News Column

GLADSTONE CAPITAL CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (dollar amounts in thousands, except per share amounts and as otherwise indicated)

July 30, 2014

All statements contained herein, other than historical facts, may constitute "forward-looking statements." These statements may relate to, among other things, our future operating results, our business prospects and the prospects of our portfolio companies, actual and potential conflicts of interest with Gladstone Management Corporation and its affiliates, the use of borrowed money to finance our investments, the adequacy of our financing sources and working capital, and our ability to co-invest, among other factors. In some cases, you can identify forward-looking statements by terminology such as "estimate," "may," "might," "believe," "will," "provided," "anticipate," "future," "could," "growth," "plan," "intend," "expect," "should," "would," "if," "seek," "possible," "potential," "likely" or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to: (1) the recurrence of adverse events in the economy and the capital markets; (2) risks associated with negotiation and consummation of pending and future transactions; (3) the loss of one or more of our executive officers, in particular David Gladstone, Terry Lee Brubaker or Bob Marcotte; (4) changes in our investment objectives and strategy; (5) availability, terms (including the possibility of interest rate volatility) and deployment of capital; (6) changes in our industry, interest rates, exchange rates or the general economy; (7) the degree and nature of our competition; (8) our ability to maintain our qualification as a RIC and as business development company; and (9) those factors described in the "Risk Factors" section of our Annual Report on Form 10-K filed with the SEC on November 20, 2013. We caution readers not to place undue reliance on any such forward-looking statements. Actual results could differ materially from those anticipated in our forward-looking statements and future results could differ materially from historical performance. We have based forward-looking statements on information available to us on the date of this report. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this Quarterly Report on Form 10-Q. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we have filed or in the future may file with the Securities and Exchange Commission ("SEC"), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The following analysis of our financial condition and results of operations should be read in conjunction with our accompanying Condensed Consolidated Financial Statements and the notes thereto contained elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013, filed with the SEC on November 20, 2013. Historical financial condition and results of operations and percentage relationships among any amounts in the financial statements are not necessarily indicative of financial condition or results of operations for any future periods.



OVERVIEW

General

We were incorporated under the Maryland General Corporation Law on May 30, 2001. We were established for the purpose of investing in debt and equity securities of established private businesses in the United States ("U.S."). Our investment objectives are to: (1) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time; and (2) provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains. To achieve our objectives, our investment strategy is to invest in several categories of debt and equity securities, with each investment generally ranging from $5 million to $30 million, although investment size may vary, depending upon our total assets or available capital at the time of investment. We aim to maintain a portfolio consisting of approximately 95.0% debt investment and 5.0% equity investment, at cost. We focus on investing in small and medium-sized middle market private businesses in the U.S. that meet certain criteria, including, but not limited to, the following: the potential for growth in cash flow, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the borrower, profitable operations based on the borrower's cash flow, reasonable capitalization of the borrower (usually by leveraged buyout funds or venture capital funds) and, to a lesser extent, the potential to realize appreciation and gain liquidity in our equity position, if any. We lend to borrowers that need funds to finance growth, restructure their balance sheets or effect a change of control. We invest by ourselves or jointly with other funds and/or management of the portfolio company, depending on the opportunity. If we are participating in an investment with one or more co-investors, our investment is likely to be smaller than if we were investing alone. 38



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We operate as an externally managed, closed-end, non-diversified management investment company, and have elected to be treated as a business development company ("BDC") under the Investment Company Act of 1940, as amended (the "1940 Act"). In addition, for federal income tax purposes we have elected to be treated as a regulated investment company ("RIC") under the Internal Revenue Code of 1986, as amended (the "Code"). As a BDC and RIC, we are subject to certain constraints, including limitations imposed by the 1940 Act and the Code. We are externally managed by Gladstone Management Corporation (the "Adviser"), an investment adviser registered with the SEC and an affiliate of ours, pursuant to an investment advisory and management agreement (the "Advisory Agreement"). The Adviser manages our investment activities. We have also entered into an administration agreement (the "Administration Agreement") with Gladstone Administration, LLC (the "Administrator"), an affiliate of ours and the Adviser, whereby we pay separately for administrative services. Our shares of common stock and mandatorily redeemable preferred stock are traded on the NASDAQ Global Select Market under the trading symbols "GLAD" and "GLADO," respectively. Business Environment The strength of the global economy and the U.S. economy in particular, continues to be uncertain, although economic conditions generally appear to be improving, albeit slowly. The impacts from the 2008 recession in general, and the resulting disruptions in the capital markets in particular, have had lingering effects on our liquidity options and have increased our cost of debt and equity capital. Many of our portfolio companies, as well as those small and medium-sized companies that we evaluate for prospective investment, remain vulnerable to the impacts of the uncertain economy. Concerns linger over the ability of the U.S. Congress to pass additional debt ceiling legislation prior to March 2015, given the budget impasse that resulted in the partial shutdown of the U.S. government in October 2013. Uncertain political, regulatory and economic conditions could disproportionately impact some of the industries in which we have invested, causing us to be more vulnerable to losses in our portfolio, resulting in the number of our non-performing assets to increase and the fair market value of our portfolio to decrease. Additionally, there has been increased competitive pressure in the middle market lending marketplace from other BDCs and investment companies, as well as small banks for senior and senior subordinated debt. We have seen an increase in refinancing and recapitalization transactions; however, there is increased yield compression on higher leveraged and increasingly riskier investments in the middle market segment we focus on. We do not know if market conditions will continue to improve or if adverse conditions will recur and we do not know the full extent to which the inability of the U.S. government to address its fiscal condition in the near and long term will affect us. If market instability persists or intensifies, we may experience difficulty in raising capital. In summary, we believe we are in a protracted economic recovery; however, we do not know the full extent to which the impact of the lingering recessionary economic conditions will affect us or our portfolio companies.



Portfolio Activity

While conditions remain somewhat challenging in the marketplace, we are seeing a number of new investment opportunities that are consistent with our investment objectives and strategies. During the nine months ended June 30, 2014, we invested an aggregate of $73.0 million in 12 new proprietary and syndicate investments, resulting in a net expansion in our overall portfolio of two portfolio companies, due to eight portfolio companies paying off early at par for an aggregate of $36.6 million and our sale of two of our portfolio companies for combined net proceeds of $4.7 million. In addition, in July 2012, the SEC granted us an exemptive order that expands our ability to co-invest with certain of our affiliates by permitting us, under certain circumstances, to co-invest with Gladstone Investment Corporation ("Gladstone Investment") and any future BDC or closed-end management investment company that is advised by the Adviser (or sub-advised by the Adviser if it controls the fund) or any combination of the foregoing subject to the conditions in the SEC's order. We believe this ability to co-invest has enhanced and will continue to enhance our ability to further our investment objectives and strategies. We co-invested with Gladstone Investment in four new proprietary investments during the nine months ended June 30, 2014, as discussed under "-Investment Highlights."



Regulatory Compliance

Challenges in the current market are intensified for us by certain regulatory limitations under the Code and the 1940 Act, as well as contractual restrictions under the agreement governing our $137.0 million revolving line of credit (our "Credit Facility," described more fully under "Liquidity and Capital Resources-Revolving Credit Facility") that further constrain our ability to access the capital markets. To qualify to be taxed as a RIC, we must distribute to our stockholders at least 90.0% of our "investment company taxable income," which is generally our net ordinary income plus the excess of our net short-term capital gains over net long-term capital losses. Because we are required to satisfy the RIC annual stockholder distribution requirement, and because the illiquidity of many of 39



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our investments makes it difficult for us to finance new investments through the sale of current investments, our ability to make new investments is highly dependent upon external financing. Our external financing sources include the issuance of equity securities, debt securities or other leverage, such as borrowings under our Credit Facility. Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act that require us to have an asset coverage ratio (as defined in Section 18(h) of the 1940 Act) of at least 200.0% on our senior securities representing indebtedness and our senior securities that are stock. We believe that market conditions have affected and may continue to affect the trading price of our common stock and our ability to finance new investments through the issuance of equity. On July 29, 2014, the closing market price of our common stock was $10.13, a 17.5% premium to our June 30, 2014, net asset value ("NAV") per common share of $8.62. During the last six months, our common stock has generally traded at a premium to our NAV, however from time to time over the last four years, our common stock has traded below NAV per share. When our common stock trades below NAV per share, the 1940 Act restricts our ability to obtain additional capital by issuing common stock. Generally, the 1940 Act provides that we may not issue and sell our common stock at a price below our then current NAV per share, other than to our then existing common stockholders pursuant to a rights offering, without first obtaining approval from our stockholders and our independent directors. To date, we have never issued common stock below our then current NAV per share. At our Annual Meeting of Stockholders held on February 13, 2014, our stockholders approved a proposal authorizing us to sell shares of our common stock at a price below our then current NAV per share subject to certain limitations (including, but not limited to, that the number of shares issued and sold pursuant to such authority does not exceed 25.0% of our then outstanding common stock immediately prior to each such sale) for a period of one year from the date of approval, provided that our board of directors (our "Board of Directors") makes certain determinations prior to any such sale. The current uncertain economic conditions may also continue to cause the value of the collateral securing some of our loans to fluctuate, as well as the value of our equity investments, which has impacted and may continue to impact our ability to borrow under our Credit Facility. Additionally, our Credit Facility contains covenants regarding the maintenance of certain minimum loan concentrations and net worth covenants, which are affected by the decrease in value of our portfolio. Failure to meet these requirements would result in a default which, if we are unable to obtain a waiver from our lenders, would cause an acceleration of our repayment obligations under our Credit Facility. As of June 30, 2014, we were in compliance with all of our Credit Facility's covenants. We expect that, given these regulatory and contractual constraints in combination with current market conditions, debt and equity capital may be costly for us to access in the near term. However, we believe that our recent issuance of 6.75% Series 2021 Term Preferred Stock (our "Series 2021 Term Preferred Stock," described more fully under "Liquidity and Capital Resources-Equity-Term Preferred Stock"), our Credit Facility amendments which decreased the interest rate on advances by removing the London Interbank Offered Rate ("LIBOR") floor of 1.5% and extended the maturity one year until 2016 along with our ability to co-invest with Gladstone Investment and certain other affiliated investment funds, should increase our ability to make investments in businesses that we believe will help us achieve attractive long-term returns for our stockholders. During the first nine months of the 2014 fiscal year, we have continued to focus on building our pipeline with deals that we believe are generally recession resistant and making investments that meet our objectives and strategies and provide appropriate returns, given the risks.



Investment Highlights

During the nine months ended June 30, 2014, we invested an aggregate of $73.0 million in 12 new portfolio companies and an aggregate of $10.2 million to existing portfolio companies. In addition, during the nine months ended June 30, 2014, we sold our investments in two portfolio companies and we received scheduled and unscheduled contractual principal repayments of approximately $47.3 million from existing portfolio companies, including eight early payoffs at par. Since our initial public offering in August 2001, we have made 366 different loans to, or investments in, 184 companies for a total of approximately $1.3 billion, before giving effect to principal repayments on investments and divestitures.



