HERCULES CAPITAL, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND OPERATING RESULTS (Form 10-Q)
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Forward-looking statements
The matters discussed in this report, as well as in future oral and written statements by management ofHercules Capital, Inc. , that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms or other similar expressions. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this report should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this report include statements as to: ? our current and future management structure; ? our future operating results; ? our business prospects and the prospects of our prospective portfolio companies; ? the impact of investments that we expect to make; ? our informal relationships with third parties including in the venture capital industry; ? the expected market for venture capital investments and our addressable market; ? the dependence of our future success on the general economy and its impact on the industries in which we invest; ? our ability to access debt markets and equity markets; ? the current and future effects of the COVID-19 pandemic on us and our portfolio companies; ? the ability of our portfolio companies to achieve their objectives; ? our expected financings and investments; ? our regulatory structure and tax status; ? our ability to operate as a BDC, a SBIC and a RIC; ? the adequacy of our cash resources and working capital; ? the timing of cash flows, if any, from the operations of our portfolio companies; ? the timing, form and amount of any distributions; ? the impact of fluctuations in interest rates on our business; ? the valuation of any investments in portfolio companies, particularly those having no liquid trading market; and ? our ability to recover unrealized depreciation on investments. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this report. The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this report. In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Item 1A- "Risk Factors" of Part II of this quarterly report on Form 10-Q, Item 1A- "Risk Factors" of our annual report on Form 10-K filed with theSEC onFebruary 23, 2021 and under "Forward-Looking Statements" of this Item 2. 65
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Use of non-GAAP measures
Throughout this MD&A, we present our financial condition and results of operations in the way we believe will be most meaningful and representative of our business results. Some of the measurements we use are "non-GAAP financial measures" underSEC rules and regulations. GAAP is the acronym for "generally accepted accounting principles" inthe United States . The non-GAAP financial measures we present may not be comparable to similarly-named measures reported by other companies. COVID-19 Developments The COVID-19 pandemic, which began in late 2019 has and threatens to continue to create market volatility and disruption in theU.S. and across the global capital markets. We are continuing to closely monitor the impact of COVID-19 on all aspects of our business, including impacts to our portfolio companies, employees, due diligence and underwriting processes, and financial markets. With the rollout of vaccination programs in theU.S. and globally, several countries, as well as certain states in theU.S. , have lifted or reduced certain travel restrictions, business restrictions, and other quarantine measures. This has contributed to a positive economic recovery since 2020, and reduced volatility in theU.S. capital market. Although the economic recovery and rollout of vaccination programs are promising, the potential exists for the Delta variant or other variants to impede the global economic recovery. Many areas have since experienced a surge in the reported number of cases, hospitalizations and deaths related to the COVID-19 pandemic. These surges have led to the re-introduction of such restrictions and business shutdowns in certain states withinthe United States and globally and could continue to lead to the re-introduction of such restrictions elsewhere. As a result of the pressures on liquidity and financial results to certain of our portfolio companies caused by the COVID-19 pandemic, portfolio companies may draw on most, if not all, of the unfunded portion of any revolving or delayed draw term loans made by us, subject to availability under the terms of such loans. The extent to which the COVID-19 pandemic will continue to affect the financial condition and liquidity of our portfolio companies' results of operations will depend on future developments, such as the speed and extent of further vaccine distribution and the impact of the Delta variant or other variants that might arise, which are highly uncertain and cannot be predicted. Equally the extent of the impact of the COVID-19 pandemic on our own operational and financial performance, including our ability to execute our business strategies and initiatives in the expected time frame, will depend to a large extent on future developments regarding the duration and severity of the coronavirus, effectiveness of vaccination deployment and the actions taken by governments (including stimulus measures or the lack thereof) and their citizens to contain the coronavirus or treat its impact, all of which are beyond our control. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition. Given the fluidity of the situation, neither our management nor our Board is able to predict the full impact of COVID-19 on our business, future results of operations, financial position, or cash flows at this time. Overview We are a specialty finance company focused on providing senior secured loans to high-growth, innovative venture capital-backed companies in a variety of technology, life sciences, and sustainable and renewable technology industries. We source our investments through our principal office located inPalo Alto, CA , as well as through our additional offices inBoston, MA ,New York, NY ,Bethesda, MD , andSan Diego, CA. Our goal is to be the leading structured debt financing provider for venture capital-backed companies in technology-related industries requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare, and sustainable and renewable technology and to offer a full suite of growth capital products. We invest primarily in structured debt with warrants and, to a lesser extent, in senior debt and equity investments. We invest primarily in private companies but also have investments in public companies. We use the term "structured debt with warrants" to refer to any debt investment, such as a senior or subordinated secured loan, that is coupled with an equity component, including warrants, options or other rights to purchase or convert into common or preferred stock. Our structured debt with warrants investments typically are secured by some or all of the assets of the portfolio company. We also provide "unitranche" loans, which are loans that combine both senior and mezzanine debt, generally in a first lien position. Our investment objective is to maximize our portfolio total return by generating current income from our debt investments and capital appreciation from our warrant and equity investments. Our primary business objectives are to increase our net income, net investment income, and net asset value ("NAV") by investing in structured debt with warrants and equity of venture capital-backed companies in technology-related industries with attractive current yields and the potential for equity appreciation and realized gains. Our equity ownership in our portfolio companies may exceed 25% of the voting securities of such companies, which represents a controlling interest under the 1940 Act. In some cases, we receive the right to make additional equity investments in our portfolio 66
-------------------------------------------------------------------------------- companies in connection with future equity financing rounds. Capital that we provide directly to venture capital-backed companies in technology-related industries is generally used for growth and general working capital purposes as well as in select cases for acquisitions or recapitalizations. We also make investments in qualifying small businesses through our wholly owned SBICs. We currently have one active SBIC, HC IV, which holds approximately$128.0 million in tangible assets which accounted for approximately 4.6% of our total assets as ofSeptember 30, 2021 . We have qualified as and have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. Pursuant to this election, we generally will not be subject to corporate-level taxes on any income and gains that we distribute as dividends for federal income tax purposes to our stockholders. However, our qualification and election to be treated as a RIC requires that we comply with provisions contained in Subchapter M of the Code. For example, as a RIC we must earn 90% or more of our gross income during each taxable year from qualified sources, typically referred to as "good income," as well as satisfy certain quarterly asset diversification and annual income distribution requirements. We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in "qualifying assets," which includes securities of privateU.S. companies, cash, cash equivalents and high-quality debt investments that mature in one year or less. InMay 2020 ,Hercules Adviser LLC (the "Adviser Subsidiary") was formed as our wholly ownedDelaware limited liability subsidiary to provide investment advisory and related services to investment vehicles ("Adviser Funds") owned by one or more unrelated third-party investors ("External Parties"). The Adviser Subsidiary receives fee income for the services provided to Adviser Funds. We have been granted no-action relief by the staff of theSEC to allow the Adviser Subsidiary to register as a registered investment adviser under the 1940 Act, as amended. Our portfolio is comprised of, and we anticipate that our portfolio will continue to be comprised of, investments primarily in technology, life sciences, and sustainable and renewable technology related companies at various stages of their development. Consistent with requirements under the 1940 Act, we invest primarily inU.S. based companies and to a lesser extent in foreign companies. We regularly engage in discussions with third parties with respect to various potential transactions. We may acquire an investment or a portfolio of investments or an entire company or sell a portion of our portfolio on an opportunistic basis. We, our subsidiaries, or our affiliates may also agree to manage certain other funds that invest in debt, equity, or provide other financing or services to companies in a variety of industries for which we may earn management or other fees for our services. We may also invest in the equity of these funds, along with other third parties, from which we would seek to earn a return and/or future incentive allocations. Some of these transactions could be material to our business. Consummation of any such transaction will be subject to completion of due diligence, finalization of key business and financial terms (including price) and negotiation of final definitive documentation as well as a number of other factors and conditions including, without limitation, the approval of our Board and required regulatory or third-party consents and, in certain cases, the approval of our stockholders. Accordingly, there can be no assurance that any such transaction would be consummated. Any of these transactions or funds may require significant management resources either during the transaction phase or on an ongoing basis depending on the terms of the transaction.
