Note 6. Transactions with Related Parties (continued)
While the Investment Advisory Agreement with the Advisor neither includes nor contemplates the inclusion of unrealized gains in the calculation of the capital gains incentive fee, pursuant to an interpretation of an American Institute for Certified Public Accountants Technical Practice Aid for investment companies, the Company includes unrealized gains in the calculation of the capital gains incentive fee expense and related accrued capital gains incentive fee. This accrual reflects the incentive fees that would be payable to the Advisor if the Company’s entire portfolio was liquidated at its fair value as of the balance sheet date even though the Advisor is not entitled to an incentive fee with respect to unrealized gains unless and until such gains are actually realized.
Incentive fees for the three and nine months ended September 30, 2022 were $578,218 and $1,085,908, respectively. For three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, the Company incurred incentive fees of $124,180 respectively in each period, which were subsequently waived. For the three and nine months ended September 30, 2022 Star Mountain Fund Management, LLC elected to voluntarily waive $578,218 and $1,311,791 of such incentive fees, respectively. Incentive fees for the period from May 14, 2021 (date of formation) to September 30, 2022 were $1,311,791. The incentive fees waived for the three and nine months ended September 30, 2022 are not recoupable and there is no guarantee that Star Mountain Fund Management, LLC will waive incentive fees in the future, and Star Mountain Fund Management, LLC may discontinue or modify any such waivers in the future at its discretion. As of September 30, 2022 no incentive fees remained payable and as of December 31, 2021, $225,883 remained payable which had subsequently been waived.
Administration Fees
The Company has entered into the Administration Agreement with Star Mountain Fund Management, LLC, under which the Company reimburses the Administrator for its allocable portion of overhead and other expenses, including the costs of furnishing the Company with office facilities and equipment and providing clerical, bookkeeping, record-keeping and other administrative services at such facilities, and the Company’s allocable portion of the cost of the chief financial officer and chief compliance officer and their respective staffs. To the extent that the Administrator outsources any of its functions, the Company will pay the fees associated with such functions on a direct basis, without incremental profit, to the Administrator. For the three and nine months ended September 30, 2022 the Company incurred reimbursement expenses of $24,960 and $177,926 included under General and Administrative fees on the Statements of Operations, respectively. For the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021 reimbursement expense was $(6,917) and $115,068 as shown under General and Administrative fees on the Statements of Operations, respectively. As of September 30, 2022, $85,683 of reimbursement expense was payable as shown in the Statements of Assets and Liabilities as reimbursement expense payable and as of December 31, 2021 no reimbursement expense was payable.
Directors’ Fees
The Company incurs certain fees and expenses paid to the Company’s independent directors (including expenses and costs related to meetings of the independent directors); for the three and nine months ended September 30, 2022, directors’ expenses were $20,165 and $59,836, as shown on the Statements of Operations, respectively. For the three months ended September 30, 2021 and the period from May 14, 2021 (date of formation) to September 30, 2021 director expense was $20,164 and 30,685, as shown on the Statements of Operations, respectively. As of September 30, 2022 and December 31, 2021, $10,685 and $10,849 of directors’ expenses remained payable, respectively, which is included in professional fees payable as shown on the Statements of Assets and Liabilities.
The Administrator has entered into a sub-administration agreement with SS&C Technologies, Inc. (the “Sub-Administrator”), under which the Sub-Administrator provides various accounting and administrative services to the Company. Administrative services may include maintenance of the Company’s books and records, processing of investor transactions, and calculation of the NAV. For the three and nine months ended September 30, 2022, the Company incurred expenses for services provided by the Sub-Administrator of $117,226 and $245,427, respectively, which is included in professional fees on the Statements of Operations. For three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021 the Company incurred expenses for services provided by the Sub-Administrator of $39,228 and $55,292, respectively, which is included in professional fees on the Statements of Operations. As of September 30, 2022 and December 31, 2021 $45,496 and $7,139 remained payable, respectively, which are included in professional fees payable on the Statements of Assets and Liabilities.
Note 7. Borrowings
On July 2, 2021, the Company entered into a Loan and Servicing Agreement (the “Loan Agreement”) with Sterling National Bank (“SNB”), which provides for a $50 million senior secured revolving credit facility (“Secured Credit Facility”). In February 2022, SNB was subsequently acquired by Webster Bank (“Webster”), which took over the relationship with the Company. Webster serves as administrative agent and collateral agent. On January 12, 2022, the Company entered into a second amendment to the Secured Credit Facility to upsize the Secured Credit Facility to $80 million, with Webster committing $50 million ($10 million incremental), Investors Bank committing $15 million ($7.5 million incremental), and Blue Ridge Bank committing $15 million ($7.5 million incremental). On May 6, 2022, the Company entered into an amendment to the Secured Credit Facility to upsize the Secured Credit Facility to $125 million. Forbright Bank and First Foundation Bank joined the Secured Credit Facility with commitments of $17.5 million and $15.0 million, respectively. In conjunction with Forbright Bank and First Foundation Bank being admitted into the Secured Credit Facility, Webster increased its commitment by $12.5 million to $62.5 million. On July 21, 2022 Investors Bank transferred its commitment of $15 million to Apple Bank for Savings. On September 16, 2022, the Company entered into an amendment to the Secured Credit Facility to upsize the Secured Credit Facility to $200 million. In conjunction with this amendment, Mitsubishi HC Capital America, Inc., Woodforest National Bank, and Peapack-Gladstone Bank agreed to become lenders with $20 million, $20 million, and $15 million commitments, respectively, in the Secured Credit Facility. Additionally, Webster increased its commitment by $5 million to $67.5 million, Blue Ridge Bank increased its commitment by $10 million to $25 million and First Foundation Bank increased its commitment by $5 million to $20 million.
Borrowings can be increased to a maximum of $350 million in accordance with the Secured Credit Facility accordion feature terms and conditions and are limited by various advance rates and concentration limits.
As of September 30, 2022, and December 31, 2021, the total fair value of the borrowings outstanding under the Secured Credit Facility was $119,000,000 and $34,000,000, respectively.
Advances under the Secured Credit Facility bear interest at a per annum rate equal to the Prime rate in effect on such day minus 0.35%. Inclusive of syndication, agency, and administrative fees paid to Webster, the total annualized cost of capital is estimated to be 4.25%. The Company will also pay a non-utilization fee on the average daily unused amount of the aggregate commitments until the commitment termination date (as defined in the Loan Agreement). As of September 30, 2022, the total commitments under the Secured Credit Facility were $200 million. Proceeds from borrowings under the Secured Credit Facility may be used to finance certain investments, fulfill payment obligations under the Secured Credit Facility, make distributions/payments permitted by the Loan Agreement. All amounts outstanding under the Secured Credit Facility must be repaid by the fourth anniversary of the initial closing of the Secured Credit Facility. The Company’s obligations to the lenders under the Secured Credit Facility are secured by a first priority security interest in substantially all of the Company’s assets, subject to certain exclusions.
Borrowings under the Secured Credit Facility are limited by various advance rates and concentration limits. In connection with the Secured Credit Facility, the Company has made certain customary representations/warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. The Secured Credit Facility is subject to customary events of default for similar financing transactions. Upon the occurrence and during the continuation of an event of default, Webster may declare the outstanding advances and all other obligations under the Secured Credit Facility immediately due and payable.
On June 22, 2022 the Company entered into a Loan and Security Agreement with East West Bank, which provides for cash or credit advances of up to $25 million (the “Revolving Credit Line”) pursuant to the terms and conditions of the Revolving Credit Line. On September 26, 2022, the Company entered into an amendment with East West Bank, to downsize the Revolving Credit Line to $21 million. All amounts outstanding under the Revolving Credit Line must be repaid by June 22, 2023. As of September 30, 2022, and December 31, 2021, the total fair value of the borrowings outstanding under the Revolving Credit Line was $16,000,000 and $0, respectively.
Advances under the Revolving Credit Line bear interest at a per annum rate equal to the prime rate in effect on such day or 4.75%, whichever is greater. The Company will also pay certain fees under the Revolving Credit Line, including unused fees of 0.35% per annum of the average unused portion of the Revolving Credit Line during any fiscal quarter when the average daily balance of the aggregate outstanding principal amount of the Advances in any fiscal quarter during the term of the Revolving Credit Line equals or exceeds 60% of the Revolving Credit Line amount and 0.75% per annum of the average unused portion of the Revolving Credit Line during any fiscal quarter when the average daily balance of the aggregate outstanding principal amount of the Advances in any fiscal quarter during the term of the Revolving Credit Line is less than 60% of the Revolving Credit Line amount.
Note 7. Borrowings (continued)
Proceeds from borrowings under the Revolving Credit Line may be used for working capital, to finance the acquisition by the Company of certain investments, to make deposits, to pay management fees and legal fees, and to fund obligations in accordance with the Company’s certificate of incorporation.
The Company’s obligations to East West Bank under the Revolving Credit Line are secured by a first priority security interest in the capital commitments of the Company’s investors, subject to certain exclusions.
In connection with the Revolving Credit Line, the Company has made certain customary representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. In addition, under the Revolving Credit Line, the Lender may prohibit the Company from repurchasing its shares of common stock from its investors during a quarter if, in the prior quarter, repurchase requests from the Company’s investors exceed 10% of the Company’s total capital commitments. The Revolving Credit Line is subject to customary events of default for similar financing transactions. Upon the occurrence and during the continuation of an event of default, East West Bank may declare the outstanding advances and all other obligations under the Revolving Credit Line immediately due and payable.
