Investcorp Credit Management BDC, Inc 10-K, filed Sep 22, 2020
Investcorp Credit Management BDC, Inc. (ICMB)
About this 10-K
Investcorp Credit Management BDC, Inc filed this 10-K on September 22, 2020, covering the fiscal year ended June 30, 2020.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE FISCAL YEAR ENDED JUNE 30, 2020
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
COMMISSION FILE NUMBER: 814-01054
INVESTCORP CREDIT MANAGEMENT BDC, INC.
(Exact Name of Registrant as Specified in Its Charter)
| Maryland | 46-2883380 | |
| (State of Incorporation) | (I.R.S. Employer Identification No.) | |
| 280 Park Avenue 39th Floor New York, NY |
10017 | |
| (Address of principal executive offices) | (Zip Code) | |
(212) 257-5199
(Registrant’s telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
|
Title of Each Class |
Trading Symbol(s) |
Name of Each Exchange on Which Registered | ||
| Common Stock, par value $0.001 per share | ICMB | The NASDAQ Global Select Market | ||
| 6.125% Notes due 2023 | CMFNL | The NASDAQ Global Select Market |
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted 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 and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “accelerated filer,” “large accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | ☐ | Accelerated filer | ☐ | |||
| Non-accelerated filer | ☒ (Do not check if a smaller reporting company) | Smaller reporting company | ☐ | |||
| Emerging Growth Company | ☐ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $89.2 million based upon the last sale price for the Registrant’s common stock on that date.
There were 13,894,635 shares of the Registrant’s common stock outstanding as of September 18, 2020.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive Proxy Statement relating to the Registrant’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year, are incorporated by reference in Part III of this Annual Report on Form 10-K as indicated herein.
INVESTCORP CREDIT MANAGEMENT BDC, INC.
FORM 10-K FOR THE FISCAL YEAR
ENDED JUNE 30, 2020
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| ITEM 1B. |
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MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 75 | ||||
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| ITEM 7. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 78 | ||||
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| ITEM 8. |
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CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON ACCOUNTING AND FINANCIAL DISCLOSURE | 145 | ||||
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CONTROLS AND PROCEDURES | 145 | ||||
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OTHER INFORMATION | 146 | ||||
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 149 | ||||
| ITEM 13. |
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | 149 | ||||
| ITEM 14. |
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i
| Item 1. | Business |
Except as otherwise indicated, the terms “we,” “us,” “our,” “Investcorp Credit” and the “Company” refer to Investcorp Credit Management BDC, Inc. (formerly known as CM Finance Inc through August 30, 2019) and “CM Investment Partners” and the “Adviser” refer to our investment adviser and administrator, CM Investment Partners LLC.
We were formed in February 2012 and commenced operations in March 2012 as CM Finance LLC, a Maryland limited liability company. Immediately prior to the pricing of our initial public offering, CM Finance LLC was merged with and into CM Finance Inc, a Maryland corporation (the “Merger”). On August 30, 2019, we changed our name to Investcorp Credit Management BDC, Inc. We are an externally managed, non-diversified closed-end management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”).
We are a specialty finance company that invests primarily in the debt of U.S. middle-market companies, which we generally define as those companies that have an enterprise value, which represents the aggregate of debt value and equity value of the entity, of less than $750 million. We are externally managed by CM Investment Partners. The Adviser is led by Michael C. Mauer and Christopher E. Jansen, who together have over 40 years of experience in the leveraged debt markets. Our primary investment objective is to maximize total return to stockholders in the form of current income and capital appreciation by investing in debt and related equity of privately held middle-market companies.
We seek to invest primarily in middle-market companies that have annual revenues of at least $50 million and EBITDA of at least $15 million. We focus on companies with leading market positions, significant asset or franchise values, strong free cash flow and experienced senior management teams, with emphasis on companies with high-quality sponsors. Our investments typically range in size from $5 million to $25 million. We expect that our portfolio companies will use our capital for organic growth, acquisitions, market or product expansion, refinancings, and/or recapitalizations. We invest, and intend to continue to invest, in unitranche loans and standalone second and first lien loans, with an emphasis on floating rate debt. Unitranche loans are loans structured as first lien loans with certain characteristics of mezzanine loan risk in one security. We also selectively invest in unsecured debt, bonds and in the equity of portfolio companies through warrants and other instruments, in most cases taking such upside participation interests as part of a broader investment relationship.
We strive to maintain a strong focus on credit quality, investment discipline and investment selectivity. We believe that investing in the debt of private middle-market companies generally provides a more attractive relative value proposition than investing in broadly syndicated debt due to the conservative capital structures and superior default and loss characteristics typically associated with middle-market companies. We believe that, because private middle-market companies have limited access to capital providers, debt investments in these companies typically carry above-market interest rates and include more favorable protections, resulting in attractive risk-adjusted returns across credit cycles while better preserving capital. The companies in which we invest typically are highly leveraged, and, in most cases, our investments in such companies are not rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating that is often referred to as “junk.”
We have, through CM Finance SPV Ltd. (“CM SPV”), our wholly owned subsidiary, entered into a $122.0 million term secured financing facility (the “Term Financing”), due December 5, 2021 with UBS AG, London Branch (together with its affiliates “UBS”). The Term Financing is collateralized by a portion of the debt investments in our portfolio. Prior to amending the Term Financing on June 21, 2019, borrowings under the Term Financing bore interest (i) at a rate per annum equal to one-month LIBOR plus 2.75% through December 4, 2018, and (ii) at a rate per annum equal to one-month LIBOR plus 2.55% from December 5, 2018 through December 5, 2020 (the “Term Financing Rate”). We also incurred an annual fee of approximately 1% of the
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outstanding borrowings under the Term Financing. On June 21, 2019, we amended the Term Financing to increase the Term Financing by $20.0 million from $102.0 million to $122.0 million. On April 15, 2020, we decided not to exercise an option to increase the Term Financing by up to $53.0 million (the “Option”) and repaid $20.0 million of the Term Financing.
Borrowings under the Term Financing, as amended, bear interest (a) with respect to the $102.0 million (i) at a rate per annum equal to one-month LIBOR plus 2.55% through December 4, 2019, and (ii) at a rate per annum equal to one-month LIBOR plus 3.55% from December 5, 2019 through December 4, 2020, and (iii) at a rate per annum equal to one-month LIBOR plus 3.15% from December 5, 2020 through December 5, 2021, and (b) with respect to the additional $20.0 million under the Term Financing, (i) at a rate per annum equal to one-month LIBOR plus 3.15% through April 14, 2020, and (ii) at a rate per annum equal to one-month LIBOR plus 2.90% from April 15, 2020 through December 5, 2021.
As of June 30, 2020 and June 30, 2019, there were $102.0 million and $122.0 million borrowings outstanding under the Term Financing, respectively.
On November 20, 2017, we entered into a $50 million revolving financing facility (the “2017 UBS Revolving Financing”) with UBS. On June 21, 2019, we amended the 2017 UBS Revolving Financing to reduce the size of the 2017 UBS Revolving Financing to $30.0 million and extend the maturity date (as amended, the “Revolving Financing”). Borrowings under the Revolving Financing generally bear interest at a rate per annum equal to one-month LIBOR plus 3.15%. We will pay a fee on any undrawn amounts of 2.25% per annum; provided that if 50% or less of the Revolving Financing is drawn, the fee will be 2.50% per annum. Any amounts borrowed under the Revolving Financing will mature, and all accrued and unpaid interest will be due and payable, on December 7, 2020. As of June 30, 2020, there were $30.0 million borrowings outstanding under the Revolving Financing. We refer to the Term Financing and the Revolving Financing together as the “Financing Facilities.”
On July 2, 2018, we closed the public offering of $30 million in aggregate principal amount of 6.125% notes due 2023 (the “Existing Notes”). On July 12, 2018, the underwriters exercised their over-allotment option to purchase an additional $4.5 million in aggregate principal amount of the Existing Notes. The total net proceeds to us from the Existing Notes, including the exercise of the underwriters’ over-allotment option, after deducting underwriting discounts and commissions of approximately $1.0 million and estimated offering expenses of approximately $230,000, were approximately $33.2 million.
On October 18, 2019, we closed the public offering of $15 million in aggregate principal amount of additional 6.125% notes due 2023 (the “Notes,” and together with the Existing Notes, the “2023 Notes”). The Notes constitute a further issuance of, rank equally in right of payment with, and form a single series with the $34.5 million in Existing Notes. On November 7, 2019, the underwriters exercised their option to purchase an additional $1.875 million in aggregate principal of the Notes. The total net proceeds received by us from the sale of the Notes, including the exercise of the underwriters’ over-allotment option, was approximately $16.4 million, based on the purchase price paid by the underwriters of 96.875% of the aggregate principal amount of the Notes, after deducting estimated offering expenses of approximately $255,000.
The 2023 Notes will mature on July 1, 2023 and bear interest at a rate of 6.125%. The 2023 Notes are direct unsecured obligations and rank pari passu, which means equal in right of payment, with all outstanding and future unsecured indebtedness issued by us. Because the 2023 Notes are not secured by any of our assets, they are effectively subordinated to all of our existing and future secured unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest), to the extent of the value of the assets securing such indebtedness. The 2023 Notes are structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries and financing vehicles, including, without limitation, borrowings under the Financing Facilities. The 2023 Notes are obligations exclusively of Investcorp Credit Management BDC, Inc. and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the 2023 Notes and the 2023 Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future.
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The 2023 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after July 1, 2020. Interest on the 2023 Notes is payable quarterly on January 1, April 1, July 1 and October 1 of each year. The 2023 Notes are listed on the NASDAQ Global Select Market under the trading symbol “CMFNL.” We may from time to time repurchase the 2023 Notes in accordance with the 1940 Act and the rules promulgated thereunder. As of June 30, 2020 and June 30, 2019, the outstanding principal balance of the 2023 Notes was approximately $51.4 million and 34.5 million, respectively, and had an estimated fair value of $44.9 million and $34.7 million, respectively, based on the closing price as of June 30, 2020 and June 30, 2019, respectively, as traded on NASDAQ.
The indenture under which the 2023 Notes are issued (the “Indenture”) contains certain covenants, including covenants (i) requiring our compliance with the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a) of the 1940 Act, whether or not we continue to be subject to such provisions of the 1940 Act; (ii) requiring our compliance, under certain circumstances, with the requirements set forth in Section 18(a)(1)(B) as modified by Section 61(a) of the 1940 Act, whether or not we continue to be subject to such provisions of the 1940 Act, prohibiting the declaration of any cash dividend or distribution upon any class of our capital stock (except to the extent necessary for us to maintain its treatment as a RIC under Subchapter M of the Code), or purchasing any such capital stock, if our asset coverage, as defined in the 1940 Act, is below 150% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution, or purchase; and (iii) requiring us to provide financial information to the holders of the 2023 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These covenants are subject to limitations and exceptions that are described in the Indenture.
On May 2, 2018, our board of directors, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the board, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the Small Business Credit Availability Act. As a result, our asset coverage requirements for senior securities changed from 200% to 150%, effective as of May 2, 2019.
Portfolio Composition
As of June 30, 2020, our portfolio consisted of debt and equity investments in 38 portfolio companies with a fair value of $270.6 million. As of June 30, 2020, our portfolio at fair value consisted of 83.6% first lien investments, 10.2% second lien investments, 4.0% unitranche loans, and 2.2% equity, warrant or other positions. At June 30, 2020, the weighted average total yield of debt and income producing securities at amortized cost (which includes income and amortization of fees and discounts) was 9.58%. At June 30, 2020, our weighted average total yield on investments at amortized cost (which includes interest income and amortization of fees and discounts) was 9.01%. The weighted average total yield was computed using an internal rate of return calculation of our debt investments based on contractual cash flows, including interest and amortization payments, and, for floating rate investments, the spot London Interbank Offered Rate (“LIBOR”), as of June 30, 2020 of all of our debt investments. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. The weighted average total yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before payment of all of our fees and expenses, including any sales load paid in connection with an offering of our securities. There can be no assurance that the weighted average total yield will remain at its current level.
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The industry composition of our portfolio at fair value at June 30, 2020 was as follows:
| Percentage of Total Portfolio at June 30, 2020 |
||||
| Professional Services |
11.48 | % | ||
| Construction & Engineering |
11.18 | |||
| Energy Equipment & Services |
10.92 | |||
| Trading Companies & Distributors |
9.09 | |||
| Media |
7.09 | |||
| Containers & Packaging |
5.93 | |||
| Diversified Telecommunication Services |
4.64 | |||
| Commercial Services & Supplies |
4.58 | |||
| Retail |
4.32 | |||
| Distributors |
3.49 | |||
| Internet Software & Services |
3.41 | |||
| Consumer Finance |
3.37 | |||
| Airlines |
3.35 | |||
| Construction Materials |
2.41 | |||
| Auto Components |
2.31 | |||
| Internet & Direct Marketing Retail |
2.29 | |||
| Specialty Retail |
2.08 | |||
| Household Durables |
1.82 | |||
| Chemicals |
1.77 | |||
| Road & Rail |
1.43 | |||
| Hotels, Restaurants & Leisure |
1.42 | |||
| IT Services |
1.10 | |||
| Technology Hardware, Storage & Peripherals |
0.52 | |||
| Wireless Telecommunication Services |
— | |||
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| 100.00 | % | |||
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CM Investment Partners LLC
CM Investment Partners, our external investment adviser, was formed in July 2013 and is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The Adviser is responsible for sourcing investment opportunities, conducting industry research, performing diligence on potential investments, structuring our investments and monitoring our portfolio companies on an ongoing basis. The Adviser is led by its Co-Chief Investment Officers, Michael C. Mauer and Christopher E. Jansen. Mr. Mauer also serves as the Chairman of our board of directors and our Chief Executive Officer, and Mr. Jansen also serves as our President and Secretary. Mr. Mauer was formerly Global Co-Head of Leveraged Finance and Global Co-Head of Fixed Income Currency and Commodity Distribution at Citigroup Inc. and a senior member of its credit committee responsible for all underwriting and principal commitments of leveraged finance capital worldwide. Mr. Jansen was a founding Managing Partner and Senior Portfolio Manager for Stanfield Capital Partners and had a leading role in planning its strategic direction. At Stanfield, Mr. Jansen was responsible for the management of 15 different portfolios aggregating in excess of $7 billion in assets consisting of large corporate loans, middle-market loans, second lien loans, high yield bonds and structured finance securities.
On August 30, 2019, Investcorp Credit Management US LLC (“Investcorp”) acquired an approximate 76% ownership interest in the Adviser through the acquisition of the interests held by Stifel Venture Corp. (“Stifel”) and certain funds managed Cyrus Capital Partners, L.P. (the “Cyrus Funds”) and through a direct purchase of equity from the Adviser (the “Investcorp Transaction”). Investcorp is a leading global credit investment platform
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with assets under management of $13.1 billion as of June 30, 2020. Investcorp manages funds that invest primarily in senior secured corporate debt issued by mid and large-cap corporations in Western Europe and the United States. The Investcorp business has a strong track record of consistent performance and growth, employing approximately 40 investment professionals in London, New York and Singapore. Investcorp is a subsidiary of Investcorp Bank Holdings B.S.C. (“Investcorp Holdings”). Investcorp Holdings and its consolidated subsidiaries, including Investcorp, are referred to as “Investcorp Group”. Investcorp Group is a global provider and manager of alternative investments, offering such investments to its high-net-worth private and institutional clients on a global basis. As of June 30, 2020, Investcorp Group had $32.2 billion in total assets under management, including assets managed by third party managers and assets subject to a non-discretionary advisory mandate where Investcorp Group receives fees calculated on the basis of assets under management. Investcorp Group employs approximately 450 people across its offices in New York, London, Bahrain, Abu Dhabi, Riyadh, Doha, Mumbai and Singapore. Investcorp Group has been engaged in the investment management and related services business since 1982, and brings enhanced capabilities to the Adviser.
The Adviser’s investment team, led by Messrs. Mauer and Jansen, is supported by three additional investment professionals, who, together with Messrs. Mauer and Jansen, we refer to as the “Investment Team.” The members of the Investment Team have over 100 combined years of structuring customized debt solutions for middle-market companies, which we believe will enable us to generate favorable returns across credit cycles with an emphasis on preserving capital. Messrs. Mauer and Jansen have developed an investment process for reviewing lending opportunities, structuring transactions and monitoring investments throughout multiple credit cycles. The members of the Investment Team have extensive networks for sourcing investment opportunities through direct corporate relationships and relationships with private equity firms, investment banks, restructuring advisors, law firms, boutique advisory firms and distressed/specialty lenders. The members of the Investment Team also have extensive experience across various industries, including aviation, cable, defense, healthcare, media, mining, oil and gas, power, retail, telecommunications, trucking and asset-backed special situations. As a result, we believe we will be able to achieve appropriate risk-adjusted returns by investing in companies that have restructured but do not have sufficient track records to receive traditional lending terms from a commercial bank or the broadly syndicated leveraged finance market. We believe the members of the Investment Team share a common investment philosophy built on a framework of rigorous business assessment, extensive due diligence and disciplined risk valuation methodology.
Every initial investment by us requires the approval by a majority of the Adviser’s investment committee (the “Investment Committee”) and such majority must include both Messrs. Mauer and Jansen. Every follow-on investment decision in an existing portfolio company and every investment disposition require approval by a majority of the Investment Committee. The Investment Committee currently consists of Messrs. Mauer and Jansen, the Co-Chief Investment Officers of the Adviser, and Andrew Muns, a Managing Director of the Adviser. In addition, Jeremy Ghose, the Managing Director and Head of Investcorp Credit Management, has a non-voting observer role on the Investment Committee.
In connection with the Investcorp Transaction, on June 26, 2019, our board of directors, including all of the directors who are not “interested persons” of the Company, as defined in Section 2(a)(19) of the 1940 Act (each, an “Independent Director”), unanimously approved a new investment advisory agreement (the “Advisory Agreement”) and recommended that the Advisory Agreement be submitted to our stockholders for approval, which our stockholders approved at the Special Meeting of Stockholders held on August 28, 2019. At the closing of the Investcorp Transaction on August 30, 2019, we entered into the Advisory Agreement with the Adviser, pursuant to which we pay the Adviser a management fee equal to 1.75% of our gross assets, payable in arrears on a quarterly basis. In addition, pursuant to the Advisory Agreement, we pay the Adviser an incentive fee equal to 20.0% of pre-incentive fee net investment income, subject to an annualized hurdle rate of 8.0% with a “catch up” fee for returns between the 8.0% hurdle and 10.0%, as well as 20.0% of net capital gains. The Advisory Agreement has substantially the same terms as the prior investment advisory agreement, dated February 5, 2014, between us and the Adviser (the “Prior Advisory Agreement”).
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At the closing of the Investcorp Transaction on August 30, 2019, we entered into a new administration agreement with the Adviser (the “Administration Agreement”). Under the Administration Agreement, the Adviser provides us with our chief financial officer, accounting and back-office professionals, equipment and clerical, bookkeeping, recordkeeping and other administrative services. The terms of the Administration Agreement, including the reimbursement of expenses by the Company to the Adviser, are identical to those contained in the Company’s prior administration agreement with the Adviser (the “Prior Administration Agreement”).
In connection with the Investcorp Transaction, on June 26, 2019, the Company entered into a definitive stock purchase and transaction agreement with Investcorp BDC Holdings Limited (“Investcorp BDC”), an affiliate of Investcorp (the “Stock Purchase Agreement”). Under the Stock Purchase Agreement, Investcorp BDC is required by August 30, 2021 to purchase (i) 680,985 newly issued shares of the Company’s common stock, par value $0.001 per share, at the most recently determined net asset value per share of the Company’s common stock at the time of such purchase, as adjusted as necessary to comply with Section 23 of the 1940 Act, and (ii) 680,985 shares of the Company’s common stock in open-market or secondary transactions. As of June 30, 2020, Investcorp BDC had purchased 227,000 newly issued shares of our common stock pursuant to the requirement under the Stock Purchase Agreement. See “Part II. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Sales of Unregistered Securities”” for more information. As of June 30, 2020, Investcorp BDC had purchased 281,775 shares of our common stock in open-market transactions pursuant to its obligation under the Stock Purchase Agreement.
Market Opportunity
We believe that the current investment environment presents a compelling case for investing in secured debt (including unitranche debt and standalone second and first lien loans) and unsecured debt (including mezzanine/structured equity) of middle-market companies. The following factors represent the key drivers of our focus on this attractive market segment:
| • | Reduced Availability of Capital for Middle-Market Companies. We believe there are fewer providers of financing and less capital available for middle-market companies compared to prior to the economic downturn that began in mid-2007. We believe that, as a result of that downturn: |
| • | many financing providers have chosen to focus on large, liquid corporate loans and syndicated capital markets transactions rather than lending to middle-market businesses; |
| • | regulatory changes, including the introduction of international capital and liquidity requirements for banks under the 2012 Basel III Accords have decreased their capacity to hold non-investment grade leveraged loans, causing banks to curtail lending to middle-market companies; |
| • | hedge funds and collateralized loan obligation managers are less likely to pursue investment opportunities in our target market as a result of reduced availability of funding for new investments; and |
| • | consolidation of regional banks into money center banks has reduced their focus on middle-market lending. |
As a result, we believe that less competition facilitates higher quality deal flow and allows for greater selectivity throughout the investment process.
| • | Robust Demand for Debt Capital. According to Pitchbook, a market research firm, private equity firms had approximately $636 billion of uncalled capital as of December 31, 2019. They have expanded their focus to include middle-market opportunities due to the lack of opportunities in large capital buyout transactions. We expect the large amount of uninvested capital and the expanded focus on middle-market opportunities to drive buyout activity over the next several years, which should, in turn, continue to create lending opportunities for us. |
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| • | Attractive Deal Pricing and Structures. We believe that, in general, middle-market debt investments are priced more attractively to lenders than larger, more liquid, public debt financings, due to the more limited universe of lenders as well as the highly negotiated nature of these financings. Middle-market transactions tend to offer stronger covenant packages, higher interest rates, lower leverage levels and better call protection compared to larger financings. In addition, middle-market loans typically offer other investor protections such as default penalties, lien protection, change of control provisions and information rights for lenders. |
| • | Specialized Lending Requirements. We believe that several factors render many U.S. financial institutions ill-suited to lend to U.S. middle-market companies. For example, based on the Investment Team’s experience, lending to private U.S. middle-market companies is generally more labor-intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of information for such companies. Lending to smaller capitalization companies requires due diligence and underwriting practices consistent with the demands and economic limitations of the middle-market and may also require more extensive ongoing monitoring by the lender. As a result, middle-market companies historically have been served by a limited segment of the lending community. |
Competitive Strengths
We believe that the Adviser’s disciplined approach to origination, portfolio construction and risk management should allow us to achieve favorable risk-adjusted returns while preserving our capital. We believe that the following competitive strengths provide positive returns for our investors:
| • | Large and Experienced Team with Substantial Resources. The Adviser and its Investment Team is led by Messrs. Mauer and Jansen, each with over 25 years of experience investing in, providing corporate finance services to, restructuring and consulting with middle-market companies. Messrs. Mauer and Jansen are supported by three additional investment professionals, who collectively have over 100 combined years of structuring strategic capital for business expansion, refinancings, capital restructuring, post-reorganization financing and servicing the general corporate needs of middle-market companies. We believe that the Investment Team and its resources provide a significant advantage and contribute to the strength of our business and enhance the quantity and quality of investment opportunities available to us. |
| • | Capitalize on the Investment Team’s Extensive Relationships with Middle-Market Companies, Private Equity Sponsors and Intermediaries. The members of the Investment Team have extensive networks for sourcing investment opportunities through corporate relationships and relationships with private equity firms, investment banks, restructuring advisors, law firms, boutique advisory firms and distressed/specialty lenders. We believe that the strength of these relationships in conjunction with the Investment Team’s ability to structure financing solutions for companies that incorporate credit protections at attractive returns for us provide us with a competitive advantage in identifying investment opportunities in our target market. |
| • | Disciplined Underwriting Policies and Rigorous Portfolio Management. Messrs. Mauer and Jansen have an established credit analysis and investment process to analyze investment opportunities thoroughly. This process, followed by the Investment Team, includes structuring loans with appropriate covenants and pricing loans based on our knowledge of the middle-market and our rigorous underwriting standards. We focus on capital preservation by extending loans to portfolio companies with assets that we believe will retain sufficient value to repay us even in depressed markets or under liquidation scenarios. Each investment is analyzed from its initial stages by either Mr. Mauer or Mr. Jansen, as the Adviser’s Co-Chief Investment Officers, and a senior investment professional of the Investment Team. The Investment Committee consists of Messrs. Mauer, Jansen and Muns, with Mr. Ghose as a non-voting observer. Every initial investment requires approval by a majority of the Investment Committee and such majority must include both Messrs. Mauer and Jansen. Every follow-on investment decision in an existing portfolio company and every investment disposition require approval by at least a |
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| majority of the Investment Committee. Under the supervision of Messrs. Mauer and Jansen, the Investment Team’s senior investment professionals also monitor the portfolio for developments on a daily basis, perform credit updates on each investment, review financial performance on at least a quarterly basis, and have regular discussions with the management of portfolio companies. We believe the Adviser’s investment and monitoring process and the depth and experience of the Investment Team gives us a competitive advantage in identifying investments and evaluating risks and opportunities throughout the life cycle of an investment. |
| • | Ability to Structure Investments Creatively. Our Investment Team has the expertise and ability to structure investments across all levels of a company’s capital structure. These individuals have extensive experience in cash flow, asset-based lending, workout situations and investing in distressed debt, which should enable us to take advantage of attractive investments in recently restructured companies. Furthermore, we believe we are in a better position to leverage the existing knowledge and relationships that the Investment Team has developed to lead investments that meet our investment criteria. We believe that current market conditions allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts (“OID”), early redemption premiums, payment-in-kind (“PIK”) interest and certain forms of equity securities. |
Investment Strategy
We invest in unitranche loans, standalone second and first lien loans, and selectively in unsecured debt, bonds and in the equity of portfolio companies through warrants and other instruments, in most cases taking advantage of a potential benefit from an increase in the value of such portfolio company as part of an overall relationship. We seek to invest primarily in middle-market companies that have annual revenues of at least $50 million and EBITDA of at least $15 million. Our investments typically range in size from $5 million to $25 million. We may invest in smaller or larger companies if there is an attractive opportunity, especially when there are dislocations in the capital markets, including the high yield and large syndicated loan markets. During such dislocations, we expect to see more deep value investment opportunities offering prospective returns that are disproportionate to the associated risk profile. We focus on companies with leading market positions, significant asset or franchise values, strong free cash flow and experienced senior management teams, with an emphasis on companies with high-quality sponsors.
Our primary investment objective is to maximize current income and capital appreciation by investing directly in privately held middle-market companies. The Adviser pursues investments for us with favorable risk-adjusted returns, including debt investments that offer cash origination fees and lower leverage levels. The Adviser seeks to structure our debt investments with strong protections, including default penalties, information rights, and affirmative and negative financial covenants, such as lien protection and restrictions concerning change of control. We believe these protections, coupled with the other features of our investments, allow us to reduce our risk of capital loss and achieve attractive risk-adjusted returns, although there can be no assurance that we are always able to structure our investments to minimize risk of loss and achieve attractive risk-adjusted returns.
Investment Criteria
The Investment Team uses the following investment criteria and guidelines to evaluate prospective portfolio companies. However, not all of these criteria and guidelines are used or met in connection with each of our investments.
| • | Established companies with a history of positive operating cash flow. We seek to invest in established companies with sound historical financial performance. The Adviser typically focuses on companies with a history of profitability on an operating cash flow basis. We do not intend to invest in start-up companies or companies with speculative business plans. |
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| • | Defensible and sustainable business. We seek to invest in companies with proven products and/or services that provide a competitive advantage versus its competitors or new entrants. The Adviser places an emphasis on the strength of historical operations and profitability and the generation of free cash flow to reinvest in the business or to utilize for debt service. The Adviser also focuses on the relative strength of the valuation and liquidity of collateral used to provide security for our investments, when applicable. |
| • | Seasoned management team with meaningful equity ownership. The Adviser generally requires that our portfolio companies have a seasoned management team, with strong corporate governance. The Adviser also seeks to invest in companies with management teams that have meaningful equity ownership. The Adviser believes that companies that have proper incentives in place, including having significant equity interests, motivate management teams to enhance enterprise value, which will act in accordance with our interests. |
| • | Significant Invested Capital. The Adviser seeks investments in portfolio companies where it believes that the aggregate enterprise value significantly exceeds aggregate indebtedness, after consideration of our investment. The Adviser believes that the existence of significant underlying equity value (i.e., the amount by which the aggregate enterprise value exceeds the aggregate indebtedness) provides important support to our debt investments. |
| • | Investment Partnerships. We seek to invest where private equity sponsors have demonstrated capabilities in building enterprise value. In addition, we seek to partner with specialty lenders and other financial institutions. The Adviser believes that private equity sponsors and specialty lenders can serve as committed partners and advisors that will actively work with the Adviser, the company and its management team to meet company goals and create value. |
| • | Ability to exert meaningful influence. We target investment opportunities in which we will be a significant investor in the tranche and in which we can add value through active participation in the direction of the company, sometimes through advisory positions. |
| • | Exit strategy. We generally seek to invest in companies that the Adviser believes possess attributes that will provide us with the ability to exit our investments. We typically expect to exit our investments through one of three scenarios: (i) the sale of the company resulting in repayment of all outstanding debt, (ii) the recapitalization of the company through which our loan is replaced with debt or equity from a third party or parties or (iii) the repayment of the initial or remaining principal amount of our loan then outstanding at maturity. In some investments, there may be scheduled amortization of some portion of our loan, which would result in a partial exit of our investment prior to the maturity of the loan. |
Deal Origination
The Adviser’s deal-originating efforts are focused on its direct corporate relationships and relationships with private equity firms, investment banks, restructuring advisers, law firms, and boutique advisory firms and distressed/specialty lenders. The Adviser’s investment team continues to enhance and expand these relationships.
The origination process is designed to thoroughly evaluate potential financings and to identify the most attractive of these opportunities on the basis of risk-adjusted returns. Each investment is analyzed from its initial stages through our investment by one of the Co-Chief Investment Officers of the Adviser and a senior investment professional. If an opportunity fits our criteria for investment and merits further review and consideration, the investment is presented to the Investment Committee. This first stage of analysis involves a preliminary, but detailed, description of the potential financing. An investment summary is then generated after preliminary due diligence. The opportunity may be discussed several times by members of the Investment Team. Prior to funding, every initial investment requires the approval of a majority of the Investment Committee and such majority must include both Messrs. Mauer and Jansen. Follow-on investment decisions in existing portfolio companies and investment dispositions require the approval of a majority of the Investment Committee.
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If the Adviser decides to pursue an opportunity, a preliminary term sheet will be produced for the target portfolio company. This term sheet serves as a basis for the discussion and negotiation of the critical terms of the proposed financing. At this stage, the Adviser begins its formal underwriting and investment approval process as described below. After the negotiation of a transaction, the financing is presented to the Investment Committee of the Adviser for approval. Upon approval of a financing transaction, the parties will prepare the relevant loan documentation. An investment is funded only after all due diligence is satisfactorily completed and all closing conditions have been satisfied. Each of the investments in our portfolio is monitored on a daily basis by a member of the Investment Committee aided by the senior investment professionals of the Investment Team, who also perform credit updates on each investment quarterly.
Underwriting
Underwriting Process and Investment Approval
The Adviser makes investment decisions only after considering a number of factors regarding the potential investment including, but not limited to:
| • | historical and projected financial performance; |
| • | company and industry specific characteristics, such as strengths, weaknesses, opportunities and threats; |
| • | composition and experience of the management team; and |
| • | track record of the private equity sponsor leading the transaction, if applicable. |
This methodology is employed to screen a high volume of potential investment opportunities on a consistent basis.
If an investment is deemed appropriate to pursue, a more detailed and rigorous evaluation is made after considering relevant investment parameters. The following outlines the general parameters and areas of evaluation and due diligence for investment decisions, although not all are necessarily considered or given equal weighting in the evaluation process.
Business model and financial assessment
The Adviser undertakes a review and analysis of the financial and strategic plans for the potential investment. There is significant evaluation of and reliance upon the due diligence performed by the private equity sponsor, if applicable, and third-party experts, including accountants and consultants. Areas of evaluation include:
| • | historical and projected financial performance; |
| • | quality of earnings, including source and predictability of cash flows; |
| • | customer and vendor interviews and assessments; |
| • | potential exit scenarios, including probability of a liquidity event; |
| • | internal controls and accounting systems; and |
| • | assets, liabilities and contingent liabilities. |
Industry dynamics
The Adviser evaluates the portfolio company’s industry, and may, if considered appropriate, consult or retain industry experts. The following factors are among those the Adviser analyzes:
| • | sensitivity to economic cycles; |
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| • | competitive environment, including number of competitors, threat of new entrants or substitutes; |
| • | fragmentation and relative market share of industry leaders; |
| • | growth potential; and |
| • | regulatory and legal environment. |
Management assessment
The Adviser makes an in-depth assessment of the management team, including evaluation along several key metrics:
| • | background checks; |
| • | the number of years in their current positions; |
| • | track record; |
| • | industry experience; |
| • | management incentive, including the level of direct investment in the enterprise; and |
| • | completeness of the management team (positions that need to be filled or added). |
Sponsor Assessment
Among critical due diligence investigations is the evaluation of a private equity sponsor or specialty lender that has, or is also making, an investment in the portfolio company. A private equity sponsor is typically a controlling stockholder upon completion of an investment and as such is considered critical to the success of the investment. In addition, a management team with meaningful equity ownership can serve as a committed partner to us and any private equity sponsor or specialty lender. The Adviser evaluates a private equity sponsor or specialty lender along several key criteria, including:
| • | investment track record; |
| • | industry experience; |
| • | capacity and willingness to provide additional financial support to the company through additional capital contributions, if necessary; and |
| • | reference checks. |
Investments
The following describes the types of loans we generally make:
Unitranche loans. Unitranche loans are loans structured as first lien loans with certain characteristics of mezzanine loan risk in one security. Unitranche loans typically provide for moderate loan amortization in the initial years of the loan with the majority of the principal repayment deferred until loan maturity. Unitranche loans usually provide us with greater control over a portfolio company’s capital structure, as they provide a one-stop financing solution and limit “frictional costs” (e.g., negotiations with, and concessions to, other lien holders) in the event of a workout process. Consistent with our focus on capital preservation, unitranche loans typically have less volatile returns than standalone second lien or mezzanine loans.
Standalone second lien loans. Standalone second lien loans are loans that are typically senior on a lien basis to other liabilities in the issuer’s capital structure and have the benefit of a security interest over the assets of the borrower, although ranking junior to first lien loans. Standalone second lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity.
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Standalone second lien loans can incur greater “frictional costs” (e.g., increased professional costs relating to resolving conflicts among the lenders) in the event of a workout and, partly because of this possible impact on recovery rates, we expect to demand a significantly higher risk premium in the form of higher spreads, call protection and/or warrants for extending standalone second lien loans, compared to first lien loans of similar credit quality.
Standalone first lien loans. Standalone first lien loans are loans that are typically senior on a lien basis to other liabilities in the issuer’s capital structure and have the benefit of a security interest on the assets of the portfolio company. Standalone first lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity.
Mezzanine loans/structured equity. Mezzanine loans are subordinated to senior secured loans on a payment basis, are typically unsecured and rank pari passu with other unsecured creditors of the issuer. As with standalone second lien loans, we expect to demand a significantly higher risk premium in the form of higher spreads, call protection and/or warrants for mezzanine loans, given the lower recovery rates for such securities due in part to the greater “frictional costs” (e.g., increased professional costs relating to resolving conflicts among the lenders) in a protracted workout. We may take mezzanine type risk in the form of “structured equity” investments. In cases where portfolio companies may be constrained in their ability to raise additional capital in the form of debt, we may have the opportunity to structure preferred equity or other equity-like instruments. These equity instruments typically have redemption rights and will either be convertible into common equity at our option or will have detachable warrants compensating us for the additional risk inherent in such investments. In most cases, these equity instruments will have debt-like characteristics, which provide more downside protection than a typical equity instrument.
Equity components. In connection with some of our debt investments, we will also invest in preferred or common stock or receive nominally priced warrants or options to buy an equity interest in the portfolio company. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. The Adviser may structure such equity investments and warrants to include provisions protecting our rights as a minority-interest holder, as well as a “put,” or right to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights.
Portfolio Management Strategy
Each of the investments in our portfolio is monitored on a daily basis by a member of the Investment Committee aided by the senior investment professionals of the Investment Team, who also perform credit updates on each investment quarterly.
Risk Ratings
In addition to various risk management and monitoring tools, we use the Adviser’s investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment rating system uses a five-level numeric rating scale. The following is a description of the conditions associated with each investment rating:
| Investment Rating 1 | Investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment. | |
| Investment Rating 2 | Investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2. | |
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| Investment Rating 3 | Investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with their financial covenants. | |
| Investment Rating 4 | Investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in workout. Investments with a rating of 4 are those for which some loss of return but no loss of principal is expected. | |
| Investment Rating 5 | Investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in workout. Investments with a rating of 5 are those for which some loss of return and principal is expected. | |
If the Adviser determines that an investment is underperforming, or circumstances suggest that the risk associated with a particular investment has significantly increased, the Adviser will increase its monitoring intensity and prepare regular updates for the Investment Committee, summarizing current operating results and material impending events and suggesting recommended actions. While the investment rating system identifies the relative risk for each investment, the rating alone does not dictate the scope and/or frequency of any monitoring that will be performed. The frequency of the Adviser’s monitoring of an investment is determined by a number of factors, including, but not limited to, the trends in the financial performance of the portfolio company, the investment structure and the type of collateral securing the investment.
The following table shows the investment rankings of the debt investments in our portfolio:
| As of June 30, 2020 | As of June 30, 2019 | |||||||||||||||||||||||
| Investment Rating |
Fair Value | % of Portfolio |
Number of Investments |
Fair Value | % of Portfolio |
Number of Investments |
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| 1 |
$ | 25,254,600 | 9.3 | % | 3 | $ | 6,358,750 | 2.1 | % | 1 | ||||||||||||||
| 2 |
162,252,467 | 60.0 | 30 | 223,645,544 | 73.0 | 32 | ||||||||||||||||||
| 3 |
64,792,766 | 23.9 | 16 | 67,535,327 | 22.0 | 8 | ||||||||||||||||||
| 4 |
9,848,588 | 3.7 | 3 | 8,851,371 | 2.9 | 3 | ||||||||||||||||||
| 5 |
8,473,288 | 3.1 | 3 | 1 | — | 1 | ||||||||||||||||||
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| Total |
$ | 270,621,709 | 100.0 | % | 55 | $ | 306,390,993 | 100.0 | % | 45 | ||||||||||||||
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Determination of Net Asset Value and Portfolio Valuation Process
The net asset value per share of our outstanding shares of common stock is determined quarterly by dividing total assets minus liabilities by the total number of shares outstanding.
In calculating the value of our total assets, investment transactions will be recorded on the trade date. Realized gains or losses will be computed using the specific identification method. Investments for which market quotations are readily available are valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our board of directors based on the input of our management and audit committee. In addition, our board of directors retains one or more independent valuation firms to review each quarter, the valuation of each portfolio investment for which a market quotation is not available. We also have adopted Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurements and Disclosures, or “ASC 820.” This accounting statement requires us to assume that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the market in which we can exit portfolio investments with the greatest volume and level activity is considered our principal market.
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Investments for which market quotations are readily available are valued at such market quotations unless the quotations are deemed not to represent fair value. We generally obtain market quotations from recognized exchanges, market quotation systems, independent pricing services or one or more broker dealers or market makers.
Debt and equity securities for which market quotations are not readily available or for which market quotations are deemed not to represent fair value are valued at fair value as determined in good faith by our board of directors. Because a readily available market value for many of the investments in our portfolio is often not available, we value many of our portfolio investments at fair value as determined in good faith by our board of directors using a consistently applied valuation process in accordance with a documented valuation policy that has been reviewed and approved by our board of directors. Due to the inherent uncertainty and subjectivity of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments and may differ materially from the values that we may ultimately realize. In addition, changes in the market environment and other events may have differing impacts on the market quotations used to value some of our investments than on the fair values of our investments for which market quotations are not readily available. Market quotations may also be deemed not to represent fair value in certain circumstances where we believe that facts and circumstances applicable to an issuer, a seller or purchaser, or the market for a particular security causes current market quotations not to reflect the fair value of the security. Examples of these events could include cases where a security trades infrequently, causing a quoted purchase or sale price to become stale, where there is a “forced” sale by a distressed seller, where market quotations vary substantially among market makers, or where there is a wide bid-ask spread or significant increase in the bid ask spread.
Those investments for which market quotations are not readily available or for which market quotations are deemed not to represent fair value 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 amount (discounted). The measurement is based on the 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 determining the fair value of our investments include, as relevant and among other factors: 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, merger and acquisition comparables, our principal market (as the reporting entity) and enterprise values.
With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:
| • | our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals of the Adviser responsible for the portfolio investment; |
| • | preliminary valuation conclusions are then documented and discussed with our senior management and the Adviser; |
| • | on a periodic basis, at least once annually, the valuation for each portfolio investment is reviewed by an independent valuation firm engaged by our board of directors; |
| • | the valuation committee of our board of directors then reviews these preliminary valuations and makes a recommendation to our board of directors regarding the fair value of each investment; and |
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| • | the board of directors then discusses these preliminary valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of the Adviser, the independent valuation firm and the valuation committee. |
Realization of Investments
The potential exit scenarios of a portfolio company will play an important role in evaluating investment decisions. The Adviser will formulate specific exit strategies at the time of each investment. Our debt orientation will provide for increased potential exit opportunities, including the sale of investments in the private markets, the refinancing of investments held, often due to maturity or recapitalizations, and other liquidity events including the sale or merger of the portfolio company. Since we seek to maintain a debt orientation in our investments, we generally expect to receive interest income over the course of the investment period, receiving a significant return on invested capital well in advance of final exit.
Derivatives
We may utilize hedging techniques such as interest rate swaps to mitigate potential interest rate risk on our indebtedness. Such interest rate swaps would principally be used to protect us against higher costs on our indebtedness resulting from increases in both short-term and long-term interest rates. We also may use various hedging and other risk management strategies to seek to manage various risks, including changes in currency exchange rates and market interest rates. Such hedging strategies would be utilized to seek to protect the value of our portfolio investments, for example, against possible adverse changes in the market value of securities held in our portfolio.
Managerial Assistance
As a BDC, we offer, and must provide upon request, managerial assistance to our portfolio companies. This assistance could involve 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. The Adviser will provide such managerial assistance on our behalf to portfolio companies that request this assistance. We may receive fees for these services and will reimburse the Adviser for its allocated costs in providing such assistance, subject to the review by our board of directors, including our Independent Directors.
Competition
Our primary competitors in providing financing to middle-market companies include public and private funds, other BDCs, commercial and investment banks, commercial finance companies and, to the extent they provide an alternative form of financing, private equity funds and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or to the distribution and other requirements we must satisfy to maintain our qualification as a RIC.
We use the expertise of the investment professionals of the Adviser to assess investment risks and determine appropriate pricing for our investments in portfolio companies. In addition, we believe the relationships of these investment professionals will enable us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in the industries in which we seek to invest.
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Staffing
We do not have any direct employees, and our day-to-day investment operations are managed by the Adviser. We have a Chief Executive Officer, President, Chief Financial Officer and Chief Compliance Officer. To the extent necessary, our board of directors may hire additional personnel in the future. Our officers are all employees of the Adviser and our allocable portion of the cost of Rocco DelGuercio, as our Chief Financial Officer and Chief Compliance Officer, and his staff, is paid by us pursuant to the Administration Agreement with the Adviser.
At the closing of the Investcorp Transaction on August 30, 2019, the Adviser entered into a services agreement with Investcorp International Inc. (“Investcorp International”), an affiliate of Investcorp (the “Investcorp Services Agreement”), through which the Adviser can utilize the expertise of Investcorp’s accounting and back-office professionals on an as-needed basis upon the request of the Adviser. Prior to the closing of the Investcorp Transaction, the Adviser had a similar strategic relationship with Cyrus Capital Partners, L.P.
Management Agreements
Advisory Agreement and Prior Advisory Agreement
The Advisory Agreement went into effect on August 30, 2019 (the “Commencement Date”). Subject to the few exceptions discussed below, the terms of the Advisory Agreement, including (i) the investment management services to be provided by the Adviser to the Company thereunder, (ii) the base management fee and incentive compensation payable, (iii) the allocation of expenses between the Adviser and the Company, (iv) the indemnification provisions thereunder and (v) the provisions regarding termination and amendment, are substantially the same as those of the Prior Advisory Agreement.
Management Services
Subject to the overall supervision of our board of directors and in accordance with the 1940 Act, the Adviser manages our day-to-day operations and provides investment advisory services to us. Under the terms of the Advisory Agreement and identical to the terms of the Prior Advisory Agreement, the Adviser:
| • | determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes; |
| • | identifies, evaluates and negotiates the structure of the investments we make; |
| • | executes, closes, services and monitors the investments we make; |
| • | determines the securities and other assets that we will purchase, retain or sell; |
| • | performs due diligence on prospective portfolio companies; and |
| • | provides us with such other investment advisory, research and related services as we may, from time to time, reasonably require for the investment of our funds. |
The Adviser’s services under the Advisory Agreement, as with the Prior Advisory Agreement, are not exclusive, and it may furnish similar services to other entities.
Management Fee
As with the Prior Advisory Agreement, under the Advisory Agreement, we have agreed to pay the Adviser a fee for investment advisory and management services consisting of two components — a base management fee (the “Base Management Fee”) and an incentive fee (the “Incentive Fee”). The cost of both the Base Management Fee and the Incentive Fee will ultimately be borne by our stockholders.
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Base Management Fee
Identical to the terms of the Prior Advisory Agreement, under the Advisory Agreement, the Base Management Fee will be calculated at an annual rate of 1.75% of our gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents (such amount, “Gross Assets”). The Base Management Fee is payable quarterly in arrears and the Base Management Fees for any partial month or quarter will be appropriately pro-rated.
Under the Prior Advisory Agreement, the Base Management Fee was calculated based on the average value of our Gross Assets at the end of the two most recently completed calendar quarters. Under the Advisory Agreement, for the period from the Commencement Date through the end of the first and second fiscal quarters after the Commencement Date, the Base Management Fee will be calculated based on the value of our Gross Assets as of the end of such quarter. Subsequently, the Base Management Fee will be calculated based on the average value of our Gross Assets at the end of the two most recently completed fiscal quarters. Base Management Fees for any partial month or quarter will be appropriately pro-rated.
Incentive Fee
Substantially the same as the terms of the Prior Advisory Agreement, under the Advisory Agreement, the Incentive Fee, which provides the Adviser with a share of the income that it generates for the Company, has two components, ordinary income (the “Income-Based Fee”) and capital gains (the “Capital Gains Fee”). Incentive Fees are calculated as described below and payable quarterly in arrears (or, upon termination of the Advisory Agreement, as of the termination date).
Income-Based Fee
Under the Advisory Agreement and the Prior Advisory Agreement, the Income-Based Fee is calculated and payable quarterly in arrears based on our Pre-Incentive Fee Net Investment Income (as defined below) for the immediately preceding fiscal quarter, subject to a total return requirement (the “Total Return Requirement”) and deferral of non-cash amounts, and is 20.0% of the amount, if any, by which our Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of our net assets attributable to its common stock, for the immediately preceding fiscal quarter, exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each fiscal quarter. Under this provision, in any fiscal quarter, the Adviser receives no Incentive Fee until our Pre-Incentive Fee Net Investment Income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of our Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than 2.5% (which is 10.0% annualized). The effect of the “catch-up” provision is that, subject to the Total Return Requirement and deferral provisions discussed below, if Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter, the Adviser receives 20.0% of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply.
“Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the fiscal quarter, minus the Company’s operating expenses for the quarter (including the Base Management Fee, expenses payable under the Administration Agreement and any interest expense and any 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 OID, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash.
Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the Incentive Fee, it is possible that we may pay an Incentive Fee in a quarter where we incur a loss, subject to the Total Return Requirement and
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deferral of non-cash amounts. For example, if we receive Pre-Incentive Fee Net Investment Income in excess of the quarterly minimum hurdle rate, we would pay the applicable Incentive Fee even if we have incurred a loss in that quarter due to realized and unrealized capital losses. Our net investment income used to calculate this component of the Incentive Fee is also included in the amount of its gross assets used to calculate the 1.75% Base Management Fee. These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter.
Under both the Advisory Agreement and the Prior Advisory Agreement, the Income-Based Fee is subject to the Total Return Requirement, however, the beginning date for the Lookback Period (as defined below) differs under the Agreements.
Under the Prior Advisory Agreement, no Income-Based Fee was payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeded the cumulative Incentive Fees accrued and/or paid for the 11 preceding quarters. In other words, any Income-Based Fee that was payable in a quarter was limited to the lesser of (i) 20.0% of the amount by which the Company’s Pre-Incentive Fee Net Investment Income for such quarter exceeded the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20.0% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative Incentive Fees accrued and/or paid for the 11 preceding quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of Pre-Incentive Fee Net Investment Income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters.
Under the Advisory Agreement, the calculation period for the Pre-Incentive Fee Net Investment Income is based on fiscal quarters rather than calendar quarters. In addition, effective on the Commencement Date, the Total Return Requirement for the Income-Based Fee was reset to begin on September 30, 2019. No Income-Based Fee is payable under the Advisory Agreement except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the fiscal quarter for which fees are being calculated and the Lookback Period exceeds the cumulative Incentive Fees accrued and/or paid for the Lookback Period. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of Pre-Incentive Fee Net Investment Income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current fiscal quarter and the Lookback Period. The “Lookback Period” means (1) through June 30, 2022, the period that on the last day of the fiscal quarter in which the Commencement Date occurs and ends on the last day of the fiscal quarter immediately preceding the fiscal quarter for which the Income-Based Fee is being calculated, and (2) after June 30, 2022, the eleven fiscal quarters immediately preceding the fiscal quarter for which the Income-Based Fee is being calculated.
In addition, under both the Advisory Agreement and the Prior Advisory Agreement, the portion of such Incentive Fee that is attributable to deferred interest (such as PIK interest or OID) will be paid to the Adviser only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such accounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of Incentive Fees payable) and would result in a reduction and possible elimination of the Incentive Fees for such quarter. Notwithstanding any such Incentive Fee reduction or elimination, there is no accumulation of amounts on the hurdle rate from quarter to quarter, and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle, and there is no delay of payment if prior quarters are below the quarterly hurdle.
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The following is a graphic representation of the calculation of the Income-Based Fee:
Quarterly Incentive Fee Based on Net Investment Income
Pre-incentive Fee Net Investment Income
(expressed as a percentage of the value of net assets)
Percentage of Pre-incentive Fee Net Investment Income
Allocated to Income-Based Fee
Capital Gains Fee
Under the Prior Advisory Agreement, the Capital Gains Fee was determined and payable in arrears as of the end of each calendar year (or upon termination of the Prior Advisory Agreement, as of the termination date), commencing with the calendar year ending on December 31, 2014, and was equal to 20.0% of our cumulative aggregate realized capital gains from inception through the end of each calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gains Fees. If such amount is negative, then no Capital Gains Fee is payable for such year. Additionally, if the Prior Advisory Agreement was terminated as of a date that is not a calendar year end, the termination date was treated as though it were a calendar year end for purposes of calculating and paying the Capital Gains Fee. No Capital Gains Fee was paid to the Adviser under the Prior Advisory Agreement.
Substantially the same as the terms of the Prior Advisory Agreement, under the Advisory Agreement, the Capital Gains Fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), commencing with the fiscal year ending June 30, 2021, and will equal to 20.0% of our cumulative aggregate realized capital gains from the Commencement Date through the end of that fiscal year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gains Fees. If such amount is negative, then no Capital Gains Fee will be payable for such year. Additionally, if the Advisory Agreement is terminated as of a date that is not a fiscal year end, the termination date will be treated as though it were a fiscal year end for purposes of calculating and paying the Capital Gains Fee. For the avoidance of doubt, realized capital gains, realized capital losses, unrealized capital appreciation and unrealized capital depreciation with respect to the Company’s portfolio as of the end of the fiscal year ended June 30, 2020 will be excluded from the calculations of the Capital Gains Fee.
Under U.S. generally accepted accounting principles, was calculate the Capital Gains Fee as if we had realized all assets at their fair values as of the reporting date. Accordingly, we accrue a provisional Capital Gains Fee taking into account any unrealized gains or losses. As the provisional Capital Gains Fee is subject to the performance of investments until there is a realization event, the amount of the provisional Capital Gains Fee accrued at a reporting date may vary from the Capital Gains Fee that is ultimately realized and the differences could be material.
