UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

 

Commission file number 814-00201

 

 

MVC Capital, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code

(914) 701-0310

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to section 12(g) of the Act:

None

 

 

(Title of class)

 

 

(Title of class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ.

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o.

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes þ     No o.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ.

 

Approximate aggregate market value of common stock held by non-affiliates of the registrant as of the last business day of the Fund’s most recently completed fiscal second quarter: $76,500,125 computed on the basis of $12.29 per share, closing price of the common stock on the New York Stock Exchange (the “NYSE”) on April 30, 2006. For purposes of calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates.

 

There were 19,096,256 shares of the registrant’s common stock, $.01 par value, outstanding as of January 8, 2007.

 

DOCUMENT INCORPORATED BY REFERENCE:

 

Proxy Statement for the Fund’s Annual Meeting of Shareholders 2006, incorporated by reference in Part III, Items 10, 11, 12 and 14.

 

 

MVC Capital, Inc.

 

(A Delaware Corporation)

 

Index

 

 

Factors That May Affect Future Results

 

This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the federal securities laws that involve substantial uncertainties and risks. The Fund’s future results may differ materially from its historical results and actual results could differ materially from those projected in the forward-looking statements as a result of certain risk factors. These factors are described in the “Risk Factors” section below. Readers should pay particular attention to the considerations described in the section of this report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Readers should also carefully review the risk factors described in the other documents the Fund files, or has filed, from time to time with the United States Securities and Exchange Commission (the “SEC”).

 

In this Annual Report on Form 10-K, unless otherwise indicated, “MVC Capital,” “we,” “us,” “our” or the “Fund” refer to MVC Capital, Inc. and its wholly-owned subsidiary company, MVC Financial Services, Inc. and “TTG Advisers” or the “Adviser” refers to The Tokarz Group Advisers LLC. Unless the context dictates otherwise, “we” also refers to TTG Advisers acting on behalf of MVC Capital.

 

General

 

MVC Capital, Inc. is an externally managed, non-diversified closed-end management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended (the “1940 Act”). MVC Capital provides equity and debt investment capital to fund growth, acquisitions and recapitalizations of small and middle-market companies in a variety of industries primarily located in the United States. Our investments can take the form of common and preferred stock and warrants or rights to acquire equity interests, senior and subordinated loans, or convertible securities. Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “MVC.” During the fiscal year, MVC Capital was an internally managed investment company. Effective November 1, 2006, the Fund is externally managed by The Tokarz Group Advisers LLC (“TTG Advisers”) pursuant to an Investment Advisory and Management Agreement, dated October 31, 2006 (the “Advisory Agreement”).

 

Although the Fund has been in operation since 2000, the year 2003 marked a new beginning for the Fund. In February 2003, shareholders elected an entirely new board of directors. The board of directors developed a new long-term strategy for the Fund. In September 2003, upon the recommendation of the board of directors, shareholders voted to adopt a new investment objective for the Fund of seeking to maximize total return from capital appreciation and/or income. The Fund’s prior objective had been limited to seeking long-term capital appreciation from venture capital investments in the information technology industries. Consistent with our broader objective, we adopted a more flexible investment strategy of providing equity and debt financing to small and middle-market companies in a variety of industries. With the recommendation of the board of directors, shareholders also voted to appoint Michael Tokarz as Chairman and Portfolio Manager to lead the implementation of our new objective and strategy and to stabilize the existing portfolio. Prior to the arrival of Mr. Tokarz and his new management team in November 2003, the Fund had experienced significant valuation declines from investments made by the former management team. After three quarters of operations under the new management team, the Fund posted a profitable third quarter for fiscal 2004 reversing a trend of 12 consecutive quarters of net investment losses and earned a profit of approximately $18,000 for fiscal year 2004. The Fund has continued to be profitable in each of the last eight quarters since fiscal 2004 posting annual net operating income of $5.7 million and $3.9 million in fiscal years 2005 and 2006, respectively. Similarly, the change in net assets resulting from operations increased from $11.6 million at the end of fiscal 2004 to $26.3 million as of the end of fiscal 2005, and increasing to $47.3 million as of the end of fiscal 2006.

 

Fiscal year 2006, represented a very positive year for the Fund. The Fund made sixteen new investments and eight follow-on investments in fiscal 2006, which is an increase from six new investments and three follow-on investments in fiscal 2005 and seven new investments in fiscal 2004. The Fund committed a total of $166.3 million of capital in fiscal 2006, compared to $53.8 million and $60.7 million in fiscal 2005 and 2004, respectively. The fiscal 2006 new investments include: Turf Products, LLC (“Turf”), Strategic Outsourcing, Inc. (“SOI”), Henry Company (“Henry”), SIA BM Auto (“BM Auto”), Storage Canada, LLC (“Storage Canada”), Phoenix Coal

Corporation (“Phoenix”), Harmony Pharmacy & Health Center, Inc. (“Harmony Pharmacy”), Total Safety U.S., Inc. (“Total Safety”), PreVisor, Inc. (“PreVisor”), Marine Exhibition Corporation (“Marine”), BP, Velocitius B.V. (“Velocitius”), Summit Research Labs, Inc. (“Summit”), Octagon, auto MOTOL BENI (“BENI”), and Innovative Brands LLC (“Innovative Brands”). The fiscal 2006 follow-on investments include: Dakota, Baltic, SGDA, Amersham, Timberland, SP, Harmony, and Velocitius.

 

The fiscal 2005 investments include: JDC Lighting, LLC (“JDC”), SGDA Sanierungsgesellschaft fur Deponien und Altasten mbH (“SGDA”), SP Industries, Inc. (“SP”), BP Clothing, LLC (“BP”), Ohio Medical Corporation (“Ohio”), Amersham Corporation (“Amersham”), Timberland, Vestal, and Impact.

 

The fiscal 2004 investments include: Vestal Manufacturing Enterprises, Inc. (“Vestal”), Octagon Credit Investors, LLC (“Octagon”), Baltic Motors Corporation (“Baltic”), Dakota Growers Pasta Company, Inc. (“Dakota”), Impact Confections, Inc. (“Impact”), Timberland Machines & Irrigation, Inc. (“Timberland”), and Vitality Foodservice, Inc. (“Vitality”).

 

We continue to perform due diligence and seek new investments that are consistent with our objective of maximizing total return from capital appreciation and/or income. We believe that we have extensive relationships with private equity firms, investment banks, business brokers, commercial banks, accounting firms, law firms, hedge funds, other investment firms, industry professionals and management teams of several companies, which can continue to provide us with investment opportunities.

 

We are currently working on an active pipeline of potential new investment opportunities. We expect that our equity and loan investments will generally range between $3 million and $25 million each, though we may occasionally invest smaller or greater amounts of capital depending upon the particular investment. While the Fund does not adhere to a specific equity and debt asset allocation mix, no more than 25% of the value of our total assets may be invested in the securities of one issuer (other than U.S. government securities), or of two or more issuers that are controlled by us and are engaged in the same or similar or related trades or businesses as of the close of each quarter. Our portfolio company investments are typically illiquid and are made through privately negotiated transactions. We generally seek to invest in companies with a history of strong, predictable, positive EBITDA (net income before net interest expense, income tax expense, depreciation and amortization).

 

Our portfolio company investments currently consist of common and preferred stock, other forms of equity interests and warrants or rights to acquire equity interests, senior and subordinated loans, and convertible securities. At October 31, 2006, the value of all investments in portfolio companies was approximately $275.9 million and our gross assets were approximately $347.0 million compared to the value of investments in portfolio companies of approximately $122.3 million and gross assets of approximately $201.4 million at October 31, 2005.

 

We expect that our investments in senior loans and subordinated debt will generally have stated terms of three to ten years. However, there are no constraints on the maturity or duration of any security in our portfolio. Our debt investments are not, and typically will not be, rated by any rating agency, but we believe that if such investments were rated, they would be below investment grade (rated lower than “Baa3” by Moody’s or lower than “BBB−” by Standard & Poor’s). In addition, we may invest without limit in debt of any rating, including debt that has not been rated by any nationally recognized statistical rating organization.

 

On July 16, 2004, the Fund formed a wholly-owned subsidiary, MVC Financial Services, Inc. (“MVCFS”). MVCFS is incorporated in Delaware and its principal purpose is to provide advisory, administrative and other services to the Fund, the Fund’s portfolio companies and other entities (including other private equity firms or business development companies). The Fund does not hold MVCFS for investment purposes. The results of MVCFS are consolidated into the Fund and all inter-company accounts have been eliminated in consolidation.