The components of the Company’s interest expense and other debt financing expenses, average outstanding balances and average stated interest rates (i.e. the rate in effect plus spread) were as follows:
| | | For the three months ended September 30, 2022 | | | For the three months ended September 30, 2021 | |
| Interest expense - Secured Credit Facility | | $ | 1,321,447 | | | $ | 13,586 | |
| Interest expense - Revolving Credit Line | | | 226,872 | | | | - | |
| Unused commitment fees | | | 54,776 | | | | 91,229 | |
| Amortization of deferred financing costs | | | 165,612 | | | | 17,532 | |
| Utilization fees | | | 233,252 | | | | 1,188 | |
| Total interest and other debt financing fees | | $ | 2,001,959 | | | $ | 123,535 | |
| Average debt outstanding | | $ | 120,184,783 | | | $ | 1,869,565 | |
| Average stated interest rate | | | 5.11 | % | | | 2.88 | % |
| | | For the nine months ended September 30, 2022 | | | Period from May 14, 2021 to September 30, 2021 | |
| Interest expense - Secured Credit Facility | | $ | 2,242,628 | | | $ | 13,586 | |
| Interest expense - Revolving Credit Line | | | 236,632 | | | | - | |
| Unused commitment fees | | | 152,638 | | | | 91,229 | |
| Amortization of deferred financing costs | | | 264,230 | | | | 17,532 | |
| Utilization fees | | | 348,064 | | | | 1,188 | |
| Total interest and other debt financing fees | | $ | 3,244,192 | | | $ | 123,535 | |
| Average debt outstanding | | $ | 77,025,641 | | | $ | 1,228,571 | |
| Average stated interest rate | | | 4.30 | % | | | 2.88 | % |
The fair value of the borrowings outstanding under the Secured Credit Facility and the Revolving Credit Line are based on a market yield approach and current interest rates, which are Level 3 inputs to the market yield model. Interest expense incurred for the three and nine months ended September 30, 2022, totaled $1,548,319 and $2,479,260, respectively, which is included in interest and other financing fees on the Statements of Operations. Interest expense incurred for the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, totaled $13,586, which is included in interest and other financing fees on the Statements of Operations. The unused commitment fees, amortization of deferred financing costs, and utilization fees for the three and nine months ended September 30, 2022, amounted to $453,640 and $764,932, respectively, which is included in interest and other financing fees on the Statements of Operations. The unused commitment fees, amortization of deferred financing costs, and utilization fees for the period from May 14, 2021 (date of formation) to September 30, 2021, amounted to $109,949, which is included in interest and other financing fees on the Statements of Operations. The unused fees payable and interest expense payable as of September 30, 2022, and December 31, 2021, are included in the credit facility interest payable on the Statements of Assets and Liabilities. The utilization fees payable as of September 30, 2022, and December 31, 2021, are included in other payables on the Statements of Assets and Liabilities.
Note 8. Income Taxes
The amount of taxable income to be paid out as a distribution is determined by the Board each quarter and generally is based upon the annual earnings estimated by management of the Company. Net capital gains, if any, are distributed at least annually, although the Company may decide to retain all or some of those capital gains for investment and pay corporate-level income taxes on those retained amounts. If the Company chooses to do so, this generally would increase expenses and reduce the amount available to be distributed to stockholders. In the event the Company’s taxable income (including any net capital gains) for a fiscal year fall below the amount of distributions declared and paid with respect to that year, however, a portion of the total amount of those distributions may be deemed a return of capital for tax purposes to the Company’s stockholders.
Because federal income tax regulations differ from accounting principles generally accepted in the United States, distributions in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Differences may be permanent or temporary in nature. Permanent differences are reclassified among capital accounts in the financial statements to reflect their appropriate tax character. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the future.
The following table sets forth the tax cost basis and the estimated aggregate gross unrealized appreciation and depreciation from investments for federal income tax purposes as of and for the period ended September 30, 2022 and December 31, 2021:
| | | As of September 30, 2022 | | | As of December 31, 2021 | |
| Tax Cost of Investments | | $ | 244,887,705 | | | $ | 100,461,162 | |
| | | As of September 30, 2022 | | | As of December 31, 2021 | |
| Unrealized appreciation | | $ | 9,736,902 | | | $ | 4,230,974 | |
| Unrealized depreciation | | | (7,667,995 | ) | | | (1,051,771 | ) |
| Net unrealized appreciation/(depreciation) from investments | | | 2,068,907 | | | | 3,179,203 | |
Note 9. Stock Issuances
As of September 30, 2022 and December 31, 2021, the total number of shares of all classes of capital stock that the Company has the authority to issue was 200,000,000 shares of Common Stock, par value $0.001 per share.
New Stockholders admitted to the Company or existing Stockholders increasing their Capital Commitments at a particular closing will be required to purchase shares of the Company with an aggregate purchase price necessary to ensure that all Stockholders in the Company have generally contributed the same percentage of their Capital Commitments to the Company immediately following such purchase (a “Catch-up Purchase”) and each such Stockholder shall be issued a number of shares of the Company based on a per share purchase price determined by the Board. A Catch-up Purchase may be made in multiple installments as determined by the Advisor based on the Company’s capital requirements. The per share purchase price shall be at least equal to the net asset value per share in accordance with the limitations of Section 23 of the 1940 Act. The Board may set the price per share above the net asset value per share based on a variety of factors, including without limitation, the total amount of the Company’s organizational and other expenses that will have accrued following the Company’s initial closing.
For the nine months ended September 30, 2022, the Company entered into subscription agreements (collectively, the “Subscription Agreements”) with new investors, providing for the private placement of common shares. Under the terms of the Subscription Agreements, investors are required to fund drawdowns to purchase common shares up to the amount of their respective capital commitments on an as-needed basis with a minimum of 8 business days’ prior notice. As of September 30, 2022 and December 31, 2021, the Company had received capital commitments totaling $199,683,470 and $143,588,000, respectively.
Pursuant to a capital drawdown notice to its investors, the Company issued and sold 708,935 shares of the Company’s Common Stock, par value $0.001 per share, on March 25, 2022, for an aggregate offering price of $18,142,000.
Pursuant to a capital drawdown notice to its investors, the Company issued and sold 446,880 shares of the Company’s Common Stock, par value $0.001 per share, on April 21, 2022, for an aggregate offering price of $11,448,234.
Note 9. Stock Issuances (continued)
Pursuant to a capital drawdown notice to its investors, the Company issued and sold 441,121 shares of the Company’s Common Stock, par value $0.001 per share, on September 12, 2022, for an aggregate offering price of $11,283,885.
As of September 30, 2022 net contributions of $110,207,229 had been made by Stockholders and $89,476,241 remained available to be drawn by the Company.
The following tables summarize the issuance of shares for the three and nine months ended September 30, 2022 and for the period from May 14, 2021 (date of formation) to September 30, 2021:
| Date | | Price per share | | | Shares Issued | | | Proceeds | |
| For the nine months ended September 30, 2022: | | | | | | | | | |
| March 25, 2022 | | $ | 25.59 | | | | 708,935 | | | $ | 18,142,000 | |
| April 21, 2022 | | | 25.73 | | | | 446,880 | | | | 11,448,234 | |
| September 12, 2022 | | | 25.58 | | | | 441,121 | | | | 11,283,885 | |
| | | | | | | | 1,596,936 | | | $ | 40,874,119 | |
| | | | | | | | | | | | | |
| Stock issued in connection with dividend reinvestment plan | | | | | | | | | | | | |
| January 14, 2022 | | | 25.32 | | | | 24,306 | | | | 615,437 | |
| May 20, 2022 | | | 25.64 | | | | 21,875 | | | | 560,883 | |
| July 29, 2022 | | | 25.51 | | | | 36,141 | | | | 921,955 | |
| | | | | | | | 82,322 | | | $ | 2,098,275 | |
| Total | | | | | | | 1,679,258 | | | $ | 42,972,394 | |
| Date | | Price per share | | | Shares Issued | | | Proceeds | |
| Period from May 14, 2021 to September 30, 2021: | | | | | | | | | |
| May 14, 2021 | | $ | 25.00 | | | | 1,688,601 | | | $ | 42,215,029 | |
| June 11, 2021 | | | 25.191 | | | | 629,240 | | | | 15,851,000 | |
| August 17, 2021 | | | 25.10 | | | | 244,608 | | | | 6,139,651 | |
| Total | | | | | | | 2,562,449 | | | $ | 64,205,680 | |
| | | | | | | | | | | | | |
| Stock issued in connection with dividend reinvestment plan | | | | | | | | | | | | |
| August 20, 2021 | | | 25.07 | | | | 11,997 | | | | 300,751 | |
| Total | | | | | | | 2,574,446 | | | $ | 64,506,431 | |
Note 10. Discretionary Repurchase of Shares of Common Stock and Distributions
Beginning with the quarter ended September 30, 2022, the Company began to conduct quarterly tender offers, at the Board’s discretion, in accordance with the requirements of Rule 13e-4 under the Exchange Act and the 1940 Act, to permit Stockholders to tender their shares of common stock at a specific per share price (“Purchase Price”) based on the Company’s net asset value as of the last date of the quarter in which the tender offer is conducted. The Company intends to conduct each tender offer to repurchase up to 2.5% of the number of shares of common stock outstanding as of the end of the prior quarter in which the tender offer is conducted, subject to numerous restrictions that limit Stockholders’ ability to sell their shares of common stock.
Note 10. Discretionary Repurchase of Shares of Common Stock and Distributions (continued)
During the quarter ended September 30, 2022, the Company commenced a tender offer (the “Q3 2022 Tender Offer”) pursuant to which the Company offered to repurchase up to 99,486 shares of common stock for $2,564,753 from the Stockholders at a Purchase Price of $25.78, which represented 2.5% of the Company’s outstanding shares of common stock as of June 30, 2022. Stockholders who tendered shares of common stock in the Q3 2022 Tender Offer received, at the expiration of the Q3 2022 Tender Offer, a non-interest bearing, non-transferable promissory note entitling such Stockholders to an amount in cash equal to the number of shares of common stock accepted for purchase multiplied by the Purchase Price. The Q3 2022 Tender Offer expired on September 23, 2022.
The following table summarizes shares of common stock purchased during the nine months ended September 30, 2022: Quarter Ended Payment Date Shares of Common Stock Dollar Amount September 30, 2022 November 15, 2022 99,486 $2,564,753
| Quarter Ended | | Payment Date | | Shares of Common Stock | | Dollar Amount |
| September 30, 2022 | | November 15, 2022 | | 99,486 | | $2,564,753 |
The Company’s distributions are recorded on the record date. For the nine months ended September 30, 2022 distributions declared to Stockholders totaled $3,455,555, of which $1,972,717 was paid as a cash distribution and $1,482,838 was paid in the form of 58,016 shares of the Company’s common stock issued to existing Stockholders. Distribution payments have been made in accordance with Stockholders DRP payment election as disclosed in Note 2.