Portfolio and investment activity
The total fair value of our investment portfolio was approximately$2.5 billion and$2.4 billion as ofSeptember 30, 2021 andDecember 31, 2020 , respectively. The fair value of our debt investment portfolio as ofSeptember 30, 2021 was approximately$2.3 billion , compared to a fair value of approximately$2.1 billion atDecember 31, 2020 . The fair value of the equity portfolio as ofSeptember 30, 2021 was approximately$204.4 million , compared to a fair value of approximately$224.7 million as ofDecember 31, 2020 . The fair value of the warrant portfolio as ofSeptember 30, 2021 was approximately$42.9 million , compared to a fair value of approximately$34.6 million as ofDecember 31, 2020 .
Portfolio activity
Our investments in portfolio companies take a variety of forms, including
unfunded contractual commitments and funded investments. From time to time,
unfunded contractual commitments depend upon a portfolio company reaching
certain milestones before the debt commitment is available to the portfolio
company, which is expected to affect our funding levels. These commitments are
subject to the same underwriting and ongoing portfolio maintenance as the
on-balance sheet financial instruments that we hold. Debt commitments generally
fund over the two succeeding quarters from close. Not all debt commitments
represent future cash requirements. Similarly, unfunded contractual commitments
may expire without being drawn and thus do not represent future cash
requirements.
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-------------------------------------------------------------------------------- Prior to entering into a contractual commitment, we generally issue a non-binding term sheet to a prospective portfolio company. Non-binding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. These non-binding term sheets generally convert to contractual commitments in approximately 90 days from signing. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements. During the nine months endedSeptember 30, 2021 , a total of$204.5 million of investment commitments made, representing$139.5 million of debt, equity, and warrant fundings during the period, were assigned to, directly funded or originated by the Adviser Funds.
Our portfolio activity for the nine months ended
(in millions) September 30, 2021 September 30, 2020 Gross Debt Commitments Originated byHercules Capital and the Adviser Funds (1) New portfolio company $ 1,258.1 $ 744.5 Existing portfolio company 413.6 290.8 Sub-total 1,671.7 1,035.3 Less: Debt commitments assigned to or directly committed by the Adviser Funds (3) (202.5 ) - Net Debt Commitments $ 1,469.2 $
1035.3
Gross Debt Fundings byHercules Capital and the Adviser Funds (2) New portfolio company $ 786.2 $ 348.0 Existing portfolio company 258.4 281.4 Sub-total 1,044.6 629.4 Less: Debt fundings assigned to or directly funded by the Adviser Funds (3) (137.6 ) - Net Debt Fundings $ 907.0 $ 629.4 Equity Investments and Investment Funds and Vehicles Fundings byHercules Capital and the Adviser Funds New portfolio company $ 15.3 $ - Existing portfolio company 5.2 2.0 Sub-total $ 20.5 $ 2.0 Less: Equity fundings assigned to or directly funded by the Adviser Funds (3) (2.0 ) - Total $ 18.5 $ 2.0 Unfunded Contractual Commitments (4) Total $ 309.9 $ 242.5 Non-Binding Term Sheets New portfolio company $ 185.2 $ 77.5 Existing portfolio company 63.0 20.4 Total $ 248.2 $ 97.9 (1) Includes restructured loans and renewals in addition to new commitments. (2) Funded amounts include debt on revolving facilities. (3) Commitments and fundings include amounts assigned to, directly committed or originated, funded by the Adviser Funds, as applicable. (4) Amount represents unfunded commitments, including undrawn revolving facilities, which are available at the request of the portfolio company. Amount excludes unfunded commitments which are unavailable due to the borrower having not met certain milestones. This excludes$7.2 million of unfunded commitments as ofSeptember 30, 2021 , to portfolio companies related to loans assigned to or directly committed by the Adviser Funds. We receive principal payments on our debt investment portfolio based on scheduled amortization of the outstanding balances. In addition, we receive principal repayments for some of our loans prior to their scheduled maturity date. The frequency or volume of these early principal repayments may fluctuate significantly from period to period. During the nine months endedSeptember 30, 2021 , we received approximately$740.3 million in aggregate principal repayments. Of the approximately$740.3 million of aggregate principal repayments, approximately$62.0 million were scheduled principal payments and approximately$678.3 million were early principal repayments related to 36 portfolio companies.$63.8 million of the early principal repayments were early repayments due to merger and acquisition transactions of five portfolio investments. 68
-------------------------------------------------------------------------------- Total portfolio investment activity (inclusive of unearned income and excluding activity related to taxes payable and escrow receivables) as of and for the nine months endedSeptember 30, 2021 andSeptember 30, 2020 was as follows: (in millions) September 30, 2021 September 30, 2020 Beginning portfolio $ 2,354.1 $ 2,314.5 New fundings and restructures 1,065.1 631.4 Fundings assigned to or directly funded by the Adviser Funds(1) (139.6 ) - Warrants not related to current period fundings 0.7 (0.2 ) Principal payments received on investments (62.0 ) (54.0 ) Early payoffs (678.3 ) (426.7 ) Accretion of loan discounts and paid-in-kind principal 32.7 33.1 Net acceleration of loan discounts and loan fees due to early payoff or restructure (14.0 ) (8.6 ) New loan fees (12.2 ) (7.7 ) Sale of investments (97.9 ) (22.1 ) Gain (loss) on investments due to sales or write offs 15.5 (41.4 ) Net change in unrealized appreciation (depreciation) 47.8 2.5 Ending portfolio $ 2,511.9 $ 2,420.8 (1)
The amounts financed include
As ofSeptember 30, 2021 , we held debt, warrants, or equity positions in one company that has filed a registration statement on Form S-1 with theSEC in contemplation of a potential initial public offering, and four companies that have filed definitive agreements for reverse merger initial public offerings with special purpose acquisition companies. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all.
The following table presents certain selected information concerning our portfolio of investments in debt securities in the
September 30, 2021 December 31, 2020
Number of portfolio companies with debt
outstanding 91 97
Percentage of debt bearing a floating rate 95.9 % 96.9 %
Percentage of debt bearing a fixed rate 4.1 % 3.1 %
Weighted average core yield (1) 11.4 % 11.6 %
Weighted average effective yield (2) 12.7 % 12.9 %
Prime rate at the end of the period 3.3 % 3.3 %
(1)
The core yield on our debt investments excludes the effects of fee and income
accelerations attributed to early payoffs, restructuring, loan modifications,
other one-time events, and includes income from expired commitments.
(2)
The effective yield on our debt investments includes the effects of fee and
income accelerations attributed to early payoffs, restructuring, loan
modifications, and other one-time events. The effective yield is derived by
dividing total investment income by the weighted average earning investment
portfolio assets outstanding during the year, excluding non-interest earning
assets such as warrants and equity investments.