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Examples of Quarterly Incentive Fee Calculation
Example 1: Income Related Portion of Incentive Fee before Total Return Requirement Calculation:
Alternative 1
Assumptions
Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 0.6125%
Pre-incentive fee net investment income does not exceed hurdle rate, therefore there is no income-related incentive fee.
Alternative 2
Assumptions
Investment income (including interest, dividends, fees, etc.) = 2.9%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 2.2625%
Incentive fee = 100% × Pre-incentive fee net investment income (subject to “catch-up”)(4)
= 100% × (2.2625% – 2.0%)
= 0.2625%
Pre-incentive fee net investment income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision; therefore, the income related portion of the incentive fee is 0.2625%.
Alternative 3
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 2.8625%
| Incentive fee = | 100% × Pre-incentive fee net investment income (subject to “catch-up”)(4) | |
| Incentive fee = | 100% × “catch-up” + (20.0% × (Pre-Incentive Fee Net Investment Income – 2.5%)) | |
| “Catch-up” = 2.5% – 2.0% | ||
| = 0.5% | ||
| Incentive fee = | (100% × 0.5%) + (20.0% × (2.8625% – 2.5%)) | |
| = 0.5% + (20.0% × 0.3625%) | ||
| = 0.5% + 0.725% | ||
| = 0.5725% | ||
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Pre-incentive fee net investment income exceeds the hurdle rate, and fully satisfies the “catch-up” provision; therefore, the income related portion of the incentive fee is 0.5725%.
| (1) | Represents 8.0% annualized hurdle rate. |
| (2) | Represents 1.75% annualized base management fee. |
| (3) | Excludes organizational and offering expenses. |
| (4) | The “catch-up” provision is intended to provide the Adviser with an incentive fee of 20.0% on all pre-incentive fee net investment income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter. |
Example 2: Income Portion of Incentive Fee with Total Return Requirement Calculation:
Alternative 1:
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000 20.0% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $8,000,000
Although our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% (as shown in Alternative 3 of Example 1 above), no incentive fee is payable because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters did not exceed the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters.
Alternative 2:
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000 20.0% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $10,000,000
Because our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% and because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters, an incentive fee would be payable, as shown in Alternative 3 of Example 1 above.
| (1) | Represents 8.0% annualized hurdle rate. |
| (2) | Represents 1.75% annualized base management fee. |
| (3) | Excludes organizational and offering expenses. |
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| (4) | The “catch-up” provision is intended to provide the Adviser with an incentive fee of 20.0% on all pre-incentive fee net investment income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter. |
Example 3: Capital Gains Portion of Incentive Fee(*):
Alternative 1:
Assumptions
| Year 1: | $2.0 million investment made in Company A (“Investment A”), and $3.0 million investment made in Company B (“Investment B”) | |
| Year 2: | Investment A sold for $5.0 million and fair market value (“FMV”) of Investment B determined to be $3.5 million | |
| Year 3: | FMV of Investment B determined to be $2.0 million | |
| Year 4: | Investment B sold for $3.25 million | |
The capital gains portion of the incentive fee would be:
| Year 1: | None | |
| Year 2: | Capital gains incentive fee of $0.6 million — ($3.0 million realized capital gains on sale of Investment A multiplied by 20.0%) | |
| Year 3: | None — $0.4 million (20.0% multiplied by ($3.0 million cumulative capital gains less $1.0 million cumulative capital depreciation)) less $0.6 million (previous capital gains fee paid in Year 2) | |
| Year 4: | Capital gains incentive fee of $50,000 — $0.65 million ($3.25 million cumulative realized capital gains multiplied by 20%) less $0.6 million (capital gains incentive fee taken in Year 2) | |
Alternative 2
Assumptions
| Year 1: | $2.0 million investment made in Company A (“Investment A”), $5.25 million investment made in Company B (“Investment B”) and $4.5 million investment made in Company C (“Investment C”) | |
| Year 2: | Investment A sold for $4.5 million, FMV of Investment B determined to be $4.75 million and FMV of Investment C determined to be $4.5 million | |
| Year 3: | FMV of Investment B determined to be $5.0 million and Investment C sold for $5.5 million | |
| Year 4: | FMV of Investment B determined to be $6.0 million | |
| Year 5: | Investment B sold for $4.0 million | |
The capital gains incentive fee, if any, would be:
| Year 1: | None | |
| Year 2: | Capital gains incentive fee of $0.4 million — 20.0% multiplied by $2.0 million ($2.5 million realized capital gains on Investment A less $0.5 million unrealized capital depreciation on Investment B) | |
| Year 3: | $0.25 million capital gains incentive fee(1) — $0.65 million (20.0% multiplied by $3.25 million ($3.5 million cumulative realized capital gains less $0.25 million unrealized capital depreciation)) less $0.4 million capital gains incentive fee received in Year 2 | |
| Year 4: | $0.05 million capital gains incentive fee — $0.7 million ($3.50 million cumulative realized capital gains multiplied by 20.0%) less $0.65 million cumulative capital gains incentive fee paid in Year 2 and Year 3 | |
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| Year 5: | None — $0.45 million (20.0% multiplied by $2.25 million (cumulative realized capital gains of $3.5 million less realized capital losses of $1.25 million)) less $0.7 million cumulative capital gains incentive fee paid in Year 2, Year 3 and Year 4(2) | |
| * | The hypothetical amounts of returns shown are based on a percentage of our total net assets and assume no leverage. There is no guarantee that positive returns will be realized and actual returns may vary from those shown in this example. |
| (1) | As illustrated in Year 3 of Alternative 1 above, if a portfolio company were to be wound up on a date other than its fiscal year end of any year, it may have paid aggregate capital gains incentive fees that are more than the amount of such fees that would be payable if such portfolio company had been wound up on its fiscal year end of such year. |
| (2) | As noted above, it is possible that the cumulative aggregate capital gains fee received by the Adviser ($0.70 million) is effectively greater than $0.45 million (20% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($2.25 million)). |
Payment of Our Expenses
Identical to the Prior Advisory Agreement, the Base Management Fee and Incentive Fee compensation provided for in the Advisory Agreement remunerates the Adviser for work in identifying, evaluating, negotiating, closing and monitoring our investments. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without limitation, those relating to:
| • | our organization, the formation transactions and offerings; |
| • | calculating our net asset value (including the cost and expenses of any independent valuation firm(s)); |
| • | fees and expenses payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments; |
| • | interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts; |
| • | other offerings of our common stock and other securities; |
| • | administration fees and expenses, if any, payable under the Administration Agreement (including our allocable portion of the Adviser’s overhead in performing its obligations under the Administration Agreement, including rent and the allocable portion of the cost of our Chief Compliance Officer, Chief Financial Officer and their respective staffs); |
| • | transfer agent, dividend agent and custodial fees and expenses; |
| • | costs associated with our reporting and compliance obligations under the 1940 Act, as amended, and other applicable federal and state securities laws, and stock exchange listing fees; |
| • | fees and expenses associated with independent audits and outside legal costs; |
| • | U.S. federal, state and local taxes; |
| • | Independent Directors’ fees and expenses; |
| • | costs of any reports, proxy statements or other notices to or communications and meetings with stockholders; |
| • | costs associated with investor relations; |
| • | costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums; |
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| • | direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff; and |
| • | all other expenses incurred by us or the Adviser in connection with administering our business. |
Duration and Termination
Unless terminated earlier as described below, the Advisory Agreement will be in effect for an initial two-year term and will continue in effect from year-to-year thereafter if approved annually by our board of directors, including a majority of the Independent Directors, or by the affirmative vote of the holders of a majority of the Company’s outstanding voting securities and a majority of the Independent Directors.
As with the Prior Advisory Agreement, the Advisory Agreement may be terminated by either party without penalty by delivering notice of termination upon not less than 60 days’ written notice to the other party and will automatically terminate in the event of its assignment. The holders of a majority of our outstanding voting securities may also terminate the Advisory Agreement without penalty upon 60 days’ written notice.
Indemnification
As with the Prior Advisory Agreement, the Advisory Agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Adviser’s services under the Advisory Agreement or otherwise as the Adviser.
Board Approval of the Advisory Agreement
Our board of directors approved the Prior Advisory Agreement at its first meeting, held on October 8, 2013, which became effective in February 2014. At a meeting of our board of directors held on June 26, 2019, our board of directors, including all of the Independent Directors, unanimously approved the Advisory Agreement and recommended that the Advisory Agreement be submitted to our stockholders for approval. Our stockholders approved the Advisory Agreement at the Special Meeting of Stockholders held on August 28, 2019. In its consideration of the Advisory Agreement, our board of directors took into consideration (1) the nature, quality and extent of the advisory and other services to be provided to the Company by the Adviser after the closing of the Investcorp Transaction; (2) comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment objectives; (3) the Company’s operating expenses and expense ratio compared to BDCs with similar investment objectives; (4) the expected profitability of the Adviser after the closing of the Investcorp Transaction; (5) information about the services to be performed and the personnel performing such services under the Advisory Agreement; (6) the organizational capability and financial condition of the Adviser and its affiliates after the closing of the Investcorp Transaction; and (7) other factors our board of directors deemed to be relevant. Our board of directors also specifically reviewed the qualifications and capabilities of Investcorp to control the Adviser. In its deliberations, our board of directors did not identify any single piece of information discussed below that was all-important, controlling or determinative of its decision.
In voting to approve the Advisory Agreement, our board of directors, including all of the Independent Directors, made the following conclusions:
| • | Nature, Extent and Quality of Services. In considering the nature, extent and quality of the services to be provided by the Adviser, our board of directors discussed the experience of current key personnel of the Adviser and considered its experience with the Adviser providing investment management services to the Company. Our board of directors considered that, although the ownership of the Adviser would |
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| change in connection with the completion of the Investcorp Transaction, key senior management of the Adviser would continue to operate in the same professional capacity as prior to the Investcorp Transaction, including the Adviser’s Co-Chief Investment Officers, Messrs. Mauer and Jansen, and that the Adviser’s current management would continue to determine the investment strategies and policies of the Adviser following completion of the Investcorp Transaction. In addition, our board of directors considered that the Adviser expected that, following the completion of the Investcorp Transaction, its investment process would not substantially change and, instead, would be enhanced because of the resources of Investcorp that would be available to the Adviser following the Investcorp Transaction. Our board of directors considered that it and the Company’s management believe that the Investcorp Transaction and Investcorp’s majority ownership of the Adviser would result in significant benefits for the Company and its stockholders. Our board of directors considered that management of the Company and our board of directors believe that the Company and its stockholders will benefit from Investcorp’s access to greater scale and resources while maintaining continuity in the investment advisory services and personnel that have been provided by the Adviser to the Company. Specifically, management of the Company and our board of directors believe that the Adviser and the Company will benefit through enhanced investment capabilities by joining a large platform like Investcorp Group. Additionally, given Investcorp Group’s existing research capabilities across geographies, sectors, and products, the Company will have access to additional resources when evaluating investment opportunities. Investcorp also provides the Adviser a global distribution network and can provide the Adviser with capital to create a middle market lending platform for the Company to invest alongside. |
Our board of directors also considered that the compliance and operational infrastructure of the Adviser would remain in place following completion of the Investcorp Transaction. Our board of directors further considered the quality of the Adviser’s compliance infrastructure and past reports from the Company’s Chief Compliance Officer. Our board of directors noted that it had previously reviewed responses prepared by Investcorp and the Adviser to a detailed series of questions which included, among other things, information about the background and experience of the Adviser’s management and staff. Our board of directors also considered other services to be provided to the Company, such as monitoring adherence to the Company’s investment restrictions and monitoring compliance with various Company policies and procedures and with applicable securities laws and regulations. Our board of directors also noted that, after the completion of the Investcorp Transaction, Investcorp would provide the Adviser with access to significant administrative resources, which was expected to benefit the Company. Based on the factors above, as well as those discussed below, our board of directors concluded that it was satisfied with the nature, extent and quality of the services to be provided to the Company by the Adviser under the Advisory Agreement.
| • | Comparison to Other Business Development Companies. Our board of directors reviewed a detailed comparison of performance metrics of the Company and a sample of peer BDCs. In considering the appropriate performance metrics by which to benchmark the Company’s performance against its peers, our board of directors focused on certain factors that it believes are significant drivers of stockholder value. Our board of directors considered the comparison of performance metrics as it relates to the management and incentive fees to be paid to the Adviser under the Advisory Agreement, in comparison to the fees paid to other externally managed BDCs. |
Our board of directors noted that the exclusion of cash and cash equivalents from the Base Management Fee calculation makes it more beneficial to stockholders than certain other fee structures in the peer group. Our board of directors also noted the stockholder-friendly three-year Total Return Requirement, which would result in the net investment income amount utilized for the income-based Incentive Fee calculation being reduced to the extent of any net realized losses and net unrealized depreciation during the applicable three-year period, beginning upon the Closing. Our board of directors also discussed that no Capital Gains Fee, if any, would be earned and payable until the fiscal year ending June 30, 2021.
In addition to reviewing the appropriateness of the terms of the Advisory Agreement and the relative performance of the Adviser and the Company, our board of directors considered the differentiated
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investment strategy of the Company, which focuses on generating both current income and capital appreciation by investing in debt and related equity investments of privately held middle-market companies. The Company invests primarily in middle-market companies in the form of unitranche loans and standalone first and second lien loans. The Company may also invest in unsecured debt and bonds and in the equity of portfolio companies through warrants and other instruments. The Company generally defines middle market companies as those with an enterprise value that represents the aggregate of debt value and equity value of the entity of less than $750 million, although it may invest in larger or smaller companies. As of June 30, 2020, 97.8% of the Company’s portfolio was invested in senior secured loans and 2.2% was invested in equity, warrant or other positions.
Our board of directors considered that Investcorp does not advise any accounts that are comparable to the Company in terms of investment strategies and policies or other relevant criteria but noted Investcorp’s experience in managing CLO funds that pursue a similar investment strategy to the Company. Our board of directors also considered that Investcorp’s research capabilities in the middle-market space through its well-established private equity business will complement the Company’s investment strategy, and noted Investcorp’s commitment to growing a middle-market lending platform for the Company to invest alongside
| • | Costs of Services Provided and Economies of Scale. Our board of directors considered the costs incurred by the Company and the Adviser to provide services to the Company, the expected costs to be incurred by the Adviser, the profit that the Adviser may realize, and the Adviser’s financial condition following the Investcorp Transaction, including the resources of Investcorp and its affiliates. Based on its review, our board of directors concluded that the Adviser is financially able to provide the Company with the services enumerated in the Advisory Agreement. Our board of directors also noted that it does not pay any other fees to the Adviser and that the Adviser does not derive any material indirect benefits from its relationship to the Company. |
Our board of directors considered the extent to which economies of scale may be realized as the Company grows and concluded that there were no material economies of scale to be realized at the Company’s current asset level.
| • | Other Benefits. Our board of directors considered certain indirect benefits that were then-currently received by the Adviser, and that may be received by Investcorp, in connection with acting as Adviser to the Company, including reimbursements to the Adviser of allocable expenses under the Administration Agreement. Our board of directors also considered indirect benefits to the Adviser, Investcorp and their affiliates expected to be derived from their relationships with the Company as a result of the Investcorp Transaction and noted that no additional benefits were reported by the Adviser or Investcorp. |
Our board of directors concluded that the proposed advisory fees are reasonable, taking into consideration these other indirect benefits.
Conclusions. No single factor was determinative of the decision of our board of directors, including all of the Independent Directors, to approve the Advisory Agreement and individual directors may have weighed certain factors differently. Throughout the process, the Independent Directors were advised by independent counsel. Following this process, our board of directors, including all of the Independent Directors, unanimously voted to approve the Advisory Agreement subject to stockholder approval at the Special Meeting.
Administration Agreement
As with the Prior Administration Agreement, under the Administration Agreement, the Adviser furnishes us with office facilities and equipment and provides us with clerical, bookkeeping, recordkeeping and other administrative services at such facilities. Under the Administration Agreement, the Adviser performs, or oversees the performance of, our required administrative services, which includes, among other things, being responsible for the financial and other records that we are required to maintain and preparing reports to our stockholders and reports and other materials filed with the SEC. In addition, the Adviser assists us in determining and publishing
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our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports and other materials to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the Administration Agreement, the Adviser also provides managerial assistance on our behalf to those portfolio companies that have accepted our offer to provide such assistance. The Adviser may satisfy certain of its obligations under the Administration Agreement to us through the Investcorp Services Agreement, including supplying us with accounting and back-office professionals upon the request of the Adviser.
Payments under the Administration Agreement equal an amount based upon our allocable portion (subject to the review of our board of directors) of the Adviser’s overhead in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions and our allocable portion of the cost of our Chief Financial Officer and Chief Compliance Officer and their respective staffs. In addition, if requested to provide significant managerial assistance to our portfolio companies, the Adviser will be paid an additional amount based on the services provided, which shall not exceed the amount we receive from such portfolio companies for providing this assistance. The Administration Agreement has an initial term of two years and may be renewed with the approval of our board of directors. The Administration Agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. To the extent that the Adviser outsources any of its functions, we pay the fees associated with such functions on a direct basis without any incremental profit to the Adviser.
Indemnification
The Administration Agreement provides that, absent criminal conduct, willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, the Adviser and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Adviser’s services under the Administration Agreement or otherwise as our administrator.
License Agreement
We have entered into a license agreement with the Adviser under which the Adviser has agreed to grant us a non-exclusive, royalty-free license to use the name “Investcorp.” Under this agreement, we have a right to use the “Investcorp” name for so long as the Adviser or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have no legal right to the “Investcorp” name. This license agreement will remain in effect for so long as the Advisory Agreement with the Adviser is in effect and Investcorp is the majority owner of the Adviser.
Exchange Act Reports
We maintain a website at www.icmbdc.com. The information on our website is not incorporated by reference in this annual report on Form 10-K.
We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the SEC in accordance with the Exchange Act. These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.
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Regulation as a BDC
We are a BDC under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act. Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition financing or other investments. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances. We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, we generally cannot acquire more than 3% of the voting stock of any registered investment company, 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 these policies is fundamental and may be changed without stockholder approval upon 60 days’ prior written notice to stockholders.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred to as “qualifying assets,” unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are the following:
| (1) | Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. Under the 1940 Act and the rules thereunder, “eligible portfolio companies” include (1) private domestic operating companies, (2) public domestic operating companies whose securities are not listed on a national securities exchange (e.g., NASDAQ), and (3) public domestic operating companies having a market capitalization of less than $250 million. Public domestic operating companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC are not listed on a national securities exchange and therefore are eligible portfolio companies. |
| (2) | Securities of any eligible portfolio company which we control. |
| (3) | Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident to such a private transaction, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements. |
| (4) | Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company. |
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| (5) | Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights relating to such securities. |
| (6) | Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one year or less from the date of investment. |
The regulations defining qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take advantage of any regulatory, legislative, administrative or judicial actions in this area.
Managerial Assistance to Portfolio Companies
Business development companies generally must offer to make available to the issuer of the securities significant managerial assistance, except in circumstances where either (i) the business development company controls such issuer of securities or (ii) the business development company purchases such securities in conjunction with one or more other persons acting together and one of the other persons in the group makes available such managerial assistance. Making available managerial assistance means any arrangement whereby the business development company, through its directors, officers, employees or agents, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. The Adviser will provide such managerial assistance on our behalf to portfolio companies that request this assistance.
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, repurchase agreements and high-quality debt investments that mature in one year or less from the date of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets or temporary investments. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, so long as the agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests in order to qualify as a RIC for U.S. federal income tax purposes. Accordingly, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. The Adviser will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Senior Securities
We are generally 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 senior securities remain outstanding, we must make provisions to prohibit any distribution to our stockholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. However, the Small Business Credit Availability Act has modified the 1940 Act by allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met.
In accordance with the Small Business Credit Availability Act, on May 2, 2018, our board of directors, including a “required majority,” approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, our asset coverage requirements for senior securities changed from 200% to 150%,
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effective May 2, 2019. For a discussion of the Small Business Credit Availability Act, see “Risk Factors — Risks Related to Our Business and Structure — The Small Business Credit Availability Act allows us to incur additional leverage.” 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. For a discussion of the risks associated with leverage, see “Risk Factors — Risks Relating to our Business and Structure — Regulations governing our operation as a business development company will affect our ability to, and the way in which we, raise additional capital. As a business development company, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.”
Common Stock
We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock at a price below the current net asset value of the common stock if our board of directors determines that such sale is in our best interests and that of our stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities (less any distributing commission or discount).
Codes of Ethics
We and the Adviser 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 such 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 such code’s requirements. Each code of ethics is available on the EDGAR Database on the SEC’s website at www.sec.gov. You may also obtain copies of each code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to the Adviser. The Proxy Voting Policies and Procedures of the Adviser are set out below. The guidelines will be reviewed periodically by the Adviser and our directors who are not “interested persons,” and, accordingly, are subject to change.
Introduction
As an investment adviser registered under the Advisers Act, the Adviser has a fiduciary duty to act solely in our best interests. As part of this duty, the Adviser recognizes that it must vote our securities in a timely manner free of conflicts of interest and in our best interests.
The Adviser’s policies and procedures for voting proxies for its investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy Policies
The Adviser votes proxies relating to our portfolio securities in what it perceives to be the best interest of our stockholders. The Adviser reviews on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities we hold. In most cases, the Adviser will vote in favor of proposals that the Adviser believes are likely to increase the value of the portfolio securities we hold. Although the Adviser will generally vote against proposals that may have a negative effect on our portfolio securities, the Adviser may vote for such a proposal if there exist compelling long-term reasons to do so.
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The Adviser has established a proxy voting committee and adopted proxy voting guidelines and related procedures. The proxy voting committee establishes proxy voting guidelines and procedures, oversees the internal proxy voting process, and reviews proxy voting issues. To ensure that the Adviser’s vote is not the product of a conflict of interest, the Adviser requires that (1) anyone involved in the decision-making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (2) employees involved in the decision- making process or vote administration are prohibited from revealing how the Adviser intends to vote on a proposal in order to reduce any attempted influence from interested parties. Where conflicts of interest may be present, the Adviser will disclose such conflicts to us, including to our Independent Directors, and may request guidance from us on how to vote such proxies.
Proxy Voting Records
You may obtain information about how the Adviser voted proxies by making a written request for proxy voting information to: Investcorp Credit Management BDC, Inc., Attention: Investor Relations, 280 Park Avenue, 39th Floor, New York, New York 10017, or by calling us collect at (212) 257-5199. The SEC also maintains a website at www.sec.gov that contains this information.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.
Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party administrator).
We restrict access to nonpublic personal information about our stockholders to employees of the Adviser and its affiliates with a legitimate business need for the information. We intend to maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.
Other
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
We and the Adviser are each required to adopt and implement written policies and procedures reasonably designed to prevent violation of relevant federal securities laws, review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and designate a chief compliance officer to be responsible for administering the policies and procedures.
We may be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our board of directors who are not interested persons and, in some cases, prior approval by the SEC. Thus, based on current SEC interpretations, co-investment transactions involving a BDC like us and an entity that is advised by the Adviser or an affiliated adviser generally could not be effected without SEC relief. The staff of the SEC has, however, granted no-action relief permitting purchases of a single class of privately placed securities, provided that the adviser negotiates no term other than price and certain other
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conditions are met. As a result, we only expect to co-invest on a concurrent basis with investment funds, accounts or investment vehicles managed by the Adviser when each of us and such investment fund, account or investment vehicle will own the same securities of the issuer and when no term is negotiated other than price. Any such investment would be made, subject to compliance with existing regulatory guidance, applicable regulations and our allocation procedures. If opportunities arise that would otherwise be appropriate for us and for an investment fund, account or investment vehicle managed by the Adviser to invest in different securities of the same issuer, the Adviser will need to decide which fund will proceed with the investment. Moreover, except in certain circumstances, we will be unable to invest in any issuer in which an investment fund, account or investment vehicle managed by the Adviser has previously invested.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us. For example:
| • | pursuant to Rule 13a-14 under the Exchange Act, our principal executive officer and principal financial officer must certify the accuracy of the financial statements contained in our periodic reports; |
| • | pursuant to Item 307 under Regulation S-K, our periodic reports must disclose our conclusions about the effectiveness of our disclosure controls and procedures; |
| • | pursuant to Rule 13a-15 under the Exchange Act, our management must prepare an annual report regarding its assessment of our internal control over financial reporting; and |
| • | pursuant to Item 308 of Regulation S-K and Rule 13a-15 under the Exchange Act, our periodic reports must disclose whether there were significant changes in our internal controls over financial reporting or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. |
Taxation as a Regulated Investment Company
As a BDC, we intend to elect to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level U.S. federal income taxes on any income that we distribute to our stockholders as dividends. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to qualify for RIC tax treatment we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses (the “Annual Distribution Requirement”).
If we qualify as a RIC and satisfy the Annual Distribution Requirement, then we generally will not be subject to U.S. federal income tax on the portion of our income we distribute (or are deemed to distribute) to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) to our stockholders.
We will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar year and (3) any income recognized, but not distributed, in preceding years (the “Excise Tax Avoidance Requirement”).
In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:
| • | continue to qualify as a BDC under the 1940 Act at all times during each taxable year; |
| • | derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to loans of certain securities, gains from the sale of stock or other securities, net income from |
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| certain “qualified publicly traded partnerships,” or other income derived with respect to our business of investing in such stock or securities (the “90% Income Test”); and |
| • | diversify our holdings so that at the end of each quarter of the taxable year: |
| • | at least 50% of the value of our assets consists of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and |
| • | no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships” (the “Diversification Tests”). |
We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in income other amounts that we have not yet received in cash, such as PIK interest and deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order to satisfy the distribution requirements. However, under the 1940 Act, we are not permitted in certain circumstances to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
In accordance with certain applicable Treasury regulations and a revenue procedure issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or the revenue procedure.
Failure to Maintain our Qualification as a RIC
If we fail to satisfy the 90% Income Test or the Diversification Tests for any taxable year, we may nevertheless continue to qualify as a RIC for such year if certain relief provisions are applicable (which may, among other things, require us to pay certain corporate-level U.S. federal income taxes or to dispose of certain assets).
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If we were unable to qualify for treatment as a RIC and the foregoing relief provisions are not applicable, we would be subject to tax on all of our taxable income at regular corporate rates, regardless of whether we make any distributions to our stockholders. Distributions would not be required, and any distributions would be taxable to our stockholders as ordinary dividend income that, subject to certain limitations, may be eligible for the 20% maximum rate to the extent of our current and accumulated earnings and profits provided certain holding period and other requirements were met. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. To requalify as a RIC in a subsequent taxable year, we would be required to satisfy the RIC qualification requirements for that year and dispose of any earnings and profits from any year in which we failed to qualify as a RIC. Subject to a limited exception applicable to RICs that qualified as such under Subchapter M of the Code for at least one year prior to disqualification and that requalify as a RIC no later than the second year following the nonqualifying year, we could be subject to tax on any unrealized net built-in gains in the assets held by us during the period in which we failed to qualify as a RIC that are recognized within the subsequent five years, unless we made a special election to pay corporate-level U.S. federal income tax on such built-in gain at the time of our requalification as a RIC.
The NASDAQ Stock Market Corporate Governance Regulations
Our common stock is listed on the NASDAQ Global Select Market under the symbol “ICMB”. The Notes are listed on the NASDAQ Global Select Market under the symbol “CMFNL”. The NASDAQ Stock Market has adopted corporate governance regulations with which listed companies must comply. We are in compliance with such corporate governance listing standards applicable to BDCs. Prior to September 3, 2019, our common stock was listed on the NASDAQ Global Select Market under the symbol “CMFN”.
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| Item 1A. | Risk Factors |
Investing in our securities involves a number of significant risks. Before you invest in our securities, you should be aware of various risks, including those described below. You should carefully consider these risk factors, together with all of the other information included in this annual report on Form 10-K, before you decide whether to make an investment in our securities. The risks set out below are the principal risks with respect to an investment in our securities generally and with respect to a BDC with investment objectives, investment policies, capital structures or trading markets similar to ours. However, they may not be the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us may also impair our operations and performance. If any of the following events occur, our business, financial condition, results of operations and cash flows could be materially and adversely affected. In such case, the net asset value of our common stock and the trading price of our securities could decline, and you may lose all or part of your investment.
Risks Relating to Our Business and Structure
The capital markets are currently in a period of disruption and economic uncertainty. Such market conditions have materially and adversely affected the debt and equity capital markets, which has had, and may continue to have, a negative impact on our business, financial condition and results of operations.
From time to time, capital markets experience periods of disruption and instability. For example, the U.S. and global capital markets experienced extreme volatility and disruption during the economic downturn that began in mid-2007, and the U.S. economy was in a recession for several consecutive calendar quarters during the same period. Most recently, the U.S. capital markets have experienced extreme volatility and disruption following the global outbreak of a novel strain of the coronavirus, also known as “COVID-19,” as evidenced by the volatility in global stock markets as a result of, among other things, uncertainty surrounding the COVID-19 pandemic and the fluctuating price of commodities such as oil. Despite actions of the U.S. federal government and foreign governments, these events have contributed to worsening general economic conditions that are materially and adversely impacting the broader financial and credit markets and reducing the availability of debt and equity capital for the market as a whole. These conditions could continue for a prolonged period of time or worsen in the future.
Current market conditions may make it difficult to raise equity capital because, subject to some limited exceptions, as a BDC, we are generally not able to issue additional shares of our common stock at a price less than the net asset value per share without first obtaining approval for such issuance from our stockholders and the Independent Directors. We generally seek approval from our stockholders so that we have the flexibility to issue up to 25% of our then outstanding shares of our common stock at a price below net asset value. Pursuant to approval granted at a meeting of our stockholders initially convened on November 6, 2019 and reconvened on December 5, 2019, we are permitted to sell or otherwise issue shares of our common stock at a price below net asset value, subject to certain limitations and determinations that must be made by our board of directors. Such stockholder approval expires on November 6, 2020.
Significant changes or volatility in the capital markets may also have a negative effect on the valuations of our investments. While most of our investments are not publicly traded, applicable accounting standards require us to assume as part of our valuation process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity).
Significant changes in the capital markets, such as the recent disruption in economic activity caused by the COVID-19 pandemic, have adversely affected, and may continue to adversely affect, the pace of our investment activity and economic activity generally. Additionally, the recent disruption in economic activity caused by the COVID-19 pandemic has had, and may continue to have, a negative effect on the potential for liquidity events involving our investments. The illiquidity of our investments may make it difficult for us to sell such investments to access capital if required, and as a result, we could realize significantly less than the value at which we have recorded our investments if we were required to sell them for liquidity purposes. An inability to raise or access
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capital, and any required sale of all or a portion of our investments as a result, could have a material adverse effect on our business, financial condition or results of operations.
Political, social and economic uncertainty, including uncertainty related to the COVID-19 pandemic, creates and exacerbates risks.
Social, political, economic and other conditions and events (such as natural disasters, epidemics and pandemics, terrorism, conflicts and social unrest) will occur that create uncertainty and have significant impacts on issuers, industries, governments and other systems, including the financial markets, to which companies and their investments are exposed. As global systems, economies and financial markets are increasingly interconnected, events that once had only local impact are now more likely to have regional or even global effects. Events that occur in one country, region or financial market will, more frequently, adversely impact issuers in other countries, regions or markets, including in established markets such as the United States. These impacts can be exacerbated by failures of governments and societies to adequately respond to an emerging event or threat.
Uncertainty can result in or coincide with, among other things: increased volatility in the financial markets for securities, derivatives, loans, credit and currency; a decrease in the reliability of market prices and difficulty in valuing assets (including portfolio company assets); greater fluctuations in spreads on debt investments and currency exchange rates; increased risk of default (by both government and private obligors and issuers); further social, economic, and political instability; nationalization of private enterprise; greater governmental involvement in the economy or in social factors that impact the economy; changes to governmental regulation and supervision of the loan, securities, derivatives and currency markets and market participants and decreased or revised monitoring of such markets by governments or self-regulatory organizations and reduced enforcement of regulations; limitations on the activities of investors in such markets; controls or restrictions on foreign investment, capital controls and limitations on repatriation of invested capital; the significant loss of liquidity and the inability to purchase, sell and otherwise fund investments or settle transactions (including, but not limited to, a market freeze); unavailability of currency hedging techniques; substantial, and in some periods extremely high, rates of inflation, which can last many years and have substantial negative effects on credit and securities markets as well as the economy as a whole; recessions; and difficulties in obtaining and/or enforcing legal judgments.
For example, in December 2019, COVID-19 emerged in China and has since spread rapidly to other countries, including the United States. This outbreak has led and for an unknown period of time will continue to lead to disruptions in local, regional, national and global markets and economies affected thereby. While several countries, as well as certain states in the United States, have begun to lift the public health restrictions with a view to reopening their economies, recurring COVID-19 outbreaks have led to the re-introduction of such restrictions in certain states in the United States and globally and could continue to lead to the re-introduction of such restrictions elsewhere. Even after the COVID-19 pandemic subsides, the U.S. economy and most other major global economies may continue to experience a recession, and we anticipate our business and operations could be materially adversely affected by a prolonged recession in the U.S. and other major markets.
With respect to the U.S. credit markets (in particular for middle-market loans), this outbreak has resulted in, and until fully resolved is likely to continue to result in, the following among other things: (i) government imposition of various forms of shelter in place orders and the closing of “non-essential” businesses, resulting in significant disruption to the businesses of many middle-market loan borrowers including supply chains, demand and practical aspects of their operations, as well as in lay-offs of employees, and, while these effects are hoped to be temporary, some effects could be persistent or even permanent; (ii) increased draws by borrowers on revolving lines of credit; (iii) increased requests by borrowers for amendments and waivers of their credit agreements to avoid default, increased defaults by such borrowers and/or increased difficulty in obtaining refinancing at the maturity dates of their loans; (iv) volatility and disruption of these markets including greater volatility in pricing and spreads and difficulty in valuing loans during periods of increased volatility, and liquidity issues; and (v) rapidly evolving proposals and/or actions by state and federal governments to address problems being experienced by the markets and by businesses and the economy in general which will not
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necessarily adequately address the problems facing the loan market and middle-market businesses. This outbreak is having, and any future outbreaks could have, an adverse impact on the markets and the economy in general, which could have a material adverse impact on, among other things, the ability of lenders to originate loans, the volume and type of loans originated, and the volume and type of amendments and waivers granted to borrowers and remedial actions taken in the event of a borrower default, each of which could negatively impact the amount and quality of loans available for investment by us and returns to us, among other things. As of the date of this Annual Report, it is impossible to determine the scope of this outbreak, or any future outbreaks, how long any such outbreak, market disruption or uncertainties may last, the effect any governmental actions will have or the full potential impact on us, the Adviser and our portfolio companies.
Although it is impossible to predict the precise nature and consequences of these events, or of any political or policy decisions and regulatory changes occasioned by emerging events or uncertainty on applicable laws or regulations that impact us, our portfolio companies and our investments, it is clear that these types of events are impacting and will, for at least some time, continue to impact us and our portfolio companies and, in many instances, the impact will be adverse and profound. For example, middle-market companies in which we invest may be significantly impacted by these emerging events and the uncertainty caused by these events. The effects of a public health emergency may materially and adversely impact (i) the value and performance of us and our portfolio companies, (ii) the ability of our borrowers to continue to meet loan covenants or repay loans provided by us on a timely basis or at all, which may require us to restructure our investments or write down the value of our investments, (iii) our ability to repay debt obligations, on a timely basis or at all, or (iv) our ability to source, manage and divest investments and achieve our investment objectives, all of which could result in significant losses to us. We will also be negatively affected if the operations and effectiveness of the Adviser or a portfolio company (or any of the key personnel or service providers of the foregoing) is compromised or if necessary or beneficial systems and processes are disrupted.
Disruptions in the capital markets caused by the COVID-19 pandemic have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. These and future market disruptions and/or illiquidity can be expected to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events have limited and could continue to limit our investment originations, limit our ability to grow and have a material negative impact on our and our portfolio companies’ operating results and the fair values of our debt and equity investments.
The COVID-19 pandemic has caused severe disruptions in the U.S. economy and has disrupted financial activity in the areas in which we or our portfolio companies operate.
The COVID-19 pandemic has caused widespread outbreaks of illness and numerous deaths, adversely impacted global commercial activity and contributed to significant volatility in certain equity and debt markets. The global impact of the outbreak is rapidly evolving, and many countries have reacted by instituting quarantines, prohibitions on travel and the closure of offices, businesses, schools, retail stores and other public venues. Businesses are also implementing similar precautionary measures. Such measures, as well as the general uncertainty surrounding the dangers and impact of COVID-19, have created significant disruption in supply chains and economic activity and are having a particularly adverse impact on retail, transportation, hospitality, tourism, entertainment and other industries, including industries in which certain of our portfolio companies operate. The impact of COVID-19 has led to significant volatility and declines in the global public equity markets and it is uncertain how long this volatility will continue. As COVID-19 continues to spread, the potential impacts, including a global, regional or other economic recession, are increasingly uncertain and difficult to assess. Some economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a world-wide economic downturn.
Disruptions in the capital markets caused by the COVID-19 pandemic have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets.
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These and future market disruptions and/or illiquidity would be expected to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events have limited and could continue to limit our investment originations, limit our ability to grow and have a material negative impact on our and our portfolio companies’ operating results and the fair values of our debt and equity investments.
Any public health emergency, including the COVID-19 pandemic or any outbreak of other existing or new epidemic diseases, or the threat thereof, and the resulting financial and economic market uncertainty could have a significant adverse impact on us and the fair value of our investments and our portfolio companies.
The extent of the impact of any public health emergency, including the COVID-19 pandemic, on our and our portfolio companies’ operational and financial performance will depend on many factors, including the duration and scope of such public health emergency, the actions taken by governmental authorities to contain its financial and economic impact, the extent of any related travel advisories and restrictions implemented, the impact of such public health emergency on overall supply and demand, goods and services, investor liquidity, consumer confidence and levels of economic activity and the extent of its disruption to important global, regional and local supply chains and economic markets, all of which are highly uncertain and cannot be predicted. In addition, our and our portfolio companies’ operations may be significantly impacted, or even temporarily or permanently halted, as a result of government quarantine measures, voluntary and precautionary restrictions on travel or meetings and other factors related to a public health emergency, including its potential adverse impact on the health of any of our or our portfolio companies’ personnel. This could create widespread business continuity issues for us and our portfolio companies.
These factors may also cause the valuation of our investments to differ materially from the values that we may ultimately realize. Our valuations, and particularly valuations of private investments and private companies, are inherently uncertain, may fluctuate over short periods of time and are often based on estimates, comparisons and qualitative evaluations of private information that may not show the complete impact of the COVID-19 pandemic and the resulting measures taken in response thereto. Any public health emergency, including the COVID-19 pandemic or any outbreak of other existing or new epidemic diseases, or the threat thereof, and the resulting financial and economic market uncertainty could have a significant adverse impact on us and the fair value of our investments and our portfolio companies.
The current period of capital markets disruption and economic uncertainty may make it difficult to extend the maturity of, or refinance, our existing indebtedness or obtain new indebtedness and any failure to do so could have a material adverse effect on our business, financial condition or results of operations.
Current market conditions may make it difficult to extend the maturity of or refinance our existing indebtedness or obtain new indebtedness with similar terms and any failure to do so could have a material adverse effect on our business. The debt capital that will be available to us in the future, if at all, may be at a higher cost and on less favorable terms and conditions than what we currently experience, including being at a higher cost in rising rate environments. If we are unable to raise or refinance debt, then our equity investors may not benefit from the potential for increased returns on equity resulting from leverage and we may be limited in our ability to make new commitments or to fund existing commitments to our portfolio companies. An inability to extend the maturity of, or refinance, our existing indebtedness or obtain new indebtedness could have a material adverse effect on our business, financial condition or results of operations.
We cannot predict how tax reform legislation will affect us, our investments, or our stockholders, and any such legislation could adversely affect our business.
Legislative or other actions relating to taxes could have a negative effect on us. The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the
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Internal Revenue Service and the U.S. Treasury Department. The U.S. House of Representatives and U.S. Senate passed tax reform legislation (the “TCJA”) in December 2017, which the President signed into law shortly thereafter. Such legislation made many changes to the Code, including, among other things, significant changes to the taxation of business entities, the deductibility of interest expense, and the tax treatment of capital investment. We cannot predict with certainty how these or any other changes in the tax laws might affect us, investors, or our portfolio investments. Such legislation could significantly and negatively affect our ability to qualify as a RIC and have adverse U.S. federal income tax consequences to us and our stockholders. Additionally, the U.S. Treasury Department and Internal Revenue Service have issued and may issue additional regulations and administrative interpretations of the TCJA, and any such regulations, interpretations, any court decisions interpreting the TCJA or the regulations or administrative interpretations thereunder, or any other changes in the tax laws could similarly, significantly and negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax consequences to us and our stockholders of such qualification, or could have other adverse consequences. Stockholders are urged to consult with their tax advisor regarding tax legislative, regulatory, or administrative developments and proposals and their potential effect on an investment in our securities.
The United Kingdom referendum decision to leave the European Union may create significant risks and uncertainty for global markets and our investments.
The decision made in the United Kingdom referendum in June 2016 to leave the European Union (commonly known as “Brexit”) has led to volatility in global financial markets, and in particular in the markets of the United Kingdom and across Europe, and may also lead to weakening in consumer, corporate and financial confidence in the United Kingdom and Europe. The United Kingdom left the European Union on January 31, 2020, governed by transitional terms that will expire on December 31, 2020. During this transitional phase, the United Kingdom and the European Union will seek to negotiate and finalize a new, more permanent trade deal. Due to political uncertainty, it is not possible to anticipate whether the United Kingdom and the European Union will be able to agree on and implement a new trade agreement or what the nature of such trade agreement will be. In the absence of such an agreement, there would be no transitional provisions and the relationship between the United Kingdom and the European Union would be based on the World Trade Organization rules. The process for the United Kingdom to exit the European Union and the longer term economic, legal, political, regulatory and social framework to be put in place between the United Kingdom and the European Union remain unclear at this stage and are likely to lead to ongoing political and economic uncertainty and periods of exacerbated volatility in both the United Kingdom and in wider European markets for some time. The mid-to-long term uncertainty may have a negative effect on the performance of any investments located or with operations in the United Kingdom or Europe. Additionally, the decision made in the United Kingdom referendum may lead to a call for similar referenda in other European jurisdictions which may cause increased economic volatility and uncertainty in the European and global markets. This volatility and uncertainty may have an adverse effect on the economy generally and on the ability of us and our portfolio companies to execute our respective strategies and to receive attractive returns.
In particular, currency volatility may mean that the returns of us and our portfolio companies are adversely affected by market movements and may make it more difficult, or more expensive, for us to implement appropriate currency hedging. Fluctuations in the value of the British Pound and/or the euro, along with the potential downgrading of the United Kingdom’s sovereign credit rating, may also have an impact on the performance of our portfolio companies located in the United Kingdom or Europe.
We depend upon key personnel of the Adviser for our future success. If the Adviser were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.
We depend on the diligence, skill, experience and network of business contacts of the Investment Team of the Adviser, in particular Messrs. Mauer and Jansen, who are also members of the Investment Committee, our executive officers and Mr. Mauer is chairman of our board of directors. We can offer no assurance that Messrs.
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Mauer and Jansen will continue to provide investment advice to us. The loss of either Mr. Mauer or Mr. Jansen could limit our ability to achieve our investment objective and operate as we anticipate.
In addition, we are dependent on the other members of the Investment Team. If any of the members of the Investment Team were to resign, we may not be able to hire investment professionals with similar expertise and ability to provide the same or equivalent services on acceptable terms. If we are unable to do so quickly, our operations are likely to experience a disruption, and our financial condition, business and results of operations may be adversely affected. Even if we are able to retain comparable professionals the integration of such investment professionals and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.
Our business model depends to a significant extent upon our Adviser’s network of relationships. Any inability of the Adviser to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
We depend upon the Adviser to maintain its relationships with private equity sponsors, placement agents, investment banks, management groups and other financial institutions and we expect to rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the Adviser or members of the Investment Team fail to maintain such relationships, or to develop new relationships with other sources of investment opportunities, we may not be able to grow our investment portfolio. In addition, individuals with whom the Adviser has relationships are not obligated to provide us with investment opportunities, and we can offer no assurance that these relationships will generate investment opportunities for us in the future.
Our relationship with Investcorp may create conflicts of interest.
Investcorp has an approximate 76% interest in the Adviser. Pursuant to the services agreement with Investcorp International Inc. (“Investcorp International”), an affiliate of Investcorp (the “Investcorp Services Agreement”), the Adviser is able to utilize personnel of Investcorp International and its affiliates to provide services to the Company from time-to-time on an as-needed basis related to human resources, compensation and technology services. The Adviser may rely on the Investcorp Services Agreement to satisfy its obligations under the Administration Agreement. The personnel of Investcorp International may also provide services for the funds managed by Investcorp, which could result in conflicts of interest and may distract them from their responsibilities to us.
There are significant potential conflicts of interest that could negatively affect our investment returns.
There may be times when the Adviser or the members of the Investment Team have interests that differ from those of our stockholders, giving rise to conflicts of interest. The members of the Investment Committee and the Investment Team serve, or may serve, as officers, directors, members, or principals of entities that operate in the same or a related line of business as we do or of investment funds, accounts, or investment vehicles managed by the Adviser, Investcorp or their affiliates. Similarly, the Adviser or the members of the Investment Team may have other clients with similar, different or competing investment objectives. In serving in these multiple capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in the best interests of us or our stockholders. In addition, the Adviser and some of its affiliates, including our officers and our non-Independent Directors, are not prohibited from raising money for, or managing, another investment entity that makes the same types of investments as those we target.
The members of the Investment Team may, from time to time, possess material non-public information, limiting our investment discretion.
Members of the Investment Team may serve as directors of, or in a similar capacity with, portfolio companies in which we invest. In the event that material nonpublic information is obtained with respect to such companies, or we become subject to trading restrictions under the internal trading policies of those companies or
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as a result of applicable law or regulations, we could be prohibited for a period of time from purchasing or selling the securities of such companies, and this prohibition may have an adverse effect on us.
There are conflicts related to other arrangements with the Adviser.
We have entered into a license agreement with the Adviser under which the Adviser has agreed to grant us a non-exclusive, royalty-free license to use the name “Investcorp.” See “Business — Management Agreements — License Agreement.” In addition, we have entered into the Administration Agreement with the Adviser pursuant to which we are required to pay to the Adviser our allocable portion of overhead and other expenses incurred by the Adviser in performing its obligations under such Administration Agreement, such as rent, equipment and our allocable portion of the cost of our Chief Financial Officer and Chief Compliance Officer and his respective staff’s compensation and compensation-related expenses. This will create conflicts of interest that our board of directors will monitor. For example, under the terms of the license agreement, we will be unable to preclude the Adviser from licensing or transferring the ownership of the “Investcorp” name to third parties, some of whom may compete against us. Consequently, we will be unable to prevent any damage to goodwill that may occur as a result of the activities of the Adviser or others. Furthermore, in the event the license agreement is terminated, we will be required to change our name and cease using “Investcorp” as part of our name. Any of these events could disrupt our recognition in the market place, damage any goodwill we may have generated and otherwise harm our business.
Our financial condition, results of operations and cash flows will depend on our ability to manage our business effectively.
Our ability to achieve our investment objective will depend on our ability to manage our business and to grow our investments and earnings. This will depend, in turn, on the Adviser’s ability to identify, invest in and monitor portfolio companies that meet our investment criteria. The achievement of our investment objective on a cost-effective basis will depend upon the Adviser’s execution of our investment process, its ability to provide competent, attentive and efficient services to us and, to a lesser extent, our access to financing on acceptable terms. The Adviser’s investment professionals may have substantial responsibilities in connection with the management of other investment funds, accounts and investment vehicles. The personnel of the Adviser may also be called upon to provide managerial assistance to our portfolio companies. These activities may distract them from identifying new investment opportunities for us or slow our rate of investment. Any failure to manage our business and our future growth effectively could have a material adverse effect on our business, financial condition, results of operations and cash flows.
The Adviser’s incentive fee structure may create incentives to it that are not fully aligned with the interests of our stockholders.
In the course of our investing activities, we pay management and incentive fees to the Adviser. We have entered into the Advisory Agreement with the Adviser that provides that these fees will be based on the value of our gross assets. As a result, investors in our common stock will invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in a lower rate of return than one might achieve through direct investments. Because these fees are based on the value of our gross assets, the Adviser will benefit when we incur debt or use leverage. This fee structure may encourage the Adviser to cause us to borrow money to finance additional investments. Under certain circumstances, the use of borrowed money may increase the likelihood of default, which would disfavor our stockholders.
Our board of directors is charged with protecting our interests by monitoring how the Adviser addresses these and other conflicts of interests associated with its management services and compensation. While our board of directors is not expected to review or approve each investment decision, borrowing or incurrence of leverage, the Independent Directors will periodically review the Adviser’s services and fees as well as its portfolio management decisions and portfolio performance. In connection with these reviews, the Independent Directors
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will consider whether our fees and expenses (including those related to leverage) remain appropriate. As a result of this arrangement, the Adviser may from time to time have interests that differ from those of our stockholders, giving rise to a conflict.
Our incentive fee may induce the Adviser to make speculative investments.
The Adviser receives an incentive fee based, in part, upon net capital gains realized on our investments. Unlike that portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. Additionally, under the incentive fee structure, the Adviser may benefit when we recognize capital gains and, because the Adviser will determine when to sell a holding, the Adviser will control the timing of the recognition of such capital gains. As a result, the Adviser may have a tendency to invest more capital in investments likely to result in capital gains, compared to income-producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.
We may be obligated to pay the Adviser incentive compensation even if we incur a loss and may pay more than 20.0% of our net capital gains because we cannot recover payments made in previous years.
The Adviser is entitled to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our investment income for that quarter (before deducting incentive compensation) above a threshold return for that quarter. Thus, we may be required to pay the Adviser incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter. If we pay an incentive fee of 20% of our realized capital gains (net of all realized capital losses and unrealized capital depreciation on a cumulative basis) and thereafter experience additional realized capital losses or unrealized capital depreciation, we will not be able to recover any portion of the incentive fee previously paid.
PIK interest payments we receive will increase our assets under management and, as a result, will increase the amount of base management fees and incentive fees payable by us to the Adviser.
Certain of our debt investments contain provisions providing for the payment of PIK interest. Because PIK interest results in an increase in the size of the loan balance of the underlying loan, the receipt by us of PIK interest will have the effect of increasing our assets under management. As a result, because the Base Management Fee that we pay to the Adviser is based on the value of our gross assets, receipt of PIK interest will result in an increase in the amount of the Base Management Fee payable by us. In addition, any such increase in a loan balance due to the receipt of PIK interest will cause such loan to accrue interest on the higher loan balance, which will result in an increase in our pre-incentive fee net investment income and, as a result, an increase in incentive fees that are payable to the Adviser.
The involvement of our interested directors in the valuation process may create conflicts of interest.
We expect to make most of our portfolio investments in the form of loans and securities that are not publicly traded and for which there are limited or no market-based price quotations available. As a result, our board of directors will determine the fair value of these loans and securities in good faith as described below in “— Most of our portfolio investments will be recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.” In connection with that determination, investment professionals from the Adviser may provide our board of directors with valuations based upon the most recent portfolio company financial statements available and projected financial results of each portfolio company. While the valuation for each portfolio investment will be reviewed by an independent valuation firm quarterly, the ultimate determination of fair value will be made by our board of directors and not by such third-party valuation firm. In addition, Mr. Mauer, an interested member of our board of directors, has a direct or indirect pecuniary interest in the Adviser. The participation of the Adviser’s investment professionals in our valuation process, and the pecuniary interest in the Adviser by certain members of our board of directors, could result in a conflict of interest as the Adviser’s management fee is based, in part, on the value of our gross assets, and our incentive fees will be based, in part, on realized gains and realized and unrealized losses.
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The Advisory Agreement and the Administration Agreement with the Adviser were not negotiated on an arm’s length basis and may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
The Advisory Agreement and the Administration Agreement were negotiated between related parties. Consequently, their terms, including fees payable to the Adviser, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our ongoing relationship with the Adviser and its affiliates. Any such decision, however, would breach our fiduciary obligations to our stockholders.
Our incentive fee arrangements with the Adviser may vary from those of other investment funds, account or investment vehicles that the Adviser may manage in the future, which may create an incentive for the Adviser to devote time and resources to a higher fee-paying fund.
