 31, 2017				For the Year Ended December 31, 2016				For the Year Ended December 31, 2015
Professional fees		$	612			$	800			$	521
Director fees			41				37				50
Insurance			117				114				96
Interest expense			58				206				33
Management fees – related parties			867				640				784
Administrative services – related parties			264				228				216
General and administrative (includes CFO salary and related party travel expenses)			463				489				721
Transfer agent fees			131				137				165
Offering expense			—				—				96
Total operating expenses		$	2,553			$	2,651			$	2,682

 

For the years ended December 31, 2017, 2016 and 2015, our operating expenses were $2.6 million, $2.7 million and $2.7 million, respectively. Included within general and administrative expenses for the years ended December 31, 2017, 2016 and 2015, were $0.1 million, $0.1 million and $0.1 million respectively for the cost of our chief financial officer’s salary reimbursed to the Manager. Also included within general and administrative expenses for the years ended December 31, 2017, 2016 and 2015 were $0.03 million, $0.04 million and $0.1 million, respectively, for related party travel expenses reimbursed to the Manager.

 

The slight decrease in expenses for the year ended December 31, 2017 as compared to December 31, 2016 was primarily due to lower interest expense as the line of credit was closed in early 2017. The professional fees were also lower in 2017 as legal fees in connection with the settlement of UCI International and Relativity Media legal matters, partially offset by increased legal costs related to conversion of the Fund to an Interval Fund.

 

 

Management fees for the years ended December 31, 2017, 2016 and 2015 remained at a single rate 2% of the net asset value. The offering costs were consistent at 1.5% of the gross closing proceeds for the years ended December 31, 2017, 2016 and 2015. However, since the Fund has not been open to new investments, there has not been any offering costs expense since June 30, 2015.

 

Net Investment Income

 

Our net investment income totaled $1.7 million, $0.5 million and $0.8 million for the years ended December 31, 2017, 2016 and 2015, respectively. For the years ended December 31, 2017, 2016 and 2015, total investment income was $4.2 million, $3.1 million, and $3.5 million respectively. For the years ended December 31, 2017, 2016 and 2015, the total investment income included $0.3 million, $0.1 million and $0.6 million of non-recurring fees, respectively.

 

The increase in net investment income for the year ended December 31, 2017 as compared to the year ended December 31, 2016 was primarily due to the positive returns posted by almost all of the fixed income sectors in 2017, and additional direct lending investments in the senior secured first lien notes that earn high yield and also a fee income in form of 3% origination fees. For the years ended December 31, 2017, 2016 and 2015, total operating expenses were $2.6 million, $2.7 million and $2.7 million, respectively.

 

Net Realized Gains or Losses from Investments

 

For the years ended December 31, 2017, 2016 and 2015, we had $17.3 million, $30.6 million and $19.7 million of sales, maturities, write-offs and principal repayments, resulting in $(3.9) million, $(13.3) million and $0.4 million of realized gains (losses), respectively.

 

Net Change in Unrealized Appreciation or Depreciation on Investments

 

For the year ended December 31, 2017, we experienced $19.1 million of unrealized appreciation, mainly because of increased valuation estimates of equity securities of Ansgar, LLC, GeoCommerce, Inc., and Nima, LLC, and also because of receipt of in-the-money warrants from investments in Digital Golf Technologies, LLC and Vieste Group, LLC. For the years ended December 31, 2016 and 2015 we experienced $20.4 million and $(14.6) million of unrealized appreciation (depreciation), respectively.

 

The unrealized appreciation during the year ended December 31, 2017 has been partially offset by a number of positions that either initiated a restructuring of their indebtedness (either in Chapter 11 bankruptcy or prepackaged bankruptcy) or announced that they were considering a restructuring. Such announcements generally reduce liquidity in the secondary market creating greater mispricing in underlying bonds. Until the bankruptcy or other restructuring process is complete, it becomes difficult to ascertain whether some of these positions will result in a loss of principal or full recovery of principal given their position in the capital structure of the issuer and the underlying asset values. Generally, we expect much higher recoveries or full payment for senior secured first lien type bonds, as compared to senior secured second lien or unsecured bonds for defaulted bonds.

 

 Changes in Net Assets from Operations

 

For the years ended December 31, 2017, 2016 and 2015, we recorded a net increase (decrease) in net assets resulting from operations of $16.9 million, $7.6 million and $(13.4) million, respectively. For the years ended December 31, 2017, 2016 and 2015, this increase (decrease) was mainly due to net unrealized appreciation (depreciation) of $19.1 million, $20.4 million and $(14.6) million, respectively, and net investment income of $1.7 million, $0.5 million and $0.8 million respectively, partially offset by net realized gains (losses) from investments of $(3.9) million, $(13.3) million and $0.4 million, respectively, on our portfolio investments. The increase in 2017 is largely due to increase in the valuation of Class B units of Ansgar Media, LLC, GeoCommerce, Inc., and warrants of Nima, LLC. Overall, the portfolio experienced a market value increase, with an increase in net unrealized appreciation on investments of $19.1 for the year ended December 31, 2017. Based on 6,403,225, 6,256,208 and 6,077,127 weighted average common shares outstanding for the years ended December 31, 2017, 2016 and 2015, respectively, our per share net increase (decrease) in net assets resulting from operations was $2.64, $1.22 and $(2.20), respectively. 

 

Liquidity and Capital Resources

 

On August 4, 2015, we entered an agreement with Wells Fargo Advisors, LLC for obtaining a revolving line of credit.

 

The line was paid off in April 2017 and the remaining securities held at Wells Fargo were transferred to U.S. Bank National Association, the Fund’s administrator. In May 2017, the line of credit and corresponding collateral account were closed at Wells Fargo.

 

We generate cash flows primarily 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. As of December 31, 2017, we had issued 6.8 million shares of common stock, including 0.7 million shares under our distribution reinvestment plan (“DRIP”) less 0.3 million shares redeemed under our tender offer. As of December 31, 2017, we had received gross proceeds from our continuous offering of $63.8 million, including $5.9 million under our DRIP less $2.9 million paid to redeem shares in our prior quarterly tender offers.

 

 

As of December 31, 2017, we had approximately $18,000 in money market funds and subsequent to year end, we have delayed payments to service providers, substantially curtailed shareholder distributions, and extended certain of our loans’ maturity dates, thereby delaying the timing of cash inflows. This raises substantial doubt about the ability of the Fund to continue as a going concern. Management plans to work with portfolio companies that are in default of loan repayments to refinance their outstanding debt obligations to the Fund. In addition, management plans to raise cash by selling certain of its loans to other parties. Also, management has requested the Board of the Directors to reduce shareholder distributions. Based upon the Fund’s plans to sell portfolio investments to raise capital, receipt of loan payments and reducing shareholder distributions, the Fund believes it is probable it will have sufficient resources to meet its financial obligations for the next 12 months from the issuance of these financial statements.

 

If we are unable to sell our investments or receive loan repayments in a timely manner, we may be required to reduce, defer, or discontinue certain or all of our operations or we would be less able to create and maintain a broad portfolio of investments and achieve our investment objective, which may negatively impact our results of operations and reduce our ability to make distributions to our shareholders or we may not be able to continue as a going concern.

 

In the event the Fund is able to reorganize and convert to a closed-end Interval Fund and raise new capital, the net proceeds from the sale of common stock will be used for our investment opportunities, operating expenses and for payment of various fees and expenses such as base management fees, inventive fees and other expenses. Any working capital reserves we maintain may not be sufficient for investment purposes, and we may require debt or equity financing to operate. Any loan defaults from portfolio companies will negatively impact our results of operations, reduce our overall liquidity and cash flows needed to continue as a going concern. Any defaults would also increase the difficulty in securing alternative sources of funding, and there can be no assurances that we will be able to obtain such funding on favorable terms or at all.

 

When our registration statement becomes effective, we will sell our shares on a continuous basis. On May 23, 2016, our Board of Directors and the Pricing Committee of the Board made a final decision to approve a price reduction from $9.25 to $8.75 per share. On November 24, 2015, our Board of Directors and the Pricing Committee of the Board had approved a price reduction from $9.75 to $9.25 per share effective for our next closing date and next declared distribution date. 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. However, since April 30, 2015, we have not been able to sell any shares in our continuous offering because our registration statement has been under review by the SEC.

 

For the year ended December 31, 2017, we experienced a net decrease in money market investments of $0.1 million. For the year ended December 31, 2017, approximately $9.2 million was used for our financing activities, which primarily consisted of $8.6 million repayments of the priority credit line and $2.8 million in distributions, partially offset by $2.2 million received through the priority credit line. We generated approximately $9.2 million of cash provided by our operating activities mainly as the result of the receipt of proceeds from the sale of, repayment of and principal payments on portfolio debt investments of $17.3 million, partially offset by the purchase of new portfolio debt investments of $7.8 million.

 

Distributions

 

Subject to our Board of Director’s discretion and applicable legal restrictions, we have historically declared and paid ordinary cash distributions at a rate equal to 7.35% of our latest offering price per share. Prior to the September 30, 2015, we paid distributions on a semi-monthly basis. We changed to paying distributions monthly in order to reduce costs. Any distributions to our shareholders will be declared out of assets legally available for distribution. We may fund our cash distributions to shareholders from any sources of funds available to us, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, and dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies. We have not established limits on the amount of funds we may use from available sources to make distributions.

 

Based upon our current level of operations, we estimate that about 55% of our distributions will constitute a return of capital. Our distributions historically have not been based on our investment performance. Prior to September 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities constitutes the return of capital previously paid to us for shares of our common stock.

  

The following table shows the percentage of our distributions which have been funded from net investment income, realized capital gains and paid in capital since January 2015:

 

Period		Per Share				Net Investment Income				Realized  Gain From Investments				Return of Capital
January 1, 2015 - March 31, 2015			0.179154				15	%			5	%			80	%
April 1, 2015 - June 30, 2015			0.179154				63	%			15	%			22	%
July 1, 2015 - September 30, 2015			0.209015				19	%			11	%			70	%
October 1, 2015 - December 31, 2015 *			0.170315				—	%			6	%			94	%
January 1, 2016 – March 31, 2016 **			0.169969				1	%			—	%			99	%
April 1, 2016 – June 30, 2016***			0.107188				—	%			—	%			100	%
July 1, 2016 – September 30, 2016****			0.214372				23	%			—	%			77	%
October 1, 2016 – December 31, 2016			0.107186				24	%			11	%			65	%
January 1, 2017 – March 31, 2017			0.160779				22	%			4	%			74	%
April 1, 2017 - June 30, 2017			0.160779				35	%			6	%			59	%
July 1, 2017 – September 30, 2017*****			0.160779				55	%			—	%			45	%
October 1, 2017 – December 31, 2017******			0.160779				50	%			—	%			50	%

 

 

* For the period from October 31, 2015 to December 31, 2015, the Fund had a net investment loss of approximately $268 thousand. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

** For the period from January 1, 2016 to March 31, 2016, the Fund had a realized loss from investments of approximately $700 thousand. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

*** For the period from April 1, 2016 to June 30, 2016, the Fund had a net investment loss of approximately $4 thousand and a realized loss from investments of approximately $12.6 million. These amounts are reflected on the source of distributions table below in the distributions from paid in capital amount.

 

**** For the period from July 1, 2016 to September 30, 2016, the Fund had a realized loss from investments of approximately $0.04 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

***** For the period from July 1, 2017 to September 30, 2017, the Fund had a realized loss from investments of approximately $0.5 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

****** For the period from October 1, 2017 to December 31, 2017, the Fund had a realized loss from investments of approximately $3.5 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

We expect to continue making distributions as declared by our Board of Directors, based on the current offering price, 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 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.

 

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. We expect to continue paying distributions at the same distribution rate, based on the current offering price, and that a substantial part of those distributions will constitute a return of capital for the foreseeable future. Furthermore, our ability to generate net investment income sufficient to cover a dividend has been hindered by the fact that we have several investments that are on non-accrual status, and because we hold more equity investments that do not generate regular interest or dividend income. Our distributions will continue to constitute a return of capital until our net investment income is sufficient to support our distribution rate if, our mix of interest and dividend paying assets increase, or our assets increase enough to lower our expense ratio, which we do not expect to occur until we have significantly more net assets than we do at present. As a result, for the foreseeable future, a significant portion of the distributions we make will 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.

 

The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. The actual tax characteristics of distributions to shareholders are reported to shareholders annually on a Form 1099-DIV. 

 

 We have elected to be treated, beginning with our taxable year ended December 31, 2013, 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 ended on October 31^st 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.

 

The following table reflects the sources of the cash distributions on a tax basis that the Fund has paid on its common stock (dollars in thousands) during the fiscal years ended December 31, 2017, 2016 and 2015:

 

Source of Distributions:		Year ended December 31, 2017								Year ended December 31, 2016								Year ended December 31, 2015
Distributions from net investment income		$	1,681				40.8	%		$	473				12.6	%		$	830				18.5	%
Distributions from realized gain on investments			98				2.4	%			78				2.1	%			425				9.5	%
Distributions from paid in capital			2,339				56.8	%			3,195				85.3	%			3,235				72.0	%
Total		$	4,118				100.0	%		$	3,746				100.0	%		$	4,490				100.0	%

 

 

 Distribution Reinvestment Plan

 

We have adopted an “opt-in” 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 is required on their part to do so. If shareholders elect to participate in the DRIP program, they are not charged selling commissions, dealer manager fees or other sales charges for the purchase of DRIP shares. The purchase price of the DRIP shares is 95% of the current offering price of the shares at the time of the distribution. Shares issued pursuant to our DRIP will have the same voting rights as our shares of common stock offered pursuant to our prospectus.

 

When the Fund is able to raise new capital, it incurs offering expenses of 1.5% of the gross offering proceeds. However, the Fund has not been able to raise additional capital since April 2015. The chart below shows the percentages of distributions from net investment income excluding offering costs:

 

				Offering Expenses				Distribution from Net Investment Income excluding offering costs				% Distribution from Net Investment Income excluding offering costs				% Distributions from Realized Gains excluding offering costs				% Distributions from Paid In Capital excluding offering costs
	2017			$	—			$	1,681				41	%			2	%		57	%
	2016			$	—			$	473				13	%			2	%		85	%
	2015			$	96			$	926				21	%			9	%		70	%

 

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. 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 agreements with the Manager, whereby we pay certain fees and reimbursements. These include 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 the management of our day-to-day operations provided to us by our Manager, pursuant to various agreements that we have entered into. 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 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 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.

 

The managing members of VII Peaks Capital are also officers of Alesiatec. Inc, a software technology. In 2016, GeoCommerce made a non-recurring engineering payment of $400,000 to Alesiatec to use Alesiatec software technology. In addition, Alesiatec also issued $100,000 of Series A stock to GeoCommerce to use GeoCommerce's online database technology.

 

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. 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

 

 

Due from related party of $196,000 at December 31, 2017 consists of approximately $35,000 of true up for management fees from writing down certain portfolio investments at the end of a quarter in prior quarters, $45,000 in Blue Sky state filing fees paid by the Fund instead of our Manager, $25,000 in allocation of the Directors and Officers insurance policy costs to our Manager, and $91,000 in expenses related to legal and other operational costs allocated to our Manager instead of the Fund.

 

Due from related party at December 31, 2016 of $239,000 consisted of approximately $67,000 of true up for management fees from writing down certain portfolio investments at the end of a quarter in prior quarters, $67,000 in Blue Sky state filing fees by the Fund instead of our Manager, $13,000 in allocation of the Directors and Officers insurance policy costs to out Manager, and $90,000 in expenses related to legal and other operational costs allocated to out Manager instead of the Fund.

 

Due diligence fees received by the Fund from the borrowers related to the Fund’s direct lending transactions are remitted to our Manager, VII Peaks Capital, LLC, as the collateral and administrative agent for the loans. Due diligence fees received are not revenues or expenses of the Fund and therefore are not reflected in the financial statements. Fees for the year ended December 31, 2017, 2016 and 2015 totaled $222,500, $475,000, and $25,000, respectively.

 

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.

 

Assuming that our current financial condition remains constant and no actions are taken to alter our existing interest rate sensitivity, a 100 basis point move in interest rates up or down from their December 31, 2017 levels would result in an increase or decrease in net asset value of $0.5 million or 1.0%.

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Index to Financial Statements

 

	Page
Report of Independent Registered Public Accounting Firm	F-1
Report of Previous Independent Registered Public Accounting Firm	F-2
Statements of Assets and Liabilities as of December 31, 2017 and 2016	F-3
Statements of Operations for the Years Ended December 31, 2017, 2016 and 2015	F-4
Statements of Changes in Net Assets for the Years Ended December 31, 2017, 2016 and 2015	F-5
Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015	F-6
Schedules of Investments as of December 31, 2017 and 2016	F-7
Notes to Financial Statements	F-11

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders of

VII Peaks Co-Optivist Income BDC II, Inc.

Orinda, California

 

Opinion on the Financial Statements

 

We have audited the accompanying statements of assets and liabilities of VII Peaks Co-Optivist Income BDC II, Inc. (the “Fund”), including the schedules of investments, as of December 31, 2017 and 2016, and the related statements of operations, changes in net assets, and cash flows for each of the two years in the period ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Fund at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on the Fund’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting 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.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our procedures included confirmation of investments owned as of December 31, 2017 and 2016 by correspondence with the custodian and portfolio companies, or by other appropriate auditing procedures where replies were not received. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ OUM & Co. LLP
San Francisco, California
November 5, 2018
We have served as the Fund's auditor since 2016.