Investment Activity

During the nine months ended June 30, 2014, we executed the following transactions with certain of our portfolio companies:

Issuances and Originations

During the nine months ended June 30, 2014, we extended an aggregate of $62.0 million of investments to seven new proprietary portfolio companies and an aggregate of $11.0 million to five new syndicated portfolio companies (The Active Network, Inc., ARSloane Acquisition, LLC, Envision Acquisition Company, LLC, GTCR Valor Companies, Inc. and Vitera Healthcare Solutions, LLC). Below are significant issuances and originations during the nine months ended June 30, 2014: 40



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In October 2013, we invested $7.0 million in Alloy Die Casting Co. ("ADC")

through a combination of senior term debt and equity. ADC, headquartered

in Buena Park, California, is a manufacturer of high quality, finished

aluminum and zinc metal components for a diverse range of end markets.

This was a co-investment with one of our affiliated funds, Gladstone

Investment. Gladstone Investment invested an additional $16.3 million

under the same terms as us.



In December 2013, we invested $5.5 million in Behrens Manufacturing, LLC

("Behrens") through a combination of senior term debt and equity. Behrens,

headquartered in Winona, Minnesota, is a manufacturer and marketer of high

quality, classic looking, utility products and containers. Gladstone

Investment participated as a co-investor by investing an additional $12.9

million under the same terms as us.



In December 2013, we invested $17.0 million in senior subordinated term

debt in J.America, Inc. ("J.America"). J.America, headquartered in

Webberville, Michigan, is a supplier of licensed decorated and undecorated

apparel and headwear to collegiate, resort and military markets, wholesale

distributors and apparel decorators.



In December 2013, we invested $5.6 million in Meridian Rack & Pinion, Inc.

("Meridian") through a combination of senior term debt and equity.

Meridian, headquartered in San Diego, CA, is a provider of aftermarket and

OEM replacement automotive parts, which it sells through both wholesale

channels and online at www.BuyAutoParts.com. Gladstone Investment

participated as a co-investor by investing an additional $13.0 million

under the same terms as us. In February 2014, we invested $11.1 million in Edge Adhesives Holdings,



Inc. ("Edge") through a combination of senior term debt, senior

subordinated term debt and equity. Edge, headquartered in Fort Worth, TX,

is a leading developer and manufacturer of innovative adhesives, sealants,

tapes and related solutions used in building products, transportation,

electrical and HVAC, among other markets. Gladstone Investment

participated as a co-investor by investing an additional $16.7 million

under the same terms as us. In March 2014, we invested $11.3 million in WadeCo Specialties Inc.



("WadeCo") through a combination of senior term debt and equity. WadeCo,

headquartered in Midland, TX, provides production well chemicals to oil

well operators used for corrosion prevention; separating oil, gas and

water once extracted; bacteria growth management; and conditioning water

utilized for hydraulic fracturing.



In March 2014, we invested $7.0 million in Lignetics, Inc. ("Lignetics")

through a combination of senior subordinated term debt and equity. Lignetics, headquartered in Sandpoint, ID, is a manufacturer and distributor of branded wood pellets, which are used as a renewable fuel



for home and industrial heating, animal bedding, moisture absorption

products used in fluid management in the energy production industry, and

fire logs and fire starters.

Repayments and Sales:

During the nine months ended June 30, 2014, 23 borrowers made principal repayments totaling $47.3 million in the aggregate, consisting of $45.2 million of unscheduled principal and revolver repayments, as well as $2.1 million in contractual principal amortization. Below are the significant repayments and exits during the nine months ended June 30, 2014.



Included in the unscheduled principal payments were the net proceeds at

par from the early payoffs of the following: Syndicated investment payoffs: Ascend Learning, LLC of $1.0 million, Allied Security Holdings, Inc. of $1.0 million, Steinway Musical Instruments, Inc. of $0.3 million and Wall Street Systems Holdings, Inc. of $3.0 million.



Proprietary investment payoffs: Allen Edmonds Shoe Corporation of

$19.5 million, POP Radio, LLC ("POP") of $7.8 million, Profit Systems Acquisition Co. of $2.0 million and Thibaut Acquisition Co. ("Thibaut") of $2.1 million.



In December 2013, we sold our investment in LocalTel, LLC ("LocalTel") for

net proceeds that are contingent on an earn-out agreement, which resulted

in a realized loss of $10.8 million recorded in the three months ended

December 31, 2013. LocalTel had been on non-accrual status at the time of

the sale.



In March 2014, we sold our investment in BAS Broadcasting ("BAS") for net

proceeds of $4.7 million, which resulted in a realized loss of $2.8

million recorded in the three months ended March 31, 2014.

Refer to Note 13-Subsequent Events in the accompanying Condensed Consolidated Financial Statements included elsewhere in this Form 10-Q for investment activity occurring subsequent to June 30, 2014.

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Table of Contents Recent Developments Term Preferred Stock Offering In May 2014, we completed a public offering of approximately 2.4 million shares of our Series 2021 Term Preferred Stock, at a public offering price of $25.00 per share and a 6.75% rate. Net proceeds of the offering, after deducting underwriting discounts, commissions and offering expenses borne by us were approximately $58.5 million and were used to voluntarily redeem all outstanding shares of our then existing 7.125% Series 2016 Term Preferred Stock (our "Series 2016 Term Preferred Stock") and to repay a portion of outstanding borrowings under our Credit Facility. Refer to "Liquidity and Capital Resources-Equity-Term Preferred Stock") for further discussion of our term preferred stock.



Executive Officers

On January 7, 2014, our Board of Directors appointed Robert L. Marcotte as the Company's President. David Gladstone, the Company's prior interim President, remained Chief Executive Officer and Chairman of the Company.



Registration Statement

On December 23, 2013, we filed Post-effective Amendment No. 1 to our universal shelf registration statement (our "Registration Statement") on Form N-2 (File No. 333-185191) and subsequently filed Post-effective Amendment No. 2 on February 14, 2014, which the SEC declared effective on February 21, 2014. Our Registration Statement registers an aggregate of $300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock or preferred stock. We currently have the ability to issue up to $239.0 million in securities under our Registration Statement through one or more transactions. 42



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RESULTS OF OPERATIONS

Comparison of the Three Months Ended June 30, 2014, to the Three Months Ended June 30, 2013 Three Months Ended June 30, 2014 2013 $ Change % Change INVESTMENT INCOME Interest income $ 8,184$ 8,351$ (167 ) (2.0 )% Other income 1,996 200 1,796 898.0 Total investment income 10,180 8,551 1,629 19.1 EXPENSES Base management fee 1,461 1,382 79 5.7 Loan servicing fee 917 941 (24 ) (2.6 ) Incentive fee 1,266 998 268 26.9 Administration fee 219 183 36 19.7 Interest expense on borrowings 710 756 (46 ) (6.1 ) Dividend expense on mandatorily redeemable preferred stock 937 686 251 36.6 Amortization of deferred financing fees 314 313 1 0.3 Other expenses 277 378



(101 ) (26.7 )

Expenses before credits from Adviser 6,101 5,637 464 8.2 Credits to base management fee-loan servicing fee (917 ) (941 ) (24 ) (2.6 ) Credits to fees from Adviser-other (67 ) (555 ) 488 87.9 Total expenses net of credits 5,117 4,141 976 23.6 NET INVESTMENT INCOME 5,063 4,410 653 14.8 NET REALIZED AND UNREALIZED LOSS Net realized gain (loss) on investments and escrows 54 (2,388 ) 2,442 NM Realized loss on extinguishment of debt (1,297 ) - (1,297 ) (100.0 ) Net unrealized depreciation of investments (22,849 ) (4,701 ) (18,148 ) (386.0 ) Net unrealized (appreciation) depreciation of other (1,146 ) 620 (1,766 ) NM Net loss from investments and other (25,238 ) (6,469 )



(18,769 ) (290.1 )

NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (20,175 )$ (2,059 )$ (18,116 ) (879.8 )% NM = Not Meaningful Investment Income Total interest income decreased slightly by 2.0% for the three months ended June 30, 2014, as compared to the prior year period. This decrease was due primarily to three early payoffs at par offset by one new syndicate investment during the period. The level of interest income from investments is directly related to the principal balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average principal balance of our interest-bearing investment portfolio during the three months ended June 30, 2014, was $285.3 million, compared to $287.8 million for the prior year period, a decrease of less than 1.0%. The annualized weighted average yield on our interest-bearing investment portfolio is based on the current stated interest rate on interest-bearing investments and remained consistent at 11.5% and 11.6% for the three months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, three of our portfolio companies were on non-accrual, with an aggregate debt cost basis of approximately $52.1 million, or 16.2%, of the cost basis of all debt investments in our portfolio. As of June 30, 2013, three portfolio companies were on non-accrual, with an aggregate debt cost basis of approximately $53.7 million, or 15.9%, of the cost basis of all debt investments in our portfolio. Effective June 1, 2014 we placed Midwest Metal Distribution, Inc. ("Midwest Metal") on non-accrual. During the three months ended June 30, 2013, we sold our investment in one portfolio company that had been on non-accrual status. There were no other new non-accruals added and no non-accruals placed on accrual during the three months ended June 30, 2014 and 2013. 43



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For the three months ended June 30, 2014, other income consisted primarily of $0.7 million in dividend income received from Fedcap Partners, LLC ("FedCap"), $0.5 million in success fees received from the early payoff at par of Thibaut, $0.4 million in legal settlement proceeds received related to an investment which was previously sold and $0.2 million in success fees received related to our sale of substantially all of the assets of Lindmark Acquisition, LLC ("Lindmark") and the ensuing pay down of our debt investments in Lindmark at par in September 2013. Other income for the three months ended June 30, 2013, consisted of $0.2 million in aggregate prepayment fees which related to the early payoffs of three of our syndicated investments at par during the period.



The following tables list the investment income for our five largest portfolio company investments at fair value during the respective periods:

As of Three Months Ended June 30, 2014 June 30, 2014 % of Investment % of Total Company Fair Value Portfolio Income Income J.America, Inc.(A) $ 17,045 6.4 % $ 473 4.7 % Francis Drilling Fluids, Ltd. 15,677 5.9 459 4.5 AG Transportation Holdings, LLC(B) 12,903 4.9 456 4.5 RBC Acquisition Corp. 12,496 4.7 808 7.9 Defiance Integrated Technologies, Inc. 12,133 4.6 184 1.8 Subtotal-five largest investments 70,254 26.5 2,380 23.4 Other portfolio companies 194,829 73.5 7,796 76.6 Other non-portfolio company revenue - - 4 - Total Investment Portfolio $ 265,083 100.0 % $ 10,180 100.0 % As of Three Months Ended June 30, 2013 June 30, 2013 % of Investment % of Total Company Fair Value Portfolio Income Income RBC Acquisition Corp. $ 21,818 8.5 % $ 799 9.3 % Allen Edmonds Shoe Corporation(C) 19,531 7.7 542 6.4 Midwest Metal Distribution, Inc. 17,687 6.9 559 6.5 Francis Drilling Fluids, Ltd. 14,325 5.6 455 5.3 AG Transportation Holdings, LLC(B) 12,909 5.1 459 5.4 Subtotal-five largest investments 86,270 33.8 2,814 32.9 Other portfolio companies 169,001 66.2 5,714 66.8 Other non-portfolio company revenue - - 23 0.3 Total Investment Portfolio $ 255,271 100.0 % $ 8,551 100.0 %



(A) Investment added in December 2013.

(B) Investment added in December 2012.

(C) Investment exited in December 2013 at par.