If the Adviser is paid a higher performance-based fee from any other fund that it may manage in the future, it may have an incentive to devote more research and development or other activities, and/or recommend the allocation of investment opportunities, to such higher fee-paying fund. For example, to the extent the Adviser’s incentive compensation is not subject to a hurdle or total return requirement with respect to another fund, it may have an incentive to devote time and resources to such other fund. As a result, the investment professionals of the Adviser may devote time and resources to a higher fee-paying fund.
The Adviser’s liability is limited under the Advisory Agreement and we have agreed to indemnify the Adviser against certain liabilities, which may lead the Adviser to act in a riskier manner on our behalf than it would when acting for its own account.
Under the Advisory Agreement, the Adviser has not assumed any responsibility to us other than to render the services called for under that agreement. It will not be responsible for any action of our board of directors in following or declining to follow the Adviser’s advice or recommendations. Under the Advisory Agreement, the Adviser, its officers, members and personnel, and any person controlling or controlled by the Adviser will not be liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the Advisory Agreement, except those resulting from acts constituting gross negligence, willful misconduct, bad faith or reckless disregard of the duties that the Adviser owes to us under the Advisory Agreement. In addition, as part of the Advisory Agreement, we have agreed to indemnify the Adviser and each of its officers, directors, members, managers and employees from and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority granted by the Advisory Agreement, except where attributable to gross negligence, willful misconduct, bad faith or reckless disregard of such person’s duties under the Advisory Agreement. These protections may lead the Adviser to act in a riskier manner when acting on our behalf than it would when acting for its own account.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.
A number of entities compete with us to make the types of investments that we make. We compete with public and private funds, other BDCs, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some of our competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act
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imposes on us as a BDC or the source-of-income, asset diversification and distribution requirements we must satisfy to maintain our RIC qualification. The competitive pressures we face may have a material adverse effect on our business, financial condition, results of operations and cash flows. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we may not be able to identify and make investments that are consistent with our investment objective.
With respect to the investments we make, we do not seek to compete based primarily on the interest rates we offer, and we believe that some of our competitors may make loans with interest rates that will be lower than the rates we offer. With respect to all investments, we may lose some investment opportunities if we do not match our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we may experience decreased net interest income, lower yields and increased risk of credit loss.
We will be subject to corporate-level U.S. federal income tax if we are unable to maintain our qualification as a RIC under Subchapter M of the Code.
To maintain our qualification as a RIC under Subchapter M of the Code, we must meet certain source-of-income, asset diversification and distribution requirements. The source-of-income 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 distribution requirement for a RIC is satisfied if we 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 stockholders on an annual basis. Because we incur debt, we will be subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to maintain our qualification as a RIC. If we are unable to obtain cash from other sources, we may fail to maintain our qualification as a RIC and, thus, may be subject to corporate-level U.S. federal income tax. To maintain our qualification as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of our qualification as a RIC. Because most of our investments are in private or thinly traded public companies, any such dispositions may be made at disadvantageous prices and may result in substantial losses. No certainty can be provided that we will satisfy the asset diversification requirements of the other requirements necessary to maintain our qualification as a RIC. If we fail to maintain our qualification as a RIC for any reason and become subject to corporate-level U.S. federal income tax, the resulting taxes could substantially reduce our net assets, the amount of income available for distributions to our stockholders and the amount of funds available for new investments. Such a failure would have a material adverse effect on us and our stockholders. See “Business — Taxation as a Regulated Investment Company.”
We may need to raise additional capital to grow because we must distribute most of our income.
We may need additional capital to fund new investments and grow our portfolio of investments. We intend to access the capital markets periodically to issue debt or equity securities or borrow from financial institutions in order to obtain such additional capital. Unfavorable economic conditions 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. A reduction in the availability of new capital could limit our ability to grow. In addition, we are required to 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 stockholders to maintain our qualification as a RIC. As a result, these earnings will not be available to fund new investments. An inability on our part to access the capital markets successfully could limit our ability to grow our business and execute our business strategy fully and could decrease our earnings, if any, which would have an adverse effect on the value of our securities.
Our distributions to stockholders may be funded, in part, from waivers of investment advisory fees by the Adviser.
To the extent, any distributions by us are funded through waivers of the incentive fee portion of our investment advisory fees such distributions will not be based on our investment performance, and can only be
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sustained if we achieve positive investment performance in future periods and/or the Adviser continues to waive such fees. Any such waivers in no way imply that the Adviser will waive incentive fees in any future period. There can be no assurance that we will achieve the performance necessary or that the Adviser will waive all or any portion of the incentive fee necessary to be able to pay distributions at a specific rate or at all.
There is a risk that you may not receive distributions or that our distributions may not grow over time or a portion of your distributions may be a return of capital.
We intend to make distributions on a quarterly basis to our stockholders out of assets legally available for distribution. We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. Our ability to pay distributions might be adversely affected by the impact of one or more of the risk factors described in this annual report on Form 10-K, including the COVID-19 pandemic described above. For example, if the temporary complete or partial closure of many corporate offices, retail stores, and manufacturing facilities and factories in the jurisdictions, including the United States, affected by the COVID-19 pandemic were to continue for an extended period of time it could result in reduced cash flows to us from our existing portfolio companies, which could reduce cash available for distribution to our stockholders. Due to the asset coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make distributions. If we violate certain covenants under our existing or future credit facilities or other leverage, we may be limited in our ability to make distributions. If we declare a distribution and because more of our stockholders have opted to receive cash distributions rather than participate in our dividend reinvestment plan, we may be forced to sell some of our investments in order to make cash distribution payments. To the extent we make distributions to stockholders that include a return of capital, such portion of the distribution essentially constitutes a return of the stockholder’s investment. Although such return of capital may not be taxable, such distributions would generally decrease a stockholder’s basis in our common stock and may therefore increase such stockholder’s tax liability for capital gains upon the future sale of such stock. A return of capital distribution may cause a stockholder to recognize a capital gain from the sale of our common stock even if the stockholder sells its shares for less than the original purchase price. All distributions will be made at the discretion of our board of directors and will depend on our earnings, financial condition, maintenance of RIC status, compliance with applicable BDC regulations, and such other factors as our board of directors may deem relative from time to time. We cannot assure you that we will make distributions to our stockholders in the future.
Due to the COVID-19 pandemic or other disruptions in the economy, we may not be able to increase our dividends and may reduce or defer our dividends and choose to incur U.S. federal excise tax in order preserve cash and maintain flexibility.
As a BDC, we are not required to make any distributions to stockholders other than in connection with our election to be taxed as a RIC under subchapter M of the Code. In order to maintain our tax treatment as a RIC, we must distribute to shareholders for each taxable year at least 90% of our investment company taxable income (i.e., net ordinary income plus realized net short-term capital gains in excess of realized net long-term capital losses). If we qualify for taxation as a RIC, we generally will not be subject to corporate-level U.S. federal income tax on our investment company taxable income and net capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) that we timely distribute to stockholders. We will be subject to a 4% U.S. federal excise tax on undistributed earnings of a RIC unless we distribute each calendar year at least the sum of (i) 98.0% 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 ending on October 31 of the calendar 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.
Under the Code, we may satisfy certain of our RIC distributions with dividends paid after the end of the current year. In particular, if we pay a distribution in January of the following year that was declared in October, November, or December of the current year and is payable to stockholders of record in the current year, the
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dividend will be treated for all US federal tax purposes as if it were paid on December 31 of the current year. In addition, under the Code, we may pay dividends, referred to as “spillover dividends,” that are paid during the following taxable year that will allow us to maintain our qualification for taxation as a RIC and eliminate our liability for corporate-level U.S. federal income tax. Under these spillover dividend procedures, we may defer distribution of income earned during the current year until December of the following year. For example, we may defer distributions of income earned during 2020 until as late as December 31, 2021. If we choose to pay a spillover dividend, we will incur the 4% U.S. federal excise tax on some or all of the distribution.
Due to the COVID-19 pandemic or other disruptions in the economy, we may take certain actions with respect to the timing and amounts of our distributions in order to preserve cash and maintain flexibility. For example, we may not be able to increase our dividends. In addition, we may reduce our dividends and/or defer our dividends to the following taxable year. If we defer our dividends, we may choose to utilize the spillover dividend rules discussed above and incur the 4% U.S. federal excise tax on such amounts. To further preserve cash, we may combine these reductions or deferrals of dividends with one or more distributions that are payable partially in our stock, as discussed under “—We may in the future choose to pay dividends in our own stock, in which case you may be required to pay U.S. federal income taxes in excess of the cash you receive.”
We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
For U.S. federal income tax purposes, we will include in income certain amounts that we have not yet received in cash, such as the accrual of OID. This may arise if we receive warrants in connection with the making of a loan and in other circumstances, or through contracted PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. Such OID, which could be significant relative to our overall investment activities and increases in loan balances as a result of contracted PIK arrangements will be included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we will not receive in cash.
Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to maintain our qualification as a RIC. In such a case, we may have to sell some of our investments at times we would not consider advantageous or raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements. If we are not able to obtain such cash from other sources, we may fail to maintain our qualification as a RIC and thus be subject to corporate-level U.S. federal income tax. See “Business — Taxation as a Regulated Investment Company.”
We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive.
We may distribute taxable dividends that are payable in part in our stock. Under certain applicable provisions of the Code and the Treasury regulations, distributions payable in cash or in shares of stock at the election of stockholders are treated as taxable dividends. The Internal Revenue Service has issued a revenue procedure indicating that this rule will apply if the total amount of cash to be distributed is not less than 20% (which has been temporarily reduced to 10% for distributions declared on or after April 1, 2020, and on or before December 31, 2020) of the total distribution. Under this revenue procedure, if too many stockholders elect to receive their distributions in cash, each such stockholder would receive a pro rata share of the total cash to be distributed and would receive the remainder of their distribution in shares of stock. If we decide to make any distributions consistent with this revenue procedure that are payable in part in our stock, taxable stockholders receiving such dividends will be required to include the full amount of the dividend (whether received in cash, our stock, or combination thereof) as ordinary income (or as long-term capital gain to the extent such distribution is properly designated as a capital gain dividend) to the extent of our current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with
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respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. If a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our stock.
Regulations governing our operation as a BDC affect our ability to, and the way in which we raise additional capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, we are permitted as a BDC to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 150% of our gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we would not be able to borrow additional funds until we were able to comply with the 150% asset coverage ratio under the 1940 Act. Also, any amounts that we use to service our indebtedness would not be available for distributions to our common stockholders. If we issue senior securities, we will be exposed to typical risks associated with leverage, including an increased risk of loss.
As a result of the COVID-19 pandemic, generally the stocks of BDCs as an industry have traded below net asset value at or near historic lows as a result of concerns over liquidity, leverage restrictions and distribution requirements. We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below then-current net asset value per share of our common stock if our board of directors determines that such sale is in our best interests. At a meeting initially convened on November 6, 2019 and reconvened on December 5, 2019, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one year anniversary of the date of the Company’s 2019 Annual Meeting of Stockholders and the date of the Company’s 2020 Annual Meeting of Stockholders, which we expect to be held in November 2020. Our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. In addition, we cannot issue shares of our common stock below net asset value unless our board of directors determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In addition, continuous sales of common stock below net asset value may have a negative impact on total returns and could have a negative impact on the market price of our shares of common stock. 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 may experience dilution.
The 1940 Act allows us to incur additional leverage.
The 1940 Act generally prohibits us from incurring indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). However, on March 23, 2018, the 1940 Act was amended to allow BDCs to decrease their asset coverage requirement from 200% to 150%, if certain requirements are met.
On May 2, 2018, our board of directors, including a “required majority” approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, our asset coverage requirements for senior securities changed from 200% to 150%, effective May 2, 2019.
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Leverage magnifies the potential for loss on investments and on invested equity capital. As we use leverage to partially finance our investments, you will experience increased risks of investing in our securities. 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 our business. 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 net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to pay common stock dividends, scheduled debt payments or other payments related to our securities. Increased leverage may also cause a downgrade of our credit rating. See the risk factor below. Leverage is generally considered a speculative investment technique. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. If we continue to use leverage to partially finance our investments through banks, insurance companies and other lenders, you will experience increased risks of investment in our common stock. Lenders of these funds have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect such lenders to seek recovery against our assets in the event of a default.
As of June 30, 2020, substantially all of our assets were pledged as collateral under the Financing Facilities. In addition, under the terms of the Financing Facilities and any borrowing facility or other debt instrument we may enter into, we are likely to be required to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed under such facility or instrument before applying such net proceeds to any other uses. 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, thereby magnifying losses or eliminating our stake in a leveraged investment. Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would also negatively affect our ability to make distributions with respect to our common stock or preferred stock. Our ability to service any debt will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures. Moreover, as the Base Management Fee payable to the Adviser will be payable based on the value of our gross assets, including those assets acquired through the use of leverage, the Adviser will have a financial incentive to incur leverage, which may not be consistent with our stockholders’ interests. In addition, our common stockholders will bear the burden of any increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the Base Management Fee payable to the Adviser.
In addition, our debt facilities may impose financial and operating covenants that restrict our business activities, including limitations that hinder our ability to finance additional loans and investments or to make the distributions required to maintain our qualification as a RIC under the Code.
We may default under the Financing Facilities or any future borrowing facility we enter into or be unable to amend, repay or refinance any such facility on commercially reasonable terms, or at all, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
In the event we default under the Financing Facilities or any other future borrowing facility, our business could be adversely affected as we may be forced to sell a portion of our investments quickly and prematurely at prices that may be disadvantageous to us in order to meet our outstanding payment obligations and/or support working capital requirements under the Financing Facilities or such future borrowing facility, any of which would have a material adverse effect on our business, financial condition, results of operations and cash flows. In addition, following any such default, the agent for the lenders under the Financing Facilities or such future borrowing facility could assume control of the disposition of any or all of our assets, including the selection of such assets to be disposed and the timing of such disposition, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.
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Provisions in the Financing Facilities or any other future borrowing facility may limit our discretion in operating our business.
The Financing Facilities are, and any future borrowing facility may be, backed by all or a portion of our loans and securities on which the lenders will or, in the case of a future facility, may have a security interest. We may pledge up to 100% of our assets and may grant a security interest in all of our assets under the terms of any debt instrument we enter into with lenders. We expect that any security interests we grant will be set forth in a pledge and security agreement and evidenced by the filing of financing statements by the agent for the lenders. In addition, we expect that the custodian for our securities serving as collateral for such loan would include in its electronic systems notices indicating the existence of such security interests and, following notice of occurrence of an event of default, if any, and during its continuance, will only accept transfer instructions with respect to any such securities from the lender or its designee. If we were to default under the terms of any debt instrument, the agent for the applicable lenders would be able to assume control of the timing of disposition of any or all of our assets securing such debt, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.
In addition, any security interests as well as negative covenants under the Financing Facilities or any other borrowing facility may limit our ability to create liens on assets to secure additional debt and may make it difficult for us to restructure or refinance indebtedness at or prior to maturity or obtain additional debt or equity financing. In addition, if our borrowing base under the Financing Facilities or any other borrowing facility were to decrease, we would be required to secure additional assets in an amount equal to any borrowing base deficiency. In the event that all of our assets are secured at the time of such a borrowing base deficiency, we could be required to repay advances under the Financing Facilities or any other borrowing facility or make deposits to a collection account, either of which could have a material adverse impact on our ability to fund future investments and to make stockholder distributions.
In addition, under the Financing Facilities or any future borrowing facility we will be subject to limitations as to how borrowed funds may be used, which may include restrictions on geographic and industry concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings, as well as regulatory restrictions on leverage, which may affect the amount of funding that may be obtained. There may also be certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, a violation of which could limit further advances and, in some cases, result in an event of default. An event of default under the Financing Facilities or any other borrowing facility could result in an accelerated maturity date for all amounts outstanding thereunder, which could have a material adverse effect on our business and financial condition. This could reduce our revenues and, by delaying any cash payment allowed to us under the Financing Facilities or any other borrowing facility until the lenders have been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our qualification as a RIC.
Because we borrow money to make our investments, if market interest rates were to increase, our cost of capital could increase, which could reduce our net investment income.
Because we borrow money to make investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates would not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. There is no limit on our ability to enter derivative transactions.
In addition, a rise in the general level of interest rates typically leads to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates may result in an increase of the amount of our pre-incentive fee net investment income and, as a result, an increase in incentive fees payable to the Adviser.
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Adverse developments in the credit markets may impair our ability to secure debt financing.
In past economic downturns, such as the financial crisis in the United States that began in mid-2007 and during other times of extreme market volatility, many commercial banks and other financial institutions stopped lending or significantly curtailed their lending activity. In addition, in an effort to stem losses and reduce their exposure to segments of the economy deemed to be high risk, some financial institutions limited routine refinancing and loan modification transactions and even reviewed the terms of existing facilities to identify bases for accelerating the maturity of existing lending facilities. If these conditions recur, for example as a result of the COVID-19 pandemic, it may be difficult for us to obtain desired financing to finance the growth of our investments on acceptable economic terms, or at all.
So far, the COVID-19 pandemic has resulted in, and until fully resolved is likely to continue to result in, among other things, increased draws by borrowers on revolving lines of credit and increased requests by borrowers for amendments, modifications and waivers of their credit agreements to avoid default or change payment terms, increased defaults by such borrowers and/or increased difficulty in obtaining refinancing at the maturity dates of their loans. In addition, the duration and effectiveness of responsive measures implemented by governments and central banks cannot be predicted. The commencement, continuation, or cessation of government and central bank policies and economic stimulus programs, including changes in monetary policy involving interest rate adjustments or governmental policies, may contribute to the development of or result in an increase in market volatility, illiquidity and other adverse effects that could negatively impact the credit markets and the Company.
If we are unable to consummate credit facilities on commercially reasonable terms, our liquidity may be reduced significantly. If we are unable to repay amounts outstanding under any facility we may enter into and are declared in default or are unable to renew or refinance any such facility, it would limit our ability to initiate significant originations or to operate our business in the normal course. These situations may arise due to circumstances that we may be unable to control, such as inaccessibility of the credit markets, a severe decline in the value of the U.S. dollar, a further economic downturn or an operational problem that affects third parties or us and could materially damage our business. Moreover, we are unable to predict when economic and market conditions may become more favorable. Even if such conditions improve broadly and significantly over the long term, adverse conditions in particular sectors of the financial markets could adversely impact our business.
Our ability to enter into transactions involving derivatives and financial commitment transactions may be limited.
In November 2019, the SEC proposed a rule regarding the ability of a BDC (or a registered investment company) to use derivatives and other transactions that create future payment or delivery obligations (except reverse repurchase agreements and similar financing transactions). If adopted as proposed, BDCs that use derivatives would be subject to a value-at-risk (“VaR”) leverage limit, certain other derivatives risk management program and testing requirements and requirements related to board reporting. These new requirements would apply unless the BDC qualified as a “limited derivatives user,” as defined in the SEC’s proposal. A BDC that enters into reverse repurchase agreements or similar financing transactions would need to aggregate the amount of indebtedness associated with the reverse repurchase agreements or similar financing transactions with the aggregate amount of any other senior securities representing indebtedness when calculating the BDC’s asset coverage ratio. Under the proposed rule, a BDC may enter into an unfunded commitment agreement that is not a derivatives transaction, such as an agreement to provide financing to a portfolio company, if the BDC has a reasonable belief, at the time it enters into such an agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to all of its unfunded commitment agreements, in each case as it becomes due. If the BDC cannot meet this test, it is required to treat unfunded commitments as a derivatives transaction subject to the requirements of the rule. Collectively, these proposed requirements, if adopted, may limit our ability to use derivatives and/or enter into certain other financial contracts.
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The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.
The occurrence of a disaster such as a cyber-attack against us or against a third party that has access to our data or networks, a natural catastrophe, an industrial accident, a terrorist attack or war, events unanticipated in our disaster recovery systems, or a support failure from external providers, could have an adverse effect on our ability to conduct business and on our results of operations and financial condition, particularly if those events affect our computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a significant number of our managers were unavailable in the event of a disaster, our ability to effectively conduct our business could be severely compromised.
We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems could be subject to cyber-attacks and unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other companies, we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could result in damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer dissatisfaction or loss.
Third parties with which we do business may also be sources of cybersecurity or other technological risks. We outsource certain functions and these relationships allow for the storage and processing of our information, as well as customer, counterparty, employee and borrower information. While we engage in actions to reduce our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure or destruction of data, or other cybersecurity incidents, with increased costs and other consequences, including those described above.
We and our service providers may be impacted by quarantines and similar measures enacted by governments in response to virus pandemics such as COVID-19, which may obstruct the regular functioning of business workforces (including requiring employees to work from external locations and their homes). Accordingly, the risks described above are heightened under current conditions.
Increased geopolitical unrest, terrorist attacks, or acts of war may affect any market for our common stock, impact the businesses in which we invest, and harm our business, operating results, and financial conditions.
Terrorist activity and the continued threat of terrorism and acts of civil or international hostility, both within the United States and abroad, as well as ongoing military and other actions and heightened security measures in response to these types of threats, may cause significant volatility and declines in the global markets, loss of life, property damage, disruptions to commerce and reduced economic activity, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have a material adverse impact on our business, operating results, and financial condition. Losses from terrorist attacks are generally uninsurable.
Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies and, in turn, harm us.
There has been ongoing discussion and commentary regarding potential significant changes to United States trade policies, treaties and tariffs. The current administration, along with Congress, has created significant uncertainty about the future relationship between the United States and other countries with respect to the trade policies, treaties and tariffs. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States.
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Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and have a material adverse effect on their business, financial condition and results of operations, which in turn would negatively impact us.
Economic sanction laws in the United States and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and companies.
Economic sanction laws in the United States and other jurisdictions may prohibit us or our affiliates from transacting with certain countries, individuals and companies. In the United States, the U.S. Department of the Treasury’s Office of Foreign Assets Control administers and enforces laws, executive orders and regulations establishing U.S. economic and trade sanctions, which prohibit, among other things, transactions with, and the provision of services to, certain non-U.S. countries, territories, entities and individuals. These types of sanctions may significantly restrict or completely prohibit investment activities in certain jurisdictions, and if we, our portfolio companies or other issuers in which we invest were to violate any such laws or regulations, we may face significant legal and monetary penalties.
The Foreign Corrupt Practices Act, or FCPA, and other anti-corruption laws and regulations, as well as anti-boycott regulations, may also apply to and restrict our activities, our portfolio companies and other issuers of our investments. If an issuer or we were to violate any such laws or regulations, such issuer or we may face significant legal and monetary penalties. The U.S. government has indicated that it is particularly focused on FCPA enforcement, which may increase the risk that an issuer or us becomes the subject of such actual or threatened enforcement. In addition, certain commentators have suggested that private investment firms and the funds that they manage may face increased scrutiny and/or liability with respect to the activities of their underlying portfolio companies. As such, a violation of the FCPA or other applicable regulations by us or an issuer of our portfolio investments could have a material adverse effect on us. We are committed to complying with the FCPA and other anti-corruption laws and regulations, as well as anti-boycott regulations, to which it is subject. As a result, we may be adversely affected because of our unwillingness to enter into transactions that violate any such laws or regulations.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs of customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or services is material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition, through decreased revenues. Extreme weather conditions in general require more system backup, adding to costs, and can contribute to increased system stresses, including service interruptions.
If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to maintain our qualification as a BDC or be precluded from investing according to our current business strategy.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe to be attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in
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existing portfolio companies (which could result in the dilution of our position) or could require us to dispose of investments at inappropriate times in order to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it could be difficult to dispose of such investments on favorable terms. We may not be able to find a buyer for such investments and, even if we do find a buyer, we may have to sell the investments at a substantial loss. Any such outcomes would have a material adverse effect on our business, financial condition, results of operations and cash flows.
If we do not maintain our status as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act. As a registered closed-end investment company, we would be subject to substantially more regulatory restrictions under the 1940 Act, which would significantly decrease our operating flexibility.
Substantially all of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.
Substantially all of our portfolio investments are securities that are not publicly traded. The fair value of loans, securities and other investments that are not publicly traded may not be readily determinable, and we will value these investments at fair value as determined in good faith by our board of directors, including to reflect significant events affecting the value of our investments. Most, if not all, of our investments (other than cash and cash equivalents) will be classified as Level 3 under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 820: Fair Value Measurements and Disclosures (“ASC 820”). This means that our portfolio valuations will be based on unobservable inputs and our own assumptions about how market participants would price the asset or liability in question. Inputs into the determination of fair value of our portfolio investments require significant management judgment or estimation. Even if observable market data are available, such information may be the result of consensus pricing information or broker quotes, which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimers materially reduces the reliability of such information. We have retained the services of independent service providers to review the valuation of these loans and securities. The types of factors that the board of directors may take into account in determining the fair value of our investments generally include, as appropriate, comparison to publicly traded securities including such factors as yield, maturity and measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business and other relevant factors. 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 loans and securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such loans and securities.
We adjust quarterly the valuation of our portfolio to reflect our board of directors’ determination of the fair value of each investment in our portfolio. Any changes in fair value are recorded in our statement of operations as net change in unrealized appreciation or depreciation.
We may experience fluctuations in our quarterly operating results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on the loans and debt securities we acquire, the default rate on such loans and securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. In light of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
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Efforts to comply with Section 404 of the Sarbanes-Oxley Act involve significant expenditures, and if we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.
We are subject to the Sarbanes-Oxley Act, and the related rules and regulations promulgated by the SEC. Under current SEC rules, we are required to report on internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act 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.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations. In addition, any testing by us conducted in connection with Section 404 of the Sarbanes-Oxley Act may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive changes to our consolidated financial statements or identify other areas for further attention or improvement. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
As a non-accelerated filer, we are not required to comply with the auditor attestation requirements of the Sarbanes-Oxley Act.
As of June 30, 2020, we are a non-accelerated filer under the Exchange Act and, therefore, we are not required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act. Therefore, our internal controls over financial reporting will not receive the level of review provided by the process relating to the auditor attestation included in annual reports of issuers that are subject to the auditor attestation requirements. In addition, we cannot predict if investors will find our common stock less attractive because we are not required to comply with the auditor attestation requirements. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and trading price for our common stock may be negatively affected.
New or amended laws or regulations governing our operations may adversely affect our business.
We and our portfolio companies will be subject to regulation by laws at the U.S. federal, state and local levels. These laws and regulations, as well as their interpretation, may change from time to time, and new laws, regulations and interpretations may also come into effect. Any such new or changed laws or regulations could have a material adverse effect on our business.
Additionally, changes to the laws and regulations governing our operations related to permitted investments may cause us to alter our investment strategy in order to avail ourselves of new or different opportunities. Such changes could result in material differences to the strategies and plans set forth in this annual report on Form 10-K and our filings with the SEC, and may shift our investment focus from the areas of expertise of the Adviser to other types of investments in which the Adviser may have little or no expertise or experience. Any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment.
Our board of directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.
Our board of directors has the authority, except as otherwise provided in the 1940 Act, to modify or waive our investment objective or certain of our operating policies and strategies without prior notice and without
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stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and the market price of our common stock. Nevertheless, any such changes could adversely affect our business and impair our ability to make distributions to our stockholders.
The Adviser can resign as the Adviser or administrator upon 60 days’ notice and we may not be able to find a suitable replacement within that time, or at all, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
The Adviser has the right under the Advisory Agreement to resign as the Adviser at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. Similarly, the Adviser has the right under the Administration Agreement to resign at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. If the Adviser were to resign, we may not be able to find a new investment adviser or administrator or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions to our stockholders are likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management and investment or administrative activities, as applicable, is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by the Adviser. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.
We are dependent on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.
Our business is highly dependent on the communications and information systems of the Adviser, which are provided to us on behalf of the Adviser by Investcorp pursuant to the Investcorp Services Agreement directly or through third party service providers. Any failure or interruption of those systems, including as a result of the termination of the Investcorp Services Agreement or an agreement with any third-party service providers, could cause delays or other problems in our activities. Our financial, accounting, data processing, backup or other operating systems and facilities may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control and adversely affect our business. There could be:
| • | sudden electrical or telecommunications outages; |
| • | natural disasters such as earthquakes, tornadoes and hurricanes; |
| • | disease pandemics; |
| • | events arising from local or larger scale political or social matters, including terrorist acts; and |
| • | cyber-attacks. |
These events, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay dividends to our stockholders.
The current state of the economy and financial markets of the United States, China and other several countries in the European Union increases the likelihood of adverse effects on our financial position and results of operations.
Due to federal budget deficit concerns, S&P downgraded the federal government’s credit rating from AAA to AA+ for the first time in history on August 5, 2011. Further, Moody’s and Fitch had warned that they may
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downgrade the federal government’s credit rating. Further downgrades or warnings by S&P or other rating agencies, and the United States government’s credit and deficit concerns in general, could cause interest rates and borrowing costs to rise, which may negatively impact both the perception of credit risk associated with our debt portfolio and our ability to access the debt markets on favorable terms. In addition, a decreased U.S. government credit rating could create broader financial turmoil and uncertainty, which may weigh heavily on our financial performance and the value of our common stock.
In 2010, a financial crisis emerged in Europe, triggered by high budget deficits and rising direct and contingent sovereign debt in Greece, Ireland, Italy, Portugal and Spain, which created concerns about the ability of these nations to continue to service their sovereign debt obligations. While the financial stability of many of such countries has improved significantly, risks resulting from any future debt crisis in Europe or any similar crisis could have a detrimental impact on the global economic recovery, sovereign and non-sovereign debt in these countries and the financial condition of European financial institutions. In July and August 2015, Greece reached agreements with its international creditors for bailouts that provide aid in exchange for austerity terms that had previously been rejected by Greek voters. Market and economic disruptions have affected, and may in the future affect, consumer confidence levels and spending, personal bankruptcy rates, levels of incurrence and default on consumer debt and home prices, among other factors. We cannot assure you that market disruptions in Europe, including the increased cost of funding for certain governments and financial institutions, will not impact the global economy, and we cannot assure you that assistance packages will be available, or if available, be sufficient to stabilize countries and markets in Europe or elsewhere affected by a financial crisis. To the extent uncertainty regarding any economic recovery in Europe negatively impacts consumer confidence and consumer credit factors, our business, financial condition and results of operations could be significantly and adversely affected.
In the second quarter of 2015, stock prices in China experienced a significant drop, resulting primarily from continued selloff of shares trading in Chinese markets. In addition, in August 2015, Chinese authorities sharply devalued China’s currency. Since then, the Chinese capital markets have continued to experience periods of instability. In June 2016, British voters passed a referendum to exit the European Union leading to heightened volatility in global markets and foreign currencies. These market and economic disruptions have affected, and may in the future affect, the U.S. capital markets, which could adversely affect our business, financial condition or results of operations.
In October 2014, the Federal Reserve announced that it was concluding its bond-buying program, or quantitative easing, which was designed to stimulate the economy and expand the Federal Reserve’s holdings of long-term securities, suggesting that key economic indicators, such as the unemployment rate, had showed signs of improvement since the inception of the program. It is unclear what effect, if any, the conclusion of the Federal Reserve’s bond-buying program will have on the value of our investments. Additionally, the Federal Reserve decreased its Federal Funds Rate in July 2019, which marked the first decrease since 2008. In March 2020, the Federal Reserve again decreased its Federal Funds Rate in response to the COVID-19 pandemic. The effect of this and other recent efforts taken by the Federal Reserve to address the economic impact of the COVID-19 pandemic are not yet fully known. For more information, see “—The capital markets are currently in a period of disruption and economic uncertainty. Such market conditions have materially and adversely affected the debt and equity capital markets, which has had, and may continue to have, a negative impact on our business, financial condition and results of operations.” However, if key economic indicators, such as the unemployment rate or inflation, do not progress at a rate consistent with the Federal Reserve’s objectives, the target range for the Federal Funds Rate may increase.
These developments, including the United States government’s credit and deficit concerns, the European sovereign debt crisis, the economic slowdown in China, and global market volatility resulting from the COVID-19 pandemic, could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms.
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Uncertainty of the U.S. political climate could negatively impact our business, financial condition and earnings.
The same party currently controls the executive branch and the senate portion of the legislative branch of government, which increases the likelihood that legislation may be adopted that could significantly affect the regulation of U.S. financial markets. Areas subject to potential change, amendment or repeal include the Dodd-Frank Wall Street Reform and Consumer Protection Act and the authority of the Federal Reserve and the Financial Stability Oversight Council. The United States may also potentially withdraw from or renegotiate various trade agreements and take other actions that would change current trade policies of the United States. We cannot predict which, if any, of these actions will be taken or, if taken, their effect on the financial stability of the United States. Such actions could have a significant adverse effect on our business, financial condition and results of operations. We cannot predict the effects of these or similar events in the future on the U.S. economy and securities markets or on its investments. We monitor developments and seek to manage investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
The current U.S. presidential administration has called for significant changes to U.S. trade, healthcare, immigration, foreign and government regulatory policy. In this regard, there is significant uncertainty with respect to legislation, regulation and government policy at the federal level, as well as the state and local levels. Recent events have created a climate of heightened uncertainty and introduced new and difficult-to-quantify macroeconomic and political risks with potentially far-reaching implications. There has been a corresponding meaningful increase in the uncertainty surrounding interest rates, inflation, foreign exchange rates, trade volumes and fiscal and monetary policy. To the extent the U.S. Congress or the current administration implements changes to U.S. policy, those changes may impact, among other things, the U.S. and global economy, international trade and relations, unemployment, immigration, corporate taxes, healthcare, the U.S. regulatory environment, inflation and other areas. Although we cannot predict the impact, if any, of these changes to business, they could adversely affect our business, financial condition, operating results and cash flows. Until we know what policy changes are made and how those changes impact business and the business of our competitors over the long term, we will not know if, overall, we will benefit from them or be negatively affected by them.
Our board of directors is authorized to reclassify any unissued shares of common stock into one or more classes of preferred stock, which could convey special rights and privileges to its owners.
Under Maryland General Corporation Law and our charter, our board of directors is authorized to classify and reclassify any authorized but unissued shares of stock into one or more classes of stock, including preferred stock. Prior to issuance of shares of each class or series, the board of directors will be required by Maryland law and our charter to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to stockholder distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of preferred stock with terms and conditions that could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our common stock or that otherwise might be in their best interest. The cost of any such reclassification would be borne by our common stockholders. The issuance of preferred shares convertible into shares of common stock may also reduce the net income and net asset value per share of our common stock upon conversion, provided, that we will only be permitted to issue such convertible preferred stock to the extent we comply with the requirements of Section 61 of the 1940 Act, including obtaining common stockholder approval. These effects, among others, could have an adverse effect on your investment in our common stock.
Certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock. For example, the 1940 Act provides that holders of preferred stock are entitled to vote separately from holders of common stock to elect two preferred stock directors. We currently have no plans to issue preferred stock.
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Provisions of the Maryland General Corporation Law and of our charter and bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.
Our board of directors is divided into three classes of directors serving staggered terms. A classified board may render a change in control of us or removal of our incumbent management more difficult. The Maryland General Corporation Law and our charter and bylaws contain additional provisions that may discourage, delay or make more difficult a change in control of Investcorp Credit Management BDC, Inc. or the removal of our directors. We are subject to the Maryland Business Combination Act, subject to any applicable requirements of the 1940 Act. Our board of directors has adopted a resolution exempting from the Business Combination Act any business combination between us and any other person, subject to prior approval of such business combination by our board of directors, including approval by a majority of the Independent Directors. If the resolution exempting business combinations is repealed or our board of directors does not approve a business combination, the Business Combination Act may discourage third parties from trying to acquire control of us and increase the difficulty of consummating such an offer. Our bylaws exempt from the Maryland Control Share Acquisition Act acquisitions of our stock by any person. If we amend our bylaws to repeal the exemption from the Control Share Acquisition Act, the Control Share Acquisition Act also may make it more difficult for a third party to obtain control of us and increase the difficulty of consummating such a transaction.
We have also adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our charter classifying our board of directors in three classes serving staggered three-year terms, and authorizing our board of directors to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our stock, to amend our charter without stockholder approval and to increase or decrease the number of shares of stock that we have authority to issue. These provisions, as well as other provisions of our charter and bylaws, may delay, defer or prevent a transaction or a change in control that might otherwise be in the best interests of our stockholders.
Risks Relating to our Investments
Economic recessions or downturns could adversely affect our portfolio companies, leading to defaults on our investments, which would harm our operating results.
Many of the portfolio companies in which we expect to make investments, including those currently included in our portfolio, are likely to be susceptible to economic slowdowns or recessions and may be unable to repay our loans during such periods. In such event, the number of our non-performing assets is likely to increase and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions may decrease the value of collateral securing some of our loans and debt securities and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investments and harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the loans and debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company.
We may hold the loans and debt securities of leveraged companies that may, due to the significant operating volatility typical of such companies, enter into bankruptcy proceedings, and we could lose all or part of our investment, which would harm our operating results.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which we invest may have limited financial resources and may be unable to meet their obligations under their loans and debt securities that we hold. Such developments may be accompanied by a deterioration in the value of any
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collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in connection with our investment. Smaller leveraged companies also may have less predictable operating results and may require substantial additional capital to support their operations, finance their expansion or maintain their competitive position.
Leveraged companies may also experience bankruptcy or similar financial distress. The bankruptcy process has a number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversarial proceedings and are beyond the control of the creditors. A bankruptcy filing by a portfolio company may adversely and permanently affect that company. If the proceeding is converted to a liquidation, the value of the portfolio company may not equal the liquidation value that was believed to exist at the time of the investment. The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on investment can be adversely affected by delays until the plan of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for example, claims for taxes) may be substantial.
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 assets. This could trigger cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations under the loans or 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.
Credit risk is the potential loss we may incur from a failure of a company to make payments according to the terms of a contract. We are subject to credit risk because of our strategy of investing in the debt of leveraged companies and our involvement in derivative instruments. Our exposure to credit risk on our investments is limited to the fair value of the investments. Our derivative contracts are executed pursuant to an International Swaps and Derivatives Association master agreement that we currently have in place with UBS with respect to the Term Financing. Any material exposure due to counter-party risk under the Term Financing or the Financing Facilities, generally, could have a material adverse effect on our operating results.
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, even though we may have structured our interest as senior debt, depending on the facts and circumstances, including the extent to which we may have actually provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to that of other creditors. In addition, lenders can be subject to lender liability claims for actions taken by them where they become too involved in the borrower’s business or exercise control over the borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken if we actually render significant managerial assistance.
Our investments in private and middle-market portfolio companies are risky, and we could lose all or part of our investment.
Investment in private and middle-market companies involves a number of significant risks. Generally, little public information exists about these companies, and we will rely on the ability of the Adviser’s investment professionals to obtain adequate information to evaluate the potential returns and risks from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully
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informed investment decision, and we may lose money on our investments. Middle-market companies may have limited financial resources and may be unable to meet their obligations under their loans and 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 our realizing any guarantees we may have obtained in connection with our investment. In addition, such companies typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. Additionally, middle-market companies are more likely to depend on the management talents and efforts of a small group of persons. Therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on one or more of the portfolio companies we invest in and, in turn, on us. Middle-market companies also may be parties to litigation and may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence. In addition, our executive officers, directors and investment adviser may, in the ordinary course of business, be named as defendants in litigation arising from our investments in portfolio companies.
Our investments may include PIK interest.
To the extent that we invest in loans with a PIK interest component and the accretion of PIK interest constitutes a portion of our income, we will be exposed to risks associated with the requirement to include such non-cash income in taxable and accounting income prior to receipt of cash, including the following:
| • | loans with a PIK interest component may have higher interest rates that reflect the payment deferral and increased credit risk associated with these instruments, and PIK instruments generally represent a significantly higher credit risk than coupon loans; |
| • | loans with a PIK interest component may have unreliable valuations because their continuing accruals require continuing judgments about the collectability of the deferred payments and the value of any associated collateral; |
| • | the deferral of PIK interest increases the loan-to-value ratio, which is a fundamental measure of loan risk; and |
| • | even if the accounting conditions for PIK interest accrual are met, the borrower could still default when the borrower’s actual payment is due at the maturity of the loan. |
We may expose ourselves to risks if we engage in hedging transactions.
If we engage in hedging transactions, we may expose ourselves to risks associated with such transactions. We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
The success of our hedging transactions will depend on our ability to correctly predict movements in currencies and interest rates. Therefore, while we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being
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hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency fluctuations.
The lack of liquidity in our investments may adversely affect our business.
All of our assets may be invested in illiquid loans and securities, and a substantial portion of our investments in leveraged companies will be subject to legal and other restrictions on resale or will otherwise be less liquid than more broadly traded public securities. The illiquidity of these investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. Also, as noted above, we may be limited or prohibited in our ability to sell or otherwise exit certain positions in our initial portfolio as such a transaction could be considered a joint transaction prohibited by the 1940 Act.
Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by our board of directors. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair value of our investments:
| • | 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 and the markets in which it does business; |
| • | comparisons of financial ratios of peer companies that are public; |
| • | comparable merger and acquisition transactions; and |
| • | principal market and enterprise values. |
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our valuation. We record decreases in the market values or fair values of our investments as unrealized depreciation. Declines in prices and liquidity in the corporate debt markets may result in significant net unrealized depreciation in our portfolio. The effect of all of these factors on our portfolio may reduce our net asset value by increasing net unrealized depreciation in our portfolio. Depending on market conditions, we could incur substantial realized losses and may suffer additional unrealized losses in future periods, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
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
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securities of a single issuer. Beyond the asset diversification requirements associated with our qualification as a RIC under the Code, we do not have fixed guidelines for diversification. To the extent that we assume large positions in the securities of a small number of issuers or our investments are concentrated in relatively few industries, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company.
Our portfolio may be concentrated in a limited number of industries, which may subject us to a risk of significant loss if there is a downturn in a particular industry in which a number of our investments are concentrated.
Our portfolio may be concentrated in a limited number of industries. A downturn in any particular industry in which we are invested could significantly impact the aggregate returns we realize.
As of June 30, 2020, our investments in the professional services industry represented approximately 11.48% of the fair value of our portfolio, our investments in the construction and engineering industry represented approximately 11.18% of the fair value of our portfolio, and in the energy equipment and services industry represented approximately 10.92% of the fair value of our portfolio. If an industry in which we have significant investments suffers from adverse business or economic conditions, as these industries have to varying degrees, a material portion of our investment portfolio could be affected adversely, which, in turn, could adversely affect our financial position and results of operations.
Our investments in the professional services industry face considerable uncertainties including significant regulatory challenges.
Our investments in portfolio companies that operate in the professional services industry represent approximately 11.48% of our total portfolio as of June 30, 2020. Our investments in portfolio companies in the professional services sector include those that provide services related to data and information, building, cleaning and maintenance services, and energy efficiency services. Portfolio companies in the professional services sector are subject to many risks, including the negative impact of regulation, changing technology, a competitive marketplace and difficulty in obtaining financing. Portfolio companies in the professional services industry must respond quickly to technological changes and understand the impact of these changes on customers’ preferences. Adverse economic, business, or regulatory developments affecting the professional services sector could have a negative impact on the value of our investments in portfolio companies operating in this industry, and therefore could negatively impact our business and results of operations.
Our investments in the construction and engineering industry face considerable uncertainties including significant regulatory challenges.
Our investments in portfolio companies that operate in the construction and engineering industry represent approximately 11.18% of our total portfolio as of June 30, 2020. The renovation, refurbishment or expansion by a borrower under a mortgaged or leveraged property involves risks of cost overruns and non-completion. Costs of construction or improvements to bring a property up to standards established for the market position intended for that property may exceed original estimates, possibly making a project uneconomical. Other risks may include environmental risks and construction, rehabilitation and subsequent leasing of the property not being completed on schedule. If such construction or renovation is not completed in a timely manner, or if it costs more than expected, the borrower may experience a prolonged impairment of net operating income and may not be able to make payments on our investment. Adverse economic, business, or regulatory developments affecting the construction and engineering sector could have a negative impact on the value of our investments in portfolio companies operating in this industry, and therefore could negatively impact our business and results of operations.
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Our investments in the energy equipment and services and oil, gas and consumable fuels industries face considerable uncertainties including substantial regulatory challenges.
Our investments in portfolio companies that operate in the energy equipment and services industry together with oil, gas and consumable fuels represented approximately 10.92%, in the aggregate, of our total portfolio as of June 30, 2020. The revenues, income (or losses) and valuations of companies in these industries are highly dependent upon the valuations of oil and gas companies, which can fluctuate suddenly and dramatically due to any one or more of the following factors:
Commodity Pricing Risk. In general, commodity prices directly affect oil and gas companies, especially for those who own the underlying commodity. In addition, the volatility of commodity prices can affect other oil and gas companies due to the impact of prices on the volume of commodities produced, transported, processed, stored or distributed and on the cost of fuel for power generation companies. The volatility of commodity prices can also affect oil and gas companies’ ability to access the capital markets in light of market perception that their performance may be directly tied to commodity prices. Historically, energy commodity prices have been cyclical and exhibited significant volatility as evident in the recent and sudden decline in oil prices during the second half of 2014.
Regulatory Risk. Changes in the regulatory environment could adversely affect the profitability of oil and gas companies. Federal, state and local governments heavily regulate the businesses of oil and gas companies in diverse matters, such as the way in which assets are constructed, maintained and operated and the prices oil and gas companies may charge for their products and services. Such regulation can change over time in scope and intensity.
Production Risk. The volume of crude oil, natural gas or other energy commodities available for producing, transporting, processing, storing, distributing or generating power may materially impact the profitability of energy companies. A significant decrease in the production of natural gas, crude oil, coal or other energy commodities, due to the decline of production from existing facilities, import supply disruption, depressed commodity prices, political events, OPEC actions or otherwise, could reduce revenue and operating income or increase operating costs of energy companies and, therefore, their ability to pay debt or dividends.
Demand Risk. A sustained decline in demand for crude oil, natural gas and refined petroleum products could materially affect revenues and cash flows of energy companies. Factors that could lead to a decrease in market demand include a recession or other adverse economic conditions, increases in the market price of the underlying commodity, higher taxes or other regulatory actions that increase costs, or shifts in consumer demand for such products.
Depletion and Exploration Risk. Oil and gas companies’ commodities naturally deplete over time. Depletion could have a material adverse impact on such company’s ability to maintain its revenue. Further, estimates of reserves may not be accurate and, even if accurate, reserves may not be produced profitably. In addition, exploration of energy resources, especially of oil and natural gas, is inherently risky and requires large amounts of capital.
Weather Risk. Unseasonable extreme weather patterns could result in significant volatility in demand for energy and power or may directly affect the operations of individual companies. This weather-related risk may create fluctuations in earnings of energy companies.
Operational Risk. Oil and gas companies are subject to various operational risks, such as failed drilling or well development, unscheduled outages, underestimated cost projections, unanticipated operation and maintenance expenses, failure to obtain the necessary permits to operate and failure of third-party contractors to perform their contractual obligations.
Competition Risk. The oil and gas companies in which we may invest will face substantial competition in acquiring properties, enhancing and developing their assets, marketing their commodities, securing trained
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personnel and operating their properties. Many of their competitors may have financial and other resources that substantially exceed their resources.
Valuation Risk. The valuation of our holdings in oil and gas portfolio companies is subject to uncertainties inherent in estimating quantities of reserves of oil, natural gas and coal and in projecting future rates of production and the timing of development expenditures, which are dependent upon many factors beyond our control. The estimates rely on various assumptions, including, but not limited to, commodity prices, operating expenses, capital expenditures and the availability of funds, and are therefore inherently imprecise indications of future net cash flows. Actual future production, cash flows, taxes, operating expenses, development expenditures and quantities of recoverable reserves may vary substantially from those assumed in the estimates. Any significant variance in these assumptions could materially affect the value of our investments in oil and gas companies.
Climate Change. There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs of customers of oil and gas companies vary with weather conditions, primarily temperature and humidity. To the extent climate changes affect weather conditions, energy use could increase or decrease depending on the duration and magnitude of any changes. Increased oil and gas use due to weather changes may require additional investments by our portfolio companies in more pipelines and other infrastructure to serve increased demand. A decrease in oil and gas use due to weather changes may affect our portfolio companies’ financial condition through decreased revenues. Extreme weather conditions in general require more system backup, adding to costs, and can contribute to increased system stresses, including service interruptions. Potential lawsuits against or taxes or other regulatory costs imposed on greenhouse gas emitters could also affect oil and gas companies, based on links drawn between greenhouse gas emissions and climate change.
A prolonged continuation of depressed oil and natural gas prices could negatively impact the energy equipment and services industries and energy-related investments within our investment portfolio.
Prices for oil and natural gas, which historically have been volatile and may continue to be volatile, may be subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas. A prolonged continuation of depressed oil and natural gas prices would adversely affect the credit quality and performance of certain of our debt and equity investments in energy equipment and services companies. A decrease in credit quality and performance would, in turn, negatively affect the fair value of these investments, which would consequently negatively affect our net asset value. Should a prolonged period of depressed oil and natural gas prices occur, the ability of certain of our portfolio companies in the energy equipment and services industries to satisfy financial or operating covenants imposed by us or other lenders may be adversely affected, which could, in turn, negatively impact their financial condition and their ability to satisfy their debt service and other obligations. Likewise, should a prolonged period of depressed oil and natural gas prices occur, it is possible that the cash flow and profit generating capacity of these portfolio companies could also be adversely affected thereby negatively impacting their ability to pay us dividends or distributions on our investments.
Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on” investments, including exercising warrants, options or convertible securities that were acquired in the original or subsequent financing; in seeking to:
| • | increase or maintain in whole or in part our position as a creditor or our equity ownership percentage in a portfolio company; |
| • | preserve or enhance the value of our investment. |
We have discretion to make follow-on investments, subject to the availability of capital resources. Failure on our part to make follow-on investments may, in some circumstances, jeopardize the continued viability of a
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portfolio company and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to increase our level of risk, because we prefer other opportunities or because we are inhibited by compliance with BDC requirements of the 1940 Act or the desire to maintain our qualification as a RIC.
Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.
We do not hold controlling equity positions in any of the portfolio companies included in our portfolio and, although we may do so in the future, we do not currently intend to hold controlling equity positions in our portfolio companies. As a result, we will be subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity investments that we expect to hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore suffer a decrease in the value of our investments.
Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and ability to make stockholder distributions and result in a decline in the market price of our shares.
We are subject to the risk that the debt investments we make in portfolio companies may be repaid prior to maturity. We expect that our investments will generally allow for repayment at any time subject to certain penalties. When this occurs, we intend to generally reinvest these proceeds in temporary investments, pending their future investment in accordance with our investment strategy. These temporary investments will typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our ability to make, or the amount of, stockholder distributions with respect to our common stock, which could result in a decline in the market price of our shares.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We intend to invest a portion of our capital in second lien and subordinated loans issued by our portfolio companies. The portfolio companies usually have, or may be permitted to incur, other debt that ranks equally with, or senior to, the loans in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the loans in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying senior creditors, a portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with loans in which we invest, we would have to share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
Additionally, certain loans that we may make to portfolio companies may be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the
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collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The holders of obligations secured by 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 sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the portfolio company’s remaining assets, if any.
We may also make unsecured loans to portfolio companies, meaning that such loans will not benefit from any interest in collateral of such companies. Liens on such portfolio companies’ collateral, if any, will secure the portfolio company’s obligations under its outstanding secured debt and may secure certain future debt that is permitted to be incurred by the portfolio company under its secured loan agreements. The holders of obligations secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their obligations in full before us. In addition, the value of such 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 sales of such collateral would be sufficient to satisfy our unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding secured loan obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of such senior debt. Under a typical 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.
The disposition of our investments may result in contingent liabilities.
We currently expect that substantially all of our investments will involve loans and private securities. In connection with the disposition of such an investment, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to potential liabilities. These arrangements may result in contingent liabilities that ultimately result in funding obligations that we must satisfy through our return of distributions previously made to us.
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The interest rates of our term loans to our portfolio companies that extend beyond 2021 might be subject to change based on recent regulatory changes.