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

  

To the Board of Directors and

Stockholders of VII Peaks Co-Optivist Income BDC II, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying statements of operations, changes in net assets and cash flows for the year ended December 31, 2015, and the related notes (collectively referred to as the “financial statements”) of VII Peaks Co-Optivist Income BDC II, Inc. (the “Fund”). In our opinion, the financial statements present fairly, in all material respects, the results of the Fund’s operations and its cash flows for the year ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.

  

Basis for Opinion

 

These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on the Fund’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

 

We ceased to serve as the Company’s auditor in 2016.

 

/s/ BPM LLP
San Francisco, California
April 14, 2016

 

 

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, 2017				December 31, 2016
ASSETS
Investments, at fair value
Non-controlled/non-affiliate investments (cost of $23,403 and $35,575, respectively)		$	30,949			$	30,977
Affiliate investments (cost of $6,050 and $5,850, respectively)			16,546				9,368
Investments, money market at fair value (cost of $18 and $157, respectively)			18				157
Total investments, at fair value			47,513				40,502
Interest receivable			582				402
Prepaid expenses			12				76
Due from related party, net			196				239
Receivable for unsettled trades			127				-
Total assets		$	48,430			$	41,219
LIABILITIES
Priority credit line -Wells Fargo		$	-			$	6,366
Interest payable			-				3
Deferred loan fee			217				268
Prepaid interest from investments (includes prepaid interest of $29 from Digital Golf Technologies, LLC, $81 from Nima, LLC, $139 from Vieste Group, LLC and $21 from Ansgar Media, LLC at December 31, 2017)			270				779
Accounts payable and accrued liabilities			166				121
Stockholder distributions payable			144				-
Total liabilities			797				7,537
Commitments and Contingencies (Note 11)
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; 6,778,976 and 6,639,019 shares issued and 6,477,563 and 6,337,606 outstanding as of December 31, 2017 and December 31, 2016, respectively			6				6
Paid-in capital in excess of par value			61,347				60,185
Treasury stock at cost, 301,413 and 301,413 shares, respectively			(2,891	)			(2,891	)
Accumulated distribution in excess of net investment income and net realized gain (loss) on investments			(28,872	)			(22,538	)
Net unrealized appreciation (depreciation) on investments			18,043				(1,080	)
Total net assets			47,633				33,682
Total liabilities and net assets		$	48,430			$	41,219
Net asset value per share		$	7.35			$	5.31

 

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

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

 

		For the Year Ended				For the Year Ended				For the Year Ended
		December 31, 2017				December 31, 2016				December 31, 2015
Investment income:
Interest from investments
Non-controlled/non-affiliate investments		$	3,285			$	2,513			$	2,863
Affiliate investments			697				504				80
Interest from cash and cash equivalents
Non-controlled/non-affiliate investments			1				-				1
Fee income
Non-controlled/non-affiliate investments			183				66				545
Affiliate investments			68				37				10
Other income
Non-controlled/non-affiliate investments			-				-				13
Total investment income			4,234				3,120				3,512
Operating expenses:
Professional fees			612				800				521
Directors fees			41				37				50
Insurance			117				114				96
Interest expense			58				206				33
Management fees - related parties			867				640				784
Administrative services - related parties			264				228				216
General and administrative (includes $142, $124 and $110 of CFO salary (accounting) and $27, $42 and $118 of related party travel expenses, respectively for the year ended December 31, 2017)			463				489				721
Transfer agent fees			131				137				165
Offering expense			-				-				96
Total operating expenses			2,553				2,651				2,682
Net investment income			1,681				469				830
Realized and unrealized gain (loss) on investments:
Net realized gain (loss) on non-controlled/non-affiliate investments			(3,897	)			(13,263	)			425
Net unrealized appreciation (depreciation) on non-controlled/non-affiliate investments			12,145				18,992				(16,716	)
Net unrealized appreciation on affiliate investments			6,977				1,416				2,102
Net realized and unrealized gain (loss) on investments			15,225				7,145				(14,189	)
Net increase (decrease) in net assets resulting from operations		$	16,906			$	7,614			$	(13,359	)
Per share information - basic and diluted:
Net investment income		$	0.26			$	0.07			$	0.14
Net increase (decrease) in net assets resulting from operations		$	2.64			$	1.22			$	(2.20	)
Weighted average common shares outstanding			6,403,225				6,256,208				6,077,127

 

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

 

 

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, 2017				For the Year Ended December 31, 2016				For the Year Ended December 31, 2015
Operations:
Net investment income		$	1,681			$	469			$	830
Net realized gain (loss) from investments			(3,897	)			(13,263	)			425
Net unrealized appreciation (depreciation) on investments			19,122				20,408				(14,614	)
Net increase (decrease) in net assets from operations			16,906				7,614				(13,359	)
Stockholder distributions:
Distributions from net investment income			(1,681	)			(473	)			(830	)
Distributions from net realized gain on investments			(98	)			(78	)			(425	)
Distributions from paid in capital			(2,339	)			(3,195	)			(3,235	)
Net decrease in net assets from stockholder distributions			(4,118	)			(3,746	)			(4,490	)
Capital share transactions:
Issuance of common stock, net of issuance costs			-				-				6,232
Reinvestment of stockholder distributions			1,163				1,324				1,532
Treasury capital (redemptions)			-				-				(2,113	)
Net increase in net assets from capital share transactions			1,163				1,324				5,651
Total increase (decrease) in net assets			13,951				5,192				(12,198	)
Net assets at beginning of year			33,682				28,490				40,688
Net assets at end of year		$	47,633			$	33,682			$	28,490
Net asset value per common share		$	7.35			$	5.31			$	4.61
Common shares outstanding at end of year			6,477,563				6,337,606				6,181,515
Accumulated distribution in excess of net investment income and net realized gain (loss) on investments		$	(28,872	)		$	(22,538	)		$	(5,997	)

 

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

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF CASH FLOWS

(in thousands, except share and per share data)

 

		For the Year Ended December 31, 2017				For the Year Ended December 31, 2016				For the Year Ended December 31, 2015
Operating activities:
Net increase (decrease) in net assets resulting from operations		$	16,906			$	7,614			$	(13,359	)
Adjustments to reconcile net increase (decrease) in net assets from operations to net cash provided by (used in) operating activities:
Paid-in-kind interest income			(22	)			(12	)			-
Net accretion of discounts and amortization of premiums			(1,461	)			(513	)			74
Sales and repayments of investments			17,343				30,593				19,688
Purchase of investments			(7,785	)			(36,545	)			(23,245	)
Repayments of investments - money market			21,821				37,314				44,215
Purchase of investments - money market			(21,682	)			(31,262	)			(47,319	)
Net realized (gain) loss from investments			3,897				13,263				(425	)
Net unrealized (appreciation) depreciation on investments			(19,122	)			(20,408	)			14,614
Proceeds from loan fees received			181				310				60
Accretion of deferred loan fees			(232	)			(92	)			(10	)
(Increase) decrease in operating assets:
Interest receivable			(180	)			127				521
Prepaid expenses			64				(64	)			6
Due from related party, net			43				(86	)			14
Origination fee receivable			-				63				(63	)
Receivable for unsettled trades			(127	)			-				614
Increase (decrease) in operating liabilities:
Interest payable			(3	)			2				1
Payable for unsettled trades			-				-				(1,340	)
Management fees payable			-				-				(7	)
Prepaid interest from investments			(509	)			779				-
Accounts payable and accrued liabilities			45				(146	)			84
Net cash provided by (used in) operating activities			9,177				937				(5,877	)
Financing activities:
Proceeds from issuance of shares of common stock, net			-				-				6,232
Stockholder distributions			(2,811	)			(2,772	)			(2,773	)
Treasury stock, net of redemption of common stock			-				-				(2,113	)
Borrowings - priority credit line			2,201				13,522				4,531
Repayments - priority credit line			(8,567	)			(11,687	)			-
Net cash provided by (used in) financing activities			(9,177	)			(937	)			5,877
Net change in cash and cash equivalents			-				-				-
Cash and cash equivalents, beginning of year			-				-				-
Cash and cash equivalents, end of year		$	-			$	-			$	-
Supplemental disclosure of non-cash information:
Distribution reinvestment plan distribution payable		$	-			$	-			$	123
Cash distribution payable		$	143			$	-			$	227
Distribution reinvestment plan distribution paid		$	1,163			$	1,324			$	1,532
Supplemental disclosure of cash flow information:
Cash interest paid during the year		$	61			$	204			$	32

 

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

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars and shares in thousands)

 

December 31, 2017

 

Portfolio Company		Industry		Investment Coupon Rate, Maturity Date			Principal / No. of Shares			Amortized Cost			Fair Value			% of Net Assets
Senior Secured First Lien Debt - 42.9% (b)
Ansgar Media, LLC (e) (g)		Media: Broadcasting & Subscription			12.00%, 1/11/2019		$	2,000		$	2,000		$	2,000			4.2	%
Ansgar Media, LLC (e) (g)		Media: Broadcasting & Subscription			12.00%, 10/24/2018			400			400			400			0.8	%
Ansgar Media, LLC (e) (g)		Media: Broadcasting & Subscription			12.00%, 10/27/2018			1,650			1,650			1,650			3.5	%
Ansgar Media, LLC (e) (g)		Media: Broadcasting & Subscription			12.00%, 9/8/2019			2,000			2,000			2,000			4.2	%
Digital Golf Technologies, LLC (g)		Services: Consumer			13.00%, 1/11/2020			1,000			932			1,000			2.1	%
GeoCommerce, Inc.		Technology			12.00%, 4/27/2018			1,500			1,316			1,500			3.1	%
GeoCommerce, Inc.		Technology			12.00%, 5/15/2018			1,000			917			1,000			2.1	%
GeoCommerce, Inc.		Technology			12.00%, 10/14/2018			750			549			750			1.6	%
GeoCommerce, Inc.		Technology			12.00%, 12/21/2018			750			514			750			1.6	%
Goodman Networks, Inc. (c) (h)		Telecommunications			8.00%, 5/11/2022			277			848			190			0.4	%
Nima, LLC (g)		Consumer Electronics			12.00%, 5/20/2018			2,000			1,717			2,000			4.2	%
Nima, LLC (g)		Consumer Electronics			12.00%, 8/11/2018			1,000			1,000			1,000			2.1	%
Nima, LLC (g)		Consumer Electronics			12.00%, 11/2/2018			750			750			750			1.6	%
Nima, LLC (g)		Consumer Electronics			12.00%, 12/21/2018			750			750			750			1.6	%
Nima, LLC (g)		Consumer Electronics			12.00%, 2/16/2019			450			450			450			0.9	%
Nima, LLC (g)		Consumer Electronics			12.00%, 4/6/2019			500			500			500			1.0	%
Nima, LLC (g)		Consumer Electronics			12.00%, 6/19/2019			500			500			500			1.0	%
Nima, LLC (g)		Consumer Electronics			12.00%, 8/4/2019			300			300			300			0.6	%
Nima, LLC (g)		Consumer Electronics			12.00%, 8/31/2019			225			225			225			0.5	%
Nima, LLC (g)		Consumer Electronics			12.00%, 10/16/2018			332			332			332			0.7	%
Vieste Group, LLC (f) (g)		Renewable Energy			13.00%, 4/7/2019			1,340			1,257			1,340			2.8	%
Vieste Group, LLC (f) (g)		Renewable Energy			13.00%, 7/14/2019			150			139			150			0.3	%
Vieste Group, LLC (f) (g)		Renewable Energy			13.00%, 8/1/2019			240			222			240			0.5	%
Vieste Group, LLC (f) (g)		Renewable Energy			13.00%, 8/17/2019			150			139			150			0.3	%
Vieste Group, LLC (f) (g)		Renewable Energy			13.00%, 8/31/2019			120			111			120			0.4	%
Vieste Group, LLC (f) (g)		Renewable Energy			13.00%, 10/2/2019			380			349			380			0.8	%
Sub Total Senior Secured First Lien Debt							$	20,514		$	19,867		$	20,427			42.9	%
Senior Secured Second Lien Debt - 0.4% (b)
Logan's Roadhouse, Inc. PIK Exit Facility Term Loan		Beverage, Food & Tobacco			9.50% PIK, 11/23/2020		$	179		$	165		$	179			0.4	%
Sub Total Senior Secured Second Lien Debt							$	179		$	165		$	179			0.4	%
Senior Unsecured Debt - 0.3% (b)
Colt Defense, LLC		Aerospace and Defense			8.00%, 7/12/2021		$	148		$	1,043		$	148			0.3	%
DynCorp International Inc.		Aerospace and Defense			11.88%, 11/30/2020			4			2			4			0.0	%
Gymboree Corp.(c) (h)		Retail			9.13%, 12/1/2018			810			755			9			0.0	%
Sub Total Senior Unsecured Debt							$	962		$	1,800		$	161			0.3	%
Equity Securities - 56.1% (b)
Aspect Software, Inc. (c)		Telecommunications						8		$	244		$	331			0.7	%
Aspire Holdings (c)		Energy: Oil & Gas						26			551			39			0.1	%
Education Management, LLC (c)		Services: Consumer						2,530			5			0			0.0	%
Logan's Roadhouse, Inc. (c)		Beverage, Food & Tobacco						86			633			87			0.2	%
NII Holdings, Inc. (a) (c) (h)		Telecommunications						17			768			7			0.0	%
UCI International, Inc. (c)		Automobile						31			1,354			255			0.5	%
Total Common Stock											3,555			719			1.5	%
Ansgar Media, LLC - Class B Units (c) (d) (e)		Media: Broadcasting & Subscription						-			-			10,496			22.0	%
Digital Golf Technologies, LLC (c)		Services: Consumer						22			91			100			0.2	%
Education Management, LLC (c)		Services: Consumer						1,554			876			0			0.0	%
GeoCommerce, Inc. (c)		Technology						875			1,883			10,282			21.6	%
Nima, LLC (c)		Consumer Electronics						2,000			1,000			4,887			10.3	%
Vieste Group, LLC (c)		Renewable Energy						173			216			244			0.5	%
Total Warrants											4,066			26,009			54.6	%
Sub Total Equity Securities											7,621			26,728			56.1	%
Investments - Money Market - 0.0% (b)
Investments - U.S. Bank Money Market					0.20%		$	18		$	18		$	18			0.0	%
Sub Total Investments - Money Market							$	18		$	18		$	18			0.0	%
TOTAL INVESTMENTS - 99.7% (b)										$	29,471		$	47,513			99.7	%

 

(a)

Represents a non-qualifying investment as defined under Section 55 (a) of the Investment Company Act of 1940, as amended. Non-qualifying investments represent 0.01% of the Fund's (VII Peaks Co-OptivistTM Income BDC, II, Inc.) portfolio at fair value. As a BDC, the Fund can only invest 30% of its portfolio in non-qualifying assets.

(b)

Percentages are based on net assets of $47,633 as of December 31, 2017.

(c)

Non-income producing as of December 31, 2017.

(d)

2,500 Class B Units, which are not entitled to an allocation of profits or losses until the earlier to occur of September 30, 2020 or a change of control of Ansgar Media, LLC.

(e)

As defined in the 1940 Act, Affiliated Investments are defined as those Non-Control Investments in companies in which we own between 5.0% and 25.0% of the voting securities. Transactions during the year ended December 31, 2017 in which the issuer was an Affiliate is as follows:

 

Portfolio Company		Principal / No. of Shares				Fair Value at December 31, 2016				Gross Addition				Gross Reductions				Net Realized Gains (Losses)				Change in Unrealized Gains (Losses)				Fair Value at December 31, 2017				Dividends and Interest Income				Other income
Ansgar Media, LLC		$	6,050			$	5,850			$	200			$	-			$	-			$	-			$	6,050			$	697			$	68
Ansgar Media, LLC - Class B Units			-				3,519				-				-				-				6,977				10,496				-				-
						$	9,369			$	200			$	-			$	-			$	6,977			$	16,546			$	697			$	68

(f)

The Fund entered into a Senior Secured First Lien Loan Agreement with Vieste Group, LLC on April 7, 2017, for a total loan amount of $4,250 thousand. As of December 31, 2017, the Fund has loaned Vieste Group, LLC $2,380 thousand; the time and amounts of the additional $1,870 thousand in funding will be at the mutual agreement between the Fund and Vieste Group, LLC.

(g)

Borrower also pays an end-of-term fee or exit fee, upon loan maturity or full repayment of the principal amount equal to 1% of the total investment amount.

(h)

Other than the investments noted by this footnote, the fair value of the Fund's investments is determined using unobservable inputs that are significant to the overall fair value measurement. See Note 3 for more information regarding the fair value of the Fund's investments.