Operating Expenses

Operating expenses, net of credits from the Adviser, increased for the three months ended June 30, 2014, by 23.6%, as compared to the prior year period. This increase was primarily due to increases in the net base management and incentive fees, as well as the increase in the dividend expense on our mandatorily redeemable preferred stock during the three months ended June 30, 2014. The increase of $0.7 million in the net incentive fee earned by the Adviser during the three months ended June 30, 2014, as compared to the prior year period, was due primarily to the partial incentive fee waiver in the prior year period and also to the increase in other income during the three months ended June 30, 2014. In the prior year period, there was a partial incentive fee waiver provided by the Adviser to ensure distributions to stockholders were covered entirely by net investment income. There was no incentive fee waiver needed during the three months ended June 30, 2014.



The increase of $0.2 million in the net base management fee during the three months ended June 30, 2014, as compared to the prior year period, was due primarily to an increase in the average total assets subject to the base management fee during the current period.

The base management fee, incentive fee and associated credits are computed quarterly, as described under "Investment Advisory and Management Agreement" in Note 4 of the notes to our accompanying Condensed Consolidated Financial Statements and are summarized in the following table:

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Average total assets subject to base management fee(A) $ 292,200$ 276,400 Multiplied by prorated annual base management fee of 2.0% 0.5 %

0.5 % Base management fee(B) $ 1,461$ 1,382 Portfolio fee credit (38 ) (95 ) Senior syndicated loan fee waiver (29 ) (42 ) Net Base Management Fee $ 1,394$ 1,245 Loan servicing fee(B) 917 941 Credits to base management fee-loan servicing fee(B) (917 ) (941 ) Net Loan Servicing Fee $ - $ - Incentive fee(B) 1,266 998 Incentive fee credit - (418 ) Net Incentive Fee $ 1,266$ 580 Portfolio fee credit (38 ) (95 ) Senior syndicated loan fee waiver (29 ) (42 ) Incentive fee credit -



(418 )

Credit to Fees From Adviser-other(B) $ (67 )$ (555 )



(A) Average total assets subject to the base management fee is defined as total

assets, including investments made with proceeds of borrowings, less any

uninvested cash or cash equivalents resulting from borrowings, valued at the

end of the applicable quarter within the respective period and adjusted

appropriately for any share issuances or repurchases during the period.

(B) Reflected as a line item on our accompanying Condensed Consolidated

Statements of Operations.

The increase of $0.3 million in dividend expense on our mandatorily redeemable preferred stock during the three months ended June 30, 2014, as compared to the prior year period, was primarily due to the higher monthly distribution amount on our Series 2021 Term Preferred Stock which was issued in May 2014, as compared to our Series 2016 Term Preferred Stock, which was issued in November 2011 (resulting from more shares of our Series 2021 Term Preferred Stock being issued and outstanding, partially offset by a lower rate). Refer to "Liquidity and Capital Resources-Equity-Term Preferred Stock") for further discussion of our term preferred stock.



Realized Gains (Losses) and Unrealized Depreciation

Net Realized Gain (Loss) on Investments and Escrows

For the three months ended June 30, 2014, there were minimal realized gains on investments. For the three months ended June 30, 2013, we recorded a net realized loss on investments and escrows of $2.4 million, which primarily consisted of a realized loss of $2.9 million resulting from the sale of Kansas Cable Holdings, Inc. ("KCH") during the period for net proceeds of $0.6 million. This realized loss was partially offset by realized gains of $0.5 million, which consisted of a combined $0.4 million of escrowed proceeds received in connection with exits of two investments in fiscal year 2012 and an aggregated $0.1 million of unamortized discounts related to the early payoffs at par of three syndicated investments during the period.



Realized Loss on Extinguishment of Debt

Realized loss on extinguishment of debt of $1.3 million is comprised primarily of the unamortized deferred financing costs at the time of the voluntary redemption of our then existing Series 2016 Term Preferred Stock in May 2014.

Net Unrealized Depreciation

Net unrealized appreciation (depreciation) of investments is the net change in the fair value of our investment portfolio during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are actually realized. During the three months ended June 30, 2014, we recorded net unrealized depreciation of investments in the aggregate amount of $22.8 million, which included reversals totaling $0.1 million in cumulative unrealized appreciation. Excluding reversals, we had $22.7 million in net unrealized depreciation for the three months ended June 30, 2014. Over our entire portfolio, the net unrealized depreciation (excluding reversals) for the three months ended June 30, 2014, consisted of approximately $24.4 million of depreciation on our debt investments and approximately $1.7 million of appreciation on our equity investments. 45



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The net realized gains (losses) and unrealized appreciation (depreciation) across our investments for the three months ended June 30, 2014, were as follows: Three Months Ended June 30, 2014 Unrealized Reversal of Realized Appreciation Unrealized Net Gain Portfolio Company Gain (Depreciation) Appreciation (Loss) Defiance Integrated Technologies, Inc. $ - $ 2,381 $ - $ 2,381 WP Evenflo Group Holdings, Inc. - 954 - 954 Francis Drilling Fluids, Ltd. - 712 - 712 International Junior Golf Training Acquisition Company - 554 - 554 Westland Technologies, Inc. - 517 - 517 Edge Adhesives Holdings, Inc. - 511 - 511 Funko, LLC - 329 - 329 Lignetics, Inc. - 299 - 299 Alloy Die Casting Co. - (459 ) - (459 ) Saunders & Associates - (641 ) - (641 ) Ameriqual Group, LLC - (815 ) - (815 ) FedCap Partners, LLC - (933 ) - (933 ) GFRC Holdings, LLC - (1,201 ) - (1,201 ) Precision Acquisition Group Holdings, Inc. - (3,408 ) - (3,408 ) Midwest Metal Distribution, Inc. - (3,491 ) - (3,491 ) RBC Acquisition Corp. - (18,230 ) - (18,230 ) Other, net ($250) 54 232 (160 ) 126 Total: $ 54$ (22,689 ) $ (160 ) $ (22,795 ) The largest driver of our net unrealized depreciation for the three months ended June 30, 2014, was due to a decrease in financial and operating performance and, to a lesser extent, a decrease in comparable multiples used in valuing RBC Acquisition Corp. ("RBC") ($18.2 million), Midwest ($3.5 million) and Precision Acquisition Group Holdings, Inc. ("Precision") ($3.4 million). This unrealized depreciation for the three months ended June 30, 2014, was partially offset by unrealized appreciation due to an incremental improvement in the financial and operational performance and, to a lesser extent, an increase in comparable multiples used in valuing Defiance Integrated Technologies, Inc. ("Defiance") ($2.4 million), WP Evenflo Group Holdings, Inc. ($1.0 million) and Francis Drilling Fluids, Ltd. ("FDF") ($0.7 million). During the three months ended June 30, 2013, we recorded net unrealized depreciation of investments in the aggregate amount of $4.7 million, which included the reversal of $2.9 million in unrealized depreciation related to the sale of KCH. Excluding reversals, we had $7.4 million in net unrealized depreciation for the three months ended June 30, 2013. Over our entire portfolio, the net unrealized depreciation (excluding reversals) for the three months ended June 30, 2013, consisted of approximately $6.2 million on our debt investments and approximately $1.2 million on our equity investments. The net realized (losses) gains and unrealized appreciation (depreciation) across our investments for the three months ended June 30, 2013, were as follows: 46



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Table of Contents Three Months Ended June 30, 2013 Reversal of Realized Unrealized Unrealized (Loss) Appreciation Depreciation Net Gain Portfolio Company Gain (Depreciation) (Appreciation) (Loss) RBC Acquisition Corp. $ - $ 732 $ - $ 732 FedCap Partners, LLC - 384 - 384 Legend Communications of Wyoming, LLC - 298 - 298 Kansas Cable Holdings, Inc. (2,906 ) - 2,922 16 Lindmark Acquisition, LLC - (287 ) - (287 ) GFRC Holdings, LLC - (290 ) - (290 ) Midwest Metal Distribution, Inc. - (323 ) - (323 ) AG Transportation Holdings, LLC - (404 ) - (404 ) Sunshine Media Holdings - (439 ) - (439 ) Westland Technologies, Inc. - (448 ) - (448 ) International Junior Golf Training Acquisition Company - (486 ) - (486 ) BAS Broadcasting - (560 ) - (560 ) Sunburst Media-Louisiana, LLC - (600 ) - (600 ) CMI Acquisition, LLC - (642 ) - (642 ) Heartland Communications Group - (681 ) - (681 ) Saunders & Associates - (740 ) - (740 ) Precision Acquisition Group Holdings, Inc. - (964 ) - (964 ) Defiance Integrated Technologies, Inc. - (1,276 ) - (1,276 ) Other, net ($250) 518 (698 ) (199 ) (379 ) Total: $ (2,388 )$ (7,424 ) $ 2,723 $ (7,089 ) The primary drivers of our net unrealized depreciation of investments for the three months ended June 30, 2013, were due to decreased financial and operational performance and, to a lesser extent, decreases in certain comparable multiples used in valuing several portfolio companies, most notably Defiance and Precision. This unrealized depreciation was partially offset by the reversal of unrealized depreciation of $2.9 million due to the sale of KCH and unrealized appreciation of $0.7 million on RBC, which was due to an incremental improvement in this portfolio company's financial and operational performance when compared to the prior quarter. As of June 30, 2014, the fair value of our investment portfolio was less than its cost basis by approximately $85.3 million, and our entire investment portfolio was valued at 75.7% of cost, as compared to cumulative net unrealized depreciation of $62.5 million and a valuation of our entire portfolio at 82.4% of cost as of March 31, 2014. This decrease quarter over quarter represents net unrealized depreciation of our investments of $22.8 million for the three months ended June 30, 2014. Of our current investment portfolio, 12 portfolio companies originated before December 31, 2007, representing 31.1% of the entire cost basis of our portfolio, were valued at 47.0% of cost and include our three investments on non-accrual status. Our 37 portfolio companies which originated after December 31, 2007, representing 68.9% of the entire cost basis of our portfolio, were valued at 88.6% of cost and none of these portfolio companies are on non-accrual status. We believe that our aggregate investment portfolio was valued at a depreciated value as of June 30, 2014, primarily due to the lingering effects of the recession that began in 2008 and its affect on the performance of certain of our portfolio companies and also because we were invested in certain industries that were disproportionately impacted by the recession. The cumulative net unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders; however, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution to stockholders.