Portfolio income
We generate revenue in the form of interest income, primarily from our investments in debt securities, and fee income primarily from commitment and facility fees. Interest income is recognized in accordance with the contractual terms of the loan agreement to the extent that such amounts are expected to be collected. Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity securities that we acquire from our portfolio companies. Our investments generally range from$15.0 million to$40.0 million , although we may make investments in amounts above or below that range. As ofSeptember 30, 2021 , our debt investments generally have a term of between two and seven years and typically bear interest at a rate ranging from approximately 7.0% to approximately 14.5%. In addition to the cash yields received on our debt investments, in some instances, our debt investments may also include any of the following: exit fees, balloon payment fees, commitment fees, success fees, PIK provisions or prepayment fees which may be required to be included in income prior to receipt. Interest on debt securities is generally payable monthly, with amortization of principal typically occurring over the term of the investment. In addition, our loans may include an interest-only period ranging from three to eighteen months or longer. In limited instances in which we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest become due at the maturity date. Loan origination and commitment fees which are received in full at the inception of a loan are deferred and amortized into fee income as an enhancement to the related loan's yield over the contractual life of the loan. We recognize nonrecurring fees amortized 69
-------------------------------------------------------------------------------- over the remaining term of the loan commencing in the quarter relating to specific loan modifications. We had approximately$39.2 million of unamortized fees as ofSeptember 30, 2021 , of which approximately$33.7 million was included as an offset to the cost basis of our current debt investments and approximately$5.5 million was deferred contingent upon the occurrence of a funding or milestone. As ofDecember 31, 2020 , we had approximately$39.2 million of unamortized fees, of which approximately$32.2 million was included as an offset to the cost basis of our current debt investments and approximately$7.0 million was deferred contingent upon the occurrence of a funding or milestone. Loan exit fees to be paid at the termination of the loan are accreted into interest income over the contractual life of the loan. As ofSeptember 30, 2021 , we had approximately$38.4 million in exit fees receivable, of which approximately$35.1 million was included as a component of the cost basis of our current debt investments and approximately$3.3 million was a deferred receivable related to expired commitments. As ofDecember 31, 2020 , we had approximately$40.9 million in exit fees receivable, of which approximately$37.6 million was included as a component of the cost basis of our current debt investments and approximately$3.3 million was a deferred receivable related to expired commitments. We have debt investments in our portfolio that earn PIK interest. The PIK interest, computed at the contractual rate specified in each loan agreement, is recorded as interest income and added to the principal balance of the loan on specified capitalization dates. To maintain our ability to be subject to tax as a RIC, this non-cash source of income must be distributed to stockholders with other sources of income in the form of dividend distributions even though we have not yet collected any cash from the borrower. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments. We recorded approximately$2.9 million and$2.3 million in PIK income during the three months endedSeptember 30, 2021 and 2020, respectively. We recorded approximately$8.1 million and$6.5 million in PIK income during the nine months endedSeptember 30, 2021 and 2020, respectively. The core yield on our debt investments, a non-GAAP measure, which excludes the effects of fee and income accelerations attributed to early payoffs, restructuring, loan modifications, other one-time events, and includes income from expired commitments, was 11.8% and 11.3% during the three months endedSeptember 30, 2021 and 2020, respectively. The core yield is derived by dividing total GAAP investment income by the weighted average earning investment portfolio assets at amortized cost outstanding during the year, excluding fee and income accelerations attributed to early payoffs, restructuring, loan modifications, and other one-time events, but including income from expired commitments. We believe this measure is useful for our investors as it provides the yield at which our debt investments are originated and eliminates one-off items that can fluctuate significantly from period to period, thereby allowing for a more meaningful comparison with our peer companies. The effective yield on our debt investments, which includes the effects of fee and income accelerations attributed to early payoffs, restructuring, loan modifications and other one-time events, was 12.7% and 12.6% for the three months endedSeptember 30, 2021 and 2020, respectively. The effective yield is derived by dividing total GAAP investment income by the weighted average earning investment portfolio assets at amortized cost outstanding during the quarter, excluding non-interest earning assets such as warrants and equity investments. We believe this measure is useful for our investors as it provides the yield for our entire debt portfolio, which investors can compare with that of our peer companies. Both the core yield and effective yield may be higher than what our common stockholders may realize as the core yield and effective yield do not reflect our expenses and any sales load paid by our common stockholders. The total yield, a non-GAAP measure, on our investment portfolio was 11.8% and 11.3% during the three months endedSeptember 30, 2021 and 2020, respectively. The total yield is derived by dividing total GAAP investment income by the weighted average investment portfolio assets outstanding during the quarter, including non-interest earning assets such as warrants and equity investments at amortized cost. We believe this measure is useful for our investors as it provides the total yield for our investments comprising of debt, equity, and warrants at origination to allow a more meaningful comparison with our peer companies. The comparable total yield calculated on a GAAP basis on our investment portfolio was 11.1% and 11.5% for the three months endedSeptember 30, 2021 and 2020, respectively. The comparable GAAP measure is calculated by dividing total GAAP investment income by our total investment portfolio assets at fair value outstanding at the beginning of the year. The total return for our investors was approximately 23.1% and (10.2)% during the nine months endedSeptember 30, 2021 and 2020, respectively. The total return equals the change in the ending market value over the beginning of the period price per share plus distributions paid per share during the period, divided by the beginning price assuming the distribution is reinvested on the date of the distribution. The total return does not reflect any sales load that must be paid by investors. See "Note 10 - Financial Highlights" included in the notes to our consolidated financial statements appearing elsewhere in this report. 70
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Portfolio composition
The companies in our portfolio are mainly private and public companies active in sectors characterized by high margins, high growth rates, opportunities for consolidation and expansion of products and markets.
The following table presents the fair value of the Company’s portfolio by sector of activity at
September 30, 2021 December 31, 2020
Investments at Percentage of Investments at Percentage of
(in thousands) Fair Value Total Portfolio Fair Value Total Portfolio
Drug Discovery & Development $ 974,136 38.8 % $ 757,163 32.2 %
Software 671,352 26.7 % 780,045 33.1 %
Internet Consumer & Business 452,019 18.0 % 514,538
Services 21.9 %
All other industries (1) 414,347 16.5 % 302,332 12.8 %
Total $ 2,511,854 100.0 % $ 2,354,078 100.0 %
(1)
See "Note 4 - Investments" for complete list of industry sectors and
corresponding amounts of investments at fair value as a percentage of the total
portfolio. As of September 30, 2021 , the fair value as a percentage of total
portfolio does not exceed 4.0% for any individual industry sector other than
"Drug Discovery & Development", "Software", or "Internet Consumer & Business
Services".
Industry and sector concentrations vary as new loans are recorded and loans are
paid off. Loan revenue, consisting of interest, fees, and recognition of gains
on equity and warrants or other equity interests, can fluctuate materially when
a loan is paid off or a warrant or equity interest is sold. Revenue recognition
in any given year can be highly concentrated in several portfolio companies.
For the nine months ended September 30, 2021 and the year ended December 31,
2020 , our ten largest portfolio companies represented approximately 32.8% and
27.9% of the total fair value of our investments in portfolio companies,
respectively. As of September 30, 2021 and December 31, 2020 , we had seven and
three investments, respectively, that represented 5% or more of our net assets.
As of September 30, 2021 , we had seven equity investments representing
approximately 57.7% of the total fair value of our equity investment portfolio,
and each represented 5% or more of the total fair value of our equity
investments. As of December 31, 2020 , we had four equity investments which
represented approximately 63.7% of the total fair value of our equity investment
portfolio, and each represented 5% or more of the total fair value of our equity
investments. No single portfolio investment represented more than 10% of the
fair value of our total investments as of September 30, 2021 and December 31,
2020 .
As of September 30, 2021 , approximately 95.9% of the debt investment portfolio
was priced at floating interest rates or floating interest rates with a Prime or
LIBOR-based interest rate floor. Changes in interest rates, including Prime rate
and LIBOR, may affect the interest income and the value of our investment
portfolio for portfolio investments with floating rates. We believe we are well
positioned to benefit should market interest rates rise in the future.
Our investments in senior secured debt may also have detachable equity
enhancement features, typically in the form of warrants or other equity
securities designed to provide us with an opportunity for capital appreciation.
These features are treated as OID and are accreted into interest income over the
term of the loan as a yield enhancement. Our warrant coverage generally ranges
from 3% to 20% of the principal amount invested in a portfolio company, with a
strike price generally equal to the most recent equity financing round. As of
September 30, 2021 , we held warrants in 94 portfolio companies, with a fair
value of approximately $42.9 million . The fair value of our warrant portfolio
increased by approximately $8.3 million , as compared to a fair value of $34.6
million as of December 31, 2020 primarily related to the increase in fair value
of portfolio companies.
Our existing warrant holdings would require us to invest approximately $63.6
million to exercise such warrants as of September 30, 2021 . Warrants may
appreciate or depreciate in value depending largely upon the underlying
portfolio company's performance and overall market conditions. As attractive
investment opportunities arise, we may exercise certain of our warrants to
purchase stock, and could ultimately monetize our investments. Of the warrants
that we have monetized since inception, we have realized multiples in the range
of approximately 1.02x to 42.71x based on the historical rate of return on our
investments. We may also experience losses from our warrant portfolio in the
event that warrants are terminated or expire unexercised.