 

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

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars in thousands)

 

The following table shows the portfolio composition by industry grouping at fair value at December 31, 2017:

 

		At December 31, 2017
		Investments at Fair Value				Percentage of Total Portfolio
Media: Broadcasting & Subscription		$	16,546				34.9	%
Technology			14,282				30.1
Consumer Electronics			11,694				24.6
Renewable Energy			2,624				5.5
Services: Consumer			1,100				2.3
Telecommunications			528				1.1
Beverage, Food & Tobacco			266				0.6
Automobile			255				0.5
Aerospace and Defense			152				0.3
Energy: Oil & Gas			39				0.1
Investments - Money Market			18				—
Retail			9				—
Total		$	47,513				100.0	%

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars and shares in thousands)

 

December 31, 2016

 

Portfolio Company		Industry		Investment Coupon Rate, Maturity Date			Principal / No. of Shares			Amortized Cost			Fair Value			% of Net Assets
Senior Secured First Lien Debt -50.6% (b)
Ansgar Media, LLC (e)		Media: Broadcasting & Subscription			12.00%, 1/11/2018		$	2,000		$	2,000		$	2,000			5.9	%
Ansgar Media, LLC (e)		Media: Broadcasting & Subscription			12.00%, 9/18/2017			2,000			2,000			2,000			5.9	%
Ansgar Media, LLC (e)		Media: Broadcasting & Subscription			12.00%, 10/24/2018			310			310			310			0.9	%
Ansgar Media, LLC (e)		Media: Broadcasting & Subscription			12.00%, 10/27/2018			1,540			1,540			1,540			4.6	%
APX Group, Inc.		Services: Consumer			6.38%, 12/1/2019			825			825			849			2.6	%
Claire's Stores, Inc. Term Loan (h)		Retail			9.00%, 9/20/2021			125			263			125			0.4	%
CLSIP LLC Term Loan (h)		Retail			9.00%, 9/20/2021			407			856			407			1.2	%
GeoCommerce, Inc.		Technology			12.00%, 4/27/2018			1,000			745			1,000			3.0	%
GeoCommerce, Inc.		Technology			12.00%, 5/15/2018			1,500			898			1,500			4.5	%
GeoCommerce, Inc.		Technology			12.00%, 10/14/2018			750			390			750			2.2	%
GeoCommerce, Inc.		Technology			12.00%, 12/21/2018			750			368			750			2.2	%
Nima, LLC		Consumer Electronics			12.00%, 5/20/2018			2,000			1,201			2,000			5.9	%
Nima, LLC		Consumer Electronics			12.00%, 8/11/2018			1,000			1,000			1,000			3.0	%
Nima, LLC		Consumer Electronics			12.00%, 11/2/2018			750			750			750			2.2	%
Nima, LLC		Consumer Electronics			12.00%, 12/21/2018			750			750			750			2.2	%
Goodman Networks, Inc.		Telecommunications			12.13%, 7/1/2018			800			823			240			0.7	%
Kratos Defense & Security Solutions, Inc.		Aerospace and Defense			7.00%, 5/15/2019			1,112			1,015			1,079			3.2	%
Sub Total Senior Secured First Lien Debt							$	17,619		$	15,734		$	17,050			50.6	%
Senior Secured Second Lien Debt - 1.5% (b)
Nuverra Environmental Solutions, Inc.		Environmental Industries			12.50%, 4/15/2022		$	1,408		$	1,362		$	269			0.8	%
Logan's Roadhouse, Inc. (c) (f)		Beverage, Food & Tobacco			10.75%, 10/15/2017			674			633			87			0.2	%
Logan's Roadhouse, Inc. PIK Exit Facility Term Loan (f)		Beverage, Food & Tobacco			9.50% PIK, 11/23/2020			162			146			162			0.5	%
Saratoga Resources, Inc. (c)		Energy: Oil & Gas			12.50%, 7/1/2016			885			912			2			0.0	%
Sub Total Senior Secured Second Lien Debt							$	3,129		$	3,053		$	520			1.5	%
Senior Unsecured Debt - 14.5% (b)
APX Group, Inc.		Services: Consumer			8.75%, 12/1/2020		$	575		$	559		$	579			1.7	%
Claire’s (Gibraltar) Holdings Limited Term Loan (h)		Retail			9.00%, 9/20/2021			188			395			188			0.6	%
Clear Channel Communications		Media: Broadcasting & Subscription			10.00%, 1/15/2018			1,400			1,375			1,050			3.1	%
Colt Defense, LLC		Aerospace and Defense			8.00%, 7/12/2021			137			1,033			137			0.4	%
DynCorp International Inc.		Aerospace and Defense			11.88%, 11/30/2020			1,020			1,032			908			2.7	%
Gymboree Corp.		Retail			9.13%, 12/1/2018			810			785			364			1.1	%
Seitel, Inc.		Energy: Oil & Gas			9.50%, 4/15/2019			1,575			1,575			1,418			4.2	%
UCI International, Inc. (c) (i)		Automobile			8.63%, 2/15/2019			1,400			1,354			238			0.7	%
Sub Total Senior Unsecured Debt							$	7,105		$	8,108		$	4,882			14.5	%
Senior Subordinated Debt - 3.1% (b)
DJO Finance, LLC		Healthcare & Pharmaceuticals			10.75%, 4/15/2020		$	1,265		$	1,320		$	1,050			3.1	%
Sub Total Senior Subordinated Debt							$	1,265		$	1,320		$	1,050			3.1	%
Equity Securities - 28.7% (b)
Affinion Group, Inc. (c)		Media: Advertising, Printing & Publishing						13		$	689		$	50			0.2	%
Aspire Holdings (c)		Energy: Oil & Gas						26			551			40			0.1	%
Aspect Software, Inc. (c) (g)		Telecommunications						8			244			331			1.0	%
Education Management, LLC (c)		Services: Consumer						2,530			4			-			0.0	%
NII Holdings, Inc. (a) (c)		Telecommunications						17			768			36			0.1	%
Total Common Stock											2,256			457			1.4	%
Ansgar Media, LLC - Class B Units (c) (d) (e)		Media: Broadcasting & Subscription						-			-			3,519			10.4	%
Total Preferred Stock											-			3,519			10.4	%
GeoCommerce, Inc. (c)		Technology						875			1,883			3,684			11.0	%
Nuverra Environmental Solutions, Inc. (c)		Environmental Industries						61			-			10			0.0	%
Nima, LLC (c)		Consumer Electronics						2,000			1,000			2,000			5.9	%
Education Management, LLC (c)		Services: Consumer						1,554			876			-			0.0	%
Total Warrants											3,759			5,694			16.9	%
Sub Total Equity Securities										$	6,015		$	9,670			28.7	%
U.S. Government Securities - 21.3% (b)
U.S. Treasury Bill					0.63%, 8/31/2017		$	800		$	799		$	799			2.4	%
U.S. Treasury Bill					0.75%, 10/31/2017			1,600			1,599			1,598			4.8	%
U.S. Treasury Bill					0.75%, 8/15/2019			1,710			1,700			1,684			5.0	%
U.S. Treasury Bill					0.63%, 11/30/2017			1,700			1,699			1,696			5.0	%
U.S. Treasury Bill					0.75%, 4/15/2018			1,400			1,398			1,396			4.1	%
Sub Total U.S. Government Securities							$	7,210		$	7,195		$	7,173			21.3	%
Investments - Money Market - 0.5% (b)
Investments - U.S. Bank Money Market					0.10%		$	34		$	34		$	34			0.1	%
Investments - Wells Fargo Money Market					0.01%			123			123			123			0.4	%
Sub Total Investments - Money Market							$	157		$	157		$	157			0.5	%
TOTAL INVESTMENTS - 120.2% (b)										$	41,582		$	40,502			120.2	%

 

(a)

Represents a non-qualifying investment as defined under Section 55 (a) of the Investment Company Act of 1940, as amended. Non-qualifying investments represent 0.1% of the Fund's (VII Peaks Co-OptivistTM Income BDC, II, Inc.) portfolio at fair value. As a BDC, the Fund can only invest 30% of its portfolio in non-qualifying assets.

(b)

Percentages are based on net assets of $33,682 as of December 31, 2016.

(c)

Non-income producing as of December 31, 2016.

(d)

2,500 Class B Units, which are not entitled to an allocation of profits or losses until the earlier to occur of September 30, 2020 or a change of control of Ansgar Media, LLC.

(e)

As defined in the 1940 Act, Affiliated Investments are defined as those Non-Control Investments in companies in which we own between 5.0% and 25.0% of the voting securities.

 

Portfolio Company		Principal / No. of Shares				Fair Value at December 31, 2015				Gross Addition				Gross Reductions				Net Realized Gains (Losses)				Change in Unrealized Gains (Losses)				Fair Value at December 31, 2016				Dividends and Interest Income				Other income
Ansgar Media, LLC		$	5,850			$	2,000			$	3,850			$	-			$	-			$	-			$	5,850			$	504			$	-
Ansgar Media, LLC - Class B Units			-				2,102				-				-				-				1,417				3,519				-				-
						$	4,102			$	200			$	-			$	-			$	1,417			$	9,369			$	504			$	-

(f)

The company filed for bankruptcy in Delaware on August 8, 2016 and is in the final stages of restructuring. The Fund participated in DIP financing as part of company’s restructuring process during bankruptcy and has received PIK Second Lien Exit Facility T/L in exchange. Equity exchange is still in process.

(g)

On November 25, 2016, 3.00% PIK senior unsecured convertible notes were exchanged out for mandatory conversion to shares of common stock of Aspect Software Parent, Inc. at a rate of 1/30 i.e. one common share per $30.00 in principal amount of notes outstanding.

(h)

On September 20, 2016, Claire's Stores 10.50% senior subordinated notes and 8.875% senior secured second lien notes were exchanged out for mandatory conversion to Claire's Stores, Inc. First Lien Term Loan, CLSIP LLC Term Loan and Claire's (Gibraltar) Holdings Limited Term Loan.

(i)

On December 31, 2016, the bankruptcy court entered an order confirming the plan of reorganization of UCI International, LLC according to which the holders of senior unsecured notes will receive new common stock at the rate of $21.94 per $1,000 par value of notes. The Fund received notification of delivery of shares on April 10, 2017.

 

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

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars in thousands)

 

 The following table shows the portfolio composition by industry grouping at fair value at December 31, 2016:

 

		At December 31, 2016
		Investments at Fair Value				Percentage of Total Portfolio
Media: Broadcasting & Subscription		$	10,418				25.7	%
Technology			7,684				19.0
U.S. Government			7,173				17.7
Consumer Electronics			6,500				16.0
Aerospace and Defense			2,124				5.3
Energy: Oil & Gas			1,460				3.6
Services: Consumer			1,428				3.5
Retail			1,084				2.7
Healthcare & Pharmaceuticals			1,050				2.6
Telecommunications			607				1.5
Environmental Industries			279				0.7
Beverage, Food & Tobacco			249				0.6
Automobile			238				0.6
Investments – Money Market			157				0.4
Media: Advertising, Printing & Publishing			51				0.1
Total		$	40,502				100.0	%

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

NOTES TO FINANCIAL STATEMENTS

 

December 31, 2017

 

Note 1.  Nature of Operations

 

VII Peaks Co-Optivist ^TM Income BDC II, Inc. (the “Fund”, “our” or “we”), 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 or (“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”).

 

We invest in discounted corporate debt, senior secured term loan 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”) 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. Co-Optivist ^TM is a registered trademark of VII Peaks Capital, LLC, or (“VII Peaks” or the “Manager”), and is being used with their permission. 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 for new securities during refinance. In addition, we also provide direct loans with equity warrant coverage to portfolio companies to help facilitate corporate expansion.

 

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 also invest directly in debt of private companies. We define a “redemption event” as a maturity event or a put event (where investors in the target company’s debt security can have a redemption right at a pre-determined price). We hold such debt an average of 24 months, during which time we anticipate working actively with the target company’s management to effect and/or participate in a restructuring or exchange of the invested securities for new securities.

 

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 $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 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 also make senior secured direct loan investments in companies with a minimum enterprise value of $5.0 million. For such senior secured direct loan investments, we may receive equity securities to boost overall returns. We expect our portfolio to be predominantly composed of senior secured term loans and high-yield 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 shareholders 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 making distributions on a monthly basis to our shareholders.

 

We are managed by VII Peaks Capital, LLC, which is registered as an investment adviser with the U.S. Securities and Exchange Commission, or (“SEC”). Our Manager is responsible for sourcing potential investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis.

 

 

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 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, 2017, we issued 6.8 million shares of common stock, including 0.7 million shares under our distribution reinvestment plan (“DRIP”), less 0.3 million shares redeemed under our tender offer. Gross proceeds from our common stock issuances total $63.8 million, including $5.9 million under our DRIP less $2.9 million paid to redeem shares in our prior quarterly tender offers.

 

Liquidity and Going Concern

 

Our audited financial statements for the year ended December 31, 2017 have been prepared assuming we will continue to operate as a going concern, although because of our portfolio defaults and inability to convert to an Interval Fund and raise additional capital, it raises substantial doubt about our ability to continue as such.

 

As of December 31, 2017, we had approximately $18,000 in money market funds and subsequent to year end, we have delayed payments to service providers, substantially curtailed shareholder distributions, and extended certain of our loans’ maturity dates, thereby delaying the timing of cash inflows. This raises substantial doubt about the ability of the Fund to continue as a going concern. Management plans to work with portfolio companies that are in default of loan repayments to refinance their outstanding debt obligations to the Fund. In addition, management plans to raise cash by selling certain of its loans to other parties. Also, management has requested the Board of the Directors to reduce shareholder distributions. Based upon the Fund’s plans to sell portfolio investments to raise capital, receipt of loan payments and reducing shareholder distributions, the Fund believes it is probable it will have sufficient resources to meet its financial obligations for the next 12 months from the issuance of these financial statements.

 

If we are unable to sell our investments or receive loan repayments in a timely manner, we may be required to reduce, defer, or discontinue certain or all of our operations or we would be less able to create and maintain a broad portfolio of investments and achieve our investment objective, which may negatively impact our results of operations and reduce our ability to make distributions to our shareholders or we may not be able to continue as a going concern.

 

In the event the Fund is able to reorganize and convert to a closed-end Interval Fund and raise new capital, the net proceeds from the sale of common stock will be used for our investment opportunities, operating expenses and for payment of various fees and expenses such as base management fees, inventive fees and other expenses. Any working capital reserves we maintain may not be sufficient for investment purposes, and we may require debt or equity financing to operate. Any loan defaults from portfolio companies will negatively impact our results of operations, reduce our overall liquidity and cash flows needed to continue as a going concern. Any defaults would also increase the difficulty in securing alternative sources of funding, and there

 

Note 2.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Fund is considered an investment company as defined in Accounting Standards Codification (“ASC”) Topic 946 – Financial Services – Investment Companies (“ASC 946”). The financial statements of the Fund included herein were prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") and pursuant to the requirements for reporting on Form 10-K and Articles 6 or 10 of Regulation S-X. The Fund is a single reportable segment.

 

Our audited financial statements for the year ended December 31, 2017 have been prepared assuming we will continue to operate as a going concern, although because of our portfolio defaults and inability to convert to an Interval Fund and raise additional capital, it raises substantial doubt about our ability to continue as such.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of the accompanying financial statements in conformity with U.S. 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.

 

Prepaid Interest from Investments

 

The Fund receives prepaid interest when it makes direct senior secured first lien loans. The total prepaid interest of $270 and $779 at December 31, 2017 and December 31, 2016, respectively (in thousands) is comprised of $81 and $333, respectively, from Nima, LLC; zero and $258, respectively, from GeoCommerce, Inc.; $21 and $188, respectively, from Ansgar Media, LLC; $29 and zero, respectively, from Digital Golf Technologies, LLC; and $139 and zero, respectively, from Vieste Group, LLC.

 

Investment Classification

 

The Fund classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which we own more than 25.0% of the voting securities or maintain greater than 50.0% of the board representation. Under the 1940 Act, “Affiliated Investments” are defined as those non-control investments in companies in which we own between 5.0% and 25.0% of the voting securities. Under the 1940 Act, “Non-affiliated Investments” are defined as investments that are neither Control Investments nor Affiliated Investments.

 

 

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 initial cost of the organizational and offering expenses, but the Fund is obligated to reimburse the Manager for such costs to the extent of 1.5% of the gross offering proceeds in our continuous offering. The Fund also agreed to reimburse the Manager for organization and offering expenses incurred by a prior manager in consideration for the Manager’s agreement to pay $1.3 million owed to the Fund by the prior manager under an expense reimbursement agreement, which amount the Manager paid in full during the year ended December 31, 2014. 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 (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.

 

The Fund has evaluated the implications of Accounting Standards Codification (“ASC”) Topic 740, Accounting for Income Taxes, (“ASC Topic 740”) for all tax years and in all major tax jurisdictions, and determined that there is no material impact on the financial statements.

 

Accounting Pronouncements Adopted

 

In October 2016, the SEC adopted new rules and amended existing rules (together, “final rules”) intended to modernize the reporting and disclosure of information by registered investment companies. In part, the final rules amend Regulation S-X and require standardized, enhanced disclosures about derivatives in investment company financial statements, as well as other amendments. The compliance date for the amendments to Regulation S-X was August 1, 2017. As such, Management has adopted those amendments of Regulation S-X that impact the Fund’s financial statements and related disclosures.