The following table summarizes the settlement of distributions declared and recorded as of December 31, 2021 and for the nine months ended September 30, 2022 and the subsequent payment and issuance of those distributions for the nine months ended September 30, 2022:
| Date Declared | | Record Date | | Payment/Issuance Date | | Amount Per Share | | | Amount Paid in Cash | | | Amount Settled via Newly Issued Shares | | | Total | |
| Nine months ended September 30, 2022 | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2021 | | January 14, 2022 | | $ | 0.46 | | | $ | 662,190 | | | $ | 615,437 | | | $ | 1,277,627 | |
| May 18, 2022 | | May 18, 2022 | | May 20, 2022 | | | 0.30 | | | | 626,388 | | | | 560,883 | | | | 1,187,271 | |
| June 30, 2022 | | June 30, 2022 | | July 29, 2022 | | | 0.57 | | | | 1,346,329 | | | | 921,955 | | | | 2,268,284 | |
| Total | | | | | | $ | 1.33 | | | $ | 2,634,907 | | | $ | 2,098,275 | | | $ | 4,733,182 | |
The following table summarizes the settlement of distributions declared and recorded as of September 30, 2021 and the subsequent payment and issuance of those distributions for the period from May 14, 2021 (date of formation) to September 30, 2021:
| Date Declared | | Record Date | | Payment/Issuance Date | | Amount Per Share | | | Amount Paid in Cash | | | Amount Settled via Newly Issued Shares | | | Total | |
| Period from May 14, 2021 to September 30, 2021: | | | | | | | | | | | | | | | |
August 10, 2021 | | August 10, 2021 | | August 20, 2021 | | $ | 0.13 | | | $ | 568 | | | $ | 300,751 | | | $ | 301,319 | |
| Total | | | | | | $ | 0.13 | | | $ | 568 | | | $ | 300,751 | | | $ | 301,319 | |
Note 11. Commitments, Contingencies, and Risks
Commitments: As of September 30, 2022, the Company had $23,772,273 in outstanding commitments to direct investments and $1,887,375 in outstanding commitments to fund investments.
| September 30, 2022 | | Outstanding Commitments | |
| Direct Investments | | | |
| PPC Event Services, Inc. | | $ | 3,159,041 | |
| Rock Gate Capital, LLC (dba 160 Driving Academy) | | | 3,890,543 | |
| TCP Acquisition, LLC | | | 10,000,000 | |
| The Range NYC, LLC (dba Five Iron Golf) | | | 6,722,689 | |
| Total Direct Investments | | $ | 23,772,273 | |
| | | | | |
| Fund Investments | | | | |
| Madryn Select Opportunities, LP | | $ | 1,887,375 | |
| Total Fund Investments | | $ | 1,887,375 | |
Management believes that the Company’s available cash balances provide sufficient funds to cover its unfunded commitments as of September 30, 2022.
Indemnifications: In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties that provide general indemnification. The Company’s maximum exposure under these agreements is unknown, as these involve future claims that may be made against the Company but that have not occurred. The Company expects the risk of any future obligations under these indemnification provisions to be remote.
Legal proceedings: In the normal course of business, the Company may be subject to legal and regulatory proceedings that are generally incidental to its ongoing operations. While there can be no assurance of the ultimate disposition of any such proceedings, the Company is not currently aware of any such proceedings or disposition that would have a material adverse effect on the Company’s financial statements.
Concentration of credit and counterparty risk: Credit risk arises primarily from the potential inability of counterparties to perform in accordance with the terms of the contract. In the event that the counterparties do not fulfill their obligations, the Company may be exposed to risk. The risk of default depends on the creditworthiness of the counterparties or issuers of the instruments. It is the Company’s policy to review, as necessary, the credit standing of each counterparty.
Note 12. Financial Highlights
The following is a schedule of financial highlights for the nine months ended September 30, 2022 and for the period May 14, 2021 (date of formation) to September 30, 2021:
| | | Nine months ended
September 30, 2022 | | | For the period
May 14, 2021 to September 30, 2021 | |
| Per share data: | | | | | | |
| Net asset value at beginning of period | | $ | 25.26 | | | $ | 25.00 | |
Net investment income (loss) (1) | | | 1.73 | | | | 0.35 | |
Net realized and unrealized gain (loss) (1) | | | (0.30 | ) | | | 0.27 | |
Net increase (decrease) in net assets resulting from operations (1) | | | 1.43 | | | | 0.62 | |
Stockholder distributions (2) | | | (0.50 | ) | | | (0.13 | ) |
Dividend reinvestment plan distributions (2) | | | (0.37 | ) | | | - | |
Other (3) | | | (0.04 | ) | | | - | |
| Net asset value at end of period | | $ | 25.78 | | | $ | 25.49 | |
| Net assets at end of period | | $ | 112,317,046 | | | $ | 65,621,497 | |
| Shares outstanding at end of period | | | 4,357,221 | | | | 2,574,446 | |
Total return (4) | | | 5.55 | % | | | 1.96 | % |
| Ratio/Supplemental data: | | | | | | | | |
Ratio of expenses to average net assets before incentive fees and waivers(5) | | | 10.21 | % | | | 6.56 | % |
Ratio of expenses to average net assets after incentive fees and before waivers(5) | | | 11.35 | % | | | 6.56 | % |
Ratio of expenses to average net assets after incentive fees and waivers (5) | | | 9.86 | % | | | 6.56 | % |
Ratio of net investment income (loss) to average net assets before incentive fees and waivers(5) | | | 8.62 | % | | | 4.46 | % |
Ratio of net investment income (loss) to average net assets after incentive fees and before waivers(5) | | | 7.47 | % | | | 4.46 | % |
Ratio of net investment income (loss) to average net assets after incentive fees and waivers(5) | | | 8.97 | % | | | 4.46 | % |
Portfolio turnover (6) | | | 5.57 | % | | | 1.17 | % |
| | (1) | The per share data was derived by using the weighted average shares outstanding during the period presented. |
| (2) | Management monitors available taxable earnings, including net investment income and realized capital gains, to determine if a tax return of capital may occur for the year. To the extent the Company’s taxable earnings fall below the total amount of the Company’s distributions for that fiscal year, a portion of those distributions may be deemed a tax return of capital to the Company’s stockholders. The tax character of distributions will be determined at the end of the fiscal year. |
| (3) | Includes the impact of different share amounts used in calculating per share data as a result of calculating certain per share data based on weighted average shares outstanding during the period and certain per share data based on shares outstanding as of a period end or transaction date. |
| (4) | Total return is calculated as the change in NAV per share during the period, divided by the beginning NAV per share and assumes reinvestment of dividends at NAV. Total return is not annualized. |
| (5) | Ratios are annualized. To the extent incentive fees and waivers are included within the ratio, they are not annualized. |
| (6) | Ratio is not annualized. |
13. Subsequent Events
The Company has evaluated subsequent events through November 14, 2022, the date on which the financial statements were issued.
On October 4, 2022 the Company declared a dividend of $0.66 per share with a record date of October 4, 2022 to be paid in the form of cash and shares on November 4, 2022, the distribution payment date. On November 4, 2022 the Company paid a total distribution of $2,875,766, of which $1,630,216 was paid in cash and $1,245,550 in the form of shares.
On October 4, 2022, the Company issued a capital call of $55,697,812.
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward Looking Statements
Statements contained in this on Form 10-Q (including those relating to current and future market conditions and trends in respect thereof) that are not historical facts are based on current expectations, estimates, projections, opinions and/or beliefs of Star Mountain Lower Middle-Market Capital Corp. (the “Company”), Star Mountain Fund Management, LLC (the “Advisor”) and Star Mountain Capital, LLC (“Star Mountain”). Such statements involve known and unknown risks, uncertainties and other factors and undue reliance should not be placed thereon. Certain information contained in this Form 10-Q constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “seek,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” “target,” or “believe” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of the Company may differ materially from those reflected or contemplated in such forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond the Company’s control and are difficult to predict, that could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements including, without limitation, the risks, uncertainties and other factors the Company identifies in the section entitled “Item 1A. Risk Factors” and elsewhere in this Form 10-Q and in the Company’s filings with the Securities and Exchange Commission (“SEC”).
Although the Company believes that the assumptions on which these forward-looking statements are based are reasonable, some of those assumptions are based on the work of third parties and any of those assumptions could prove to be inaccurate; as a result, the forward-looking statements based on those assumptions also could prove to be inaccurate. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Form 10-Q should not be regarded as a representation by us that the Company’s plans and objectives will be achieved. These risks and uncertainties include those described or identified in the section entitled “Item 1A. Risk Factors” and elsewhere in this Form 10-Q. Investors should not place undue reliance on these forward-looking statements, which apply only as of the date of this Form 10-Q. The Company does not undertake any obligation to update or revise any forward-looking statements or any other information contained herein, except as required by applicable law. The safe harbor provisions of Section 21E of the Securities Exchange Act, which preclude civil liability for certain forward-looking statements, do not apply to the forward-looking statements in this Form 10-Q because the Company is an investment company.
The following factors are among those that may cause actual results to differ materially from the Company’s forward-looking statements:
| | • | the Company’s future operating results; |
| • | changes in political, economic or industry conditions, the interest rate environment or conditions affecting the financial and capital markets, including with respect to changes from the impact of the COVID-19 pandemic; |
| • | interest rate volatility, including volatility associated with the decommissioning of London Interbank Offered Rate (“LIBOR”) and the transition to new reference rates; |
| • | the Company’s business prospects and the prospects of the Company’s prospective portfolio companies; |
| • | the impact of increased competition; |
| • | the Company’s contractual arrangements and relationships with third parties; |
| • | the dependence of the Company’s future success on the general economy and its impact on the industries in which the Company invests; |
| • | the ability of the Company’s prospective portfolio companies to achieve their objectives; |
| • | the relative and absolute performance of the Advisor; |
| • | the ability of the Advisor and its affiliates to retain talented professionals; |
| • | the Company’s expected financings and investments; |
| • | the Company’s ability to pay dividends or make distributions; |
| • | the adequacy of the Company’s cash resources; |
| • | risks associated with possible disruptions in the Company’s operations or the economy generally due to war or terrorism; |
| • | the impact of future acquisitions and divestitures; |
| • | the Company’s regulatory structure and tax status as a business development company (“BDC”) and a regulated investment company (a “RIC”); and |
| • | future changes in laws or regulations and conditions in the Company’s operating areas. |
Overview:
Star Mountain Lower Middle-Market Corp. is an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a BDC under the 1940 Act, as amended. In addition, for U.S. federal income tax purposes, the Company has elected to be treated and intends to continue to be treated as a RIC under the subchapter M of the Internal Revenue Code of 1986, as amended. As such, the Company is required to comply with various regulatory requirements, such as the requirement to invest at least 70% of the Company’s assets in “qualifying assets,” source of income limitations, asset diversification requirements, and the requirement to distribute annually at least 90% of the Company’s taxable income.