Portfolio rating
We use an investment rating system, which rates each debt investment on a scale of 1 to 5 to characterize and monitor our expected level of risk on our portfolio debt investments, with 1 being the highest quality. The following table shows the
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distribution of our outstanding debt investments on the 1 to 5 investment
grading scale at fair value as of September 30, 2021 and December 31, 2020 ,
respectively:
(in
thousands) September 30, 2021 December 31, 2020
Debt Debt
Investments Investments
Investment Number of at Fair Percentage of Number of at Fair Percentage of
Grading Companies Value Total Portfolio Companies Value Total Portfolio
1 21 $ 692,120 30.6 % 16 $ 410,955 19.6 %
2 46 1,103,844 48.8 % 46 1,027,931 49.1 %
3 22 458,178 20.2 % 28 621,323 29.7 %
4 1 8,294 0.4 % 3 25,313 1.2 %
5 1 1,106 0.0 % 4 8,913 0.4 %
91 $ 2,263,542 100.0 % 97 $ 2,094,435 100.0 %
As of September 30, 2021 and December 31, 2020 , our debt investments had a
weighted average investment grading of 1.92 and 2.16 on a cost basis,
respectively. Our policy is to downgrade our portfolio companies as they
approach the point in time when they will require additional equity capital.
Additionally, we may downgrade our portfolio companies if they are not meeting
our financing criteria or are underperforming relative to their respective
business plans. Various companies in our portfolio will require additional
funding in the near term or have not met their business plans and therefore have
been downgraded until their funding is complete or their operations improve.
As the COVID-19 pandemic and related disruption to markets and businesses
continues to evolve, we are continuing to monitor and work with the management
teams and stakeholders of our portfolio companies to navigate the significant
market, operational and economic challenges created by the continuing COVID-19
pandemic. This includes continuing to proactively assess and manage potential
risks across our debt investment portfolio.
Unrecognized investments
The following table shows the amortized cost of our productive investments not recognized in the
As of September 30, As of December 31,
2021 2020
Percentage of Percentage of
Total Total
Portfolio at Portfolio at
Amortized Amortized
(in millions) Amortized Cost Cost Amortized Cost Cost
Performing $ 2,401 99.0 % $ 2,284 98.7 %
Non-accrual 24 1.0 % 31 1.3 %
Total Investments $ 2,425 100.0 % $ 2,315 100.0 %
Debt investments are placed on non-accrual status when it is probable that
principal, interest or fees will not be collected according to contractual
terms. When a debt investment is placed on non-accrual status, we cease to
recognize interest and fee income until the portfolio company has paid all
principal and interest due or demonstrated the ability to repay our current and
future contractual obligations. We may not apply the non-accrual status to a
loan where the investment has sufficient collateral value to collect all of the
contractual amount due and is in the process of collection. Interest collected
on non-accrual investments are generally applied to principal.
Results of operations
Comparison of the three and nine months ended
Investment income
Total investment income for the three months endedSeptember 30, 2021 was approximately$70.2 million as compared to approximately$70.3 million for the three months endedSeptember 30, 2020 . Total investment income for the nine months endedSeptember 30, 2021 was approximately$208.5 million as compared to approximately$211.9 million for the nine months endedSeptember 30, 2020 . 72 --------------------------------------------------------------------------------
Interest income
For the three and nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
(in thousands) 2021 2020 2021 2020
Contractual interest income
150,901$ 154,741 Exit fee interest income 9,029 10,824 26,599 30,271 PIK interest income 2,893 2,319 8,105 6,466 Other interest income (1) 793 703 2,795 3,656 Total interest income$ 63,312 $ 65,375 $ 188,400 $ 195,134 (1)
Other interest income includes interest income from OID and interest recorded on other assets.
Interest income for the three months endedSeptember 30, 2021 totaled approximately$63.3 million as compared to approximately$65.4 million for the three months endedSeptember 30, 2020 . Interest income for the nine months endedSeptember 30, 2021 totaled approximately$188.4 million as compared to approximately$195.1 million for the nine months endedSeptember 30, 2020 . The decrease in interest income for the three and nine months endedSeptember 30, 2021 as compared to the same period endedSeptember 30, 2020 is primarily attributable to decrease in the weighted average principal outstanding of loans. Of the$63.3 million in interest income for the three months endedSeptember 30, 2021 , approximately$60.1 million represents recurring income from the contractual servicing of our loan portfolio and approximately$3.2 million represent income related to the acceleration of income due to early loan repayments and other one-time events during the period. Of the$65.4 million in interest income for the three months endedSeptember 30, 2020 , approximately$61.0 million represents income from recurring interest and approximately$4.4 million represents the acceleration of interest income due to early loan repayments and other one-time events during the period. Of the$188.4 million in interest income for the nine months endedSeptember 30, 2021 , approximately$178.3 million represents recurring income from the contractual servicing of our loan portfolio and approximately$10.1 represents income related to the acceleration of income due to early loan repayments and other one-time events during the period. Of the$195.1 million in interest income for the nine months endedSeptember 30, 2020 , approximately$183.1 million represents recurring interest and approximately$12.0 million represents acceleration of interest income due to early loan repayments and other one-time events during the period.
The following table presents the activity related to PIKs for the nine months ended.
Nine Months Ended September 30,
(in thousands) 2021 2020
Balance of interest receivable at start of PIK $ 14,817
14,498
PIK interest income during the period 8,105
6 466
PIK accrued (capitalized) to principal but not recorded as income during the period - (5,684 ) Payments received from PIK loans (5,692 ) (1,330 ) Realized gain (loss) (180 ) - Ending PIK interest receivable balance $ 17,050 $
13,950
The increase in PIK interest income during the nine months endedSeptember 30, 2021 as compared to the nine months endedSeptember 30, 2020 is due to an increase in the weighted average principal outstanding for loans on accrual which bear PIK interest. Payments on PIK loans are normally received only in the event of payoffs. PIK receivable at bothSeptember 30, 2021 andSeptember 30, 2020 represents less than 1% of total debt investments.
Fee income
Fee income from commitment, facility and loan related fees for the three and nine months endedSeptember 30, 2021 totaled approximately$6.9 million and$20.1 million respectively, as compared to approximately$5.0 million and$16.8 million for the three and nine months endedSeptember 30, 2020 respectively. The increase in fee income for the three and nine months endedSeptember 30, 2021 is primarily due to an increase in the facilities fees and acceleration of fee income due to early repayments. For the three and nine months endedSeptember 30, 2021 , of the$6.9 million and$20.1 million , respectively, in fee income from commitment, facility, and loan related fees, approximately$1.9 million and$5.6 million represents income from recurring fee amortization, approximately$0.9 million and$2.4 million represents the acceleration of unamortized fees from expired commitments, 73 -------------------------------------------------------------------------------- and approximately$4.1 million and$12.1 million represents income due to the acceleration of unamortized fees related to early payoffs during the period, each respectively. For the three and nine months endedSeptember 30, 2020 , of the$5.0 million and$16.8 million , respectively, in fee income, approximately$2.1 million and$7.8 million represents income from recurring fee amortization, and approximately$2.9 million and$9.0 million represents acceleration of unamortized fees due to early loan repayments, respectively. In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the three and nine months endedSeptember 30, 2021 or 2020.
Operating Expenses
Our operating expenses are comprised of interest and fees on our debt, general and administrative expenses, and employee compensation and benefits. During the three and nine months endedSeptember 30, 2021 and 2020, our net operating expenses totaled approximately$32.1 million and$31.6 million , respectively for the three month periods, and approximately$98.9 million and$96.9 million , respectively for the nine months.
Interest and charges on our debt
Interest and fees on our debt totaled approximately$14.7 million and$16.6 million for the three months endedSeptember 30, 2021 and 2020, respectively. Lower weighted average debt outstanding and lower borrowing costs during the three months endedSeptember 30, 2021 , resulted in a decline of interest and fee expenses as compared to the three months endedSeptember 30, 2020 . Interest and fees on our debt totaled approximately$49.0 million and$49.7 million , for the nine months endedSeptember 30, 2021 and 2020, respectively. Our interest and fee expense during the nine months endedSeptember 30, 2021 , was also lower as compared to the nine months endedSeptember 30, 2020 due to lower weighted average debt outstanding and borrowing costs. We had a weighted average cost of debt, comprised of interest and fees, of approximately 4.9% and 5.1% for the three months endedSeptember 30, 2021 and 2020, respectively, and 5.1% and 5.1% for the nine months endedSeptember 30, 2021 and 2020, respectively. The decrease in the weighted average cost of debt for the three months endedSeptember 30, 2021 , as compared to 2020, was primarily driven by a lower average higher cost debt outstanding attributable to our refinancing activities during the period.