 

In August 2014, FASB issued ASU No. 2014-15, Presentation of Financial Statements- Going Concern (Subtopic 205-40) ("ASU 2014-15"). ASU 2014-15 requires management to assess an entity's ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period, including interim periods, (3) provide principles for considering the mitigating effect of Management's plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of Management's plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The amendments in ASU 2014-15 are effective for the annual period ending after December 15, 2016, and for any annual periods and interim periods thereafter. We adopted the provisions of ASU 2014-15 in 2016. The adoption of ASU 2014-15 required any additional disclosures regarding the Fund’s ability as a going concern in the Fund’s financial statements. Note 2 of our financial statements include our disclosure regarding the Fund’s ability to continue as a going concern.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue with Contracts from Customers (Topic 606), to provide guidance on revenue recognition. ASU No. 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which provided for the adoption of the new standard for fiscal years beginning after December 15, 2017. Accordingly, ASU No. 2014-09 is effective for the Company in the first quarter of 2018. Early adoption up to the first quarter of 2017 was permitted. Upon adoption, ASU No. 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The FASB has also issued the following standards which clarify ASU No. 2014-09 and have the same effective date as the original standard:

 

 

	·	ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net);
	·	ASU No. 2016-10, Identifying Performance Obligations and Licensing (Topic 606);
	·	ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting;
	·	ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients; and
	·	ASU No. 2016-20, Revenue from Contracts with Customers (Topic 606): Technical Corrections and Improvements.

 

The new standard became effective on January 1, 2018. The Company has completed its evaluation and believes the adoption of the ASU will not have any material impact on the Fund’s financial statements as the Company does not have any contracts with customers.

 

In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”). ASU 2016-18 requires that the statements of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statements of cash flows. The new guidance is effective for annual and interim periods, beginning after December 15, 2017, and early adoption is permitted and is to be applied on a retrospective basis. Management does not believe that the adoption of this guidance will have a material impact on the Fund's financial statements, as the Fund does not currently have restricted cash.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). In February of 2018, the FASB issued ASU 2018-03: Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10) to further clarify the guidance. ASU’s 2016-01 and 2018-03, retain many current requirements for the classification and measurement of financial instruments; however, the new guidance significantly revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. ASU 2016-01 also amends certain disclosure requirements associated with the fair value of financial instruments. This guidance is effective for annual and interim periods beginning after December 15, 2017, and early adoption is not permitted for public business entities. Management is currently evaluating the impact this guidance will have on the Fund's financial statements.

  

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, addressing eight specific cash flow issues in an effort to reduce diversity in practice. The amended guidance is effective for fiscal years beginning after December 15, 2017, and for interim periods within those years. Early adoption is permitted. The Company does not expect the amended guidance to have a material impact on its Statements of Cash Flows.

 

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, to address stakeholder concerns that hedge accounting is often difficult to interoperate and to improve clarity in the financial statements regarding an entity’s risk management strategy. The amended guidance is effective for fiscal years beginning after December 15, 2018, and for interim periods within those years. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of this standard on the Fund’s Financial Statements. 

 

Revenue Recognition

 

We generate investment income in the form of interest, dividend and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt, senior unsecured convertible debt and collateralized securities in our portfolio. Fee income received is non-recurring in nature. The level of income we receive is directly related to the balance of collectible income producing investments multiplied by the coupon rate of our investments. Coupon interest income is adjusted for the amortization of premiums and accretion of discounts. We record interest income on an accrual basis to the extent that we expect to collect such amounts. The Fund stops accruing when the invested company defaults in payment and has passed the 30-day grace period, files for bankruptcy or goes through reorganization converting bonds to equity. We expect the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases.

 

 Dividend income is recognized on the ex-dividend date for common equity securities and on an accrual basis for preferred equity securities to the extent that such amounts are expected to be collected or realized. In determining the amount of dividend income to recognize, if any, from cash distributions on common equity securities, we will assess many factors including a portfolio company’s cumulative undistributed income and operating cash flow. Cash distributions from common equity securities received in excess of such undistributed amounts are recorded first as a reduction of our investment and then as a realized gain on investment. We stop accruing interest or dividends on our investments when it is determined that the interest or dividend is not collectible. We assess the collectability of the interest and dividends based on many factors including the portfolio company’s ability to service our loan based on current and projected cash flows as well as the current valuation of the portfolio company’s current total enterprise value. For investments with payment-in-kind (“PIK”) interest and cumulative dividends, we base income and dividend accruals on the valuation of the PIK notes or securities received from the borrower or the redemption value of the security. If the portfolio company valuation indicates a value of the PIK notes or securities or redemption value that is not sufficient to cover the contractual interest or dividend, we will not accrue interest or dividend income on the notes or securities and will record an allowance for any accrued interest or dividend receivable as a reduction of interest or dividend income in the period we determine it is not collectible.

 

 

In connection with our debt investments, we may receive warrants or similar equity-related securities ("Warrants"). We determine the cost basis of Warrants based upon their fair values on the date of receipt relative to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the Warrants is treated as original issue discount (“OID”) and accreted into interest income over the life of the debt investment using a method that approximates the effective interest method. Similarly, loan origination fees are capitalized and amortized as other income over the life of the loan.

 

For loans and debt securities with contractual 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 when we receive such amounts.

 

Our total investment income was $4.2 million for the year ended December 31, 2017, as compared to $3.1 million for the year ended December 31, 2016 and $3.5 million for the year ended December 31, 2015, respectively. The increase in 2017 as compared to 2016 was attributable to the increase in interest income and fee income from direct lending investments in senior secured notes. At December 31, 2017, the weighted average coupon yield was 12.1%, as compared to 8.6% at December 31, 2016 and 7.6% at December 31, 2015. This coupon yield is for the non-defaulted and non-equity positions. Based on current and prior three quarter’s net assets, average net assets as of December 31, 2017 were $43.1 million, as compared to $31.8 and $39.2 million for the years ended December 31, 2016 and 2015, respectively.

  

For the year ended December 31, 2017, thirteen of the investments in the portfolio did not accrue interest as either the investment was an equity security or the issuers were in default of the coupon payment for more than the thirty-day grace period. Interest income was accrued through the date of the last coupon payment received for the debt investments. The following table presents those thirteen investments:

 

Portfolio Company		Asset Type			Investment Coupon Rate				Maturity Date
Ansgar Media, LLC - Class B Units		Equity – Preferred Stock				—			—
Aspect Software, Inc. (1)		Equity – Common Stock				—			—
Aspire Holdings (2)		Equity – Common Stock				—			—
Digital Golf Technologies, LLC		Warrant				—			—
Education Management LLC (3)		Equity – Common Stock				—			—
Education Management LLC (3)		Warrant				—			—
GeoCommerce, Inc.		Warrant				—			—
Gymboree Corp.		Senior Unsecured Debt				9.13	%		December 1, 2018
Logan's Roadhouse, Inc. (4)		Equity – Common Stock				—			—
NII Holdings, Inc. (5)		Equity – Common Stock				—			—
Nima, LLC		Warrant				—			—
UCI International, Inc. (6)		Equity – Common Stock				—			—
Vieste Group, LLC		Warrant				—			—

 

(1)	Converted from exchange of 3.00% PIK senior unsecured convertible notes.
(2)	Converted from exchange of 12.00% Endeavour International Corp First Lien Bonds.
(3)	Received in exchange of 15.00% Cash/PIK bonds.
(4)	The company filed for bankruptcy in Delaware on August 8, 2016. The Fund participated in DIP financing as part of the company’s restructuring process during bankruptcy and has received a PIK Second Lien Exit Facility T/L in exchange. On April 28, 2017, the remaining unexchanged bonds were converted to equity.
(5)	Received in exchange of 10.00% senior unsecured debt.
(6)	Received in exchange of 8.625% senior unsecured notes.

 

Note 3. Valuation of Portfolio Investments

 

The Fund has adopted FASB ASC Topic 820, Fair Value Measurements and Disclosures (“ASC Topic 820”), which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP 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.

 

The investment portfolio is recorded on a trade date basis. 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. Six investments were valued using the closing market price at period end December 31, 2017.

 

Due to the inherent uncertainty of determining the fair value of Level 3 investments, the fair value of the investments may differ significantly from the values that would have been used had a ready market or observable inputs existed for such investments and may differ materially from the values that may ultimately be received or settled. If the Company were required to liquidate a portfolio in a forced or liquidation sale, the Company might realize significantly less than the value at which such investment had previously been recorded.

 

The following table presents investments that are not publicly-traded or have no closing market price, as of December 31, 2017:

 

Portfolio Company		Asset Type			Investment Coupon Rate				Maturity Date
Ansgar Media, LLC - Class B Units		Equity – Preferred Stock				—			—
Ansgar Media, LLC		Senior Secured First Lien Debt				12.00	%		January 11, 2019
Ansgar Media, LLC		Senior Secured First Lien Debt				12.00	%		September 8, 2019
Ansgar Media, LLC (8)		Senior Secured First Lien Debt				12.00	%		October 24, 2018
Ansgar Media, LLC (8)		Senior Secured First Lien Debt				12.00	%		October 27, 2018
Aspect Software, Inc. (1)		Equity – Common Stock				—			—
Aspire Holdings (2)		Equity – Common Stock				—			—
Colt Defense, LLC (3)		Senior Unsecured Debt				8.00	%		July 12, 2021
Digital Golf Technologies, LLC		Senior Secured First Lien Debt				13.00	%		January 11, 2020
Digital Golf Technologies, LLC		Warrant				—			—
Education Management LLC		Equity – Common Stock				—			—
Education Management LLC		Warrant				—			—
GeoCommerce, Inc. (4)		Senior Secured First Lien Debt				12.00	%		April 27, 2018
GeoCommerce, Inc. (4)		Senior Secured First Lien Debt				12.00	%		May 15, 2018
GeoCommerce, Inc. (4)		Senior Secured First Lien Debt				12.00	%		October 14, 2018
GeoCommerce, Inc.		Senior Secured First Lien Debt				12.00	%		December 21, 2018
GeoCommerce, Inc.		Warrant				—			—
Logan's Roadhouse, Inc. (5)		Equity – Common Stock				—			—
Logan's Roadhouse, Inc. PIK Exit Facility Term Loan (5)		Senior Secured Second Lien Debt				9.50	%		November 23, 2020
Nima, LLC (6)		Senior Secured First Lien Debt				12.00	%		May 20, 2018
Nima, LLC (6)		Senior Secured First Lien Debt				12.00	%		August 11, 2018
Nima, LLC (6)		Senior Secured First Lien Debt				12.00	%		October 16, 2018
Nima, LLC		Senior Secured First Lien Debt				12.00	%		November 2, 2018
Nima, LLC		Senior Secured First Lien Debt				12.00	%		December 21, 2018
Nima, LLC		Senior Secured First Lien Debt				12.00	%		February 16, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		April 6, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		June 19, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		August 4, 2019
Nima, LLC		Senior Secured First Lien Debt				12.00	%		August 31, 2019
Nima, LLC		Warrant				—			—
UCI International, Inc. (7)		Equity – Common Stock				—			—
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		April 7, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		July 14, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		August 1, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		August 17, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		August 31, 2019
Vieste Group, LLC		Senior Secured First Lien Debt				13.00	%		October 2, 2019
Vieste Group, LLC		Warrant				—			—

 

 

(1)	The original 10.63% senior secured second lien notes due on May 15, 2017 defaulted. As part of Aspect’s bankruptcy and planned reorganization process, the Fund participated in a rights offering to purchase a new 3.00% PIK senior unsecured convertible note maturing on May 23, 2023 in an effort to facilitate recovery of its previous investment in the senior secured lien notes in Aspect. On November 25, 2016, the 3.00% PIK senior unsecured convertible notes were exchanged out for mandatory conversion to shares of common stock of Aspect Software Parent, Inc. at a rate of 1/30 i.e. one common share per $30.00 in principal amount of notes outstanding.
(2)	Converted from exchange of 12.00% Endeavour International Corp, senior secured first lien debt.
(3)	On January 19, 2016, there was a mandatory exchange offer to exchange all of the 8.75% senior unsecured notes to 8.00% PIK third lien notes.
(4)	GeoCommerce, Inc. has requested loan extensions for the loans in default.  We have sent those extensions along with our reservation of rights letters. However, GeoCommerce, Inc. has not taken any action on the loan extensions as they are working to secure financing to repay the loans.
(5)	The company filed for bankruptcy in Delaware on August 8, 2016. The Fund participated in DIP financing as part of the company’s restructuring process during bankruptcy and has received a PIK second lien exit facility T/L in exchange. On April 28, 2017, the remaining unexchanged bonds were converted to equity.
(6)	Nima, LLC is currently in default of three of their loans. We are currently in discussion with Nima, LLC to either extend the loans or renegotiate the terms.
(7)	On June 2, 2016, UCI International, LLC and certain of its affiliates filed voluntary petitions for relief under Chapter 11 Bankruptcy in the District of Delaware. As per the Plan of Reorganization and based on Rank contribution being reached, the fund received 30,714 shares of the company on March 29, 2017.
(8)	We expect to give loan extensions to Ansgar Media, LLC

 

Securities that are not publicly-traded are valued at fair value as determined in good faith by the Management, and submitted to the Board of Directors or a committee thereof, for review. In connection with that determination, the 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.

 

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

 

	•	each portfolio company or investment is initially valued by members of our investment committee, with such valuation taking into account information received from our independent valuation firm, if applicable;
	•	preliminary valuations are then documented and reviewed with the members of our Board of Directors, or a committee thereof; and
	•	the Board of Directors, or committee thereof, reviews the 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, mergers and acquisition comparables, the principal market and enterprise values, among other factors.

 

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, 2017 per the fair value hierarchy (dollars in thousands):

 

		Level 1				Level 2				Level 3				Total
Investments – Money Market		$	18			$	—			$	—			$	18
Senior Secured First Lien Debt			—				190				20,237				20,427
Senior Secured Second Lien Debt			—				—				179				179
Senior Unsecured Debt			—				13				148				161
Equity Securities			—				7				26,721				26,728
Total		$	18			$	210			$	47,285			$	47,513

 

  

 The following table presents fair value measurements of investments, by major class, as of December 31, 2016 per the fair value hierarchy (dollars in thousands):

 

		Level 1				Level 2				Level 3				Total
Investments – Money Market		$	157			$	—			$	—			$	157
U.S. Government Securities			—				7,173				—				7,173
Senior Secured First Lien Debt			—				2,168				14,882				17,050
Senior Secured Second Lien Debt			—				2				518				520
Senior Unsecured Debt			—				4,557				325				4,882
Senior Subordinated Debt			—				1,050				—				1,050
Equity Securities			—				86				9,584				9,670
Total		$	157			$	15,036			$	25,309			$	40,502

 

There was one transfer from Level 2 to Level 3 for the year ended December 31, 2017. The transfer was UCI International, Inc. 8.63% senior unsecured debt, due February 15, 2019, which was converted to equity. There were two transfers from Level 3 to Level 2 for the year ended December 31, 2017. The transfers were Nuverra Environmental Solutions, Inc. 10% senior secured second lien debt, due April 15, 2021 and Nuverra Environmental Solutions, Inc. warrants.

 

During the year ended December 31, 2017, the following were the transfers in or out of levels (dollars in thousands):

 

		Level 1				Level 2				Level 3				Total
Senior Secured First Lien Debt		$	—			$	—			$	—			$	—
Senior Secured Second Lien Debt			—				269				(269	)			—
Senior Unsecured Debt			—				(238	)			—				(238	)
Equity Securities			—				11				227				238
Total		$	—			$	42			$	(42	)		$	—

 

There were five transfers from Level 2 to Level 3 for the year ended December 31, 2016. Transfers were Claire’s Stores, Inc. Term Loan 9.00% senior secured first lien debt, due September 20, 2021; CLSIP, LLC Term Loan 9.00% senior secured first lien debt, due September 20, 2021; Claire’s (Gibraltar) Holdings Limited Term Loan 9.00% senior unsecured debt, due September 20, 2021; Nuverra Environmental Solutions, Inc. senior secured second lien debt 12.50%, due April 15, 2022; and Logan’s Roadhouse, Inc. 10.75% senior secured second lien debt, due October 15, 2017, which will be converted to senior secured term loans once the company’s restructuring completes. There was one transfer from Level 3 to Level 2 for the year ended December 31, 2016. The transfer was Affinion Group, Inc. common stock equity.

 

During the year ended December 31, 2016, the following were the transfers in or out of levels (dollars in thousands):

 

		Level 1				Level 2				Level 3				Total
Senior Secured First Lien Debt		$	—			$	(533	)		$	533			$	—
Senior Secured Second Lien Debt			—				(356	)			356				—
Senior Unsecured Debt			—				(188	)			188				—
Equity Securities			—				51				(51	)			—
Total		$	—			$	(1,026	)		$	1,026			$	—

 

The following table presents additional information about Level 3 assets measured at fair value. Both observable and unobservable inputs may be used to determine the fair value of positions that the Fund has classified within the Level 3 category. As a result, the net unrealized appreciation (depreciation) for assets within the Level 3 category may include changes in fair value that were attributable to both observable and unobservable inputs.