Net Unrealized (Appreciation) Depreciation of Other

Net unrealized (appreciation) depreciation of other is primarily made up of the net change in the fair value of our Credit Facility during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized. During the three months ended June 30, 2014, we recorded net unrealized appreciation of borrowings of $1.1 million compared to net unrealized depreciation of borrowings of $0.6 million for the three months ended June 30, 2013. Our Credit Facility was fair valued at $36.6 million and $47.1 million as of June 30, 2014 and September 30, 2013, respectively. 47



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Comparison of the Nine Months Ended June 30, 2014, to the Nine Months Ended June 30, 2013 For the Nine Months Ended June 30, 2014 2013 $ Change % Change INVESTMENT INCOME Interest income $ 24,546$ 24,954$ (408 ) (1.6 )% Other income 3,357 1,848 1,509 81.7 Total investment income 27,903 26,802 1,101 4.1 EXPENSES Base management fee 4,421 4,233 188 4.4 Loan servicing fee 2,628 2,707 (79 ) (2.9 ) Incentive fee 3,361 3,167 194 6.1 Administration fee 635 521 114 21.9 Interest expense 1,994 2,415 (421 ) (17.4 ) Dividend expense on mandatorily redeemable preferred stock 2,309 2,057 252 12.3 Amortization of deferred financing fees 944 898 46 5.1 Other 1,553 1,227 326 26.6



Expenses before credits from Adviser 17,845 17,225

620 3.6 Credits to base management fee- loan servicing fee (2,628 ) (2,707 ) (79 ) (2.9 ) Credits to fees from Adviser-other (1,272 ) (1,395 ) 123 8.8 Total expenses net of credits 13,945 13,123 822 6.3 NET INVESTMENT INCOME 13,958 13,679 279 2.0 NET REALIZED AND UNREALIZED LOSS Net realized loss on investments and escrows (13,259 ) (5,406 ) (7,853 ) (145.3 ) Realized loss on extinguishment of debt (1,297 ) - (1,297 ) (100.0 ) Net unrealized depreciation of investments (9,912 ) (7,449 ) (2,463 ) (33.1 ) Net unrealized (appreciation) depreciation of other (1,261 ) 2,720 (3,981 ) NM



Net loss from investments and other (25,729 ) (10,135 )

(15,594 ) (153.9 )

NET (DECREASE) INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (11,771 )$ 3,544$ (15,315 ) NM % NM = Not Meaningful Investment Income Total interest income decreased slightly by 1.6% for the nine months ended June 30, 2014, as compared to the prior year period. This decrease was due primarily to several early payoffs at par during the nine months ended June 30, 2014, offset by new investments funding later during the period. The level of interest income from investments is directly related to the principal balance of the interest-bearing investment portfolio outstanding during the period, multiplied by the weighted average yield. The weighted average principal balance of our interest-bearing investment portfolio during the nine months ended June 30, 2014, was $282.7 million, compared to $286.2 million for the prior year period, a decrease of 1.2%. The annualized weighted average yield on our interest-bearing investment portfolio is based on the current stated interest rate on interest-bearing investments and remained consistent at 11.6% for the nine months ended June 30, 2014 and 2013. As of June 30, 2014, three of our portfolio companies were on non-accrual, with an aggregate debt cost basis of approximately $52.1 million, or 16.2%, of the cost basis of all debt investments in our portfolio. As of June 30, 2013, three portfolio companies were on non-accrual with an aggregate debt cost of approximately $53.7 million, or 15.9%, of the cost basis of all debt investments in our portfolio. Effective January 1, 2014, we placed Heartland Communications Group on non-accrual status and effective June 1, 2014 we placed Midwest Metal on non-accrual status. During the three months ended December 31, 2013, we sold our investment in LocalTel that had been on non-accrual status. See "Overview-Investment Highlights" for more information. During the nine months ended June 30, 2013, we sold our investments in three portfolio companies that had been on non-accrual status and wrote off our investment in one portfolio company that had been on non-accrual status. There were no other new non-accruals added and no non-accruals placed on accrual during the nine months ended June 30, 2014 and 2013. 48



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For the nine months ended June 30, 2014, other income consisted primarily of $0.7 million in dividend income received from Fedcap, $0.5 million in success fees received related to the early payoff of Thibaut at par, $0.4 million in legal settlement proceeds received related to a portfolio company previously sold, $0.5 million in prepaid success fees received from FDF, $0.1 million in prepayment fees received from POP, $0.3 million in dividend and other fees received from FDF and $0.6 million in success fees received related to our sale of substantially all of the assets of Lindmark and the ensuing pay down of our debt investments in Lindmark at par in September 2013. For the nine months ended June 30, 2013, other income consisted primarily of $1.1 million in success fees received from the early payoff of Westlake Hardware, Inc. ("Westlake") in December 2012 at par and an aggregate of $0.7 million in prepayment fees related to early payoffs of seven syndicate investments at par during the period.



The following tables list the investment income for our five largest portfolio company investments at fair value during the respective periods:

As of Nine Months Ended June 30, 2014 June 30, 2014 % of % of Investment Total Company Fair Value Portfolio Income Income J.America, Inc.(A) $ 17,045 6.4 % $ 966 3.5 % Francis Drilling Fluids, Ltd. 15,677 5.9 2,181 7.8 AG Transportation Holdings, LLC(B) 12,903 4.9 1,367 4.9 RBC Acquisition Corp. 12,496 4.7 2,986 10.7 Defiance Integrated Technologies, Inc. 12,133 4.6 559 2.0 Subtotal-five largest investments 70,254 26.5 8,059 28.9 Other portfolio companies 194,829 73.5 19,832 71.1 Other non-portfolio company revenue - - 12 - Total Investment Portfolio $ 265,083 100.0 % $ 27,903 100.0 % As of Nine Months Ended June 30, 2013 June 30, 2013 % of % of Investment Total Company Fair Value Portfolio Income Revenues RBC Acquisition Corp. $ 21,818 8.5 % $ 1,597 6.0 % Allen Edmonds Shoe Corporation(C) 19,531 7.7 1,169 4.4 Midwest Metal Distribution, Inc. 17,687 6.9 1,678 6.3 Francis Drilling Fluids, Ltd. 14,325 5.6 1,515 5.6 AG Transportation Holdings, LLC(B) 12,909 5.1 946 3.5 Subtotal-five largest investments 86,270 33.8 6,905 25.8 Other portfolio companies 169,001 66.2 19,777 73.8 Other non-portfolio company revenue - - 120 0.4 Total Investment Portfolio $ 255,271 100.0 % $ 26,802 100.0 %



(A) Investment added in December 2013.

(B) Investment added in December 2012.

(C) Investment exited in December 2013 at par.

Operating Expenses

Operating expenses, net of credits to fees from the Adviser, increased for the nine months ended June 30, 2014, by 6.3%, as compared to the prior year period. This increase was primarily due to increases in the net incentive fee, interest expense on our mandatorily redeemable preferred stock, and other expenses, which were partially offset by a decrease in interest expense on our Credit Facility. The increase of $0.7 million in the net incentive fee earned by the Adviser during the nine months ended June 30, 2014, as compared to the prior year period, was due primarily to the larger partial incentive fee waiver in the prior year period and, to a lesser extent, the increase in other income during the nine months ended June 30, 2014. During both nine month periods, there was a partial incentive fee waiver provided by the Adviser to ensure distributions to stockholders were covered entirely by net investment income.



The base management fee, incentive fee and associated credits are computed quarterly, as described under "Investment Advisory and Management Agreement" in Note 4 of the notes to our accompanying Condensed Consolidated Financial Statements and are summarized in the following table:

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Average total assets subject to base management fee(A) $ 294,700$ 282,200 Multiplied by prorated annual base management fee of 2.0% 1.5 %

1.5 %

Base management fee(B) $ 4,421$ 4,233 Portfolio company fee credit (669 ) (235 ) Senior syndicated loan fee waiver (88 ) (146 ) Net Base Management Fee $ 3,664$ 3,852 Loan servicing fee(B) 2,628 2,707 Credits to base management fee-loan servicing fee(B) (2,628 ) (2,707 ) Net Loan Servicing Fee $ - $ - Incentive fee(B) 3,361 3,167 Incentive fee credit (515 ) (1,014 ) Net Incentive Fee $ 2,846$ 2,153 Portfolio company fee credit (669 ) (235 ) Senior syndicated loan fee waiver (88 ) (146 ) Incentive fee credit (515 )



(1,014 )

Credit to Fees From Adviser-other(B) $ (1,272 )$ (1,395 )



(A) Average total assets subject to the base management fee is defined as total

assets, including investments made with proceeds of borrowings, less any

uninvested cash or cash equivalents resulting from borrowings, valued at the

end of the applicable quarter within the respective period and adjusted

appropriately for any share issuances or repurchases during the period.

(B) Reflected as a line item on our accompanying Condensed Consolidated

Statements of Operations.

The increase of $0.3 million in dividend expense on our mandatorily redeemable preferred stock during the nine months ended June 30, 2014, as compared to the prior year period, was primarily due to the higher monthly distribution amount on our Series 2021 Term Preferred Stock, which was issued in May 2014, as compared to our Series 2016 Term Preferred Stock, which was issued in November 2011 (resulting from more shares of our Series 2021 Term Preferred Stock being issued and outstanding, partially offset by a lower rate). Refer to "Liquidity and Capital Resources-Equity-Term Preferred Stock") for further discussion of our term preferred stock. The increase of $0.3 million in other expenses during the nine months ended June 30, 2014, as compared to the prior year period, was primarily due to the receipt of certain previously reserved for reimbursable deal expenses in the prior year period. Additionally there were increased due diligence expenses related to certain prospective portfolio companies during the nine months ended June 30, 2014, when compared to the prior year period.



Realized Losses and Unrealized Depreciation

Net Realized Loss on Investments and Escrows

For the nine months ended June 30, 2014, we recorded a net realized loss on investments and escrows of $13.3 million, which primarily consisted of realized losses of $10.8 million due to our sale of LocalTel for proceeds contingent on an earn-out and $2.8 million due to our sale of BAS for net proceeds of $4.7 million. For the nine months ended June 30, 2013, we recorded a net realized loss on investments and escrows of $5.4 million, which primarily consisted of realized losses of $2.4 million due to our sale of Viapack, Inc. ("Viapack") for net proceeds of $5.9 million, $0.9 million due to the write off of Access Television Network, Inc. ("Access TV") and $2.9 million due to our sale of KCH for net proceeds of $0.6 million. These realized losses were partially offset by realized gains of $0.8 million, which consisted of a combined $0.5 million of escrowed proceeds received in connection with exits on two investments in fiscal year 2012 and an aggregated $0.3 million of unamortized discounts related to the early payoffs at par of ten syndicated investments during the period. 50



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Realized Loss on Extinguishment of Debt

Realized loss on extinguishment of debt of $1.3 million is comprised primarily of the unamortized deferred financing costs at the time of the voluntary redemption of our then existing Series 2016 Term Preferred Stock in May 2014.