General and administrative expenses
General and administrative expenses include legal fees, consulting fees, accounting fees, printer fees, insurance premiums, taxes, rent, expenses associated with the workout of underperforming investments, and various other expenses. Our general and administrative expenses increased to$6.5 million from$5.3 million for the three months endedSeptember 30, 2021 and 2020, respectively, and increased to$17.3 million from$17.2 million for the nine months endedSeptember 30, 2020 . The increase in general and administrative expenses for the three and nine months endedSeptember 30, 2021 is primarily attributable to an increase in excise tax expenses.
Employee compensation
Employee compensation and benefits totaled$8.9 million and$27.1 million , respectively, for the three and nine months endedSeptember 30, 2021 as compared to$7.2 million and$22.6 million respectively, for the three and nine months endedSeptember 30, 2020 . The increase between the three and nine months endedSeptember 30, 2021 and 2020 was primarily due to increased variable compensation and payroll related expenses. Employee stock-based compensation totaled$3.3 million and$9.0 million respectively, for the three and nine months endedSeptember 30, 2021 as compared to$2.5 million and$7.5 million respectively, for the three and nine months endedSeptember 30, 2020 . The increase in employee stock-based compensation for the three and nine months endedSeptember 30, 2021 was primarily attributable to the issuance of additional stock-based compensation awards and higher weighted average grant date fair value.
Fees allocated to the Subsidiary Advisor
InMarch 2021 , we entered into a shared services agreement with the Adviser Subsidiary ("Sharing Agreement"), through which the Adviser Subsidiary will utilize our human capital resources (including administrative functions) and other resources and infrastructure (including office space and technology). Under the terms of the Sharing Agreement, we allocate the related expenses of shared services to the Adviser Subsidiary. Our total net operating expenses for the three and nine months endedSeptember 30, 2021 74 -------------------------------------------------------------------------------- are net of expenses allocated to the Adviser Subsidiary of$1.3 million and$3.5 million respectively. As ofSeptember 30, 2021 , no amounts remained receivable from the Adviser Subsidiary related to the expenses allocated during the period.
Net realized gains and losses and net change in unrealized capital gains and depreciation
Realized gains or losses on investments are measured by the difference between the net proceeds from the repayment or sale and the cost basis of an investment without regard to unrealized appreciation or depreciation previously recognized, and includes investments written off during the period, net of recoveries. Realized loss on debt extinguishment relates to additional fees, costs, and accelerated recognition of remaining debt issuance costs, which are recognized in the event debt is extinguished before its stated maturity. The net change in unrealized appreciation or depreciation on investments primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.
A summary of net realized gains and losses on investments for the three and nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
(in thousands) 2021 2020 2021 2020
Gains realized on investments
(2,186 ) (49,964 ) (66,063 ) (57,575 ) Realized loss on debt extinguishment (1,702 ) - (1,702 ) - Net realized gains (losses)$ 21,111 $ (48,501 ) $ 14,599$ (41,393 ) During the three and nine months endedSeptember 30, 2021 , we recognized net realized gains of$21.1 million and$14.6 million , respectively. During the three and nine months endedSeptember 30, 2021 , we recorded gross realized gains of$25.0 million and$82.4 million , respectively, primarily from the sale of DoorDash, Inc., Palantir Technologies,Ology Bioservices , and TransMedics Group, Inc. Our gains were offset by gross realized losses of$2.2 million and$66.1 million , respectively, primarily from the write-off of our investments in Intent (p.k.a.Intent Media, Inc. ) andSolar Spectrum Holdings, LLC . During the three and nine months endedSeptember 30, 2020 , we recognized net realized gains of$48.5 million and$41.4 million , respectively, on the portfolio. During the three and nine months endedSeptember 30, 2020 , we recorded gross realized gains of$1.5 million and$16.2 million , respectively, primarily from the sale of public equity holdings. These gains were offset by gross realized losses of$50.0 million and$57.6 million , respectively, primarily from the write-off of our debt investments inPatron Techology and Motif BioSciences, Inc. , as well as liquidation or write-off of our equity or warrant positions during the period. Additionally, onJuly 1, 2021 , we fully redeemed the aggregate outstanding$75.0 million of principal and$0.6 million of accrued interest pursuant to the redemption terms of theApril 2025 Notes Indenture. Combined with other debt redemptions, we accelerated recognition of$1.7 million of debt issuance costs associated with the extinguishment of the debt, which is included as a realized loss within the "Loss on debt extinguishment" on the Consolidated Statement of Operations for the three and nine months endedSeptember 30, 2021 . There was no debt extinguishment losses recognized during the three and nine months endedSeptember 30, 2020 . The net change in unrealized appreciation and depreciation on investments is based on the fair value of each investment determined in good faith by our Board. The following table summarizes the movements in net change in unrealized appreciation or depreciation on investments for the three and nine months endedSeptember 30, 2021 and 2020: Three Months Ended
Nine months ended
September 30,
(in thousands) 2021 2020 2021 2020
Gross unrealized appreciation on
portfolio investments $ 27,946 $ 30,238 $ 142,016 $ 101,271
Gross unrealized depreciation on
portfolio investments (35,827 ) (15,183 ) (88,866 ) (135,072 )
Reversal of prior period net unrealized
appreciation (depreciation) upon a
realization event (27,770 ) 37,779 (5,404 ) 36,305
Net unrealized appreciation
(depreciation) on debt, equity, warrant
and fund investments (35,651 ) 52,834 47,746 2,504
Other net unrealized appreciation
(depreciation) - - (1,515 ) -
Total net unrealized appreciation
(depreciation) on investments $ (35,651 ) $ 52,834 $
46 231
During the three months endedSeptember 30, 2021 , we recorded$35.6 million of net unrealized depreciation which was primarily from net unrealized depreciation from our debt, equity, warrant, and investment funds and vehicles investments. For the three months endedSeptember 30, 2021 , we recorded a net$3.7 million of unrealized depreciation on our debt investments. The net unrealized depreciation of our debt investments was comprised of$4.1 million of unrealized depreciation due to 75
-------------------------------------------------------------------------------- the reversal of unrealized appreciation upon write-off of our debt investments and pay-off of our portfolio companies during the period. The net unrealized depreciation was partially offset by$0.4 million unrealized appreciation during the period attributable to valuation movements. For the three months endedSeptember 30, 2021 , we recorded net unrealized depreciation of$27.2 million on our equity investments,$4.6 million on our warrant investments and$0.1 million on our investment funds. The total net unrealized depreciation of$31.9 million on the equity, warrant portfolio, and investment fund portfolio for the three months endedSeptember 30, 2021 , was primarily attributable to$23.6 million of unrealized depreciation due to the reversal of unrealized appreciation upon acquisition or liquidation of our equity and warrant investments, and$8.3 million of net unrealized depreciation attributable to valuation movements on the equity, warrant portfolio, and investment fund portfolio. During the nine months endedSeptember 30, 2021 we recorded cumulative$46.2 million of net unrealized appreciation which was primarily from net unrealized appreciation from our debt, equity, warrant, and investment funds and vehicles investments. For the nine months endedSeptember 30, 2021 , we recorded$5.9 million of net unrealized appreciation on our debt investments. The net unrealized on our debt investments was comprised of$2.9 million of net unrealized appreciation attributable to valuation movements and$3.0 million of unrealized appreciation due to the reversal of unrealized depreciation upon write-off of our debt investments and pay-off of our portfolio companies during the period. For the nine months endedSeptember 30, 2021 , we recorded$34.0 million of net unrealized appreciation on our equity investments,$8.1 million of net unrealized appreciation on our warrant investments and$0.2 million of net unrealized depreciation on our investment funds. The total net unrealized appreciation of$41.9 million on the equity, warrant portfolio, and investment fund portfolio for the nine months endedSeptember 30, 2021 , was primarily attributable to$50.3 million of unrealized appreciation due to valuation movements on the equity, warrant portfolio, and investment fund portfolio and$8.4 million of unrealized depreciation due to the reversal of unrealized appreciation upon acquisition or liquidation of our equity and warrant investments. During the three months endedSeptember 30, 2020 , we recorded cumulative$52.8 million of net unrealized appreciation, from our debt, equity and warrant investments. During the nine months endedSeptember 30, 2020 , we recorded$2.5 million of net unrealized depreciation, from our debt, equity, and warrant investments. We recorded$43.3 million of net unrealized appreciation on our debt investments for the three and nine months endedSeptember 30, 2020 . The total net unrealized appreciation on our debt investments was comprised of$7.4 million of net unrealized appreciation on the debt portfolio and$35.9 million of unrealized appreciation due to the reversal of unrealized depreciation upon write-off or pay-off of our debt investments during the period. During the nine months endedSeptember 30, 2020 we recorded$2.3 million of net unrealized appreciation on our debt investments. The net unrealized appreciation was primarily related to$34.9 million of unrealized depreciation on the debt portfolio offset by$37.2 million of unrealized appreciation due to the reversal of unrealized depreciation upon write-off or pay-off of our debt investments. We recorded$6.5 million of net unrealized appreciation on our equity investments and$3.0 million appreciation on our warrant investments during the three months endedSeptember 30, 2020 . The total net unrealized appreciation of$9.5 million on our equity and warrant investments was primarily attributable to$7.6 million of unrealized appreciation on the equity and warrant portfolio and$1.9 million of unrealized appreciation due to the reversal of unrealized depreciation upon acquisition or liquidation of our equity and warrant investments. We recorded$7.6 million of net unrealized depreciation on our equity investments and$7.8 million of net unrealized appreciation on our warrant investments during the nine months endedSeptember 30, 2020 . The total net unrealized appreciation of$0.2 million on our equity and warrant investments, was primarily attributable to$1.1 million of unrealized appreciation on the equity and warrant portfolio and$0.9 million of unrealized depreciation due to the reversal of unrealized appreciation upon acquisition or liquidation of our equity and warrant investments.