 

 

Changes in Level 3 assets measured at fair value for the year ended December 31, 2017 are as follows (dollars in thousands):

  

		Fair Value at December 31, 2016				Transfers in / (out)				Reclassification				Purchases (Sales and Settlement) (1)				Amortization and Accretion of Fixed Income Premiums and Discounts				Realized and Unrealized Gains (Losses)				Fair Value at December 31, 2017				Change in Unrealized appreciation (depreciation) for investments held as of December 31, 2017
Senior Secured First Lien Debt		$	14,882			$	-			$	-			$	5,203			$	1,488			$	(1,336	)		$	20,237			$	(1,344	)
Senior Secured Second Lien Debt			518				(269	)			(87	)			17				1				(1	)			179				(1	)
Senior Unsecured Debt			325				-				-				(140	)			5				(42	)			148				1
Equity Securities			9,584				227				87				308				-				16,515				26,721				16,487
Total		$	25,309			$	(42	)		$	-			$	5,388			$	1,494			$	15,136			$	47,285			$	15,143

 

(1)	Includes purchases of new investments, effects of refinancing and restructurings, PIK interest, net proceeds from investments sold and principal payments received.

 

 Realized and unrealized gains and losses are included in net realized gain (loss) from investments and net unrealized appreciation on investments in the statements of operations. The change in unrealized appreciation (depreciation) for Level 3 investments still held as of December 31, 2017 of $15.1 million is included in net unrealized appreciation on investments in the statements of operations for the year ended December 31, 2017.

 

Changes in Level 3 assets measured at fair value for the year ended December 31, 2016 are as follows (dollars in thousands):

 

		Fair Value at December 31, 2015				Transfers in / (out)				Reclassification				Purchases (Sales and Settlement) (1)				Amortization and Accretion  of Fixed Income Premiums and Discounts				Realized and Unrealized Gains				Fair Value at December 31, 2016				Change in Unrealized appreciation (depreciation) for Investments held as of December 31, 2016
Senior Secured First Lien Debt		$	2,525			$	533			$	(525	)		$	12,349			$	-			$	-			$	14,882			$	(586	)
Senior Secured Second Lien Debt			8				356				-				139				-				15				518				(513	)
Senior Unsecured Debt			132				188				-				-				4				1				325				(205	)
Equity Securities			3,126				(51	)			525				244				-				5,740				9,584				5,740
Total		$	5,791			$	1,026			$	-			$	12,732			$	4			$	5,756			$	25,309			$	4,436

 

(1)	Includes purchases of new investments, effects of refinancing and restructurings, PIK interest, net proceeds from investments sold and principal payments received.

 

Realized and unrealized gains and losses are included in net realized gain (loss) from investments and net unrealized appreciation (depreciation) on investments in the statements of operations. The change in unrealized appreciation for Level 3 investments still held as of December 31, 2016 of $4.4 million is included in net unrealized appreciation on investments in the statements of operations for the year ended December 31, 2016.

 

The following table provides quantitative information regarding Level 3 fair value measurements as of December 31, 2017 (dollars in thousands):

 

													Range
		Fair Value				Valuation Technique		Unobservable Input		Mean			Minimum			Maximum
Senior Secured First Lien Debt		$	20,237			Discounted Cash Flow analysis / EBITDA multiples / Enterprise Value		Transaction Value Market premium for loan interest rate		$	20,237		$	20,237		$	20,237
Senior Secured Second Lien Debt			179			Liquidation		Transaction Value			179			179			179
Senior Unsecured Debt			148			Liquidation		Transaction Value			148			148			148
Equity Securities			26,721			Income Approach / Market Approach		Transaction Value / Discounted Cash Flows			26,721			22,427			26,721
Total		$	47,285

 

As part of liquidation analysis, the Fund performs a leveraged buyout analysis of its portfolio companies and calculates asset coverage and recovery value for each individual loan.

 

The $25.67million (Ansgar Media,, LLC, Geocommerce, Inc. and Nima, LLC) of the $26.72 million equity securities were valued using the Discounted Cash Flow (DCF) and Guideline Public Company (GPC) method. The range of discount rate used for DCF method was 30% to 75% and the range for EBITDA multiple used for GPC method was 2.5x to 15x.

 

 

The following table provides quantitative information regarding Level 3 fair value measurements as of December 31, 2016 (dollars in thousands):

 

													Range
		Fair Value				Valuation Technique		Unobservable Input		Mean			Minimum			Maximum
Senior Secured First Lien Debt		$	14,882			Discounted Cash Flow analysis / EBITDA multiples / Enterprise Value		Transaction Value Market premium for loan interest rate		$	14,882		$	14,882		$	14,882
Senior Secured Second Lien Debt			518			Liquidation		Transaction Value			518			518			518
Senior Unsecured Debt			325			Liquidation		Transaction Value			325			325			325
Equity Securities			9,584			Income Approach / Market Approach		Transaction Value / Discounted Cash Flows			12,825			9,584			16,066
Total		$	25,309

 

The primary significant unobservable inputs used in the fair value measurement of the Fund's senior secured second lien debt and senior unsecured debt were the fair value of the exchanged bonds/equity offered by the issuer or the price as evidenced by trades in the secondary market (Colt Defense, LLC, Claire's Stores Gibraltar T/L, two Logan's Roadhouse, Inc. and Nuverra Environmental Co.).

 

The composition of the Fund’s investments as of December 31, 2017, 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		$	18			$	18				0.0	%
Senior Secured First Lien Debt			19,867				20,427				43.0
Senior Secured Second Lien Debt			165				179				0.4
Senior Unsecured Debt			1,800				161				0.3
Equity Securities			7,621				26,728				56.3
Total		$	29,471			$	47,513				100.0	%

 

The composition of the Fund’s investments as of December 31, 2016, 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		$	157			$	157				0.4	%
U.S. Government Securities			7,195				7,173				17.7
Senior Secured First Lien Debt			15,734				17,050				42.1
Senior Secured Second Lien Debt			3,053				520				1.3
Senior Unsecured Debt			8,108				4,882				12.0
Senior Subordinated Debt			1,320				1,050				2.6
Equity Securities			6,015				9,670				23.9
Total		$	41,582			$	40,502				100.0	%

 

Purchases and sales and repayments of securities during the year ended December 31, 2017, other than short-term securities and U.S. government obligations, were $7.8 million and $17.3 million, respectively. Purchases and sales and repayments of securities during the year ended December 31, 2016, other than short-term securities and U.S. government obligations, were $36.5 million and $30.6 million, respectively. Purchases and sales and repayments of securities during the year ended December 31, 2015, other than short-term securities and U.S. government obligations, were $23.2 million and $19.7 million, respectively.

   

Note 4.  Related Party Transactions

 

We have entered 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.

 

 

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.

 

The managing members of VII Peaks Capital are also officers of Alesiatec. Inc, a software technology. In 2016, GeoCommerce made a non-recurring engineering payment of $400,000 to Alesiatec to use Alesiatec software technology. In addition, Alesiatec also issued $100,000 of Series A stock to GeoCommerce to use GeoCommerce’s online database technology.

 

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 relief 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.

 

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.

 

Due from related party of $196,000 at December 31, 2017 consists of approximately $35,000 of true up for management fees from writing down certain portfolio investments at the end of a quarter in prior quarters, $45,000 in Blue Sky state filing fees paid by the Fund instead of our Manager, $25,000 in allocation of the Directors and Officers insurance policy costs to our Manager, and $91,000 in expenses related to legal and other operational costs allocated to our Manager instead of the Fund.

  

 Due from related party at December 31, 2016 of $239,000 consisted of approximately $67,000 of true up for management fees from writing down certain portfolio investments at the end of a quarter in prior quarters, $67,000 in Blue Sky state filing fees by the Fund instead of our Manager, $13,000 in allocation of the Directors and Officers insurance policy costs to our Manager, and $90,000 in expenses related to legal and other operational costs allocated to out Manager instead of the Fund.

 

Due diligence fees received by the Fund from the borrowers related to the Fund’s direct lending transactions are remitted to our Manager, VII Peaks Capital, LLC, as the collateral and administrative agent for the loans. Due diligence fees received are not revenues or expenses of the Fund and therefore are not reflected in the financial statements. Fees for the year ended December 31, 2017, 2016 and 2015 totaled $222,500, $475,000 and $25,000, respectively.

 

Investment Advisory Agreement

 

The Fund has entered into an investment advisory agreement with the Manager to manage the Fund’s investment activities. 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, or a committee thereof. 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. The initial investment advisory agreement was signed on August 20, 2013 and was effective for two years. The agreement must be re-approved annually thereafter by a majority of the non-interested members of the Board of Directors. On September 12, 2017, the non-interested members of the Board of Directors re-approved the agreement between the Manager and the Fund under the agreement’s existing terms.

 

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 single rate base management fee is 2% of net assets below $100.0 million; 1.75% of net assets between $100.0 million and $250.0 million; and 1.5% of net assets over $250.0 million. For the years ended December 31, 2017, 2016 and 2015, the Fund incurred $0.9 million, $0.6 million and $0.8 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 and incentive fees. For the years ended December 31, 2017, 2016 and 2015, the Fund did not incur any incentive fees related to net investment income or capital gains.

 

Under U.S. 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. U.S. 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. 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. The Fund expenses organizational and offering costs as they become payable to the Manager under the investment advisory agreement.

 

 

Administration Agreement

 

Our Manager serves as our administrator. Pursuant to an administration agreement, our Manager furnishes us with office facilities, equipment, clerical, bookkeeping 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, transfer agency and other service providers supervision and oversight, preparation and supervision of the financial records for which we are required to maintain for SEC reporting, stockholder reporting and other Fund needs, implementation and supervision of a robust compliance program and oversight and administration of the quarterly share repurchase program. In addition, our Manager assists us in activities which include, among other things, performance and supervision of investor relations, the Fund’s Board of Directors communication and reporting, determining and publishing our net asset value, overseeing the preparation and filing of our tax returns, the communication, printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and other events such as distributions, 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 overseeing and performing the compliance functions and our allocable portion of the compensation of our chief financial officer, chief compliance officer and any administrative support staff; however, to date, cost of the chief financial officer, fund administration accounting and the chief compliance officer are charged directly to the Fund. 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 also provides the reimbursement to the Fund by the Manager for the Manager’s share of the Directors and Officers insurance, which is paid by the Fund in full. 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.

 

Note 5.  Common Stock

 

Initially, 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. The Manager sold these shares on June 27, 2014.

 

On July 10, 2012, the Fund had raised sufficient proceeds to break escrow on its IPO and through December 31, 2017, the Fund has issued 6.8 million shares of common stock net of 301,413 treasury shares, for gross proceeds of $63.8 million including the purchases made by the Manager.

 

During the year ended December 31, 2017, the Fund did not sell any shares of common stock as its prospectus was not effective. Also, for the year ended December 31, 2017, there were no treasury shares repurchased.

 

Note 6. Borrowings

 

Wells Fargo Credit Facility

 

On August 4, 2015, the Fund entered an agreement with Wells Fargo Advisors, LLC for a revolving line of credit. The amount the Fund could borrow was based upon the value of cash deposited in an account at Wells Fargo Advisors, LLC and the treasury notes that Wells Fargo purchased, which served as collateral for the loan. As of December 31, 2017 and December 31, 2016, the outstanding balance under this credit line was $0 and $6.4 million, respectively.

 

At the end of March 2017, the Fund began selling the treasury notes that Wells Fargo held as collateral for the line of credit. The line was paid off in April 2017 and the remaining securities held at Wells Fargo were transferred to U.S. Bank National Association, the Fund’s administrator. In May 2017, the line of credit and corresponding collateral account were closed at Wells Fargo.

 

Note 7.  Income Taxes

 

The Fund has elected to be treated as a RIC under Subchapter M of the Code. As a RIC, the Fund is not taxed on any investment company taxable income or capital gains which it distributes to shareholders. The Fund intends to make the requisite distributions to its stockholders which will relieve the Fund from U.S. federal income taxes. Accordingly, no provision for U.S. federal income tax has been made in the financial statements.

 

 

Dividends from net investment income and distributions from net realized capital gains are determined in accordance with U.S. federal tax regulations, which may differ from amounts in accordance with U.S. GAAP and those differences could be material.

 

Significant U.S. federal tax reform legislation was recently enacted that, among other things, permanently reduces the maximum federal corporate income tax rate, reduces the maximum individual income tax rate (effective for taxable years 2018 through 2025), restricts the deductibility of business interest expense, changes the rules regarding the calculation of net operating loss deductions that may be used to offset taxable income, and, under certain circumstances, requires accrual method taxpayers to recognize income for U.S. federal income tax purposes no later than the income is taken into account as revenue in an applicable financial statement.

 

We cannot predict with certainty how any future changes in the tax laws might affect us, our investors or our portfolio investments. New legislation and any U.S. Treasury regulations, administrative interpretations or court decisions interpreting such legislation could significantly and negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax consequences to us and our investors of such qualification, or could have other adverse consequences. Investors are urged to consult with their tax advisor regarding tax legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our securities.

 

Note 8.  Earnings (Loss) Per Share

 

In accordance with the provisions of FASB ASC 260, Earnings per Share (“ASC 260”), net increase (decrease) in net assets per share is computed by dividing net increase (decrease) in net assets resulting from operations available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and their related impact, are considered when calculating diluted net increase in net assets from operations per share.

 

The following information sets forth the computation of the weighted average basic and diluted net increase (decrease) in net assets from operations per share for the years ended December 31, 2017, 2016 and 2015 (dollars in thousands except share and per share amounts):

 

		For the Year Ended December 31,				For the Year Ended December 31,				For the Year Ended December 31,
		2017				2016				2015
Basic and diluted:
Net increase (decrease) in net assets resulting from operations		$	16,906			$	7,614			$	(13,359	)
Weighted average common shares outstanding			6,403,225				6,256,208				6,077,127
Net increase (decrease) in net assets resulting from operations, per share		$	2.64			$	1.22			$	(2.20	)

 

The Fund had no potentially dilutive securities as of December 31, 2017, resulting in the same number of shares for basic and diluted computations.

 

Note 9. Tender Offer Program

 

We do not currently intend to list our shares on any securities exchange and do not expect a public market for them to develop in the foreseeable future. Therefore, shareholders should not expect to be able to sell their shares promptly or at a desired price. Beginning with the fourth calendar quarter of 2013, and on a quarterly basis through June 30, 2015, the Board of Directors approved a tender offer to repurchase shares of our common stock at a price equal to 90% of our offering price on the date of repurchase. In the third quarter of 2015, the Board of Directors decided to suspend the repurchase program, as the Fund was not raising any new capital. When a tender offer is approved by the Board of Directors, we 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 5.0% in each quarter, though the actual number of shares that we offer to repurchase may be less considering the limitations noted above. We will offer to repurchase such shares on each date of repurchase at a price equal to 90% of our offering price. For the year ended December 31, 2017, no tender offer was approved by the Board of Directors.

 

The following table reflects certain information regarding the tender offers that we have conducted since January 2015:

 

For the period ended		Repurchase Date		Shares Repurchased				Percent of Shares Tendered that were Repurchased				Repurchase Price Per Share				Aggregate Consideration For Repurchased Shares (‘000s)*
March 31, 2015		March 30, 2015			5,811				100	%		$	8.775			$	51
June 30, 2015		June 29, 2015			215,935				69	%			8.775				1,895
September 30, 2015		September 30, 2015**			—				—				—				—
December 31, 2015		December 31, 2015**			—				—				—				—
March 31, 2016		March 31, 2016**			—				—				—				—
June 30, 2016		June 30, 2016**			—				—				—				—
September 30, 2016		September 30, 2016**			—				—				—				—
December 31, 2016		December 31, 2016**			—				—				—				—
March 31, 2017		March 31, 2017**			—				—				—				—
June 30, 2017		June 30, 2017**			—				—				—				—
September 30, 2017		September 30, 2017**			—				—				—				—
December 31, 2017		December 31, 2017**			—				—				—				—
																$	1,946

 

 

* The difference between an increase in treasury capital and aggregate consideration for repurchased shares is allocated to the capital/owners, equity account dealer fees.

 

**The Board of Directors did not declare a tender offer for the quarters ended September 30, 2015, December 31, 2015, March 31, 2016, June 30, 2016, September 30, 2016, December 31, 2016, March 31, 2017, June 30, 2017, September 30, 2017, and December 31, 2017.

 

Our quarterly repurchases will be conducted on such terms as may be determined by our Board of Directors, or a committee thereof, in its complete and absolute discretion unless, in the judgment of the independent directors of our Board of Directors, or a committee thereof, such repurchases would not be in the best interests of our stockholders or would violate applicable law. We will conduct such repurchase offers in accordance with the requirements of Rule 13e-4 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the 1940 Act. In the months in which we repurchase shares, we will conduct repurchases on the same date that we hold our first monthly closing for the sale of shares in this offering. Any offer to repurchase shares will be conducted solely through tender offer materials mailed to each stockholder.

 

Note 10.  Distributions

 

Subject to our Board of Director’s discretion and applicable legal restrictions, we have historically declared and paid ordinary cash distributions at a rate equal to 7.35% of our latest offering price per share of $8.75. Prior to the September 30, 2015, we paid distributions on a semi-monthly basis. We changed to paying distributions monthly, when declared by our Board of Directors, in order to reduce costs. We may fund our cash distributions to shareholders from any sources of funds available to us, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, and dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies. We have not established limits on the amount of funds we may use from available sources to make distributions.

 

Our distributions historically have not been based on our investment performance. Prior to September 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities.

 

As of December 31, 2017, the Fund has accrued $0.1 million stockholder distributions that were unpaid. As of December 31, 2016, the Fund had not accrued any distributions that were unpaid.