Net Unrealized Depreciation

Net unrealized appreciation (depreciation) of investments is the net change in the fair value of our investment portfolio during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are actually realized. During the nine months ended June 30, 2014, we recorded net unrealized depreciation of investments in the aggregate amount of $9.9 million, which included reversals totaling $16.7 million in cumulative unrealized depreciation, primarily related to our sales of LocalTel and BAS. Excluding reversals, we had $26.6 million in net unrealized depreciation for the nine months ended June 30, 2014. Over our entire portfolio, the net unrealized depreciation (excluding reversals) for the nine months ended June 30, 2014, consisted of approximately $26.3 million on our debt investments and approximately $0.3 million on our equity investments. The net realized gains (losses) and unrealized appreciation (depreciation) across our investments for the nine months ended June 30, 2014, were as follows: Nine Months Ended June 30, 2014 Reversal of Realized Unrealized Unrealized (Loss) Appreciation Depreciation Net Gain Portfolio Company Gain (Depreciation) (Appreciation) (Loss) BAS Broadcasting $ (2,765 ) $ 187 $ 6,905 $ 4,327 Defiance Integrated Technologies, Inc. - 3,639 - 3,639 Legend Communications of Wyoming, LLC - 2,703 - 2,703 Sunshine Media Holdings - 2,247 - 2,247 Francis Drilling Fluids, Ltd. - 1,118 - 1,118 WP Evenflo Group Holdings, Inc. - 1,105 - 1,105 Funko, LLC - 1,047 - 1,047 Sunburst Media-Louisiana, LLC - 974 - 974 GFRC Holdings, LLC - 600 45 645 Edge Adhesives Holdings, Inc. - 511 - 511 Westland Technologies, Inc. - 328 - 328 North American Aircraft Services, LLC - 326 - 326 Lignetics, Inc. - 299 - 299 LocalTel, LLC (10,774 ) - 10,218 (556 ) Targus Group International, Inc. - (640 ) - (640 ) Ameriqual Group, LLC - (829 ) - (829 ) FedCap Partners, LLC - (933 ) - (933 ) Alloy Die Casting Co. - (1,364 ) - (1,364 ) Precision Acquisition Group Holdings, Inc. - (3,831 ) - (3,831 ) Midwest Metal Distribution, Inc. - (13,452 ) - (13,452 ) RBC Acquisition Corp. - (21,117 ) - (21,117 ) Other, net ($250) 280 447 (445 ) 282 Total: $ (13,259 )$ (26,635 )$ 16,723$ (23,171 ) The largest driver of our net unrealized depreciation (excluding reversals) for the nine months ended June 30, 2014, was due to a decrease in financial and operational performance and, to a lesser extent, a decrease in comparable multiples used in valuing RBC ($21.1 million) and Midwest ($13.5 million). This unrealized depreciation for the nine months ended June 30, 2014, was partially offset by unrealized appreciation on certain portfolio companies due to incremental improvements in their financial and operational performance, and to a lesser extent, an increase in comparable multiples used in valuations, most notably that of Defiance ($3.6 million). During the nine months ended June 30, 2014, we invested $2.7 million in additional preferred equity capital in RBC. During the nine months ended June 30, 2013, we recorded net unrealized depreciation of investments in the aggregate amount of $7.4 million, which included the reversal of an aggregate of $10.7 million in combined unrealized depreciation primarily related to the sale of Viapack, the write off of Access TV and the sale of KCH. Excluding reversals, we had $18.2 million in net unrealized depreciation for the nine months ended June 30, 2013. Over our entire portfolio, the net unrealized depreciation is comprised of approximately $0.5 million of depreciation on our debt investments and approximately $6.9 million of depreciation on our equity investments for the nine months ended June 30, 2013. 51



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The net realized (losses) gains and unrealized appreciation (depreciation) across our investments for the nine months ended June 30, 2013, were as follows: Nine Months Ended June 30, 2013 Reversal of Realized Unrealized Unrealized (Loss) Appreciation Depreciation Net Gain Portfolio Company Gain (Depreciation) (Appreciation) (Loss) Viapack, Inc. $ (2,407 ) $ - $ 6,660 $ 4,253 Sunshine Media Holdings - 1,194 - 1,194 Westlake Hardware, Inc. - - 640 640 Kansas Cable Holdings, Inc. (2,906 ) 401 2,922 417 FedCap Partners, LLC - 384 - 384 Access Television Network, Inc. (903 ) - 903 - International Junior Golf Training Acquisition Company - 355 - 355 Westland Technologies, Inc. - (315 ) - (315 ) LocalTel, LLC - (327 ) - (327 ) Heartland Communications Group - (497 ) - (497 ) WP Evenflo Group Holdings, Inc. - (575 ) 3 (572 ) Saunders & Associates - (592 ) - (592 ) Sunburst Media-Louisiana, LLC - (750 ) - (750 ) Precision Acquisition Group Holdings, Inc. - (918 ) - (918 ) CMI Acquisition, LLC - (927 ) - (927 ) Legend Communications of Wyoming, LLC - (1,042 ) - (1,042 ) Francis Drilling Fluids, Ltd. - (1,060 ) - (1,060 ) BAS Broadcasting - (1,120 ) - (1,120 ) AG Transportation Holdings, LLC - (1,133 ) - (1,133 ) Lindmark Acquisition, LLC - (1,140 ) - (1,140 ) GFRC Holdings, LLC - (1,461 ) - (1,461 ) Defiance Integrated Technologies, Inc. - (2,867 ) - (2,867 ) RBC Acquisition Corp. - (6,741 ) - (6,741 ) Other, net ($250) 810 933 (379 ) 1,364 Total: $ (5,406 )$ (18,198 )$ 10,749$ (12,855 ) The largest driver of our net unrealized depreciation for the nine months ended June 30, 2013, was the notable net unrealized depreciation of RBC of $6.7 million due to a decline in its financial and operational performance. As noted earlier, we acquired a controlling position in RBC and infused $2.0 million of additional equity capital in the company in the form of preferred equity in March 2013. In addition, there was unrealized depreciation of Defiance of $2.9 million which was also due to a decline in its financial and operational performance and, to a lesser extent, a decrease in the comparable multiples used to estimate the fair value. This unrealized depreciation was partially offset by the reversal of unrealized depreciation of $6.7 million on Viapack, $2.9 million on KCH, $0.6 million on Westlake and $0.9 million on Access TV, all related to sales, write offs or payoffs during the period, as well as unrealized appreciation of Sunshine Media Holdings of $1.2 million due to an incremental improvement in the financial and operational performance of this portfolio company. As of June 30, 2014, the fair value of our investment portfolio was less than its cost basis by approximately $85.3 million, and our entire investment portfolio was valued at 75.7% of cost, as compared to cumulative net unrealized depreciation of $75.4 million and a valuation of our entire portfolio at 77.3% of cost as of September 30, 2013. This represents net unrealized depreciation of our investments of $9.9 million for the nine months ended June 30, 2014. Of our current investment portfolio, 12 portfolio companies originated before December 31, 2007, representing 31.1% of the entire cost basis of our portfolio, were valued at 47.0% of cost and include our three investments on non-accrual status. Our 37 portfolio companies originated after December 31, 2007, representing 68.9% of the entire cost basis of our portfolio, were valued at 88.6% of cost, none of these portfolio companies are on non-accrual status. We believe that our aggregate investment portfolio was valued at a depreciated value as of June 30, 2014, primarily due to the lingering effects of the recession that began in 2008 and its affect on the performance of certain of our portfolio companies and also because we were invested in certain industries that were disproportionately impacted by the recession. The cumulative net unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders; however, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution to stockholders. 52



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Net Unrealized (Appreciation) Depreciation of Other

Net unrealized (appreciation) depreciation of other is primarily made up of the net change in the fair value of our Credit Facility during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized. During the nine months ended June 30, 2014, we recorded net unrealized appreciation of borrowings of ($1.3) million compared to net unrealized depreciation of borrowings of $2.7 million for the nine months ended June 30, 2013. Our Credit Facility was fair valued at $36.6 million and $47.1 million as of June 30, 2014 and September 30, 2013, respectively.



LIQUIDITY AND CAPITAL RESOURCES

Operating Activities

Our cash flows from operating activities are primarily generated from the interest payments on debt securities that we receive from our portfolio companies, as well as net proceeds received through repayments or sales of our investments. We utilize this cash primarily to fund new investments, make interest payments on our Credit Facility, make distributions to our stockholders, pay management fees to the Adviser, and for other operating expenses. Net cash used in operating activities during the nine months ended June 30, 2014, was $0.8 million, as compared to net cash provided by operating activities of $19.8 million for the nine months ended June 30, 2013. The difference was primarily due to an increase in new investments, partially offset by a decrease in principal repayments during the nine months ended June 30, 2014. As of June 30, 2014, we had loans to, syndicated participations in, or equity investments in 49 private companies with an aggregate cost basis of approximately $350.4 million. As of June 30, 2013, we had loans to, syndicated participations in and/or equity investments in 46 private companies with an aggregate cost basis of approximately $353.8 million.



The following table summarizes our total portfolio investment activity during the nine months ended June 30, 2014 and 2013, at fair value:

Nine Months Ended June 30, 2014 2013



Beginning investment portfolio, at fair value $ 256,878$ 273,960

New investments 72,981



65,728

Disbursements to existing portfolio companies 10,180



5,129

Scheduled principal repayments (2,164 )



(5,425 )

Unscheduled principal repayments (45,169 )



(63,999 )

Net proceeds from sales of investments (4,700 )



(6,557 )

Net unrealized depreciation of investments (26,635 )



(18,198 )

Reversal of prior period depreciation on realization 16,723 10,749

Net realized loss on investments (13,289 )



(5,892 )

Increase in investment balance due to PIK(A) 208 133 Net change in premiums, discounts and amortization 70 (357 ) Investment Portfolio, at Fair Value $ 265,083 $

255,271



(A) Paid-in-kind ("PIK") interest is a non-cash source of income calculated at

the contractual rate stated in a loan agreement and is added to the principal

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The following table summarizes the contractual principal repayment and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments, as of June 30, 2014: For the Fiscal Years Ending September 30:



Amount

For the remaining three months ending September 30: 2014 $ 57,733 2015 29,023 2016 79,617 2017 27,431 2018 43,131 Thereafter 85,057 Total contractual repayments $ 321,992 Equity investments 29,131 Adjustments to cost basis on debt investments (740 ) Total Cost Basis of Investments Held at June 30, 2014: $ 350,383 Financing Activities Net cash used in financing activities for the nine months ended June 30, 2014 of $5.3 million consisted primarily of $13.2 million of distributions to common stockholders and $11.8 million of net repayments on our Credit Facility. These net uses were partially offset by the proceeds from the issuance of our Series 2021 Term Preferred Stock, net of the voluntary redemption of the then existing Series 2016 Term Preferred Stock. Net cash used in financing activities for the nine months ended June 30, 2013 of $13.0 million consisted primarily of distributions to common stockholders of $13.2 million.



Distributions to Stockholders

Common Stock Distributions

To qualify to be taxed as a RIC and thus avoid corporate-level federal income tax on the income that we distribute to our stockholders, we are required to distribute to our stockholders on an annual basis at least 90.0% of our investment company taxable income. Additionally, the covenants in our Credit Facility generally restrict the amount of distributions to stockholders that we can pay out to be no greater than our net investment income in each fiscal year. In accordance with these requirements, we declared and paid monthly cash distributions of $0.07 per common share for each of the nine months from October 2013 through June 2014, which totaled an aggregate of $13.2 million. In July 2014, our Board of Directors declared a monthly distribution of $0.07 per common share for each of July, August and September 2014. Our Board of Directors declared these distributions to our stockholders based on our estimates of our investment company taxable income for the fiscal year ending September 30, 2014. For the fiscal year ended September 30, 2013, which includes the three months ended December 31, 2012, our aggregate distributions to common stockholders totaled approximately $17.7 million, which were declared based on estimates of our investment company taxable income for that fiscal year. For our fiscal year ended September 30, 2013, our common stockholder distributions declared and paid exceeded our current and accumulated earnings and profits (after taking into account our preferred stock dividends), resulting in a partial return of capital of approximately $1.3 million. The return of capital was primarily due to accounting principles generally accepted in the U.S. ("GAAP") realized losses being recognized as ordinary losses for federal income tax purposes. The characterization of the common stockholder distributions declared and paid for the fiscal year ending September 30, 2014 will be determined at fiscal yearend based upon our taxable income for the full year and distributions paid during the full year. Such a characterization made on a quarterly basis may not be representative of the actual full year characterization. If we characterized our common stockholder distributions as of June 30, 2014, 100.0% would be a return of capital and 0.0% would be from ordinary income, primarily due to GAAP realized losses being recognized as ordinary losses for federal income tax purposes.