 

Our board of directors has the authority to change any of the strategies described in this report without seeking the approval of our shareholders. However, the 1940 Act prohibits us from altering or changing our investment objective, strategies or policies such that we cease to be a business development company, nor can we voluntarily withdraw our election to be regulated as a business development company, without the approval of the holders of a “majority”, as defined in the 1940 Act, of our outstanding voting securities.

 

Substantially all amounts not invested in securities of portfolio companies are invested in short-term, highly liquid money market investments or held in cash in an interest bearing account. As of October 31, 2006, the Fund’s investments in short-term securities, cash equivalents and cash were valued at $66.2 million.

Corporate History And Offices

 

The Fund was organized on December 2, 1999. Prior to July 2004, our name was meVC Draper Fisher Jurvetson Fund I, Inc. On March 31, 2000, the Fund raised $330 million in an initial public offering whereupon it commenced operations as a closed-end investment company. On December 4, 2002, the Fund announced it had commenced doing business under the name MVC Capital.

 

We are a Delaware corporation and a non-diversified closed-end management investment company that has elected to be regulated as a business development company under the 1940 Act. On July 16, 2004, the Fund formed MVCFS.

 

The Fund has been “internally managed,” i.e., has had no investment adviser from June 2002 through the end of the fiscal year ended October 31, 2006. Effective November 1, 2006, pursuant to the Advisory Agreement, the Fund is externally managed by TTG Advisers, which serves as the Fund’s investment adviser. The Advisory Agreement was unanimously approved by the independent directors on May 30, 2006 and by shareholders at the annual meeting of shareholders on September 7, 2006. TTG Advisers is a registered investment adviser that is controlled by Mr. Tokarz. All of the individuals (including the Fund’s investment professionals) that had been employed by the Fund as of the fiscal year ended October 31, 2006 are now employed by TTG Advisers and are expected to continue to provide services to the Fund. It is currently anticipated that the Fund’s investment strategy and selection process will remain the same under the externalized management structure. Accordingly, the section below entitled “Our Investment Strategy” is currently expected to remain applicable to the Fund under external management.

 

All but one of the independent members of the current board of directors were first elected at the February 28, 2003 Annual Meeting of the shareholders, replacing the previous board of directors in its entirety. The new board of directors then worked on developing a new long-term strategy for the Fund. Then, in September 2003, upon the recommendation of the board of directors, shareholders voted to adopt our new investment objective. With the recommendation of the board of directors, shareholders also voted to appoint Mr. Tokarz as Chairman and Portfolio Manager to lead the implementation of our new objective and strategy and to stabilize the existing portfolio. Mr. Tokarz and his team managed the Fund under an internal structure through October 31, 2006. On September 7, 2006, the shareholders of the Fund approved the Advisory Agreement (with over 92% of the votes cast on the agreement voting in its favor) that provided for the Fund to be externally managed by TTG Advisers. The agreement took effect on November 1, 2006. TTG Advisers is a registered investment adviser that is controlled by Mr. Tokarz. All of the individuals (including the Fund’s investment professionals) that had been previously employed by the Fund as of the fiscal year ended October 31, 2006 are now employed by TTG Advisers and are expected to continue to provide services to the Fund.

 

Our principal executive office is located at 287 Bowman Avenue, Purchase, New York 10577 and our telephone number is (914) 701-0310. Our website is http://www.mvccapital.com. Copies of the Fund’s annual regulatory filings on Form 10-K, quarterly regulatory filings on Form 10-Q, Form 8-K, other regulatory filings, code of ethics, audit committee charter, compensation committee charter, nominating and corporate governance committee charter, corporate governance guidelines, and privacy policy may be obtained from our website, free of charge.

 

Our Investment Strategy

 

On November 6, 2003, Mr. Tokarz assumed his current positions as Chairman and Portfolio Manager. We seek to implement our investment objective (i.e., to maximize total return from capital appreciation and/or income) through making a broad range of private investments in a variety of industries. The investments can include common and preferred stock, other forms of equity interests and warrants or rights to acquire equity interests, senior and subordinated loans, or convertible securities. During the fiscal year ended October 31, 2006, the Fund made sixteen new investments and eight follow-on investments, committing a total of $166.3 million of capital to these investments.

 

Prior to the adoption of our current investment objective, the Fund’s investment objective had been to achieve long-term capital appreciation from venture capital investments in information technology companies. The Fund’s investments had thus previously focused on investments in equity and debt securities of information technology companies. As of October 31, 2006, 2.42% of our assets consisted of investments made by the Fund’s former management team pursuant to the prior investment objective. We are, however, seeking to manage these legacy investments to try and realize maximum returns. We generally seek to capitalize on opportunities to realize cash

returns on these investments when presented with a potential “liquidity event,” i.e., a sale, public offering, merger or other reorganization.

 

Our new portfolio investments are made pursuant to our new objective and strategy. We are concentrating our investment efforts on small and middle-market companies that, in our view, provide opportunities to maximize total return from capital appreciation and/or income. Under our investment approach, we have the authority to invest, without limit, in any one portfolio company, subject to any diversification limits that may be required in order for us to continue to qualify as a “regulated investment company” (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).

 

We participate in the private equity business generally by providing negotiated equity and/or long-term debt investment capital. Our financing is generally used to fund growth, buyouts, acquisitions, recapitalizations, note purchases, and/or bridge financings. We may or may not be a lead investor in such transactions and may also provide equity and debt financing to companies led by private equity firms. We generally invest in private companies, though, from time to time, we may invest in small public companies that may lack adequate access to public capital. We may also seek to achieve our investment objective by establishing a subsidiary or subsidiaries that would serve as general partner to a private equity or other investment fund(s). In fact, during 2006, we established MVC Partners, LLC for this purpose. Additionally, we may also acquire a portfolio of existing private equity or debt investments held by financial institutions or other investment funds.

 

At October 31, 2006, October 31, 2005 and October 31, 2004, the fair value of the invested portion (excluding cash and short-term securities) of our net assets consisted of the following:

 

 

Substantially all amounts not invested in securities of portfolio companies are invested in short-term, highly liquid money market investments or held in cash in an interest bearing account. As of October 31, 2006, these investments were valued at approximately $66.2 million or 27.94% of net assets.

 

The current portfolio has investments in a variety of industries including food and food service, value-added distribution, industrial manufacturing, financial services, consumer products, automotive dealerships, and information technology. The current portfolio also has investments in a variety of geographical areas including United States, Europe, and Asia.

 

Market.  We have developed and maintained relationships with intermediaries, including investment banks, financial services companies and private mezzanine and equity sponsors, through which we source investment opportunities. Through these relationships, we have been able to strengthen our position as an investor. For the transactions in which we may provide debt capital, an equity sponsor can provide a source of additional equity capital if a portfolio company requires additional financing. Private equity sponsors also assist us in confirming our own due diligence findings when assessing a new investment opportunity, and they may provide assistance and leadership to the portfolio company’s management throughout our investment period.

 

Investment Criteria.  Prospective investments are evaluated by the investment team based upon criteria that may be modified from time to time. The criteria currently being used by management in determining whether to make an investment in a prospective portfolio company include, but are not limited to, management’s view of:

 

 

 

Due diligence includes a thorough review and analysis of the business plan and operations of a potential portfolio company. We generally perform financial and operational due diligence, study the industry and competitive landscape, and meet with current and former employees, customers, suppliers and/or competitors. In addition, as applicable, we engage attorneys, independent accountants and other consultants to assist with legal, environmental, tax, accounting and marketing due diligence.

 

Investment Sourcing.  Mr. Tokarz and the other investment professionals have established an extensive network of investment referral relationships. Our network of relationships with investors, lenders and intermediaries includes:

 

 

Allocation of Investment Opportunities.  In allocating investment opportunities, TTG Advisers adheres to the following policy, which was approved by the board of directors on October 31, 2006: (1) absent the consent of the board of directors, TTG Advisers will allocate to the Fund all investment opportunities in (i) mezzanine and debt securities or (ii) equity or other “non-debt” investments that are (a) expected to be equal to or less than the lesser of 10% of the Fund’s net assets or $25 million; and (b) issued by U.S. companies with less than $150 million in revenues; (2) notwithstanding Item 1 any private fund managed or co-managed by TTG Advisers and a person or entity not affiliated with TTG Advisers or MVC Partners, LLC, a subsidiary of the Fund (“MVC Partners”), is permitted to make an investment, without regard to the Fund, if such investment is sourced by a person or entity not affiliated with TTG Advisers and MVC Partners; and (3) notwithstanding Item 1, TTG Advisers shall not have an obligation to seek the consent of the board of directors nor be required to allocate to the Fund any equity investment where the investor would hold a majority of the outstanding “voting securities” (as defined by the 1940 Act) of the relevant company, provided that such investment is allocated, in its entirety, to MVC Partners.