Income and excise taxes
We account for income taxes in accordance with the provisions of ASC Topic 740
Income Taxes, under which income taxes are provided for amounts currently
payable and for amounts deferred based upon the estimated future tax effects of
differences between the financial statements and tax basis of assets and
liabilities given the provisions of the enacted tax law. Valuation allowances
may be used to reduce deferred tax assets to the amount likely to be realized.
We intend to timely distribute to our stockholders substantially all of our
annual taxable income for each year, except that we may retain certain net
capital gains for reinvestment and, depending
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depending on the level of taxable income earned in a year, we may elect to defer taxable income for distribution in the following year and pay any applicable amount
Because federal income tax regulations differ from accounting principles generally accepted inthe 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. Permanent differences are reclassified among capital accounts in the financial statements to reflect their appropriate tax character. Permanent differences may also result from the classification of certain items, such as the treatment of short-term gains as ordinary income for tax purposes. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the future.
Net change in net assets from operations and earnings per share
For the three and nine months endedSeptember 30, 2021 , we had a net increase in net assets resulting from operations of approximately$23.5 million and$170.4 million , respectively. For the three and nine months endedSeptember 30, 2020 , we had a net increase in net assets resulting from operations of approximately$43.0 million and$76.1 million , respectively. The basic and fully diluted net change in net assets per common share were$0.20 and$0.20 per share and$1.47 and$1.46 per share for the three and nine months endedSeptember 30, 2021 , respectively. For the three and nine months endedSeptember 30, 2020 the basic net change in net assets per common share was$0.38 and$0.68 per share, respectively. For the same period, the diluted net change in net assets per common share were$0.38 and$0.67 per share, respectively. For the purpose of calculating diluted earnings per share for the three and nine months endedSeptember 30, 2021 , the dilutive effect of the 2022 Convertible Notes, outstanding options, restricted stock units and awards and Retention PSUs under the treasury stock method was considered. As disclosed in "Note 9 - Earnings Per Share", the dilutive impact of the 2022 Convertible Notes includes only the portion expected to be settled in stock in the calculations of diluted shares outstanding for the three and nine months endedSeptember 30, 2021 . The effect of the 2022 Convertible Notes was excluded from these calculations for the three and nine months endedSeptember 30, 2020 as our share price was less than the conversion price in effect which results in anti-dilution.
Hercules Adviser LLC , the Adviser Subsidiary, receives fee income for the services provided to the Adviser Funds. The Adviser Subsidiary's contribution to our net investment income is derived from dividend income declared by the Adviser Subsidiary. For the three and nine months endedSeptember 30, 2021 and 2020, no dividends were declared by the Adviser Subsidiary. In March andJuly 2021 , the Adviser Subsidiary entered into investment management agreements (the "IMAs") with the Adviser Funds. Pursuant to the IMAs, the Adviser Subsidiary provides investment advisory and management services to the Adviser Funds in exchange for an asset-based fee and certain incentive fees. The Adviser Funds are privately offered investment funds exempt from registration under the 1940 Act that invests in debt and equity investments in venture or institutionally backed technology related and life sciences companies.
Financial situation, liquidity and capital resources
Our liquidity and capital resources are derived from our debt borrowings and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our debt and the proceeds from the turnover of our portfolio and from public and private offerings of securities to finance our investment objectives. We may also raise additional equity or debt capital through registered offerings off a shelf registration, ATM, and private offerings of securities, by securitizing a portion of our investments, or by borrowing from the SBA through our SBICs. This "Financial Condition, Liquidity and Capital Resources" section should be read in conjunction with the "COVID-19 Developments" section above. During the nine months endedSeptember 30, 2021 , we principally funded our operations from (i) cash receipts from interest, dividend, and fee income from our investment portfolio and (ii) cash proceeds from the realization of portfolio investments through the repayments of debt investments and the sale of debt and equity investments, and (iii) debt offerings along with borrowings on our credit facilities. During the nine months endedSeptember 30, 2021 , our operating activities provided$28.7 million of cash and cash equivalents, compared to$24.0 million used during the nine months endedSeptember 30, 2020 . This$52.7 million increase in cash provided by operating activities was primarily driven by a$257.6 million increase in principal and fee payments received on investments and 77
--------------------------------------------------------------------------------$76.5 million of proceeds from the sale of equity investments, which was offset by an increase of$294.0 million in purchases of investments (net of assignments to Adviser Funds). During the nine months endedSeptember 30, 2021 , our investing activities used approximately$12 thousand of cash, compared to$115 thousand used during the nine months endedSeptember 30, 2020 . The$103 thousand decrease in cash used in investing activities was due to a decrease in purchases of capital equipment. During the nine months endedSeptember 30, 2021 , our financing activities used$16.9 million of cash, compared to$42.8 million used in financing activities during the nine months endedSeptember 30, 2020 . The$25.9 million decrease of cash flows used in financing activities was primarily due to$439.5 million of new debt issuances related to theSeptember 2026 Notes,March 2026 B Notes, and HC IV SBA Debentures. The debt issuances were offset by repayments of$99.0 million of HT III related SBA Debentures,$75.0 million to retire theApril 2025 Notes, and pay downs of$65.6 million and$76.2 million on the 2027 Asset-Backed Notes and 2028 Asset-Based Notes, respectively, during the nine months endedSeptember 30, 2021 , compared to the nine months endedSeptember 30, 2020 . Additionally, we distributed$130.0 million in dividends during the nine months endedSeptember 30, 2021 , which increased from$114.4 million compared to the nine months endedSeptember 30, 2020 . Lastly, we did not issue any new common stock during the nine months endedSeptember 30, 2021 , compared to the$73.6 million issued during the nine months endedSeptember 30, 2020 . As ofSeptember 30, 2021 , our net assets totaled$1.3 billion , with a NAV per share of$11.54 . We intend to continue to operate in order to generate cash flows from operations, including income earned from investments in our portfolio companies. Our primary use of funds will be investments in portfolio companies and cash distributions to holders of our common stock. As described above, our diverse and well-structured balance sheet is designed to provide a long-term focused and sustainable investment platform. Currently, we believe we have ample liquidity to support our near-term capital requirements. As the impact of the COVID-19 pandemic and related disruption to markets and businesses continues to impact the economy, we will continue to evaluate our overall liquidity position and take proactive steps to maintain the appropriate liquidity position based upon the current circumstances.