LIBOR, the London Interbank Offered Rate, is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally. We typically use LIBOR as a reference rate in term loans we extend to portfolio companies such that the interest due to us pursuant to a term loan extended to a partner company is calculated using LIBOR. The terms of our debt investments generally include minimum interest rate floors which are calculated based on LIBOR.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it will not compel panel banks to contribute to LIBOR after 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. Central banks and regulators in a number of major jurisdictions (for example, United States, United Kingdom, European Union, Switzerland and Japan) have convened working groups to find, and implement the transition to, suitable replacements for interbank offered rates (“IBORs”). The E.U. Benchmarks Regulation imposed conditions under which only compliant benchmarks may be used in new contracts after 2021. To identify a successor rate for U.S. dollar LIBOR, the Alternative Reference Rates Committee (“ARRC”), a U.S.-based group convened by the Federal Reserve Board and the Federal Reserve Bank of New York, was formed. The ARRC has identified the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative rate for LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. In addition, on March 25, 2020, the U.K. Financial Conduct Authority reaffirmed the central assumption that firms cannot rely on LIBOR being published after the end of 2021. However, the outbreak of COVID-19 may adversely impact the timing of many firms’ transition planning, and we continue to assess the potential impact of the COVID-19 outbreak on our transition plans. Although SOFR appears to be the preferred replacement rate for U.S. dollar LIBOR, at this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates, whether the COVID-19 outbreak will have further effect on LIBOR transition timelines or plans, or other reforms to LIBOR that may be enacted in the United States, United Kingdom or elsewhere. The elimination of LIBOR or any other changes or reforms to the determination or supervision of LIBOR or alternative reference rates could have an adverse impact on the market for or value of any LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us. In addition, if LIBOR ceases to exist, we may need to renegotiate the credit agreements extending beyond 2021 with our portfolio companies that utilize LIBOR as a factor in determining the interest rate, in order to replace LIBOR with the new standard that is established, which may have an adverse effect on our overall financial condition or results of operations. As such, some or all of these credit agreements may bear a lower interest rate, which would adversely impact our financial condition or results of operations. Moreover, if LIBOR ceases to exist, we may need to renegotiate certain terms of the Financing Facilities. If we are unable to do so, amounts drawn under the Financing Facilities may bear interest at a higher rate, which would increase the cost of our borrowings and, in turn, affect our results of operations.
A reduction in the interest rates on new investments relative to interest rates on current investments could also have an adverse impact on our net interest income. However, an increase in interest rates could decrease the value of any investments we hold which earn fixed interest rates, including subordinated loans, senior and junior secured and unsecured debt securities and loans and high yield bonds, and also could increase our interest expense, thereby decreasing our net income.
In periods of rising interest rates, to the extent we borrow money subject to a floating interest rate, our cost of funds would increase, which could reduce our net investment income. Further, rising interest rates could also adversely affect our performance if such increases cause our borrowing costs to rise at a rate in excess of the rate that our investments yield. Further, rising interest rates could also adversely affect our performance if we hold investments with floating interest rates, subject to specified minimum interest rates (such as a LIBOR floor), while at the same time engaging in borrowings subject to floating interest rates not subject to such minimums. In
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such a scenario, rising interest rates may increase our interest expense, even though our interest income from investments is not increasing in a corresponding manner as a result of such minimum interest rates.
If general interest rates rise, there is a risk that the portfolio companies in which we hold floating rate securities will be unable to pay escalating interest amounts, which could result in a default under their loan documents with us. Rising interest rates could also cause portfolio companies to shift cash from other productive uses to the payment of interest, which may have a material adverse effect on their business and operations and could, over time, lead to increased defaults. In addition, rising interest rates may increase pressure on us to provide fixed rate loans to our portfolio companies, which could adversely affect our net investment income, as increases in our cost of borrowed funds would not be accompanied by increased interest income from such fixed-rate investments.
We may not realize gains from our equity investments.
When we invest in loans and debt securities, we may acquire warrants or other equity securities of portfolio companies as well. We may also invest in equity securities directly. To the extent we hold equity investments, we will attempt to dispose of them and realize gains upon our disposition of them. However, the equity interests we receive may not appreciate in value and may decline in value. As a result, 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.
Risks Relating to Our Common Stock
Shares of closed-end investment companies, including BDCs, may trade at a discount to their net asset value.
Shares of closed-end investment companies, including BDCs, may trade at a discount from net asset value if certain conditions are met (e.g., shareholder approval). This characteristic of closed-end investment companies and BDCs is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our common stock will trade at, above or below net asset value. At a meeting initially convened on November 6, 2019 and reconvened on December 5, 2019, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one year anniversary of the date of the Company’s 2019 Annual Meeting of Stockholders and the date of the Company’s 2020 Annual Meeting of Stockholders, which we expect to be held in November 2020. Our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. In addition, we cannot issue shares of our common stock below net asset value unless our board of directors determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In addition, continuous sales of common stock below net asset value may have a negative impact on total returns and could have a negative impact on the market price of our shares of common stock. See “— Existing stockholders may incur dilution if, in the future, we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock” for a discussion of a proposal approved by our stockholders that permits us to issue shares of our common stock below net asset value.
Stockholders may experience dilution in their ownership percentage if they do not participate in our dividend reinvestment plan.
All distributions declared in cash payable to stockholders that are participants in our dividend reinvestment plan are generally automatically reinvested in shares of our common stock. As a result, stockholders that do not participate in the dividend reinvestment plan may experience dilution over time. Stockholders who receive distributions in shares of common stock may experience accretion to the net asset value of their shares if our shares are trading at a premium and dilution if our shares are trading at a discount. The level of accretion or
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discount would depend on various factors, including the proportion of our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and the amount of the distribution payable to a stockholder.
Existing stockholders may incur dilution if, in the future, we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock.
The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value per share of such stock, with certain exceptions. One such exception is prior stockholder approval of issuances below net asset value provided that our board of directors makes certain determinations. In this regard, at a meeting initially convened on November 6, 2019 and reconvened on December 5, 2019, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one year anniversary of the date of the Company’s 2019 Annual Meeting of Stockholders and the date of the Company’s 2020 Annual Meeting of Stockholders, which we expect to be held in November 2020. Our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. In addition, we cannot issue shares of our common stock below net asset value unless our board of directors determines that it would be in our and our stockholders’ best interests to do so. Continued access to this exception will require approval of similar proposals at future stockholder meetings. Any decision to sell shares of our common stock below the then current net asset value per share of our common stock would be subject to the determination by our board of directors that such issuance is in our and our stockholders’ best interests.
If we were to sell shares of our common stock below net asset value per share, such sales would result in an immediate dilution to the net asset value per share. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance.
Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted; however, the example below illustrates the effect of dilution to existing stockholders resulting from the sale of common stock at prices below the net asset value of such shares.
Illustration: Example of Dilutive Effect of the Issuance of Shares Below Net Asset Value. The example assumes that Company XYZ has 13,500,000 common shares outstanding, $300,000,000 in total assets and $100,000,000 in total liabilities. The current net asset value and net asset value per share are thus $200,000,000 and $14.81. The table illustrates the dilutive effect on nonparticipating Stockholder A of (1) an offering of 1,350,000 shares (10% of the outstanding shares) at $13.33 per share after offering expenses and commissions (a 10% discount from net asset value).
| Prior to Sale Below NAV |
Following Sale Below NAV |
Percentage Change |
||||||||||
| Reduction to NAV |
||||||||||||
| Total Shares Outstanding |
13,500,000 | 14,850,000 | 10.00 | % | ||||||||
| NAV per share |
$ | 14.81 | $ | 14.68 | (0.91 | )% | ||||||
| Dilution to Existing Stockholder |
||||||||||||
| Shares Held by Stockholder A |
135,000 | 135,000 | (1) | 0.0 | % | |||||||
| Percentage Held by Stockholder A |
1.00 | % | 0.91 | % | (9.09 | )% | ||||||
| Total Interest of Stockholder A in NAV |
$ | 2,000,000 | $ | 1,981,818 | (0.91 | )% | ||||||
| (1) | Assumes that Stockholder A does not purchase additional shares in the sale of shares below NAV. |
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Our shares might trade at premiums that are unsustainable or at discounts from net asset value.
Shares of BDCs like us may, during some periods, trade at prices higher than their net asset value per share and, during other periods, as frequently occurs with closed-end investment companies, trade at prices lower than their net asset value per share. The perceived value of our investment portfolio may be affected by a number of factors including perceived prospects for individual companies we invest in, market conditions for common stock generally, for initial public offerings and other exit events for venture capital backed companies, and the mix of companies in our investment portfolio over time. Negative or unforeseen developments affecting the perceived value of companies in our investment portfolio could result in a decline in the trading price of our common stock relative to our net asset value per share.
The possibility that our shares will trade at a discount from net asset value or at premiums that are unsustainable are risks separate and distinct from the risk that our net asset value per share will decrease. The risk of purchasing shares of a BDC that might trade at a discount or unsustainable premium is more pronounced for investors who wish to sell their shares in a relatively short period of time because, for those investors, realization of a gain or loss on their investments is likely to be more dependent upon changes in premium or discount levels than upon increases or decreases in net asset value per share.
Investing in our common stock may involve an above average degree of risk.
The investments we make in accordance with our investment objective may result in a higher amount of risk, and higher volatility or loss of principal, than alternative investment options. Our investments in portfolio companies may be speculative and, therefore, an investment in our common stock may not be suitable for someone with lower risk tolerance.
The market price of our common stock may fluctuate significantly.
The market price and liquidity of the market for our securities may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:
| • | price and volume fluctuations in the overall stock market from time to time; |
| • | investor demand for our shares; |
| • | significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies; |
| • | changes in regulatory policies or tax guidelines, particularly with respect to RICs or BDCs; |
| • | loss of our qualification as a RIC or BDC; |
| • | changes in earnings or variations in operating results; |
| • | changes in the value of our portfolio of investments; |
| • | increases in the interest rates we pay; |
| • | changes in accounting guidelines governing valuation of our investments; |
| • | any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts; |
| • | departure of the Adviser’s key personnel; |
| • | change in the Adviser’s relationship with Investcorp under the Investcorp Services Agreement; |
| • | operating performance of companies comparable to us; and |
| • | general economic trends and other external factors. |
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In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Due to the potential volatility of our stock price, we may become the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business.
Sales of substantial amounts of our common stock in the public market may have an adverse effect on the market price of our common stock.
Our two largest investors are Stifel and funds managed by Cyrus Capital, which we refer to as the Cyrus Funds. Stifel owns approximately 16% of our total outstanding common stock, and the Cyrus Funds own, in the aggregate, approximately 27% of our total outstanding common stock. The shares held by Stifel and the Cyrus Funds are generally freely tradable in the public market, subject to the volume limitations, applicable holding periods and other provisions of Rule 144 under the Securities Act. Sales of substantial amounts of our common stock, the availability of such common stock for sale or the registration of such common stock for sale and the ability of our stockholders, including Stifel and the Cyrus Funds to sell their respective shares at a price per share that is below our then current net asset value per share could adversely affect the prevailing market prices for our common stock. If this occurs and continues it could impair our ability to raise additional capital through the sale of securities should we desire to do so and negatively impact the market of our common stock.
Risks Relating to Our 2023 Notes
The 2023 Notes are unsecured and therefore are effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future and rank pari passu with, or equal to, all outstanding and future unsecured indebtedness issued by us and our general liabilities.
The 2023 Notes are not be secured by any of our assets or any of the assets of any of our subsidiaries. As a result, the 2023 Notes are effectively subordinated to any secured indebtedness we or our subsidiaries have outstanding (including the Financing Facilities) or that we or our subsidiaries may incur in the future (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our secured indebtedness or secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the 2023 Notes. As of June 30, 2020, we had, through CM SPV, $102.0 million and $30.0 million in outstanding indebtedness under the Term Financing and the Revolving Financing, respectively, which are secured by the assets held at CM SPV. The indebtedness under the Financing Facilities is effectively senior to the Notes to the extent of the value of the assets securing such indebtedness. The 2023 Notes also rank pari passu with, or equal to, our general liabilities, which consist of trade and other payables, including any outstanding dividend payable, base and incentive management fees payable, interest and debt fees payable, vendor payables and accrued expenses such as auditor fees, legal fees, director fees, etc. In total, these general liabilities were $7.4 million as of June 30, 2020.
The 2023 Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
The 2023 Notes are obligations exclusively of Investcorp Credit Management BDC, Inc., and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the 2023 Notes, and the 2023 Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future. Any assets of our subsidiaries will not be directly available to satisfy the claims of our creditors, including holders of the 2023 Notes. Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have priority over our equity interests in such entities (and therefore the claims of our creditors, including holders of the 2023 Notes) with respect to the assets of such entities. Even if we are recognized as a creditor of one or more of these entities, our claims would still be effectively subordinated to any security interests in the assets of any such current or future subsidiary and to any indebtedness or other liabilities of any such current or future subsidiary senior to our claims, including under the Financing Facilities. Consequently, the
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2023 Notes are structurally subordinated to all indebtedness and other liabilities, including trade payables, of any of our existing or future subsidiaries.
The indenture under which the 2023 Notes are issued contains limited protection for holders of the 2023 Notes.
The Indenture offers limited protection to holders of the 2023 Notes. The terms of the Indenture and the 2023 Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on your investment in the 2023 Notes. In particular, the terms of the Indenture and the 2023 Notes do not place any restrictions on our or our subsidiaries’ ability to:
| • | issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the 2023 Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the 2023 Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the 2023 Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in those entities and therefore rank structurally senior to the 2023 Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in each case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowings. In accordance with the Small Business Credit Availability Act, on May 2, 2018, our board of directors, including a “required majority” approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, our asset coverage requirements for senior securities changed from 200% to 150%, effective May 2, 2019. See “—The 1940 Act allows us to incur additional leverage”. |
| • | pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the 2023 Notes, including subordinated indebtedness, in each case other than dividends, purchases, redemptions or payments that would cause our asset coverage to fall below the threshold specified in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time or any successor provisions, giving effect to (i) any exemptive relief granted to us by the SEC and (ii) no-action relief granted by the SEC to another BDC (or to us if we determine to seek such similar no-action or other relief) permitting the BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to us from time to time in order to maintain the BDC’s status as a RIC under Subchapter M of the Code. These provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, is below 150% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase; |
| • | sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets); |
| • | create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions; |
| • | make investments; or |
| • | create restrictions on the payment of dividends or other amounts to us from our subsidiaries. |
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In addition, the Indenture does not require us to make an offer to purchase the 2023 Notes in connection with a change of control or any other event.
Furthermore, the terms of the Indenture and the 2023 Notes do not protect holders of the 2023 Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, if any, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow or liquidity.
Our ability to recapitalize, incur additional debt (including additional debt that matures prior to the maturity of the 2023 Notes) and take a number of other actions that are not limited by the terms of the 2023 Notes may have important consequences for you as a holder of the 2023 Notes, including making it more difficult for us to satisfy our obligations with respect to the Notes or negatively affecting the trading value of the Notes.
Other debt we issue or incur in the future could contain more protections for its holders than the Indenture and the Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for trading levels and prices of the Notes.
Even though the Notes are listed on the NASDAQ Global Select Market, an active trading market for the Notes may not develop, which could limit your ability to sell the Notes or affect the market price of the Notes.
We cannot provide any assurances that an active trading market will develop for the Notes, or that, if it does develop, it will be sustained or that you will be able to sell your Notes. The Notes may trade at a discount from the price paid for the notes depending on prevailing interest rates, the market for similar securities, our credit ratings, if any, general economic conditions, our financial condition, performance and prospects and other factors.
Accordingly, we cannot assure you that a liquid trading market will develop for the Notes or that, if an active trading market for the Notes does develop, it will be sustained, that you will be able to sell your Notes at a particular time or that the price you receive when you sell will be favorable. To the extent an active trading market does not develop, the liquidity and trading price for the Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the Notes for an indefinite period of time.
If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the Notes.
Any default under the agreements governing our indebtedness, including a default under the Financing Facilities or other indebtedness to which we may be a party that is not waived by the required lenders, and the remedies sought by lenders or the holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the Notes and substantially decrease the market value of the Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness (including the Financing Facilities), we could be in default under the terms of the agreements governing such indebtedness, including the Notes. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the Financing Facilities or other debt we may incur in the future could elect to terminate their commitment, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation.
Our ability to generate sufficient cash flow in the future is, to some extent, subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from investment activities, or that future borrowings will be available to us under the Financing Facilities or otherwise, in an amount sufficient to enable us to meet our payment obligations under the Notes, our other debt, and to fund other liquidity needs.
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If our operating performance declines and we are not able to generate sufficient cash flow to service our debt obligations, we may in the future need to refinance or restructure our debt, including any Notes sold, sell assets, reduce or delay capital investments, seek to raise additional capital or seek to obtain waivers from the lenders under the Financing Facilities or other debt that we may incur in the future to avoid being in default. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the Notes and our other debt. If we breach our covenants under the Financing Facilities or any of our other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders thereof. If this occurs, we would be in default under the Financing Facilities or other debt, the lenders or holders could exercise rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations could proceed against the collateral securing the debt, including the Financing Facilities. Because the Financing Facilities have, and any future credit facilities will likely have, customary cross-default provisions, if we have a default under the terms of the Notes, the obligations under the Financing Facilities or any future credit facility may be accelerated and we may be unable to repay or finance the amounts due.
| Item 1B. | Unresolved Staff Comments |
Not applicable.
| Item 2. | Properties |
We do not own any real estate. Our principal executive offices are currently located at 280 Park Avenue 39h Floor, New York, New York 10017. All locations are provided to us by the Adviser pursuant to the Administration Agreement. We believe that our office facilities are and will be suitable and adequate for our business as we contemplate conducting it.
| Item 3. | Legal Proceedings |
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.
| Item 4. | Mine Safety Disclosures |
Not applicable.
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| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Price Range of Common Stock
Our common stock is traded on the NASDAQ Global Select Market under the symbol “ICMB.” The following table sets forth, for the periods indicated, the range of high and low sales prices of our common stock, as reported on the NASDAQ Global Select Market:
| NAV Per Share(1) |
Closing Sales Price(2) |
Premium or Discount of High Sales to NAV(3) |
Premium or Discount of Low Sales to NAV(3) |
|||||||||||||||||
| Fiscal Year Ended |
High | Low | ||||||||||||||||||
| June 30, 2021 |
||||||||||||||||||||
| First quarter (through September 18, 2020) |
$ | * | $ | 4.38 | $ | 3.09 | *% | *% | ||||||||||||
| June 30, 2020 |
||||||||||||||||||||
| Fourth quarter |
7.79 | 4.84 | 2.95 | (37.87 | )% | (62.13 | )% | |||||||||||||
| Third quarter |
8.15 | 7.65 | 1.49 | (6.13 | )% | (81.72 | )% | |||||||||||||
| Second quarter |
10.15 | 7.32 | 6.45 | (27.88 | )% | (36.45 | )% | |||||||||||||
| First quarter |
10.19 | 7.65 | 6.65 | (24.93 | )% | (34.74 | )% | |||||||||||||
| June 30, 2019 |
||||||||||||||||||||
| Fourth quarter |
10.51 | 7.61 | 7.05 | (27.59 | )% | (32.92 | )% | |||||||||||||
| Third quarter |
11.14 | 8.15 | 6.21 | (26.84 | )% | (44.25 | )% | |||||||||||||
| Second quarter |
11.49 | 8.77 | 5.90 | (23.67 | )% | (48.65 | )% | |||||||||||||
| First quarter |
12.41 | 9.40 | 8.60 | (24.25 | )% | (30.70 | )% | |||||||||||||
| June 30, 2018 |
||||||||||||||||||||
| Fourth quarter |
12.57 | 9.88 | 7.90 | (21.40 | )% | (37.15 | )% | |||||||||||||
| Third quarter |
12.55 | 8.70 | 7.75 | (30.68 | )% | (38.25 | )% | |||||||||||||
| Second quarter |
12.50 | 9.65 | 7.70 | (22.80 | )% | (38.40 | )% | |||||||||||||
| First quarter |
12.39 | 10.30 | 9.25 | (16.87 | )% | (25.34 | )% | |||||||||||||
| (1) | NAV is determined as of the last date in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low sales prices. The NAVs shown are based on outstanding shares at the end of each period. |
| (2) | Closing sales price is determined as the high or low closing sales price noted within the respective quarter, not adjusted for dividends. |
| (3) | Calculated as of the respective high or low sales price divided by the quarter end NAV. |
The last reported sale price for our common stock on the NASDAQ Global Select Market on September 18, 2020 was $4.38 per share. As of September 18, 2020, we had 29 stockholders of record, which did not include stockholders for whom shares are held in nominee or “street” name.
Shares of BDCs may trade at a market price that is less than the value of the net assets attributable to those shares. The possibility that our shares of common stock will trade at a discount from net asset value per share or at premiums that are unsustainable over the long term are separate and distinct from the risk that our net asset value per share will decrease. It is not possible to predict whether the common stock will trade at, above, or below net asset value per share.
Dividends
Our dividends, if any, are determined by our board of directors. We intend to elect to be treated for U.S. federal income tax purposes as a RIC under Subchapter M of the Code. If we qualify as a RIC, we will not be
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taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
To qualify for RIC tax treatment, we must, among other things, distribute at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any.
Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% U.S. federal excise tax on such income. Any such carryover taxable income must be distributed through a dividend declared prior to filing the final tax return related to the year which generated such taxable income. We may, in the future, make actual distributions to our stockholders of our net capital gains. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings.
We have adopted an “opt out” dividend reinvestment plan (“DRIP”) for our common stockholders. As a result, if we make cash distributions, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash distributions.
The following table reflects, for the periods indicated, the distributions per share that our board of directors has declared on our common stock:
| Fiscal Year Ended |
Distribution | Date Declared | Record Date | Pay Date | Amount Per Share |
|||||||||||||||
| June 30, 2021 |
||||||||||||||||||||
| First Quarter |
Base | August 26, 2020 | September 25, 2020 | October 15, 2020 | $ | 0.1500 | ||||||||||||||
| First Quarter |
Supplemental | August 26, 2020 | September 25, 2020 | October 15, 2020 | $ | 0.0300 | ||||||||||||||
| June 30, 2020 |
||||||||||||||||||||
| Fourth Quarter |
Base | May 7, 2020 | June 19, 2020 | July 10, 2020 | $ | 0.1500 | ||||||||||||||
| Fourth Quarter |
Supplemental | May 7, 2020 | June 19, 2020 | July 10, 2020 | $ | 0.0300 | ||||||||||||||
| Third Quarter |
Base | February 4, 2020 | March 13, 2020 | April 2, 2020 | $ | 0.2500 | ||||||||||||||
| Second Quarter |
Base | November 6, 2019 | December 13, 2019 | January 2, 2020 | $ | 0.2500 | ||||||||||||||
| First Quarter |
Base | August 28, 2019 | September 26, 2019 | October 16, 2019 | $ | 0.2500 | ||||||||||||||
| June 30, 2019 |
||||||||||||||||||||
| Fourth Quarter |
Base | May 1, 2019 | June 14, 2019 | July 5, 2019 | $ | 0.2500 | ||||||||||||||
| Third Quarter |
Base | February 5, 2019 | March 15, 2019 | April 4, 2019 | $ | 0.2500 | ||||||||||||||
| Second Quarter |
Base | November 6, 2018 | December 14, 2018 | January 3, 2019 | $ | 0.2500 | ||||||||||||||
| First Quarter |
Base | August 23, 2018 | September 18, 2018 | October 5, 2018 | $ | 0.2500 | ||||||||||||||
| June 30, 2018 |
||||||||||||||||||||
| Fourth Quarter |
Base | May 2, 2018 | June 15, 2018 | July 5, 2018 | $ | 0.2500 | ||||||||||||||
| Third Quarter |
Base | February 6, 2018 | March 16, 2018 | April 5, 2018 | $ | 0.2500 | ||||||||||||||
| Second Quarter |
Base | November 7, 2017 | December 15, 2017 | January 4, 2018 | $ | 0.2500 | ||||||||||||||
| First Quarter |
Base | August 24, 2017 | September 8, 2017 | October 5, 2017 | $ | 0.2500 | ||||||||||||||
|
|
|
|||||||||||||||||||
| Total |
$ | 3.1100 | ||||||||||||||||||
|
|
|
|||||||||||||||||||
Sales of Unregistered Securities
During the year ended June 30, 2020, Investcorp BDC purchased 227,000 newly issued shares of the Company’s common stock pursuant to the requirement under the Stock Purchase Agreement for an aggregate
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offering price of $2,308,590. These issuances were exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) thereof and Regulation D thereunder. Investcorp BDC is an “accredited investor” as that term is defined in Rule 501(a) of Regulation D under the Securities Act. For more information, see our Current Reports on Form 8-K filed with the SEC on March 6, 2020 and December 5, 2019, respectively.
Purchases of Equity Securities
None.
Stock Performance Graph
This graph compares the return on our common stock with that of the Wells Fargo BDC Index, the NASDAQ Financial Index and a customized peer group of six companies that includes Crescent Capital BDC, Inc., Garrison Capital Inc., OFS Capital Corp., Stellus Capital Investment Corporation, First Eagle Alternative Capital BDC, Inc., and WhiteHorse Finance Inc., for the period from February 6, 2014 (initial public offering) through June 30, 2020. The graph assumes that, on February 6, 2014, an investment of $100 (with reinvestment of all dividends) was made in our common stock (at the initial public offering price of $15.00 per share), in each index and in the peer group. The graph measures total stockholder return, which takes into account both changes in stock price and dividends. It assumes that dividends paid are invested in like securities.
The graph and other information furnished under this Part II Item 5 of this Form 10-K shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the 1934 Act. The stock price performance included in the above graph is not necessarily indicative of future stock price performance.
| Item 6. | Selected Financial Data |
The following selected financial data for the years ended June 30, 2020, June 30, 2019, and June 30, 2018 is derived from our financial statements which have been audited by RSM US LLP, our independent registered public accounting firm. The following selected financial data for the years ended June 30, 2017 and June 30,
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2016, is derived from our financial statements which have been audited by Ernst & Young LLP, our former independent registered public accounting firm. The data should be read in conjunction with our financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.
| For the year ended June 30, | ||||||||||||||||||||
| Statement of Operations Data: |
2020 | 2019 | 2018 | 2017 | 2016 | |||||||||||||||
| Total investment income |
$ | 34,460,604 | $ | 34,397,822 | $ | 40,791,752 | $ | 31,012,197 | $ | 35,579,922 | ||||||||||
| Total expenses, net of fee waiver |
$ | 20,295,322 | $ | 20,898,983 | $ | 21,816,119 | $ | 15,313,613 | $ | 15,725,966 | ||||||||||
| Net investment income |
$ | 14,165,282 | $ | 13,498,839 | $ | 18,975,633 | $ | 15,698,584 | $ | 19,853,956 | ||||||||||
| Net increase (decrease) in net assets resulting from operations |
$ | (24,656,475 | ) | $ | (14,542,229 | ) | $ | 15,625,480 | $ | 23,579,465 | $ | (9,344,770 | ) | |||||||
| Per Share Data(1): |
||||||||||||||||||||
| Net asset value |
$ | 7.79 | $ | 10.51 | $ | 12.57 | $ | 12.41 | $ | 11.90 | ||||||||||
| Net investment income |
$ | 1.03 | $ | 0.99 | $ | 1.39 | $ | 1.15 | $ | 1.45 | ||||||||||
| Net increase (decrease) in net assets resulting from operations |
$ | (1.79 | ) | $ | (1.07 | ) | $ | 1.14 | $ | 1.72 | $ | (0.68 | ) | |||||||
| Distributions declared |
$ | 0.93 | $ | 1.00 | $ | 1.00 | $ | 1.20 | $ | 1.83 | ||||||||||
| Balance Sheet Data: |
||||||||||||||||||||
| Investments at fair value |
$ | 270,621,709 | $ | 306,390,993 | $ | 293,592,013 | $ | 254,907,171 | $ | 272,114,164 | ||||||||||
| Cash and cash equivalents |
$ | 14,876,444 | $ | 19,706,281 | $ | 5,620,441 | $ | 10,646,697 | $ | 18,433,066 | ||||||||||
| Total assets |
$ | 296,794,509 | $ | 336,947,992 | $ | 314,534,581 | $ | 296,033,878 | $ | 321,471,906 | ||||||||||
| Total liabilities |
$ | 188,669,514 | $ | 193,864,102 | $ | 143,011,915 | $ | 126,085,766 | $ | 158,722,023 | ||||||||||
| Total net assets |
$ | 108,124,995 | $ | 143,083,890 | $ | 171,522,666 | $ | 169,948,112 | $ | 162,749,883 | ||||||||||
| Other Data: |
||||||||||||||||||||
| Number of portfolio companies at period end |
38 | 33 | 25 | 23 | 22 | |||||||||||||||
| Weighted average yield on debt investments (at cost) at period end |
9.58 | % | 10.50 | % | 11.19 | % | 9.73 | % | 9.80 | % | ||||||||||
| Weighted average yield on total investments (at cost) at period end |
9.01 | % | 10.25 | % | 11.12 | % | 9.64 | % | 9.70 | % | ||||||||||
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Some of the statements in this annual report on Form 10-K constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K involve risks and uncertainties, including statements as to:
| • | our, or our portfolio companies’, future business, operations, operating results or prospects; |
| • | the return or impact of current and future investments; |
| • | the impact of global health epidemics, such as the current novel coronavirus (“COVID-19”) pandemic, on our or our portfolio companies’ business and the global economy; |
| • | the impact of fluctuations in interest rates on our business; |
| • | the impact of a protracted decline in the liquidity of credit markets on our business; |
| • | our contractual arrangements and relationships with Investcorp and its affiliates; |
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| • | our contractual arrangements and relationships with lenders and other third parties; |
| • | actual and potential conflicts of interest with the Adviser; |
| • | the dependence of our future success on the general economy, interest rates and the effects of each on the industries in which we invest; |
| • | changes in political, economic or industry conditions, the interest rate environment or conditions affecting the financial and capital markets, including changes from the impact of the current COVID-19 pandemic and sharp declines in energy prices; |
| • | the ability of our portfolio companies to achieve their objectives or service their debt obligations to us, including as a result of the current COVID-19 pandemic; |
| • | our ability to continue to effectively manage our business due to the disruptions caused by the current COVID-19 pandemic; |
| • | the use of borrowed money to finance a portion of our investments; |
| • | the adequacy of our financing sources and working capital; |
| • | the timing of cash flows, if any, from the operations of our portfolio companies; |
| • | the ability of the Adviser to locate suitable investments for us and to monitor and administer our investments; |
| • | the ability of the Adviser to attract and retain highly talented professionals; |
| • | our ability to qualify and maintain our qualification as a RIC and as a BDC; and |
| • | the effect of changes to tax legislation and our tax position and other legislative and regulatory changes. |
Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words.
We have based the forward-looking statements included in this annual report on Form 10-K on information available to us on the date of this report on Form 10-K. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or SEC rule or regulation. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Overview
We are a closed-end, externally managed, non-diversified management investment company that has elected to be regulated as a BDC under the 1940 Act. In addition, for U.S. federal income tax purposes, we intend to continue to qualify to be treated as a RIC under Subchapter M of the Code.
Our primary investment objective is to maximize total return to stockholders in the form of current income and capital appreciation by investing directly in debt and related equity of privately held middle market companies to help these companies fund acquisitions, growth or refinancing. We invest primarily in middle- market companies in the form of unitranche loans, standalone first and second lien and mezzanine loans. We may also invest in unsecured debt, bonds and in the equity of portfolio companies through warrants and other instruments.
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On February 5, 2014, we priced our initial public offering, selling 7,666,666 shares of our common stock, par value $0.001, including the underwriters’ over-allotment, at a price of $15.00 per share with net proceeds of approximately $111.5 million.
CM Finance LLC, a Maryland limited liability company, commenced operations in March 2012. Immediately prior to our initial public offering, CM Finance LLC merged with and into us (the “Merger”). In connection with the Merger, we issued 6,000,000 shares of common stock and $39.8 million in debt to the pre-existing CM Finance LLC investors, consisting of certain funds (the “Cyrus Funds” managed by Cyrus Capital. CM Finance Inc had no assets or operations prior to completion of the Merger and, as a result, the books and records of CM Finance LLC became our books and records, as the surviving entity. Immediately after the Merger, we issued 2,181,818 shares of our common stock to Stifel Venture Corp. (“Stifel”) in exchange for $32.7 million in cash. We used all of the proceeds of the sale of shares to Stifel to repurchase 2,181,818 shares of common stock from the Cyrus Funds. Immediately after the completion of the initial public offering, we had 13,666,666 shares outstanding. We also used a portion of the net proceeds of the initial public offering to repay 100% of the debt issued to the Cyrus Funds in connection with the Merger.
On August 30, 2019, Investcorp Credit Management (“Investcorp”) acquired an approximate 76% ownership interest in the Adviser through the acquisition of the interests held by the Cyrus Funds and Stifel and through a direct purchase of equity from the Adviser (the “Investcorp Transaction”). Investcorp is a leading global credit investment platform with assets under management of $13.1 billion as of June 30, 2020. Investcorp manages funds that invest primarily in senior secured corporate debt issued by mid and large-cap corporations in Western Europe and the United States.
In connection with the Investcorp Transaction, on June 26, 2019, our board of directors, including all of the directors who are not “interested persons” of the Company, as defined in Section 2(a)(19) of the 1940 Act (each, an “Independent Director”), unanimously approved a new investment advisory agreement (the “Advisory Agreement”) and recommended that the Advisory Agreement be submitted to our stockholders for approval, which our stockholders approved at the Special Meeting of Stockholders held on August 28, 2019.
In addition, on June 26, 2019, we entered into a definitive stock purchase and transaction agreement with Investcorp BDC Holdings Limited (“Investcorp BDC”), an affiliate of Investcorp (the “Stock Purchase Agreement”), pursuant to which, Investcorp BDC is required by August 30, 2021 to purchase (i) 680,985 newly issued shares of our common stock, par value $0.001 per share, at the most recently determined net asset value per share of our common stock at the time of such purchase, as adjusted as necessary to comply with Section 23 of the 1940 Act, and (ii) 680,985 shares of our common stock in open-market or secondary transactions.
As of June 30, 2020, Investcorp BDC had purchased 227,000 newly issued shares of our common stock pursuant to the requirement under the Stock Purchase Agreement. See “Part II. Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Sales of Unregistered Securities”” for more information. As of June 30, 2020, Investcorp BDC had purchased 281,775 shares of our common stock in open-market transactions pursuant to its obligation under the Stock Purchase Agreement.
At the Closing, we entered into the Advisory Agreement with the Adviser, pursuant to which we have agreed to pay the Adviser a fee for investment advisory and management services consisting of two components — a base management fee (the “Base Management Fee”) and an incentive fee (the “Incentive Fee”). The Base Management Fee is equal to 1.75% of our gross assets, payable in arrears on a quarterly basis. The Incentive Fee, which provides the Adviser with a share of the income that it generates for the Company, has two components, ordinary income (the “Income-Based Fee”) and capital gains (the “Capital Gains Fee”). The Income-Based Fee is equal to 20.0% of pre-incentive fee net investment income, subject to an annualized hurdle rate of 8.0% with a “catch up” fee for returns between the 8.0% hurdle and 10.0%. The Capital Gains Fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), commencing with the fiscal year ending June 30, 2021, and will equal to 20.0% of the Company’s cumulative aggregate realized capital gains from the Commencement Date through the
80
end of that fiscal year, computed net of the Company’s aggregate cumulative realized capital losses and the Company’s aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gains Fees. The Advisory Agreement has substantially the same terms as the prior investment advisory agreement, dated February 5, 2014, between us and the Adviser (the “Prior Advisory Agreement”).
At the Closing, we entered into a new administration agreement with the Adviser (the “Administration Agreement”). Under the Administration Agreement, the Adviser provides us with our chief financial officer, accounting and back-office professionals, equipment and clerical, bookkeeping, recordkeeping and other administrative services. The terms of the Administration Agreement, including the reimbursement of expenses by the Company to the Adviser, are identical to those contained in the Company’s prior administration agreement with the Adviser (the “Prior Administration Agreement”).
During the year ended June 30, 2020, our operating results were negatively impacted by the uncertainty surrounding the COVID-19 pandemic that has caused severe disruptions in the global economy and negatively impacted the fair value and performance of our investment portfolio. We have closely monitored our portfolio companies throughout this period, including assessing portfolio companies’ operational and liquidity exposure and outlook. For the year ended June 30, 2020, the resulting changes in net unrealized depreciation on investments were largely due to widening credit spreads as market participants expected a higher yield on similar investments given the significant market volatility generated by the COVID-19 pandemic. For additional information concerning the COVID-19 pandemic and its potential impact on our business and our operating results, see Part I, Item 1A. Risk Factors.
From time to time, we may form certain taxable subsidiaries (the “Taxable Subsidiaries”), that are taxed as corporations for U.S. federal income tax purposes. At June 30, 2020, we had no Taxable Subsidiaries. At June 30, 2019, we had one Taxable Subsidiary: Zinc Borrower Blocker, LLC. The Taxable Subsidiaries, if any, allow the Company to hold equity securities of portfolio companies organized as pass-through entities while continuing to satisfy the requirements applicable to a RIC under the Code.
Critical accounting policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. Management considers the following critical accounting policies important to understanding the financial statements. In addition to the discussion below, our critical accounting policies are further described in the notes to our consolidated financial statements.
Valuation of portfolio investments
We value our portfolio investments at fair value based upon the principles and methods of valuation set forth in policies adopted by our board of directors. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. Market participants are buyers and sellers in the principal (or most advantageous) market for the asset that (a) are independent of us, (b) are knowledgeable, having a reasonable understanding about the asset based on all available information (including information that might be obtained through due diligence efforts that are usual and customary), (c) are able to transact for the asset, and (d) are willing to transact for the asset or liability (that is, they are motivated but not forced or otherwise compelled to do so).
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Investments for which market quotations are readily available are valued at such market quotations unless the quotations are deemed not to represent fair value. We generally obtain market quotations from recognized exchanges, market quotation systems, independent pricing services or one or more broker dealers or market makers.
Debt and equity securities for which market quotations are not readily available or for which market quotations are deemed not to represent fair value are valued at fair value as determined in good faith by our board of directors. Because a readily available market value for many of the investments in our portfolio is often not available, we value many of our portfolio investments at fair value as determined in good faith by our board of directors using a consistently applied valuation process in accordance with a documented valuation policy that has been reviewed and approved by our board of directors. Due to the inherent uncertainty and subjectivity of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments and may differ materially from the values that we may ultimately realize. In addition, changes in the market environment and other events may have differing impacts on the market quotations used to value some of our investments than on the fair values of our investments for which market quotations are not readily available. Market quotations may also be deemed not to represent fair value in certain circumstances where we believe that facts and circumstances applicable to an issuer, a seller or purchaser, or the market for a particular security causes current market quotations not to reflect the fair value of the security. Examples of these events could include cases where a security trades infrequently, causing a quoted purchase or sale price to become stale, where there is a “forced” sale by a distressed seller, where market quotations vary substantially among market makers, or where there is a wide bid- ask spread or significant increase in the bid ask spread.
Those investments for which market quotations are not readily available or for which market quotations are deemed not to represent fair value 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 amount (discounted). The measurement is based on the 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 determining the fair value of our investments include, as relevant and among other factors: 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, merger and acquisition comparables, our principal market (as the reporting entity) and enterprise values.
With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:
| • | our quarterly valuation process begins with each portfolio company or investment being initially valued by the members of the Investment Team responsible for the portfolio investment; |
| • | preliminary valuation conclusions are then documented and discussed by our senior management and the Adviser; |
| • | on a periodic basis, at least once annually, the valuation for each portfolio investment is reviewed by an independent valuation firm engaged by our board of directors; |
| • | the valuation committee of our board of directors then reviews these preliminary valuations and makes a recommendation to our board of directors regarding the fair value of each investment; and |
| • | the board of directors then reviews and discusses these preliminary valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of the Adviser, the independent valuation firm and the valuation committee. |
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When valuing all of our investments, we strive to maximize the use of observable inputs and minimize the use of unobservable inputs. Inputs refer broadly to the assumptions that market participants would use in pricing an asset, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions about the assumptions market participants would use in pricing an asset or liability developed based on the best information available under the circumstances.
Our investments are categorized based on the types of inputs used in their valuation. The level in the GAAP valuation hierarchy in which an investment falls is based on the lowest level input that is significant to the valuation of the investment in its entirety. Investments are classified by GAAP into the three broad levels as follows:
Level 1 — valuation is based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2 — valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as (a) quoted prices for similar assets or liabilities in active markets; (b) quoted prices for identical or similar assets or liabilities in markets that are not active, that is, markets in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly; (c) inputs other than quoted prices that are observable for the asset or liability; or (d) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 — valuation is based on unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability. Therefore, unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Unobservable inputs are developed based on the best information available under the circumstances, which might include the Company’s own data. The Company’s own data used to develop unobservable inputs is adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.
As of June 30, 2020, and June 30, 2019 all of our investments were classified as Level 3 investments, determined based on valuations by our board of directors.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our financial statements express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on the consolidated financial statements.
Revenue recognition
Our revenue recognition policies are as follows:
Net realized gains (losses) on investments: Gains or losses on the sale of investments are calculated using the specific identification method.
Interest Income: Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing, commitment, and amendment fees, purchase and original issue discounts associated with loans to portfolio companies are accreted into interest income over the respective terms of the applicable loans. Accretion of discounts or premiums is calculated by the effective interest or straight-line method, as applicable, as of the purchase date and adjusted only for material amendments or prepayments. Upon
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the prepayment of a loan or debt security, any prepayment penalties and unamortized fees and discounts are recorded as interest income and are non-recurring in nature.
Structuring fees and similar fees are recognized as income as earned, usually when received. Structuring fees, excess deal deposits, net profits interests and overriding royalty interests are included in other fee income.
We may hold debt investments in our portfolio that contain a PIK interest provision. The PIK interest, which represents contractually deferred interest added to the investment balance that is generally due at maturity, is recorded on the accrual basis to the extent such amounts are expected to be collected.
Non-accrual: Loans are placed on non-accrual status when principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be collected. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment about ultimate collectability of principal. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current. PIK interest is not accrued if we do not expect the issuer to be able to pay all principal and interest when due. As of June 30, 2020, we had no investments on non-accrual status. As of June 30, 2019, we had one investment on non-accrual status, which represented approximately 3.0% of our portfolio at fair value.
Financing Facilities
We have, through CM SPV, our wholly owned subsidiary, entered into a $122.0 million term secured financing facility (the “Term Financing”), due December 5, 2021 with UBS AG, London Branch (together with its affiliates “UBS”). The Term Financing is collateralized by a portion of the debt investments in our portfolio. Prior to amending the Term Financing on June 21, 2019, borrowings under the Term Financing bear interest (i) at a rate per annum equal to one-month LIBOR plus 2.75% through December 4, 2018, and (ii) at a rate per annum equal to one-month LIBOR plus 2.55% from December 5, 2018 through December 5, 2020 (the “Term Financing Rate”). We also incurred an annual fee of approximately 1% of the outstanding borrowings under the Term Financing. On June 21, 2019, we amended the Term Financing and increased the Term Financing by $20.0 million from $102.0 million to $122.0 million. On April 15, 2020, we decided not to exercise an option to increase the Term Financing by up to $53.0 million (the “Option”) and repaid $20.0 million of the Term Financing.
Borrowings under the Term Financing, as amended, bear interest (a) with respect to the $102.0 million (i) at a rate per annum equal to one-month LIBOR plus 2.55% through December 4, 2019, and (ii) at a rate per annum equal to one-month LIBOR plus 3.55% from December 5, 2019 through December 4, 2020, and (iii) at a rate per annum equal to one-month LIBOR plus 3.15% from December 5, 2020 through December 5, 2021, and (b) with respect to the additional $20.0 million increase in the Term Financing, (i) at a rate per annum equal to one-month LIBOR plus 3.15% through April 14, 2020, and (ii) at a rate per annum equal to one-month LIBOR plus 2.90% from the April 15, 2020 through December 5, 2021.
As of June 30, 2020, and June 30, 2019, there were $102.0 million and $122.0 million in borrowings outstanding under the Term Financing, respectively.
On November 20, 2017, we entered into a $50 million revolving financing facility (the “2017 UBS Revolving Financing”) with UBS. On June 21, 2019, we amended the 2017 UBS Revolving Financing to reduce the size of the 2017 UBS Revolving Financing to $30.0 million and extend the maturity date (as amended, the “Revolving Financing”). Borrowings under the Revolving Financing will generally bear interest at a rate per annum equal to one-month LIBOR plus 3.15%. The Company will pay a fee on any undrawn amounts of 2.25% per annum; provided that if 50% or less of the Revolving Financing is drawn, the fee will be 2.50% per annum. Any amounts borrowed under the Revolving Financing will mature, and all accrued and unpaid interest will be due and payable, on December 7, 2020. As of June 30, 2020, there were $30.0 million borrowings outstanding under the Revolving Financing. We refer to the Term Financing and the Revolving Financing together as the “Financing Facilities.”
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Notes due 2023
On July 2, 2018, we closed the public offering of $30 million in aggregate principal amount of 6.125% notes due 2023 (the “Existing Notes”). On July 12, 2018, the underwriters exercised their over-allotment option to purchase an additional $4.5 million in aggregate principal amount of the Existing Notes. The total net proceeds to us from the Existing Notes, including the exercise of the underwriters’ over-allotment option, after deducting underwriting discounts and commissions of approximately $1.0 million and estimated offering expenses of approximately $230,000, were approximately $33.2 million.
On October 18, 2019, we closed the public offering of $15 million in aggregate principal amount of additional 6.125% notes due 2023 (the “Notes,” and together with the Existing Notes, the “2023 Notes”). The Notes constitute a further issuance of, rank equally in right of payment with, and form a single series with the $34.5 million in Existing Notes. On November 7, 2019, the underwriters exercised their option to purchase an additional $1.875 million in aggregate principal of the Notes. The total net proceeds received by us from the sale of the Notes, including the exercise of the underwriters’ over-allotment option, was approximately $16.4 million, based on the purchase price paid by the underwriters of 96.875% of the aggregate principal amount of the Notes, after deducting estimated offering expenses of approximately $255,000 payable by us.
The 2023 Notes will mature on July 1, 2023 and bear interest at a rate of 6.125%. The 2023 Notes are direct unsecured obligations and rank pari passu, which means equal in right of payment, with all outstanding and future unsecured indebtedness issued by us. Because the 2023 Notes are not secured by any of our assets, they are effectively subordinated to all of our existing and future secured unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest), to the extent of the value of the assets securing such indebtedness. The 2023 Notes are structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries and financing vehicles, including, without limitation, borrowings under the Financing Facilities. The 2023 Notes are obligations exclusively of Investcorp Credit Management BDC, Inc. and not of any of its subsidiaries. None of our subsidiaries is a guarantor of the 2023 Notes and the 2023 Notes will not be required to be guaranteed by any subsidiary we may acquire or create in the future.
The 2023 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after July 1, 2020. Interest on the Notes is payable quarterly on January 1, April 1, July 1 and October 1 of each year. The 2023 Notes are listed on the NASDAQ Global Select Market under the trading symbol “CMFNL.” We may from time to time repurchase the 2023 Notes in accordance with the 1940 Act and the rules promulgated thereunder. As of June 30, 2020 and June 30, 2019, the outstanding principal balance of the 2023 Notes was approximately $51.4 million and 34.5 million, respectively, and had an estimated fair value of $44.9 million and $34.7 million, respectively, based on the closing price as of June 30, 2020 and June 30, 2019, respectively, as traded on NASDAQ.
The indenture under which the 2023 Notes are issued (the “Indenture”) contains certain covenants, including covenants (i) requiring our compliance with the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a) of the 1940 Act, whether or not we continue to be subject to such provisions of the 1940 Act; (ii) requiring our compliance, under certain circumstances, with the requirements set forth in Section 18(a)(1)(B) as modified by Section 61(a) of the 1940 Act, whether or not we continue to be subject to such provisions of the 1940 Act, prohibiting the declaration of any cash dividend or distribution upon any class of our capital stock (except to the extent necessary for us to maintain its treatment as a RIC under Subchapter M of the Code), or purchasing any such capital stock, if our asset coverage, as defined in the 1940 Act, is below 150% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution, or purchase; and (iii) requiring us to provide financial information to the holders of the Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These covenants are subject to limitations and exceptions that are described in the Indenture.
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Investments
Our level of investment activity can and does vary substantially from period to period depending on many factors, including the amount we have available to invest as well as the amount of debt and equity capital available to middle-market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.
As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we may not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million. In each case, the company must be organized in the United States. As of June 30, 2020, approximately 10.75% of our total assets were non-qualifying assets.
To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income we distribute to our stockholders.
Revenues
We generate revenues primarily in the form of interest on the debt we hold. We also generate revenue from royalty income, dividends on our equity interests and capital gains on the sale of warrants and other debt or equity interests that we acquire. Our investments in fixed income instruments generally have an expected maturity of three to five years, although we have no lower or upper constraint on maturity. Interest on our debt investments is generally payable quarterly or semi-annually. Payments of principal of our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments and preferred stock investments may defer payments of cash interest or dividends or PIK interest. Any outstanding principal amount of our debt investments and any accrued but unpaid interest will generally become due at the maturity date. In addition, we may generate revenue in the form of prepayment fees, commitment, origination, structuring or due diligence fees, fees for providing significant managerial assistance, consulting fees and other investment related income.
Expenses
Our primary operating expenses include the payment of the Base Management Fee and, depending on our operating results, incentive fees, expenses reimbursable by us under the Prior Advisory Agreement or the Advisory Agreement, as applicable, and administration fees and our allocable portion of overhead under the Prior Administration Agreement or Administration Agreement, as applicable. The Base Management Fee and Incentive Fee compensation remunerates the Adviser for work in identifying, evaluating, negotiating, closing and monitoring our investments. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without limitation, those relating to:
| • | our organization and our offering; |
| • | valuing our assets and calculating our net asset value per share (including the cost and expenses of any independent valuation firm(s)); |
| • | fees and expenses payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments; |
| • | interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts; |
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| • | offerings of our common stock and other securities; |
| • | administration fees and expenses, if any, payable under the Prior Administration Agreement or Administration Agreement, as applicable (including our allocable portion of the Adviser’s overhead in performing its obligations under such Administration Agreement, including rent, equipment and the allocable portion of the cost of our Chief Compliance Officer, Chief Financial Officer and his staffs’ compensation and compensation-related expenses); |
| • | transfer agent and custody fees and expenses; |
| • | federal and state registration fees; |
| • | costs of registration and listing our shares on any securities exchange; |
| • | U.S. federal, state and local taxes; |
| • | Independent Directors’ fees and expenses; |
| • | costs of preparing and filing reports or other documents required by the SEC or other regulators; |
| • | costs of any reports, proxy statements or other notices to stockholders including printing costs; |
| • | costs associated with individual or group stockholders; |
| • | costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums; |
| • | direct costs and expenses of administration and operation, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs; and |
| • | all other non-investment advisory expenses incurred by us or the Adviser in connection with administering our business. |
Portfolio and investment activity
Portfolio composition
We invest primarily in middle-market companies in the form of unitranche loans and standalone first and second lien loans. We may also invest in unsecured debt, bonds and in the equity of portfolio companies through warrants and other instruments.
As of June 30, 2020, our investment portfolio of $270.6 million (at fair value) consisted of debt and equity investments in 38 portfolio companies, of which 83.6% were first lien investments, 10.2% were second lien investments, 4.0% were unitranche loans, and 2.2% were in equities, warrants and other positions. At June 30, 2020, our average and largest portfolio company investment at fair value was $7.1 million and $15.0 million, respectively.
As of June 30, 2019, our investment portfolio of $306.4 million (at fair value) consisted of debt and equity investments in 33 portfolio companies, of which 77.6% were first lien investments, 18.7% were second lien investments, 3.7% were unitranche loans, and 0.0% were in equities, warrants and other positions. At June 30, 2019, our average and largest portfolio company investment at fair value was $9.3 million and $17.3 million, respectively.
As of June 30, 2020, and June 30, 2019, our weighted average total yield of debt and income producing securities at amortized cost (which includes interest income and amortization of fees and discounts) was 9.58% and 10.50%, respectively. As of June 30, 2020, and June 30, 2019, our weighted average total yield on investments at amortized cost (which includes interest income and amortization of fees and discounts) was 9.01% and 10.25%, respectively. The weighted average total yield was computed using an internal rate of return calculation of our debt investments based on contractual cash flows, including interest and amortization
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payments, and, for floating rate investments, the spot LIBOR, as of June 30, 2020 of all of our debt investments. The weighted average total yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before payment of all of our fees and expenses, including any sales load paid in connection with an offering of our securities. There can be no assurance that the weighted average total yield will remain at its current level.