 

Co-Investments.  The Fund is permitted to co-invest in certain portfolio companies with its affiliates, subject to specified conditions set forth in an exemptive order obtained from the Securities and Exchange Commission (the “SEC”). Under the terms of the exemptive order, portfolio companies purchased by the Fund and its affiliates are required to be approved by the directors who are not “interested persons” of the Fund (the “Independent Directors”) and are required to satisfy certain other conditions established by the SEC.

 

Investment Structure.  Portfolio company investments typically will be negotiated directly with the prospective portfolio company or its affiliates. The investment professionals will structure the terms of a proposed investment, including the purchase price, the type of security to be purchased or financing to be provided and the future involvement of the Fund and affiliates in the portfolio company’s business (including potential representation on its board of directors). The investment professionals will seek to structure the terms of the investment as to provide for the capital needs of the portfolio company and at the same time seek to maximize the Fund’s total return.

 

Once we have determined that a prospective portfolio company is suitable for investment, we work with the management and, in certain cases, other capital providers, such as senior, junior and/or equity capital providers, to structure an investment. We negotiate on how our investment is expected to relate relative to the other capital in the portfolio company’s capital structure.

 

We make preferred and common equity investments in companies as a part of our investing activities, particularly when we see a unique opportunity to profit from the growth of a company and the potential to enhance our returns. At times, we may invest in companies that are undergoing a restructuring but have several of the above attributes and a management team that we believe has the potential to achieve a successful turnaround. Preferred

equity investments may be structured with a dividend yield, which may provide us with a current return, if earned and received by the Fund.

 

Our senior, subordinated and mezzanine debt investments are tailored to the facts and circumstances of the deal. The specific structure is negotiated over a period of several weeks and is designed to seek to protect our rights and manage our risk in the transaction. We may structure the debt instrument to require restrictive affirmative and negative covenants, default penalties, lien protection, equity calls, take control provisions and board observation. Our debt investments are not, and typically will not be, rated by any rating agency, but we believe that if such investments were rated, they would be below investment grade quality (rated lower than “Baa3” by Moody’s or lower than “BBB−” by Standard & Poor’s, commonly referred to as “junk bonds”).

 

Our mezzanine debt investments are typically structured as subordinated loans (with or without warrants) that carry a fixed rate of interest. The loans may have interest-only payments in the early years and payments of both principal and interest in the later years, with maturities of three to ten years, although debt maturities and principal amortization schedules vary.

 

Our mezzanine debt investments may include equity features, such as warrants or options to buy a minority interest in the portfolio company. Any warrants or other rights we receive with our debt securities generally require only a nominal cost to exercise, and thus, as the portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure the warrants to provide minority rights provisions and event-driven puts. We may seek to achieve additional investment return from the appreciation and sale of our warrants.

 

Under certain circumstances, we may acquire more than 50% of the common stock of a company in a control buyout transaction. In addition to our common equity investment, we may also provide additional capital to the controlled portfolio company in the form of senior loans, subordinated debt or preferred stock.

 

We fund new investments using cash, the reinvestment of accrued interest and dividends in debt and equity securities, or the current reinvestment of interest and dividend income through the receipt of a debt or equity security (payment-in-kind income). From time to time, we may also opt to reinvest accrued interest receivable in a new debt or equity security, in lieu of receiving such interest in cash and funding a subsequent investment. We may also acquire investments through the issuance of common or preferred stock, debt, or warrants representing rights to purchase shares of our common or preferred stock. The issuance of our stock as consideration may provide us with the benefit of raising equity without having to access the public capital markets in an underwritten offering, including the added benefit of the elimination of any commissions payable to underwriters.

 

Providing Management Assistance.  As a business development company, we are required to make significant managerial assistance available to the companies in our investment portfolio. In addition to the interest and dividends received from our investments, we often generate additional fee income for the structuring, diligence, transaction, administration, and management services and financial guarantees we provide to our portfolio companies through the Fund or our wholly-owned subsidiary MVCFS. In some cases, officers, directors and employees of the Fund or the Adviser may serve as members of the board of directors of portfolio companies. The Fund may provide guidance and management assistance to portfolio companies with respect to such matters as budgets, profit goals, business and financing strategy, management additions or replacements and plans for liquidity events for portfolio company investors such as a merger or initial public offering. MVCFS may also generate additional fee income for providing administrative and other management services to other entities, including private equity firms or other business development companies (as it currently does for Brantley Capital Corporation).

 

Portfolio Company Monitoring.  We monitor our portfolio companies closely to determine whether or not they continue to be attractive candidates for further investment. Specifically, we monitor their ongoing performance and operations and provide guidance and assistance where appropriate. We would decline additional investments in portfolio companies that, in our view, do not continue to show promise. However, we may make follow on investments in portfolio companies that we believe may perform well in the future.

 

We follow established procedures for monitoring equity and loan investments. The investment professionals have developed a multi-dimensional flexible rating system for all of the Fund’s portfolio investments. These rating

grids are updated regularly and reviewed by the Portfolio Manager, together with the investment team. Additionally, the Fund’s Valuation Committee (the “Valuation Committee”) meets at least quarterly, to review a written valuation memorandum for each portfolio company and to discuss business updates. Furthermore, the Fund’s Chief Compliance Officer administers the Fund’s compliance policies and procedures, specifically as they relate to the Fund’s investments in portfolio companies.

 

We exit our investments generally when a liquidity event takes place, such as the sale, recapitalization or initial public offering of a portfolio company. Our equity holdings, including shares underlying warrants, after the exercise of such warrants, typically includes registration rights which would allow us to sell the securities if the portfolio company completes a public offering.

 

Investment Approval Procedures.  Generally, prior to approving any new investment, we follow the process outlined below. We usually conduct one to four months of due diligence and structuring before an investment is considered for approval. However, depending on the type of investment being contemplated, this process may be longer or shorter.

 

The typical key steps in our investment approval process are:

 

 

Employees

 

At October 31, 2006, Michael Tokarz served as Chairman & Portfolio Manager of the Fund and we employed 13 individuals, including investment and portfolio management professionals, operations professionals and administrative staff. Substantially all of these individuals are located in the Purchase, New York office. We believe that our relations with our employees are excellent. All of the individuals (including the Fund’s investment professionals) that had been employed by the Fund as of the fiscal year ended October 31, 2006 are now employed by TTG Advisers and are expected to continue to provide services to the Fund. The Fund no longer has any direct employees.

 

Operating Expenses

 

During the fiscal year ended October 31, 2006, the Fund bore the costs of obtaining office space, facilities, equipment, personnel and other administrative costs necessary to conduct the Fund’s business. The Fund also bears other costs relating to the Fund’s operations, including fees and expenses of the Independent Directors; fees of unaffiliated transfer agents, registrars and disbursing agents; legal and accounting expenses; costs of printing and mailing proxy materials and reports to shareholders; NYSE fees; custodian fees; litigation costs; costs of disposing

of investments including brokerage fees and commissions; and other extraordinary or nonrecurring expenses and other expenses properly payable by the Fund. For the year ended October 31, 2006, operating expenses including tax expense constituted 6.85% of average net assets.