The Company’s investment objectives are to generate current income and capital appreciation. The Company seeks to achieve its investment objectives by investing primarily in privately negotiated loans and equity investments to SMBs generally with annual revenues greater than $15 million and earnings before interest, taxes, depreciation and amortization of less than $50 million. Generally, these businesses are owner-operated with an average 20+ year operating history. To accomplish this, the Company makes direct investments in SMBs and makes investments in investment funds focused primarily on investing in SMBs generally not owned by large private equity firms.
The Company seeks to provide investors with access to a diversified portfolio of credit investments generating current income distributions with equity upside. Capital protection is achieved through defensive structures with affirmative, negative and financial maintenance covenants and active portfolio management which results in generally low volatility and low correlation to public market indices. The Company aims to target diversification of assets by vintage, industry and geography through direct originations and acquisitions of loan portfolios.
The Company’s investment strategy may be complemented by secondary fund investments and secondary loans, consisting of generally non-brokered purchases of limited partnership interests in lower middle-market credit-oriented funds and secondary loans. This complementary strategy may result in portfolio construction and diversification benefits.
The Company’s investments are subject to a number of risks. See “Part II. Item 1A. Risk Factors.”
Characteristics of and Risks Related to Investments in Private Companies:
Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses for the Stockholders in those investments and accordingly should be considered speculative. There is generally no publicly available information about the companies in which the Company invests, and the Company relies significantly on the diligence of its service providers and agents to obtain information in connection with investment decisions. If the Company is unable to identify all material information about these companies, among other factors, the Company may fail to receive the expected return on investment or lose some or all of the money invested in these companies. In addition, these businesses may have shorter operating histories, narrower product lines, smaller market shares and less experienced management than their larger competitors and may be more vulnerable to customer preferences, market conditions, and loss of key personnel, or economic downturns, which may adversely affect the return on, or the recovery of, investments in such businesses.
The Company generally invests in limited partnership interests of funds focused on making investments in SMBs and in long-term loans to and private equity investments in small and medium-sized private companies that do not have an established trading market. The Company typically exits its debt and equity investments through structured terms and amortization or when the portfolio company has a liquidity event such as a sale, recapitalization, or initial public offering of the company. The illiquidity of the Company’s investments may adversely affect the Company’s ability to dispose of debt and equity securities at times when it may be otherwise advantageous for the Company to liquidate such investments. In addition, if the Company were forced to immediately liquidate some or all of the investments in the portfolio, the proceeds of such liquidation could be significantly less than the current value of such investments.
Operating and Regulatory Structure:
The Company’s investment activities are managed by Star Mountain Fund Management, LLC and supervised by the Board, a majority of whom are independent. Under the Investment Advisory Agreement, the Company pays Star Mountain Fund Management, LLC a quarterly management fee based on the Company’s average gross assets as well as incentive fees based on the Company’s performance.
The Company has entered into an Administration Agreement with Star Mountain Fund Management, LLC to serve as Administrator for the Company. Pursuant to the Administration Agreement, Star Mountain Fund Management, LLC provides the Company with services such as accounting, financial reporting, legal and compliance support and investor relations support, necessary for the Company to operate or engage a third-party firm to perform some or all of these functions. The Company has entered into a sub-administration agreement with SS&C Technologies, Inc. (the “Sub-Administrator”), under which the Sub-Administrator provides various accounting and administrative services to the Company.
Revenues:
The Company generates revenues primarily through receipt of interest income from the Portfolio Investments the Company holds. In addition, the Company generates income from various loan origination and other fees and dividends on direct equity investments. The debt the Company invests in will typically not be rated by any rating agency, but if it were, it is likely that such debt would be rated below investment grade.
Expenses:
Under the Administration Agreement, the Administrator is authorized to incur and pay, in the name and on behalf of the Company, all expenses which it deems necessary or advisable.
The Advisor is responsible for and will pay, or cause to be paid, all Overhead Expenses, except to the extent provided below. For this purpose, “Overhead Expenses” include overhead expenses of an ordinarily recurring nature such as rent, utilities, supplies, secretarial expenses, stationery, charges for furniture, fixtures and equipment, employee benefits including insurance, payroll taxes and compensation of all employees.
The Company reimburses the Advisor or its affiliates, as applicable, for all costs and expenses incurred in connection with administering the Company’s business including out of pocket expenses (including travel, lodging and meals), the Company’s allocable portion of the Advisor’s or any affiliated Administrator’s overhead expenses in performing its obligations under the Advisory Agreement or any Administration Agreement, as applicable, including rent and the allocable portion of the compensation paid by the Advisor or its affiliates, as applicable, to the Company’s Chief Compliance Officer and Chief Financial Officer and their respective staffs (based on the percentage of time such individuals devote, on an estimated basis, to the business affairs of the Company), third- party software licensing, implementation, data management and recovery services and custom development costs.
All other expenses are borne by the Company, including legal, accounting, tax, auditing, consulting and other professional expenses (including, without limitation, expenses relating to establishing reputation and public relations in connection with self-sourced lending or other financial transactions); the Management Fee and Incentive Compensation; professional liability insurance (including costs relating to directors’ and officers’ liability insurance and errors and omissions insurance); research and market data expenses; interest on indebtedness; custodial fees; bank service fees; investment-related fees and expenses (such as third-party sourcing fees, fees and expenses of legal and other professionals, due diligence expenses and travel, lodging and meal expenses) related to the analysis, purchase or sale of investments, whether or not the investments are consummated; expenses related to special purpose vehicles (each, an “SPV”) (including, without limitation, Overhead Expenses related thereto); interest payable on debt, if any, incurred to finance the Company’s investments; other expenses related to the purchase, monitoring, sale, settlement, custody or transmittal of Company assets (directly or through trading affiliates) as will be determined by the Advisor or an affiliate thereof, as applicable, in its sole discretion (including costs associated with systems and software used in connection with investment-related activities); costs of reporting to Stockholders and Stockholder meetings; administration fees and expenses charged by any third-party provider of administration services; entity-level taxes; expenses relating to the offer, transfer, sale and marketing of shares; filing fees and expenses; Federal and state registration fees and expenses; regulatory and compliance fees and expenses of the Company (including with respect to any registration activities of the Company); costs of winding up and liquidating the Company; costs associated with ensuring compliance with the applicable BDC and RIC requirements, including, but not limited to, costs incurred in connection with the organization of, and transfer of assets to, a private investment vehicle; expenses incurred in connection with a Stockholder that defaults in respect of a Capital Commitment; and other expenses associated with the operation of the Company and its investment activities, including extraordinary expenses such as litigation, workout and restructuring and indemnification expenses, if any. For the avoidance of doubt, the Company will also bear its allocable share (based on invested capital) of any of the expenses listed above incurred by any Subsidiary Investment Vehicle.
Management fees for the three and nine months ended September 30, 2022 were $995,180 and $2,242,172, respectively. During the nine months ended September 30, 2022, Star Mountain Fund Management, LLC elected to voluntarily waive $104,726 of such management fees. The management fees waived are not recoupable by Star Mountain Fund Management, LLC. For the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, the Company incurred Management Fee expenses of $263,221 and $363,761, respectively. As of September 30, 2022 and December 31, 2021, $2,172,200 and $757,520 of management fees remained payable, respectively. There is no guarantee that Star Mountain Fund Management, LLC will waive management fees in the future, and Star Mountain Fund Management, LLC may discontinue or modify any such waivers in the future at its discretion.
Incentive fees for the three and nine months ended September 30, 2022 were $578,218 and $1,085,908, respectively. For the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, the Company incurred incentive fees of $124,180 and $124,180, respectively, which were subsequently waived. Star Mountain Fund Management, LLC elected to voluntarily waive $578,218 and $1,311,791 of such incentive fees for the three and nine months ended September 30, 2022, respectively. Incentive fees for the period from May 14, 2021 (date of formation) to September 30, 2022 were $1,311,791. The incentive fees waived for the three and nine months ended September 30, 2022 are not recoupable and there is no guarantee that Star Mountain Fund Management, LLC will waive incentive fees in the future, and Star Mountain Fund Management, LLC may discontinue or modify any such waivers in the future at its discretion. As of September 30, 2022 no incentive fees remained payable and as of December 31, 2021, $225,883 remained payable which have subsequently been waived.
The Company is also responsible for the costs of the offering of common shares and other securities, including, but not limited to, all expenses incurred in connection with an IPO; costs and expenses relating to distributions paid to Stockholders; costs of effecting sales and repurchases of the Company’s securities; allocated costs incurred by the Advisor or its affiliate in providing managerial assistance to those companies in which the Company has invested who request it; transfer agent fees; fees and expenses paid to the Company’s independent directors (including expenses and costs related to meetings of the independent directors); costs of preparing and filing reports with the SEC and other Company reporting and compliance costs, including registration and listing fees; the Company’s allocable portion of the fidelity bond; the costs of reports, proxy statements or other notices to Stockholders, including printing and mailing costs; the costs of any Stockholders’ meetings and communications; expenses payable under any underwriting agreement, including associated fees, expenses and any indemnification obligations; and all other expenses incurred by the Company in connection with maintaining its status as a BDC. In addition, the Company may make investments in investment funds focused primarily on investing in SMBs. As a result, the Company (and the Stockholders, indirectly through the Company) bear the Company’s proportionate share of the fees and expenses paid by the shareholders of such investment fund.
Generally, expenses incurred directly in connection with a particular investment (or proposed investment) of the Company and other Star Mountain accounts in which Star Mountain conducts substantial investment and other activities in their own accounts and the accounts of other clients (the “Star Mountain Accounts”) will be allocated among the Company and other Star Mountain Accounts pro rata based upon capital invested (or proposed to be invested) in such investment; provided that expenses specifically attributable to the Company or any other Star Mountain Account may be allocated to the Company or any such other Star Mountain Account, as applicable. The Advisor will allocate other expenses among the Company and other Star Mountain Accounts in a fair and equitable manner taking into account such factors as it deems appropriate.