We use Global Industry Classification Standard (“GICS”) codes to identify the industry groupings. At June 30, 2020 and June 30, 2019, respectively, the industry composition of our portfolio in accordance with GICS at fair value was as follows:
| Percentage of Total Portfolio at June 30, 2020 |
Percentage of Total Portfolio at June 30, 2019 |
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| Professional Services |
11.48 | % | 13.52 | % | ||||
| Construction & Engineering |
11.18 | 9.80 | ||||||
| Energy Equipment & Services |
10.92 | 10.21 | ||||||
| Trading Companies & Distributors |
9.09 | 2.40 | ||||||
| Media |
7.09 | 9.91 | ||||||
| Containers & Packaging |
5.93 | 4.22 | ||||||
| Diversified Telecommunication Services |
4.64 | 5.65 | ||||||
| Commercial Services & Supplies |
4.58 | 8.65 | ||||||
| Retail |
4.32 | 4.68 | ||||||
| Distributors |
3.49 | 4.82 | ||||||
| Internet Software & Services |
3.41 | 2.89 | ||||||
| Consumer Finance |
3.37 | — | ||||||
| Airlines |
3.35 | — | ||||||
| Construction Materials |
2.41 | 2.26 | ||||||
| Auto Components |
2.31 | 2.88 | ||||||
| Internet & Direct Marketing Retail |
2.29 | — | ||||||
| Specialty Retail |
2.08 | — | ||||||
| Household Durables |
1.82 | 3.08 | ||||||
| Chemicals |
1.77 | 1.55 | ||||||
| Road & Rail |
1.43 | — | ||||||
| Hotels, Restaurants & Leisure |
1.42 | 3.62 | ||||||
| IT Services |
1.10 | 1.89 | ||||||
| Technology Hardware, Storage & Peripherals |
0.52 | 2.40 | ||||||
| Wireless Telecommunication Services |
— | 0.75 | ||||||
| Business Services |
— | 2.42 | ||||||
| Health Care Equipment & Supplies |
— | 2.40 | ||||||
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| 100.00 | % | 100.00 | % | |||||
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During the year ended June 30, 2020, we added 23 new investments and 11 separate draws on existing revolving credit facilities and delayed draw term loans, totaling approximately $101.8 million. Of these investments, 12 were in new portfolio companies and 11 were in existing portfolio companies. Of these new investments, 98.63% consisted of first lien investments and 1.37% in equity, warrants, and other investments.
During the year ended June 30, 2019, we added 50 new investments and 10 separate draws on existing revolving credit facilities and delayed draw term loans, totaling approximately $195.2 million. Of these investments, 25 were in new portfolio companies and 25 were in existing portfolio companies. Of these new investments, 93.50% consisted of first lien investments, 6.10% second lien investments, and 0.4% in equity, warrants, and other investments.
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At June 30, 2020, 99.5% of our debt investments bore interest based on floating rates based on indices such as LIBOR (in certain cases, subject to interest rate floors), and 0.5% bore interest at fixed rates. At June 30, 2019, 96.8% of our debt investments bore interest based on floating rates based on indices such as LIBOR (in certain cases, subject to interest rate floors), and 3.2% bore interest at fixed rates.
Our investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require us to provide funding when requested by portfolio companies in accordance with the terms of the underlying loan agreements. As of June 30, 2020, we had four such investments with aggregate unfunded commitments of $7,854,384. As of June 30, 2019, we had three such investments with aggregate unfunded commitments of $6,655,745. We maintain sufficient liquidity to fund such unfunded loan commitments should the need arise.
Asset Quality
In addition to various risk management and monitoring tools, we use the Adviser’s investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment rating system uses a five-level numeric rating scale. The following is a description of the conditions associated with each investment rating:
| Investment Rating 1 | Investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment. | |
| Investment Rating 2 | Investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans will initially be rated 2. | |
| Investment Rating 3 | Investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with their financial covenants. | |
| Investment Rating 4 | Investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in workout. Investments with a rating of 4 will be those for which some loss of return but no loss of principal is expected. | |
| Investment Rating 5 | Investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in workout. Investments with a rating of 5 will be those for which some loss of return and principal is expected. | |
If the Adviser determines that an investment is underperforming, or circumstances suggest that the risk associated with a particular investment has significantly increased, the Adviser will increase its monitoring intensity and prepare regular updates for the Investment Committee, summarizing current operating results and material impending events and suggesting recommended actions. While the investment rating system identifies the relative risk for each investment, the rating alone does not dictate the scope and/or frequency of any monitoring that will be performed. The frequency of the Adviser’s monitoring of an investment will be determined by a number of factors, including, but not limited to, the trends in the financial performance of the portfolio company, the investment structure and the type of collateral securing the investment.
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The following table shows the investment rankings of the debt investments in our portfolio:
| As of June 30. 2020 | As of June 30, 2019 | |||||||||||||||||||||||
| Fair Value | % of Portfolio |
Number of Investments |
Fair Value | % of Portfolio |
Number of Investments |
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| 1 |
$ | 25,254,600 | 9.3 | % | 3 | $ | 6,358,750 | 2.1 | % | 1 | ||||||||||||||
| 2 |
162,252,467 | 60.0 | 30 | 223,645,544 | 73.0 | 32 | ||||||||||||||||||
| 3 |
64,792,766 | 23.9 | 16 | 67,535,327 | 22.0 | 8 | ||||||||||||||||||
| 4 |
9,848,588 | 3.7 | 3 | 8,851,371 | 2.9 | 3 | ||||||||||||||||||
| 5 |
8,473,288 | 3.1 | 3 | 1 | — | 1 | ||||||||||||||||||
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| Total |
$ | 270,621,709 | 100.0 | % | 55 | $ | 306,390,993 | 100.0 | % | 45 | ||||||||||||||
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Results of Operations
Comparison of the years ended June 30, 2020 and June 30, 2019
Investment income
Investment income, attributable primarily to dividends, interest and fees on our debt investments, for the year ended June 30, 2020 remained relatively flat at $34.5 million from $34.4 million for the year ended June 30, 2019, primarily due to an increase in other fee income related to pre-payment investments offset by a decrease in yield spreads.
Expenses
Total expenses (including waiver, if applicable) for the year ended June 30, 2020 decreased to $20.3 million from $20.9 million for the year ended June 30, 2019, due primarily to a decrease in our income-based incentive fee offset by an increase in interest expense due to the issuance of additional 2023 Notes.
Net investment income
Net investment income increased to $14.2 million for the year ended June 30, 2020 from $13.5 million for the year ended June 30, 2019, due to an increase in investment income primarily due to other fee income related pre-payment investments, a decrease in incentive fee expense offset by an increase in interest expense.
Net realized gain or loss
The net realized loss on investments totaled $7.6 million for the year ended June 30, 2020, primarily due to the restructure of Fusion Connect Inc and 4L Technologies Inc., during the period.
The net realized loss on investments totaled $22.0 million for the year ended June 30, 2019, primarily due to the write off of Trident USA Health Services, LLC during the period.
Net change in unrealized (depreciation) appreciation on investments
We recorded a net change in unrealized depreciation of $31.2 million for the year ended June 30, 2020, primarily due to a decrease in fair value of our investments in 1888 Industrials, Bioplan, Exela Technologies, Premiere Global Services, Inc., and Techniplas during the period.
We recorded a net change in unrealized depreciation of $6.1 million for the year ended June 30, 2019, primarily due to a decrease in fair value of our investments in 4L Technologies Inc, Fusion Connect Inc., Montreign Operating Company, LLC and Premiere Global Services, Inc., offset by the write off of Trident USA Health Services, LLC during the period.
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Comparison of the years ended June 30, 2019 and June 30, 2018
Investment income
Investment income, attributable primarily to dividends, interest and fees on our debt investments, for the year ended June 30, 2019 decreased to $34.4 million from $40.8 million for the year ended June 30, 2018, primarily due to a decrease in income related to dividends received from our wholly-owned subsidiaries of Bird Electric Blocker, LLC and U.S. Well Services Blocker, LLC.
Expenses
Total expenses (including waiver, if applicable) for the year ended June 30, 2019 decreased to $20.9 million from $21.8 million for the year ended June 30, 2018, due primarily to a decrease in our income-based incentive fee and our tax provision related to dividend income received from our wholly-owned subsidiaries of Bird Electric Blocker, LLC and U.S. Well Services Blocker, LLC.
Net investment income
Net investment income decreased to $13.5 million for the year ended June 30, 2019 from $19.0 million for the year ended June 30, 2018, due to a decrease in investment income primarily due to the dividend income received from our wholly-owned subsidiaries of Bird Electric Blocker, LLC and U.S. Well Services Blocker, LLC offset by our income-based incentive and our tax provision related to the dividend received from our wholly-owned subsidiaries of Bird Electric Blocker, LLC and U.S. Well Services Blocker, LLC.
Net realized gain or loss
The net realized loss on investments totaled $22.0 million for the year ended June 30, 2019, primarily due to the write off of Trident USA Health Services, LLC during the period.
The net realized loss on investments totaled $9.9 million for the year ended June 30, 2018, primarily due to the restructuring of Bird Electric, LLC and the sale of Dayton Superior Corporation during the period.
Net change in unrealized (depreciation) appreciation on investments
We recorded a net change in unrealized appreciation of $6.5 million for the year ended June 30, 2019, primarily due to a decrease in fair value of our investments in 4L Technologies Inc, Fusion Connect Inc., Montreign Operating Company, LLC and Premiere Global Services, Inc., offset by the write off of Trident USA Health Services, LLC during the period.
We recorded a net change in unrealized appreciation of $6.5 million for the year ended June 30, 2018, primarily due to an increase in fair value of our investments in Caelus Energy Alaska 03, LLC, AP NMT Acquisition BV and the restructuring of Bird Electric, LLC offset by the restructuring of Trident USA Health Services, LLC during the period.
Liquidity and capital resources
Cash flows
For the year ended June 30, 2020, our cash balance decreased by $6.0 million. During that period, we used $10.6 million in cash towards operating activities, primarily due to investments of $101.9 million in portfolio companies, offset by proceeds from repayment and sale of investments in portfolio companies of $105.7 million. During the same period, we generated $4.5 million from financing activities, resulting primarily from proceeds from the 2023 Notes and borrowings from our Revolving Financing offset by distributions to stockholders and repayments to our Term Financing and Revolving Financing.
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Capital Resources
As of June 30, 2020, we had $14.9 million of cash as well as $5.4 million in restricted cash and $0.0 million of capacity under the Revolving Financing. As of June 30, 2020, we had approximately $183.4 million of senior securities outstanding and our asset coverage ratio was 159.3%. We intend to generate additional cash primarily from future offerings of securities, future borrowings under the 2017 UBS Revolving Financing as well as cash flows from operations, including income earned from investments in our portfolio companies and, to a lesser extent, from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less. Our primary liquidity needs include interest and principal repayments on our Financing Facilities, our unfunded loan commitments (if any), investments in portfolio companies, dividend distributions to our stockholders and operating expenses.
As discussed below in further detail, we have elected to be treated as a RIC under the Code. To maintain our RIC status, we generally must distribute substantially all of our net taxable income to stockholders in the form of dividends. Our net taxable income does not necessarily equal our net income as calculated in accordance with U.S. GAAP.
Senior Securities
Information about our senior securities is shown in the following table as of each of the fiscal years ended June 30, 2020, 2019, 2018, 2017, 2016, 2015, 2014 and 2013, respectively. The report of RSM US LLP, our independent registered public accounting firm, on the senior securities table as of June 30, 2020, is attached as an exhibit to this Annual Report on Form 10-K.
| Class and Year |
Total Amount Outstanding Exclusive of Treasury Securities(1) |
Asset Coverage per Unit(2) |
Involuntary Liquidating Preference per Unit(3) |
Average Market Value per Unit(4) |
||||||||||||
| UBS Financing Facility |
||||||||||||||||
| Fiscal Year ended June 30, 2020 |
$ | 132,000,000 | (5) | $ | 2,200 | — | N/A | |||||||||
| Fiscal Year ended June 30, 2019 |
$ | 133,026,670 | (5) | $ | 2,329 | — | N/A | |||||||||
| Fiscal Year ended June 30, 2018 |
$ | 119,823,000 | (5) | $ | 2,431 | — | N/A | |||||||||
| Fiscal Year ended June 30, 2017 |
$ | 102,000,000 | $ | 2,666 | — | N/A | ||||||||||
| Fiscal Year ended June 30, 2016 |
$ | 132,478,329 | (6) | $ | 2,229 | — | N/A | |||||||||
| Fiscal Year ended June 30, 2015 |
$ | 150,847,459 | (6) | $ | 2,306 | — | N/A | |||||||||
| Fiscal Year ended June 30, 2014 |
$ | 85,591,314 | (6) | $ | 3,339 | — | N/A | |||||||||
| Fiscal Year ended June 30, 2013 |
$ | 76,500,000 | $ | 1,860 | — | N/A | ||||||||||
| Citi Revolving Financing(7) |
||||||||||||||||
| December 31, 2018 |
$ | — | N/A | — | N/A | |||||||||||
| Fiscal Year ended June 30, 2018 |
$ | — | N/A | — | N/A | |||||||||||
| Fiscal Year ended June 30, 2017 |
$ | — | N/A | — | N/A | |||||||||||
| Notes due 2023 |
||||||||||||||||
| Fiscal Year ended June 30, 2020 |
$ | 51,375,000 | $ | 5,674 | — | $ | 926 | |||||||||
| Fiscal Year ended June 30, 2019 |
$ | 34,500,000 | $ | 8,969 | — | $ | 1,012 | |||||||||
| December 31, 2018 |
$ | 34,500,000 | $ | 8,446 | — | $ | 1,002 | |||||||||
| (1) | Total amount of senior securities outstanding at the end of the period presented. |
| (2) | Asset coverage per unit is the ratio of the carrying value of our total assets, less all liabilities and indebtedness not represented by senior securities, in relation to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtedness. |
| (3) | The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it. The “—” indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities. |
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| (4) | Not applicable, except for the Notes due 2023, which are publicly traded. The Average Market Value Per Unit is calculated by taking the daily average closing price during the period and dividing it by twenty-five dollars per share and multiplying the result by one thousand to determine a unit price per thousand consistent with Asset Coverage Per Unit. |
| (5) | Includes senior securities outstanding under the 2017 UBS Revolving Financing and the Term Financing. |
| (6) | Includes senior securities under the 2013 UBS Revolving Financing and the Term Financing. In connection with the expiration of the 2013 UBS Revolving Financing in accordance with its terms on December 5, 2016, we repaid in full all indebtedness, liabilities and other obligations thereunder. |
| (7) | On December 8, 2017, we repaid in full all indebtedness, liabilities and other obligations under, and terminated, the Citi Revolving Financing. |
Regulated Investment Company Status and Distributions
We have elected to be treated as a RIC under Subchapter M of the Code. If we qualify as a RIC, we will not be subject to corporate-level U.S. federal income tax on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.
To qualify for RIC tax treatment, we must, among other things, distribute to our stockholders, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). We will also be subject to a federal excise tax, based on distributive requirements of our taxable income on a calendar year basis.
We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, the covenants contained in the Financing Facilities may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a BDC under the 1940 Act and due to provisions in the Financing Facilities. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.
In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder elects to receive his or her entire distribution in either cash or stock of the RIC, subject to a
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limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.
Advisory Agreement
Effective August 30, 2019 (the “Commencement Date”), we entered into the Advisory Agreement with the Adviser. Under the Advisory Agreement, the Base Management Fee is calculated at an annual rate of 1.75% of our gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents (such amount, “Gross Assets”). The Base Management Fee is payable quarterly in arrears and the Base Management Fees for any partial month or quarter will be appropriately pro-rated.
Under the Advisory Agreement, for the period from the Commencement Date through the end of the first and second fiscal quarters after the Commencement Date, the Base Management Fee is calculated based on the value of our Gross Assets as of the end of such quarter. Subsequently, the Base Management Fee will be calculated based on the average value of the Company’s Gross Assets at the end of the two most recently completed fiscal quarters. Base Management Fees for any partial month or quarter will be appropriately pro-rated.
For the year ended June 30, 2020, $5,385,814 in Base Management Fees were earned by the Adviser, of which $269,815 was waived and $1,196,937 was payable at June 30, 2020. For the years ended June 30, 2019 and June 30, 2018, $5,436,135 and $4,871,706, respectively, in Base Management Fees were earned by the Adviser, of which $0 and $1,319,853 was payable under the Prior Advisory Agreement at June 30, 2019 and June 30, 2018, respectively. No Base Management Fees were waived for the years ended June 30, 2019 and June 30, 2018.
Under the Advisory Agreement, the Income-Based Fee is calculated and payable quarterly in arrears based on our Pre-Incentive Fee Net Investment Income (as defined below) for the immediately preceding fiscal quarter, subject to a total return requirement (the “Total Return Requirement”) and deferral of non-cash amounts, and is 20.0% of the amount, if any, by which our Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of our net assets attributable to its common stock, for the immediately preceding fiscal quarter, exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each fiscal quarter. Under this provision, in any fiscal quarter, the Adviser receives no Incentive Fee until our Pre-Incentive Fee Net Investment Income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of our Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than 2.5% (which is 10.0% annualized). The effect of the “catch-up” provision is that, subject to the Total Return Requirement and deferral provisions discussed below, if Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter, the Adviser receives 20.0% of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply.
“Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the fiscal quarter, minus our operating expenses for the quarter (including the Base Management Fee, expenses payable under the Administration Agreement and any interest expense and any 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 (“OID”), debt instruments with payment-in-kind (“PIK”) interest and zero coupon securities), accrued income that we have not yet received in cash.
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Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation.
No Income-Based Fee is payable under the Advisory Agreement except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the fiscal quarter for which fees are being calculated and the Lookback Period exceeds the cumulative Incentive Fees accrued and/or paid for the Lookback Period. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of Pre-Incentive Fee Net Investment Income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current fiscal quarter and the Lookback Period. The “Lookback Period” means (1) through June 30, 2022, the period that on the last day of the fiscal quarter in which the Commencement Date occurs and ends on the last day of the fiscal quarter immediately preceding the fiscal quarter for which the Income-Based Fee is being calculated, and (2) after June 30, 2022, the eleven fiscal quarters immediately preceding the fiscal quarter for which the Income-Based Fee is being calculated.
For the year ended June 30, 2020, we incurred $832,472 of Income-Based Fees, of which $336,971 was waived for the year ended June 30, 2020. As of June 30, 2020, $707,796 of such Income-Based Fees are currently payable to the Adviser and $707,796 of Income-Based Fees incurred by us were generated from deferred interest (i.e. PIK and certain discount accretion) and are not payable until such amounts are received in cash. For the year ended June 30, 2019, we incurred $1,720,707 of Income-Based Fees, of which $503,229 was waived. As of June 30, 2019, $545,991 of such Income-Based Fees were payable to the Adviser under the Prior Advisory Agreement and $545,991 of Income-Based Fees incurred by us were generated from deferred interest (i.e., PIK and certain discount accretion) under the Prior Advisory Agreement and were not payable until such amounts are received in cash. For the year ended June 30, 2018, we incurred $3,932,710 of Income-Based Fees, of which $527,224 was waived. As of June 30, 2018, $2,294,678 of such Income-Based Fees were currently payable to the Adviser under the Prior Advisory Agreement and $772,234 of Income-Based Fees incurred by us were generated from deferred interest (i.e. PIK and certain discount accretion) and are not payable until such amounts are received in cash. Past waivers by the Adviser in no way imply that the Adviser will agree to waive any Income-Based Fees in any future period.
Under the Advisory Agreement, the Capital Gains Fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), commencing with the fiscal year ending June 30, 2021, and will equal to 20.0% of our cumulative aggregate realized capital gains from the Commencement Date through the end of that fiscal year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gains Fees. If such amount is negative, then no Capital Gains Fee will be payable for such year. Additionally, if the Advisory Agreement is terminated as of a date that is not a fiscal year end, the termination date will be treated as though it were a fiscal year end for purposes of calculating and paying the Capital Gains Fee. For the avoidance of doubt, realized capital gains, realized capital losses, unrealized capital appreciation and unrealized capital depreciation with respect to our portfolio as of the end of the fiscal year ended June 30, 2020 will be excluded from the calculations of the Capital Gains Fee.
Under U.S. generally accepted accounting principles, we calculate the Capital Gains Fee as if we had realized all assets at their fair values as of the reporting date. Accordingly, we accrue a provisional Capital Gains Fee taking into account any unrealized gains or losses. As the provisional Capital Gains Fee is subject to the performance of investments until there is a realization event, the amount of the provisional Capital Gains Fee accrued at a reporting date may vary from the Capital Gains Fee that is ultimately realized and the differences could be material.
As of June 30, 2020, there was no Capital Gains Fee accrued, earned or payable to the Adviser under the Advisory Agreement. As of June 30, 2019, there was no Capital Gains Fee accrued, earned or payable to the Adviser under the Prior Advisory Agreement.
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The Advisory Agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Adviser’s services under the Advisory Agreement or otherwise as the Adviser.
Prior Advisory Agreement
The following is a description of the Prior Advisory Agreement, which was terminated on August 30, 2019. Pursuant to the Prior Advisory Agreement, we agreed to pay to the Adviser a Base Management Fee of 1.75% of gross assets, as adjusted, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents and “fair value of derivatives associated with our financing”, and the Incentive Fee consisting of two parts.
Under the Prior Advisory Agreement, the first part of the Incentive Fee, or the Income-Based Fee, which is calculated and payable quarterly in arrears, equals 20.0% of the “pre-incentive fee net investment income” (as defined in the Prior Advisory Agreement) for the immediately preceding quarter, subject to a hurdle rate of 2.0% per quarter (8.0% annualized), and is subject to a “catch-up” feature. The Incentive Fee is subject to a total return requirement, which provides that no Incentive Fee in respect of the Company’s pre-incentive fee net investment income will be payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. The net pre-incentive fee investment income used to calculate the Income-Based Fee is also included in the amount of our gross assets used to calculate the 1.75% Base Management Fee.
Under the Prior Advisory Agreement, the second part of the incentive fee, or the Capital Gains Fee, is calculated and payable in arrears as of the end of each calendar year and equals 20.0% of the aggregate cumulative realized capital gains from inception through the end of each calendar year, computed net of aggregate cumulative realized capital losses and aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gain Fees.
The Capital Gains Fee consists of fees related to both realized gains and unrealized gains. As of June 30, 2020, there was no Capital Gains Fee payable to the Adviser under the Prior Advisory Agreement. As of June 30, 2019, there was no Capital Gains Fee payable to the Adviser under the Prior Advisory Agreement.
With respect to the incentive fee expense accrual relating to the Capital Gains Fee, U.S. GAAP requires that the Capital Gains Fee accrual consider the cumulative aggregate unrealized appreciation in the calculation, as a Capital Gains Fee would be payable if such unrealized appreciation were realized, even though such unrealized appreciation is not permitted to be considered in calculating the fee actually payable under the Prior Advisory Agreement.
The Prior Advisory Agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the Prior Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Adviser’s services under the Prior Advisory Agreement or otherwise as the Adviser.
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Off-Balance Sheet Arrangements
We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of June 30, 2020, our off-balance sheet arrangements consisted of $2.1 million in unfunded commitments to three of our portfolio companies. As of June 30, 2019, our off-balance sheet arrangements consisted of $6.7 million in unfunded commitments to four of our portfolio companies.
Recent Developments
We have evaluated the need for disclosures and/or adjustments resulting from subsequent events through the date the consolidated financial statements were issued.
Subsequent to June 30, 2020 and through September 18, 2020, the Company invested $13.3mm in one existing portfolio company and two new portfolio companies, inclusive of funding a revolving commitment, and the Company received $19.7mm in repayments.
On August 26, 2020, our board of directors declared a distribution for the quarter ended September 30, 2020 of $0.15 per share payable on October 15, 2020 to stockholders of record as of September 25, 2020 and a supplemental distribution for the quarter ended September 30, 2020 of $0.03 per share payable on October 15, 2020 to stockholders of record as of September 25, 2020.
| Item 7A. | Quantitative and Qualitative Disclosure about Market Risk |
We are subject to financial market risks, including changes in interest rates. At June 30, 2020, 99.5% of our debt investments bore interest based on floating rates, such as LIBOR, the Euro Interbank Offered Rate, the Federal Funds Rate or the Prime Rate. The interest rates on such investments generally reset by reference to the current market index after one to six months. Floating rate investments subject to a floor generally reset by reference to the current market index after one to six months only if the index exceeds the floor.
Generally, we believe higher yielding assets such as those in our investment portfolio do not necessarily follow a linear interest rate relationship and are less sensitive in price to interest rate changes than many other debt investments. Our investments in fixed rate assets are generally exposed to changes in value due to interest rate fluctuations, and our floating rate assets are generally exposed to cash flow variability from fluctuation in rates. Consequently, our net interest income (interest income less interest expense) is exposed to risks related to interest rate fluctuations. Based on our in-place portfolio with certain interest rate floors and our financing at June 30, 2020, a 1.00% increase in interest rates would increase our net interest income by approximately (4.4)% and a 2.00% increase in interest rates would increase our net interest income by approximately 4.0%. Variable-rate instruments subject to a floor generally reset periodically to the applicable floor and, in the case of investments in our portfolio, quarterly to a floor based on LIBOR, only if the floor exceeds the index. Under these loans, we do not benefit from increases in interest rates until such rates exceed the floor and thereafter benefit from market rates above any such floor.
Although management believes that this analysis is indicative of our existing sensitivity to interest rate changes, it does not adjust for changes in the credit markets, the size, credit quality or composition of the assets in our portfolio and other business developments, including borrowing, that could affect the net increase in net assets resulting from operations, or net income. It also does not adjust for the effect of the time lag between a change in the relevant interest rate index and the rate adjustment under the applicable loan. Accordingly, we can offer no assurances that actual results would not differ materially from the statement above.
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| Item 8. | Financial Statements and Supplementary Data |
| 99 | ||||
| CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES AS OF JUNE 30, 2020 AND JUNE 30, 2019 |
100 | |||
| 101 | ||||
| 102 | ||||
| 103 | ||||
| 104 | ||||
| 107 | ||||
| 110 | ||||
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Report of Independent Registered Public
Accounting Firm
To the Stockholders and the Board of Directors of
Investcorp Credit Management BDC, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of assets and liabilities, including the consolidated schedules of investments, of Investcorp Credit Management BDC, Inc. and Subsidiaries (formerly CM Finance Inc) (the Company) as of June 30, 2020 and 2019, and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended June 30, 2020, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with 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 Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting for the year ended June 30, 2020. 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 for the year ended June 30, 2020.
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 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. Our procedures included confirmation of investments owned as of June 30, 2020 and 2019, by correspondence with the custodian or the agents of the underlying investments or by other appropriate auditing procedures where replies from the custodian or agents were not received. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company’s auditor since 2017.
New York, New York
September 21, 2020
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Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Statements of Assets and Liabilities
| June 30, 2020 |
June 30, 2019 |
|||||||
| Assets |
||||||||
| Non-controlled, non-affiliated investments, at fair value (amortized cost of $316,924,638 and $321,504,359, respectively) |
$ | 270,621,709 | $ | 306,390,993 | ||||
| Cash |
14,876,444 | 19,706,281 | ||||||
| Cash, restricted |
5,417,118 | 6,589,901 | ||||||
| Receivable for investments sold |
1,576,730 | 820,332 | ||||||
| Interest receivable |
2,301,641 | 3,090,639 | ||||||
| Payment-in-kind interest receivable |
514,643 | — | ||||||
| Deferred offering costs |
— | 121,922 | ||||||
| Other receivables |
1,135,563 | — | ||||||
| Prepaid expenses and other assets |
350,661 | 227,924 | ||||||
|
|
|
|
|
|||||
| Total Assets |
$ | 296,794,509 | $ | 336,947,992 | ||||
|
|
|
|
|
|||||
| Liabilities |
||||||||
| Notes payable: |
||||||||
| Term loan |
$ | 102,000,000 | $ | 122,000,000 | ||||
| Revolving credit facility |
30,000,000 | 11,026,670 | ||||||
| 2023 Notes payable |
51,375,000 | 34,500,000 | ||||||
| Deferred debt issuance costs |
(1,042,497 | ) | (2,000,262 | ) | ||||
|
|
|
|
|
|||||
| Notes payable, net |
182,332,503 | 165,526,408 | ||||||
| Payable for investments purchased |
— | 22,276,343 | ||||||
| Dividend payable |
2,499,360 | 3,404,923 | ||||||
| Deferred financing costs payable |
— | 1,037,000 | ||||||
| Income-based incentive fees payable |
707,796 | 545,991 | ||||||
| Base management fees payable |
1,196,937 | — | ||||||
| Accrued provision for taxes |
— | 13,778 | ||||||
| Interest payable |
1,000,452 | 724,222 | ||||||
| Directors’ fees payable |
24,559 | 95,240 | ||||||
| Accrued expenses and other liabilities |
907,907 | 240,197 | ||||||
|
|
|
|
|
|||||
| Total Liabilities |
188,669,514 | 193,864,102 | ||||||
| Commitments and Contingencies (Note 6) |
||||||||
| Net Assets |
||||||||
| Common stock, par value $0.001 per share (100,000,000 shares authorized, 13,885,335 and 13,619,690 shares issued and outstanding, respectively) |
13,885 | 13,620 | ||||||
| Additional paid-in capital |
200,779,949 | 198,398,831 | ||||||
| Distributable earnings (loss) |
(92,668,839 | ) | (55,328,561 | ) | ||||
|
|
|
|
|
|||||
| Total Net Assets |
108,124,995 | 143,083,890 | ||||||
|
|
|
|
|
|||||
| Total Liabilities and Net Assets |
$ | 296,794,509 | $ | 336,947,992 | ||||
|
|
|
|
|
|||||
| Net Asset Value Per Share |
$ | 7.79 | $ | 10.51 | ||||
See notes to consolidated financial statements.
100
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Statements of Operations
| For the Years ended June 30, | ||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Investment Income: |
||||||||||||
| Interest income |
$ | 28,485,264 | $ | 32,591,488 | $ | 28,691,187 | ||||||
| Payment in-kind interest income |
4,629,033 | 953,928 | 2,609,037 | |||||||||
| Dividend income |
— | 133,858 | 9,005,887 | |||||||||
| Payment in-kind dividend income |
— | — | 333,333 | |||||||||
| Other fee income |
1,346,307 | 718,548 | 152,308 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total investment income |
34,460,604 | 34,397,822 | 40,791,752 | |||||||||
| Expenses: |
||||||||||||
| Interest expense |
9,535,751 | 8,866,796 | 6,310,842 | |||||||||
| Base management fees |
5,385,814 | 5,436,135 | 4,871,706 | |||||||||
| Income-based incentive fees |
832,472 | 1,720,707 | 3,932,710 | |||||||||
| Provision for tax expense |
144,709 | 158,028 | 2,579,337 | |||||||||
| Professional fees |
1,530,314 | 1,130,816 | 1,063,528 | |||||||||
| Allocation of administrative costs from advisor |
1,402,422 | 1,354,247 | 1,198,397 | |||||||||
| Amortization of deferred debt issuance costs |
135,262 | 781,508 | 695,470 | |||||||||
| Insurance expense |
375,753 | 336,629 | 351,923 | |||||||||
| Directors’ fees |
270,000 | 405,000 | 402,240 | |||||||||
| Custodian and administrator fees |
373,034 | 285,799 | 295,032 | |||||||||
| Offering expense |
433,089 | 207,000 | 186,513 | |||||||||
| Other expenses |
483,488 | 719,547 | 455,645 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total expenses |
20,902,108 | 21,402,212 | 22,343,343 | |||||||||
| Waiver of base management fees |
(269,815 | ) | — | — | ||||||||
| Waiver of income-based incentive fees |
(336,971 | ) | (503,229 | ) | (527,224 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Net expenses |
20,295,322 | 20,898,983 | 21,816,119 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net investment income |
14,165,282 | 13,498,839 | 18,975,633 | |||||||||
| Net realized and unrealized gain/(loss) on investments: |
||||||||||||
| Net realized gain (loss) from investments |
(7,632,194 | ) | (21,982,973 | ) | (9,855,453 | ) | ||||||
| Net change in unrealized appreciation (depreciation) in value of investments |
(31,189,563 | ) | (6,058,095 | ) | 6,505,300 | |||||||
|
|
|
|
|
|
|
|||||||
| Total realized and unrealized gain (loss) on investments |
(38,821,757 | ) | (28,041,068 | ) | (3,350,153 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Net increase (decrease) in net assets resulting from operations |
$ | (24,656,475 | ) | $ | (14,542,229 | ) | $ | 15,625,480 | ||||
|
|
|
|
|
|
|
|||||||
| Basic and diluted: |
||||||||||||
| Net investment income per share |
$ | 1.03 | $ | 0.99 | $ | 1.39 | ||||||
| Earnings per share |
$ | (1.79 | ) | $ | (1.07 | ) | $ | 1.14 | ||||
| Weighted average shares of common stock outstanding |
13,741,743 | 13,630,661 | 13,689,823 | |||||||||
| Distributions paid per common share |
$ | 0.93 | $ | 1.00 | $ | 1.00 | ||||||
See notes to consolidated financial statements.
101
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Statements of Changes in Net Assets
| For the years ended June 30, | ||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Net assets at beginning of year |
$ | 143,083,890 | $ | 171,522,666 | $ | 169,948,112 | ||||||
| Increase (decrease) in net assets resulting from operations: |
||||||||||||
| Net investment income |
14,165,282 | 13,498,839 | 18,975,633 | |||||||||
| Net realized gain/(loss) on investments |
(7,632,194 | ) | (21,982,973 | ) | (9,855,453 | ) | ||||||
| Net change in unrealized appreciation (depreciation) on investments |
(31,189,563 | ) | (6,058,095 | ) | 6,505,300 | |||||||
|
|
|
|
|
|
|
|||||||
| Net increase (decrease) in net assets resulting from operations |
(24,656,475 | ) | (14,542,229 | ) | 15,625,480 | |||||||
| Stockholder distributions: |
||||||||||||
| Distributions from net investment income |
(12,810,438 | ) | (13,640,442 | ) | (13,685,762 | ) | ||||||
| Distributions from net realized gains |
— | — | — | |||||||||
|
|
|
|
|
|
|
|||||||
| Net decrease in net assets resulting from stockholder distributions |
(12,810,438 | ) | (13,640,442 | ) | (13,685,762 | ) | ||||||
| Capital transactions: |
||||||||||||
| Issuance of common shares (227,000, 0 and 0, respectively) |
2,308,590 | — | — | |||||||||
| Reinvestments of stockholder distributions |
195,028 | 102,468 | 25,014 | |||||||||
| Other paid in capital |
4,400 | — | — | |||||||||
| Repurchase of common stock |
— | (358,573 | ) | (390,178 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Net increase (decrease) in net assets resulting from capital transactions |
2,508,018 | (256,105 | ) | (365,164 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Net increase (decrease) in net assets |
(34,958,895 | ) | (28,438,776 | ) | 1,574,554 | |||||||
|
|
|
|
|
|
|
|||||||
| Net assets at end of period |
$ | 108,124,995 | $ | 143,083,890 | $ | 171,522,666 | ||||||
|
|
|
|
|
|
|
|||||||
See notes to consolidated financial statements.
102
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
| For the years ended June 30, | ||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Cash Flows from Operating Activities |
||||||||||||
| Net increase (decrease) in net assets resulting from operations |
$ | (24,656,475 | ) | $ | (14,542,229 | ) | $ | 15,625,480 | ||||
| Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by (used in) operating activities: |
||||||||||||
| Origination and purchase of investments |
(101,884,993 | ) | (201,933,500 | ) | (172,238,259 | ) | ||||||
| Payment in-kind interest |
(4,114,390 | ) | (953,928 | ) | (2,609,037 | ) | ||||||
| Payment in-kind dividends |
— | — | (333,333 | ) | ||||||||
| Sales and repayments of investments |
105,678,135 | 165,479,578 | 137,045,592 | |||||||||
| Net realized (gain) loss on investments |
7,632,194 | 21,982,973 | 9,855,453 | |||||||||
| Net change in unrealized (appreciation) depreciation on investments |
31,189,563 | 6,058,095 | (6,505,300 | ) | ||||||||
| Amortization of discount/premium on investments |
(2,731,225 | ) | (3,432,198 | ) | (3,899,958 | ) | ||||||
| Amortization of deferred debt issuance costs |
135,262 | 781,508 | 695,470 | |||||||||
| Net (increase) decrease in operating assets: |
||||||||||||
| Interest receivable |
788,998 | 920,811 | (2,383,676 | ) | ||||||||
| Payment-in-kind interest receivable |
(514,643 | ) | — | — | ||||||||
| Receivable for investments sold |
(756,398 | ) | 6,931,543 | (7,751,875 | ) | |||||||
| Other receivables |
(1,135,563 | ) | 245,550 | (245,550 | ) | |||||||
| Prepaid expenses and other assets |
(122,737 | ) | 27,215 | (36,094 | ) | |||||||
| Net increase (decrease) in operating liabilities: |
||||||||||||
| Payable for investments purchased |
(22,276,343 | ) | 9,706,893 | 79,450 | ||||||||
| Interest payable |
276,230 | 421,069 | 98,126 | |||||||||
| Accrued provision for income taxes |
(13,778 | ) | (2,565,559 | ) | 2,579,337 | |||||||
| Directors fees payable |
(70,681 | ) | (4,056 | ) | (704 | ) | ||||||
| Accrued expenses and other liabilities |
667,710 | (17,789 | ) | (331,055 | ) | |||||||
| Base management fees payable |
1,196,937 | (1,319,853 | ) | 187,462 | ||||||||
| Income-based incentive fees payable |
161,805 | (1,748,687 | ) | 2,020,605 | ||||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by (used in) operating activities |
(10,550,392 | ) | (13,962,564 | ) | (28,147,866 | ) | ||||||
| Cash Flows from Financing Activities: |
||||||||||||
| Payment for deferred financing costs |
(214,497 | ) | (1,862,166 | ) | (620,500 | ) | ||||||
| Deferred offering costs |
121,922 | — | 64,591 | |||||||||
| Issuance of common shares |
2,308,590 | — | — | |||||||||
| Distributions to stockholders |
(13,520,973 | ) | (13,550,899 | ) | (13,665,207 | ) | ||||||
| Repurchase of common stock |
— | (358,573 | ) | (390,178 | ) | |||||||
| Other paid in capital |
4,400 | — | — | |||||||||
| Proceeds from Term loan |
— | 20,000,000 | — | |||||||||
| Repayments of Term loan |
(20,000,000 | ) | — | — | ||||||||
| Proceeds from 2023 Notes |
16,875,000 | 34,500,000 | — | |||||||||
| Proceeds from borrowing on revolving credit facility |
38,020,881 | 49,491,354 | 53,378,000 | |||||||||
| Repayments of borrowing on revolving credit facility |
(19,047,551 | ) | (56,287,684 | ) | (35,555,000 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by (used in) financing activities |
4,547,772 | 31,932,032 | 3,211,706 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net change in cash |
(6,002,620 | ) | 17,969,468 | (24,936,160 | ) | |||||||
| Cash: |
||||||||||||
| Cash and restricted cash at beginning of year |
26,296,182 | 8,326,714 | 33,262,874 | |||||||||
|
|
|
|
|
|
|
|||||||
| Cash and restricted cash at end of period |
$ | 20,293,562 | $ | 26,296,182 | $ | 8,326,714 | ||||||
|
|
|
|
|
|
|
|||||||
| Supplemental and non-cash financing cash flow information: |
||||||||||||
| Cash paid for interest |
$ | 9,259,523 | $ | 8,445,728 | $ | 6,212,715 | ||||||
| Cash paid for taxes |
$ | 158,488 | $ | 2,723,561 | $ | — | ||||||
| Issuance of shares pursuant to Dividend Reinvestment Plan |
$ | 195,028 | $ | 102,468 | $ | 25,014 | ||||||
| Non-cash purchase of investments |
$ | (26,043,112 | ) | $ | — | $ | — | |||||
| Non-cash sale of investments |
$ | 26,043,112 | $ | — | $ | — | ||||||
See notes to consolidated financial statements.
103
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Schedule of Investments
June 30, 2020
| Investments(1)(2) |
Industry |
Interest Rate |
Initial |
Maturity |
Principal Shares(3) |
Amortized |
Fair Value |
% of Net |
||||||||||||||||||||
|
Non-Controlled/Non-Affiliates |
||||||||||||||||||||||||||||
| Senior Secured First Lien Debt Investments |
||||||||||||||||||||||||||||
| 1888 Industrial Services, LLC – Term A(4)(10) |
Energy Equipment & Services | 3M L + 5.00% PIK (1.00% Floor) | 9/30/2016 | 9/30/2021 | $ | 5,398,087 | $ | 5,398,087 | $ | 5,398,087 | 4.99 | % | ||||||||||||||||
| 1888 Industrial Services, LLC – Term B(4)(10) |
Energy Equipment & Services | 3M L + 8.00% PIK (1.00% Floor) |
9/30/2016 | 9/30/2021 | 13,970,775 | 8,196,669 | 2,794,155 | 2.58 | % | |||||||||||||||||||
| 1888 Industrial Services, LLC – Term C(4)(10) |
Energy Equipment & Services | 3M L + 5.00% PIK (1.00% Floor) |
6/25/2019 | 9/30/2021 | 678,820 | 678,820 | 678,820 | 0.63 | % | |||||||||||||||||||
| 1888 Industrial Services, LLC – Term D(4)(10) |
Energy Equipment & Services | 3M L + 5.00% PIK (1.00% Floor) |
9/19/2019 | 9/19/2020 | 104,607 | 104,607 | 104,607 | 0.10 | % | |||||||||||||||||||
| 1888 Industrial Services, LLC – Term E(4)(10) |
Energy Equipment & Services | 3M L + 5.00% PIK (1.00% Floor) |
10/18/2019 | 9/19/2020 | 469,381 | 469,381 | 469,381 | 0.43 | % | |||||||||||||||||||
| 1888 Industrial Services, LLC – Revolver(4)(5)(10) |
Energy Equipment & Services | 3M L + 5.00% (1.00% Floor) |
10/11/2016 | 9/30/2021 | 1,928,042 | 1,928,042 | 1,928,042 | 1.78 | % | |||||||||||||||||||
| 4L Technologies Inc |
Technology Hardware, Storage & Peripheral | 3M L + 7.50% (1.00% Floor) |
2/4/2020 | 2/3/2024 | 1,229,925 | 1,229,925 | 1,186,877 | 1.10 | % | |||||||||||||||||||
| ACProducts, Inc |
Household Durables | 1M L + 6.50% (1.00% Floor) | 2/14/2020 | 8/18/2025 | 4,968,750 | 5,071,498 | 4,919,063 | 4.55 | % | |||||||||||||||||||
| Alta Equipment Group, Inc |
Trading Companies & Distributors | 3M L + 8.00% (1.80% Floor) | 2/7/2020 | 8/13/2025 | 7,900,000 | 7,637,767 | 7,663,000 | 7.09 | % | |||||||||||||||||||
| Altern Marketing, LLC – Revolver(5) |
Internet & Direct Marketing Retail | 3M L + 6.00% (2.00% Floor) | 10/7/2019 | 10/7/2024 | 1,261,330 | 1,235,014 | 1,236,103 | 1.14 | % | |||||||||||||||||||
| Altern Marketing, LLC |
Internet & Direct Marketing Retail | 3M L + 6.00% (2.00% Floor) | 10/7/2019 | 10/7/2024 | 5,059,053 | 5,014,210 | 4,957,872 | 4.59 | % | |||||||||||||||||||
| Barri Financial Group, LLC |
Consumer Finance | 1M L + 7.75% (1.00% Floor) | 10/21/2019 | 10/22/2024 | 9,395,000 | 9,191,666 | 9,113,150 | 8.43 | % | |||||||||||||||||||
| Bioplan USA, Inc |
Containers & Packaging | 1M L + 4.75% (1.00% Floor) | 8/9/2018 | 9/23/2021 | 13,552,685 | 13,246,307 | 9,486,879 | 8.77 | % | |||||||||||||||||||
| BW Gas & Convenience |
Specialty Retail | 1M L + 6.25% (1.00% Floor) | 3/9/2020 | 11/18/2024 | 5,815,591 | 5,652,965 | 5,641,123 | 5.22 | % | |||||||||||||||||||
| CareerBuilder, LLC |
Professional Services | 1M L + 6.75% (1.00% Floor) | 7/27/2017 | 7/31/2023 | 8,041,808 | 8,007,703 | 7,961,390 | 7.36 | % | |||||||||||||||||||
| CB URS Holdings Corporation |
Road & Rail | 1M L + 5.75% (1.00% Floor) | 7/31/2019 | 9/1/2024 | 4,841,686 | 4,794,839 | 3,873,349 | 3.58 | % | |||||||||||||||||||
| Cook & Boardman Group, LLC |
Distributors | 6M L + 5.75% (1.00% Floor) | 10/12/2018 | 10/17/2025 | 9,850,000 | 9,769,324 | 9,456,000 | 8.75 | % | |||||||||||||||||||
| Deluxe Toronto Ltd.(7) |
Media | 1M L + 5.80% (1.00% Floor) | 6/29/2018 | 6/30/2021 | 4,913,111 | 4,902,911 | 4,176,144 | 3.86 | % | |||||||||||||||||||
| Empire Office Inc |
Commercial Services & Supplies | 1M L + 6.75% (1.50% Floor) | 3/28/2019 | 4/12/2024 | 13,055,455 | 12,846,896 | 12,402,682 | 11.47 | % | |||||||||||||||||||
| Empire Resorts, Inc. |
Hotels, Restaurants & Leisure | 3M L + 2.25% | 3/23/2020 | 3/22/2021 | 3,846,750 | 3,846,750 | 3,846,750 | 3.55 | % | |||||||||||||||||||
| Exela Intermedia LLC |
IT Services | 3M L + 6.50% (1.00% Floor) | 6/5/2018 | 7/12/2023 | 5,588,676 | 5,622,832 | 2,514,904 | 2.33 | % | |||||||||||||||||||
| Exela Intermedia LLC |
IT Services | Fixed 10.00% | 5/22/2019 | 7/15/2023 | 1,000,000 | 924,540 | 450,000 | 0.42 | % | |||||||||||||||||||
| FR Flow Control CB LLC – Term B(8) |
Trading Companies & Distributors | 3M L + 6.00% (1.00% Floor) | 5/10/2019 | 6/28/2026 | 5,346,000 | 5,250,683 | 5,132,160 | 4.75 | % | |||||||||||||||||||
| FR Flow Control CB LLC – Term C(8) |
Trading Companies & Distributors | 3M L + 6.00% (1.00% Floor) | 5/10/2019 | 6/26/2026 | 2,100,000 | 2,062,553 | 2,016,000 | 1.86 | % | |||||||||||||||||||
| Fusion Connect Inc. – Exit Term Loan |
Internet Software & Services | 3M L + 9.50% (2.00% Floor) | 12/11/2019 | 1/14/2025 | 5,700,000 | 5,593,377 | 5,700,000 | 5.27 | % | |||||||||||||||||||
| Fusion Connect Inc. – Take-Back Term Loan |
Internet Software & Services | 3M L + 8.00% (2.00% Floor) | 1/14/2020 | 7/14/2025 | 4,748,553 | 4,748,553 | 3,323,987 | 3.07 | % | |||||||||||||||||||
| GEE Group, Inc.(6) |
Professional Services | 1M L + 10.00% + 8.00% PIK | 3/26/2018 | 6/30/2023 | 11,277,314 | 11,277,314 | 10,713,448 | 9.91 | % | |||||||||||||||||||
See notes to consolidated financial statements.
104
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Schedule of Investments – (continued)
June 30, 2020
| Investments(1)(2) |
Industry |
Interest Rate |
Initial |
Maturity |
Principal Shares(3) |
Amortized |
Fair Value |
% of Net |
||||||||||||||||||||
| Senior Secured First Lien Debt Investments, continued |
||||||||||||||||||||||||||||
| GS Operating, LLC |
Trading Companies & Distributors | 3M L + 6.50% (1.50% Floor) | 2/24/2020 | 2/28/2025 | $ | 9,975,000 | $ | 9,785,941 | $ | 9,775,500 | 9.04 | % | ||||||||||||||||
| Horus Infrastructure IA LLC |
Energy Equipment & Services | 1M L + 3.00% | 11/8/2019 | 10/25/2022 | 4,875,000 | 4,462,442 | 4,631,250 | 4.28 | % | |||||||||||||||||||
| Hyperion Materials & Technologies, Inc. |
Construction Materials | 1M L + 5.50% (1.00% Floor) | 8/16/2019 | 8/14/2026 | 4,975,000 | 4,883,396 | 4,676,500 | 4.32 | % | |||||||||||||||||||
| Infrastructure & Energy Alternatives, Inc. |
Construction & Engineering | 3M L + 6.75% | 11/14/2018 | 9/25/2024 | 7,222,695 | 7,025,879 | 7,078,241 | 6.55 | % | |||||||||||||||||||
| KIK Custom Products Inc. |
Chemicals | 1M L + 4.00% (1.00% Floor) | 3/11/2019 | 5/15/2023 | 5,000,000 | 4,792,021 | 4,800,000 | 4.44 | % | |||||||||||||||||||
| Liberty Oilfield Services LLC(7) |
Energy Equipment & Services | 1M L + 7.625% (1.00% Floor) | 9/19/2017 | 9/19/2022 | 6,233,750 | 6,173,631 | 6,171,413 | 5.71 | % | |||||||||||||||||||
| Limbach Holdings, Inc.(5) |
Construction & Engineering | 1M L + 11.00% (2.00% Floor) | 4/11/2019 | 4/12/2023 | 9,461,538 | 9,397,473 | 9,272,308 | 8.58 | % | |||||||||||||||||||
| Northstar Group Services Inc. |
Construction & Engineering | 3M L + 5.00% (1.00% Floor) | 9/5/2019 | 9/8/2025 | 4,962,500 | 4,918,209 | 4,912,875 | 4.54 | % | |||||||||||||||||||
| One Sky Flight LLC |
Airlines | 1M L + 7.50% (1.00% Floor) | 12/19/2019 | 12/19/2024 | 9,750,000 | 9,525,503 | 9,067,500 | 8.39 | % | |||||||||||||||||||
| Pixelle Specialty Solutions LLC |
Containers & Packaging | 3M L + 6.50% (1.00% Floor) | 1/31/2020 | 10/31/2024 | 6,911,616 | 6,782,657 | 6,566,035 | 6.07 | % | |||||||||||||||||||
| Potpourri Group, Inc. |
Retail | 1M L + 8.25% (1.00% Floor) | 6/27/2019 | 7/3/2024 | 12,187,500 | 12,064,697 | 11,700,000 | 10.82 | % | |||||||||||||||||||
| Premiere Global Services, Inc. |
Diversified Telecommunication Services | 2M L + 6.50% (1.00% Floor) | 5/6/2016 | 9/6/2023 | 10,123,065 | 9,723,867 | 6,883,684 | 6.37 | % | |||||||||||||||||||
| ProFrac Services LLC |
Energy Equipment & Services | 6M L + 7.50% (1.25% Floor) | 9/7/2018 | 9/7/2023 | 8,021,376 | 7,977,811 | 7,379,666 | 6.83 | % | |||||||||||||||||||
| Qualtek USA LLC |
Construction & Engineering | 1M L + 6.25% (1.00% Floor) | 7/15/2018 | 7/18/2025 | 9,562,500 | 9,427,039 | 8,988,750 | 8.31 | % | |||||||||||||||||||
| RPX Corporation |
Professional Services | 1M L + 6.00% | 6/8/2018 | 6/19/2024 | 5,341,725 | 5,314,868 | 5,341,725 | 4.94 | % | |||||||||||||||||||
| Specialty Building Products Holdings LLC |
Construction Materials | 1M L + 5.75% | 9/25/2018 | 9/25/2025 | 1,952,651 | 1,931,132 | 1,855,018 | 1.72 | % | |||||||||||||||||||
| Techniplas LLC |
Auto Components | Fixed 10.00% | 6/19/2020 | 6/19/2027 | 542,857 | 542,857 | 835,186 | 0.77 | % | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Senior Secured First Lien Debt Investments |
269,140,172 | 259,432,656 | 237,079,624 | 219.26 | % | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Senior Secured Second Lien Debt Investments |
||||||||||||||||||||||||||||
| AP NMT Acquisition BV(7)(8) |
Media | 3M L + 9.00% (1.00% Floor) | 8/12/2014 | 8/13/2022 | 15,000,000 | 14,603,326 | 15,000,000 | 13.87 | % | |||||||||||||||||||
| Premiere Global Services, Inc. (3) |
Diversified Telecommunication Services | 3M L + 9.50% (1.00% Floor) | 11/30/2016 | 6/6/2024 | 16,226,093 | 16,004,515 | 5,679,133 | 5.26 | % | |||||||||||||||||||
| ZeroChaos Parent, LLC |
Professional Services | 3M L + 8.25% (1.00% Floor) | 11/21/2017 | 10/31/2023 | 8,000,000 | 7,912,554 | 7,040,000 | 6.51 | % | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Senior Secured Second Lien Debt Investments |
1/14/2025 | 39,226,093 | 38,520,395 | 27,719,133 | 25.64 | % | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
See notes to consolidated financial statements.