 

The following table reflects the distributions per share paid or payable in cash or with the DRIP on the Fund’s common stock since January 2015 (dollars in thousands except per share amounts), as well as the source of the distributions:

 

Source of Distribution by Cash vs. DRIP:

 

					Net Investment			Realized Gain From			Return of						Paid in
Period		Per Share			Income			Investments			Capital			Total			Cash			DRIP
January 1, 2015 - March 31, 2015		$	0.179154		$	153		$	52		$	824		$	1,029		$	652		$	377
April 1, 2015 - June 30, 2015			0.179154			705			163			243			1,111			719			392
July 1, 2015 - September 30, 2015			0.209015			240			142			904			1,286			836			450
October 1, 2015 - December 31, 2015*			0.170315			—			68			996			1,064			685			379
January 1, 2016 – March 31, 2016 **			0.169969			8			—			1,045			1,053			684			369
April 1, 2016 - June 30, 2016***			0.107188			—			—			669			669			452			217
July 1, 2016 - September 30, 2016****			0.214372			305			—			1,042			1,347			934			413
October 1, 2016 - December 31, 2016			0.107186			160			78			439			677			473			204
January 1, 2017 – March 31, 2017			0.160779			226			41			754			1,021			721			300
April 1, 2017 - June 30, 2017			0.160779			358			57			611			1,026			735			291
July 1, 2017 – September 30, 2017*****			0.160779			570			—			462			1,032			746			286
October 1, 2017 - December 31, 2017******			0.160779			527			—			512			1,039			609			286
TOTAL		$	1.979469		$	3,252		$	601		$	8,501		$	12,354		$	8,248		$	3,962

 

 

* For the period from October 31, 2015 to December 31, 2015, the Fund had a net investment loss of approximately $268 thousand. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

** For the period from January 1, 2016 to March 31, 2016, the Fund had a realized loss from investments of approximately $700 thousand. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

*** For the period from April 1, 2016 to June 30, 2016, the Fund had a net investment loss of approximately $4 thousand and a realized loss from investments of approximately $12.6 million. These amounts are reflected on the source of distributions table below in the distributions from paid in capital amount.

 

**** For the period from July 1, 2016 to September 30, 2016, the Fund had a realized loss from investments of approximately $0.04 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

***** For the period from July 1, 2017 to September 30, 2017, the Fund had a realized loss from investments of approximately $0.5 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount.

 

****** For the period from October 1, 2017 to December 31, 2017, the Fund had a realized loss from investments of approximately $3.5 million. That amount is reflected on the source of distributions table below in the distributions from paid in capital amount. The Fund had stockholder distributions payable of $0.1 million.

 

 The following table shows the percentage of our distributions, which have been funded from net investment income, realized capital gains and paid in capital since January 2015:

 

Percentage of Distributions by Source:

 

						Net				Realized				Return
						Investment				Gain From				of
Period		Per Share				Income				Investments				Capital
January 1, 2015 - March 31, 2015			0.179154				15	%			5	%			80	%
April 1, 2015 - June 30, 2015			0.179154				63	%			15	%			22	%
July 1, 2015 - September 30, 2015			0.209015				19	%			11	%			70	%
October 1, 2015 - December 31, 2015			0.170315				—	%			6	%			94	%
January 1, 2016 – March 31, 2016			0.169969				1	%			—	%			99	%
April 1, 2016 - June 30, 2016			0.107188				—	%			—	%			100	%
July 1, 2016 - September 30, 2016			0.214372				23	%			—	%			77	%
October 1, 2016 – December 31, 2016			0.107186				24	%			11	%			65	%
January 1, 2017 – March 31, 2017			0.160779				22	%			4	%			74	%
April 1, 2017 - June 30, 2017			0.160779				35	%			6	%			59	%
July 1, 2017 – September 30, 2017			0.160779				55	%			—	%			45	%
October 1, 2017 – December 31, 2017			0.160779				50	%			—	%			50	%

 

The following table reflects the sources of the cash distributions on a tax basis that the Fund has paid on its common stock (dollars in thousands) during the fiscal years ended December 31, 2017, 2016 and 2015:

  

Source of Distributions:		Year ended December 31, 2017								Year ended December 31, 2016								Year ended December 31, 2015
Distributions from net investment income		$	1,681				40.8	%		$	473				12.6	%		$	830				18.5	%
Distributions from realized gains			98				2.4	%			78				2.1	%			425				9.5	%
Distributions from paid in capital			2,339				56.8	%			3,195				85.3	%			3,235				72.0	%
Total		$	4,118				100.0	%		$	3,746				100.0	%		$	4,490				100.0	%

 

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

 

We expect to continue paying distributions at the same distribution rate, based on the current offering price, and that a substantial part of those distributions will constitute a return of capital for the foreseeable future subject to Board approval. Our distributions will continue to constitute return of capital until our net investment income is sufficient to support our distribution rate, which will probably not occur until our Manager enters into an expense support agreement with us, our mix of interest and dividend paying assets increase, or our assets increase enough to lower our expense ratio, which we do not expect to occur until we have significantly more net assets than we do at present.

 

 

When the Fund is able to raise new capital, it incurs offering expenses of 1.5% of the gross offering proceeds. However, the Fund has not been able to raise additional capital since April 2015. The chart below shows the percentages of distributions from net investment income excluding offering costs: (dollars in thousands)

 

			Offering Expenses				Distribution from Net Investment Income excluding offering costs				% Distribution from Net Investment Income excluding offering costs				% Distributions from Realized Gains excluding offering costs				% Distributions from Paid In Capital excluding offering costs
2017			$	—			$	1,681				41	%			2	%		57	%
2016			$	—			$	473				13	%			2	%		85	%
2015			$	96			$	926				21	%			9	%		70	%

 

Note 11.  Commitments and Contingencies

 

Unfunded commitments as of December 31, 2017 and December 31, 2016 were as follows: (dollars in thousands)

  

Name of Portfolio Company		Investment Type		December 31, 2017			December 31, 2016
Vieste Group, LLC		Senior Secured First Lien Debt		$	1,870		$	—
				$	1,870		$	—

 

The Fund entered into a Senior Secured First Lien Loan Agreement with Vieste Group, LLC on April 7, 2017, for a total loan amount of $4,250 thousand. As of December 31, 2017, the Fund has loaned Vieste Group, LLC $2,380 thousand; the time and amounts of the additional $1,870 thousand in funding will be at the mutual agreement between the Fund and Vieste Group, LLC.

 

From time to time, the Fund is involved in legal proceedings in the normal course of its business. Although the outcome of such litigation cannot be predicted with any certainty, management is of the opinion, based on the advice of the legal counsel, that final disposition of any litigation should not have a material adverse effect on the financial position of the Fund.

 

Note 12.  Financial Highlights

 

The following is a schedule of financial highlights for the years ended December 31, 2017, 2016, 2015, 2014 and 2013:

 

		For the year ended December 31, 2017				For the year ended December 31, 2016				For the year ended December 31, 2015				For the year ended December 31, 2014				For the year ended December 31, 2013
Per share data:
Net asset value, beginning of period		$	5.31			$	4.61			$	7.34			$	8.70			$	8.77
Results of operations (1)
Net investment income			0.26				0.07				0.14				0.19				0.37
Net realized gain (loss) on investments			(0.61	)			(2.12	)			0.06				0.04				0.18
Net unrealized appreciation (depreciation) on investments			2.99				3.27				(2.40	)			(1.46	)			(0.23	)
Net increase (decrease) in net assets resulting from operations			2.64				1.22				(2.20	)			(1.23	)			0.32
Stockholder distributions (2)
Distributions from net investment income			(0.26	)			(0.08	)			(0.14	)			(0.19	)			(0.37	)
Distributions from realized gains			(0.02	)			(0.01	)			(0.06	)			(0.04	)			(0.18	)
Distributions from capital			(0.37	)			(0.51	)			(0.54	)			(0.50	)			(0.24	)
Net decrease in net assets resulting from stockholder distributions			(0.65	)			(0.60	)			(0.74	)			(0.73	)			(0.79	)
Capital share transactions
Impact from issuance of common stock (3)			—				—				0.21				0.60				0.40
Impact from reinvestment of stockholder distributions (4)			0.07				0.10				—				—				—
Net increase in net assets resulting from capital share transactions			0.07				0.10				0.21				0.60				0.40
Other (5)			(0.02	)			(0.02	)			—				—				—
Net asset value, end of period		$	7.35			$	5.31			$	4.61			$	7.34			$	8.70
Shares outstanding at end of period			6,477,563				6,337,606				6,181,515				5,546,292				3,151,376
Total return (7)			49.52	%			23.62	%			(31.96	)%			(8.88	)%			7.72	%
Ratio/Supplemental data:
Net assets, end of period (in thousands)		$	47,633			$	33,682			$	28,490			$	40,688			$	27,424
Average net assets (in thousands)		$	43,106			$	31,831			$	39,246			$	36,686			$	21,372
Ratio of net investment income to average net assets (6) (9)			3.90	%			1.47	%			2.12	%			2.23	%			3.73	%
Ratio of operating expenses to average net assets (6) (9)			5.92	%			8.33	%			6.83	%			6.65	%			4.03	%
Ratio of expenses reimbursed to average net assets (9)			—	%			0.65	%			—	%			—	%			3.63	%
Portfolio turnover ratio (8)			17.65	%			83.71	%			56.67	%			36.08	%			59.80	%

 

 

 

(1)	The per share amounts were derived by using the weighted average shares outstanding during the period. There was no expense waiver and reimbursement for the years ended December 31, 2017, December 31, 2016, December 31, 2015 and December 31, 2014. Net investment income per share excluding the expense reimbursements equals ($0.06) for the year ended December, 31, 2013.
(2)	The per share data for distributions reflects the actual amount of distributions declared per share during the period.
(3)	The issuance of common stock on a per share basis reflects the incremental net asset value changes as a result of the issuance of shares of common stock in the Fund’s continuous offering.
(4)	The impact from reinvestment of stockholder distributions on a per share basis reflects the incremental net asset value changes as a result of the reinvestment of stockholder distributions.
(5)	Includes the impact of different share amounts used in calculating per share data as a result of calculating certain per share data based on weighted average shares outstanding during the period and certain per share data based on shares outstanding as of a period end or transaction date.
(6)	The ratios are after giving effect to amounts reimbursed by the Manager under an expense reimbursement agreement. See “Note 4 – Related Party Transactions.” For the years ended December 31, 2017, December 31, 2016, December 31, 2015 and December 31, 2014, there was no expense waiver and reimbursement. For the year ended December 31, 2013, excluding the expense reimbursement, the ratio of net investment income and operating expenses to average net assets is (0.14)% and 7.90%, respectively.
(7)	Total return is calculated assuming a purchase of shares at the current net asset value on the first day and a sale at the current net asset value on the last day of the periods reported. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the DRIP. For the years ended December 31, 2017, December 31, 2016, December 31, 2015 and December 31, 2014, there was no expense reimbursement. The total return based on net asset value for the year ended December 31, 2013, includes the effect of the expense reimbursement which equaled 3.63%.
(8)	Portfolio turnover rate is calculated using the lesser of year-to-date sales or purchases over the average of the invested assets at fair value.
(9)	Ratios calculated based on average net assets using current and prior 3 quarters’ net assets.

 

Note 13.  Selected Quarterly Data (Unaudited)

 

The following is the quarterly results of operations for the years ended December 31, 2017 and 2016. The operating results for any quarter are not necessarily indicative of results for any future period (dollars in thousands except share and per share amounts):

 

		Quarter Ended
		December 31, 2017				September 30, 2017				June 30, 2017				March 31, 2017
Investment income		$	1,148			$	1,105			$	1,002			$	979
Operating expenses			621				535				644				753
Net investment income			527				570				358				226
Realized and unrealized gain, net			3,976				445				6,696				4,108
Net increase in net assets resulting from operations		$	4,503			$	1,015			$	7,054			$	4,334
Per share information - basic and diluted
Net investment income		$	0.08			$	0.09			$	0.06			$	0.04
Net increase in net assets resulting from operations		$	0.70			$	0.16			$	1.10			$	0.68
Weighted average shares outstanding			6,455,063				6,420,505				6,385,751				6,350,239

 

		Quarter Ended
		December 31, 2016				September 30, 2016 (restated) (1)				June 30, 2016 (restated) (1)				March 31, 2016
Investment income		$	785			$	959			$	739			$	637
Operating expenses			625				654				743				629
Net investment income (loss)			160				305				(4	)			8
Realized and unrealized gain, net			812				1,630				4,132				571
Net increase in net assets resulting from operations		$	972			$	1,935			$	4,128			$	579
Per share information - basic and diluted
Net investment income		$	0.03			$	0.05			$	0.00			$	0.00
Net increase in net assets resulting from operations		$	0.15			$	0.31			$	0.66			$	0.09
Weighted average shares outstanding			6,313,427				6,276,081				6,237,728				6,196,289

 

(1)	For the quarters ended September 30, 2016 and June 30, 2016, the investment income, net investment income and realized and unrealized gain, net amounts are different than previously reported as a result of the correction of an accounting error.

 

 

Note 14.  Subsequent Events

 

Management of the Fund has evaluated subsequent events in the preparation of the Fund’s financial statements and has determined that no events require recognition or disclosure in the financial statements except for the following:

 

On March 5, 2018, the Fund sold the $1 million Digital Golf Technologies Senior Secured First Lien Loan, at par, to a private party. The Fund still holds a warrant for 22,222 shares of Series A Preferred Stock in Digital Golf.

 

On March 6, 2018, the Board of Directors of the Fund declared two monthly distributions and consented to keep the annual distribution rate at 7.35% of the current $8.75 gross offering price. The distributions were to shareholders of record on March, 6, 2018, payable March 30, 2018 and to shareholders of record on April 2, 2018, payable April 30, 2018. However, the March distribution was not paid until May 17, 2018 due to the default of the loans and interest from two of the portfolio companies, GeoCommerce, Inc. and Nima, LLC. On September 28, 2018, the Board of Directors of the Company revised the previously declared distribution for April 2018 and declared a monthly distribution of $.00384 per share. This distribution year to date, reflects a reduced 2.23% annualized distribution rate based on the current offering price of $8.75. The distribution was to stockholders of record on September 28, 2018, and paid on October 3, 2018. As of the issuance date of these financial statements, there have been no additional declarations of distributions.

 

On June 6, 2018, the Fund amended the Senior Secured First Lien Loan Agreement with GeoCommerce, Inc., governing its $1.5 million note originally entered into on April 27, 2016 with a maturity date of April 27, 2018, to extend the maturity date to June 22, 2018. As part of this amendment, the Fund received a warrant for an additional 375,000 shares. The interest rate accrued from the original maturity date of April 27, 2018 to the amended maturity date of June 22, 2018 at a rate of 14% per annum. Because the loan was not repaid by the amended maturity date of June 22, 2018, interest is now accruing at a rate of 16% per annum. As of the date of this filing, only partial repayments of $366,333 have been made. GeoCommerce, Inc. requested a loan extension, which we sent along with our reservation of rights letter. However, GeoCommerce, Inc. has not taken any action on the loan extensions as they are working to secure financing to repay the loan.

 

On June 6, 2018, the Fund amended the Senior Secured First Lien Loan Agreement with GeoCommerce, Inc., governing its $1 million note originally entered into on May 15, 2016 with a maturity date of May 15, 2018, to extend the maturity date to June 30, 2018. As part of this amendment, the Fund received a warrant for an additional 125,000 shares. The interest rate accrued from the original maturity date of May 15, 2018 to the amended maturity date of June 30, 2018 at a rate of 14% per annum. Because the loan was not repaid by amended maturity date of June 30, 2018, interest is accruing at a rate of 16% per annum. As of the date of this filing, the loan has not been repaid. GeoCommerce, Inc. requested a loan extension, which we sent along with our reservation of rights letter. However, GeoCommerce, Inc. has not taken any action on the loan extensions as they are working to secure financing to repay the loan. GeoCommerce, Inc. is also currently in default of its loan agreement originally entered into on October 14, 2016.

 

Nima, LLC is currently in default of three of their loans totaling $3,436,750. We are currently in discussion with Nima, LLC to either extend the loans or renegotiate the terms.

 

On September 11, 2018, the Fund sold 30,714 shares of UCI International common stock for a net of $502,942 to a private party. 

 

  

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

(a)

Dismissal of BPM LLP

 

(1)

Effective June 27, 2016, we dismissed BPM LLP as our principal independent registered public accounting firm.  Our audit committee approved the dismissal of BPM LLP.

 

(2)

The report of BPM on our financial statements for the fiscal years ended December 31, 2015 and 2014 did not contain an adverse opinion or disclaimer of opinion, nor was it modified as to uncertainty, audit scope or accounting principles.

 

(3)

During the fiscal year ended December 31, 2015 and during the subsequent period through the date of BPM’s dismissal, there were no disagreements between us and BPM, whether or not resolved, on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which if not resolved to the satisfaction of BPM, would have caused BPM to make reference thereto in its report on our audited financial statements. In connection with the audits of the fiscal years ended December 31, 2015 and 2014, and the interim period ended March 31, 2016, there have been no “reportable events” (as defined in Item 304(a)(1)(v) of Regulation S-K).