Notwithstanding the foregoing, in light of the Company’s investment mandate, which may include investments in small loans, niche credits and other similar securities, it may not be practical to specifically allocate certain investment-related expenses to the particular loans to which they relate. The Advisor, in its absolute and sole discretion, may instead allocate such expenses (along with expenses that relate to transactions that are not consummated) pro rata across one or more investments.
Advisor Expenses:
The Advisor shall pay (a) the respective compensation and expenses of the officers and employees of the Advisor, including salaries and benefits of the officers and employees of the Advisor, except as otherwise specified; (b) expenses associated with office space and facilities, utilities and telephone services, news, quotation and similar information and pricing services, computer equipment, travel expenses and support of the Advisor incurred in connection with Company operations; and (c) organizational expenses in excess of $1,000,000.
Board Approval of the Investment Advisory Agreement:
The Investment Advisory Agreement was approved by the Board at a meeting of the Board called, in part, for such purpose, on February 24, 2021. Such approval was made in accordance with, and on the basis of an evaluation satisfactory to the Board as required by, Section 15(c) of the 1940 Act and applicable rules and regulations thereunder, including a consideration of, among other factors, (i) the nature, quality and extent of the advisory and other services to be provided under the agreement, (ii) the investment performance of the personnel who manage investment portfolios with objectives similar to the Company’s, (iii) comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment objectives and (iv) information about the services to be performed and the personnel performing such services under the agreement.
Net gain (loss)
We recognize realized gains or losses on investments based on the difference between the net proceeds from the disposition and the cost basis of the investment without regard to unrealized gains or losses previously recognized. We record current period changes in fair value of investments within net change in unrealized gain (loss) on the statements of operations.
Portfolio and Investment Activity:
For the three months ended September 30, 2022, the Company invested (net of original issue discount) $34.9 million in 5 new portfolio companies and $13.9 million in 9 existing portfolio companies as reflected in the Schedule of Investments.
Purchases (including accretion, amortization, PIK interest) for the three and nine months ended September 30, 2022 amounted to $49,188,532 and $154,924,258 of fair value, respectively. Purchases (including accretion, amortization, PIK interest) and transfers for the period from May 14, 2021 (date of formation) to December 31, 2021 amounted to $64,171,739 and $42,865,258 of fair value, respectively.
The Company had $2,294,916 and $7,701,274 in principal repayments for the three and nine months ended September 30, 2022, respectively, of which $6,483,030 was paid in cash as of September 30, 2022 (with the remaining balance as receivable).
As of September 30, 2022 and December 31, 2021, the Company’s investments consisted of the following:
| | | September 30, 2022 | | | December 31, 2021 | |
| Fair Value: | | | | | | | | | | | | �� |
| First Lien Senior Secured Loan | | $ | 201,235,860 | | | | 81.5 | % | | $ | 79,686,882 | | | | 76.9 | % |
| Second Lien Senior Secured Loan | | | 15,229,278 | | | | 6.2 | | | | 9,748,549 | | | | 9.4 | |
| Preferred Equity Securities | | | 22,769,730 | | | | 9.2 | | | | 10,604,516 | | | | 10.2 | |
| Warrants and Other Equity Securities | | | 5,509,969 | | | | 2.2 | | | | 3,600,418 | | | | 3.5 | |
| Fund Investments | | | 2,211,775 | | | | 0.9 | | | | - | | | | - | |
| Total | | $ | 246,956,612 | | | | 100.0 | % | | $ | 103,640,365 | | | | 100.0 | % |
The table below describes investments by industry composition based on fair value as of September 30, 2022 and December 31, 2021:
| | | September 30, 2022 | | | December 31, 2021 | |
| Fair Value: | | | | | | | | | | | | |
| Aerospace & Defense | | $ | 5,793,932 | | | | 2.3 | % | | $ | 3,406,449 | | | | 3.3 | % |
| Commercial Services & Supplies | | | 10,739,989 | | | | 4.3 | | | | 9,446,485 | | | | 9.1 | |
| Construction & Engineering | | | 29,253,068 | | | | 11.8 | | | | 21,566,475 | | | | 20.9 | |
| Consumer Finance | | | 3,862,783 | | | | 1.6 | | | | 2,872,016 | | | | 2.8 | |
| Diversified Consumer Services | | | 12,000,399 | | | | 4.9 | | | | 4,707,478 | | | | 4.5 | |
| Diversified Financials | | | 2,211,775 | | | | 0.9 | | | | 8,835,342 | | | | 8.5 | |
| Diversified Telecommunication Services | | | 13,241,967 | | | | 5.4 | | | | 9,903,617 | | | | 9.6 | |
| Entertainment | | | 11,862,003 | | | | 4.8 | | | | 1,464,446 | | | | 1.4 | |
| Food Products | | | 7,044,696 | | | | 2.9 | | | | 4,229,816 | | | | 4.1 | |
| Healthcare Providers & Services | | | 16,028,566 | | | | 6.5 | | | | 3,716,607 | | | | 3.6 | |
| Hotels, Restaurants & Leisure | | | 4,942,119 | | | | 2.0 | | | | - | | | | - | |
| Household Durables | | | 2,548,171 | | | | 1.0 | | | | 1,999,150 | | | | 1.9 | |
| Household Products | | | 2,960,714 | | | | 1.2 | | | | 4,632,103 | | | | 4.5 | |
| IT Services | | | 14,153,340 | | | | 5.7 | | | | 7,094,439 | | | | 6.8 | |
| Leisure Products | | | 4,839,454 | | | | 2.0 | | | | 4,590,821 | | | | 4.4 | |
| Machinery | | | 6,399,796 | | | | 2.6 | | | | - | | | | - | |
| Media | | | 30,817,450 | | | | 12.5 | | | | 8,029,455 | | | | 7.7 | |
| Personal Products | | | 4,388,791 | | | | 1.8 | | | | 1,013,686 | | | | 1.0 | |
| Professional Services | | | 33,313,472 | | | | 13.5 | | | | 6,131,980 | | | | 5.9 | |
| Road & Rail | | | 14,600,381 | | | | 5.9 | | | | - | | | | - | |
| Software | | | 6,038,746 | | | | 2.4 | | | | - | | | | - | |
| Trading Companies & Distributors | | | 9,915,000 | | | | 4.0 | | | | - | | | | - | |
| Total | | $ | 246,956,612 | | | | 100.0 | % | | $ | 103,640,365 | | | | 100.0 | % |
Portfolio Asset Quality:
The Advisor employs an investment risk rating to assign each investment an investment grade no less than quarterly. The system is intended primarily to reflect the underlying risk of a portfolio investment relative to the Company’s initial cost basis in respect of such portfolio investment (i.e., at the time of origination), although it may also take into account under certain circumstances, the portfolio company’s cash flow generation relative to underwriting expectations, recent business performance trends, collateral coverage and other relevant factors.
When necessary, the Advisor will update its investment risk ratings, borrowing base criteria and covenant compliance reports. The investment risk rating of a particular investment should not, however, be deemed to be a guarantee of the investment’s future performance.
Investment Performance Risk Rating | | Summary Description |
| Grade 1 | | Investment is performing above expectations. Full return of principal, interest and dividend income is expected. |
| Grade 2 | | Investment is performing in-line with expectations. Risk factors remain neutral or favorable compared with initial underwriting. All investments are given a “2” at the time of origination |
| Grade 3 | | Investment is performing below expectations. Capital impairment or payment delinquency is not anticipated. The investment may also be out of compliance with certain financial covenants. |
| Grade 4 | | Investment is performing below expectations. Quantitative or qualitative risks have increased materially. Delinquency of interest and / or dividend payments is anticipated. No loss of principal anticipated. |
| Grade 5 | | Investment is performing substantially below expectations. It is anticipated that the Company will not recoup its initial cost basis and may realize a loss upon exit. Most or all of the debt covenants are out of compliance. Amortization, interest and / or dividend payments are substantially delinquent. |
In the event of credit deterioration, the Advisor may form a team or engage outside advisors to preserve the value of the Company’s investment, including requirement of additional equitization from the ownership group or exercising other creditor rights.
For investments rated Grade 4 or Grade 5, the Advisor enhances its level of scrutiny over the monitoring of such portfolio company and will develop an action plan to address the underperformance. The Advisor’s senior investment team has extensive experience managing investments through workouts, restructurings, and bankruptcies.