105
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Schedule of Investments – (continued)
June 30, 2020
| Investments(1)(2) |
Industry |
Interest Rate |
Initial |
Maturity |
Principal Shares(3) |
Amortized |
Fair Value |
% of Net |
||||||||||||||||||||
| Equity, Warrants and Other Investments |
||||||||||||||||||||||||||||
| 1888 Industrial Services, LLC (Equity Interest)(4)(9)(10) |
Energy Equipment & Services | 18,708 | $ | 170,691 | $ | — | 0.00 | % | ||||||||||||||||||||
| 4L Technologies Inc Common Stock(9) |
Technology Hardware, Storage & Peripherals | 149,918 | 2,171,581 | 10,494 | 0.01 | % | ||||||||||||||||||||||
| 4L Technologies Inc Preferred Stock(9) |
Technology Hardware, Storage & Peripherals | 2,289 | 209,004 | 209,004 | 0.19 | % | ||||||||||||||||||||||
| Fusion Connect Inc., Common Stock(9) |
Internet Software & Services | 22 | 306 | 22 | 0.00 | % | ||||||||||||||||||||||
| Fusion Connect Inc., (Warrants)(9) |
Internet Software & Services | 202,171 | 2,814,455 | 202,171 | 0.19 | % | ||||||||||||||||||||||
| Limbach Holdings, Inc.(Warrants) (9) |
Construction & Engineering | 4/12/2024 | 1 | — | 1 | 0.00 | % | |||||||||||||||||||||
| PR Wireless, Inc., $0.01 strike (Warrants)(9) |
Wireless Telecommunication Services | 6/27/2027 | 201 | 1,374,009 | — | 0.00 | % | |||||||||||||||||||||
| Techniplas LLC Common Stock(9)(10) |
Auto Components | 540,126 | 12,231,541 | 5,401,260 | 5.00 | % | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Equity, Warrants and Other |
913,436 | 18,971,587 | 5,822,952 | 5.39 | % | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Non-Controlled/Non-Affiliates |
$ | 309,279,701 | $ | 316,924,638 | $ | 270,621,709 | 250.29 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Liabilities in excess other assets |
(162,496,714 | ) | (150.29 | %) | ||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||
| Net Assets |
$ | 108,124,995 | 100.00 | % | ||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||
| (1) | The Company’s investments are generally acquired in private transactions exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”) and, therefore, are generally subject to limitations on resale, and may be deemed to be “restricted securities’’ under the Securities Act of 1933. |
| (2) | All investments are non-controlled and non-affiliated issuers. All investments are valued in good faith by the board of directors. |
| (3) | Principal amount includes capitalized PIK interest unless otherwise noted. |
| (4) | Effective 10/1/17, AAR Intermediate Holdings, LLC changed its name to 1888 Industrial Services, LLC. |
| (5) | Refer to Note 6 for more detail on the unfunded commitments. |
| (6) | First Lien Unitranche Last Out Investment, which accounts for 3.96% of our investment portfolio at fair value. |
| (7) | The investment is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940. The Company may not acquire any non-qualifying asset unless, at the time of acquisition, qualifying assets represent at least 70% of the Company’s total assets. Non-qualifying assets represent 10.95% of total assets. |
| (8) | A portfolio company domiciled in the Netherlands. The jurisdiction of the security issuer may be a different country than the domicile of the portfolio company. |
| (9) | Securities are non-income producing. |
| (10) | As defined in the 1940 Act, the Company is deemed to be an “Affiliated Person” of this portfolio company because it owns 5% or more of the portfolio company’s outstanding voting securities. |
1M L — 1 month LIBOR (0.16 % as of June 30, 2020)
2M L — 2 month LIBOR (0.24 % as of June 30, 2020)
3M L — 3 month LIBOR (0.30 % as of June 30, 2020)
6M L — 6 month LIBOR (0.37 % as of June 30, 2020)
PIK — Payment-In-Kind
See notes to consolidated financial statements.
106
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Schedule of Investments
June 30, 2019
| Investments(1)(2) |
Industry |
Interest Rate |
Initial |
Maturity |
Principal Shares(3) |
Amortized |
Fair Value |
% of Net |
||||||||||||||||||||
|
Non-Controlled/Non-Affiliates |
||||||||||||||||||||||||||||
| Senior Secured First Lien Debt Investments |
||||||||||||||||||||||||||||
| 1888 Industrial Services, LLC – Term A(4)(12) |
Energy Equipment & Services | 3M L + 5.00% (1.00% Floor) | 9/30/2016 | 9/30/2021 | $ | 4,950,495 | $ | 4,950,495 | $ | 4,950,495 | 3.46 | % | ||||||||||||||||
| 1888 Industrial Services, LLC – Term B(3)(4)(12) |
Energy Equipment & Services | 3M L + 8.00% PIK (1.00% Floor) | 9/30/2016 | 9/30/2021 | 12,304,681 | 6,530,574 | 8,613,277 | 6.02 | % | |||||||||||||||||||
| 1888 Industrial Services, LLC – Term C(3)(4)(12) |
Energy Equipment & Services | 3M L + 5.00% (1.00% Floor) | 6/25/2019 | 9/30/2021 | 632,594 | 632,594 | 632,594 | 0.45 | % | |||||||||||||||||||
| 1888 Industrial Services, LLC – Revolver(4)(5)(12) |
Energy Equipment & Services | 3M L + 5.00% (1.00% Floor) | 10/11/2016 | 9/30/2021 | 1,881,188 | 1,881,188 | 1,881,188 | 1.31 | % | |||||||||||||||||||
| 4L Technologies Inc(6) |
Technology Hardware, Storage & Peripheral | 3M L + 4.50% (1.00% Floor) | 8/21/2018 | 5/8/2020 | 10,194,409 | 10,103,240 | 7,339,974 | 5.13 | % | |||||||||||||||||||
| ACProducts, Inc |
Household Durables | 3M L + 5.50% (1.00% Floor) | 2/26/2019 | 2/14/2024 | 9,937,500 | 9,465,902 | 9,440,625 | 6.60 | % | |||||||||||||||||||
| Bioplan USA, Inc |
Containers & Packaging | 3M L + 4.75% (1.00% Floor) | 8/9/2018 | 9/23/2021 | 13,623,828 | 13,089,944 | 12,942,636 | 9.04 | % | |||||||||||||||||||
| CareerBuilder, LLC |
Professional Services | 3M L + 6.75% (1.00% Floor) | 7/27/2017 | 7/31/2023 | 13,079,231 | 12,845,118 | 13,079,231 | 9.14 | % | |||||||||||||||||||
| Carlton Group |
Business Services | 3M L + 7.00% (1.00% Floor) | 3/27/2019 | 9/30/2022 | 5,425,670 | 5,425,670 | 5,425,670 | 3.79 | % | |||||||||||||||||||
| Cook & Boardman Group, LLC |
Distributors | 3M L + 5.75% (1.00% Floor) | 10/12/2018 | 10/17/2025 | 9,950,000 | 9,857,462 | 9,850,500 | 6.89 | % | |||||||||||||||||||
| Deluxe Toronto Ltd.(8) |
Media | 3M L + 5.50% (1.00% Floor) | 6/29/2018 | 12/7/2020 | 4,949,749 | 4,916,962 | 4,949,749 | 3.46 | % | |||||||||||||||||||
| Empire Office Inc |
Commercial Services & Supplies | 3M L + 7.00% (1.00% Floor) | 3/28/2019 | 4/12/2024 | 14,812,500 | 14,526,409 | 14,516,250 | 10.14 | % | |||||||||||||||||||
| Exela Intermedia LLC |
IT Services | 3M L + 6.50% (1.00% Floor) | 6/5/2018 | 7/12/2023 | 5,856,626 | 5,902,727 | 4,978,132 | 3.48 | % | |||||||||||||||||||
| Exela Intermedia LLC |
IT Services | Fixed 10.00% | 5/22/2019 | 7/15/2023 | 1,000,000 | 905,579 | 820,000 | 0.57 | % | |||||||||||||||||||
| FPC Holdings, Inc. |
Distributors | 3M L + 4.50% (1.00% Floor) | 1/28/2019 | 4/2/2026 | 4,987,500 | 4,891,828 | 4,912,688 | 3.43 | % | |||||||||||||||||||
| FR Flow Control CB LLC – Term B(6) |
Trading Companies & Distributors | 3M L + 6.00% (1.00% Floor) | 5/10/2019 | 5/10/2026 | 5,400,000 | 5,292,000 | 5,292,000 | 3.70 | % | |||||||||||||||||||
| FR Flow Control CB LLC – Term C(6) |
Trading Companies & Distributors | 3M L + 6.00% (1.00% Floor) | 5/10/2019 | 5/10/2026 | 2,100,000 | 2,058,000 | 2,058,000 | 1.44 | % | |||||||||||||||||||
| Fusion Connect, Inc.(13)(#) |
Internet Software & Services | 3M L + 7.50% (1.00% Floor) | 7/21/2018 | 5/4/2023 | 11,874,210 | 11,371,040 | 8,074,463 | 5.64 | % | |||||||||||||||||||
| Fusion Connect, Inc. – Super Senior Secured(6) |
Internet Software & Services | 3M L + 10.00% (1.00% Floor) | 5/16/2019 | 6/3/2019 | 401,503 | 393,473 | 393,473 | 0.27 | % | |||||||||||||||||||
| Fusion Connect, Inc. – Superpriority Secured Debtor-In-Possession(6) |
Internet Software & Services | 3M L + 10.00% (1.00% Floor) | 6/13/2019 | 10/7/2019 | 401,503 | 400,440 | 383,435 | 0.27 | % | |||||||||||||||||||
| GEE Group, Inc.(6)(7) |
Professional Services | 2M L + 18.00% (1.00% Floor) | 3/26/2018 | 3/31/2021 | 11,319,236 | 11,319,236 | 11,319,236 | 7.91 | % | |||||||||||||||||||
| Infrastructure & Energy Alternatives, Inc.(#) |
Construction & Engineering | 3M L + 8.25% | 11/14/2018 | 9/25/2024 | 11,875,000 | 11,491,066 | 11,221,875 | 7.84 | % | |||||||||||||||||||
| Immucor, Inc. |
Health Care Equipment & Supplies | 3M L + 5.00% (1.00% Floor) | 6/27/2017 | 6/15/2021 | 7,350,000 | 7,310,573 | 7,350,000 | 5.14 | % | |||||||||||||||||||
| KIK Custom Products Inc. |
Chemicals | 3M L + 4.00% (1.00% Floor) | 3/11/2019 | 5/15/2023 | 5,000,000 | 4,730,171 | 4,750,000 | 3.32 | % | |||||||||||||||||||
| Liberty Oilfield Services LLC(8) |
Energy Equipment & Services | 1M L + 7.625% (1.00% Floor) | 9/19/2017 | 9/19/2022 | 6,358,750 | 6,272,383 | 6,358,750 | 4.44 | % | |||||||||||||||||||
See notes to consolidated financial statements.
107
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Schedule of Investments – (continued)
June 30, 2019
| Investments(1)(2) |
Industry |
Interest Rate |
Initial |
Maturity |
Principal Shares(3) |
Amortized |
Fair Value |
% of Net |
||||||||||||||||||||
| Senior Secured First Lien Debt Investments, continued |
||||||||||||||||||||||||||||
| Limbach Holdings, Inc.(#) |
Construction & Engineering | 1M L + 8.00% (1.00% Floor) | 4/11/2019 | 4/12/2023 | $ | 9,230,769 | $ | 9,143,579 | $ | 9,138,462 | 6.39 | % | ||||||||||||||||
| Montreign Operating Company, LLC |
Hotels, Restaurants & Leisure | 1M L + 8.25% (1.00% Floor) | 12/16/2016 | 1/24/2023 | 13,064,995 | 13,140,133 | 11,105,246 | 7.76 | % | |||||||||||||||||||
| Potpourri Group, Inc.(6) |
Retail | 3M L + 8.25% (1.00% Floor) | 6/27/2019 | 7/3/2024 | 12,500,000 | 12,350,000 | 12,350,000 | 8.63 | % | |||||||||||||||||||
| PR Wireless LLC(5) |
Wireless Telecommunication Services | 3M L + 5.25% (1.00% Floor) | 11/15/2017 | 6/29/2020 | 2,293,932 | 2,293,932 | 2,293,932 | 1.60 | % | |||||||||||||||||||
| Premiere Global Services, Inc.(8) |
Diversified Telecommunication Services | 3M L + 6.50% (1.00% Floor) | 5/6/2016 | 9/6/2023 | 10,141,266 | 9,604,558 | 7,403,124 | 5.17 | % | |||||||||||||||||||
| ProFrac Services LLC |
Energy Equipment & Services | 3M L + 5.75% (1.00% Floor) | 9/7/2018 | 9/7/2023 | 8,929,431 | 8,859,820 | 8,840,137 | 6.18 | % | |||||||||||||||||||
| Qualtek USA LLC |
Construction & Engineering | 3M L + 5.75% (1.00% Floor) | 7/15/2018 | 7/18/2025 | 9,812,500 | 9,652,203 | 9,665,312 | 6.75 | % | |||||||||||||||||||
| RPX Corporation |
Professional Services | 3M L + 6.00% | 6/8/2018 | 6/19/2024 | 9,250,000 | 9,167,538 | 9,157,500 | 6.40 | % | |||||||||||||||||||
| Sears Holding Company |
Retail | 3M L + 7.25% (1.00% Floor) | 2/11/2019 | 2/12/2024 | 2,000,000 | 1,981,026 | 2,000,000 | 1.40 | % | |||||||||||||||||||
| Specialty Building Products Holdings LLC |
Construction Materials | 3M L + 5.75% | 9/25/2018 | 9/25/2025 | 6,982,500 | 6,888,014 | 6,912,675 | 4.84 | % | |||||||||||||||||||
| Techniplas LLC |
Auto Components | Fixed 10.00% | 11/13/2018 | 5/1/2020 | 9,500,000 | 9,185,104 | 8,835,000 | 6.17 | % | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Senior Secured First Lien Debt Investments |
269,371,566 | 258,829,981 | 249,235,629 | 174.17 | % | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Senior Secured Second Lien Debt Investments |
||||||||||||||||||||||||||||
| AP NMT Acquisition BV(8)(9) |
Media | 3M L + 9.00% (1.00% Floor) | 8/12/2014 | 8/13/2022 | 15,000,000 | 14,455,174 | 14,943,750 | 10.44 | % | |||||||||||||||||||
| Carlton Group |
Business Services | 3M L + 11.50% (1.00% Floor) | 3/27/2019 | 9/29/2023 | 2,000,000 | 2,000,000 | 2,000,000 | 1.40 | % | |||||||||||||||||||
| Lionbridge Technologies, Inc.(3) |
Commercial Services & Supplies | 1M L + 9.75% (1.00% Floor) | 2/6/2017 | 2/28/2025 | 12,000,000 | 11,812,039 | 12,000,000 | 8.39 | % | |||||||||||||||||||
| Premiere Global Services, Inc. |
Diversified Telecommunication Services | 3M L + 9.50% (1.00% Floor) | 11/30/2016 | 6/6/2022 | 15,000,000 | 14,701,257 | 9,900,000 | 6.92 | % | |||||||||||||||||||
| TouchTunes Interactive Networks, Inc. |
Media | 1M L + 8.25% (1.00% Floor) | 5/4/2017 | 5/27/2022 | 10,451,613 | 10,440,999 | 10,451,613 | 7.30 | % | |||||||||||||||||||
| ZeroChaos Parent, LLC |
Professional Services | 2M L + 8.25% (1.00% Floor) | 11/21/2017 | 10/31/2023 | 8,000,000 | 7,890,900 | 7,860,000 | 5.49 | % | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Senior Secured Second Lien Debt Investments |
62,451,613 | 61,300,369 | 57,155,363 | 39.94 | % | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
See notes to consolidated financial statements.
108
Investcorp Credit Management BDC, Inc. and Subsidiaries
Consolidated Schedule of Investments – (continued)
June 30, 2019
| Investments(1)(2) |
Industry |
Interest Rate |
Initial |
Maturity |
Principal Shares(3) |
Amortized |
Fair Value |
% of Net |
||||||||||||||||||||
| Equity, Warrants and Other Investments |
||||||||||||||||||||||||||||
| 1888 Industrial Services, LLC (Equity Interest)(4)(10) |
Energy Equipment & Services | 11,880 | $ | — | $ | 1 | 0.00 | % | ||||||||||||||||||||
| Limbach Holdings, Inc. (Warrants) |
Construction Materials | 4/12/2024 | 1 | — | — | 0.00 | % | |||||||||||||||||||||
| PR Wireless, Inc., $0.01 strike (Warrants)(10) |
Wireless Telecommunication Services | 6/27/2027 | 201 | 1,374,009 | — | 0.00 | % | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Equity, Warrants and Other |
12,082 | 1,374,009 | 1 | 0.00 | % | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total Non-Controlled/Non-Affiliates |
$ | 331,835,261 | $ | 321,504,359 | $ | 306,390,993 | 214.11 | % | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Liabilities in excess other assets |
(163,293,325 | ) | (114.11 | %) | ||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||
| Net Assets |
$ | 143,097,668 | 100.00 | % | ||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||
| (1) | The Company’s investments are generally acquired in private transactions exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”) and, therefore, are generally subject to limitations on resale, and may be deemed to be “restricted securities’’ under the Securities Act of 1933. |
| (2) | All investments are non-controlled and non-affiliated issuers. All investments are valued in good faith by the board of directors. |
| (3) | Principal amount includes capitalized PIK interest unless otherwise noted. |
| (4) | Effective 10/1/17, AAR Intermediate Holdings, LLC changed its name to 1888 Industrial Services, LLC. |
| (5) | Refer to Note 6 for more detail on the unfunded commitments. |
| (6) | Security, or a portion thereof, unsettled as of June 30, 2019. |
| (7) | First Lien Unitranche Last Out Investment, which accounts for 3.69% of our investment portfolio at fair value. |
| (8) | The investment is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940. The Company may not acquire any non-qualifying asset unless, at the time of acquisition, qualifying assets represent at least 70% of the Company’s total assets. Non-qualifying assets represent 9.85% of total assets. |
| (9) | A portfolio company domiciled in the Netherlands. The jurisdiction of the security issuer may be a different country than the domicile of the portfolio company. |
| (10) | Securities are non-income producing. |
| (12) | As defined in the 1940 Act, the Company is deemed to be an “Affiliated Person” of this portfolio company because it owns 5% or more of the portfolio company’s outstanding voting securities. |
| (13) | As of 4/1/2019, this investment has been in default. |
| # | Classified as non-accrual asset. |
1M L — 1 month LIBOR (2.40 % as of June 30, 2019)
2M L — 2 month LIBOR (2.33 % as of June 30, 2019)
3M L — 3 month LIBOR (2.32 % as of June 30, 2019)
PIK — Payment-In-Kind
See notes to consolidated financial statements.
109
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 1. Organization
Investcorp Credit Management BDC, Inc. (“ICMB” or the “Company”) (formerly known as CM Finance Inc through August 30, 2019), a Maryland corporation formed in May 2013, is a closed-end, externally managed, non-diversified management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), and has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code (the “Code”) for U.S. federal income tax purposes. The Company is an investment company and accordingly follows the investment company accounting and reporting guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standard Codification Topic 946 Financial Services — Investment Companies.
On February 11, 2014, the Company completed its initial public offering (the “Offering”), selling 7,666,666 shares of its common stock, par value $0.001, including the underwriters’ over-allotment, at a price of $15.00 per share with net proceeds of approximately $111.5 million.
CM Finance LLC, a Maryland limited liability company, commenced operations in March 2012. Immediately prior to the Offering, CM Finance LLC was merged with and into the Company (the “Merger”). In connection with the Merger, the Company issued 6,000,000 shares of common stock and $39.8 million in debt to the pre-existing CM Finance LLC investors, consisting of funds managed by Cyrus Capital Partners, L.P. (the “Original Investors” or the “Cyrus Funds”). The Company had no assets or operations prior to completion of the Merger and, as a result, the books and records of CM Finance LLC became the books and records of the Company, as the surviving entity. Immediately after the Merger, the Company issued 2,181,818 shares of its common stock to Stifel Venture Corp. in exchange for $32.7 million in cash. The Company used all of the proceeds of the sale of shares to Stifel (“Stifel”), to repurchase 2,181,818 shares of common stock from the Original Investors. Immediately after the completion of the Offering, the Company had 13,666,666 shares outstanding. The Company used a portion of the net proceeds of the Offering to repay 100% of the debt issued to the Original Investors in connection with the Merger.
On August 30, 2019, Investcorp Credit Management US LLC (“Investcorp”), a subsidiary of Investcorp Bank Holdings B.S.C., acquired the interests in CM Investment Partners LLC, the Company’s investment adviser (the “Adviser”), which were previously held by the Cyrus Funds and Stifel and paid off certain debt owed by the Adviser, resulting in Investcorp having a majority ownership interest in the Adviser (the “Investcorp Transaction”).
In connection with the Investcorp Transaction, on June 26, 2019, the Company entered into a definitive stock purchase and transaction agreement with Investcorp BDC Holdings Limited (“Investcorp BDC”), an affiliate of Investcorp (the “Stock Purchase Agreement”). Under the Stock Purchase Agreement, Investcorp BDC is required by August 30, 2021 to purchase (i) 680,985 newly issued shares of the Company’s common stock, par value $0.001 per share, at the most recently determined net asset value per share of the Company’s common stock at the time of such purchase, as adjusted as necessary to comply with Section 23 of the 1940 Act, and (ii) 680,985 shares of the Company’s common stock in open-market or secondary transactions.
In connection with the Investcorp Transaction, on June 26, 2019, the Company’s board of directors, including all of the directors who are not “interested persons” of the Company, as defined in Section 2(a)(19) of the 1940 Act (each, an “Independent Director”), unanimously approved a new investment advisory agreement (the “Advisory Agreement”) which was subsequently approved by the Company’s stockholders at a special meeting of stockholders held on August 28, 2019. In connection with the closing of the Investcorp Transaction, on August 30, 2019, the Company entered into the Advisory Agreement and a new administration agreement (the
110
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 1. Organization – (continued)
“Administration Agreement”) with the Adviser as its investment adviser and administrator, respectively. The Advisory Agreement and the Administration Agreement are substantially similar to the Company’s prior investment advisory agreement, dated February 5, 2014, between the Company and the Adviser (the “prior Advisory Agreement”) and the Company’s prior administration agreement (the “Prior Administration Agreement”), respectively. In addition, on August 30, 2019, the Company changed its name to Investcorp Credit Management BDC, Inc.
The Company’s primary investment objective is to maximize total return to stockholders in the form of current income and capital appreciation by investing directly in debt and related equity of privately held middle- market companies to help these companies fund acquisitions, growth or refinancing. The Company invests primarily in middle-market companies in the form of unitranche loans, standalone first and second lien and mezzanine loans. The Company may also invest in unsecured debt, bonds and in the equity of portfolio companies through warrants and other instruments.
As a BDC, the Company is required to comply with certain regulatory requirements. For instance, as a BDC, the Company must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of total assets are qualifying assets. Qualifying assets include investments in “eligible portfolio companies.” Under the relevant Securities and Exchange Commission (“SEC”) rules, the term “eligible portfolio company” includes all private operating companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized and with their principal of business in the United States.
During the third and fourth quarters of the year ended June 30, 2020, the Company’s operating results were negatively impacted by the uncertainty surrounding the COVID-19 pandemic, which has caused severe disruptions in the global economy and negatively impacted the fair value and performance of the Company’s investment portfolio. The Company closely monitored its portfolio companies throughout this period, including assessing portfolio companies’ operation and liquidity exposure and outlook.
From time-to-time, the Company may form taxable subsidiaries which are taxed as corporations for U.S. federal income tax purposes (the “Taxable Subsidiaries”). At June 30, 2020, the Company had no taxable subsidiaries. At June 30, 2019, the Company had one Taxable Subsidiary: Zinc Borrower Blocker, LLC. The Taxable Subsidiaries allow the Company to hold equity securities of portfolio companies organized as pass-through entities while continuing to satisfy the requirements applicable to a RIC under the Code.
Note 2. Significant Accounting Policies
The following is a summary of significant accounting policies followed by the Company.
a. Basis of Presentation
The accompanying consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) and all values are stated in U.S. dollars, unless noted otherwise. The financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the periods included herein as required by U.S. GAAP. These adjustments are normal and recurring in nature.
111
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the fair value of investments and other amounts reported in the consolidated financial statements and accompanying notes. Management believes that the estimates utilized in preparing the Company’s consolidated financial statements are reasonable and prudent. Actual results could differ materially from these estimates. All material inter-company balances and transactions have been eliminated.
As permitted under Regulation S-X and ASC Topic 946, the Company will generally not consolidate its investment in a portfolio company other than an investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Accordingly, the Company consolidated the results of the Company’s wholly-owned subsidiaries, CM Finance SPV Ltd. (“SPV”) and CM Finance SPV LLC (“LLC”), which are special purpose vehicles used to finance certain investments, and Zinc Borrower Blocker, LLC in its consolidated financial statements. All intercompany balances and transactions have been eliminated.
b. Revenue Recognition, Security Transactions, and Realized/Unrealized Gains or Losses
Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis. Origination, closing, commitment, and amendment fees, purchase and original issue discounts associated with loans to portfolio companies are accreted into interest income over the respective terms of the applicable loans. Accretion of discounts or premiums is calculated by the effective interest or straight-line method, as applicable, as of the purchase date and adjusted only for material amendments or prepayments. Upon the prepayment of a loan or debt security, any prepayment penalties are included in other fee income and unamortized fees and discounts are recorded as interest income and are non-recurring in nature.
Loans are placed on non-accrual status when principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be collected. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment about ultimate collectability of principal. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current.
Dividend income is recorded on the ex-dividend date.
Origination, closing, commitment, and amendment fees, purchase and original issue discounts associated with loans to portfolio companies are accreted into interest income over the respective terms of the applicable loans. Accretion of discounts or premiums is calculated by the effective interest method as of the purchase date and adjusted only for material amendments or prepayments. Upon the prepayment of a loan or debt security, any prepayment penalties are included in other fee income and unamortized fees and discounts are recorded as interest income and are non-recurring in nature. During the years ended June 30, 2020, June 30, 2019 and June 30, 2018, $1,030,405, $2,063,954 and $2,839,313 of prepayment penalties and unamortized discounts upon prepayment were recorded as interest income, respectively.
Investment transactions are accounted for on a trade-date basis. Realized gains or losses on investments are determined by calculating the difference between the net proceeds from the disposition and the amortized cost basis of the investments, without regard to unrealized gains or losses previously recognized. Realized gains or losses on the sale of investments are calculated using the specific identification method. The Company reports
112
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
changes in fair value of investments as a component of the net change in unrealized appreciation (depreciation) on investments in the Consolidated Statements of Operations.
Management reviews all loans that become 90 days or more past due on principal or interest or when there is reasonable doubt that principal or interest will be collected for possible placement on non-accrual status. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current, although management may make exceptions to this general rule if the loan has sufficient collateral value and is in the process of collection. As of June 30, 2020, there were no loans on non-accrual status.
The Company may hold debt investments in its portfolio that contain a payment-in-kind (“PIK”) interest provision. PIK interest, which represents contractually deferred interest added to the investment balance that is generally due at maturity, is recorded on an accrual basis to the extent that such amounts are expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to pay all principal and interest when due. The Company earned PIK interest of $4,629,033, $953,928 and $2,609,037 during the years ended June 30, 2020, June 30, 2019 and June 30, 2018, respectively.
The Company may hold equity investments in its portfolio that contain a PIK dividend provision. PIK dividends, which represents contractual dividend payments added to the investment balance, is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company earned PIK dividends of $0, $0 and $333,333 during the years ended June 30, 2020, June 30, 2019 and June 30, 2018, respectively.
c. Paid In Capital
The Company records the proceeds from the sale of its common stock to common stock and additional paid-in capital, after all commissions and marketing support fees.
d. Net Increase in Net Assets Resulting from Operations per Share
The net increase in net assets resulting from operations per share is calculated based upon the weighted average number of shares of common stock outstanding during the reporting period.
e. Distributions
Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend or distribution is generally determined by the board of directors each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are generally distributed annually, although the Company may decide to retain such capital gains for investment.
The Company has adopted a dividend reinvestment plan that provides for reinvestment of any distributions the Company declares in cash on behalf of the Company’s stockholders, unless a stockholder elects to receive cash. As a result, if the Company’s board of directors authorizes, and the Company declares, a cash distribution, then the Company’s stockholders who have not “opted out” of the Company’s dividend reinvestment plan will have their cash distributions automatically reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution.
113
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
f. Cash and Restricted Cash
Cash and restricted cash consist of bank demand deposits. The Company deposits its cash in financial institutions, and, at times, such balance may be in excess of the Federal Deposit Insurance Corporation insurance limits. All of the Company’s cash deposits are held at large established high credit quality financial institutions and management believes that the risk of loss associated with any uninsured balances is remote. The Company has restrictions on the uses of the cash held by SPV and LLC based on the terms of the Notes Payable. For more information on the Notes Payable, see Note 5.
g. Deferred Offering Costs
Deferred offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s common stock and bonds, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement. These costs are capitalized when incurred and recognized as a reduction of offering proceeds when the offering becomes effective.
h. Investment Transactions and Expenses
Purchases of loans, including revolving credit agreements, are recorded on a fully committed basis until the funded and unfunded portions are known or estimable, which in many cases may not be until settlement.
Expenses are accrued as incurred.
Deferred debt issuance costs, incurred in connection with the Company’s Notes Payable, are amortized using the straight-line method over the life of the notes.
Offering costs were charged to paid-in capital upon sale of shares in the Offering.
i. Investment Valuation
The Company applies fair value accounting to all of its financial instruments in accordance with the 1940 Act and ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework used to measure fair value and requires disclosures for fair value measurements. In accordance with ASC 820, the Company has categorized its investments and financial instruments carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy as discussed in Note 4. Fair value is a market-based measure considered from the perspective of the market participant who holds the financial instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that management believes market participants would use in pricing the financial instrument at the measurement date.
Fair value is defined as the price that would be received upon a sale of an asset in an orderly transaction between market participants at the measurement date. Market participants are buyers and sellers in the principal (or most advantageous) market for the asset that (a) are independent of us, (b) are knowledgeable, having a reasonable understanding about the asset based on all available information (including information that might be obtained through due diligence efforts that are usual and customary), (c) are able to transact for the asset, and (d) are willing to transact for the asset or liability (that is, they are motivated but not forced or otherwise compelled to do so).
114
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
Securities that are traded on securities exchanges (including such securities traded in the after-hour’s market) are valued on the basis of the closing price on the valuation date (if such prices are available). Securities that are traded on more than one securities exchange are valued at the closing price on the primary securities exchange on which such securities are traded on the valuation date (or if reported on the consolidated tape, then their last sales price on the consolidated tape). Listed options for which the last sales price falls between the last “bid” and “ask” prices for such options are valued at their last sales price on the date of the valuation on the primary securities exchange on which such options are traded. Options for which the last sales price on the valuation date does not fall between the last “bid” and “ask” prices are valued at the average of the last “bid” and “ask” prices for such options on that date. To the extent these securities are actively traded, and valuation adjustments are not applied, they are categorized in Level 1 of the fair value hierarchy. The Company did not hold any Level 1 investments as of June 30, 2020 or June 30, 2019.
Investments that are not traded on securities exchanges but are traded on the over-the-counter (“OTC”) markets (such as term loans, notes and warrants) are valued using various techniques, which may consider recently executed transactions in securities of the issuer or comparable issuers, market price quotations (when observable) and fundamental data relating to the issuer. These investments are categorized in Level 2 of the fair value hierarchy, or in instances when lower relative weight is placed on transaction prices, quotations, or similar observable inputs, they are categorized in Level 3.
The embedded derivative in the Term Notes and the 2017 Revolving Notes (as defined in Note 5) payable from SPV to UBS AG, London Branch (together with its affiliates, “UBS”) and total return swaps referencing the terms of the Term Notes payable and the total return of the 2017 Revolving Notes referencing the 2017 Revolving Notes (together, the “TRS”) are valued based on the change in fair value and the underlying accrued interest of the portfolio of assets held in SPV less the accrued interest payable on the financing due to the TRS counterparty, UBS. Consideration has been given to counterparty risk. The Company has assessed the unsecured risk of the counterparty, UBS, in the form of credit ratings and the trading levels of that risk and has determined that the counterparty risk is minimal. The Company also notes that counterparty risk is further mitigated by the monthly settlement of both the interest portion of the embedded derivative referencing the Term Notes and the 2017 Revolving Notes payable and the TRS. If the Company were to determine that counterparty risk were material, an adjustment to the fair value of the TRS would be made. The embedded derivative in the Term Notes and the 2017 Revolving Notes payable and the TRS have been categorized in Level 3 of the fair value hierarchy. See Note 4 and Note 5 for more detail.
Investments for which market quotations are not readily available or may be considered unreliable are fair valued, in good faith, using a method determined to be appropriate in the given circumstances. The valuation methods used include the Cost Approach, the Market Approach and the Income Approach. Inputs used in these approaches may include, but are not limited to, interest rate yield curves, credit spreads, recovery rates, comparable company transactions, trading multiples, and volatilities. The valuation method of the Company may change as changes in the underlying company dictates, such as moving from the Cost Approach to Market Approach when underlying conditions change at the company. Because of the inherent uncertainty of valuation in these circumstances, the fair values for the aforementioned investments may differ significantly from values that would have been used had a ready and liquid market for such investments existed or from the amounts that might ultimately be realized, and such differences could be material.
The Company’s valuation policies and procedures are developed by the Adviser, which is also responsible for ensuring that the valuation policies and procedures are consistently applied across all investments of the Company and approved by the Company’s board of directors. The valuations are continuously monitored and the
115
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
valuation process for Level 3 investments is completed on a quarterly basis and is designed to subject the valuation of Level 3 investments to an appropriate level of consistency, oversight and review. The valuation process begins with each portfolio company or investment being initially valued by the investment professionals of the Adviser responsible for the portfolio investment. These investment professionals prepare the preliminary valuations based on their evaluation of financial and operating data, company specific developments, market valuations of comparable securities from the same company or that of comparable companies as well as any other relevant factors including recent purchases and sales that may have occurred preceding month-end.
Valuation models are typically calibrated upon initial funding and are re-calibrated as necessary upon subsequent material events (including, but not limited to additional financing activity, changes in comparable companies, and recent trades). The preliminary valuation conclusions are then documented and discussed with senior management of the Adviser. On a periodic basis and at least once annually, independent valuation firm(s) engaged by the Company conduct independent appraisals and review the Adviser’s preliminary valuations and make their own independent assessment. The Valuation Committee of the Company’s board of directors then reviews the preliminary valuations of the Adviser and that of the independent valuation firms. The Valuation Committee discusses the valuations and makes a recommendation to the Company’s board of directors regarding the fair value of each investment in good faith based on the input of the Adviser and the independent valuation firms. Upon recommendation by the Valuation Committee and a review of the valuation materials of the Adviser and the third-party independent valuation firms, the board of directors of the Company determines, in good faith, the fair value of each investment.
For more information on the classification of the Company’s investments by major categories, see Note 4.
The fair value of the Company’s assets and liabilities that qualify as financial instruments under U.S. GAAP approximates the carrying amounts presented in the Consolidated Statements of Assets and Liabilities.
j. Income Taxes
The Company has elected to be treated, for U.S. federal income tax purposes, as a RIC under Subchapter M of the Code. To qualify and maintain qualification as a RIC, the Company must, among other things, meet certain source of income and asset diversification requirements and distribute to stockholders, for each taxable year, at least 90% of the Company’s “investment company taxable income’’ which is generally the Company’s net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses. If the Company continues to qualify as a RIC and continues to satisfy the annual distribution requirement, the Company will not have to pay corporate-level U.S. federal income taxes on any income that the Company distributes to its stockholders. The Company intends to make distributions in an amount sufficient to maintain RIC status each year and to avoid any federal income taxes on income. The Company will also be subject to nondeductible U.S. federal excise taxes if the Company does not distribute to its stockholders at least 98% of net ordinary income, 98.2% of capital gains, if any, and any recognized and undistributed income from prior year for which it paid no U.S. federal income taxes. Additionally, certain of the Company’s consolidated subsidiaries are subject to U.S. federal and state income taxes. For the years ended June 30, 2020, June 30, 2019 and June 30, 2018, the Company recorded a provision for taxes of $144,709, $158,028, and $2,579,337, respectively, for U.S. federal and state income taxes related to Taxable Subsidiaries, respectively.
Book and tax basis differences that are permanent differences are reclassified among the Company’s capital accounts, as appropriate at year-end. Additionally, the tax character of distributions is determined in accordance with the Code, which differs from U.S. GAAP. During the years ended June 30, 2020, June 30, 2019 and
116
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
June 30, 2018, the Company recorded distributions of $12.8 million, $13.6 million and $13.7 million, respectively. For certain years, the tax character of a portion of distributions may be return of capital.
U.S. GAAP requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet a more-likely-than-not threshold would be recorded as a tax expense in the current year. The Company’s policy is to recognize accrued interest and penalties associated with uncertain tax positions as part of the tax provision.
The Company has analyzed such tax positions and has concluded that no unrecognized tax benefits should be recorded for uncertain tax positions for tax years that remain subject to examination by taxing authorities (i.e., all open tax years and the interim tax period since then). This conclusion may be subject to review and adjustment at a later date based on factors, including but not limited to, ongoing analysis and changes to laws, regulations, and interpretations thereof.
Permanent differences between investment company taxable income and net investment income for financial reporting purposes are reclassified among capital accounts in the financial statements to reflect their tax character. Differences in classification may also result from the treatment of short-term gains as ordinary income for U.S. federal income tax purposes. During the years ended June 30, 2020, June 30, 2019 and June 30, 2018, the Company reclassified for book purposes amounts arising from permanent book/tax differences related to the different tax treatment of paydown gains and losses, Taxable Subsidiary partnership investments, nondeductible taxes paid and income/(loss) from wholly owned subsidiaries as follows:
| As of June 30, | ||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Additional paid-in capital |
$ | (126,635 | ) | $ | (46,092 | ) | $ | — | ||||
| Distributable earnings |
126,635 | 46,092 | — | |||||||||
The tax character of all distributions paid by the Company during the years ended June 30, 2020, June 30, 2019 and June 30, 2018 were ordinary income.
At June 30, 2020, June 30, 2019 and June 30, 2018, the components of distributable earnings on a tax basis detailed below differ from the amounts reflected in the Company’s Consolidated Statement of Assets and Liabilities by temporary and other book/tax differences, primarily relating to the tax treatment of dividends payable and non-deductible incentive fee income unvested, as follows:
| As of June 30, | ||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Undistributed net investment income |
$ | 8,108,113 | $ | 6,961,406 | $ | 7,140,649 | ||||||
| Accumulated capital gains (losses) and other |
(8,189,230 | ) | (21,939,217 | ) | (2,474,763 | ) | ||||||
| Capital loss carryover |
(43,077,639 | ) | (21,270,472 | ) | (18,612,517 | ) | ||||||
| Unrealized appreciation (depreciation) |
(46,302,927 | ) | (15,113,364 | ) | (9,055,269 | ) | ||||||
| Distributions payable |
(2,499,360 | ) | (3,404,923 | ) | (3,417,848 | ) | ||||||
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| Components of tax distributable earnings at year end |
$ | (91,961,043 | ) | $ | (54,766,570 | ) | $ | (26,419,748 | ) | |||
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117
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
For U.S. federal income tax purposes, net realized capital losses may be carried over to offset future capital gains, if any. These capital losses can be carried forward for an indefinite period and will retain their character as either short-term or long-term capital losses. As of June 30, 2020, the Company had a net short-term capital loss carryforward of $1,345,961 and a net long-term capital loss carryforward of $41,731,678 available to be carried forward for an indefinite period.
A RIC may elect to defer any capital losses incurred after October 31, 2019 (“post-October”) to the beginning of the following fiscal year. As of June 30, 2020, the Company had a post-October short-term capital loss deferral of $1,068,646 and a post-October long-term capital loss deferral of $7,120,584. These losses are deemed to arise on July 1, 2020.
k. Capital Gains Incentive Fee
The Advisory Agreement went into effect on August 30, 2019 (the “Commencement Date”). As with the Prior Advisory Agreement, under the Advisory Agreement, the Company has agreed to pay the Adviser a fee for investment advisory and management services consisting of two components — a base management fee (the “Base Management Fee”) and an incentive fee (the “Incentive Fee”). The Incentive Fee, which provides the Adviser with a share of the income that it generates for the Company, has two components, ordinary income (the “Income-Based Fee”) and capital gains (the “Capital Gains Fee”).
Under U.S. GAAP, the Company calculates the Capital Gains Fee payable to the Adviser as if the Company had realized all investments at their fair values as of the reporting date. Accordingly, the Company accrues a provisional Capital Gains Fee taking into account any unrealized gains or losses. As the provisional Capital Gains Fee is subject to the performance of investments until there is a realization event, the amount of provisional Capital Gains Fee accrued at a reporting date may vary from the incentive fee that is ultimately realized and the differences could be material.
Under the Advisory Agreement, the Capital Gains Fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), commencing with the fiscal year ending June 30, 2021, and will equal to 20.0% of the Company’s cumulative aggregate realized capital gains from the Commencement Date through the end of that fiscal year, computed net of the Company’s aggregate cumulative realized capital losses and the Company’s aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gains Fees. If such amount is negative, then no Capital Gains Fee will be payable for such year. Additionally, if the Advisory Agreement is terminated as of a date that is not a fiscal year end, the termination date will be treated as though it were a fiscal year end for purposes of calculating and paying the Capital Gains Fee. Therefore, under the Advisory Agreement, the Capital Gains Fee will not be charged until the fiscal year ending June 30, 2021.
As of June 30, 2020, June 30, 2019 and June 30, 2018, there was no capital gains incentive fee payable to the Adviser under the Advisory Agreement.
l. Share Repurchase Program
On May 2, 2018, the Company’s board of directors authorized a new discretionary repurchase program of up to $5.0 million shares of our common stock, until the earlier of (i) May 1, 2019 or (ii) the repurchase of $5.0 million in aggregate amount of the common stock unless extended by the Company’s board of directors. On May 1, 2019, the Company’s board of directors extended the share repurchase program until the earlier of
118
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 2. Significant Accounting Policies – (continued)
(i) May 1, 2020 or (ii) the repurchase of $5.0 million in aggregate amount of common stock. The share repurchase program expired on May 1, 2020. Under the discretionary repurchase program, the Company could, but was not obligated to, repurchase the outstanding common stock from time to time in the open market provided that the Company complied with the prohibitions under its insider trading policies and procedures and the applicable provisions the Securities Exchange Act of 1934, as amended. In addition, any repurchases were conducted in accordance with the 1940 Act. The timing and number of shares repurchased depended on a number of factors, including market conditions and alternative investment opportunities and no assurances can be given that any common stock, or any particular amount, will be purchased. The Company will retire immediately all shares of common stock purchased in connection with the share repurchase program. During the year ended June 30, 2020, the Company did not repurchase shares of common stock on the open market. During the year ended June 30, 2019, the Company repurchased 42,214 shares of common stock on the open market for $358,531 (including commissions). During the period ended June 30, 2018, the Company repurchased 42,627 shares of common stock on the open market for $390,178 (including commissions). Refer to Note 11 for additional information concerning share repurchases.
Certain items in the consolidated financial statements has been reclassified to conform to the June 30, 2020 presentation with no effect on net income.
Note 3. Recent Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. The Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial statements upon adoption.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 will modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. ASU 2018-13 is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period, with early adoption permitted. The Company is currently evaluating the impact ASU 2018-13 will have on the Company’s consolidated financial statements and disclosures.
Note 4. Investments
The Company’s investments at any time may include securities and other financial instruments, including, without limitation, corporate and government bonds, convertible securities, collateralized loan obligations, term loans, trade claims, equity securities, privately negotiated securities, direct placements, working interests, warrants and investment derivatives (such as credit default swaps, recovery swaps, total return swaps, options, forward contracts, and futures) (all of the foregoing collectively referred to in these financial statements as “investments”).
a. Certain Risk Factors
In the ordinary course of business, the Company manages a variety of risks including market risk, liquidity risk and credit risk. The Company identifies, measures and monitors risk through various control mechanisms, including trading limits and diversifying exposures and activities across a variety of instruments, markets and counterparties.
119
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
Market risk is the risk of potential adverse changes to the value of financial instruments because of changes in market conditions, including as a result of changes in the credit quality of a particular issuer, credit spreads, interest rates, and other movements and volatility in security prices or commodities. In particular, the Company may invest in issuers that are experiencing or have experienced financial or business difficulties (including difficulties resulting from the initiation or prospect of significant litigation or bankruptcy proceedings), which involves significant risks. The Company manages its exposure to market risk through the use of risk management strategies and various analytical monitoring techniques.
The Company’s assets may, at any time, include securities and other financial instruments or obligations that are illiquid or thinly traded, making purchase or sale of such securities and financial instruments at desired prices or in desired quantities difficult. Furthermore, the sale of any such investments may be possible only at substantial discounts, and it may be extremely difficult to value any such investments accurately.
Credit risk is the potential loss the Company may incur from a failure of an issuer to make payments according to the terms of a contract. The Company is subject to credit risk because of its strategy of investing in the debt of leveraged companies and its involvement in derivative instruments. The Company’s exposure to credit risk on its investments is limited to the fair value of the investments. The Company’s TRS contract is executed pursuant to an International Swaps and Derivatives Association (“ISDA”) master agreement (the “ISDA Agreement”) that the Company currently has in place with UBS. At June 30, 2018, the Company had all of its counterparty credit risk associated with non-performance for swaps with UBS. With regard to derivatives, the Company attempts to limit its credit risk by considering its counterparty’s (or its guarantor’s) credit rating. The Company’s policy is to not hold counterparty collateral on ISDA Agreements but would do so if the exposure were material.
b. Investments
Investment purchases, sales and principal payments/paydowns are summarized below for the years ended June 30, 2020, June 30, 2019 and June 30, 2018, respectively. These purchase and sale amounts exclude derivative instruments as well as non cash restructurings.
| Year Ended June 30, |
||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Investment purchases, at cost (including PIK interest) |
$ | 105,999,383 | $ | 202,887,428 | $ | 175,180,629 | ||||||
| Investment sales and repayments |
105,678,135 | 165,479,578 | 137,045,592 | |||||||||
The composition of the Company’s investments as of June 30, 2020, as a percentage of the total portfolio, at amortized cost and fair value, are as follows:
| Investment at Amortized Cost |
Percentage | Investments at Fair Value |
Percentage | |||||||||||||
| Senior Secured First Lien Debt Investments |
$ | 248,155,342 | 78.30 | % | $ | 226,366,176 | 83.65 | % | ||||||||
| Unitranche First Lien Debt Investment |
11,277,314 | 3.56 | 10,713,448 | 3.96 | ||||||||||||
| Senior Secured Second Lien Debt Investments |
38,520,395 | 12.15 | 27,719,133 | 10.24 | ||||||||||||
| Equity, Warrants and Other Investments |
18,971,587 | 5.99 | 5,822,952 | 2.15 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 316,924,638 | 100.00 | % | $ | 270,621,709 | 100.00 | % | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
120
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
The composition of the Company’s investments as of June 30, 2019, as a percentage of the total portfolio, at amortized cost and fair value, are as follows:
| Investment at Amortized Cost |
Percentage | Investments at Fair Value |
Percentage | |||||||||||||
| Senior Secured First Lien Debt Investments |
$ | 247,510,745 | 76.98 | % | $ | 237.916.393 | 77.66 | % | ||||||||
| Unitranche First Lien Debt Investment |
11,319,236 | 3.52 | 11,319,236 | 3.69 | ||||||||||||
| Senior Secured Second Lien Debt Investments |
61,300,369 | 19.07 | 57,155,363 | 18.65 | ||||||||||||
| Equity, Warrants and Other Investments |
1,374,009 | 0.43 | 1 | 0.00 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 321,504,359 | 100.00 | % | $ | 306,390,993 | 100.00 | % | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
The Company uses the Global Industry Classification Standard (“GICS”) codes to identify industry groupings in its portfolio. The following tables shows the portfolio composition by industry grouping at fair value at June 30, 2020:
| Industry Classification |
Investments at Fair Value |
Percentage of Total Portfolio |
||||||
| Professional Services |
$ | 31,056,563 | 11.48 | % | ||||
| Construction & Engineering |
30,252,174 | 11.18 | ||||||
| Energy Equipment & Services |
29,555,420 | 10.92 | ||||||
| Trading Companies & Distributors |
24,586,660 | 9.09 | ||||||
| Media |
19,176,144 | 7.09 | ||||||
| Containers & Packaging |
16,052,915 | 5.93 | ||||||
| Diversified Telecommunication Services |
12,562,817 | 4.64 | ||||||
| Commercial Services & Supplies |
12,402,682 | 4.58 | ||||||
| Retail |
11,700,000 | 4.32 | ||||||
| Distributors |
9,456,000 | 3.49 | ||||||
| Internet Software & Services |
9,226,180 | 3.41 | ||||||
| Consumer Finance |
9,113,150 | 3.37 | ||||||
| Airlines |
9,067,500 | 3.35 | ||||||
| Construction Materials |
6,531,518 | 2.41 | ||||||
| Auto Components |
6,236,446 | 2.31 | ||||||
| Internet & Direct Marketing Retail |
6,193,975 | 2.29 | ||||||
| Specialty Retail |
5,641,123 | 2.08 | ||||||
| Household Durables |
4,919,063 | 1.82 | ||||||
| Chemicals |
4,800,000 | 1.77 | ||||||
| Road & Rail |
3,873,349 | 1.43 | ||||||
| Hotels, Restaurants & Leisure |
3,846,750 | 1.42 | ||||||
| IT Services |
2,964,904 | 1.10 | ||||||
| Technology Hardware, Storage & Peripherals |
1,406,376 | 0.52 | ||||||
| Wireless Telecommunication Services |
— | — | ||||||
|
|
|
|
|
|||||
| Total |
$ | 270,621,709 | 100.00 | % | ||||
|
|
|
|
|
|||||
121
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
The following tables shows the portfolio composition by industry grouping at fair value at June 30, 2019:
| Industry Classification |
Investments at Fair Value |
Percentage of Total Portfolio |
||||||
| Professional Services |
$ | 41,415,967 | 13.52 | % | ||||
| Energy Equipment & Services |
31,276,442 | 10.21 | ||||||
| Media |
30,345,112 | 9.91 | ||||||
| Construction & Engineering |
30,025,649 | 9.80 | ||||||
| Commercial Services & Supplies |
26,516,250 | 8.65 | ||||||
| Diversified Telecommunication Services |
17,303,124 | 5.65 | ||||||
| Distributors |
14,763,188 | 4.82 | ||||||
| Retail |
14,350,000 | 4.68 | ||||||
| Containers & Packaging |
12,942,636 | 4.22 | ||||||
| Hotels, Restaurants & Leisure |
11,105,246 | 3.62 | ||||||
| Household Durables |
9,440,625 | 3.08 | ||||||
| Internet Software & Services |
8,851,371 | 2.89 | ||||||
| Auto Components |
8,835,000 | 2.88 | ||||||
| Business Services |
7,425,670 | 2.42 | ||||||
| Trading Companies & Distributors |
7,350,000 | 2.40 | ||||||
| Health Care Equipment & Supplies |
7,350,000 | 2.40 | ||||||
| Technology Hardware, Storage & Peripherals |
7,339,974 | 2.40 | ||||||
| Construction Materials |
6,912,675 | 2.26 | ||||||
| IT Services |
5,798,132 | 1.89 | ||||||
| Chemicals |
4,750,000 | 1.55 | ||||||
| Wireless Telecommunication Services |
2,293,932 | 0.75 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 306,390,993 | 100.00 | % | ||||
|
|
|
|
|
|||||
The following table shows the portfolio composition by geographic grouping at fair value at June 30, 2020:
| Fair Value | Percentage Total Portfolio |
|||||||
| U.S. Northeast |
$ | 70,569,020 | 26.08 | % | ||||
| U.S. Midwest |
54,134,214 | 20.00 | ||||||
| U.S. Southwest |
41,459,752 | 15.32 | ||||||
| U.S. Mid-Atlantic |
30,094,344 | 11.12 | ||||||
| International |
26,324,304 | 9.73 | ||||||
| U.S. Southeast |
25,131,283 | 9.29 | ||||||
| U.S. West |
22,908,792 | 8.46 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 270,621,709 | 100.00 | % | ||||
|
|
|
|
|
|||||
122
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
The following table shows the portfolio composition by geographic grouping at fair value at June 30, 2019:
| Fair Value | Percentage Total Portfolio |
|||||||
| U.S. Northeast |
$ | 112,966,230 | 36.87 | % | ||||
| U.S. Midwest |
48,834,830 | 15.94 | ||||||
| U.S. Southeast |
45,178,967 | 14.74 | ||||||
| International |
27,243,499 | 8.89 | ||||||
| U.S. West |
25,235,056 | 8.24 | ||||||
| U.S. Mid-Atlantic |
23,738,962 | 7.75 | ||||||
| U.S. Southwest |
23,193,449 | 7.57 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 306,390,993 | 100.00 | % | ||||
|
|
|
|
|
|||||
The Company’s primary investment objective is to maximize total return to stockholders in the form of current income and capital appreciation by investing directly in debt and related equity of privately held middle- market companies to help these companies fund acquisitions, growth or refinancing. During the year ended June 30, 2020, the Company made investments in new and existing portfolio companies of approximately $81.1 million and $15.9 million, respectively, to which it was not previously contractually committed to provide financial support. During the year ended June 30, 2020, the Company made investments of $4.8 million in companies to which it was previously committed to provide financial support through the terms of the revolvers and delayed draw term loans. The details of the Company’s investments have been disclosed on the Consolidated Schedule of Investments.
c. Derivatives
Derivative contracts include total return swaps and embedded derivatives in Notes Payable. The Company enters into derivative contracts as part of its investment strategies.