 

(b)

Engagement of OUM & Co. LLP

 

(1)

Effective June 27, 2016, we engaged OUM & Co. LLP (“OUM”) as our independent registered public accounting firm. The engagement was approved by the board of directors, which also serves the role of audit committee.

 

(2)

In connection with our appointment of OUM as our independent registered accounting firm, we had not consulted OUM on any matter relating to the application of accounting principles to a specific transaction, either completed or contemplated, or the type of audit opinion that might be rendered on our financial statements.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Disclosure Controls

 

In accordance with Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K and determined that the disclosure controls and procedures were not effective.

 

Management’s report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Exchange Act Rules 13a-15(f) and 15d-15(f), internal control over financial reporting is a process designed by, or under the supervision of, the Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, and effected by the Fund’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Based on our management’s evaluation under the framework in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), management concluded that our internal controls over financial reporting were not effective as of December 31, 2017.

 

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management had concluded it had material weaknesses resulting from the following:

 

The Fund has not been able to file its December 31, 2017 10-K report or its subsequent 2018 10-Q reports in a timing manner. The Fund had to wait for the financial statements from its privately held portfolio companies. Those companies are not required to file audited financial statements and therefore do not have the same reporting deadlines as the Fund. Once financial statements are received by the Fund, they are forwarded to a third-party to prepare independent valuations of the warrants issued by those companies. To avoid these delays in the future, management has concluded that it will use the financials from those privately held portfolio companies for the period ending September 30 to provide to its third-party valuation firm to prepare the December 31 valuations, if their December 31 financials are not available by January 30 of the following year. Management plans to bring in additional outside resources with US GAAP reporting experience to help complete financial statements in a timely manner.

 

Subsequent to December 31, 2016, our Board of Directors elected to restate our financial statements for the three and six months ended June 30, 2016, and for the three and nine months ended September 30,2016, in order to correct an error in the accounting for certain warrants received in connection with direct loans that we made. Specifically, we did not assign a cost to the warrants based upon their fair value on the date of receipt relative to the total fair value of the debt and warrants received. The difference between the face amount of the debt and its recorded cost resulting from the assignment of value to the warrants is to be treated as original issue discount, and accreted into interest income over the life of the loan. The change resulted in an increase in net investment income, and a decrease in unrealized appreciation in the same amount, in each period, and had no impact on our net asset value per share, as previously reported. Management previously concluded that its disclosure controls were effective for those periods. In response, in 2017 we implemented additional controls whereby officers will seek outside guidance in regard to accounting for transactions that we have not historically engaged in and which present novel issues.

 

In addition, we will also obtain third party valuations of certain Level III assets in certain situations to corroborate managements’ internal valuations or guide management in valuing such assets, as well as to assist us in enhancing our documentation related to valuing such investments.

 

We believe these material weaknesses will be remediated by the additional controls and procedures that have been implemented.

 

Change in Internal Control Over Financial Reporting  

 

There were no changes in internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the year ended December 31, 2017 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting except as noted above regarding financial statements from privately-held portfolio companies. 

  

ITEM 9B. OTHER INFORMATION

 

None.

 

  

Part III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Our business and affairs are managed under the direction of our Board of Directors. The responsibilities of the Board of Directors include, among other things, the oversight of our investment activities, the quarterly valuation of our assets, oversight of our financing arrangements and corporate governance activities. Pursuant to our charter, the Board is divided into three classes, designated Class I, Class II, and Class III. At each annual meeting of our stockholders, the successors to the class of directors whose terms expire at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. Each director will hold office for the term to which he or she is elected and until his or her successor is duly elected and qualifies.

 

Biographical Information

 

Biographical information for each of our executive officers and directors is set forth below. The address for each executive officer and director is c/o VII Peaks Co-Optivist Income BDC II, Inc., 4 Orinda Way, Suite 125-A, Orinda, CA 94563.

 

Directors

 

On July 23, 2018, independent director Jeya Kumar, resigned from the Board to pursue other professional opportunities. Concurrently, Stephen Shea, an interested director, resigned from the Board in order to permit the Company to maintain a majority of independent directors as required pursuant to certain provisions of the Investment Company Act of 1940. The following persons serve as our current directors and on the committees indicated:

 

Nominee

Age

Director Since

Independent

Expiration of Term

Principal Occupation or Affiliation

Committees

Robert Winspear

53

2012

Yes

2020

President of Winspear Investments, LLC

Audit, Nominating and Corporate Governance

Gurpreet (Gurprit) S. Chandhoke

44

2012

No

2018

Director and Member of Audit Committees

Chairman

Amit Mahajan

43

2012

Yes

2018

Director at PineBridge Investments

Nominating and Corporate Governance

 

Executive Officers

 

The following persons serve as our executive officers in the following capacities:

 

Name		Age		Position Held
Gurpreet (Gurprit) S. Chandhoke		44		Chief Executive Officer and President
Michelle E. MacDonald		51		Chief Financial Officer, Treasurer and Secretary
Douglas Tyre (1)		38		Chief Compliance Officer
Garima Kakani		33		Controller
Milton Balbuena (2)		50		Co-Chief Investment Officer

 

 

(1)

Douglas Tyre of Cipperman Compliance Services was appointed Chief Compliance Officer on June 28, 2018 after the previous Chief Compliance Office, Emily Silva, resigned from Cipperman Compliance to pursue other professional opportunities.

 

(2)

Milton Balbuena was appointed Co-Chief Investment Officer of VII Peaks Capital, LLC, the Fund Manager, in March of 2018.

 

Information about Directors

 

Gurpreet (Gurprit) S. Chandhoke

 

Mr. Chandhoke has been our Chief Executive Officer and President since our inception. Mr. Chandhoke has also been a Managing Partner and Chief Investment Officer of the Manager since its inception in April 2009. From August 2006 to February 2009, Mr. Chandhoke was Senior Vice President of Deutsche Bank Technology Investment Banking Group in San Francisco. From August 2005 to August 2006, Mr. Chandhoke worked for UBS Investment Bank as an Associate Director.

 

Before founding the Manager in 2009, Mr. Chandhoke had more than six years investment banking experience. Mr. Chandhoke led several different types of debt issuances and restructuring discussions and transactions with technology companies and financial sponsors while at Deutsche Bank and UBS Investment Bank. During his tenure at both institutions he also participated in diverse corporate finance and M&A transactions in the internet, enterprise software and infrastructure and communications technology sectors. Mr. Chandhoke’s responsibilities at Deutsche Bank and UBS Investment Bank also involved the issuance of debt securities ranging from bank debt, corporate debt, high yield and convertible debt securities. Mr. Chandhoke also worked on corporate finance transactions ranging from mergers and acquisitions, initial public offerings, follow-on offerings, debt issuances and recapitalizations at both Deutsche Bank and UBS Investment Bank.

 

 

Mr. Chandhoke received a Master of Business Administration in Finance and Entrepreneurship from the Wharton School of Business. Mr. Chandhoke also received a Master’s Degree of Science in Electrical Engineering and a Master Degree of Science in Mechanical Engineering from the University of Minnesota and a Bachelor’s Degree in Electrical Engineering from the Government College of Engineering, University of Pune, India. Mr. Chandhoke was chosen as a J.N. Tata Scholar to pursue his graduate studies in the United States.

 

Mr. Chandhoke’s broad and extensive investment banking experience and involvement in a number of diverse corporate finance and M&A transactions as well as his experience as Chief Investment Officer for the Manager supports his appointment to the Board.

 

Robert Winspear

  

Mr. Winspear has been the President of Winspear Investments LLC, a Dallas based private investment firm specializing in lower middle market transactions, since September 2002. Winspear Investments has made investments in a wide range of industries including banking, real estate, distribution, supply chain management, mega yacht marinas and hedge funds.

 

Robert Winspear has served as the Chief Financial Officer of Excel Corporation from May 2014 to June 2017. Excel Corporation (OTC: EXCC) provides transaction processing and related services to medium and small businesses in the US.

 

Prior to forming Winspear Investments, Mr. Winspear was Vice President and Chief Financial Officer of Associated Materials Incorporated, a nationwide manufacturer and distributor of residential building products consisting primarily of vinyl siding and windows, from June 1993 to May 2002.

 

Mr. Winspear began his professional career in the Dallas office of Arthur Andersen where he worked as an auditor from 1988 to 1993. He holds a Bachelor of Business Administration and a Master of Professional Accounting from the University of Texas at Austin.

 

Mr. Winspear is on the Board of Directors of Alpha Financial Technologies/EAM Corporation, located in Grapevine, Texas.

 

Mr. Winspear’s extensive investment experience as an executive or board member of various private and public companies as well as his investment experience at Winspear Investments support his appointment to the Board.

 

Amit Mahajan

 

Since August 2005, Mr. Mahajan has been a Director at PineBridge Investments, a global multi-asset investment manager, where he has been responsible for sourcing, due diligence, and negotiating secondary private equity transactions. Before assuming his current duties at PineBridge, Mr. Mahajan was previously responsible for executing private equity investments across several industries with a focus on global emerging markets.

 

 Mr. Mahajan has over ten years of experience in private equity, banking, and consulting, and began his career with Deloitte Consulting, where he advised multinational clients in energy, telecom, insurance, utilities, and the technology sector. He holds a Bachelor of Science in Computer Science and Engineering from the Institute of Technology, Delhi, India, and a Master of Business Administration from Columbia Business School.

 

Mr. Mahajan’s extensive experience with investments and private equity transactions at various companies support his appointment to the Board.

 

Mr. Mahajan owns interests in the following investment funds managed by the Manager:

 

Name of Director

Name of Owners and Relationships to Director

Company

Title of Class

Value of Securities

Percent of Class

Amit Mahajan

CXI Valley I, LLC (1)

VII Peaks Venture Capital II, LLC (2)

Series A-1 Preferred Shares

$

—

(3)

—

%

 

(1)

Mr. Mahajan and his spouse are the owners of CXI Valley I, LLC.

 

(2)

VII Peaks Capital, LLC is the managing member of the Fund. In addition, the Class A Interests are entitled to receive their pro rata share of a royalty payable by VII Peaks Capital, LLC in the amount of $25,000 per month.

 

(3)

Valuation is the capital account value as of December 31, 2016.

 

 

Information about Executive Officers Who Are Not Directors

 

The following information pertains to our executive officers who are not directors of the Fund.

 

Name, Address and Age		Position(s) Held with Company		Principal Occupation(s) during Past Five Years
Michelle E. MacDonald (51)		Chief Financial Officer, Treasurer and Secretary		Vice President of Compliance for VII Peaks Capital, LLC since August 2014; Chief Compliance Officer at KBR Capital Markets from April 2013 to September 2013; Chief Financial Officer for a real estate fund manager from July 2012 to April 2013; Chief Operating Office for a broker dealer from May 2006 to December 2012; instructor and tutor in securities licensing review courses from 1998 to 2015.
Douglas Tyre (38)		Chief Compliance Officer		Assistant Compliance Director of Cipperman Compliance LLC 2014 to present; Chief Services & Operations Specialist – Senior Associate of Echo Point Investment Management 2010-2014.
Milton Balbuena (50)		Co-Chief Investment Officer		Co-Chief Investment Officer VII Peaks Capital, LLC since March 2018; CEO and CIO Blue Hall Capital since March 2013; Chief Investment Officer for Contango Capital Advisors from 2004 to 2011; Research Analyst Charles Schwab from 2000 to 2002.
Garima Kakani (33)		Controller		Senior Analyst with VII Peaks Capital, LLC since December 2013; Manager of Reporting and Analytics with KBR Capital Markets from March 2011 to September 2013; Various positions at D.E. Shaw (Indian branch) from March 2007 to September 2009.

 

Corporate Governance and Board Matters

 

Our business and affairs are managed under the direction of our Board of Directors. The responsibilities of the Board of Directors include, among other things, the oversight of our investment activities, the quarterly valuation of our assets, oversight of our financing arrangements and corporate governance activities. Our Board of Directors is divided into three classes. Each class of directors holds office for a three-year term. However, the initial members of the three classes have initial terms of one, two and three years, respectively. At each annual meeting of our stockholders, the successors to the class of directors whose terms expire at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. Each director will hold office for the term to which he or she is elected and until his or her successor is duly elected and qualifies.

 

The Board of Directors currently has an audit committee and a nominating and corporate governance committee and may establish additional committees from time to time as necessary. Although the number of directors may be increased or decreased, a decrease will not have the effect of shortening the term of any incumbent director. Any director may resign at any time and may be removed with or without cause by the stockholders upon the affirmative vote of at least a majority of all the votes entitled to be cast at a meeting called for the purpose of the proposed removal. The notice of the meeting shall indicate that the purpose, or one of the purposes, of the meeting is to determine if the director shall be removed.

 

A vacancy created by an increase in the number of directors or the death, resignation, removal, adjudicated incompetence or other incapacity of a director may be filled only by a vote of a majority of the remaining directors. As provided in our charter, nominations of individuals to fill the vacancy of a Board of Directors seat previously filled by an independent director will be made by the remaining independent directors.

 

Committees of the Board of Directors

 

Our Board of Directors has the following committees:

 

Audit Committee and Financial Expert. The audit committee is responsible for selecting, engaging and discharging our independent accountants, reviewing the plans, scope and results of the audit engagement with our independent accountants, approving professional services provided by our independent accountants (including compensation therefore), reviewing the independence of our independent accountants and reviewing the adequacy of our internal controls over financial reporting. The sole member of the audit committee is Robert Winspear, who is an independent director. Robert Winspear also serves as the chairman of the audit committee. Our Board of Directors has determined that Robert Winspear is an “audit committee financial expert” as defined under SEC rules.

 

 

Nominating and Corporate Governance Committee. The nominating and corporate governance committee selects and nominates directors for election by our stockholders, selects nominees to fill vacancies on our Board of Directors or a committee thereof, develops and recommends to our Board of Directors a set of corporate governance principles and oversees the evaluation of our Board of Directors and our management. The nominating and corporate governance committee is currently composed of Amit Mahajan and Robert Winspear, both are independent.

 

Board Leadership Structure

 

Our business and affairs are managed under the direction of our Board of Directors. Among other things, our Board of Directors sets broad policies for us and approves the appointment of our investment adviser, administrator and officers. The role of our Board of Directors, and of any individual director, is one of oversight and not of management of our day-to-day affairs.

 

Under our bylaws, our Board of Directors may designate one of our directors as chair to preside over meetings of our Board of Directors and meetings of stockholders and to perform such other duties as may be assigned to him or her by our Board of Directors.

 

Presently, Mr. Gurpreet S. Chandhoke serves as the Chairman of our Board. Mr. Chandhoke is an “interested person” of the Fund as defined in Section 2(a)(19) of the 1940 Act by virtue of his role as Chief Executive Officer of the Fund, his service on the Investment Committee and is a Managing Member of the Manager. We believe that Mr. Chandhoke’s history with the Fund, familiarity with its investment platform, and extensive knowledge of the financial services industry qualify him to serve as the Chairman of our Board of Directors. We believe that the Fund is best served through this existing leadership structure, as Mr. Chandhoke’s relationship with the Manager provides an effective bridge and encourages an open dialogue between management and the Board of Directors, ensuring that both groups act with a common purpose.

 

Our Board of Directors does not currently have a designated lead independent director. We are aware of the potential conflicts that may arise when a non-independent director is chairman of the Board of Directors, but believe these potential conflicts are offset by our strong corporate governance policies. Our corporate governance policies include regular meetings of the independent directors in executive session without the presence of interested directors and management, the establishment of the audit committee and the nominating and corporate governance committee, each comprised solely of independent directors and the appointment of a chief compliance officer, with whom the independent directors meet at least once a year without the presence of interested directors and other members of management, for administering our compliance policies and procedures.

 

We recognize that different board leadership structures are appropriate for companies in different situations. We re-examine our corporate governance policies on an ongoing basis to ensure that they continue to meet our needs.

 

The independent directors play an active role on the Board of Directors. The independent directors compose a majority of our Board of Directors and are closely involved in all material deliberations related to us. Our Board of Directors believes that, with these practices, each independent director has an equal involvement in the actions and oversight role of our Board of Directors and equal accountability to us and our stockholders. Our independent directors are expected to meet separately (i) as part of each regular board meeting and (ii) with our Chief Compliance Officer, as part of at least one board meeting each year.

 

Our Board of Directors believes that its leadership structure is the optimal structure for us at this time. Our Board of Directors, which will review its leadership structure periodically as part of its annual self-assessment process, further believes that its structure is presently appropriate to enable it to exercise its oversight of us.

 

Risk Oversight and Board Structure

 

Through its direct oversight role, and indirectly through its committees, the Board of Directors performs a risk oversight function for the Fund consisting of, among other things, the following activities: (1) at regular and special board meetings, and on an ad hoc basis as needed, receiving and reviewing reports related to the performance and operations of the Fund; (2)reviewing and approving, as applicable, the compliance policies and procedures of the Fund; (3) meeting with, or reviewing reports prepared by, the representatives of key service providers, including the investment adviser, administrator, distributor, transfer agent, custodian and independent registered public accounting firm of the Fund, to review and discuss the activities of the Fund and to provide direction with respect thereto; and (4) engaging the services of the chief compliance officer of the Fund to test the compliance procedures of the Fund and its service providers. Gurpreet Chandhoke, who is an “interested person” of the Fund as defined in Section 2(a)(19) of the 1940 Act, serves as both the chief executive officer and chairman of the Board of Directors. The Board of Directors feels that Mr. Chandhoke, as chief executive officer of the Fund, is the director with the most knowledge of the Fund’s business strategy and is best situated to serve as chairman of the Board of Directors. The Fund’s charter, as well as regulations governing business development companies generally, requires that a majority of the Board of Directors be persons other than “interested persons” of the Fund, as defined in Section 2(a)(19) of the 1940 Act. The Board of Directors does not currently have a lead independent director. The Board, after considering various factors, has concluded that its structure is appropriate at this time given the fact that it is a newly-formed entity with no assets. As the Fund’s assets increase, the Board of Directors will continue to monitor its structure and determine whether it remains appropriate based on the complexity of the Fund’s operations.