Cash and capital resources available at
As ofSeptember 30, 2021 , we had$818.4 million in available liquidity, including$235.9 million in cash and cash equivalents. We had available borrowing capacity of$72.0 million under the Wells Facility,$400.0 million under the Union Bank Facility, and an additional$110.5 million available from our SBA license, as applicable, subject to existing terms, borrowing base, advance rates, regulatory requirements and regulatory approval. The Credit Facilities each have accordion provisions through which the available borrowing capacity can be increased by an aggregate$250.0 million . The 1940 Act as amended, permits BDCs to incur borrowings, issue debt securities, or issue preferred stock unless immediately after the borrowings or issuance the ratio of total assets (less total liabilities other than indebtedness) to total indebtedness plus preferred stock is less than 200% (or 150% if certain requirements are met). OnSeptember 4, 2018 andDecember 6, 2018 , our Board, including a "required majority" (as such term is defined in Section 57(o) of the 1940 Act) and our stockholders, respectively, approved the application to us of the 150% minimum asset coverage ratio set forth in Section 61(a)(2) of the 1940 Act. As ofSeptember 30, 2021 , our asset coverage ratio under our regulatory requirements as a BDC was 198.3% excluding our SBA debentures. Our exemptive order from theSEC allows us to exclude all SBA leverage from our asset coverage ratio. As a result of theSEC exemptive order, our ratio of total assets on a consolidated basis to outstanding indebtedness may be less than 150%, which while providing increased investment flexibility, also may increase our exposure to risks associated with leverage. Total asset coverage when including our SBA debentures was 193.9% as ofSeptember 30, 2021 . As ofSeptember 30, 2021 , we had$64.5 million of SBA debentures,$150.0 million of 2022 Notes,$105.0 million ofJuly 2024 Notes,$50.0 million ofFebruary 2025 Notes,$70.0 million ofJune 2025 Notes,$50.0 million ofMarch 2026 A Notes,$50.0 million ofMarch 2026 B Notes,$325.0 million ofSeptember 2026 Notes,$40.0 million of 2033 Notes,$115.4 million of 2027 Asset-Backed Notes,$173.8 million of 2028 Asset-Backed Notes, and$230.0 million of 2022 Convertible Notes payable. No amounts were outstanding with the Union Facility and Wells Facility. OnMarch 4, 2021 , we issued$50.0 million in aggregate principal amount ofMarch 2026 B Notes pursuant to the First Supplement to the 2025 Note Purchase Agreement. The sale of theMarch 2026 B Notes generated net proceeds of approximately$49.5 million . Aggregate estimated offering expenses in connection with the transaction, including the underwriter's discount and commissions, were approximately$0.5 million . 78
-------------------------------------------------------------------------------- OnSeptember 16, 2021 , we issued$325.0 million in aggregate principal amount of unsecured notes, theSeptember 2026 Notes. The issuance of the notes generated net proceeds of approximately$320.1 million , which has primarily been used to repay the remaining outstanding principal and accrued interest related to the 2027 Asset-Backed Notes and 2028 Asset-Backed Notes inOctober 2021 . Aggregate offering expenses in connection with the transaction, including the underwriter's discount and commissions, were approximately$4.1 million of costs and$0.8 million related to the discount. Additionally, we have gained access to$175.0 million of capital through the SBA debenture program. This is in addition to our regulatory capital commitment of$87.5 million to HC IV which will be used for investment purposes. As ofSeptember 30, 2021 , we have contributed$59.5 million of regulatory capital to HC IV, and drew$64.5 million of SBA debentures during the nine months endedSeptember 30, 2021 , which were available to us through HC IV. OnMay 5, 2021 , we paid down the remaining outstanding$34.0 million of HT III SBA Debentures, and onJune 15, 2021 surrendered our license for HT III. As ofSeptember 30, 2021 , we had approximately$13.5 million of restricted cash, which consists of collections of interest and principal payments on assets that are securitized. In accordance with the terms of the related securitized 2027 Asset-Backed Notes and 2028 Asset-Backed Notes, based on current characteristics of the securitized debt investment portfolios, the restricted funds may be used to pay monthly interest and principal on the securitized debt with any excess distributed to us or available for our general operations. As disclosed in "Note 5 - Debt" onOctober 20, 2021 , the Company fully repaid the aggregate outstanding$289.2 million of principal and$1.1 million of accrued interest and fees pursuant to the redemption terms of the 2027 Asset-Backed Notes & 2028 Asset-Backed Notes agreements using the available liquidity from theSeptember 2026 Notes. During the nine months endedSeptember 30, 2021 ,$65.6 million and$76.2 million was paid down on the 2027 Asset-Backed Notes and 2028 Asset-Based Notes, respectively. Refer to "Note 5 - Debt" included in the notes to our consolidated financial statements appearing elsewhere in this report for a further discussion of our debt.
Share distribution agreement
OnMay 6, 2019 , we entered into the 2019 Equity Distribution Agreement. The 2019 Equity Distribution Agreement provided that we may offer and sell up to 12.0 million shares of our common stock from time to time through JMP, as our sales agent. OnJuly 2, 2020 , we terminated the 2019 Equity Distribution Agreement and entered into a new ATM equity distribution agreement with JMP (the "2020 Equity Distribution Agreement"). As a result, the remaining shares that were available under the 2019 Equity Distribution Agreement are no longer available for issuance. The 2020 Equity Distribution Agreement provides that we may offer and sell up to 16.5 million shares of our common stock from time to time through JMP, as our sales agent. Sales of our common stock, if any, may be made in negotiated transactions or transactions that are deemed to be "at the market," as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices. There were no shares of common stock sold under the 2020 Equity Distribution Agreement during the nine months endedSeptember 30, 2021 . During the nine months endedSeptember 30, 2020 , we sold 6.0 million shares of common stock under the 2019 Equity Distribution Agreement. As ofSeptember 30, 2021 , approximately 16.2 million shares remain available for issuance and sale under the 2020 Equity Distribution Agreement.
Commitments
In the normal course of business, we are party to financial instruments with
off-balance sheet risk. These consist primarily of unfunded contractual
commitments to extend credit, in the form of loans, to our portfolio companies.
Unfunded contractual commitments to provide funds to portfolio companies are not
reflected on our balance sheet. Our unfunded contractual commitments may be
significant from time to time. A portion of these unfunded contractual
commitments are dependent upon the portfolio company reaching certain milestones
before the debt commitment becomes available. Furthermore, our credit agreements
contain customary lending provisions which allow us relief from funding
obligations for previously made unfunded commitments in instances where the
underlying company experiences materially adverse events that affect the
financial condition or business outlook for the company. These commitments will
be subject to the same underwriting and ongoing portfolio maintenance as are the
on-balance sheet financial instruments that we hold. Since these commitments may
expire without being drawn upon, the total commitment amount does not
necessarily represent future cash requirements. As such, our disclosure of
unfunded contractual commitments includes only
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those which are available at the request of the portfolio company and not encumbered with future milestones and not reached. See “Note 11 – Commitments and contingencies†included in the notes to our consolidated financial statements.
As ofSeptember 30, 2021 , we had approximately$309.9 million of unfunded commitments, including undrawn revolving facilities, which were available at the request of the portfolio company and unencumbered by future or unachieved milestones. This excludes$7.2 million of unfunded commitments which represent the portion of portfolio company commitments assigned to or directly committed by the Adviser Funds. We intend to use cash flow from normal and early principal repayments, and proceeds from debt to fund these commitments.
From
The fair value of our unfunded commitments is considered to be immaterial as the yield determined at the time of underwriting is expected to be materially consistent with the yield upon funding, given that interest rates are generally pegged to market indices and given the existence of milestones, conditions and/or obligations imbedded in the borrowing agreements. Additionally, as ofSeptember 30, 2021 certain premises are leased or licensed under agreements which expire at various dates throughJune 2027 . Total rent expense, including short-term leases, amounted to approximately$0.8 million and$2.4 million respectively during the three and nine months endedSeptember 30, 2021 and approximately$0.8 million and$2.3 million during the three and nine months endedSeptember 30, 2020 .
Compensation agreements
We have entered into indemnification agreements with our directors and executive officers. The indemnification agreements are intended to provide our directors and executive officers the maximum indemnification permitted underMaryland law and the 1940 Act. Each indemnification agreement provides that we shall indemnify the director or executive officer who is a party to the agreement, or an "Indemnitee," including the advancement of legal expenses, if, by reason of his or her corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding, to the maximum extent permitted byMaryland law and the 1940 Act.