The following tables show the distribution of the Company’s investments on the 1 to 5 investment performance risk rating scale as of September 30, 2022:
| Investment Performance Risk Rating | | | Investments at Fair Value | | | Percentage of Total Investments | |
| | 1 | | | $ | 28,942,821 | | | | 11.7 | % |
| | 2 | | | | 187,470,582 | | | | 76.0 | |
| | 3 | | | | 27,995,038 | | | | 11.3 | |
| | 4 | | | | - | | | | - | |
| | 5 | | | | 2,548,171 | | | | 1.0 | |
| Total | | | $ | 246,956,612 | | | | 100.0 | % |
The following tables show the distribution of the Company’s investments on the 1 to 5 investment performance risk rating scale as of December 31, 2021:
| Investment Performance Risk Rating | | | Investments at Fair Value | | | Percentage of Total Investments | |
| | 1 | | | $ | - | | | | - | % |
| | 2 | | | | 92,427,602 | | | | 89.2 | |
| | 3 | | | | 11,212,763 | | | | 10.8 | |
| | 4 | | | | - | | | | - | |
| | 5 | | | | - | | | | - | |
| Total | | | $ | 103,640,365 | | | | 100.0 | % |
Results of Operations:
The following tables represent the operating results for the three and nine months ended September 30, 2022, for the three months ended September 30, 2021 and for the period May 14, 2021 (date of formation) to September 30, 2021:
| | | For the three months ended September 30,
2022 | | | For the three months ended September 30, 2021 | |
| Total investment income | | $ | 6,389,840 | | | $ | 1,598,588 | |
| Total expenses | | | 4,074,160 | | | | 1,126,956 | |
| Net investment income before fee waivers | | | 2,315,680 | | | | 471,632 | |
| Management fee waiver | | | - | | | | - | |
| Incentive fee waiver | | | (578,218 | ) | | | - | |
| Net investment income after fee waivers | | | 2,893,898 | | | | 471,632 | |
| Net realized gain (loss) on investments | | | - | | | | - | |
| Net change in unrealized gain (loss) on investments | | | (1,106,586 | ) | | | 1,010,683 | |
| Net increase (decrease) in net assets resulting from operations | | $ | 1,787,312 | | | $ | 1,482,315 | |
| | | For the nine months ended September 30, 2022 | | | Period from May 14, 2021 to September 30, 2021 | |
| Total investment income | | $ | 13,293,652 | | | $ | 2,294,413 | |
| Total expenses | | | 8,292,751 | | | | 1,498,931 | |
| Net investment income before fee waivers | | | 5,000,901 | | | | 795,482 | |
| Management fee waiver | | | (104,726 | ) | | | - | |
| Incentive fee waiver | | | (1,311,791 | ) | | | - | |
| Net investment income after fee waivers | | | 6,417,418 | | | | 795,482 | |
| Net realized gain (loss) on investments | | | 23,917 | | | | - | |
| Net change in unrealized gain (loss) on investments | | | (1,127,611 | ) | | | 620,903 | |
| Net increase (decrease) in net assets resulting from operations | | $ | 5,313,724 | | | $ | 1,416,385 | |
Investment Income:
The composition of the Company’s investment income was as follows for the three and nine months ended September 30, 2022, for the three months ended September 30, 2021 and for the period May 14, 2021 (date of formation) to September 30, 2021:
| | | For the three months ended September 30, 2022 | | | For the three months ended September 30, 2021 | |
| Non-controlled/non-affiliate investment income | | | | | | |
| Interest income | | $ | 5,778,321 | | | $ | 1,434,199 | |
| PIK interest income | | | 119,128 | | | | 86,232 | |
| Dividend income | | | 114,888 | | | | 52,343 | |
| Other income | | | 206,674 | | | | | |
| Controlled/affiliate investment income | | | | | | | | |
| Interest income | | | 170,829 | | | | 25,814 | |
| Total investment income | | $ | 6,389,840 | | | $ | 1,598,588 | |
| | | For the nine months ended September 30, 2022 | | | For the period May 14, 2021 to September 30, 2021 | |
| Non-controlled/non-affiliate investment income | | | | | | |
| Interest income | | $ | 12,315,970 | | | $ | 2,041,073 | |
| PIK interest income | | | 348,977 | | | | 156,937 | |
| Dividend income | | | 152,690 | | | | 56,413 | |
| Other income | | | 257,368 | | | | - | |
| Controlled/affiliate investment income | | | | | | | | |
| Interest income | | | 218,647 | | | | 39,990 | |
| Total investment income | | $ | 13,293,652 | | | $ | 2,294,413 | |
Operating Expenses:
The composition of the Company’s operating expenses was as follows for the three and nine months ended September 30, 2022, for the three months ended September 30, 2021 and for the period May 14, 2021 (date of formation) to September 30, 2021:
| | | For the three months ended September 30, 2022 | | | For the three months ended September 30, 2021 | |
| Interest and other financing fees | | $ | 2,001,959 | | | $ | 123,535 | |
| Management fees | | | 995,180 | | | | 263,221 | |
| Incentive fees | | | 578,218 | | | | 124,180 | |
| Professional fees | | | 285,537 | | | | 164,258 | |
| General and administrative fees | | | 125,601 | | | | 22,181 | |
| Legal expenses | | | 67,500 | | | | 199,114 | |
| Directors’ expenses | | | 20,165 | | | | 20,164 | |
| Organizational expenses | | | - | | | | 210,303 | |
| Expenses | | | 4,074,160 | | | | 1,126,956 | |
| Management fee waiver | | | - | | | | - | |
| Incentive fee waiver | | | (578,218 | ) | | | - | |
| Total Expenses | | $ | 3,495,942 | | | $ | 1,126,956 | |
| | | For the nine months ended September 30, 2022 | | | For the period May 14, 2021 to September 30, 2021 | |
| Interest and other financing fees | | $ | 3,244,192 | | | $ | 123,535 | |
| Management fees | | | 2,242,172 | | | | 363,761 | |
| Incentive fees | | | 1,085,908 | | | | 124,180 | |
| Professional fees | | | 961,601 | | | | 229,099 | |
| General and administrative fees | | | 496,542 | | | | 156,002 | |
| Legal expenses | | | 202,500 | | | | 199,114 | |
| Directors’ expenses | | | 59,836 | | | | 30,685 | |
| Organizational expenses | | | - | | | | 272,555 | |
| Expenses | | | 8,292,751 | | | | 1,498,931 | |
| Management fee waiver | | | (104,726 | ) | | | - | |
| Incentive fee waiver | | | (1,311,791 | ) | | | - | |
| Total Expenses | | $ | 6,876,234 | | | $ | 1,498,931 | |
Income Taxes, Including Excise Tax:
On May 14, 2021, the Company elected to be regulated as a BDC under the 1940 Act. The Company also elected to be treated as a RIC under Subchapter M of the Code and intends to qualify annually as a RIC. As long as the Company maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its Stockholders. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s Stockholders and will not be reflected in the financial statements of the Company.
To qualify as a RIC under Subchapter M of the Code, the Company must, among other things, meet certain source-of-income and asset diversification requirements. In addition, to qualify for RIC tax treatment, the Company must distribute to its Stockholders, for each taxable year, at least 90.0% of its “investment company taxable income” for that year, which is generally its ordinary income plus the excess of its realized net short-term capital gains over its realized net long-term capital losses. In order for the Company not to be subject to U.S. federal excise taxes, it must distribute annually an amount at least equal to the sum of (i) 98.0% of its net ordinary income (taking into account certain deferrals and elections) for the calendar year, (ii) 98.2% of its capital gains in excess of capital losses for the calendar year and (iii) any net ordinary income and capital gains in excess of capital losses for preceding years that were not distributed during such years. The Company, at its discretion, may carry forward taxable income in excess of calendar year dividends and pay a 4.0% nondeductible U.S. federal excise tax on this income. For the three and nine months ended September 30, 2022, the Company did not record a net expense on the statements of operations for U.S. federal excise tax.
The Company accounts for income taxes in conformity with ASC Topic 740 — Income Taxes (“ASC Topic 740”). ASC Topic 740 provides guidelines for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. ASC Topic 740 requires the evaluation of tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax expense. The Company did not record any uncertain income tax positions for the period ending September 30, 2022 on the Statements of Assets and Liabilities.
Net Increase (Decrease) in Net Assets Resulting from Operations:
For the three and nine months ended September 30, 2022, the net increase (decrease) in net assets resulting from operations was $1,787,312 and $5,313,724, respectively. Based on the weighted average shares of Common Stock outstanding for the three and nine months ended September 30, 2022, the Company’s per share net increase (decrease) in net assets resulting from operations was $0.44 and $1.43, respectively.
For the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, the net increase (decrease) in net assets resulting from operations was $1,482,315 and $1,416,385, respectively. Based on the weighted average shares of Common Stock outstanding for the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, the Company’s per share net increase (decrease) in net assets resulting from operations was $0.61 and $0.62, respectively.
Financial Condition, Liquidity and Capital Resources:
The Company will generate cash primarily from the net proceeds generated from private offerings, and from cash flows from fees, interest and dividends earned from investments and principal repayments, proceeds from sales of investments, borrowings under the Company’s Secured Credit Facility and borrowings under the Company’s Revolving Credit Line. The Company’s primary use of funds will be direct credit and equity investments in SMBs, payments of expenses and distributions to holders of the Company’s Common Stock and, to a lesser extent, the Company may invest in limited partnership interests of funds focused on making investments in SMBs. As of September 30, 2022 and December 31, 2021, the Company had approximately $4.4 million in cash on hand and $135.0 million debt outstanding and $2.5 million in cash on hand and $34.0 million in debt outstanding, respectively.
In accordance with the 1940 Act, the Company generally is required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all borrowings and any preferred stock that may be issued in the future, of at least 150%. If this ratio declines below 150%, the Company cannot incur additional debt and could be required to sell a portion of the Company’s investments to repay some debt when it is disadvantageous to do so.
Capital Contributions:
For the nine months ended September 30, 2022, the Company entered into subscription agreements (collectively, the “Subscription Agreements”) with new investors, providing for the private placement of common shares. Under the terms of the Subscription Agreements, investors are required to fund drawdowns to purchase common shares up to the amount of their respective capital commitments on an as-needed basis with a minimum of 8 business days’ prior notice. As of September 30, 2022 and December 31, 2021, the Company had received capital commitments totaling $199.7 million and $143.6 million, respectively.
Pursuant to a capital drawdown notice to its investors, the Company issued and sold 708,935 shares of the Company’s Common Stock, par value $0.001 per share, on March 25, 2022, for an aggregate offering price of $18,142,000.
Pursuant to a capital drawdown notice to its investors, the Company issued and sold 446,880 shares of the Company’s Common Stock, par value $0.001 per share, on April 21, 2022, for an aggregate offering price of $11,448,234.
Pursuant to a capital drawdown notice to its investors, the Company issued and sold 441,121 shares of the Company’s Common Stock, par value $0.001 per share, on September 12, 2022, for an aggregate offering price of $11,283,885.
On October 4, 2022, the Company issued a capital call of $55,697,812.
As of September 30, 2022 net contributions of $110,207,229 had been made by Stockholders and $89,476,241 remained available to be drawn by the Company.
Distributions:
The Board will determine the timing and amount, if any, of the Company’s distributions. The Company intends to pay distributions on a quarterly basis. In order to avoid corporate-level tax on the distributed income as a RIC, the Company must distribute to Stockholders at least 90.0% of ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, on an annual basis out of the assets legally available for such distributions. In order for the Company to avoid certain excise taxes imposed on RICs, the Company currently intends to distribute, or be deemed to distribute, during each calendar year an amount at least equal to the sum of (1) 98.0% of the Company’s ordinary income for the calendar year, (2) 98.2% of the Company’s capital gain in excess of capital loss for the one-year period ending on October 31 of such calendar year and (3) any ordinary income and net capital gain for preceding years that were not distributed during such years and on which we paid no U.S. federal income tax.