 

 

Procedure for Contacting the Board of Directors

 

Our board of directors welcomes communications from our stockholders. Stockholders may send communications to the board of directors or to any particular director to the following address: VII Peaks Capital, LLC, Pine Grove Financial Center, 4 Orinda Way, Suite 125A, Orinda, CA 94563, attention Chief Financial Officer. Stockholders should indicate clearly the director or directors to whom the communication is being sent. All stockholder communications received in this manner will be delivered to one or more members of the board of directors.

 

Compensation Committee Interlocks and Insider Participation

 

Our board of directors did not have a separate compensation committee during the fiscal year ended December 31, 2017, and as a result our full board served as the compensation committee. Gurpreet Chandhoke and Stephen Shea were the only members of our board of directors who is an officers during the fiscal year ended December 31, 2017. The board does not pay compensation to its officers, and therefore the board of directors did not engage in deliberations regarding executive compensation. Messrs. Chandhoke and Shea are each partial owners of our Manager, which receives compensation under an investment advisory agreement with us.

 

No executive officer of us served as a member of (i) the compensation committee of another entity of which one of the executive officers of such entity served on our compensation committee (or board committee performing equivalent functions) or (ii) the board of directors of another entity of which one of the executive officers of such entity served on our board, during the fiscal year ended December 31, 2017.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Pursuant to Section 16(a) of the Exchange Act, the Fund’s directors and executive officers, and any persons holding more than 10% of its common stock, are required to report their beneficial ownership and any changes therein to the SEC and the Fund. Specific due dates for those reports have been established, and the Fund is required to report herein any failure to file such reports by those due dates. Based solely on a review of the copies of such reports and written representations delivered to the Fund by such persons, all filings were made timely during the year ending December 31, 2017.

 

ITEM 11. EXECUTIVE COMPENSATION

 

We currently have no employees. We are managed by our Manager who is registered as an investment adviser under the Investment Advisers Act of 1940, as amended, or the Advisers Act. We do not compensate our executive officers directly. Our Manager is responsible for managing our business, as well as 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, and Stephen F. Shea. 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. See “Item 13. Certain Relationships and Related Transactions, and Director Independence” for a discussion of fees and expenses payable to our Advisers and their respective affiliates.

 

Our Manager has an investment committee that is responsible for reviewing, discussing and approving each investment opportunity we seek to pursue. We anticipate that our investment committee will meet once a week to discuss new and existing opportunities and developments on current investments. Our investment committee currently consists of Mr. Chandhoke, our Chief Executive Officer, and Mr. Milton Balbuena, Co-Chief Investment Officer.

 

We entered into our current investment advisory agreement on August 20, 2013, that was approved by our shareholders on December 13, 2013. The current agreement was in effect for an initial two-year period from the date that it was approved by our shareholders, and is now annually reapproved by a majority of our directors who are not interested persons.

 

As required by the 1940 Act, the investment advisory agreement provides that we may terminate the agreement without penalty upon 60 days’ written notice to our Manager. If our Manager wishes to voluntarily terminate the investment advisory agreement, it must give stockholders a termination and must pay all expenses associated with its termination. The investment advisory agreement may also be terminated, without penalty, upon the vote of a majority of our outstanding voting securities.

 

Without the vote of a majority of our outstanding voting securities, our investment advisory agreement may not be materially amended, nor may we engage in a merger or other reorganization with our Manager. In addition, should we or our Manager elect to terminate the investment advisory agreement, a new investment adviser may not be appointed without approval of a majority of our outstanding common stock, except in limited circumstances where a temporary adviser may be appointed without stockholder consent, consistent with the 1940 Act, for a time period not to exceed 150 days following the date on which the previous contract terminates.

 

On September 11, 2018, the board conducted an annual review of the current advisory agreement. In connection with the foregoing approvals, the Board determined that the Manager had the capabilities, resources and personnel necessary to provide the services to the Fund required under the current advisory agreement. The disinterested members of the board noted that, in their consideration of advisory agreement, they relied upon the information provided to them in connection with their most recent approval of the current advisory agreement. The disinterested members further noted that the Manager confirmed that there were no material changes to such previously provided information.

 

 

In voting to approve the advisory agreement, the Board of Directors considered the overall fairness of the advisory agreement and factors it deemed relevant, including, but not limited to: (i) the nature, extent and quality of the services to be provided by the Manager, (ii) the investment performance of the Fund and the Manager’s investment personnel who would manage the Fund, (iii) the proposed fees and expenses of the Fund, including comparative expense information, (iv) the projected profitability of the Fund to the Manager and its affiliates; (v) whether the projected economies of scale would be realized as the Fund grows and whether the proposed breakpoints or any other breakpoints are appropriate and (vi) other benefits that may accrue to the Manager from its relationship with the Fund.

 

Advisory Fees

 

We pay our Manager a fee for its services under the investment advisory agreement consisting of two components — a base management fee and an incentive fee. The cost of both the base management fee payable to our Manager and any incentive fees it earns are ultimately borne by our stockholders.

 

Base Management Fee

 

Our base management fee is 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 base management fee may or may not be taken in whole or in part at the discretion of our Manager. All or any part of the base management fee not taken as to any month shall be deferred without interest and may be taken in such other month as our Manager shall determine. The base management fee for any partial month will be appropriately pro-rated.

 

Incentive Fee

 

The incentive fee has two parts. The first part, which we refer to as the subordinated incentive fee on income, is calculated and payable quarterly in arrears based upon our “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). For this purpose, “pre-incentive fee net investment income” means interest income, dividend income and any other income (including any other fees, other than fees for providing managerial assistance, such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses reimbursed to our Manager under the investment advisory agreement and any interest expense and distributions paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with payment-in-kind interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. The calculation of the subordinated incentive fee on income for each quarter is as follows:

 

•

No incentive fee is payable to our Manager in any calendar quarter in which our pre-incentive fee net investment income does not exceed the return rate of 2.0%;

 

•

20.0% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.0% in any calendar quarter (8.0% annualized) is payable to our Manager once the return is reached.

 

“Adjusted capital” shall mean cumulative gross proceeds generated from sales of our common stock (including our distribution reinvestment plan) reduced for distributions to investors of proceeds from non-liquidating dispositions of our investments and amounts paid for share repurchases pursuant to our tender offer program.

 

The second part of the incentive fee, which we refer to as 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 20.0% of our incentive fee capital gains, which equals our 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.

 

 

Director Compensation

 

Each of our independent directors is entitled to compensation for his services as a director in the amounts depicted below. We will not pay compensation to our interested directors. In addition, the independent directors will be reimbursed for reasonable out-of-pocket expenses incurred in connection with attending board and committee meetings. There are no pension or retirement benefits being offered to our directors at this time. Amounts payable under this arrangement are determined and paid quarterly in arrears as follows:

 

Net Asset Value		Annual  Retainer Fee				Board Meeting  and Committee  Meeting Fees  (in Person)			Board Meeting  and Committee  Meeting Fees  (by Phone)				Annual  Chairperson  Fee
$0 to $100 million		$	10,000			$	500/$250		$	250			$	1,500
$100 million to $300 million		$	20,000			$	1,000/$500		$	250			$	2,500
$300 million to $500 million		$	30,000			$	1,500/$750		$	250			$	3,500
Above $500 million		$	40,000			$	2,000/$1,000		$	250			$	5,000

 

The following table sets forth the compensation of the Fund’s directors for the year ended December 31, 2017:

 

Name		Fees Earned and Payable in Cash				All Other Compensation				Total
Interested Directors
Gurpreet S. Chandhoke			—				—				—
Independent Directors			—				—				—
Amit Mahajan		$	11,520				—			$	11,520
Robert Winspear		$	14,770				—			$	14,770

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The following table sets forth, as of November 5, 2018, information with respect to the beneficial ownership of our common stock by:

 

•

Each person known to us to beneficially own more than 5% of the outstanding shares of our common stock;

 

•

Each of our directors and executive officers; and

 

•

All of our directors and executive officers as a group.

 

Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. There is no common stock subject to options that are currently exercisable or exercisable within 60 days of the offering. Percentage of beneficial ownership is based on 6,511,714 shares of common stock outstanding as of November 5, 2018.

 

		Shares Beneficially Owned Immediately Prior to This Offering
Name		Number				Percentage
5% Stockholders
None			—				—	%
Executive Officers:
Michelle E. MacDonald			—				—	%
Douglas Tyre			—				—	%
Garima Kakani			—				—	%
Interested Directors:
Gurpreet (Gurprit) S. Chandhoke			—				—	%
Independent Directors:
Amit Mahajan			—				—	%
Robert Winspear			—				—	%
All officers and directors as a group (6 persons)			—				—	%

 

The following table sets forth, as of the date of this proxy statement, the dollar range of our equity securities that is expected to be beneficially owned by each of our directors.

 

		Dollar Range of Equity Securities Beneficially Owned
Interested Directors:
Gurpreet (Gurprit) S. Chandhoke			None
Independent Directors:
Amit Mahajan			None
Robert Winspear			None

 

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

Since August 20, 2013, the Fund has been managed by VII Peaks Capital, LLC (the “Manager”).

 

Investment Advisory Agreement

 

The Fund has entered into an investment advisory agreement with the Manager to manage the Company’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 Fund’s present agreement with the Manager. On September 11, 2018, the non-interested Board Members re-approved the agreement between the Manager and the Fund under the agreement’s existing terms. 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. 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, 2017, 2016 and 2015, and the Fund incurred $0.9 million, $0.6 million and $0.8 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, 2017, 2016 and 2015, the Fund did not incur any incentive fees related to net investment income or capital gains.

 

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.

 

The Manager 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, and in consideration the Fund agreed to pay the Manager 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 Fund’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. 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.

 

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 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 to assume and pay 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, the Fund agreed to pay the Manager all organization and offering costs previously borne by the Prior Manager, subject to the limitation that such organization and offering costs may only be reimbursed to the extent of 1.5% of offering proceeds. The Manager’s right to recoup amounts paid by the Manager under the expense reimbursement agreement expired in 2016.

 

 

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, 2017, 2016 and 2015, the Fund reimbursed the Manager for $0.3 million, $0.2 million and $0.2 million in administration expenses under the administration agreement, respectively. 

  

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The table below summarizes the fees billed for the years ending December 31, 2017 and 2016 by our auditor OUM & Co., LLP.

 

		2017				2016
Audit Fees		$	102,070			$	100,377
Audit Related Fees			—				—
Tax Fees			5,500				6,343
Other			9,011				10,311
Total		$	116,581			$	117,031

 

Audit Fees: Audit fees include fees for services that normally would be provided by OUM in connection with statutory and regulatory filings or engagements and that generally only an independent accountant can provide. In addition to fees for the audit of our annual financial statements and the review of our quarterly financial statements in accordance with generally accepted auditing standard, this category contains fees for comfort letters, statutory audits, consents, and assistance with and review of documents filed with the SEC. 

  

Audit-Related Fees: Audit-related services consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees.” These services include attest services that are not required by statute or regulation and consultations concerning financial accounting and reporting standards.

 

Tax Services Fees: Tax services fees consist of fees billed for professional tax services. These services also include assistance regarding federal, state, and local tax compliance.

 

All Other Fees: Other fees would include fees for products and services other than the services reported above.

  

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

a.

The following documents are filed as part of this Annual Report:

 

The following financial statements are set forth in Item 8:

 

	Page
Report of Independent Registered Public Accounting Firm	F-1
Report of Previous Independent Registered Public Accounting Firm	F-2
Statements of Assets and Liabilities as of December 31, 2017 and 2016	F-3
Statements of Operations for the Years Ended December 31, 2017, 2016 and 2015	F-4
Statements of Changes in Net Assets for the Years Ended December 31, 2017, 2016 and 2015	F-5
Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015	F-6
Schedules of Investments as of December 31, 2017 and 2016	F-7
Notes to Financial Statements	F-11

 

b.

Exhibits:

 

The following exhibits are included, or incorporated by reference to exhibits previously filed with the SEC, in this Annual Report on Form 10-K for the year ended December 31, 2017 (and are numbered in accordance with Item 601 of Regulation S-K):

 

Exhibit No.		Description of Document
3.1		Articles of Incorporation of VII Peaks-KBR Co-Optivist Income BDC II, Inc. (Incorporated by reference to Exhibit (a)(1) to Amendment No. 1 to registration statement on Form N-2 filed on December 19, 2011)
3.2		Articles of Amendment and Restatement of VII Peaks-KBR Co-Optivist Income BDC II, Inc. (Incorporated by reference to Exhibit (a)(2) to Amendment No. 1 to registration statement on Form N-2 filed on March 1, 2012)
3.3		Second Articles of Amendment and Restatement to Articles of Incorporation of VII Peaks-KBR Co-Optivist Income BDC II, Inc. (Incorporated by reference to Exhibit 3.1 to Form 8-K filed on June 28, 2012)
3.4		Articles of Amendment to Articles of Incorporation of VII Peaks Co-Optivist Income BDC II, Inc. (Incorporated by reference to Exhibit (a) to Form 8-K filed on September 16, 2013)
3.5		Bylaws of the Registrant (Incorporated by reference to Exhibit (b) to Amendment No. 1 to registration statement on Form N-2 filed on December 19, 2011)
4.1		Form of Subscription Agreement (Incorporated by reference to Exhibit (d) to Amendment No. 7 to registration statement on Form N-2 filed on July 28, 2014)
4.2		Form of Additional Subscription Agreement ( Incorporated by reference to Exhibit (d) to Amendment No. 7 to registration statement on Form N-2 filed on July 28, 2014)
4.3		Distribution Reinvestment Plan (Incorporated by reference to Exhibit (e) to Amendment No. 2 to the registration statement on Form N-2 filed on February 15, 2012)
10.1		Investment Advisory Agreement between VII Peaks Co-Optivist Income BDC II, Inc. and VII Peaks Capital, LLC dated August 20, 2013 (Incorporated by reference to Exhibit (g) to Form 8-K filed on August 23, 2013)
10.2		Dealer Manager Agreement between VII Peaks Co-Optivist Income BDC II, Inc. and Arete Wealth Management, LLC (Incorporated by reference to Exhibit (h) to Form 8-K filed on March 11, 2016)
10.3		Form of Selected Dealer Agreement (Included as Exhibit A to the Dealer Manager Agreement) (Incorporated by reference to Exhibit (h) to Form 8-K filed on March 11, 2016)
10.4		Form of Custody Agreement (Incorporated by reference to Exhibit (j) to Amendment No. 2 to the registration statement on Form N-2 filed on February 15, 2012)
10.5		Custodian Agreement with Wells Fargo Bank, N.A. (Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed on November 30, 2016)
10.6		Administration Agreement between VII Peaks Co-Optivist Income BDC II, Inc. and VII Peaks Capital, LLC dated February 24, 2014 (Incorporated by reference to the Annual Report on Form 10-K filed on March 11, 2014)
10.7		License Agreement between VII Peaks Capital, LLC, VII Peaks-KBR BDC Advisor II, LLC and VII Peaks Co-Optivist Income BDC II, Inc. (Incorporated by reference to Exhibit (k)(2) to Amendment No. 2 to the registration statement on Form N-2 filed on February 15, 2012)

 

 

14		Code of Ethics (Incorporated by reference to Exhibit (r) to Amendment No. 2 to the registration statement on Form N-2 filed on February 15, 2012)
21.1*		Subsidiaries of VII Peaks Co-Optivist Income BDC II, Inc.
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended
31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended
32.1*		Certification of Chief Executive Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*		Certification of Chief Financial Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

ITEM 16. FORM 10-K SUMMARY

 

None.

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	VII Peaks Co-Optivist Income BDC II, Inc.
Date: November 5, 2018	By	/s/ Gurpreet S. Chandhoke
		Gurpreet S. Chandhoke
		Chairman of the Board of Directors,
		Chief Executive Officer and President
		(Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	VII Peaks Co-Optivist Income BDC II, Inc.
Date: November 5, 2018	By	/s/ Gurpreet S. Chandhoke
		Gurpreet S. Chandhoke
		Chairman of the Board of Directors,
		Chief Executive Officer and President
		(Principal Executive Officer)

 

	VII Peaks Co-Optivist Income BDC II, Inc.
Date: November 5, 2018	By	/s/ Michelle E. MacDonald
		Michelle E. MacDonald
		Chief Financial Officer,
		Treasurer and Secretary
		(Principal Financial Officer and Principal Accounting Officer)

 

Date: November 5, 2018	By	/s/ Amit Mahajan
		Amit Mahajan
		(Independent Director)

 

Date: November 5, 2018	By	/s/ Robert Winspear
		Robert Winspear
		(Independent Director)