We and our officers and directors are covered by
Distributions Our Board maintains a variable distribution policy with the objective of distributing four quarterly distributions in an amount that approximates 90% - 100% of our taxable quarterly income or potential annual income for a particular taxable year. In addition, our Board may choose to pay additional supplemental distributions, so that we may distribute approximately all of our annual taxable income in the taxable year in which it was earned or may elect to maintain the option to spill over our excess taxable income into the following taxable year as part of any future distribution payments. Distributions from our taxable income (including gains) to a stockholder generally will be treated as a dividend forU.S. federal income tax purposes to the extent of such stockholder's allocable share of our current or accumulated earnings and profits. Distributions in excess of our current and accumulated earnings and profits would generally be treated first as a return of capital to the extent of a stockholder's tax basis in our shares, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions is made annually as of the end of our taxable year based upon our taxable income for the full taxable year and distributions paid for the full taxable year. As a result, any determination of the tax attributes of our distributions made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full taxable year. Of the distributions declared during the year endedDecember 31, 2020 , 100% were distributions derived from our current and accumulated earnings and profits. There can be no certainty to stockholders that this determination is representative of what the tax attributes of our 2021 distributions to stockholders will actually be.
We maintain a “opt-out†dividend reinvestment plan which provides for the reinvestment of our distribution on behalf of our shareholders, unless a shareholder elects to receive cash. Therefore, if our board authorizes, and we declare, a cash distribution, then
80 -------------------------------------------------------------------------------- our stockholders who have not "opted out" of our dividend reinvestment plan will have their cash distribution automatically reinvested in additional shares of our common stock, rather than receiving the cash distributions. Shortly after the close of each calendar year information identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution, if any) will be provided to our stockholders subject to information reporting. To the extent our taxable earnings fall below the total amount of our distributions for any taxable year, a portion of those distributions may be deemed a tax return of capital to our stockholders. We expect to qualify to be subject to tax as a RIC under Subchapter M of the Code. In order to be subject to tax as a RIC, we are required to satisfy certain annual gross income and quarterly asset composition tests, as well as make distributions to our stockholders each taxable year treated as dividends for federal income tax purposes of an amount at least equal to 90% of the sum of our investment company taxable income, determined without regard to any deduction for dividends paid, plus our net tax-exempt income, if any. Upon being eligible to be subject to tax as a RIC, we would be entitled to deduct such distributions we pay to our stockholders in determining the overall components of our "taxable income." Components of our taxable income include our taxable interest, dividend and fee income, reduced by certain deductions, as well as taxable net realized securities gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses and generally excludes net unrealized appreciation or depreciation as such gains or losses are not included in taxable income until they are realized. In connection with maintaining our ability to be subject to tax as a RIC, among other things, we have made and intend to continue to make the requisite distributions to our stockholders each taxable year, which generally should relieve us from corporate-levelU.S. federal income taxes. As a RIC, we will be subject to a 4% nondeductibleU.S. federal excise tax on certain undistributed income and gains unless we make distributions treated as dividends forU.S. federal income tax purposes in a timely manner to our stockholders in respect of each calendar year of an amount at least equal to the Excise Tax Avoidance Requirement. We will not be subject to this excise tax on any amount on which we incurredU.S. federal corporate income tax (such as the tax imposed on a RIC's retained net capital gains). Depending on the level of taxable income earned in a taxable year, we may choose to carry over taxable income in excess of current taxable year distributions treated as dividends forU.S. federal income tax purposes from such taxable income into the next taxable year and incur a 4% excise tax on such taxable income, as required. The maximum amount of excess taxable income that may be carried over for distribution in the next taxable year under the Code is the total amount of distributions treated as dividends forU.S. federal income tax purposes paid in the following taxable year, subject to certain declaration and payment guidelines. To the extent we choose to carry over taxable income into the next taxable year, distributions declared and paid by us in a taxable year may differ from our taxable income for that taxable year as such distributions may include the distribution of current taxable year taxable income, the distribution of prior taxable year taxable income carried over into and distributed in the current taxable year, or returns of capital. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our debt. Our ability to make distributions will be limited by the asset coverage requirements under the 1940 Act. We intend to timely distribute to our stockholders substantially all of our annual taxable income for each year, except that we may retain certain net capital gains for reinvestment and, depending upon the level of taxable income earned in a year, we may choose to carry forward taxable income for distribution in the following year and pay any applicableU.S. federal excise tax.
Critical accounting conventions and estimates
The preparation of consolidated financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the period reported. On an ongoing basis, our management evaluates its estimates and assumptions, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in our estimates and assumptions could materially impact our results of operations and financial condition.
Investment valuation
The most significant estimate inherent in the preparation of our consolidated
financial statements is the valuation of investments and the related amounts of
unrealized appreciation and depreciation of investments recorded.
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As of September 30, 2021 , approximately 90.0% of our total assets represented
investments in portfolio companies whose fair value is determined in good faith
by the Board. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the
market price for those securities for which a market quotation is readily
available and (ii) for all other securities and assets, fair value is as
determined in good faith by the Board. Our investments are carried at fair value
in accordance with the 1940 Act and ASC Topic 946 and measured in accordance
with ASC Topic 820. Our debt securities are primarily invested in venture
capital-backed companies in technology-related industries including technology,
drug discovery and development, biotechnology, life sciences, healthcare and
sustainable and renewable technology at all stages of development. Given the
nature of lending to these types of businesses, substantially all of our
investments in these portfolio companies are considered Level 3 assets under ASC
Topic 820 because there generally is no known or accessible market or market
indices for these investment securities to be traded or exchanged. As such, we
value substantially all of our investments at fair value as determined in good
faith by our Board pursuant to a consistent valuation policy in accordance with
the provisions of ASC Topic 820 and the 1940 Act. Due to the inherent
uncertainty in determining the fair value of investments that do not have a
readily available market value, the fair value of our investments determined in
good faith by our Board may differ significantly from the value that would have
been used had a readily available market existed for such investments, and the
differences could be material.
In accordance with procedures established by its Board, the Company values
investments on a quarterly basis following a multistep valuation process.
Investments purchased within the preceding two calendar quarters before the
valuation date and debt investments with remaining maturities within 12 months
or less may each be valued at cost with interest accrued or discount
accreted/premium amortized to the date of maturity, unless such valuation, in
the judgment of the Company, does not represent fair value. In this case such
investments shall be valued at fair value as determined in good faith by or
under the direction of the Board. Investments that are not publicly traded or
whose market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board.
The Company engages one or more independent valuation firm(s) to provide
management with assistance in determining the fair value of selected portfolio
investments each quarter. In selecting which portfolio investments to engage an
independent valuation firm, the Company considers a number of factors,
including, but not limited to, the potential for material fluctuations in
valuation results, size, credit quality, and the time lapse since the last
valuation of the portfolio investment by an independent valuation firm. The
scope of services rendered by the independent valuation firm is at the
discretion of the Board, and the Company may engage an independent valuation
firm to value all or some of our portfolio investments. The Board are
ultimately, and solely, responsible for determining the fair value of the
Company's investments in good faith. In determining the fair value of a
portfolio investment in good faith, the Company recognizes these determinations
are made using the best available information that is knowable or reasonably
knowable. In addition, changes in the market environment, portfolio company
performance and other events that may occur over the duration of the investments
may cause the gains or losses ultimately realized on these investments to be
materially different than the valuations currently assigned. The Company
determines the fair value of each individual investment and records changes in
fair value as unrealized appreciation or depreciation.
Refer to "Note 2 - Summary of Significant Accounting Policies" included in the
notes to our consolidated financial statements appearing elsewhere in this
report for an additional discussion of our valuation policies for the three and
nine months ended September 30, 2021 and 2020.
Revenue recognition
Refer to "Note 2 - Summary of Significant Accounting Policies" included in the notes to our consolidated financial statements appearing elsewhere in this report for a discussion of our income recognition policy for the three and nine months endedSeptember 30, 2021 and 2020.
Income taxes
Refer to "Note 2 - Summary of Significant Accounting Policies" and "Note 6 -
Income Taxes" included in the notes to our consolidated financial statements
appearing elsewhere in this report, and also "Distributions" for a discussion of
our income tax policy.
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