The Company has adopted an “opt out” dividend reinvestment plan (“DRP”) for Stockholders. When a distribution is declared, Stockholders’ cash distributions will automatically be reinvested in additional shares of Common Stock unless a Stockholder specifically “opts out” of the Company’s DRP. Stockholders may opt out of the Company’s DRP by providing notice twenty (20) business days in advance of the distribution payment date.
If a Stockholder opts out, that Stockholder will receive cash distributions. Although distributions paid in the form of additional shares of Common Stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, Stockholders participating in the Company’s DRP will not receive any corresponding cash distributions with which to pay any such applicable taxes. If distributions paid exceed tax earnings and profits, portions of the distribution can be recorded as a return of capital.
Pursuant to a distribution notice to its investors, the Company issued 24,306 shares of the Company’s Common Stock, par value $0.001 per share, on January 14, 2022, for an aggregate offering price of $615,437.
Pursuant to a distribution notice to its investors, the Company distributed $0.46 per share, on January 14, 2022, for an aggregate cash distribution of $662,190 to a Stockholder that opted-out of the DRP.
Pursuant to a distribution notice to its investors, the Company issued 21,875 shares of the Company’s Common Stock, par value $0.001 per share, on May 20, 2022, for an aggregate offering price of $560,883.
Pursuant to a distribution notice to its investors, the Company distributed $0.30 per share, on May 20, 2022, for an aggregate cash distribution of $626,388 to Stockholders that opted-out of the DRP.
Pursuant to a distribution notice to its investors, the Company issued 36,141 shares of the Company’s Common Stock, par value $0.001 per share, on July 29, 2022, for an aggregate offering price of $921,955.
Pursuant to a distribution notice to its investors, the Company distributed $0.57 per share, on July 29, 2022, for an aggregate cash distribution of $1,346,329 to Stockholders that opted-out of the DRP.
Contractual Obligations:
On July 2, 2021, the Company entered into a Loan and Servicing Agreement (the “Loan Agreement”) with Sterling National Bank (“SNB”), which provides for a senior secured revolving credit facility (“Secured Credit Facility”). In February 2022, SNB was subsequently acquired by Webster Bank (“Webster”), which took over the relationship with the Company. Webster serves as administrative agent and collateral agent. On January 12, 2022, the Company entered into a second amendment to the Secured Credit Facility to upsize the Secured Credit Facility to $80 million, with Webster committing $50 million ($10 million incremental), Investors Bank committing $15 million ($7.5 million incremental), and Blue Ridge Bank committing $15 million ($7.5 million incremental). On May 6, 2022, the Company entered into an amendment to the Secured Credit Facility to upsize the Secured Credit Facility to $125 million. Forbright Bank and First Foundation Bank joined the Secured Credit Facility with commitments of $17.5 million and $15.0 million, respectively. In conjunction with Forbright Bank and First Foundation Bank being admitted into the Secured Credit Facility, Webster increased its commitment by $12.5 million to $62.5 million. On July 21, 2022 Investors Bank transferred its commitment of $15 million to Apple Bank for Savings. On September 16, 2022, the Company entered into an amendment to the Secured Credit Facility to upsize the Secured Credit Facility to $200 million. In conjunction with this amendment, Mitsubishi HC Capital America, Inc., Woodforest National Bank, and Peapack-Gladstone Bank agreed to become lenders with $20 million, $20 million, and $15 million commitments, respectively, in the Secured Credit Facility. Additionally, Webster increased its commitment by $5 million to $67.5 million, Blue Ridge Bank increased its commitment by $10 million to $25 million and First Foundation Bank increased its commitment by $5 million to $20 million.
Borrowings can be increased to a maximum of $350 million in accordance with the Secured Credit Facility accordion feature terms and conditions and are limited by various advance rates and concentration limits.
As of September 30, 2022, and December 31, 2021, the total fair value of the borrowings outstanding under the Secured Credit Facility was $119,000,000 and $34,000,000, respectively.
Advances under the Secured Credit Facility bear interest at a per annum rate equal to the Prime rate in effect on such day minus 0.35%. Inclusive of syndication, agency, and administrative fees paid to Webster, the total annualized cost of capital is estimated to be 4.25%. The Company will also pay a non-utilization fee on the average daily unused amount of the aggregate commitments until the commitment termination date (as defined in the Loan Agreement). As of September 30, 2022, the total commitments under the Secured Credit Facility were $200 million. Proceeds from borrowings under the Secured Credit Facility may be used to finance certain investments, fulfill payment obligations under the Secured Credit Facility, make distributions/payments permitted by the Loan Agreement. All amounts outstanding under the Secured Credit Facility must be repaid by the fourth anniversary of the initial closing of the Secured Credit Facility. The Company’s obligations to the lenders under the Secured Credit Facility are secured by a first priority security interest in substantially all of the Company’s assets, subject to certain exclusions.
Borrowings under the Secured Credit Facility are limited by various advance rates and concentration limits. In connection with the Secured Credit Facility, the Company has made certain customary representations/warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. The Secured Credit Facility is subject to customary events of default for similar financing transactions. Upon the occurrence and during the continuation of an event of default, Webster may declare the outstanding advances and all other obligations under the Secured Credit Facility immediately due and payable.
On June 22, 2022 the Company entered into a Loan and Security Agreement with East West Bank, which provides for cash or credit advances of up to $25 million (the “Revolving Credit Line”) pursuant to the terms and conditions of the Revolving Credit Line. On September 26, 2022, the Company entered into an amendment with East West Bank, to downsize the Revolving Credit Line to $21 million. All amounts outstanding under the Revolving Credit Line must be repaid by June 22, 2023. As of September 30, 2022, and December 31, 2021, the total fair value of the borrowings outstanding under the Revolving Credit Line was $16,000,000 and $0, respectively.
Advances under the Revolving Credit Line bear interest at a per annum rate equal to the prime rate in effect on such day or 4.75%, whichever is greater. The Company will also pay certain fees under the Revolving Credit Line, including unused fees of 0.35% per annum of the average unused portion of the Revolving Credit Line during any fiscal quarter when the average daily balance of the aggregate outstanding principal amount of the Advances in any fiscal quarter during the term of the Revolving Credit Line equals or exceeds 60% of the Revolving Credit Line amount and 0.75% per annum of the average unused portion of the Revolving Credit Line during any fiscal quarter when the average daily balance of the aggregate outstanding principal amount of the Advances in any fiscal quarter during the term of the Revolving Credit Line is less than 60% of the Revolving Credit Line amount.
Proceeds from borrowings under the Revolving Credit Line may be used for working capital, to finance the acquisition by the Company of certain investments, to make deposits, to pay management fees and legal fees, and to fund obligations in accordance with the Company’s certificate of incorporation.
The Company’s obligations to East West Bank under the Revolving Credit Line are secured by a first priority security interest in the capital commitments of the Company’s investors, subject to certain exclusions.
In connection with the Revolving Credit Line, the Company has made certain customary representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. In addition, under the Revolving Credit Line, the Lender may prohibit the Company from repurchasing its shares of common stock from its investors during a quarter if, in the prior quarter, repurchase requests from the Company’s investors exceed 10% of the Company’s total capital commitments. The Revolving Credit Line is subject to customary events of default for similar financing transactions. Upon the occurrence and during the continuation of an event of default, East West Bank may declare the outstanding advances and all other obligations under the Revolving Credit Line immediately due and payable.
The fair value of the borrowings outstanding under the Secured Credit Facility and the Revolving Credit Line are based on a market yield approach and current interest rates, which are Level 3 inputs to the market yield model. Interest expense incurred for the three and nine months ended September 30, 2022, totaled $1,548,319 and $2,479,260, respectively, which is included in interest and other financing fees on the Statements of Operations. Interest expense incurred for the three months ended September 30, 2021 and for the period from May 14, 2021 (date of formation) to September 30, 2021, totaled $13,586, which is included in interest and other financing fees on the Statements of Operations. The unused commitment fees, amortization of deferred financing costs, and utilization fees for the three and nine months ended September 30, 2022, amounted to $454,825 and $655,366, respectively, which is included in interest and other financing fees on the Statements of Operations. The unused commitment fees, amortization of deferred financing costs, and utilization fees for the period from May 14, 2021 (date of formation) to September 30, 2021, amounted to $109,949, which is included in interest and other financing fees on the Statements of Operations. The unused fees payable and interest expense payable as of September 30, 2022, and December 31, 2021, are included in the credit facility interest payable on the Statements of Assets and Liabilities. The utilization fees payable as of September 30, 2022, and December 31, 2021, are included in other payables on the Statements of Assets and Liabilities.
Off-Balance Sheet Arrangements:
The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources of the Company.
Critical Accounting Policies:
This discussion of the Company’s operating plans is based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S., or GAAP. The preparation of these financial statements will require the Advisor to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. In addition to the discussion below, the Company’s critical accounting policies, including revenue recognition and taxes, have been described in Item 1. Note 2. Summary of Significant Accounting Policies.
Valuation of Portfolio Investments:
Investments for which market quotations are readily available are typically valued at those market quotations. To validate market quotations, the Company utilizes a number of factors to determine if the quotations are representative of fair value, including the source and number of the quotations. Debt and equity securities that are not publicly traded or whose market prices are not readily available are valued quarterly at fair value as determined in good faith by the Board, based on, among other considerations, the input of the Advisor, the Company’s audit committee and independent third-party valuation firm, engaged at the direction of the Board.
The Board oversees a multi-step valuation process, which includes, among other procedures, the following:
| | • | the quarterly valuation process commences with each portfolio company or investment being initially evaluated by the investment professionals of the Advisor responsible for the monitoring of the portfolio investment; |
| • | the Advisor’s Valuation Committee reviews the valuations provided by the independent third-party valuation firm and develops a valuation recommendation. Valuation recommendations are presented to the audit committee of the Board; |
| • | the audit committee of the Board reviews valuation recommendations of the Advisor incorporating any adjustments or further supplements by the Advisor to the valuations; and |
| • | the Board discusses these valuations and determines the fair value of each investment in the portfolio in good faith, based on the input of the Advisor, the independent valuation firm, and the audit committee. |
The Company applies Financial Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurement (ASC 820), as amended, which establishes a framework for measuring fair value in accordance with U.S. GAAP and required disclosures of fair value measurements. ASC 820 determines fair value 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. Market participants are defined as buyers and sellers in the principal or most advantageous market (which may be a hypothetical market) that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the Company considers its principal market to be the market that has the greatest volume and level of activity. ASC 820 specifies a fair value hierarchy that prioritizes and ranks the level of observability of inputs used in determination of fair value.