 

Under the externalized structure, all investment professionals of TTG Advisers and its staff, when and to the extent engaged in providing services required to be provided by TTG Advisers under the Advisory Agreement, and the compensation and routine overhead expenses of such personnel allocable to such services, are provided and paid for by TTG Advisers and not by the Fund, except that costs or expenses relating to the following items are borne by the Fund: (i) the cost and expenses of any independent valuation firm; (ii) expenses incurred by TTG Advisers payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for the Fund and in monitoring the Fund’s investments and performing due diligence on its prospective portfolio companies, provided, however, the retention by TTG Advisers of any third party to perform such services shall require the advance approval of the board (which approval shall not be unreasonably withheld) if the fees for such services are expected to exceed $30,000; once the third party is approved, any expenditure to such third party will not require additional approval from the board; (iii) interest payable on debt and other direct borrowing costs, if any, incurred to finance the Fund’s investments or to maintain its tax status; (iv) offerings of the Fund’s common stock and other securities; (v) investment advisory and management fees; (vi) fees and payments due under any administration agreement between the Fund and its administrator; (vii) transfer agent and custodial fees; (viii) federal and state registration fees; (ix) all costs of registration and listing the Fund’s shares on any securities exchange; (x) federal, state and local taxes; (xi) independent directors’ fees and expenses; (xii) costs of preparing and filing reports or other documents required by governmental bodies (including the SEC); (xiii) costs of any reports, proxy statements or other notices to stockholders, including printing and mailing costs; (xiv) the cost of the Fund’s fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums; (xv) direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, independent auditors and outside legal costs; (xvi) the costs and expenses associated with the establishment of a special purpose vehicle; (xvii) the allocable portion of the cost (excluding office space) of the Fund’s Chief Financial Officer, Chief Compliance Officer and Secretary in an amount not to exceed $100,000, per year, in the aggregate; (xviii) subject to a cap of $150,000 in any fiscal year of the Fund, fifty percent of the unreimbursed travel and other related (e.g., meals) out-of-pocket expenses (subject to item (ii) above) incurred by TTG Advisers in sourcing investments for the Fund; provided that, if the investment is sourced for multiple clients of TTG Advisers, then the Fund shall only reimburse fifty percent of its allocable pro rata portion of such expenses; and (xix) all other expenses incurred by the Fund in connection with administering the Fund’s business (including travel and other out-of-pocket expenses (subject to item (ii) above) incurred in providing significant managerial assistance to a portfolio company).

 

Valuation of Portfolio Securities

 

Pursuant to the requirements of the 1940 Act, we value our portfolio securities at their current market values or, if market quotations are not readily available, at their estimates of fair values. Because our portfolio company investments generally do not have readily ascertainable market values, we record these investments at fair value in accordance with Valuation Procedures adopted by our board of directors. Our board of directors may also hire independent consultants to review our Valuation Procedures or to conduct an independent valuation of one or more of our portfolio investments.

 

Pursuant to our Valuation Procedures, the Valuation Committee (which is currently comprised of three Independent Directors) determines fair valuations of portfolio company investments on a quarterly basis (or more frequently, if deemed appropriate under the circumstances). Any changes in valuation are recorded in the statements of operations as “Net unrealized gain (loss) on investments.” Currently, our net asset value (“NAV”) per share is calculated and published on a monthly basis. The fair values determined as of the most recent quarter end are reflected, in the next calculated NAV per share. (If the Valuation Committee determines to fair value an

investment more frequently than quarterly, the most recently determined fair value would be reflected in the published NAV per share.)

 

The Fund calculates our NAV per share by subtracting all liabilities from the total value of our portfolio securities and other assets and dividing the result by the total number of outstanding shares of our common stock on the date of valuation.

 

At October 31, 2006, approximately 79.50% of our total assets represented portfolio investments recorded at fair value.

 

Initially, Fair Value Investments held by the Fund are valued at cost (absent the existence of circumstances warranting, in management’s and the Valuation Committee’s view, a different initial value). During the period that a Fair Value Investment is held by the Fund, its original cost may cease to represent an appropriate valuation, and other factors must be considered. No pre-determined formula can be applied to determine fair values. Rather, the Valuation Committee makes fair value assessments based upon the value at which the securities of the portfolio company could be sold in an orderly disposition over a reasonable period of time between willing parties, other than in a forced or liquidation sale (“Fair Value”). The liquidity event whereby the Fund exits an investment is generally the sale, the merger, the recapitalization or, in some cases, the initial public offering of the portfolio company.

 

Valuation Methodology

 

There is no one methodology to determine Fair Value and, in fact, for any portfolio security, Fair Value may be expressed as a range of values, from which the Fund derives a single estimate of Fair Value. To determine the Fair Value of a portfolio security, the Valuation Committee analyzes the portfolio company’s financial results and projections, publicly traded comparables when available, precedent exit transactions in the market when available, as well as other factors. The Fund generally requires, where practicable, portfolio companies to provide annual audited and more regular unaudited financial statements, and/or annual projections for the upcoming fiscal year.

 

The fair value of our portfolio securities is inherently subjective. Because of the inherent uncertainty of fair valuation of portfolio securities that do not have readily ascertainable market values, our estimate of fair value may significantly differ from the fair market value that would have been used had a ready market existed for the securities. Such values also do not reflect brokers’ fees or other selling costs which might become payable on disposition of such investments.

 

Equity Securities.  The Fund’s equity interests in portfolio companies for which there is no liquid public market are valued at Fair Value. The Valuation Committee’s analysis of fair value may include various factors, such as multiples of EBITDA, cash flow(s), net income, revenues or in limited instances book value or liquidation value. All of these factors may be subject to adjustments based upon the particular circumstances of a portfolio company or the Fund’s actual investment position. For example, adjustments to EBITDA may take into account compensation to previous owners or acquisition, recapitalization, or restructuring or related items.

 

The Valuation Committee may look to private merger and acquisition statistics, public trading multiples discounted for illiquidity and other factors, or industry practices in determining Fair Value. The Valuation Committee may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, as well as any other factors it deems relevant in assessing the value. The determined Fair Values may be discounted to account for restrictions on resale and minority positions.

 

Generally, the value of our equity interests in public companies for which market quotations are readily available is based upon the most recent closing public market price. Portfolio securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

 

Loans and Debt Securities.  For loans and debt securities, Fair Value generally approximates cost unless there is a reduced value or overall financial condition of the portfolio company or other factors indicate a lower Fair Value for the loan or debt security.

 

Generally, in arriving at a Fair Value for a debt security or a loan, the Valuation Committee focuses on the portfolio company’s ability to service and repay the debt and considers its underlying assets. With respect to a convertible debt security, the Valuation Committee also analyzes the excess of the value of the underlying security

over the conversion price as if the security was converted when the conversion feature is “in the money” (appropriately discounted if restricted). If the security is not currently convertible, the use of an appropriate discount in valuing the underlying security is typically considered. If the value of the underlying security is less than the conversion price, the Valuation Committee focuses on the portfolio company’s ability to service and repay the debt.

 

When the Fund receives nominal cost warrants or free equity securities (“nominal cost equity”) with a debt security, the Fund allocates its cost basis in the investment between debt securities and nominal cost equity at the time of origination.

 

Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. Origination, closing and/or closing fees associated with investments in portfolio companies are accreted into income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as income. Prepayment premiums are recorded on loans when received.

 

For loans, debt securities, and preferred securities with contractual payment-in-kind interest or dividends, which represent contractual interest/dividends accrued and added to the loan balance or liquidation preference that generally becomes due at maturity, the Fund will not accrue payment-in-kind interest/dividends if the portfolio company valuation indicates that the payment-in-kind interest is not collectible. However, the Fund may accrue payment-in-kind interest if the health of the portfolio company and the underlying securities are not in question. All payment-in-kind interest that has been added to the principal balance or capitalized is subject to ratification by the Valuation Committee.

 

Custodian

 

US Bank National Association is the primary custodian (the “Primary Custodian”) of the Fund’s portfolio securities. The principal business office of the Primary Custodian is 1555 North River Center Drive, Suite 302, Milwaukee, WI 53212.

 

Transfer Agent and Distribution Agent

 

The Fund employs Computershare Ltd. as its transfer agent to record transfers of the shares, maintain proxy records, process distributions and to act as agent for each participant in the Fund’s dividend reinvestment plan. The principal business office of such company is 250 Royall Street, Canton, Massachusetts 02021.

 

Risk Factors

 

In the normal course of its business, the Fund, in an effort to keep its shareholders and the public informed about the Fund’s operations and portfolio of investments, may from time-to-time issue certain statements, either in writing or orally, that contain or may contain forward-looking information. Generally, these statements relate to business plans or strategies of the Fund or portfolio companies, projected or anticipated benefits or consequences of such plans or strategies, projected or anticipated benefits of new or follow-on investments made by or to be made by the Fund, or projections involving anticipated purchases or sales of securities or other aspects of the Fund’s operating results. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially. As noted elsewhere in this report, the Fund’s operations and portfolio of investments are subject to a number of uncertainties, risks, and other influences, many of which are outside the control of the Fund, and any one of which, or a combination of which, could materially affect the results of the Fund’s operations, or its NAV, the market price of its common stock, and whether forward-looking statements made by the Fund ultimately prove to be accurate.

 

Investing in MVC Capital involves a number of significant risks relating to our business and investment objective. As a result, there can be no assurance that we will achieve our investment objective. In addition, the following risk factors are applicable to an investment in our common stock.

BUSINESS RISKS

 

Business risks are risks that are associated with general business conditions, the economy, and the operations of the Fund. Business risks are not risks associated with our specific investments or an offering of our securities.