Preferred Stock Distributions

Our Board of Directors also declared, and we paid, monthly cash distributions of $0.1484375 per share of our Series 2016 Term Preferred Stock for each of the nine months from October 2013 through May 2014, which totaled an aggregate of $2.3 million. In May 2014, our Board of Directors declared, and we paid, a combined May and June 2014 cash distribution of $0.1968750 per share of our Series 2021 Term Preferred Stock. This covered a prorated portion of May 2014 from the time the stock was issued and outstanding and the full month of June 2014. In July 2014, our Board of Directors declared a monthly distribution of $0.140625 per share of Series 2021 Term Preferred Stock for each of July, August and September 2014. In accordance with GAAP, we treat these monthly distributions to preferred stockholders as an operating expense. For federal income tax purposes, distributions paid by us to preferred stockholders generally constitute ordinary income to the extent of our current and accumulated earnings and profits and have been characterized as ordinary income to our preferred stockholders since our Series 2016 Term Preferred Stock was issued in November 2011 and we anticipate the same characterization for our Series 2021 Term Preferred Stock. 54



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Table of Contents Equity Registration Statement We filed Post-effective Amendment No. 1 to our universal shelf registration statement (our "Registration Statement") on Form N-2 (File No. 333-185191) with the SEC on December 23, 2013, and subsequently filed Post-effective Amendment No. 2 on February 14, 2014, which the SEC declared effective on February 21, 2014. Our Registration Statement registers an aggregate of $300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock or preferred stock. We currently have the ability to issue up to $239.0 million in securities under our Registration Statement through one or more transactions. We issued approximately 2.4 million shares of our Series 2021 Term Preferred Stock under our Registration in May 2014. No other securities have been issued under our Registration Statement.



Common Stock

We anticipate issuing equity securities to obtain additional capital in the future. However, we cannot determine the terms of any future equity issuances or whether we will be able to issue equity on terms favorable to us, or at all. Additionally, when our common stock is trading below NAV per share, as it has from time to time over the last four years, the 1940 Act restricts our ability to obtain additional capital by issuing common stock. Generally, the 1940 Act provides that we may not issue and sell our common stock at a price below our then current NAV per common share, other than to our then existing common stockholders pursuant to a rights offering, without first obtaining approval from our stockholders and our independent directors. As of July 29, 2014, our closing market price was $10.13 per common share, a 17.5% premium to our June 30, 2014 NAV per common share of $8.62. To the extent that our common stock trades at a market price below our NAV per common share, we will generally be precluded from raising equity capital through public offerings of our common stock, other than pursuant to stockholder approval or a rights offering to existing common stockholders. At our Annual Meeting of Stockholders held on February 13, 2014, our stockholders approved a proposal authorizing us to sell shares of our common stock at a price below our then current NAV per share subject to certain limitations (including, but not limited to, that the number of shares issued and sold pursuant to such authority does not exceed 25.0% of our then outstanding common stock immediately prior to each such sale) for a period of one year from the date of approval, provided that our Board of Directors makes certain determinations prior to any such sale. We have not issued any common stock since February 2008 and have never issued common stock below the then current NAV per share. Term Preferred Stock Pursuant to our Registration Statement, in May 2014, we completed a public offering of approximately 2.4 million shares of our Series 2021 Term Preferred Stock, par value $0.001 per share, at a public offering price of $25.00 per share and a 6.75% rate. Gross proceeds totaled $61.0 million and net proceeds, after deducting underwriting discounts, commissions and offering expenses borne by us, were $58.5 million, a portion of which was used to voluntarily redeem all 1.5 million outstanding shares of our then existing Series 2016 Term Preferred Stock and the remainder was used to repay a portion of outstanding borrowings under our Credit Facility. In connection with the voluntary redemption of our Series 2016 Term Preferred Stock, we recognized a realized loss on extinguishment of debt of $1.3 million, which has been reflected on the Condensed Consolidated Statement of Operations and which is primarily comprised of the unamortized deferred issuance costs at the time of redemption. We incurred $2.5 million in total offering costs related to the issuance of our Series 2021 Term Preferred Stock, which are recorded as deferred financing fees on our accompanying Condensed Consolidated Statements of Assets and Liabilities and are being amortized over the redemption period ending June 30, 2021. The shares of our Series 2021 Term Preferred Stock have a redemption date of June 30, 2021, and are traded under the ticker symbol of "GLADO" on the NASDAQ Global Select Market. Our Series 2021 Term Preferred Stock is not convertible into our common stock or any other security and provides for a fixed dividend equal to 6.75% per year, payable monthly (which equates in total to approximately $4.1 million per year). We are required to redeem all of the outstanding Series 2021 Term Preferred Stock on June 30, 2021 for cash at a redemption price equal to $25.00 per share plus an amount equal to all unpaid dividends and distributions on such share accumulated to (but excluding) the date of redemption (the "Redemption Price"). We may additionally be required to mandatorily redeem some or all of the shares of our Series 2021 Term Preferred Stock early, at the Redemption Price, in the event of the following: (1) upon the occurrence of certain events that would constitute a change in control of us, we would be required to redeem all of the outstanding Series 2021 Term Preferred Stock and (2) if we fail to maintain an asset coverage ratio of at least 240.0%, we are required to redeem a portion of the outstanding Term Preferred Stock or otherwise cure the ratio redemption trigger. We may also voluntarily redeem all or a portion of the Series 2021 Term Preferred Stock at our option at the Redemption Price, at any time on or after June 30, 2017. If we fail to redeem our Series 2021 Term Preferred Stock pursuant to the mandatory redemption required on June 30, 2021, or in any other circumstance in which we are required to mandatorily redeem our Series 2021 Term Preferred Stock, then the fixed dividend rate will increase by 4.0% for so long as such failure continues. As of June 30, 2014, we have not redeemed any of our outstanding Series 2021 Term Preferred Stock. 55



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Pursuant to our prior registration statement, in November 2011, we completed a public offering of approximately 1.5 million shares of our Series 2016 Term Preferred Stock at a public offering price of $25.00 per share and a 7.125% rate. Gross proceeds totaled $38.5 million and net proceeds, after deducting underwriting discounts, commissions and offering expenses borne by us, were $36.4 million, a portion of which was used to repay a portion of outstanding borrowings under our Credit Facility. We incurred $2.1 million in total offering costs related to these transactions, which were recorded as deferred financing fees on our accompanying Condensed Consolidated Statements of Assets and Liabilities and were amortized over the redemption period ending December 31, 2016. In May 2014 when our Series 2016 Term Preferred Stock was voluntarily redeemed, the remaining unamortized costs at that time were fully written off as part of the realized loss on extinguishment of debt discussed above. Our Series 2016 Term Preferred Stock provided for a fixed dividend equal to 7.125% per year, payable monthly (which equates in total to approximately $2.7 million per year). The shares of our Series 2016 Term Preferred were traded under the ticker symbol of "GLADP" on the NASDAQ Global Select Market. In connection with the voluntary redemption, shares of our Series 2016 Term Preferred Stock were removed from listing on May 22, 2014. Our Series 2021 Term Preferred Stock has been recorded as a liability in accordance with GAAP and, as such, affects our asset coverage, exposing us to additional leverage risks. In addition, our Series 2021 Term Preferred Stock is not convertible into our common stock or any other security.



Revolving Credit Facility

On April 26, 2013, we, through our wholly-owned subsidiary, Gladstone Business Loan, LLC ("Business Loan"), entered into Amendment No. 6 to the fourth amended and restated credit agreement (our "Credit Facility") to extend the revolver period end date for one year to January 19, 2016. Our $137.0 million revolving Credit Facility was arranged by Key Equipment Finance Inc. (effective January 1, 2014, now known as Key Equipment Finance, a division of KeyBank National Association) ("Key Equipment") as administrative agent. Keybank, Branch Banking and Trust Company and ING Capital LLC also joined our Credit Facility as committed lenders. Subject to certain terms and conditions, our Credit Facility may be expanded from $137.0 million to a maximum of $237.0 million through the addition of other committed lenders to the facility. The interest rates on advances under our Credit Facility generally bear interest at a 30-day LIBOR plus 3.75% per annum, with a commitment fee of 0.5% per annum on undrawn amounts when our facility is drawn more than 50% and 1.0% per annum on undrawn amounts when our facility is drawn less than 50%. If our Credit Facility is not renewed or extended by January 19, 2016, all principal and interest will be due and payable on or before November 30, 2016. Prior to the April 26, 2013 amendment, on January 29, 2013, we, through Business Loan, amended our Credit Facility to remove the LIBOR minimum of 1.5% on advances. We incurred fees of $0.7 million in April 2013 and $0.6 million in January 2013 in connection with these amendments, which are being amortized through our Credit Facility's revolver period end date of January 19, 2016. All other terms of our Credit Facility remained generally unchanged at the time of these amendments. Interest is payable monthly during the term of our Credit Facility. Available borrowings are subject to various constraints imposed under our Credit Facility, based on the aggregate loan balance pledged by Business Loan, which varies as loans are added and repaid, regardless of whether such repayments are prepayments or made as contractually required. Our Credit Facility also requires that any interest or principal payments on pledged loans be remitted directly by the borrower into a lockbox account with Key Equipment as custodian. Key Equipment, which also serves as the trustee of the account, generally remits the collected funds to us once a month. Our Credit Facility contains covenants that require Business Loan to maintain its status as a separate legal entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions), and restrict material changes to our credit and collection policies without the lenders' consents. Our Credit Facility also generally limits payments on distributions to our stockholders to the aggregate net investment income for each of the twelve month periods ending September 30, 2014, 2015 and 2016. Business Loan is also subject to certain limitations on the type of loan investments it can apply as collateral towards the borrowing base in order to receive additional borrowing availability credit under our Credit Facility, including restrictions on geographic concentrations, sector concentrations, loan size, payment frequency and status, average life and lien property. Our Credit Facility further requires Business Loan to comply with other financial and operational covenants, which obligate Business Loan to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum number of 20 obligors required in the borrowing base. Additionally, we are subject to a performance guaranty that requires us to maintain (i) a minimum net worth (defined in our Credit Facility to include our mandatorily redeemable preferred stock) of $190.0 million plus 50.0% of all equity and subordinated debt raised after January 19, 2012, which equates to $220.5 million as of June 30, 2014, (ii) asset coverage with respect to senior securities representing indebtedness of at least 200.0%, in accordance with Section 18 of the 1940 Act and (iii) our status as a BDC under the 1940 Act and as a RIC under the Code. As of June 30, 2014, and as defined in the performance guaranty of our Credit Facility, we had a net worth of $242.0 million, asset coverage of 290% and an active status as a BDC and RIC. In addition, we had 31 obligors in the borrowing base of our Credit Facility as of June 30, 2014. As of June 30, 2014 we were in compliance with all of our Credit Facility covenants. 56



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On July 15, 2013, we, through Business Loan, entered into an interest rate cap agreement with Keybank, effective July 9, 2013 and expiring January 19, 2016, for a notional amount of $35.0 million that effectively limits the interest rate on a portion of our borrowings under our revolving line of credit pursuant to the terms of our Credit Facility. The one month LIBOR cap is set at 5.0%. We incurred a premium fee of $62 in conjunction with this agreement, which is recorded in other assets on our accompanying Condensed Consolidated Statements of Assets and Liabilities. As of June 30, 2014 and September 30, 2013, the fair value of our interest rate cap agreement was $0 and $4, respectively.