The Company and UBS entered into two TRS transactions whereby the Company will receive the total return of the Term Notes and the Revolving Notes (as defined in Note 5) purchased by UBS and pay the Financing Rate and the Revolver Financing Rate (both as defined in Note 5). Therefore, amounts required for the future satisfaction of the swaps may be greater or less than the amount recorded. Realized and change in unrealized gains and losses on total return swaps, if any, are included in the net realized gain or loss on derivative, and net change in unrealized appreciation (depreciation) on derivative in the Consolidated Statements of Operations. On December 5, 2016, the TRS on the Revolving Notes expired.
In connection with the TRS transactions, the Company entered into an ISDA Agreement with UBS. The ISDA Agreement includes provisions for general obligations, representations, collateral and events of default or termination. Under an ISDA Agreement, the Company typically may offset with the counterparty certain derivative payable and/or receivable with collateral held and/or posted and create one single net payment (close-out netting) in the event of default or termination.
The Company’s ISDA Agreement may contain provisions for early termination of OTC derivative transactions in the event the net assets of the Company decline below specific levels (“net asset contingent features”). If these levels are triggered, the Company’s counterparty has the right to terminate such transaction and require the Company to pay or receive a settlement amount in connection with the terminated transaction.
123
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
The Company has determined that the Term Notes payable from SPV to UBS related to the Term Financing (discussed further in Note 5) contains an embedded derivative. SPV is obligated to pay UBS the net appreciation (depreciation) of the SPV Assets, as defined below, as well as pay any income generated by the SPV Assets until maturity. Therefore, amounts required for the future satisfaction of the note may be greater or less than the amount recorded. Realized and change in unrealized gains and losses on the embedded derivative is included in the net realized gain or loss on derivatives, and net change in unrealized appreciation (depreciation) on derivative in the Consolidated Statements of Operations.
At June 30, 2020, the Company held no derivative contracts.
The following table reflects the amount of gains (losses) on derivatives included in the Consolidated Statements of Operations for the years ended June 30, 2020, June 30, 2019 and June 30, 2018, respectively. None of the derivatives were designated as hedging instruments under U.S. GAAP.
| Included in net change in unrealized appreciation (depreciation) on investments and derivatives |
||||||||||||
| June 30, | ||||||||||||
| 2020 | 2019 | 2018 | ||||||||||
| Total Return Swaps |
$ | — | $ | (229,918 | ) | $ | (5,600,583 | ) | ||||
| Embedded derivatives Notes Payable |
— | 229,918 | 5,600,583 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total |
$ | — | $ | — | $ | — | ||||||
|
|
|
|
|
|
|
|||||||
d. Fair Value Measurements
ASC 820 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a framework for measuring fair value and a valuation hierarchy that prioritizes the inputs used in the valuation of an asset or liability based upon their transparency. The valuation hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Classification within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company’s assets and liabilities measured at fair value have been classified in the following three categories:
Level 1 — valuation is based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2 — valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as (a) quoted prices for similar assets or liabilities in active markets; (b) quoted prices for identical or similar assets or liabilities in markets that are not active, that is, markets in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly; (c) inputs other than quoted prices that are observable for the asset or liability; or (d) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 — valuation is based on unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
124
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability. Therefore, unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Unobservable inputs are developed based on the best information available under the circumstances, which might include the Company’s own data. The Company’s own data used to develop unobservable inputs is adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.
The availability of observable inputs can vary from security to security and is affected by a wide variety of factors, including, for example, the type of security, whether the security is new and not yet established in the marketplace, the liquidity of the market and other characteristics particular to the security. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.
Estimates of fair value for cash and restricted cash are measured using observable, quoted market prices, or Level 1 inputs. All other fair value significant estimates are measured using unobservable inputs, or Level 3 inputs.
The following table summarizes the classifications within the fair value hierarchy of the Company’s assets and liabilities measured at fair value as of June 30, 2020:
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
| Assets |
||||||||||||||||
| Investments |
||||||||||||||||
| Senior Secured First Lien Debt Investments |
$ | — | $ | — | $ | 237,079,624 | $ | 237,079,624 | ||||||||
| Senior Secured Second Lien Debt Investments |
— | — | 27,719,133 | 27,719,133 | ||||||||||||
| Equity, Warrants and Other Investments |
— | — | 5,822,952 | 5,822,952 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total Investments |
$ | — | $ | — | $ | 270,621,709 | $ | 270,621,709 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
The following table summarizes the classifications within the fair value hierarchy of the Company’s assets and liabilities measured at fair value as of June 30, 2019:
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
| Assets |
||||||||||||||||
| Investments |
||||||||||||||||
| Senior Secured First Lien Debt Investments |
$ | — | $ | — | $ | 249,235,629 | $ | 249,235,629 | ||||||||
| Senior Secured Second Lien Debt Investments |
— | — | 57,155,363 | 57,155,363 | ||||||||||||
| Equity, Warrants and Other Investments |
— | — | 1 | 1 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total Investments |
$ | — | $ | — | $ | 306,390,993 | $ | 306,390,993 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
125
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the year ended June 30, 2020:
| Senior Secured First Lien Debt Investments |
Senior Secured Second Lien Debt Investments |
Unsecured Debt Investments |
Equity, Warrants and Other Investments |
Total Investments |
||||||||||||||||
| Balance as of June 30, 2019 |
$ | 249,235,629 | $ | 57,155,363 | $ | — | $ | 1 | $ | 306,390,993 | ||||||||||
| Purchases (including PIK interest) |
103,443,595 | 1,226,093 | — | 1,329,695 | 105,999,383 | |||||||||||||||
| Sales |
(81,226,522 | ) | (24,451,613 | ) | — | — | (105,678,135 | ) | ||||||||||||
| Amortization |
2,285,680 | 445,545 | — | — | 2,731,225 | |||||||||||||||
| Net realized gains (losses) |
(7,632,194 | ) | — | — | — | (7,632,194 | ) | |||||||||||||
| Transfers in |
9,775,204 | — | — | 16,267,884 | 26,043,088 | |||||||||||||||
| Transfers out |
(26,043,088 | ) | — | — | — | (26,043,088 | ) | |||||||||||||
| Net change in unrealized (depreciation) appreciation |
(12,758,680 | ) | (6,656,255 | ) | — | (11,774,628 | ) | (31,189,563 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Balance as of June 30, 2020 |
$ | 237,079,624 | $ | 27,719,133 | $ | — | $ | 5,822,952 | $ | 270,621,709 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Change in unrealized gains (losses) relating to assets and liabilities still held as of June 30, 2020 |
$ | (21,166,534 | ) | $ | (6,457,683 | ) | $ | — | $ | (11,774,628 | ) | $ | (39,398,845 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the year ended June 30, 2019:
| Senior Secured First Lien Debt Investments |
Senior Secured Second Lien Debt Investments |
Unsecured Debt Investments |
Equity, Warrants and Other Investments |
Total Investments |
||||||||||||||||
| Balance as of June 30, 2018 |
$ | 165,136,316 | $ | 127,200,954 | $ | 731,742 | $ | 523,001 | $ | 293,592,013 | ||||||||||
| Purchases (including PIK interest) |
185,409,054 | 16,706,250 | — | — | 202,115,304 | |||||||||||||||
| Sales |
(89,397,151 | ) | (74,144,637 | ) | — | (1,307,500 | ) | (164,849,288 | ) | |||||||||||
| Amortization |
1,365,378 | 2,066,827 | — | — | 3,432,205 | |||||||||||||||
| Net realized gains (losses) |
62,768 | (22,688,414 | ) | — | 784,500 | (21,841,146 | ) | |||||||||||||
| Transfers in |
— | — | — | — | — | |||||||||||||||
| Transfers out |
— | — | — | — | — | |||||||||||||||
| Net change in unrealized (depreciation) appreciation |
(13,340,736 | ) | 8,014,383 | (731,742 | ) | (6,058,095 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Balance as of June 30, 2019 |
$ | 249,235,629 | $ | 57,155,363 | $ | — | $ | 1 | $ | 306,390,993 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Change in unrealized gains (losses) relating to assets and liabilities still held as of June 30, 2020 |
$ | (12,976,063 | ) | $ | (4,920,536 | ) | $ | — | $ | — | $ | (17,896,599 | ) | |||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
126
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
| Total Return Swaps |
Embedded derivatives – Notes Payable |
Total Derivatives |
||||||||||
| Balance as of June 30, 2018 |
$ | (229,918 | ) | $ | 229,918 | $ | — | |||||
| Net change in unrealized (depreciation) appreciation |
229,918 | 229,918 | — | |||||||||
|
|
|
|
|
|
|
|||||||
| Balance as of June 30, 2019 |
$ | — | $ | — | $ | — | ||||||
|
|
|
|
|
|
|
|||||||
| Change in unrealized gains (losses) relating to assets and liabilities still held as of June 30, 2019 |
$ | — | $ | — | $ | — | ||||||
|
|
|
|
|
|
|
|||||||
Transfers into Level 3 during or at the end of the reporting period are reported under Level 1 or Level 2 as of the beginning of the period. Transfers out of Level 3 during or at the end of the reporting period are reported under Level 3 as of the beginning of the period. Changes in unrealized gains (losses) relating to Level 3 instruments are included in net change in unrealized (depreciation) appreciation on investments and derivatives on the Consolidated Statements of Operations.
During the years ended June 30, 2020 and June 30, 2019, the Company did not transfer any investments among Levels 1, 2 and 3.
The following tables present the ranges of significant unobservable inputs used to value the Company’s Level 3 investments as of June 30, 2020 and June 30, 2019. These ranges represent the significant unobservable inputs that were used in the valuation of each type of investment. These inputs are not representative of the inputs that could have been used in the valuation of any one investment. For example, the highest market yield presented in the table for senior secured notes is appropriate for valuing a specific investment but may not be appropriate for valuing any other investment. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible ranges of, fair value measurements of the Company’s Level 3 investments. In addition to the techniques and inputs noted in the tables below, according to our valuation policy we may also use other valuation techniques and methodologies when determining our fair value measurements. The below tables are not
127
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
intended to be all-inclusive, but rather provide information on the significant unobservable inputs as they relate to the Company’s determination of fair values.
| Fair Value as of June 30, 2020 |
Valuation Methodology |
Unobservable Input(s) |
Weighted Average |
Range | ||||||||
| Senior Secured First Lien Debt Investments |
$ | 87,561,187 | Yield Analysis | Market Yields | 9.7% | 6.2% – 14.1% | ||||||
| Senior Secured First Lien Debt Investments |
46,102,876 | Market Comparable Approach |
Comparable Multiple |
23.1x | 4.0x – 50.1x | |||||||
| Senior Secured First Lien Debt Investments |
56,556,621 | Loan to Value | EBITDA Multiple | 10.3x | 6.2x – 15.4x | |||||||
| Senior Secured First Lien Debt Investments |
13,323,250 | Broker Quoted | Broker Quoted | N/A | N/A | |||||||
| Senior Secured First Lien Debt Investments |
10,951,590 | Enterprise Value | EBITDA Multiple | 5.9x | 4.5x – 7.3x | |||||||
| Senior Secured First Lien Debt Investments |
9,848,588 | Recovery Analysis | Recoverable Amount |
N/A | N/A | |||||||
| Senior Secured First Lien Debt Investments |
2,022,063 | Recent Transaction | Recent Transaction | N/A | N/A | |||||||
| Unitranche First Lien Debt Investments |
10,713,449 | Market Comparable Approach |
Comparable Multiple |
13.4x | 4.8x – 22.0x | |||||||
| Senior Secured Second Lien Debt Investments |
15,000,000 | Recent Transaction | Recent Transaction | N/A | N/A | |||||||
| Senior Secured Second Lien Debt Investments |
7,040,000 | Market Comparable Approach |
Comparable Multiple |
11.0x | 8.1x – 13.8x | |||||||
| Senior Secured Second Lien Debt Investments |
5,679,133 | Recovery Analysis | Recoverable Amount |
N/A | N/A | |||||||
| Equity, Warrants and Other Investments |
5,620,758 | Recent Transaction | Recent Transaction | N/A | N/A | |||||||
| Equity, Warrants and Other Investments |
202,194 | Enterprise Value | EBITDA Multiple | 0.0x | 0.0x – 0.0x | |||||||
| Fair Value as of June 30, 2019 |
Valuation Methodology |
Unobservable Input(s) |
Weighted Average |
Range | ||||||||
| Senior Secured First Lien Debt Investments |
$ | 58,178,487 | Yield Analysis | Market Yields | 12.1% | 5.5% – 24.9% | ||||||
| Unitranche First Lien Debt Investments |
11,319,236 | Discounted Cash Flow |
Discount Rate | 21.8% | 20.6% – 23.1% | |||||||
| Senior Secured First Lien Debt Investments |
127,490,234 | Discounted Cash Flow |
Discount Rate | 10.1% | 5.1% – 26.3% | |||||||
| Senior Secured First Lien Debt Investments |
21,179,709 | Broker Quoted | Market Comparable | 79.6% | 65.0% – 101.3% | |||||||
| Senior Secured First Lien Debt Investments |
31,067,964 | Recent Purchase | Recent Purchase | N/A | N/A | |||||||
128
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 4. Investments – (continued)
| Fair Value as of June 30, 2020 |
Valuation Methodology |
Unobservable Input(s) |
Weighted Average |
Range | ||||||||||||
| Senior Secured Second Lien Debt Investments |
2,000,000 | Yield Analysis | Market Yields | 16.7% | 16.2% – 17.2% | |||||||||||
| Senior Secured Second Lien Debt Investments |
55,155,363 | |
Discounted Cash Flow |
Discount Rate | 15.1% | 9.6% – 31.1% | ||||||||||
| Equity, Warrants and Other Investments |
1 | EV Multiple | EBITDA Multiple | 0.0x | 0.0x – 0.0x | |||||||||||
Fair value measurements categorized within Level 3 are sensitive to changes in the assumptions or methodology used to determine fair value and such changes could result in a significant increase or decrease in the fair value. Significant increases in illiquidity discounts, PIK discounts and market yields would result in significantly lower fair value measurements.
Note 5. Notes Payable
On May 23, 2013, as amended on June 6, 2013, December 4, 2013, September 26, 2014, July 20, 2015, August 14, 2015, February 28, 2017, November 20, 2017 and June 21, 2019, the Company, through SPV, entered into a $122.0 million financing transaction (the “Term Financing”) due December 5, 2021 with UBS. The Term Financing is collateralized by the portion of the Company’s assets held by SPV (the “SPV Assets”) and pledged as collateral as noted in the Consolidated Schedule of Investments. Prior to June 21, 2019, borrowings under the Term Financing bore interest (i) at a rate per annum equal to one-month London Interbank Offered Rate (“LIBOR”) plus 2.75% through December 4, 2018, and (ii) at a rate per annum equal to one-month LIBOR plus 2.55% from December 5, 2018 through December 5, 2020 (the “Term Financing Rate”). The Company also incurred an annual fee of approximately 1% of the outstanding borrowings under the Term Financing.
On June 21, 2019, the Company amended the Term Financing to increase the Term Financing by $20.0 million from $102.0 million to $122.0 million. On April 15, 2020, we decided not to exercise an option to increase the Term Financing by up to $53.0 million (the “Option”) and repaid $20.0 million of the Term Financing. Borrowings under the Term Financing, as amended, bear interest (a) with respect to the $102.0 million (i) at a rate per annum equal to one-month LIBOR plus 2.55% through December 4, 2019, and (ii) at a rate per annum equal to one-month LIBOR plus 3.55% from December 5, 2019 through December 4, 2020, and (iii) at a rate per annum equal to one-month LIBOR plus 3.15% from December 5, 2020 through December 5, 2021, and (b) with respect to the additional $20.0 million increase in the Term Financing, (i) at a rate per annum equal to one-month LIBOR plus 3.15% through April 14, 2020, and (ii) at a rate per annum equal to one-month LIBOR plus 2.90% from the April 15, 2020 through December 5, 2021.
As of June 30, 2020, and June 30, 2019, there were $102.0 million and $122.0 million borrowings outstanding under the Term Financing, respectively.
On November 20, 2017, the Company entered into a $50 million revolving financing facility (the “2017 UBS Revolving Financing”) with UBS. On June 21, 2019, we amended the 2017 UBS Revolving Financing to reduce the size of the facility to $30.0 million. Borrowings under the 2017 UBS Revolving Financing generally bear interest at a rate per annum equal to one-month LIBOR plus 3.55% (the “Revolver Financing Rate”). The Company pays a fee on any undrawn amounts of 2.50% per annum; provided that if 50% or less of the 2017 UBS Revolving Financing is drawn, the fee will be 2.75% per annum. Any amounts borrowed under the 2017 UBS
129
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 5. Notes Payable – (continued)
Revolving Financing will mature, and all accrued and unpaid interest will be due and payable, on December 7, 2020. As of June 30, 2020, and June 30, 2019, there were $30.0 million and $11.0 in borrowings outstanding under the 2017 UBS Revolving Financing, respectively.
As of December 31, 2017, SPV issued and sold an additional $50.0 million notes (the “2017 Revolving Notes”) secured by the SPV Assets to UBS. Cash is only exchanged when the 2017 Revolving Notes are drawn. Under the terms of the Indenture under which the 2017 Revolving Notes were issued (the “2017 Revolver Indenture”), the holders of the 2017 Revolving Notes are entitled to (i) periodic interest payments equal to their pro rata portion of the interest collected on the SPV Assets and (ii) their pro-rata portion of the net appreciation (depreciation) on the SPV Assets at maturity (the “Total Return of the 2017 Revolving Notes”).
The fair value of the Company’s Notes Payable is estimated based on the rate at which similar facilities would be priced. At June 30, 2020 and June 30, 2019, the fair value of the Notes Payable was estimated at $132.0 million and $133.0 million, respectively, which the Company concluded was a Level 3 fair value.
On July 2, 2018, the Company closed the public offering of $30 million in aggregate principal amount of 6.125% notes due 2023 (the “Existing Notes”). On July 12, 2018, the underwriters exercised their over-allotment option to purchase an additional $4.5 million in aggregate principal amount of the Existing Notes. The total net proceeds to the Company from the Existing Notes, including the exercise of the underwriters’ over-allotment option, after deducting underwriting discounts and commissions of approximately $1.0 million and estimated offering expenses of approximately $230,000, were approximately $33.2 million.
On October 18, 2019, the Company closed the public offering of $15 million in aggregate principal amount of additional 6.125% notes due 2023 (the “Notes,” and together with the Existing Notes, the “2023 Notes”). The Notes constitute a further issuance of, rank equally in right of payment with, and form a single series with the $34.5 million in Existing Notes that the Company initially issued on July 2, 2018 and July 12, 2018. On November 7, 2019, the underwriters exercised their option to purchase an additional $1.875 million in aggregate principal of the Notes. The total net proceeds received by the Company from the sale of the Notes, including the exercise of the underwriters’ option, was approximately $16.4 million, based on the purchase price paid by the underwriters of 96.875% of the aggregate principal amount of the Notes, after deducting estimated offering expenses of approximately $255,000 payable by the Company.
The 2023 Notes will mature on July 1, 2023 and bear interest at a rate of 6.125%. The 2023 Notes are direct unsecured obligations and rank pari passu, which means equal in right of payment, with all outstanding and future unsecured indebtedness issued by the Company. Because the 2023 Notes are not secured by any of the Company’s assets, they are effectively subordinated to all of the Company’s existing and future secured unsubordinated indebtedness (or any indebtedness that is initially unsecured as to which we subsequently grant a security interest), to the extent of the value of the assets securing such indebtedness. The 2023 Notes are structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries and financing vehicles, including, without limitation, borrowings under the Term Financing and the 2017 UBS Revolving Financing. The 2023 Notes are obligations exclusively of the Company and not of any of the Company’s subsidiaries. None of the Company’s subsidiaries is a guarantor of the 2023 Notes and the 2023 Notes will not be required to be guaranteed by any subsidiary the Company may acquire or create in the future.
The 2023 Notes may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after July 1, 2020. Interest on the 2023 Notes is payable quarterly on January 1, April 1, July 1 and October 1 of each year. The 2023 Notes are listed on the NASDAQ Global Select Market (“NASDAQ”) under
130
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 5. Notes Payable – (continued)
the trading symbol “CMFNL.” The Company may from time to time repurchase Notes in accordance with the 1940 Act and the rules promulgated thereunder.
As of June 30, 2020 and June 30, 2019, the outstanding principal balance of the 2023 Notes was approximately $51.4 million and $34.5 million, respectively, and had an estimated fair value of $44.9 million and $35.4 million, respectively, based on the closing price as of June 30, 2020 and June 30, 2019, respectively, as traded on NASDAQ. The Company concluded that this was a Level 2 fair value.
Cash, restricted (as shown on the Consolidated Statements of Assets and Liabilities) is held by the trustee of the Term Financing and the 2017 UBS Revolving Financing and is restricted to purchases of investments by SPV and LLC that must meet certain eligibility criteria identified by the Indenture. As of June 30, 2020, SPV and LLC had aggregate assets of $223.3 million, which included $219.4 million of the Company’s portfolio investments at fair value, no accrued interest receivable and $3.9 million in cash held by the trustees of the Term Financing and the 2017 UBS Revolving Financing (together, the “UBS Financing Facility”, or the “Financing Facilities”). As of June 30, 2019, SPV and LLC had assets of $234.5 million, which included $232.8 million of the Company’s portfolio investments at fair value, $0.7 million of accrued interest receivable and $1.0 million in cash held by the trustee of the Term Financing. For the year ended June 30, 2020, the weighted average outstanding debt balance and the weighted average stated interest rate under the Financing Facilities was $135.5 million and 4.60%, respectively. For the year ended June 30, 2019, the weighted average outstanding debt balance and the weighted average stated interest rate under the Financing Facilities was $109.3 million and 5.04%, respectively.
Note 6. Indemnification, Guarantees, Commitments and Contingencies
In the normal course of business, the Company enters into contracts that provide a variety of representations and warranties and general indemnifications. Such contracts include those with certain service providers, brokers and trading counterparties. Any exposure to the Company under these arrangements is unknown as it would involve future claims that may be made against the Company; however, based on the Company’s experience, the risk of loss is remote and no such claims are expected to occur. As such, the Company has not accrued any liability in connection with such indemnifications.
The Company’s Board of Directors declared the following quarterly distributions during the fiscal year:
| Declared |
Ex-Date | Record Date | Pay Date | Amount | Fiscal Quarter | |||||||||
| August 28, 2019 |
September 25, 2019 | September 26, 2019 | October 16, 2019 | $ | 0.2500 | 1st 2020 | ||||||||
| November 6, 2019 |
December 12, 2019 | December 13, 2019 | January 2, 2020 | $ | 0.2500 | 2nd 2020 | ||||||||
| February 4, 2020 |
March 12, 2020 | March 13, 2020 | April 4, 2020 | $ | 0.2500 | 3rd 2020 | ||||||||
| May 7, 2020 |
June 18, 2020 | June 19, 2020 | July 10, 2020 | $ | 0.1500 | 4th 2020 | ||||||||
| May 7, 2020* |
June 18, 2020 | June 19, 2020 | July 10, 2020 | $ | 0.0300 | 4th 2020 | ||||||||
| * Supplemental distribution |
|
|||||||||||||
Loans purchased by the Company may include revolving credit agreements or other financing commitments obligating the Company to advance additional amounts on demand. The Company generally sets aside sufficient liquid assets to cover its unfunded commitments, if any.
131
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 6. Indemnification, Guarantees, Commitments and Contingencies – (continued)
The following table details the Company’s unfunded commitments as of June 30, 2020:
| Investments |
Unfunded Commitment |
Fair Value |
Annual Non-use Fee |
Expiration Date | ||||||||||||
| 1888 Industrial Services, LLC - Revolver |
$ | 594,059 | $ | — | 0.5 | % | 9/30/21 | |||||||||
| 1888 Industrial Services, LLC - Term E |
120,845 | — | — | 9/19/22 | ||||||||||||
| Altern Marketing, LLC |
1,370,249 | — | 0.5 | % | 10/7/24 | |||||||||||
| Limbach Holdings Inc |
5,769,230 | — | 2.0 | % | 4/12/24 | |||||||||||
|
|
|
|
|
|||||||||||||
| Total Unfunded Commitments |
$ | 7,854,383 | $ | — | ||||||||||||
|
|
|
|
|
|||||||||||||
The following table details the Company’s unfunded commitments as of June 30, 2019:
| Investments |
Unfunded Commitment |
Fair Value |
Annual Non-use Fee |
Expiration Date | ||||||||||||
| 1888 Industrial Services, LLC |
$ | 495,050 | $ | — | 0.50 | 9/30/21 | ||||||||||
| Fusion Connect Inc. |
391,465 | — | — | 10/3/19 | ||||||||||||
| Limbach Holdings Inc. |
5,769,230 | — | — | 4/12/23 | ||||||||||||
|
|
|
|
|
|||||||||||||
| Total Unfunded Commitments |
$ | 6,655,745 | $ | — | ||||||||||||
|
|
|
|
|
|||||||||||||
Note 7. Agreements and Related Party Transactions
Advisory Agreement
Effective August 30, 2019, or the Commencement Date, the Company became party to the Advisory Agreement with the Adviser. See below for a description of the prior agreement. Under the Advisory Agreement, the Base Management Fee is calculated at an annual rate of 1.75% of the Company’s gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents (such amount, “Gross Assets”). The Base Management Fee is payable quarterly in arrears and the Base Management Fees for any partial month or quarter will be appropriately pro-rated.
For the year ended June 30, 2020, $5,385,814 in Base Management Fees were earned by the Adviser, of which $269,815 was waived. As of June 30, 2020, $1,196,937 of such fees were payable. For the year ended June 30, 2019, $5,436,135 in Base Management Fees were earned by the Adviser under the Prior Advisory Agreement, of which $0 was payable at June 30, 2019. For the year ended June 30, 2018, $4,871,706 in Base Management Fees were earned by the Adviser under the Prior Advisory Agreement, of which $1,319,853 was payable at June 30, 2018.
Under the Advisory Agreement, for the period from the Commencement Date through the end of the first and second fiscal quarters after the Commencement Date, the Base Management Fee is calculated based on the value of the Company’s Gross Assets as of the end of such quarter. Subsequently, the Base Management Fee will be calculated based on the average value of the Company’s Gross Assets at the end of the two most recently completed fiscal quarters. Base Management Fees for any partial month or quarter will be appropriately pro-rated.
Under the Advisory Agreement, the Income-Based Fee is calculated and payable quarterly in arrears based on the Company’s Pre-Incentive Fee Net Investment Income (as defined below) for the immediately preceding fiscal quarter, subject to a total return requirement (the “Total Return Requirement”) and deferral of non-cash
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Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 7. Agreements and Related Party Transactions – (continued)
amounts, and is 20.0% of the amount, if any, by which the Company’s Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of our net assets attributable to its common stock, for the immediately preceding fiscal quarter, exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each fiscal quarter. Under this provision, in any fiscal quarter, the Adviser receives no Incentive Fee until the Company’s Pre-Incentive Fee Net Investment Income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of the Company’s Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than 2.5% (which is 10.0% annualized). The effect of the “catch-up” provision is that, subject to the Total Return Requirement and deferral provisions discussed below, if Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter, the Adviser receives 20.0% of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply.
“Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the fiscal quarter, minus the Company’s operating expenses for the quarter (including the Base Management Fee, expenses payable under the Administration Agreement and any interest expense and any 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 (“OID”), debt instruments with payment-in-kind (“PIK”) interest and zero coupon securities), accrued income that we have not yet received in cash.
Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation.
No Income-Based Fee is payable under the Advisory Agreement except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the fiscal quarter for which fees are being calculated and the Lookback Period exceeds the cumulative Incentive Fees accrued and/or paid for the Lookback Period.
For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of Pre-Incentive Fee Net Investment Income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current fiscal quarter and the Lookback Period. The “Lookback Period” means (1) through June 30, 2022, the period that on the last day of the fiscal quarter in which the Commencement Date occurs and ends on the last day of the fiscal quarter immediately preceding the fiscal quarter for which the Income-Based Fee is being calculated, and (2) after June 30, 2022, the eleven fiscal quarters immediately preceding the fiscal quarter for which the Income-Based Fee is being calculated.
For the year ended June 30, 2020, the Company incurred $832,472 of incentive fees related to Pre-Incentive Fee Net Investment Income, of which $336,971 was waived. As of June 30, 2020, $707,796 in incentive fees related to Income-Based Fees incurred by the Company were generated from deferred interest (i.e. PIK and certain discount accretion) and are not payable until such amounts are received in cash. For the year ended June 30, 2019, the Company incurred $1,720,707 of Income-Based Fees, of which $503,229 was waived. As of June 30, 2019, $545,991 of such Income-Based Fees were payable to the Adviser under the Prior Advisory Agreement, and $561,991 of Income-Based Fees incurred by the Company were generated from deferred interest (i.e., PIK and certain discount accretion) and were not payable until such amounts are received in cash. For the
133
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 7. Agreements and Related Party Transactions – (continued)
year ended June 30, 2018, the Company incurred $3,932,710 of Income-Based Fees, of which $527,224 was waived. As of June 30, 2018, $2,294,678 of such Income-Based Fees were payable to the Adviser under the Prior Advisory Agreement, and $772,234 of Income-Based Fees incurred by the Company were generated from deferred interest (i.e. PIK and certain discount accretion) and were not payable until such amounts are received in cash. Any voluntary waivers of the incentive fee in no way implies that the Adviser will agree to waive any incentive fee in any future period.
Under the Advisory Agreement, the Capital Gains Fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement, as of the termination date), commencing with the fiscal year ending June 30, 2021, and will equal to 20.0% of our cumulative aggregate realized capital gains from the Commencement Date through the end of that fiscal year, computed net of the Company’s aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid Capital Gains Fees. If such amount is negative, then no Capital Gains Fee will be payable for such year. Additionally, if the Advisory Agreement is terminated as of a date that is not a fiscal year end, the termination date will be treated as though it were a fiscal year end for purposes of calculating and paying the Capital Gains Fee. For the avoidance of doubt, realized capital gains, realized capital losses, unrealized capital appreciation and unrealized capital depreciation with respect to the Company’s portfolio as of the end of the fiscal year ended June 30, 2020 will be excluded from the calculations of the Capital Gains Fee.
Under U.S. GAAP, the Company calculates the Capital Gains Fee as if it had realized all assets at their fair values as of the reporting date. Accordingly, the Company accrues a provisional Capital Gains Fee taking into account any unrealized gains or losses. As the provisional Capital Gains Fee is subject to the performance of investments until there is a realization event, the amount of the provisional Capital Gains Fee accrued at a reporting date may vary from the Capital Gains Fee that is ultimately realized and the differences could be material.
As of June 30, 2020, there was no Capital Gains Fee accrued, earned or payable to the Adviser under the Advisory Agreement. As of June 30, 2019, there was no Capital Gains Fee accrued, earned or payable to the Adviser under the Prior Advisory Agreement.
The Advisory Agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Adviser’s services under the Advisory Agreement or otherwise as the Adviser.
Messrs. Mauer and Jansen, together, hold an approximate 24% interest in the Adviser. Investcorp holds an approximate 76% ownership interest in the Adviser. Pursuant to the Advisory Agreement, the Company has agreed to pay to the Adviser a base management fee and an incentive fee. Mr. Mauer, an interested member of the Board, has a direct or indirect pecuniary interest in the Adviser. The incentive fee will be computed and paid on income that we may not have yet received in cash at the time of payment. This fee structure may create an incentive for the Adviser to invest in certain types of speculative securities. Additionally, the Company will rely on investment professionals from the Adviser to assist the Board with the valuation of the Company’s portfolio investments. The Adviser’s management fee and incentive fee is based on the value of our investments and,
134
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 7. Agreements and Related Party Transactions – (continued)
therefore, there may be a conflict of interest when personnel of the Adviser are involved in the valuation process for the Company’s portfolio investments.
Prior Advisory Agreement
The following is a description of the Prior Advisory Agreement, which was terminated on August 30, 2019. Pursuant to the Prior Advisory Agreement, the Company agreed to pay to the Adviser a Base Management Fee of 1.75% of gross assets, as adjusted, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents and “fair value of derivatives associated with our financing”, and the Incentive Fee consisting of two parts.
Under the Prior Advisory Agreement, the first part of the Incentive Fee, or the Income-Based Fee, which was calculated and payable quarterly in arrears, equaled 20.0% of the “pre-incentive fee net investment income” (as defined in the Prior Advisory Agreement) for the immediately preceding quarter, subject to a hurdle rate of 2.0% per quarter (8.0% annualized), and was subject to a “catch-up” feature. The Incentive Fee was subject to a total return requirement, which provided that no Incentive Fee in respect of the Company’s pre-incentive fee net investment income would be payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeded the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. The net pre-incentive fee investment income used to calculate the Income-Based Fee was also included in the amount of the Company’s gross assets used to calculate the 1.75% Base Management Fee.
Under the Prior Advisory Agreement, the second part of the Incentive Fee, or the Capital Gains Fee, was calculated and payable in arrears as of the end of each calendar year and equaled 20.0% of the aggregate cumulative realized capital gains from inception through the end of each calendar year, computed net of aggregate cumulative realized capital losses and aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid capital gain incentive fees.
With respect to the incentive fee expense accrual relating to the Capital Gains Fee, U.S. GAAP requires that the Capital Gains Fee accrual consider the cumulative aggregate unrealized appreciation in the calculation, as a Capital Gains Fee would be payable if such unrealized appreciation were realized, even though such unrealized appreciation is not permitted to be considered in calculating the fee actually payable under the Prior Advisory Agreement.
The Prior Advisory Agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the Prior Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, were entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Adviser’s services under the Prior Advisory Agreement or otherwise as the Adviser.
Administration Agreement
Pursuant to the Administration Agreement, the Adviser furnishes the Company with office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under the Administration Agreement, the Adviser performs,
135
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 7. Agreements and Related Party Transactions – (continued)
or oversees the performance of the Company’s required administrative services, which includes, among other things, being responsible for the financial records which it is required to maintain and preparing reports to its stockholders and reports filed with the SEC. In addition, the Adviser assists the Company in determining and publishing its net asset value, oversees the preparation and filing of its tax returns and the printing and dissemination of reports and other materials to its stockholders, and generally oversees the payment of its expenses and the performance of administrative and professional services rendered to it by others. Under the Administration Agreement, the Adviser also provides managerial assistance on the Company’s behalf to those portfolio companies that have accepted its offer to provide such assistance. In addition, the Adviser may satisfy certain of its obligations to the Company under the Administration Agreement through the services agreement with Investcorp International Inc., an affiliate of Investcorp, including supplying the Company with accounting and back-office professionals upon the request of the Adviser. The Company incurred costs of $1,402,422 under the Administration Agreement for the year ended June 30, 2020. The Company incurred costs of $1,354,247 under the Prior Administration Agreement for the year ended June 30, 2019. The Company incurred costs of $1,198,397 under the Prior Administration Agreement for the year ended June 30, 2018.
As of June 30, 2020, and June 30, 2019, the Company recorded no accrued expenses and other liabilities for reimbursement of expenses owed to the Adviser under the Administration Agreement and the Prior Administration Agreement, respectively.
Stock Purchase Agreement
The Company is party to the Stock Purchase Agreement with Investcorp BDC, pursuant to which, Investcorp BDC is required by August 30, 2021 to purchase (i) 680,985 newly issued shares of the Company’s common stock, par value $0.001 per share at the most recently determined net asset value per share of the Company’s common stock at the time of such purchase, as adjusted as necessary to comply with Section 23 of the 1940 Act, and (ii) 680,985 shares of the Company’s common stock in open-market or secondary transactions.
As of June 30, 2020, Investcorp BDC had purchased 227,000 newly issued shares of the Company’s common stock pursuant to the requirement under the Stock Purchase Agreement. See “Part II. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds” for more information.
As of June 30, 2020, Investcorp BDC had purchased 281,775 shares of the Company’s common stock in open-market transactions pursuant to its obligation under the Stock Purchase Agreement.
Co-investment Exemptive Relief
On March 19, 2019, the SEC issued an order granting the Company’s application for exemptive relief to co-invest, subject to the satisfaction of certain conditions, in certain private placement transactions with other funds managed by the Adviser or its affiliates and any future funds that are advised by the Adviser or its affiliated investment advisers (the “Exemptive Relief”). Under the terms of the Exemptive Relief, in order for the Company to participate in a co-investment transaction a “required majority” (as defined in Section 57(o) of the 1940 Act) of the Independent Directors must conclude that (i) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching in respect of the Company or its stockholders on the part of any person concerned, and (ii) the proposed transaction is consistent with the interests of the Company’s stockholders and is consistent with the Company’s investment objectives and strategies.
136
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 7. Agreements and Related Party Transactions – (continued)
License Agreement
The Company has entered into a license agreement with the Adviser under which the Adviser has agreed to grant the Company a non-exclusive, royalty-free license to use the name “Investcorp.” Under this agreement, the Company has a right to use the “Investcorp” name for so long as the Adviser or one of its affiliates remains the Company’s investment adviser. Other than with respect to this limited license, the Company has no legal right to the “Investcorp” name. This license agreement will remain in effect for so long as the Advisory Agreement with the Adviser is in effect and Investcorp is the majority owner of the Adviser.
Note 8. Directors Fees
Each of the Independent Directors receives (i) an annual fee of $75,000, and (ii) $2,500 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending in person or telephonically each regular board of directors meeting and each special telephonic meeting. The Independent Directors also receive $1,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with each committee meeting attended in person and each telephonic committee meeting. The chairman of the audit committee receives an annual fee of $7,500. The chairperson of the valuation committee, the nominating and corporate governance committee and the compensation committee receives an annual fee of $2,500, $2,500 and $2,500, respectively. The Company has obtained directors’ and officers’ liability insurance on behalf of the Company’s directors and officers. The Independent Directors have the option of having their directors’ fees paid in shares of the Company’s common stock issued at a price per share equal to the greater of net asset value or the market price at the time of payment. For the years ended June 30, 2020, June 30, 2019 and June 30, 2018, the Company recorded directors’ fees of $270,000, $405,000 and $402,240, respectively. As of June 30, 2020, and June 30, 2019, the Company recorded directors’ fees payable of $24,559 and $95,240, respectively.
Note 9. Net Change in Net Assets Resulting from Operations Per Share
Basic earnings per share is computed by dividing earnings available to common stockholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.
The following table sets forth the computation of the weighted average basic and diluted net increase in net assets per share from operations:
| Basic and Diluted Net Increase (Decrease) in Net Assets Per Share |
||||||||||||
| Year Ended June 30, 2020 |
Year Ended June 30, 2019 |
Year Ended June 30, 2018 |
||||||||||
| Net increase (decrease) in net assets resulting from operations |
$ | (24,656,475 | ) | $ | (14,542,229 | ) | $ | 15,625,480 | ||||
| Weighted average shares of common stock outstanding |
13,741,743 | 13,630,661 | 13,689,823 | |||||||||
| Basic/diluted net increase (decrease) in net assets from operations per share |
$ | (1.79 | ) | $ | (1.07 | ) | $ | 1.14 | ||||
On March 4, 2020, the Company issued 113,500 shares of common stock, par value $0.001 per share (the “Common Stock”), to Investcorp BDC at a price of $10.15 per share for an aggregate offering price of $1,152,025. On December 4, 2019, the Company issued 113,500 shares of the Common Stock to Investcorp BDC at a price of $10.19 per share for an aggregate offering price of $1,156,565.
137
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 9. Net Change in Net Assets Resulting from Operations Per Share – (continued)
The sales of the Common Stock were made pursuant to the Stock Purchase Agreement. The issuance of the Common Stock is exempt from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) thereof and Regulation D thereunder. Investcorp BDC is an “accredited investor” as that term is defined in Rule 501(a) of Regulation D under the Securities Act.
Note 10. Distributions
The following table reflects the cash distributions per share that the Company declared and/or paid to its stockholders since the Offering in February 2014. Stockholders of record as of each respective record date were entitled to receive the distribution:
| Declaration Date |
Record Date |
Payment Date |
Amount Per Share | |||
| March 14, 2014 |
March 24, 2014 | March 31, 2014 | $0.1812 | |||
| May 14, 2014 |
June 16, 2014 | July 1, 2014 | $0.3375 | |||
| September 4, 2014 |
September 18, 2014 | October 1, 2014 | $0.3375 | |||
| November 6, 2014 |
December 18, 2014 | January 5, 2015 | $0.3375 | |||
| January 28, 2015 |
March 18, 2015 | April 2, 2015 | $0.3469 | |||
| May 6, 2015 |
June 8, 2015 | July 5, 2015 | $0.3469 | |||
| June 10, 2015# |
September 1, 2015 | September 15, 2015 | $0.4300 | |||
| June 10, 2015 |
September 18, 2015 | October 2, 2015 | $0.3469 | |||
| November 3, 2015 |
December 18, 2015 | January 5, 2016 | $0.3469 | |||
| February 2, 2016 |
March 18, 2016 | April 7, 2016 | $0.3516 | |||
| April 28, 2016 |
June 17, 2016 | July 7, 2016 | $0.3516 | |||
| August 25, 2016 |
September 16, 2016 | October 6, 2016 | $0.3516 | |||
| November 3, 2016 |
December 16, 2016 | January 5, 2017 | $0.3516 | |||
| November 3, 2016 |
March 17, 2017 | April 6, 2017 | $0.2500 | |||
| May 2, 2017 |
June 16, 2017 | July 6, 2017 | $0.2500 | |||
| August 24, 2017 |
September 8, 2017 | October 5, 2017 | $0.2500 | |||
| November 7, 2017 |
March 16, 2018 | April 5, 2018 | $0.2500 | |||
| May 2, 2018 |
June 15, 2018 | July 5, 2018 | $0.2500 | |||
| August 23, 2018 |
September 18, 2018 | October 5, 2018 | $0.2500 | |||
| November 6, 2018 |
December 14, 2018 | January 3, 2019 | $0.2500 | |||
| February 5, 2019 |
March 15, 2019 | April 4, 2019 | $0.2500 | |||
| May 1, 2019 |
June 14, 2019 | July 5, 2019 | $0.2500 | |||
| August 28, 2019 |
September 26, 2019 | October 16, 2019 | $0.2500 | |||
| November 6, 2019 |
December 13, 2019 | January 2, 2020 | $0.2500 | |||
| February 4, 2020 |
March 13, 2020 | April 2, 2020 | $0.2500 | |||
| May 7, 2020 |
June 19, 2020 | July 10, 2020 | $0.1500 | |||
| May 7, 2020* |
June 19, 2020 | July 10, 2020 | $0.0300 |
| # | Special distribution |
| * | Supplemental distribution |
138
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 10. Distributions – (continued)
The following table reflects for U.S. federal income tax purposes the sources of the cash dividend distributions that the Company has paid on its common stock during the years ended June 30, 2020, June 30, 2019 and June 30, 2018:
| Year ended June 30, | ||||||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||||||
| Distribution Amount |
Percentage | Distribution Amount |
Percentage | Distribution Amount |
Percentage | |||||||||||||||||||
| Ordinary income and short-term capital gains |
$ | 12,810,438 | 100 | % | $ | 13,640,442 | 100 | % | $ | 13,685,762 | 100 | % | ||||||||||||
| Long-term capital gains |
— | — | — | — | — | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 12,810,438 | 100 | % | $ | 13,640,442 | 100 | % | $ | 13,685,762 | 100 | % | ||||||||||||
|
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|
|
|
|
|
|
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|
|
|
|
|||||||||||||
Note 11. Share Repurchase Program
As described in Note 2, the Company had a share repurchase program under which the Company could repurchase up to $5.0 million shares of its common stock until the earlier of (i) May 1, 2019 or (ii) the repurchase of $5.0 million in aggregate amount of its common stock unless extended by the Company’s board of directors. On May 1, 2019, the Company’s board of directors extended the share repurchase program until the earlier of (i) May 1, 2020 or (ii) the repurchase of $5.0 million in aggregate amount of the common stock. On May 1, 2020, the share repurchase program expired. During the year ended June 30, 2020, the Company did not repurchase shares of common stock on the open market. During the year ended June 30, 2019, the Company repurchased 42,214 shares of common stock on the open market for $358,531 (including commissions). The Company’s NAV per share increased by approximately $0.01 for the year ended June 30, 2019 as a result of the share repurchases. The following table summarizes the Company’s share repurchases under the share repurchase program for the years ended June 30, 2020 and June 30, 2019:
| For the Year Ended June 30, |
||||||||
| 2020 | 2019 | |||||||
| Number of shares repurchased |
— | 42,214 | ||||||
| Cost of shares repurchased, including commissions |
$ | — | $ | 358,573 | ||||
| Weighted average price per share |
$ | — | $ | 8.44 | ||||
| Net asset value per share at year end |
$ | — | $ | 10.51 | ||||
| Weighted average discount to year end net asset value |
— | 24.5 | % | |||||
139
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 12. Share Transactions
The following table summarizes the total shares issued and repurchased for the years ended June 30, 2020, June 30, 2019 and June 30, 2018:
| Year ended June 30, | ||||||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | |||||||||||||||||||
| Balance at beginning of year |
13,619,690 | $ | 199,947,288 | 13,649,504 | $ | 200,203,363 | 13,689,221 | $ | 200,568,530 | |||||||||||||||
| Issuance of common shares |
227,000 | 2,308,590 | — | — | — | — | ||||||||||||||||||
| Reinvestments of stockholder distributions |
38,645 | 195,028 | 12,400 | 102,456 | 2,910 | 25,011 | ||||||||||||||||||
| Retirement of repurchased shares |
— | — | (42,214 | ) | (358,531 | ) | (42,627 | ) | (390,178 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Balance at end of year |
13,885,335 | $ | 202,450,906 | 13,619,690 | $ | 199,947,288 | 13,649,504 | $ | 200,203,363 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Note 13. Financial Highlights
The following represents the per share data and the ratios to average net assets for Investcorp Credit Management BDC, Inc.:
| For the year ended June 30, 2020 |
For the year ended June 30, 2019 |
For the year ended June 30, 2018 |
For the year ended June 30, 2017 |
For the year ended June 30, 2016 |
||||||||||||||||
| Per Share Data:(1) |
||||||||||||||||||||
| Net asset value, beginning of period |
$ | 10.51 | $ | 12.57 | $ | 12.41 | $ | 11.90 | $ | 14.41 | ||||||||||
| Net investment income |
1.03 | 0.99 | 1.39 | 1.15 | 1.45 | |||||||||||||||
| Net realized and unrealized gains (losses) |
(2.82 | ) | (2.06 | ) | (0.24 | ) | 0.56 | (2.13 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Net increase (decrease) in net assets resulting from operations |
(1.79 | ) | (1.07 | ) | 1.15 | 1.71 | (0.68 | ) | ||||||||||||
| Capital transactions(2) |
||||||||||||||||||||
| Share repurchases |
0.00 | 0.01 | 0.01 | — | — | |||||||||||||||
| Dividends from net investment income |
(0.93 | ) | (1.00 | ) | (1.00 | ) | (1.20 | ) | (1.51 | ) | ||||||||||
| Distributions from net realized gains |
— | — | — | — | (0.32 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Net decrease in net assets resulting from capital transactions |
(0.93 | ) | (0.99 | ) | (0.99 | ) | (1.20 | ) | (1.83 | ) | ||||||||||
| Offering costs |
— | — | — | — | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Net asset value, end of period |
$ | 7.79 | $ | 10.51 | $ | 12.57 | $ | 12.41 | $ | 11.90 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Market value per share, end of period |
$ | 3.49 | $ | 7.61 | $ | 8.90 | $ | 10.00 | $ | 8.88 | ||||||||||
| Total return based on market value(3) |
(43.32 | )% | (1.49 | )% | 0.01 | % | 27.93 | % | (21.26 | )% | ||||||||||
| Shares outstanding at end of period |
13,885,335 | 13,619,690 | 13,649,504 | 13,689,221 | 13,679,686 | |||||||||||||||
140
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 13. Financial Highlights – (continued)
| For the year ended June 30, 2020 |
For the year ended June 30, 2019 |
For the year ended June 30, 2018 |
For the year ended June 30, 2017 |
For the year ended June 30, 2016 |
||||||||||||||||
| Ratio/Supplemental Data: |
||||||||||||||||||||
| Net assets, at end of year |
$ | 108,124,995 | $ | 143,083,980 | $ | 171,522,666 | $ | 169,948,112 | $ | 162,749,883 | ||||||||||
| Ratio of total expenses to average net assets |
16.02 | % | 13.58 | % | 13.06 | % | 9.38 | % | 8.97 | % | ||||||||||
| Ratio of net expenses to average net assets |
15.56 | % | 13.26 | % | 12.76 | % | 9.23 | % | 8.97 | % | ||||||||||
| Ratio of interest expense and fees and amortization of deferred debt issuance costs to average net assets |
7.41 | % | 6.13 | % | 4.10 | % | 3.42 | % | 3.13 | % | ||||||||||
| Ratio of net investment income before fee waiver to average net assets |
10.39 | % | 8.26 | % | 11.40 | % | 9.31 | % | 11.33 | % | ||||||||||
| Ratio of net investment income after fee waiver to average net assets |
10.86 | % | 8.58 | % | 11.10 | % | 9.46 | % | 11.33 | % | ||||||||||
| Total Notes Payable |
$ | 183,375,000 | $ | 167,529,670 | $ | 119,823,000 | $ | 102,000,000 | $ | 132,478,329 | ||||||||||
| Asset Coverage Ratio(4) |
1.59 | 1.85 | 2.43 | 2.67 | 2.23 | |||||||||||||||
| Portfolio Turnover Rate |
33 | % | 51 | % | 52 | % | 52 | % | 21 | % | ||||||||||
| * | Net asset value at beginning of period reflects the deduction of the sales load of $0.25 per share paid by the stockholder from the $15.00 offering price. |
| (1) | The per share data was derived by using the shares outstanding during the period. |
| (2) | The per share data for dividends and distributions declared reflects the actual amount of the dividends and distributions declared per share during the period. |
| (3) | Total returns are historical and are calculated by determining the percentage change in the market value with all dividends distributions, if any, reinvested. Dividends and distributions are assumed to be reinvested at prices obtained under the company’s dividend reinvestment plan. Total investment return does not reflect sales load. |
| (4) | Asset coverage ratio is equal to (i) the sum of (A) net assets at the end of the period and (B) debt outstanding at the end of the period, divided by (ii) total debt outstanding at the end of the period. |
Total return is calculated based on a time-weighted rate of return methodology for the stockholders and is not annualized. Total return is reflected after all investment-related and operating expenses. A stockholder’s return may vary from these returns based on the timing of capital transactions. The ratios to average stockholders’ capital are calculated based on the monthly average stockholders’ capital during the period.
The ratios to average stockholders’ capital are calculated based on the monthly average stockholders’ capital during the period. Credit facility related expenses include interest expense and amortization of deferred debt issuance costs.