 

We depend on key personnel of TTG Advisers, especially Mr. Tokarz, in seeking to achieve our investment objective.

 

We depend on the continued services of Mr. Tokarz and certain other key management personnel. If we were to lose access to any of these personnel, particularly Mr. Tokarz, it could negatively impact our operations and we could lose business opportunities. Upon the effectiveness of the Advisory Agreement, the Fund’s employment agreement with Mr. Tokarz was terminated. However, Mr. Tokarz has entered into an agreement with TTG Advisers pursuant to which he has agreed to serve as the Fund’s Portfolio Manager for the full twenty-four calendar months following November 1, 2006, absent the occurrence of certain extraordinary events. Furthermore, the Advisory Agreement may not be terminated by TTG Advisers during the initial two-year term of the Advisory Agreement. However, there is still a risk that Mr. Tokarz’s expertise may be unavailable to the Fund, which could significantly impact the Fund’s ability to achieve its investment objective.

 

Our investment adviser, TTG Advisers, is a newly-formed entity.

 

Our future success depends to a significant extent on the services of our investment adviser. We are dependent for the final selection, structuring, closing, and monitoring of our investment on the diligence and skill of our newly formed investment adviser. TTG Advisers identifies, evaluates, structures, monitors and disposes of our investments, and the services it provides significantly impact our results of operations. Because TTG Advisers is newly formed, it has a limited operating history and currently has limited equity capital. However, Mr. Tokarz and the Fund’s investment professionals that had been employed by the Fund as of the fiscal year ended October 31, 2006 are now employed by TTG Advisers and are expected to continue to provide services to the Fund.

 

Our returns may be substantially lower than the average returns historically realized by the private equity industry as a whole.

 

Past performance of the private equity industry is not necessarily indicative of that sector’s future performance, nor is it necessarily a good proxy for predicting the returns of the Fund. We cannot guarantee that we will meet or exceed the rates of return historically realized by the private equity industry as a whole. Additionally, our overall returns are impacted by certain factors related to our structure as a publicly-traded business development company, including:

 

 

Substantially all of our portfolio investments are recorded at “fair value” and, as a result, there is a degree of uncertainty regarding the carrying values of our portfolio investments.

 

Pursuant to the requirements of the 1940 Act, because our portfolio company investments do not have readily ascertainable market values, we record these investments at fair value in accordance with Valuation Procedures adopted by our board of directors.

 

At October 31, 2006, approximately 79.50% of our total assets represented portfolio investments recorded at fair value.

 

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 we make. We specifically value each individual

investment and record unrealized depreciation for an investment that we believe has become impaired, including where collection of a loan or realization of an equity security is doubtful. Conversely, we will record unrealized appreciation if we have an indication (based on a significant development) that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value, where appropriate. Without a readily ascertainable market value and because of the inherent uncertainty of fair valuation, fair value of our investments may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

 

Pursuant to our valuation procedures, our Valuation Committee (which is currently comprised of three Independent Directors) reviews, considers and determines fair valuations on a quarterly basis (or more frequently, if deemed appropriate under the circumstances). Any changes in valuation are recorded in the statements of operations as “Net change in unrealized appreciation (depreciation) on investments.”

 

Economic recessions or downturns could impair our portfolio companies and harm our operating results.

 

Many of the companies in which we have made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may affect the ability of a company to engage in a liquidity event. These conditions could lead to financial losses in our portfolio and a decrease in our revenues, net income and assets.

 

Our overall business of making private equity investments may be affected by current and future market conditions. The absence of an active mezzanine lending or private equity environment may slow the amount of private equity investment activity generally. As a result, the pace of our investment activity may slow, which could impact our ability to achieve our investment objective. In addition, significant changes in the capital markets could have an effect on the valuations of private companies and on the potential for liquidity events involving such companies. This could affect the amount and timing of any gains realized on our investments.

 

We may not realize gains from our equity investments.

 

When we invest in mezzanine and senior debt securities, we may acquire warrants or other equity securities as well. We may also invest directly in various equity securities. Our goal is ultimately to dispose of such equity interests and realize gains upon our disposition of such interests. However, the equity interests we receive or invest in may not appreciate in value and, in fact, may decline in value. In addition, the equity securities we receive or invest in may be subject to restrictions on resale during periods in which it would be advantageous to resell. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.

 

The market for private equity investments can be highly competitive. In some cases, our status as a regulated business development company may hinder our ability to participate in investment opportunities.

 

We face competition in our investing activities from private equity funds, other business development companies, investment banks, investment affiliates of large industrial, technology, service and financial companies, small business investment companies, wealthy individuals and foreign investors. As a regulated business development company, we are required to disclose quarterly the name and business description of portfolio companies and the value of any portfolio securities. Many of our competitors are not subject to this disclosure requirement. Our obligation to disclose this information could hinder our ability to invest in certain portfolio companies. Additionally, other regulations, current and future, may make us less attractive as a potential investor to a given portfolio company than a private equity fund not subject to the same regulations. Furthermore, some of our competitors have greater resources than we do. Increased competition would make it more difficult for us to purchase or originate investments at attractive prices. As a result of this competition, sometimes we may be precluded from making certain investments.

Loss of pass-through tax treatment would substantially reduce net assets and income available for dividends.

 

We have operated to qualify as a RIC. If we meet source of income, diversification and distribution requirements, we will qualify for effective pass-through tax treatment. We would cease to qualify for such pass-through tax treatment if we were unable to comply with these requirements. In addition, we may have difficulty meeting the requirement to make distributions to our shareholders because in certain cases we may recognize income before or without receiving cash representing such income. If we fail to qualify as a RIC, we will have to pay corporate-level taxes on all of our income whether or not we distribute it, which would substantially reduce the amount of income available for distribution to our shareholders. Even if we qualify as a RIC, we generally will be subject to a corporate-level income tax on the income we do not distribute. Moreover, if we do not distribute at least 98% of our income, we generally will be subject to a 4% excise tax.

 

Changes in the law or regulations that govern us could have a material impact on our business.

 

We are regulated by the SEC. Changes in the laws or regulations that govern business development companies and RICs may significantly affect our business.

 

Results may fluctuate and may not be indicative of future performance.

 

Our operating results will fluctuate and, therefore, you should not rely on current or historical period results to be indicative of our performance in future reporting periods. In addition to many of the above-cited risk factors, other factors could cause operating results to fluctuate including, among others, variations in the investment origination volume and fee income earned, variation in timing of prepayments, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions.

 

Our common stock price can be volatile.

 

The trading price of our common stock may fluctuate substantially. The price of the common stock may be higher or lower than the price you pay for your shares, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include the following:

 

 

We are subject to market discount risk.

 

As with any stock, the price of our shares will fluctuate with market conditions and other factors. If shares are sold, the price received may be more or less than the original investment. Whether investors will realize gains or losses upon the sale of our shares will not depend directly upon our NAV, but will depend upon the market price of the shares at the time of sale. Since the market price of our shares will be affected by such factors as the relative demand for and supply of the shares in the market, general market and economic conditions and other factors

beyond our control, we cannot predict whether the shares will trade at, below or above our NAV. Although our shares have recently traded at a premium to our NAV, historically, our shares, as well as those of other closed-end investment companies, have frequently traded at a discount to their NAV, which discount often fluctuates over time.

 

We have not established a minimum dividend payment level and we cannot assure you of our ability to make distributions to our shareholders in the future.

 

We cannot assure that we will achieve investment results that will allow us to make cash distributions or year-to-year increases in cash distributions. Our ability to make distributions is impacted by, among other things, the risk factors described in this report. In addition, the asset coverage test applicable to us as a business development company can limit our ability to make distributions. Any distributions will be made at the discretion of our board of directors and will depend on our earnings, our financial condition, maintenance of our RIC status and such other factors as our board of directors may deem relevant from time to time. We cannot assure you of our ability to make distributions to our shareholders.

 

We have borrowed and may continue to borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.

 

We have borrowed and may continue to borrow money (subject to the 1940 Act limits) in seeking to achieve our investment objective going forward. Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, can increase the risks associated with investing in our securities.

 

Under the provisions of the 1940 Act, we are permitted, as a business development company, to borrow money or “issue senior securities” only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous.

 

We may borrow from, and issue senior debt securities to, banks, insurance companies and other lenders. Lenders of these senior securities have fixed dollar claims on our assets that are superior to the claims of our common shareholders. If the value of our assets increases, then leveraging would cause the NAV attributable to our common stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our consolidated assets decreases, leveraging would cause NAV to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our consolidated income in excess of consolidated interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our consolidated income would cause net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common stock dividend payments. Leverage is generally considered a speculative investment technique.