Contractual Obligations and Off-Balance Sheet Arrangements

We have lines of credit with certain of our portfolio companies that have not been fully drawn. Since these commitments have expiration dates and we expect many will never be fully drawn, the total commitment amounts do not necessarily represent future cash requirements. When investing in certain private equity funds, we may have uncalled capital commitments depending on the agreed upon terms of our committed ownership interest. These capital commitments usually have a specific date in the future set as a closing date, at which time the commitment is either funded or terminates. As of June 30, 2014 and September 30, 2013, we had uncalled capital commitments related to our partnership interest in Leeds Novamark Capital I, L.P. The following table summarizes our contractual obligations as of June 30, 2014, at cost: Payments Due by Fiscal Years Less than Contractual Obligations(A) 1 Year 1-3 Years 4-5 Years After 5 Years Total Credit Facility(B) $ - $ 35,100 $ - $ - $ 35,100 Term preferred stock - - - 61,000 61,000 Interest on contractual obligations(C) 1,639 15,537 8,235 7,206 32,617 Total $ 1,639$ 50,637$ 8,235$ 68,206$ 128,717 (A) Excludes our unused line of credit and uncalled capital commitments to our portfolio companies in an aggregate amount of $7.3 million as of June 30, 2014. (B) Principal balance of borrowings under our Credit Facility, based on the



current contractual maturity as of June 30, 2014 due to the revolving nature

of the facility. In April 2013, we amended our Credit Facility to extend the

revolver period end date until January 2016.



(C) Includes estimated interest payments on our Credit Facility and dividend

obligations on our Series 2021 Term Preferred Stock. The amount of interest

calculated for purposes of this table was based upon rates and balances of

our Credit Facility as of June 30, 2014. Dividend payments on our Series

2021 Term Preferred Stock assume quarterly dividend declarations and monthly

dividend distributions to stockholders through the date of mandatory

redemption.

Of our interest bearing debt investments as of June 30, 2014, 44.0% have a success fee component, which enhances the yield on our debt investments. Unlike PIK income, we do not recognize success fees as income until they are received in cash. As a result, as of June 30, 2014, we have an aggregate off-balance sheet success fee receivable on our accruing debt investments of $11.0 million, or approximately $0.53 per common share, that would be owed to us based on our current portfolio if fully paid off. Due to their contingent nature, there are no guarantees that we will be able to collect all of these success fees or know the timing of such collections.



CRITICAL ACCOUNTING POLICIES

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported consolidated amounts of assets and liabilities, including disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the periods reported. Actual results could differ materially from those estimates under different assumptions or conditions. We have identified our investment valuation policy (the "Policy"), which is described below, as our most critical accounting policy.



Investment Valuation

The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded in our accompanying Condensed Consolidated Financial Statements. 57



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Accounting Recognition

We record our investments at fair value in accordance with the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification Topic 820, "Fair Value Measurements and Disclosures" ("ASC 820") and the 1940 Act. Investment transactions are recorded on the trade date. Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and amortized cost basis of the investment, without regard to unrealized depreciation or appreciation previously recognized, and include investments charged off during the period, net of recoveries. Unrealized depreciation or appreciation primarily reflect the change in investment fair values, including the reversal of previously recorded unrealized depreciation or appreciation when gains or losses are realized. In accordance with ASC 820, our investments' fair value is determined to be the price that would be received for an investment in a current sale, which assumes an orderly transaction between market participants on the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. ASC 820 also establishes the following three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of a financial instrument as of the measurement date.



Level 1-inputs to the valuation methodology are quoted prices (unadjusted)

for identical financial instruments in active markets;



Level 2-inputs to the valuation methodology include quoted prices for

similar financial instruments in active or inactive markets, and inputs that are observable for the financial instrument, either directly or



indirectly, for substantially the full term of the financial instrument.

Level 2 inputs are in those markets for which there are few transactions,

the prices are not current, little public information exists or instances

where prices vary substantially over time or among brokered market makers;

and Level 3-inputs to the valuation methodology are unobservable and



significant to the fair value measurement. Unobservable inputs are those

inputs that reflect assumptions that market participants would use when

pricing the financial instrument and can include the Valuation Team's

assumptions based upon the best available information.

When a determination is made to classify our investments within Level 3 of the valuation hierarchy, such determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable, or Level 3, inputs, observable inputs (or, components that are actively quoted and can be validated to external sources). The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. As of June 30, 2014 and September 30, 2013, all of our investments were valued using Level 3 inputs and during the nine months ended June 30, 2014 and 2013, there were no investments transferred into or out of Level 1, 2 or 3.



Board Responsibility

In accordance with the 1940 Act, our Board of Directors has the ultimate responsibility for reviewing and approving, in good faith, the fair value of our investments based on the established Policy. Our Board of Directors reviews valuation recommendations that are provided by professionals of the Adviser and Administrator with oversight and direction from the Valuation Officer, employed by the Administrator (the "Valuation Team"). There is no single standard for determining fair value (especially for privately-held businesses), as fair value depends upon the specific facts and circumstances of each individual investment. In determining the fair value of our investments, the Valuation Team, led by the Valuation Officer, uses the Policy, which has been approved by our Board of Directors, and each quarter our Board of Directors reviews the Policy to determine if changes thereto are advisable and also reviews whether the Valuation Team has applied the Policy consistently.



Use of Third Party Valuation Firms

The Valuation Team engages third party valuation firms to provide independent assessments of fair value of certain of our investments. Currently, the third-party service provider Standard & Poor's Securities Evaluation, Inc. ("SPSE") provides estimates of fair value on our non-syndicated debt investments.

The Valuation Team generally assigns SPSE's estimates of fair value to our debt investments where we do not have the ability to effectuate a sale of the applicable portfolio company. The Valuation Team corroborates SPSE's estimates of fair value using one or more of the valuation techniques discussed below. The Valuation Team's estimate of value on a specific debt investment may significantly differ from SPSE's. When this occurs, our Board of Directors reviews whether the Valuation Team has followed the Policy and whether the Valuation Team's recommended value is reasonable in light of the Policy and other facts and circumstances and then votes to accept or reject the Valuation Team's recommended valuation. 58



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Valuation Techniques

In accordance with ASC 820, the Valuation Team uses the following techniques when valuing our investment portfolio:

Total Enterprise Value-In determining the fair value using a total

enterprise value ("TEV"), the Valuation Team first calculates the TEV of

the portfolio company by incorporating some or all of the following

factors: the portfolio company's ability to make payments and other

specific portfolio company attributes; the earnings of the portfolio

company (the trailing or projected twelve month revenue or earnings before

interest, taxes, depreciation and amortization ("EBITDA")); EBITDA or revenue multiples obtained from our indexing methodology whereby the



original transaction EBITDA or revenue multiple at the time of our closing

is indexed to a general subset of comparable disclosed transactions and

EBITDA or revenue multiples from recent sales to third parties of similar securities in similar industries; a comparison to publicly traded securities in similar industries, and other pertinent factors. The Valuation Team generally references industry statistics and may use outside experts when gathering this information. Once the TEV is



determined for a portfolio company, the Valuation Team then allocates the

TEV to the portfolio company's securities in order of their relative

priority in the capital structure. Generally, the Valuation Team uses TEV

to value our equity investments and, in the circumstances where we have

the ability to effectuate a sale of a portfolio company, our debt

investments.

TEV is primarily calculated using EBITDA or revenue multiples; however, TEV may also be calculated using a discounted cash flow ("DCF") analysis whereby future expected cash flows of the portfolio company are discounted to determine a net present value using estimated risk-adjusted discount rates, which incorporate adjustments for nonperformance and liquidity risks. Generally, the Valuation Team uses the DCF to calculate TEV to corroborate estimates of value for our equity investments where we do not have the ability to effectuate a sale of a portfolio company or for debt of credit impaired portfolio companies.



Yield Analysis-The Valuation Team generally determines the fair value of

our debt investments using the yield analysis, which includes a DCF

calculation and the Valuation Team's own assumptions, including, but not

limited to, estimated remaining life, current market yield, current

leverage, and interest rate spreads. This technique develops a modified

discount rate that incorporates risk premiums including, among other

things, increased probability of default, increased loss upon default and

increased liquidity risk. Generally, the Valuation Team uses the yield analysis to corroborate both estimates of value provided by SPSE and market quotes.



Market Quotes-For our syndicate investments for which a limited market

exists, fair value is generally based on readily available and reliable

market quotations which are corroborated by the Valuation Team (generally

by using the yield analysis explained above). In addition, the Valuation

Team assesses trading activity for similar syndicated investments and

evaluates variances in quotations and other market insights to determine

if any available quoted prices are reliable. Typically, the Valuation Team

uses the lower indicative bid price ("IBP") in the bid-to-ask price range

obtained from the respective originating syndication agent's trading desk

on or near the valuation date. The Valuation Team may take further steps

to consider additional information to validate that price in accordance

with the Policy. Investments in Funds-For equity investments in other funds, where we



cannot effectuate a sale, the Valuation Team generally determines the fair

value of our uninvested capital at par value and of our invested capital

at the NAV provided by the fund. The Valuation Team may also determine

fair value of our investments in other investment funds based on the capital accounts of the underlying entity. In addition to the above valuation techniques, the Valuation Team may also consider the other factors when determining fair values of our investments, including but not limited to: the nature and realizable value of the collateral, including external parties' guaranties; any relevant offers or letters of intent to acquire the portfolio company; and the markets in which the portfolio company operates. If applicable, new non-syndicated debt and equity investments made during the three months ended June 30, 2014 are generally valued at original cost basis. Fair value measurements of our investments may involve subjective judgments and estimates and due to the inherent uncertainty of determining these fair values, the fair value of our investments may fluctuate from period to period. Additionally, changes in the market environment and other events that may occur over the life of the investment may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If we were required to liquidate a portfolio investment in a forced or liquidation sale, we could realize significantly less than the value at which it is recorded. Refer to Note 3-Investments in the accompanying notes to our accompanying Condensed Consolidated Financial Statements included elsewhere in this report for additional information regarding fair value measurements and our application of ASC 820. 59



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Credit Monitoring and Risk Rating