The three-tier hierarchy of inputs is summarized below.
| • | Level 1 - Quoted prices are available in active markets/exchanges for identical investments as of the reporting date. |
| • | Level 2 - Pricing inputs are observable inputs including, but not limited to, prices quoted for similar assets or liabilities in active markets/exchanges or prices quoted for identical or similar assets or liabilities in markets that are not active, and fair value is determined through the use of models or other valuation methodologies. |
| • | Level 3 - Pricing inputs are unobservable for the investment and include activities where there is little, if any, market activity for the investment. The inputs into determination of fair value require significant management judgment and estimation. |
The use of these valuation models requires significant estimation and judgment by the Advisor. The Advisor uses a third-party valuation firm to ensure fair values are determined on an independent basis. While the Company believes its valuation methods are appropriate, other market participants may value identical assets differently than the Company at the measurement date. The methods used by the Company may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. The Company may also have risk associated with its concentration of investments in certain geographic regions and industries.
To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3.
The determination of what constitutes “observable” requires significant judgment by the Company. The Company considers observable data to be market data, which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, which may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. The categorization of an investment within the hierarchy is based upon the pricing transparency of the investment and observability of prices and inputs may be reduced for many investments. This condition could cause the investment to be reclassified to a lower level within the fair value hierarchy.
In addition, on December 3, 2020, the SEC announced its adoption of Rule 2a-5 under the 1940 Act, which establishes an updated regulatory framework for determining the fair value of assets for which market quotations are not readily available in good faith for purposes of the 1940 Act. The new rule had a compliance date of September 8, 2022 and clarifies how fund boards can satisfy their valuation obligations for such assets and permits boards, subject to board oversight and certain other conditions, to designate certain parties to perform the fair value determinations for such assets. As of the date of this quarterly report on Form 10-Q, the Board has not designated any party to perform the fair valuation determinations for such assets and continues to determine the fair value of such assets in compliance with relevant provisions of the 1940 Act. The Company will continue to review the new rule and its impact on the Company and its valuation policies.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
The Company is subject to financial market risks, including changes in interest rates. The Company invests primarily in illiquid debt securities of private companies. Most of the Company’s investments do not have a readily available market price, and the Company values these investments at fair value as determined in good faith by the Board in accordance with the Company’s valuation policy. There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each Portfolio Investment while employing a consistently applied valuation process for the types of investments the Company makes.
The majority of the loans in the Company’s portfolio have floating interest rates, and we expect that the Company’s loans in the future may also have floating interest rates. These loans are usually based on a floating benchmark rate (e.g., 3-month LIBOR or SOFR) plus a spread and typically have interest rate re-set provisions that adjust applicable interest rates under such loans to current market rates on a monthly or quarterly basis. The majority of the loans in the Company’s current portfolio have interest rate floors which will effectively convert the loans to fixed rate loans in the event interest rates decrease.
On March 5, 2021, the United Kingdom’s Financial Conduct Authority announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative (i) immediately after December 31, 2021 for all four non-U.S. dollar (“USD”) LIBORs (British Pound, Euro, Swiss Franc and Japanese Yen) and for one-week and two-month USD LIBOR settings and (ii) immediately after June 30, 2023 for the remaining USD LIBOR settings. In addition, in connection with supervisory guidance from U.S. regulators, some U.S. regulated entities will cease to enter into most new LIBOR contracts after January 1, 2022. Central banks and regulators in a number of major jurisdictions (for example, United States, United Kingdom, European Union, Switzerland and Japan) have convened working groups to find, and implement the transition to, suitable replacements for LIBOR. To identify a successor rate for USD LIBOR, the Alternative Reference Rates Committee (“ARRC”), a U.S.-based group convened by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York, was formed. The ARRC has identified SOFR, or other rates derived from SOFR, as its preferred alternative rate for USD LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or other reforms to LIBOR or any other alternative reference rates that may be enacted in the United States, United Kingdom or elsewhere.
The elimination of LIBOR, the adoption of one or more alternative reference rates such as SOFR or any other changes or reforms to the determination or supervision of LIBOR or any of these alternative reference rates could have an adverse impact on the market for or value of any securities, loans, and other financial obligations or extensions of credit held by or due to the Company linked to any such reference rate or on the Company’s overall financial condition or results of operations. In addition, the Company may need to renegotiate any credit agreements extending beyond 2021 with portfolio companies that utilize LIBOR as a factor in determining the interest rate that may be in place at such time, in order to replace LIBOR with an alternative reference rate, which may have an adverse effect on the Company’s overall financial condition or results of operations. Following the replacement of LIBOR or as a result of using any alternative reference rate, some or all of the Company’s credit agreements in place at such time may bear interest a lower interest rate then would have otherwise been in effect had use of LIBOR continued, which could have an adverse impact on the Company’s results of operations. Moreover, the Company may need to renegotiate certain terms of its credit facilities in place at such time. If the Company is unable to do so, amounts drawn under the Company’s credit facilities may bear interest at a higher rate, which would increase the cost of the Company’s borrowings and, in turn, affect the Company’s results of operations.
Assuming that the Statements of Assets and Liabilities as of September 30, 2022, was to remain constant and that we took no actions to alter the Company’s existing interest rate sensitivity, the following table shows the annualized impact of hypothetical base rate changes in interest rates:
| Change in Interest Rates | | Increase (decrease) in interest income | | | Increase (decrease) in interest expense | | | Net increase (decrease) in net investment income | |
| Down 25 basis points | | $ | (545,021 | ) | | $ | (337,500 | ) | | $ | (207,521 | ) |
| Up 100 basis points | | | 2,230,020 | | | | 1,350,000 | | | | 880,020 | |
| Up 200 basis points | | | 4,476,245 | | | | 2,700,000 | | | | 1,776,245 | |
| Up 300 basis points | | | 6,722,469 | | | | 4,050,000 | | | | 2,672,469 | |
Although we believe that this analysis is indicative of the Company’s existing sensitivity to interest rate changes, it does not adjust for changes in the credit market, credit quality, the size and composition of the assets in the Company’s portfolio and other business developments, including borrowing under the credit facility or other borrowings that could affect net increase in net assets resulting from operations, or net income. Accordingly, we can offer no assurances that actual results would not differ materially from the analysis above.
Evaluation of Disclosure Controls and Procedures
The Company’s disclosure controls and procedures are designed to provide reasonable assurances that information required to be disclosed in this Form 10-Q and other reports that we file under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the required time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
The Company’s management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Company’s management, including our Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2022. It should be noted that any system of controls, regardless of design and execution, can provide only reasonable assurance of achieving the desired control objectives.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II. Other Information
The Company is not currently subject to any material legal proceedings, nor, to the Company’s knowledge, is any material legal proceeding threatened against us. From time to time, the Company may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of the Company’s rights under loans to or other contracts with the Company’s portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, the Company does not expect that these proceedings will have a material effect upon the Company’s financial condition or results of operations.
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K, as filed with the SEC on March 31, 2022. If any of such changes or risks actually occur, our business, financial condition or results of operations could be materially adversely affected. If that happens, the value of our securities could decline, and you may lose all or part of your investment.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Except as previously reported by the Company on its current reports on Form 8-K, the Company did not sell any securities during the period covered by this Form 10-Q that were not registered under the Securities Act.
| Item 3. | Defaults on Senior Securities |
Not applicable.
| Item 4. | Mine Safety Disclosures |
Not applicable.
None.
The exhibits filed as part of this Form 10-Q are set forth on the Index to Exhibits, which is incorporated herein by reference.
INDEX TO EXHIBITS
Exhibit Number | | Description of Document |
| | | |
| | Certificate of Incorporation (incorporated by reference to the Company’s Form 10 Registration Statement filed on May 7, 2021) |
| | | |
| | By-Laws (incorporated by reference to the Company’s Form 10 Registration Statement filed on May 7, 2021) |
| | | |
| | Investment Advisory Agreement (incorporated by reference to the Company’s Form 10 Registration Statement filed on May 7, 2021) |
| | | |
| | Administration Agreement (incorporated by reference to the Company’s Form 10 Registration Statement filed on May 7, 2021) |
| | | |
| | Form of Subscription Agreement (incorporated by reference to the Company’s Form 10 Registration Statement filed on May 7, 2021) |
| | | |
| | Certificate of Conversion to a Corporation (incorporated by reference to the Company’s Form 10 Registration Statement filed on May 7, 2021) |
| | | |
| | Loan and Servicing Agreement, dated as of July 2, 2021, by and among Star Mountain Lower Middle-Market Capital Corp., as borrower, the lenders party thereto and Sterling National Bank, in its capacities as collateral agent and administrative agent (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 000-56259), filed on July 15, 2021) |
| | | |
| | First Amendment to Revolving Credit Agreement, dated as of November 10, 2021, by and among the Company, as Borrower, and Sterling National Bank, as Administrative Agent and the Letter of Credit Issuer, and the Lenders party thereto. (incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on November 12, 2021) |
| | | |
| | Second Amendment to Revolving Credit Agreement, dated as of January 12, 2022, by and among the Company, as Borrower, and Sterling National Bank, as Administrative Agent and the Letter of Credit Issuer, and the Lenders party thereto. (incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on January 14, 2022) |
| | | |
| | Amendment to Loan and Servicing Agreement and Joinder Agreement, dated as of May 6, 2022, by and among the Company, as Borrower, and Webster Bank, N.A. (f/k/a Sterling National Bank), as Administrative Agent and the Letter of Credit Issuer, and the Lenders party thereto.
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| | Loan and Servicing Agreement, dated as of June 22, 2022 by and among Star Mountain Lower Middle-Market Capital Corp., as borrower, the lenders party thereto and East West Bank, in its capacity as lender |
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| | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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| | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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| | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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| | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Star Mountain Lower Middle-Market Capital Corp.
Date: November 14, 2022: | By | /s/ Brett A. Hickey | |
| | Name: | Brett A. Hickey |
| | Title: | Chief Executive Officer and President |
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Date: November 14, 2022 | By: | /s/ Christopher J. Gimbert | |
| | Name: | Christopher J. Gimbert |
| | Title: | Chief Financial Officer |
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