 

Changes in interest rates may affect our cost of capital and net operating income.

 

Because we have borrowed and may continue to borrow money to make investments, our net investment income before net realized and unrealized gains or losses, or net investment income, may be dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates would not have a material adverse effect on our net investment income. In periods of declining interest rates, we may have difficulty investing our borrowed capital into investments that offer an appropriate return. In periods of sharply rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. We may utilize our short-term credit facilities as a means to bridge to long-term financing. Our long-term fixed-rate investments are financed primarily with equity and long-term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.

We may be unable to meet our covenant obligations under our credit facility which could adversely affect our business.

 

On October 28, 2004, the Fund entered into a one-year, cash collateralized, $20 million revolving credit facility (“Credit Facility I”) with LaSalle Bank National Association (the “Bank”). On July 20, 2005, the Fund amended Credit Facility I. The maximum aggregate loan amount under Credit Facility I was increased from $20 million to $30 million. Additionally, the maturity date was extended from October 31, 2005 to August 31, 2006. Credit Facility I expired on August 31, 2006. On April 27, 2006, the Fund and MVCFS, as co-borrowers entered into a new four-year, $100 million revolving credit facility (“Credit Facility II”) with Guggenheim Corporate Funding, LLC “Guggenheim” as administrative agent to the lenders. On April 27, 2006, the Fund borrowed $45 million ($27.5 million drawn from the revolving credit facility and $17.5 million in term debt) under Credit Facility II. The $27.5 million drawn from the revolving credit facility was repaid in full on May 2, 2006. On July 28, 2006, the Fund borrowed $57.5 million ($45 million drawn from the revolving credit facility and $12.5 million in term debt) under Credit Facility II. On August 2, 2006, the Fund repaid the $45.0 million borrowed on the revolving credit facility portion of Credit Facility II. On August 31, 2006, the revolving credit facility with LaSalle Bank National Association, Credit Facility I, expired. The Credit Facility II contains covenants that we may not be able to meet. If we cannot meet these covenants, events of default would arise, which could result in payment of the applicable indebtedness being accelerated. In addition, if we require working capital greater than that provided by Credit Facility II, we may be required either to (i) seek to increase the availability under Credit Facility II or (ii) obtain other sources of financing. As of October 31, 2006, there was $50 million in term debt and $50 million on the revolving note outstanding under Credit Facility II.

 

We have a limited operating history upon which you can evaluate our new management team.

 

Although we commenced operations in 2000, we changed our investment objective and strategy in September 2003 from seeking long-term capital appreciation from venture capital investments in information technology companies (primarily in the Internet, e-commerce, telecommunications, networking, software and information services industries) to an objective of seeking to maximize total return from capital appreciation and/or income. We no longer have a strategy seeking to concentrate our investments in the information technology industries and, as a result, our new investments may be in a variety of industries. Therefore, we have only a limited history of operations under our current investment objective and strategy upon which you can evaluate our business.

 

A portion of our existing investment portfolio was not selected by the investment team of TTG Advisers.

 

As of October 31, 2006, 2.42% of the Fund’s assets are represented by investments made by the Fund’s former management team. These investments were made pursuant to the Fund’s prior investment objective of seeking long-term capital appreciation from venture capital investments in information technology companies. Generally, a cash return may not be received on these investments until a “liquidity event,” i.e., a sale, public offering or merger, occurs. Until then, these legacy investments remain in the Fund’s portfolio. We are managing them to try and realize maximum returns. Nevertheless, because they were not made in accordance with the Fund’s current investment strategy, their future performance may impact our ability to achieve our current objective.

 

Under the Advisory Agreement, TTG Advisers is entitled to compensation based on our portfolio’s performance. This arrangement may result in riskier or more speculative investments in an effort to maximize incentive compensation.

 

The way in which the compensation payable to TTG Advisers is determined may encourage the investment team to recommend riskier or more speculative investments and to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would adversely affect our shareholders, including investors in this offering. In addition, key criteria related to determining appropriate investments and investment strategies, including the preservation of capital, might be under-weighted if the investment team focuses exclusively or disproportionately on maximizing returns.

There are potential conflicts of interest that could impact our investment returns.

 

Our officers and directors, and members of the TTG Advisers investment team, may serve entities that operate in the same or similar lines of business as we do. Accordingly, they may have obligations to those entities, the fulfillment of which might not be in the best interests of us or our shareholders. It is possible that new investment opportunities that meet our investment objectives may come to the attention of one of the management team members or our officers or directors in his or her role as an officer or director of another entity or as an investment professional associated with that entity, and, if so, such opportunity might not be offered, or otherwise made available, to us.

 

Additionally, as an investment adviser, TTG Advisers has a fiduciary obligation to act in the best interests of its clients, including us. To that end, if TTG Advisers manages any additional investment vehicles or client accounts in the future, TTG Advisers will endeavor to allocate investment opportunities in a fair and equitable manner. If TTG Advisers chooses to establish another investment fund in the future, when the investment professionals of TTG Advisers identify an investment, they will have to choose which investment fund should make the investment. As a result, there may be times when the management team of TTG Advisers has interests that differ from those of our shareholders, giving rise to a conflict. In an effort to mitigate situations that give rise to such conflicts, TTG Advisers adheres to a policy (which was approved by our board) relating to allocation of investment opportunities, which generally requires, among other things, that TTG Advisers continue to offer the Fund investment opportunities in mezzanine and debt securities as well as non-control equity investments in small and middle market U.S. companies. For a further discussion of this allocation policy, please see “Our Investment Strategy — Allocation of Investment Opportunities” above.

 

The war with Iraq, terrorist attacks, the Middle East crisis and other acts of violence or war may affect any market for our common stock, impact the businesses in which we invest and harm our operations and our profitability.

 

The war with Iraq, its aftermath and the continuing occupation of Iraq are likely to have a substantial impact on the U.S. and world economies and securities markets. The nature, scope and duration of the war and occupation cannot be predicted with any certainty. Furthermore, terrorist attacks may harm our results of operations and your investment. We cannot assure you that there will not be further terrorist attacks against the United States or U.S. businesses. Such attacks and armed conflicts in the United States or elsewhere may impact the businesses in which we invest directly or indirectly, by undermining economic conditions in the United States. Losses resulting from terrorist events are generally uninsurable.

 

Our financial condition and results of operations will depend on our ability to effectively manage our future growth.

 

Our ability to achieve our investment objectives can depend on our ability to sustain continued growth. Accomplishing this result on a cost-effective basis is largely a function of our marketing capabilities, our management of the investment process, our ability to provide competent, attentive and efficient services and our access to financing sources on acceptable terms. As we grow, TTG Advisers may need to hire, train, supervise and manage new employees. Failure to effectively manage our future growth could have a material adverse effect on our business, financial condition and results of operations.

 

INVESTMENT RISKS

 

Investment risks are risks associated with our determination to execute on our business objective. These risks are not risks associated with general business conditions or those relating to an offering of our securities.

 

Investing in private companies involves a high degree of risk.

 

Our investment portfolio generally consists of loans to, and investments in, private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative. There is generally very little publicly available information about the companies in which we invest, and we rely significantly on the due diligence of the members of the Fund’s investment team to obtain information in connection with our investment decisions.

Our investments in portfolio companies are generally illiquid.

 

We generally acquire our investments directly from the issuer in privately negotiated transactions. Most of the investments in our portfolio (other than cash or cash equivalents) are typically subject to restrictions on resale or otherwise have no established trading market. We may exit our investments when the portfolio company has a liquidity event, such as a sale, recapitalization or initial public offering. The illiquidity of our investments may adversely affect our ability to dispose of equity and debt securities at times when it may be otherwise advantageous for us to liquidate such investments. In addition, if we 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.

 

Our investments in small and middle-market privately-held companies are extremely risky and the Fund could lose its entire investment.

 

Investments in small and middle-market privately-held companies are subject to a number of significant risks including the following:

 

 

Our borrowers may default on their payments, which may have an effect on our financial performance.

 

We may make long-term unsecured, subordinated loans, which may involve a higher degree of repayment risk than conventional secured loans. We primarily invest in companies that may have limited financial resources and that may be unable to obtain financing from traditional sources. In addition, numerous factors may adversely affect a portfolio company’s ability to repay a loan we make to it, including the failure to meet a business plan, a downturn in its industry or operating results, or negative economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in any related collateral.