The Adviser monitors a wide variety of key credit statistics that provide information regarding our portfolio companies to help us assess credit quality and portfolio performance and, in some instances, that is used as inputs in our valuation techniques. Generally, we, through the Adviser, participate in periodic board meetings of our portfolio companies in which we hold board seats and also require them to provide annual audited and monthly unaudited financial statements. Using these statements or comparable information and board discussions, the Adviser calculates and evaluates certain credit statistics. The Adviser risk rates all of our investments in debt securities. The Adviser does not risk rate our equity securities. For syndicated loans that have been rated by a Nationally Recognized Statistical Rating Organization ("NRSRO") (as defined in Rule 2a-7 under the 1940 Act), the Adviser generally uses the average of two corporate level NRSRO's risk ratings for such security. For all other debt securities, the Adviser uses a proprietary risk rating system. The Adviser's risk rating system uses a scale of 0 to >10, with >10 being the lowest probability of default. This system is used to estimate the probability of default on debt securities and the expected loss if there is a default. These types of systems are referred to as risk rating systems and are used by banks and rating agencies. The risk rating system covers both qualitative and quantitative aspects of the business and the securities we hold. During the three months ended June 30, 2014, we modified our risk rating model to incorporate additional factors in our qualitative and quantitative analysis. While the overall process did not change, we believe the additional factors enhance the quality of the risk ratings of our investments. No adjustments were made to prior periods as a result of this modification. For the debt securities for which the Adviser does not use a third-party NRSRO risk rating, it seeks to have its risk rating system mirror the risk rating systems of major risk rating organizations, such as those provided by an NRSRO. While the Adviser seeks to mirror the NRSRO systems, we cannot provide any assurance that the Adviser's risk rating system will provide the same risk rating as an NRSRO for these securities. The following chart is an estimate of the relationship of the Adviser's risk rating system to the designations used by two NRSROs as they risk rate debt securities of major companies. Because the Adviser's system rates debt securities of companies that are unrated by any NRSRO, there can be no assurance that the correlation to the NRSRO set out below is accurate. The Adviser believes its risk rating would be higher than a typical NRSRO risk rating because the risk rating of the typical NRSRO is designed for larger businesses. However, the Adviser's risk rating has been designed to risk rate the securities of smaller businesses that are not rated by a typical NRSRO. Therefore, when the Adviser uses its risk rating on larger business securities, the risk rating is higher than a typical NRSRO rating. The Adviser believes the primary difference between the it's risk rating and the rating of a typical NRSRO is that the Adviser's risk rating uses more quantitative determinants and includes qualitative determinants that it believes are not used in the NRSRO rating. It is the Adviser's understanding that most debt securities of medium-sized companies do not exceed the grade of BBB on an NRSRO scale, so there would be no debt securities in the middle market that would meet the definition of AAA, AA or A. Therefore, the Adviser's scale begins with the designation >10 as the best risk rating which may be equivalent to a BBB from an NRSRO; however, no assurance can be given that a >10 on the Adviser's scale is equal to a BBB or Baa2 on an NRSRO scale. The scale below gives an indication of the probability of default and the magnitude of the expected loss if there is a default. Adviser's First Second System NRSRO NRSRO Description(A) >10 Baa2 BBB Probability of Default (PD) during the next 10 years is 4.0% and the Expected Loss upon Default (EL) is 1.0% or less 10 Baa3 BBB- PD is 5% and the EL is 1.0% to 2.0% 9 Ba1 BB+ PD is 10% and the EL is 2.0% to 3.0% 8 Ba2 BB PD is 16% and the EL is 3.0% to 4.0% 7 Ba3 BB- PD is 17.8% and the EL is 4.0% to 5.0% 6 B1 B+ PD is 22% and the EL is 5.0% to 6.5% 5 B2 B PD is 25% and the EL is 6.5% to 8.0% 4 B3 B- PD is 27% and the EL is 8.0% to 10.0% 3 Caa1 CCC+ PD is 30% and the EL is 10.0% to 13.3% 2 Caa2 CCC PD is 35% and the EL is 13.3% to 16.7% 1 Caa3 CC PD is 65% and the EL is 16.7% to 20.0% 0 PD is 85% or there is a payment default and the EL is greater N/A D than 20%



(A) The default rates set forth are for a 10 year term debt security. If a debt

security is less than 10 years, then the probability of default is adjusted

to a lower percentage for the shorter period, which may move the security

higher on this risk rating scale.

The following table lists the risk ratings for all non-syndicated loans in our portfolio as of June 30, 2014 and September 30, 2013, representing approximately 78.2% and 80.5%, respectively, of the principal balance of all debt investments in our portfolio at the end of each period: 60



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Table of Contents As of As of June 30, September 30, Rating 2014 2013 Highest 9.0 10.0 Average 5.4 5.9 Weighted Average 5.0 5.5 Lowest 3.0 2.0 For syndicated loans that are currently rated by an NRSRO, the Adviser generally uses the average of two corporate level NRSRO ratings available and then converts it into a rating using the Adviser's system per the table above. The following table lists the Adviser's risk ratings for all syndicated loans in our portfolio that were rated by an NRSRO as of June 30, 2014 and September 30, 2013, representing approximately 19.5% and 13.7%, respectively, of the principal balance of all debt investments in our portfolio at the end of each period: As of As of June 30, September 30, Rating 2014 2013 Highest 10.0 5.5 Average 5.3 4.8 Weighted Average 5.4 4.9 Lowest 4.0 2.5



The following table lists the risk ratings for all syndicated loans in our portfolio that were not rated by an NRSRO. As of June 30, 2014 and September 30, 2013, these loans represented 2.3% and 5.8%, respectively, of the principal balance of all debt investments in our portfolio at the end of each period:

As of As of June 30, September 30, Rating 2014 2013 Highest 4.0 5.0 Average 4.0 4.5 Weighted Average 4.0 4.6 Lowest 4.0 4.0 Tax Status Federal Income Taxes We intend to continue to maintain our qualification as a RIC under Subchapter M of the Code for federal income tax purposes. As a RIC, we are not subject to federal income tax on the portion of our taxable income and gains that we distribute to our stockholders. To maintain our qualification as a RIC, we must meet certain source-of-income and asset diversification requirements. In addition, in order to qualify to be taxed as a RIC, we must also meet certain annual stockholder distribution requirements. To satisfy the RIC annual distribution requirement, we must distribute to stockholders at least 90.0% of our investment company taxable income, as defined by the Code. Our policy generally is to make distributions to our stockholders in an amount up to 100.0% of our investment company taxable income. In an effort to limit certain federal excise taxes imposed on RICs, we currently intend to distribute to our stockholders, during each calendar year, an amount at least equal to the sum of: (1) 98.0% of our ordinary income for the calendar year, (2) 98.2% of our capital gain net income for the one-year period ending on October 31 of the calendar year, and (3) any ordinary income and capital gain net income from preceding years that were not distributed during such years. Under the RIC Modernization Act (the "RIC Act"), we are permitted to carry forward capital losses incurred in taxable years beginning after September 30, 2011, for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused. Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under the previous regulation. 61



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Table of Contents Revenue Recognition Interest Income Recognition Interest income, adjusted for amortization of premiums, acquisition costs, and amendment fees and the accretion of original issue discounts ("OID"), is recorded on the accrual basis to the extent that such amounts are expected to be collected. Generally, when a loan becomes 90 days or more past due, or if our qualitative assessment indicates that the debtor is unable to service its debt or other obligations, we will place the loan on non-accrual status and cease recognizing interest income on that loan for financial reporting purposes until the borrower has demonstrated the ability and intent to pay contractual amounts due. However, we remain contractually entitled to this interest. Interest payments received on non-accrual loans may be recognized as income or applied to the cost basis, depending upon management's judgment. Generally, non-accrual loans are restored to accrual status when past due principal and interest are paid and, in management's judgment, are likely to remain current, or, due to a restructuring, the interest income is deemed to be collectable. As of June 30, 2014, three portfolio companies were on non-accrual with an aggregate debt cost basis of approximately $52.1 million, or 16.2% of the cost basis of all debt investments in our portfolio, and an aggregate debt fair value of approximately $13.6 million, or 5.6% of the fair value of all debt investments in our portfolio. As of September 30, 2013, two portfolio companies were on non-accrual with an aggregate debt cost basis of approximately $39.5 million, or 12.6% of the cost basis of all debt investments in our portfolio, and an aggregate debt fair value of approximately $5.8 million, or 2.4% of the fair value of all debt investments in our portfolio. We currently hold, and we expect to hold in the future, some loans in our portfolio that contain OID or PIK provisions. We recognize OID for loans originally issued at discounts and recognize the income over the life of the obligation based on an effective yield calculation. PIK interest, computed at the contractual rate specified in a loan agreement, is added to the principal balance of a loan and recorded as income over the life of the obligation and therefore, the actual collection of PIK income may be deferred until the time of debt principal repayment. To maintain our ability to be taxed as a RIC, we may need to pay out both of our OID and PIK non-cash income amounts in the form of distributions, even though we have not yet collected the cash on either. As of June 30, 2014 and September 30, 2013, we had 20 and 19 original OID loans, respectively, primarily from the syndicated investments in our portfolio. We recorded OID income of $59 and $0.2 million for the three and nine months ended June 30, 2014, respectively, as compared to $69 and $0.2 million for the three and nine months ended June 30, 2013, respectively. The unamortized balance of OID investments as of June 30, 2014 and September 30, 2013, totaled $0.8 million and $1.0 million, respectively. As of June 30, 2014, and September 30, 2013, we had three investments which had a PIK interest component. We recorded PIK income of $80 and $0.3 million for the three and nine months ended June 30, 2014, respectively, as compared to $62 and $0.2 million for the three and nine months ended June 30, 2013, respectively. We collected $0 PIK interest in cash in each of the nine months ended June 30, 2014 and 2013.



Other Income Recognition

We generally record success fees upon receipt of cash. Success fees are contractually due upon a change of control in a portfolio company, typically from an exit or sale. We received an aggregate of $1.6 million in success fees during the nine months ended June 30, 2014, which resulted from $0.5 million related to the early payoff at par of Thibaut in June 2014, $0.5 million prepayment by FDF in February 2014 and $0.6 million related to our sale of substantially all of the assets in Lindmark and the ensuing pay down of our debt investments in Lindmark at par in September 2013. We received $1.1 million in success fees during the nine months ended June 30, 2013, which resulted from the early payoff of Westlake at par in December 2012. As of June 30, 2014 and September 30, 2013, our aggregate off-balance sheet success fee receivable on our accruing debt investments totaled approximately $11.0 million and $16.9 million, respectively. We record prepayment fees upon receipt of cash. Prepayment fees are contractually due at the time we exit an investment, based on the respective investment's prepayment fee schedule. During the nine months ended June 30, 2014, we received an aggregate of $0.3 million in prepayment fees from the early payoffs at par of one of our proprietary investments and four of our syndicated investments (including one partial paydown). During the nine months ended June 30, 2013, we received an aggregate of $0.7 million of prepayment fees which resulted from the early payoffs of seven of our syndicated investments during the period. Dividend income on equity investments is accrued to the extent that such amounts are expected to be collected and if we have the option to collect such amounts in cash. During the nine months ended June 30, 2014, we recorded an aggregate of $1.0 million of dividend income, net of estimated income taxes payable, which resulted from $0.2 million on our preferred equity investment in FDF, $0.7 million on our investment in FedCap and $0.1 million on our preferred equity investment in Funko, LLC. We did not record any dividend income during the nine months ended June 30, 2013. Success fees, prepayment fees and dividend income are all recorded in other income in our accompanying Condensed Consolidated Statements of Operations. In addition, we received $0.4 million in May 2014 from a legal settlement related to a previously exited portfolio company that was recorded in other income during the three ended June 30, 2014. 62



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Table of Contents

Recent Accounting Pronouncements

See Note 2-Summary of Significant Accounting Policies in the accompanying notes to our Condensed Consolidated Financial Statements included elsewhere in this report for a description and our adoption of recent accounting pronouncements.


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Source: Edgar Glimpses


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