141
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 14. Other Fee Income
The other fee income consists of structuring fee income, amendment fee income and royalty income. The following tables summarize the Company’s other fee income for the years ended June 30, 2020, June 30, 2019 and June 30, 2018:
| Year Ended June 30, 2020 |
Year Ended June 30, 2019 |
Year Ended June 30, 2018 |
||||||||||
| Loan Amendment/Consent Fee |
$ | 1,346,307 | $ | 718,548 | $ | 152,308 | ||||||
|
|
|
|
|
|
|
|||||||
| Other Fee Income |
$ | 1,346,307 | $ | 718,548 | $ | 152,308 | ||||||
|
|
|
|
|
|
|
|||||||
Note 15. Tax Information
As of June 30, 2020, the Company’s aggregate investment unrealized appreciation and depreciation based on cost for U.S. federal income tax purposes were as follows:
| Tax cost |
$ | 316,924,638 | ||
|
|
|
|||
| Gross unrealized appreciation |
1,098,958 | |||
| Gross unrealized depreciation |
(47,401,885 | ) | ||
|
|
|
|||
| Net unrealized investment depreciation |
$ | (46,302,927 | ) | |
|
|
|
As of June 30, 2019, the Company’s aggregate investment unrealized appreciation and depreciation based on cost for U.S. federal income tax purposes were as follows:
| Tax cost |
$ | 321,504,360 | ||
|
|
|
|||
| Gross unrealized appreciation |
3,259,980 | |||
| Gross unrealized depreciation |
(18,373,346 | ) | ||
|
|
|
|||
| Net unrealized investment depreciation |
$ | (15,113,366 | ) | |
|
|
|
142
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 16. Selected Quarterly Financial Data (unaudited)
| For the Quarter Ended June 30, 2020 |
For the Quarter Ended March 31, 2020 |
For the Quarter Ended December 31, 2019 |
For the Quarter Ended September 30, 2019 |
|||||||||||||
| Total Investment Income |
$ | 7,641,041 | $ | 8,829,680 | $ | 9,431,449 | $ | 8,558,434 | ||||||||
| Total Investment Income per Common Share |
0.55 | 0.64 | 0.69 | 0.63 | ||||||||||||
| Net Investment Income |
3,432,148 | 3,443,461 | 3,755,263 | 3,534,410 | ||||||||||||
| Net Investment Income per Common Share |
0.25 | 0.25 | 0.27 | 0.26 | ||||||||||||
| Net Realized and Unrealized Gain (Loss) |
(5,905,147 | ) | (27,687,828 | ) | (787,820 | ) | (4,440,962 | ) | ||||||||
| Net Realized and Unrealized Gain (Loss) per Common Share |
(0.43 | ) | (2.01 | ) | (0.06 | ) | (0.33 | ) | ||||||||
| Net Increase (Decrease) in Net Assets Resulting from Operations |
(2,472,999 | ) | (24,244,367 | ) | 2,967,443 | (906,552 | ) | |||||||||
| Basic and Diluted Earnings per Common Share |
(0.18 | ) | (1.76 | ) | 0.22 | (0.07 | ) | |||||||||
| Net Asset Value per Common Share at End of Quarter |
7.79 | 8.15 | 10.15 | 10.19 | ||||||||||||
| For the Quarter Ended June 30, 2019 |
For the Quarter Ended March 31, 2019 |
For the Quarter Ended December 31, 2018 |
For the Quarter Ended September 30, 2018 |
|||||||||||||
| Total Investment Income |
$ | 8,121,417 | $ | 8,722,591 | $ | 9,298,924 | $ | 8,254,890 | ||||||||
| Total Investment Income per Common Share |
0.60 | 0.64 | 0.68 | 0.60 | ||||||||||||
| Net Investment Income |
2,980,787 | 3,403,422 | 3,718,912 | 3,409,496 | ||||||||||||
| Net Investment Income per Common Share |
0.22 | 0.25 | 0.27 | 0.25 | ||||||||||||
| Net Realized and Unrealized Gain (Loss) |
(8,197,445 | ) | (4,760,960 | ) | (13,101,208 | ) | (1,981,455 | ) | ||||||||
| Net Realized and Unrealized Gain (Loss) per Common Share |
(0.60 | ) | (0.35 | ) | (0.96 | ) | (0.15 | ) | ||||||||
| Net Increase (Decrease) in Net Assets Resulting from Operations |
(5,216,658 | ) | (1,357,538 | ) | (9,382,296 | ) | 1,428,041 | |||||||||
| Basic and Diluted Earnings per Common Share |
(0.38 | ) | (0.10 | ) | (0.69 | ) | 0.10 | |||||||||
| Net Asset Value per Common Share at End of Quarter |
10.51 | 11.14 | 11.49 | 12.41 | ||||||||||||
Note 17. Subsequent Events
The Company has evaluated the need for disclosures and/or adjustments resulting from subsequent events through the date the consolidated financial statements were issued.
Subsequent to June 30, 2020 and through September 18, 2020, the Company invested $13.3mm in one existing portfolio company and two new portfolio companies, inclusive of funding a revolving commitment, and the Company received $19.7mm in repayments.
Our dividend framework provides a quarterly base dividend and is supplemented (when applicable) by additional dividends determined by the level of earnings on a net investment income basis relative to the base dividend level.
143
Investcorp Credit Management BDC, Inc. and subsidiaries
Notes to Consolidated Financial Statements
June 30, 2020
Note 17. Subsequent Events – (continued)
On August 26, 2020, the Company’s board of directors declared a distribution for the quarter ended September 30, 2020 of $0.15 per share payable on October 15, 2020 to stockholders of record as of September 25, 2020 and a supplemental distribution of $0.03 per share, payable on October 15, 2020, to stockholders of record as of September 25, 2020.
144
| Item 9. | Changes in and Disagreements with Independent Registered Public Accounting Firm on Accounting and Financial Disclosure |
There were no changes in or disagreements on accounting or financial disclosure with RSM US LLP, the Company’s independent registered public accounting firm, during the fiscal year ended June 30, 2020.
| Item 9A. | Controls and Procedures |
(a) Evaluation of Disclosure Controls and Procedures
As of June 30, 2020 (the end of the period covered by this report), we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the 1934 Act). Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
(b) Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f), and for performing an assessment of the effectiveness of internal control over financial reporting as of June 30, 2020. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, and effected by our 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 generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management performed an assessment of the effectiveness of our internal control over financial reporting as of June 30, 2020 based upon the criteria set forth in Internal Control — Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO 2013”). Based on our assessment, management determined that our internal control over financial reporting was effective as of June 30, 2020. Pursuant to rules established by the SEC, this annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.
(c) Changes in Internal Control Over Financial Reporting
Management did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2020 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
145
| Item 9B. | Other Information. |
Fees and Expenses
The following table is being provided to update, as of June 30, 2020, certain information in our registration statement on Form N-2 (File No. 333-223999), declared effective by the SEC on April 10, 2019. The information is intended to assist you in understanding the costs and expenses that an investor in our common stock will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever this Annual Report on Form 10-K contains a reference to fees or expenses paid by “you,” “us” or “the Company,” or that “we” will pay fees or expenses, stockholders will indirectly bear such fees or expenses as investors in us.
| Stockholder Transaction Expenses: |
||||
| Sales load (as a percentage of offering price) |
— | %(1) | ||
| Offering expenses (as a percentage of offering price) |
— | %(2) | ||
| Dividend reinvestment plan expenses |
— | %(3) | ||
|
|
|
|||
| Total Stockholder Transaction Expenses (as a percentage of offering price |
— | %(4) | ||
| Annual Expenses (as percentage of net assets attributable to common stock) |
||||
| Base management fees |
4.73 | %(5) | ||
| Incentive fees payable under the investment advisory agreement (20.0%) |
0.46 | %(6) | ||
| Interest payments on borrowed funds |
9.54 | %(7) | ||
| Other expenses |
4.52 | %(8) | ||
|
|
|
|||
| Total annual expenses |
19.25 | % | ||
|
|
|
| (1) | In the event that our securities are sold to or through underwriters, a corresponding prospectus supplement will disclose the applicable sales load. |
| (2) | In the event that we conduct an offering of our securities, a corresponding prospectus supplement will disclose the estimated offering expenses. Our common stockholders will bear, directly or indirectly, the expenses of any offering of our securities, including debt securities. |
| (3) | The expenses of the dividend reinvestment plan are included in “Other expenses.” See “Dividend Reinvestment Plan.” |
| (4) | Total stockholder transaction expenses may include sales load and will be disclosed in a future prospectus supplement, if any. |
| (5) | Reflects the aggregate amount of base management fees that we estimate will be payable during the next twelve months. Our base management fee, payable quarterly in arrears, is 1.75% of our gross assets, including assets purchased with borrowed amounts or other forms of leverage and excluding cash and cash equivalents and is estimated by assuming the base management fee remains consistent with the base management fee incurred for the year ended June 30, 2020. See “Management Agreements—Investment Advisory Agreement.” |
| (6) | Reflects the aggregate amount of incentive fees that we estimate will be payable during the next twelve months. See “Management Agreements—Investment Advisory Agreement.” |
The incentive fee consists of two components, ordinary income and capital gains:
The ordinary income component, which is payable quarterly in arrears, equals 20.0% of the excess, if any, of our “Pre-incentive Fee Net Investment Income” over a 2.0% quarterly (8.0% annualized) hurdle rate, expressed as a rate of return on the value of our net assets attributable to our common stock, and a “catch-up” provision, measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, the Adviser receives no incentive fee until our net investment income equals the hurdle rate of 2.0% but then receives, as a “catch-up,” 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5% subject to a deferral of non-cash amounts. The effect of the “catch-up” provision is that, subject to the
146
deferral provisions discussed below, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, the Adviser will receive 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. The ordinary income component of the incentive fee will be computed on income that may include interest that is accrued but not yet received in cash. The portion of such incentive fee that is attributable to deferred interest (sometimes referred to as PIK interest, or OID) will be paid to the Adviser only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such amounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possibly elimination of the incentive fees for such quarter. Notwithstanding any such incentive fee reduction or elimination, there is no accumulation of amounts on the hurdle rate from quarter to quarter and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle and there is no delay of payment if prior quarters are below the quarterly hurdle.
The capital gains component of the incentive fee equals 20.0% of our “Incentive Fee Capital Gains,” if any, which equals our aggregate cumulative realized capital gains from inception through the end of each calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation, less the aggregate amount of any previously paid capital gain incentive fees. The second component of the incentive fee is payable, in arrears, at the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date). See “Management Agreements—Management Fee and Incentive Fee.”
| (7) | We may borrow funds from time to time to make investments to the extent we determine that the economic situation is conducive to doing so. The table includes all estimated expected borrowing costs in connection with the Financing Facilities. The costs associated with our outstanding borrowings are indirectly borne by our stockholders. |
| (8) | “Other expenses” represent amounts which are based upon the results of our operations for the year ended June 30, 2020, including our overhead expenses, including payments under the administration agreement based on our allocable portion of overhead and other expenses incurred by the Adviser. See “Management Agreements —Administration Agreement.” |
Example
The following example demonstrates the projected dollar amount of total cumulative expenses over various periods with respect to a hypothetical investment in us. In calculating the following expense amounts, we have assumed a 4.0% sales load and that our annual operating expenses would remain at the levels set forth in the table above. In the event that shares to which this prospectus relates are sold to or through underwriters, a corresponding prospectus supplement will restate this example to reflect the applicable sales load.
| 1 Year | 3 Years | 5 Years | 10 Years | |||||||||||||
| You would pay the following expenses on a $1,000 investment, assuming a 5% annual return |
$ | 212 | $ | 485 | $ | 686 | $ | 986 | ||||||||
While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%. Because the income incentive fee under our investment advisory agreement is unlikely to be significant assuming a 5% annual return, the example assumes that the 5% annual return will be generated entirely through the realization of capital gains on our assets and, as a result, will trigger the payment of a capital gains incentive fee under our investment advisory agreement. The “Pre-Incentive Fee Net Investment Income” under the investment advisory agreement, which, assuming a 5% annual return, would either not be payable or have an immaterial impact on the expense amounts shown above is not included in the example set forth above. If we achieve sufficient returns on our investments, including through the realization of capital gains, to trigger sufficient returns on our investments to trigger “Pre-Incentive Fee Net Investment
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Income” of a material amount, our expenses, and returns to our investors, would be higher. Further, while the example assumes reinvestment of all distributions at net asset value, participants in our dividend reinvestment plan will receive a number of shares of our common stock, determined by dividing the total dollar amount of the distribution payable to a participant by (a) 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our board of directors or (b) the average purchase price of all shares of common stock purchased by the administrator of the dividend reinvestment plan in the event shares are purchased in the open market to satisfy the share requirements of the dividend reinvestment plan, which may be at, above or below net asset value.
This example and the expenses in the table above should not be considered a representation of our future expenses, and actual expenses (including the cost of debt, if any, and other expenses) may be greater or less than those shown.
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We will file a definitive Proxy Statement for our 2020 Annual Meeting of Stockholders with the SEC, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to the annual report on Form 10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are incorporated by reference.
| Item 10. | Directors, Executive Officers and Corporate Governance |
The information required by Item 10 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
We have adopted a code of business conduct and ethics that applies to our directors, officers and employees. This code of ethics is published on our website at www.icmbdc.com. We intend to disclose any future amendments to, or waivers from, this code of conduct within four business days of the waiver or amendment through a Web site posting.
| Item 11. | Executive Compensation |
The information required by Item 11 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information required by Item 12 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by Item 13 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
| Item 14. | Principal Accountant Fees and Services |
The information required by Item 14 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal year.
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| Item 15. | Exhibits, Financial Statement Schedules |
a. Documents Filed as Part of this Report
The following financial statements are set forth in Item 8:
| Page | ||||
| 99 | ||||
| Consolidated Statements of Assets and Liabilities as of June 30, 2020 and June 30, 2019 |
100 | |||
| 101 | ||||
| 102 | ||||
| 103 | ||||
| 104 | ||||
| 107 | ||||
| 110 | ||||
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b. Exhibits
The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:
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| * | Filed herewith |
| (1) | Incorporated by reference to Registrant’s Registration Statement on Form N-2 (File No. 333-192370), filed on November 15, 2013. |
| (2) | Incorporated by reference to Registrant’s Post-Effective Amendment No. 3 to the Registration Statement on Form N-2 (File No. 333-223999), filed on April 9, 2019. |
| (3) | Incorporated by reference to Registrant’s Post-Effective Amendment No. 1 to the Registration Statement on Form N-2 (File No. 333-223999), filed on July 2, 2018. |
| (4) | Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 814-01054), filed on September 3, 2019. |
| (5) | Incorporated by reference to Registrant’s Registration Statement on Form N-2 (File No. 333-192370), filed on December 20, 2013. |
| (6) | Incorporated by reference to Registrant’s Form 10-K (File No. 814-01054), filed on September 6, 2017. |
| (7) | Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 814-01054), filed on June 27, 2019. |
| (8) | Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 814-01054), filed on July 1, 2019. |
| (9) | Incorporated by reference to Registrant’s Current Report on Form 8-K (File No. 814-01054), filed on March 10, 2020. |
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Pursuant to the requirements of Section 13 or 15(d) 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.
| INVESTCORP CREDIT MANAGEMENT BDC, INC. | ||||
| Date: September 21, 2020 |
/s/ Michael C. Mauer | |||
| Michael C. Mauer Chief Executive Officer | ||||
| Date: September 21, 2020 |
/s/ Rocco DelGuercio | |||
| Rocco DelGuercio Chief Financial Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated.
| Date: September 21, 2020 |
/s/ Michael C. Mauer | |||
| Michael C. Mauer Chief Executive Officer | ||||
| Date: September 21, 2020 |
/s/ Rocco DelGuercio | |||
| Rocco DelGuercio Chief Financial Officer (Principal Accounting and Financial Officer) | ||||
| Date: September 21, 2020 |
/s/ Julie Persily | |||
| Julie Persily Director | ||||
| Date: September 21, 2020 |
/s/ Lee M. Shaiman | |||
| Lee M. Shaiman Director | ||||
| Date: September 21, 2020 |
/s/ Thomas Sullivan | |||
| Thomas Sullivan Director | ||||
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Exhibit 4.5
DESCRIPTION OF SECURITIES
As of the date of this Annual Report on Form 10-K, Investcorp Credit Management BDC, Inc. (“we,” “our” or the “Company”) has two classes of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”): (i) its common stock, par value $0.001 per share (“common stock”), and (ii) its 6.125% Notes due 2023 (the “Notes”).
The following descriptions of the Company’s common stock and the Notes are based on, as applicable, the relevant portions of the Maryland General Corporation Law, the Company’s Articles of Amendment and Restatement (the “charter”), its Bylaws (the “bylaws”), its First Supplemental Indenture, dated July 2, 2018 (the “First Supplemental Indenture”), and the Base Indenture, dated July 2, 2018 (together with the First Supplemental Indenture, the “indenture”). This summary is a description of the material terms of, and is qualified in its entirety by, the charter, the bylaws and the indenture, each of which is incorporated by reference as an exhibit to this Annual Report on Form 10-K. As a result, this summary may not contain all of the information that is important to you. We refer you to the Maryland General Corporation Law, our charter, bylaws and the indenture for a more detailed description of the provisions summarized below.
Capitalized terms used but not defined herein have the meaning ascribed to them in the Annual Report on Form 10-K to which this Description of Securities is an exhibit.
Description of Our Capital Stock
Our authorized stock consists of 100,000,000 shares of stock, par value $0.001 per share, all of which are initially designated as common stock. Our common stock is listed on The NASDAQ Global Select Market under the ticker symbol “ICMB.” There are no outstanding options or warrants to purchase our stock. No stock has been authorized for issuance under any equity compensation plans. Our fiscal year-end is June 30th. Under Maryland law, our stockholders generally are not personally liable for our debts or obligations. As of June 30, 2020, we had 13,885,335 shares of our common stock issued and outstanding, and no shares of our preferred stock outstanding.
Under our charter, our board of directors is authorized to classify and reclassify any unissued shares of stock into other classes or series of stock without obtaining stockholder approval. As permitted by the Maryland General Corporation Law, our charter provides that the board of directors, without any action by our stockholders, may amend the charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have authority to issue.
Common Stock
All shares of our common stock have equal rights as to earnings, assets, voting, and distributions and, when they are issued, will be duly authorized, validly issued, fully paid and nonassessable. Distributions may be paid to the holders of our common stock if, as and when authorized by our board of directors and declared by us out of assets legally available therefor. Shares of our common stock have no preemptive, conversion or redemption rights and are freely transferable, except where their transfer is restricted by federal and state securities laws or by contract. In the event of our liquidation, dissolution or winding up, each share of our common stock would be entitled to share ratably in all of our assets that are legally available for distribution after we pay all debts and other liabilities and subject to any preferential rights of holders of our preferred stock, if any preferred stock is outstanding at such time. Each share of our common stock is entitled to one vote on all matters submitted to a vote of stockholders, including the election of directors. Except as provided with respect to any other class or series of stock, the holders of our common stock will possess exclusive voting power. There is no cumulative voting in the election of directors, which means that holders of a majority of the outstanding shares of common stock can elect all of our directors, and holders of less than a majority of such shares will be unable to elect any director.
1
Limitation on Liability of Directors and Officers; Indemnification and Advance of Expenses
Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) active and deliberate dishonesty established by a final judgment and which is material to the cause of action. Our charter contains such a provision which eliminates directors’ and officers’ liability to the maximum extent permitted by Maryland law, subject to the requirements of the 1940 Act.
Our charter authorizes us, to the maximum extent permitted by Maryland law and subject to the requirements of the 1940 Act, to indemnify any present or former director or officer or any individual who, while a director and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner or trustee, from and against any claim or liability to which that person may become subject or which that person may incur by reason of his or her status as a present or former director or officer and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. Our bylaws obligate us, to the maximum extent permitted by Maryland law and subject to the requirements of the 1940 Act, to indemnify any present or former director or officer or any individual who, while a director and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner or trustee and who is made a party to the proceeding by reason of his service in that capacity from and against any claim or liability to which that person may become subject or which that person may incur by reason of his or her status as a present or former director or officer and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. The charter and bylaws also permit us to indemnify and advance expenses to any person who served a predecessor of us in any of the capacities described above and any of our employees or agents or any employees or agents of our predecessor. In accordance with the 1940 Act, we will not indemnify any person for any liability to which such person would be subject by reason of such person’s willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office.
Maryland law requires a corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful in the defense of any proceeding to which he or she is made a party by reason of his or her service in that capacity. Maryland law permits a corporation to indemnify its present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made a party by reason of their service in those or other capacities unless it is established that (a) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (1) was committed in bad faith or (2) was the result of active and deliberate dishonesty, (b) the director or officer actually received an improper personal benefit in money, property or services or (c) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under Maryland law, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation or for a judgment of liability on the basis that a personal benefit was improperly received, unless in either case a court orders indemnification, and then only for expenses. In addition, Maryland law permits a corporation to advance reasonable expenses to a director or officer upon the corporation’s receipt of (a) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the corporation and (b) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed by the corporation if it is ultimately determined that the standard of conduct was not met.
Our insurance policy does not currently provide coverage for claims, liabilities and expenses that may arise out of activities that our present or former directors or officers have performed for another entity at our request. There is no assurance that such entities will in fact carry such insurance. However, we note that we do not expect to request our present or former directors or officers to serve another entity as a director, officer, partner or trustee unless we can obtain insurance providing coverage for such persons for any claims, liabilities or expenses that may arise out of their activities while serving in such capacities.
2
Certain Provisions of the Maryland General Corporation Law and Our Charter and Bylaws
The Maryland General Corporation Law and our charter and bylaws contain provisions that could make it more difficult for a potential acquirer to acquire us by means of a tender offer, proxy contest or otherwise. These provisions are expected to discourage certain coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of us to negotiate first with our board of directors. We believe that the benefits of these provisions outweigh the potential disadvantages of discouraging any such acquisition proposals because, among other things, the negotiation of such proposals may improve their terms.
Classified Board of Directors
Our board of directors is divided into three classes of directors serving staggered three-year terms, as nearly equal in size as is possible. A classified board may render a change in control of us or removal of our incumbent management more difficult. We believe, however, that the longer time required to elect a majority of a classified board of directors will help to ensure the continuity and stability of our management and policies.
Election of Directors
Our charter and bylaws provide that the affirmative vote of the holders of a plurality of the outstanding shares of stock entitled to vote in the election of directors cast at a meeting of stockholders duly called and at which a quorum is present will be required to elect a director. Pursuant to our charter, our board of directors may amend the bylaws to alter the vote required to elect directors.
Number of Directors; Vacancies; Removal
Our charter provides that the number of directors will be set only by the board of directors in accordance with our bylaws. Our bylaws provide that a majority of our entire board of directors may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of directors may never be less than one nor more than nine. We have elected to be subject to the provision of Subtitle 8 of Title 3 of the Maryland General Corporation Law regarding the filling of vacancies on the board of directors. Accordingly, except as may be provided by the board of directors in setting the terms of any class or series of preferred stock, any and all vacancies on the board of directors may be filled only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy will serve for the remainder of the full term of the directorship in which the vacancy occurred and until a successor is elected and qualifies, subject to any applicable requirements of the 1940 Act.
Our charter provides that a director may be removed only for cause, as defined in our charter, and then only by the affirmative vote of at least two-thirds of the votes entitled to be cast in the election of directors.
Action by Stockholders
Under the Maryland General Corporation Law, stockholder action can be taken only at an annual or special meeting of stockholders or (unless the charter provides for stockholder action by less than unanimous written consent, which our charter does not) by unanimous written consent in lieu of a meeting. These provisions, combined with the requirements of our bylaws regarding the calling of a stockholder-requested special meeting of stockholders discussed below, may have the effect of delaying consideration of a stockholder proposal until the next annual meeting.
3
Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals
Our bylaws provide that with respect to an annual meeting of stockholders, nominations of persons for election to the board of directors and the proposal of business to be considered by stockholders may be made only (a) pursuant to our notice of the meeting, (b) by the board of directors or (c) by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice procedures of our bylaws. With respect to special meetings of stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of persons for election to the board of directors at a special meeting may be made only (1) pursuant to our notice of the meeting, (2) by the board of directors or (3) provided that the board of directors has determined that directors will be elected at the meeting, by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice provisions of the bylaws. The purpose of requiring stockholders to give us advance notice of nominations and other business is to afford our board of directors a meaningful opportunity to consider the qualifications of the proposed nominees and the advisability of any other proposed business and, to the extent deemed necessary or desirable by our board of directors, to inform stockholders and make recommendations about such qualifications or business, as well as to provide a more orderly procedure for conducting meetings of stockholders. Although our bylaws do not give our board of directors any power to disapprove stockholder nominations for the election of directors or proposals recommending certain action, they may have the effect of precluding a contest for the election of directors or the consideration of stockholder proposals if proper procedures are not followed and of discouraging or deterring a third party from conducting a solicitation of proxies to elect its own slate of directors or to approve its own proposal without regard to whether consideration of such nominees or proposals might be harmful or beneficial to us and our stockholders.
Calling of Special Meetings of Stockholders
Our bylaws provide that special meetings of stockholders may be called by our board of directors and certain of our officers. Additionally, our bylaws provide that, subject to the satisfaction of certain procedural and informational requirements by the stockholders requesting the meeting, a special meeting of stockholders will be called by the secretary of the corporation upon the written request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast at such meeting.
Approval of Extraordinary Corporate Action; Amendment of Charter and Bylaws
Under Maryland law, a Maryland corporation generally cannot dissolve, amend its charter, merge, sell all or substantially all of its assets, engage in a share exchange or engage in similar transactions outside the ordinary course of business, unless approved by the affirmative vote of stockholders entitled to cast at least two-thirds of the votes entitled to be cast on the matter. However, a Maryland corporation may provide in its charter for approval of these matters by a lesser percentage, but not less than a majority of all of the votes entitled to be cast on the matter. Our charter generally provides for approval of charter amendments and extraordinary transactions by the stockholders entitled to cast at least a majority of the votes entitled to be cast on the matter. Our charter also provides that certain charter amendments, any proposal for our conversion, whether by charter amendment, merger or otherwise, from a closed-end company to an open-end company and any proposal for our liquidation or dissolution requires the approval of the stockholders entitled to cast at least 80% of the votes entitled to be cast on such matter. However, if such amendment or proposal is approved by a majority of our continuing directors (in addition to approval by our board of directors), such amendment or proposal may be approved by a majority of the votes entitled to be cast on such a matter. In either event, in accordance with the requirements of the 1940 Act, any such amendment or proposal that would have the effect of changing the nature of our business so as to cause us to cease to be, or to withdraw our election as, a business development company would be required to be approved by a majority of our outstanding voting securities, as defined under the 1940 Act. The “continuing directors” are defined in our charter as (a) our current directors, (b) those directors whose nomination for election by the stockholders or whose election by the directors to fill vacancies is approved by a majority of our current directors then on the board of directors or (c) any successor directors whose nomination for election by the stockholders or whose election by the directors to fill vacancies is approved by a majority of continuing directors or the successor continuing directors then in office.
4
Our charter and bylaws provide that the board of directors have the exclusive power to make, alter, amend or repeal any provision of our bylaws.
No Appraisal Rights
Except with respect to appraisal rights arising in connection with the Control Share Act discussed below, as permitted by the Maryland General Corporation Law, our charter provides that stockholders will not be entitled to exercise appraisal rights unless a majority of the board of directors shall determine such rights apply.
Control Share Acquisitions
The Maryland General Corporation Law provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, or the Control Share Act. Shares owned by the acquirer, by officers or by directors who are employees of the corporation are excluded from shares entitled to vote on the matter. Control shares are voting shares of stock which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquirer to exercise voting power in electing directors within one of the following ranges of voting power:
| • | one-tenth or more but less than one-third; |
| • | one-third or more but less than a majority; or |
| • | a majority or more of all voting power. |
The requisite stockholder approval must be obtained each time an acquirer crosses one of the thresholds of voting power set forth above. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval. A control share acquisition means the acquisition of control shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition may compel the board of directors of the corporation to call a special meeting of stockholders to be held within 50 days of demand to consider the voting rights of the shares. The right to compel the calling of a special meeting is subject to the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, the corporation may itself present the question at any stockholders meeting.
If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as required by the statute, then the corporation may redeem for fair value any or all of the control shares, except those for which voting rights have previously been approved. The right of the corporation to redeem control shares is subject to certain conditions and limitations, including, as provided in our bylaws, compliance with the 1940 Act. Fair value is determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquirer or of any meeting of stockholders at which the voting rights of the shares are considered and not approved. If voting rights for control shares are approved at a stockholders meeting and the acquirer becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights. The fair value of the shares as determined for purposes of appraisal rights may not be less than the highest price per share paid by the acquirer in the control share acquisition.
The Control Share Act does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b) to acquisitions approved or exempted by the charter or bylaws of the corporation. Our bylaws contain a provision exempting from the Control Share Act any and all acquisitions by any person of our shares of stock. There can be no assurance that such provision will not be amended or eliminated at any time in the future. However, we will amend our bylaws to be subject to the Control Share Act only if the board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the Control Share Act does not conflict with the 1940 Act.
5
Business Combinations
Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder, or the Business Combination Act. These business combinations include a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as:
| • | any person who beneficially owns 10% or more of the voting power of the corporation’s outstanding voting stock; or |
| • | an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of then outstanding voting stock of the corporation. |
A person is not an interested stockholder under this statute if the board of directors approved in advance the transaction by which the stockholder otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board.
After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:
| • | 80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and |
| • | two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. |
These super-majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares.
The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors before the time that the interested stockholder becomes an interested stockholder. Our board of directors has adopted a resolution that any business combination between us and any other person is exempted from the provisions of the Business Combination Act, provided that the business combination is first approved by the board of directors, including a majority of the directors who are not interested persons as defined in the 1940 Act. This resolution may be altered or repealed in whole or in part at any time; however, our board of directors will adopt resolutions so as to make us subject to the provisions of the Business Combination Act only if the board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the Business Combination Act does not conflict with the 1940 Act. If this resolution is repealed, or the board of directors does not otherwise approve a business combination, the statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.
Conflict with 1940 Act
Our bylaws provide that, if and to the extent that any provision of the Maryland General Corporation Law, including the Control Share Act (if we amend our bylaws to be subject to such Act) and the Business Combination Act, or any provision of our charter or bylaws conflicts with any provision of the 1940 Act, the applicable provision of the 1940 Act will control.
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Description of Our 6.125% Notes due 2023
On July 2, 2018, we closed a public offering of $30 million in aggregate principal amount of 6.125% notes due 2023 (the “Initial Notes”). On July 12, 2018, the underwriters exercised their over-allotment option to purchase an additional $4.5 million in aggregate principal amount of the Initial Notes. On October 18, 2019, we closed a public offering of $15 million in aggregate principal amount of additional 6.125% notes due 2023 (the “Reopened Notes,” and together with the Initial Notes, the “Notes”). The Reopened Notes were a further issuance of, rank equally in right of payment with, and form a single series with the $34.5 million in Initial Notes that we initially issued on July 2, 2018 and July 12, 2018. On November 7, 2019, the underwriters exercised their option to purchase an additional $1.875 million in aggregate principal of the Notes. The Notes are listed on The NASDAQ Global Select Market under the symbol “CMFNL”.
The Notes are governed by the indenture, as required by federal law for all bonds and notes of companies that are publicly offered, between us and U.S. Bank National Association, as trustee. An indenture is a contract between us and the financial institution acting as trustee on the Note holders’ behalf, and is subject to and governed by the Trust Indenture Act of 1939, as amended. The trustee has two main roles. First, the trustee can enforce the Note holders’ rights against us if we default as provided in the indenture. There are some limitations on the extent to which the trustee acts on the Note holders’ behalf, described below under “—Events of Default—Remedies if an Event of Default Occurs.” Second, the trustee performs certain administrative duties for us with respect to the Notes.
We are generally permitted, under specified conditions, to issue multiple classes of indebtedness if our asset coverage, as defined in the 1940 Act, is at least equal to 150% immediately after each such issuance, after giving effect to any exemptive relief granted by the SEC.
General
The Notes mature on July 1, 2023. The principal payable at maturity will be 100% of the aggregate principal amount. The interest rate of the Notes is 6.125% per year and will be paid every January 1, April 1, July 1 and October 1, and the regular record dates for interest payments will be every December 15, March 15, June 15, and September 15. If an interest payment date falls on a non-business day, the applicable interest payment will be made on the next business day and no additional interest will accrue as a result of such delayed payment.
We will issue the Notes in denominations of $25 and integral multiples of $25 in excess thereof. The Notes will not be subject to any sinking fund and holders of the Notes will not have the option to have the Notes repaid prior to the stated maturity date.
Other than as described under the captions “ —Events of Default,” “ —Other Covenants,” and “ —Merger or Consolidation” below, the indenture does not contain any provisions that give Note holders protection in the event we issue a large amount of debt or we are acquired by another entity.
We have the ability to issue indenture securities with terms different from the Notes and, without the consent of the holders thereof, to reopen the Notes and issue additional Notes.
Optional Redemption
The Notes may be redeemed in whole or in part at any time or from time to time at our option, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount of the Notes to be redeemed plus accrued and unpaid interest payments otherwise payable thereon for the then-current quarterly interest period accrued to, but excluding, the date fixed for redemption.
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Note holders may be prevented from exchanging or transferring the Notes when they are subject to redemption. In case any Notes are to be redeemed in part only, the redemption notice will provide that, upon surrender of such Note, Note holders will receive, without a charge, a new Note or Notes of authorized denominations representing the principal amount of Note holders’ remaining unredeemed Notes. Any exercise of our option to redeem the Notes will be done in compliance with the 1940 Act, to the extent applicable.
If we redeem only some of the Notes, the trustee or, with respect to the global securities, The Depository Trust Company, New York, New York, known as DTC, will determine the method for selection of the particular Notes to be redeemed, in accordance with the indenture and the 1940 Act, to the extent applicable, and in accordance with the rules of any national securities exchange or quotation system on which the Notes are listed. Unless we default in payment of the redemption price, on and after the date of redemption, interest will cease to accrue on the Notes called for redemption.
Global Securities
Each Note is issued in book-entry form and represented by a global security that we deposit with and register in the name of DTC or its nominee. A global security may not be transferred to or registered in the name of anyone other than the depositary or its nominee, unless special termination situations arise. As a result of these arrangements, the depositary, or its nominee, will be the sole registered owner and holder of all the Notes represented by a global security, and investors will be permitted to own only beneficial interests in a global security.
Termination of a Global Security
If a global security is terminated for any reason, interests in it will be exchanged for certificates in non-book-entry form (certificated securities). After that exchange, the choice of whether to hold the certificated Notes directly or in street name will be up to the investor. Investors must consult their own banks or brokers to find out how to have their interests in a global security transferred on termination to their own names, so that they will be holders.
Conversion and Exchange
The Notes are not convertible into or exchangeable for other securities.
Payment and Paying Agents
We will pay interest to the person listed in the trustee’s records as the owner of the Notes at the close of business on a particular day in advance of each due date for interest, even if that person no longer owns the Note on the interest due date. That day, usually about two weeks in advance of the interest due date, is called the “record date.” Because we will pay all the interest for an interest period to the holders on the record date, holders buying and selling the Notes must work out between themselves the appropriate purchase price. The most common manner is to adjust the sales price of the Notes to prorate interest fairly between buyer and seller based on their respective ownership periods within the particular interest period. This prorated interest amount is called “accrued interest.”
Payments on Global Securities
We will make payments on the Notes so long as they are represented by a global security in accordance with the applicable policies of the depositary as in effect from time to time. Under those policies, we will make payments directly to the depositary, or its nominee, and not to any indirect holders who own beneficial interests in the global security. An indirect holder’s right to those payments will be governed by the rules and practices of the depositary and its participants.
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Payments on Certificated Securities
In the event the Notes become represented by certificated securities, we will make payments on the Notes as follows. We will pay interest that is due on an interest payment date to the holder of the Notes as shown on the trustee’s records as of the close of business on the regular record date. We will make all payments of principal and premium, if any, by check at the office of the applicable trustee in New York, New York and/or at other offices that may be specified in the indenture or a notice to holders against surrender of the Note.
Alternatively, if the holder asks us to do so, we will pay any amount that becomes due on the debt security by wire transfer of immediately available funds to an account at a bank in New York City, on the due date. To request payment by wire, the holder must give the applicable trustee or other paying agent appropriate transfer instructions at least 15 business days before the requested wire payment is due. In the case of any interest payment due on an interest payment date, the instructions must be given by the person who is the holder on the relevant regular record date. Any wire instructions, once properly given, will remain in effect unless and until new instructions are given in the manner described above.
Payment When Offices Are Closed
If any payment is due on the Notes on a day that is not a business day, we will make the payment on the next day that is a business day. Payments made on the next business day in this situation will be treated under the indenture as if they were made on the original due date. Such payment will not result in a default under the Notes or the indenture, and no interest will accrue on the payment amount from the original due date to the next day that is a business day.
Book-entry and other indirect holders should consult their banks or brokers for information on how they will receive payments on the Notes.
Events of Default
Note holders will have rights if an Event of Default occurs in respect of the Notes and the Event of Default is not cured, as described later in this subsection.
The term “Event of Default” in respect of the Notes means any of the following:
| • | We do not pay the principal of any Note when due and payable at maturity; |
| • | We do not pay interest on any Note when due and payable, and such default is not cured within 30 days of its due date; |
| • | We remain in breach of any other covenant in respect of the Notes for 60 days after we receive a written notice of default stating we are in breach (the notice must be sent by either the trustee or holders of at least 25% of the principal amount of the outstanding Notes); |
| • | We file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and remain undischarged or unstayed for a period of 60 days; or |
| • | On the last business day of each of twenty-four consecutive calendar months, the Notes have an asset coverage (as such term is defined in the 1940 Act) of less than 100%, giving effect to any exemptive relief granted to us by the SEC. |
An Event of Default for the Notes may, but does not necessarily, constitute an Event of Default for any other series of debt securities issued under the same or any other indenture. The trustee may withhold notice to the holders of the Notes of any default, except in the payment of principal or interest, if it in good faith considers the withholding of notice to be in the best interests of the holders.
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Remedies if an Event of Default Occurs
If an Event of Default has occurred and is continuing, the trustee or the holders of not less than 25% in principal amount of the Notes may declare the entire principal amount of all the Notes to be due and immediately payable, but this does not entitle any holder of Notes to any redemption payout or redemption premium. This is called a declaration of acceleration of maturity. In certain circumstances, a declaration of acceleration of maturity may be canceled by the holders of a majority in principal amount of the Notes if (1) we have deposited with the trustee all amounts due and owing with respect to the Notes (other than principal or any payment that has become due solely by reason of such acceleration) and certain other amounts, and (2) any other Events of Default have been cured or waived.
Except in cases of default, where the trustee has some special duties, the trustee is not required to take any action under the indenture at the request of any holders unless the holders offer the trustee protection from expenses and liability reasonably satisfactory to it (called an “indemnity”). If indemnity reasonably satisfactory to the trustee is provided, the holders of a majority in principal amount of the Notes may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any remedy available to the trustee. The trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or remedy will be treated as a waiver of that right, remedy or Event of Default.
Before Note holders are allowed to bypass the trustee and bring their own lawsuit or other formal legal action or take other steps to enforce their rights or protect their interests relating to the Notes, the following must occur:
| • | Any such Note holder must give the trustee written notice that an Event of Default has occurred and remains uncured; |
| • | The holders of at least 25% in principal amount of all the Notes must make a written request that the trustee take action because of the default and must offer the trustee indemnity, security, or both, reasonably satisfactory to it against the cost and other liabilities of taking that action; |
| • | The trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity and/or security; and |
| • | The holders of a majority in principal amount of the Notes must not have given the trustee a direction inconsistent with the above notice during that 60-day period. |
However, Note holders are entitled at any time to bring a lawsuit for the payment of money due on their Notes on or after the due date.
Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make a request of the trustee and how to declare or cancel an acceleration of maturity.
Each year, we furnish to the trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with the indenture and the Notes, or else specifying any default.
Waiver of Default
The holders of a majority in principal amount of the Notes may waive any past defaults other than a default:
| • | in the payment of principal (or premium, if any) or interest; or |
| • | in respect of a covenant that cannot be modified or amended without the consent of each holder of the Notes. |
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Merger or Consolidation
Under the terms of the indenture, we are generally permitted to consolidate or merge with another entity. We are also permitted to sell all or substantially all of our assets to another entity. However, we may not take any of these actions unless all the following conditions are met:
| • | where we merge out of existence or convey or transfer our assets substantially as an entirety, the resulting entity must agree to be legally responsible for our obligations under the Notes; |
| • | immediately after giving effect to the transaction, no default or Event of Default shall have occurred and be continuing; and |
| • | we must deliver certain certificates and documents to the trustee. |
Modification or Waiver
There are three types of changes we can make to the indenture and the Notes issued thereunder:
Changes Requiring Note Holder Approval
First, there are changes that we cannot make to the Notes without Note Holders’ specific approval. The following is a list of those types of changes:
| • | change the stated maturity of the principal of (or premium, if any, on) or any installment of principal of, or interest on, the Notes; |
| • | reduce any amounts due on the Notes or reduce the rate of interest on the Notes; |
| • | reduce the amount of principal payable upon acceleration of the maturity of a Note following a default; |
| • | change the place or currency of payment on a Note; |
| • | impair the Note holders’ right to sue for payment; |
| • | reduce the percentage of holders of Notes whose consent is needed to modify or amend the indenture; and |
| • | reduce the percentage of holders of Notes whose consent is needed to waive compliance with certain provisions of the indenture or to waive certain defaults or reduce the percentage of holders of Notes required to satisfy quorum or voting requirements at a meeting of holders of the Notes. |
Changes Not Requiring Approval
The second type of change does not require any vote by the holders of the Notes. This type is limited to clarifications and certain other changes that would not adversely affect holders of the Notes in any material respect.
Changes Requiring Majority Approval
Any other change to the indenture and the Notes would require the following approval:
| • | if the change affects only the Notes, it must be approved by the holders of a majority in principal amount of the Notes; and |
| • | if the change affects more than one series of debt securities issued under the same indenture, it must be approved by the holders of a majority in principal amount of all of the series affected by the change, with all affected series voting together as one class for this purpose. |
In each case, the required approval must be given by written consent.
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The holders of a majority in principal amount of all of the series of debt securities issued under an indenture, voting together as one class for this purpose, may waive our compliance with some of our covenants in that indenture. However, we cannot obtain a waiver of a payment default or of any of the matters covered by the bullet points included above under “—Changes Requiring Note Holder Approval.”
Further Details Concerning Voting
When taking a vote, we will use the following rules to decide how much principal to attribute to the Notes:
The Notes will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their payment or redemption or if we or any affiliate of ours own any Notes. The Notes will also not be eligible to vote if they have been fully defeased as described later under “—Defeasance—Full Defeasance.”
We will generally be entitled to set any day as a record date for the purpose of determining the holders of the Notes that are entitled to vote or take other action under the indenture. However, the record date may not be earlier than 30 days before the date of the first solicitation of holders to vote on or take such action and not later than the date such solicitation is completed. If we set a record date for a vote or other action to be taken by holders of the Notes, that vote or action may be taken only by persons who are holders of the Notes on the record date and must be taken within eleven months following the record date.
Book-entry and other indirect holders should consult their banks or brokers for information on how approval may be granted or denied if we seek to change the indenture or the Notes or request a waiver.
Satisfaction and Discharge
The indenture will be discharged and will cease to be of further effect with respect to the Notes when:
| • | Either |
| • | all the Notes that have been authenticated have been delivered to the trustee for cancellation; or |
| • | all the Notes that have not been delivered to the trustee for cancellation: |
| • | have become due and payable, or |
| • | will become due and payable at their stated maturity within one year, or |
| • | are to be called for redemption within one year, |
and we, in the case of the first, second and third sub-bullets above, have irrevocably deposited or caused to be deposited with the trustee as trust funds in trust solely for the benefit of the holders of the Notes, in amounts as will be sufficient, to pay and discharge the entire indebtedness (including all principal, premium, if any, and interest) on such Notes delivered to the trustee for cancellation (in the case of Notes that have become due and payable on or prior to the date of such deposit) or to the stated maturity or redemption date, as the case may be;
| • | we have paid or caused to be paid all other sums payable by us under the indenture with respect to the Notes; and |
| • | we have delivered to the trustee an officers’ certificate and legal opinion, each stating that all conditions precedent provided for in the indenture relating to the satisfaction and discharge of the indenture and the Notes have been complied with. |
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Defeasance
The following provisions are applicable to the Notes. “Defeasance” means that, by depositing with a trustee an amount of cash and/or government securities sufficient to pay all principal and interest, if any, on the Notes when due and satisfying any additional conditions noted below, we will be deemed to have been discharged from our obligations under the Notes. In the event of a “covenant defeasance,” upon depositing such funds and satisfying similar conditions discussed below we would be released from certain covenants under the indenture relating to the Notes.
Covenant Defeasance
Under current U.S. federal income tax law and the indenture, we can make the deposit described below and be released from some of the restrictive covenants in the indenture under which the Notes were issued. This is called “covenant defeasance.” In that event, Note holders would lose the protection of those restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay their Notes. In order to achieve covenant defeasance, the following must occur:
| • | Since the Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of the Notes a combination of cash and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest, principal and any other payments on the Notes on their various due dates; |
| • | We must deliver to the trustee a legal opinion of our counsel confirming that, under current U.S. federal income tax law, we may make the above deposit without causing Note holders to be taxed on the Notes any differently than if we did not make the deposit; |
| • | We must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied with; |
| • | Defeasance must not result in a breach or violation of, or result in a default under, the indenture or any of our other material agreements or instruments; and |
| • | No default or Event of Default with respect to the Notes shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days. |
If we accomplish covenant defeasance, Note holders can still look to us for repayment of the Notes if there were a shortfall in the trust deposit or the trustee is prevented from making payment. In fact, if one of the remaining Events of Default occurred (such as our bankruptcy) and the Notes became immediately due and payable, there might be a shortfall. Depending on the event causing the default, Note holders may not be able to obtain payment of the shortfall.
Full Defeasance
If there is a change in U.S. federal income tax law, as described below, we can legally release ourselves from all payment and other obligations on the Notes (called “full defeasance”) if we put in place the following other arrangements for Note holders to be repaid:
| • | Since the Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of the Notes a combination of money and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest, principal and any other payments on the Notes on their various due dates; |
| • | We must deliver to the trustee a legal opinion confirming that there has been a change in current U.S. federal tax law or an Internal Revenue Service (“IRS”) ruling that allows us to make the above deposit without causing Note holders to be taxed on the Notes any differently than if we did not make the deposit; |
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| • | We must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, and a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied with; |
| • | Defeasance must not result in a breach or violation of, or constitute a default under, the indenture or any of our other material agreements or instruments; and |
| • | No default or Event of Default with respect to the Notes shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days. |
If we ever did accomplish full defeasance, as described above, Note holders would have to rely solely on the trust deposit for repayment of the Notes. Note holders could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from claims of our lenders and other creditors if we ever became bankrupt or insolvent.
Other Covenants
In addition to any other covenants described in the indenture, as well as standard covenants relating to payment of principal and interest, maintaining an office where payments may be made or securities can be surrendered for payment, payment of taxes by the Company and related matters, the following covenants apply to the Notes:
| • | We agree that for the period of time during which Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to the Company from time to time or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from incurring additional borrowings, including through the issuance of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowings. |
| • | We agree that for the period of time during which Notes are outstanding, the Company will not declare any dividend (except a dividend payable in stock of the issuer), or declare any other distribution, upon a class of the capital stock of the Company, or purchase any such capital stock, unless, in every such case, at the time of the declaration of any such dividend or distribution, or at the time of any such purchase, the Company has an asset coverage (as defined in the 1940 Act) of at least the threshold specified in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to the Company from time to time or any successor provisions thereto of the 1940 Act, as such obligation may be amended or superseded, after deducting the amount of such dividend, distribution or purchase price, as the case may be, and in each case giving effect to (i) any exemptive relief granted to the Company by the Commission, and (ii) any SEC no-action relief granted by the Commission to another BDC (or to the Company if it determines to seek such similar no-action or other relief) permitting the BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by such provisions of Section 61(a) of the 1940 Act as may be applicable to the Company from time to time, as such obligation may be amended or superseded, in order to maintain such BDC’s status as a regulated investment company under Subchapter M of the Code; and |
| • | If, at any time, we are not subject to the reporting requirements of Sections 13 or 15(d) of the Exchange Act to file any periodic reports with the SEC, we agree to furnish to holders of the Notes and the trustee, for the period of time during which the Notes are outstanding, our audited annual consolidated financial statements, within 90 days of our fiscal year end, and unaudited interim consolidated financial statements, within 45 days of our fiscal quarter end (other than our fourth fiscal quarter). All such financial statements will be prepared, in all material respects, in accordance with applicable U.S. GAAP. |
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Form, Exchange and Transfer of Certificated Registered Securities
If registered Notes cease to be issued in book-entry form, they will be issued:
| • | only in fully registered certificated form; |
| • | without interest coupons; and |
| • | unless we indicate otherwise, in denominations of $25 and amounts that are multiples of $25. |
Holders may exchange their certificated securities for Notes of smaller denominations or combined into fewer Notes of larger denominations, as long as the total principal amount is not changed and as long as the denomination is equal to or greater than $25.
Holders may exchange or transfer their certificated securities at the office of the trustee. We have appointed the trustee to act as our agent for registering Notes in the names of holders transferring Notes. We may appoint another entity to perform these functions or perform them ourselves.
Holders will not be required to pay a service charge to transfer or exchange their certificated securities, but they may be required to pay any tax or other governmental charge associated with the transfer or exchange. The transfer or exchange will be made only if our transfer agent is satisfied with the holder’s proof of legal ownership.
We may appoint additional transfer agents or cancel the appointment of any particular transfer agent. We may also approve a change in the office through which any transfer agent acts.
If any certificated securities of a particular series are redeemable and we redeem less than all the Notes, we may block the transfer or exchange of those Notes selected for redemption during the period beginning 15 days before the day we mail the notice of redemption and ending on the day of that mailing, in order to freeze the list of holders to prepare the mailing. We may also refuse to register transfers or exchanges of any certificated Notes selected for redemption, except that we will continue to permit transfers and exchanges of the unredeemed portion of any Note that will be partially redeemed.
If registered Notes are issued in book-entry form, only the depositary will be entitled to transfer and exchange the Notes as described in this subsection, since it will be the sole holder of the Notes.
Resignation of Trustee
The trustee may resign or be removed with respect to the Notes provided that a successor trustee is appointed to act with respect to the Notes. In the event that two or more persons are acting as trustee with respect to different series of indenture securities under the indenture, each of the trustees will be a trustee of a trust separate and apart from the trust administered by any other trustee.
Governing Law
The indenture and the Notes are governed by and construed in accordance with the laws of the State of New York.
Indenture Provisions—Ranking
The Notes will be our direct unsecured obligations and will rank:
| • | pari passu, which means equal in right of payment, with any of our existing and future unsecured, unsubordinated indebtedness; |
| • | senior to any of our future indebtedness that expressly provides it is subordinated to the Notes; |
| • | effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness; and |
| • | structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries. |
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Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the registration statement on Form N-2 of Investcorp Credit Management BDC, Inc. and Subsidiaries (formerly CM Finance Inc) (the Company) of our report dated September 21, 2020, relating to our audit of the consolidated financial statements appearing in the accompanying Form 10-K for the year ended June 30, 2020, and of our report dated September 21, 2020 relating to the senior securities table of the Company appearing as an exhibit to the Form 10-K.
We also consent to the reference to our firm under the captions “Selected Financial Data”, “Senior Securities”, and Item 9 in the Form 10-K.
/s/ RSM US LLP
New York, New York
September 21, 2020
Exhibit 31.1
I, Michael C. Mauer, certify that:
1. I have reviewed this annual report on Form 10-K of Investcorp Credit Management BDC, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: September 21, 2020
| /s/ Michael C. Mauer |
| Michael C. Mauer |
| Chief Executive Officer |
Exhibit 31.2
I, Rocco DelGuercio, certify that:
1. I have reviewed this annual report on Form 10-K of Investcorp Credit Management BDC, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: September 21, 2020
| /s/ Rocco DelGuercio |
| Rocco DelGuercio |
| Chief Financial Officer |
Exhibit 32.1
Certification of Chief Executive Officer
Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
In connection with this Annual Report on Form 10-K (the “Report”) of Investcorp Credit Management BDC, Inc. (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Michael C. Mauer, the Chief Executive Officer of the Registrant, hereby certify, to the best of my knowledge, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
| /s/ Michael C. Mauer | ||
| Name: | Michael C. Mauer | |
| Date: | September 21, 2020 |
Exhibit 32.2
Certification of Chief Financial Officer
Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)
In connection with this Annual Report on Form 10-K (the “Report”) of Investcorp Credit Management BDC, Inc. (the “Registrant”), as filed with the Securities and Exchange Commission on the date hereof, I, Rocco DelGuercio, the Chief Financial Officer of the Registrant, hereby certify, to the best of my knowledge, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
| /s/ Rocco DelGuercio | ||
| Name: | Rocco DelGuercio | |
| Date: | September 21, 2020 |
Exhibit 99.1
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of
Investcorp Credit Management BDC, Inc.
Our audits of the consolidated financial statements referred to in our report dated September 21, 2020, (appearing in the accompanying Form 10-K) also included an audit of the senior securities table of Investcorp Credit Management BDC, Inc. and Subsidiaries (formerly CM Finance Inc) (the Company) appearing in Part II, Item 7 in the accompanying Form 10-K. This table is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits of the consolidated financial statements.
In our opinion, the senior securities table, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ RSM US LLP
New York, New York
September 21, 2020