 

Our investments in mezzanine and other debt securities may involve significant risks.

 

Our investment strategy contemplates investments in mezzanine and other debt securities of privately held companies. “Mezzanine” investments typically are structured as subordinated loans (with or without warrants) that carry a fixed rate of interest. We may also make senior secured and other types of loans or debt investments. Our debt investments are not, and typically will not be, rated by any rating agency, but we believe that if such investments were rated, they would be below investment grade quality (rated lower than “Baa3” by Moody’s or lower than “BBB−” by Standard & Poor’s, commonly referred to as “junk bonds”). Loans of below investment grade quality have predominantly speculative characteristics with respect to the borrower’s capacity to pay interest and repay principal. Our debt investments in portfolio companies may thus result in a high level of risk and volatility and/or loss of principal.

 

When we are a debt or minority equity investor in a portfolio company, we may not be in a position to control the entity, and management of the company may make decisions that could decrease the value of our portfolio holdings.

 

We anticipate making debt and minority equity investments; therefore, we will be subject to the risk that a portfolio company may make business decisions with which we disagree, and the shareholders and management of such company may take risks or otherwise act in ways that do not serve our interests. Due to the lack of liquidity in the markets for our investments in privately held companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.

 

We may choose to waive or defer enforcement of covenants in the debt securities held in our portfolio, which may cause us to lose all or part of our investment in these companies.

 

Some of our loans to our portfolio companies may be structured to include customary business and financial covenants placing affirmative and negative obligations on the operation of each company’s business and its financial condition. However, from time to time, we may elect to waive breaches of these covenants, including our right to payment, or waive or defer enforcement of remedies, such as acceleration of obligations or foreclosure on collateral, depending upon the financial condition and prospects of the particular portfolio company. These actions may reduce the likelihood of our receiving the full amount of future payments of interest or principal and be accompanied by a deterioration in the value of the underlying collateral as many of these companies may have limited financial resources, may be unable to meet future obligations and may go bankrupt. This could negatively impact our ability to pay dividends and cause you to lose all or part of your investment.

 

Our portfolio companies may incur obligations that rank equally with, or senior to, our investments in such companies. As a result, the holders of such obligations may be entitled to payments of principal or interest prior to us, preventing us from obtaining the full value of our investment in the event of an insolvency, liquidation, dissolution, reorganization, acquisition, merger or bankruptcy of the relevant portfolio company.

 

Our portfolio companies may have other obligations that rank equally with, or senior to, the securities in which we invest. By their terms, such other securities may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a

portfolio company, holders of securities ranking senior to our investment in the relevant portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying investors that are more senior than us, the portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of other securities ranking equally with securities in which we invest, we would have to share on an equal basis any distributions with other investors holding such securities in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company. As a result, we may be prevented from obtaining the full value of our investment in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.

 

Our portfolio investments may be concentrated in a limited number of portfolio companies, which would magnify the effect if one of those companies were to suffer a significant loss. This could negatively impact our ability to pay you dividends and cause you to lose all or part of your investment.

 

While we aim to have a broad mix of investments in portfolio companies, our investments, at any time, may be concentrated in a limited number of companies. A consequence of this concentration is that the aggregate returns we seek to realize may be adversely affected if a small number of our investments perform poorly or if we need to write down the value of any one such investment. Beyond the applicable federal income tax diversification requirements, we do not have fixed guidelines for diversification, and our investments could be concentrated in relatively few portfolio companies. These factors could negatively impact our ability to pay dividends and cause you to lose all or part of your investment.

 

Investments in foreign debt or equity may involve significant risks in addition to the risks inherent in U.S. investments.

 

Our investment strategy has resulted in some investments in debt or equity of foreign companies (subject to applicable limits prescribed by the 1940 Act). Investing in foreign companies can expose us to additional risks not typically associated with investing in U.S. companies. These risks include exchange rates, changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility.

 

Certain Government Regulations

 

We operate in a highly regulated environment. The following discussion generally summarizes certain government regulations.

 

Business Development Company.  A business development company is defined and regulated by the 1940 Act. A business development company must be organized in the United States for the purpose of investing in or lending to primarily private companies and making managerial assistance available to them. A business development company may use capital provided by public shareholders and from other sources to invest in long-term, private investments in businesses.

 

As a business development company, we may not acquire any asset other than “qualifying assets” unless, at the time we make the acquisition, the value of our qualifying assets represent at least 70% of the value of our total assets. The principal categories of qualifying assets relevant to our business are:

 

(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An “eligible portfolio company” is defined in the 1940 Act as any issuer which:

 

(a) is organized under the laws of, and has its principal place of business in, the United States;

(b) is not an investment company (other than a small business investment company wholly owned by the business development company) or a company that would be an investment company but for certain exclusions under the 1940 Act; and

 

(c) satisfies any of the following:

 

 

The SEC recently adopted Rules 2a-46 and 55a-1 under the 1940 Act, which together expand the foregoing definition of “eligible portfolio company.”

 

(2) Securities of any eligible portfolio company which we control.

 

(3) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

 

(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

 

(5) Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.

 

(6) Cash, cash equivalents, U.S. Government securities or high-quality debt maturing in one year or less from the time of investment.

 

To include certain securities described above as qualifying assets for the purpose of the 70% test, a business development company must make available to the issuer of those securities significant managerial assistance such as providing significant guidance and counsel concerning the management, operations, or business objectives and policies of a portfolio company, or making loans to a portfolio company. We offer to provide managerial assistance to each of our portfolio companies.

 

As a business development company, we are entitled to issue senior securities in the form of stock or senior securities representing indebtedness, including debt securities and preferred stock, as long as each class of senior security has an asset coverage ratio of at least 200% immediately after each such issuance. See “Risk Factors.” We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our Independent Directors and, in some cases, prior approval by the SEC. On July 11, 2000, the SEC granted us an exemptive order permitting us to make co-investments with certain of our affiliates in portfolio companies, subject to various conditions. During the last completed fiscal year, the Fund did not engage in any transactions pursuant to this order.

 

As with other companies regulated by the 1940 Act, a business development company must adhere to certain other substantive ongoing regulatory requirements. A majority of our directors must be persons who are not “interested persons,” as that term is defined in the 1940 Act. Additionally, we are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect the business development company. Furthermore, as a business development company, we are prohibited from protecting any director or officer against any liability to the company or our shareholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

We and TTG Advisers maintain a code of ethics that establishes procedures for personal investment and restricts certain transactions by our personnel. The code of ethics generally does not permit investment by our employees in securities that may be purchased or held by us. You may read and copy the code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on operations of the Public Reference Room by calling the SEC at (202) 942-8090. In addition, the code of ethics is available on the EDGAR Database on the SEC Internet site at http://www.sec.gov. You may obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following email address: publicinfo@sec.gov, or by writing to the SEC’s Public Reference Section, 100 F Street, NE, Washington, D.C. 20549. The code of ethics is also posted on our website at http://www.mvccapital.com.

 

We may not change the nature of our business so as to cease to be, or withdraw our election as, a business development company unless authorized by vote of a “majority of the outstanding voting securities,” as defined in the 1940 Act, of our shares. A majority of the outstanding voting securities of a company is defined by the 1940 Act as the lesser of: (i) 67% or more of such company’s shares present at a meeting if more than 50% of the outstanding shares of such company are present and represented by proxy, or (ii) more than 50% of the outstanding shares of such company.

 

We are periodically examined by the SEC for compliance with the 1940 Act.

 

The Fund does not own any real estate or other physical property. Its principal executive office (the “Principal Executive Office”) is located at 287 Bowman Avenue, Purchase, New York 10577, pursuant to a sublease which is scheduled to expire on February 28, 2007 (the “Sublease”). Effective November 1, 2006, the Fund subleased its principal executive office to TTG Advisers. Future payments under the Sublease for TTG Advisers total approximately $75,000 in fiscal year 2007. The Fund’s previous lease was terminated effective March 1, 2005, without penalty. The building in which the Fund’s executive offices are located, 287 Bowman Avenue, is owned by Phoenix Capital Partners, LLC, an entity which is 97% owned by Mr. Tokarz. See Note 4 “Management” for more information on Mr. Tokarz.

 

During the year ended October 31, 2003, the Fund paid or accrued $4.0 million for legal and proxy solicitation fees and expenses, which included $2.2 million accrued and paid at the direction of the Board of Directors, to reimburse the legal and proxy solicitation fees and expenses of two major Fund shareholders, Millenco, L.P. and Karpus Investment Management, including their costs of obtaining a judgment against the Fund in the Delaware Chancery Court and costs associated with the proxy process and the election of the current Board of Directors. The Fund made a claim against its insurance carrier, Federal Insurance Company (“Federal”) for its right to reimbursement of such expenses. On June 13, 2005, the Fund reached a settlement with Federal in the amount of $473,968 which has been recorded as Other Income in the Consolidated Statement of Operations. Legal fees and expenses associated with reaching this settlement were $47,171.

 

The annual meeting of shareholders was held on September 7, 2006, for which a Definitive Proxy Statement on Schedule 14A was filed with the SEC on August 3, 2006. At the meeting, the Board of Directors was re-elected in its entirety. In addition, shareholders voted on the proposal to approve the Advisory Agreement. 92% of shareholder votes cast on the Advisory Agreement voted to approve the Advisory Agreement. 7% of shareholder votes cast on the Advisory Agreement voted against the approval of the Advisory Agreement. 1% of shareholder votes cast abstained from voting on the proposal to approve the Advisory Agreement.

 

The Fund’s shares of common stock began to trade on the NYSE on June 26, 2000, under the symbol “MVC.” The Fund had approximately 7,000 shareholders on December 1, 2006.

 

The following table reflects, for the periods indicated the high and low closing prices per share of the Fund’s common stock on the NYSE, by quarter.

 

 

Dividends

 

As a RIC, the Fund is required to distribute to its shareholders, in a timely manner, at least 90% of its investment company taxable income and tax-exempt income each year. If the Fund distributes, in a calendar year, at least 98% of its ordinary income for such calendar year and its capital gain net income for the 12-month period ending on October 31 of such calendar year (as well as any portion of the respective 2% balances not distributed in the previous year), it will not be subject to the 4% non-deductible federal excise tax on certain undistributed income of RICs.

 

Dividends and capital gain distributions, if any, are recorded on the ex-dividend date. Dividends and capital gain distributions are generally declared and paid quarterly according to the Fund’s policy established on July 11, 2005. An additional distribution may be paid by the Fund to avoid imposition of federal income tax on any remaining undistributed net investment income and capital gains. Distributions can be made payable by the Fund either in the form of a cash distribution or a stock dividend. The amount and character of income and capital gain distributions are determined in accordance with income tax regulations which may differ from accounting principles generally accepted in the United States of America. These differences are due primarily to differing treatments of income and gain on various investment securities held by the Fund, timing differences and differing characterizations of distributions made by the Fund. Permanent book and tax basis differences relating to shareholder distributions will result in reclassifications and may affect the allocation between net operating income, net realized gain (loss) and paid in capital.

 

All of our shareholders who hold shares of common stock in their own name will automatically be enrolled in our dividend reinvestment plan (the “Plan”). All such shareholders will have any cash dividends and distributions automatically reinvested by Computershare (the “Plan Agent”), in additional shares of our common stock. Of course, any shareholder may elect to receive his or her dividends and distributions in cash. Currently, the Fund has a policy of seeking to pay quarterly dividends to shareholders. For any of our shares that are held by banks, brokers or other entities that hold our shares as nominees for individual shareholders, the Plan Agent will administer the Plan on the basis of the number of shares certified by any nominee as being registered for shareholders that have not elected to receive dividends and distributions in cash. To receive your dividends and distributions in cash, you must notify the Plan Agent.

The Plan Agent serves as agent for the shareholders in administering the Plan. When we declare a dividend or distribution payable in cash or in additional shares of our common stock, those shareholders participating in the Plan will receive their dividend or distribution in additional shares of our common stock. Such shares will be either newly issued by us or purchased in the open market by the Plan Agent. If the market value of a share of our common stock on the payment date for such dividend or distribution equals or exceeds the NAV per share on that date, we will issue new shares at the NAV. If the NAV exceeds the market price of our common stock, the Plan Agent will purchase in the open market such number of shares of our common stock as is necessary to complete the distribution.

 

The Plan Agent will maintain all shareholder accounts in the Plan and furnish written confirmation of all transactions. Shares of our common stock in the Plan will be held in the name of the Plan Agent or its nominee and such shareholder will be considered the beneficial owner of such shares for all purposes.

 

There is no charge to shareholders for participating in the Plan or for the reinvestment of dividends and distributions. We will not incur brokerage fees with respect to newly issued shares issued in connection with the Plan. Shareholders will, however, be charged a pro rata share of any brokerage fee charged for open market purchases in connection with the Plan.

 

We may terminate the Plan upon providing written notice to each shareholder participating in the Plan at least 60 days prior to the effective date of such termination. We may also materially amend the Plan at any time upon providing written notice to shareholders participating in the Plan at least 30 days prior to such amendment (except when necessary or appropriate to comply with applicable law or rules and policies of the SEC or other regulatory authority). You may withdraw from the Plan upon providing notice to the Plan Agent. You may obtain additional information about the Plan from the Plan Agent.

 

For the Quarter Ended July 31, 2005

 

On July 11, 2005, our board of directors announced that it approved the establishment of a policy of seeking to pay quarterly dividends to shareholders. For the quarter, the board of directors declared a dividend of $.12 per share payable on July 29, 2005 to shareholders of record on July 22, 2005. The total distribution amounted to $2,290,289 including distributions reinvested. In accordance with the Plan, the Plan Agent re-issued 826 shares of common stock from the Fund’s treasury to shareholders participating in the Plan.

 

For the Quarter Ended October 31, 2005

 

On October 10, 2005, our board of directors declared a dividend of $.12 per share payable on October 31, 2005 to shareholders of record on October 21, 2005. The total distribution amounted to $2,290,387 including distributions reinvested. In accordance with the Plan, the Plan Agent re-issued 1,904 shares of common stock from the Fund’s treasury to shareholders participating in the Plan.

 

For the Quarter Ended January 31, 2006

 

On December 20, 2005, the Fund’s board of directors declared a dividend of $.12 per share payable on January 31, 2006 to shareholders of record on December 30, 2005. The ex-dividend date was December 28, 2005. The total distribution amounted to $2,290,616 including distributions reinvested. In accordance with the Plan, the Plan Agent re-issued 1,824 shares of common stock from the Fund’s treasury to shareholders participating in the Plan.

 

For the Quarter Ended April 30, 2006

 

On April 11, 2006, the Fund’s board of directors declared a dividend of $.12 per share payable on April 28, 2006 to shareholders of record on April 21, 2006. The ex-dividend date was April 19, 2006. The total distribution amounted to $2,290,835 including distributions reinvested. In accordance with the Plan, the Plan Agent re-issued 1,734 shares of common stock from the Fund’s treasury to shareholders participating in the Plan.

For the Quarter Ended July 31, 2006

 

On July 14, 2006, the Fund’s board of directors declared a dividend of $.12 per share payable on July 31, 2006 to shareholders of record on July 24, 2006. The ex-dividend date was July 20, 2006. The total distribution amounted to $2,291,043 including distributions reinvested. In accordance with the Plan, the Plan Agent re-issued 1,901 shares of common stock from the Fund’s treasury to shareholders participating in the Plan.

 

For the Quarter Ended October 31, 2006

 

On October 13, 2006, the Fund’s board of directors declared a dividend of $.12 per share payable on October 31, 2006 to shareholders of record on October 24, 2006. The ex-dividend date was October 20, 2006. The total distribution amounted to $2,291,271 including distributions reinvested. In accordance with the Plan, the Plan Agent re-issued 2,327 shares of common stock from the Fund’s treasury to shareholders participating in the Plan.

 

The Fund designated 7%* or a maximum amount of $621,193 of dividends declared and paid during the year ending October 31, 2006 from net operating income as qualified dividend income under the Jobs Growth and Tax Relief Reconciliation Act of 2003.

 

Corporate shareholders may be eligible for a dividend received deduction for certain ordinary income distributions paid by the Fund. The Fund designated 7%* or a maximum amount of $621,193 of dividends declared and paid during the year ending October 31, 2006 from net operating income as qualifying for the dividends received deduction. The information necessary to prepare and complete shareholder’s tax returns for the 2006 calendar year will be reported separately on form 1099-DIV, if applicable, in January 2007.

 

The Fund reserves the right to retain net long-term capital gains in excess of net short-term capital losses for reinvestment or to pay contingencies and expenses. Such retained amounts, if any, will be taxable to the Fund, and shareholders will be able to claim their proportionate share of the federal income taxes paid by the Fund on such gains as a credit against their own federal income tax liabilities. Shareholders will also be entitled to increase the adjusted tax basis of their Fund shares by the difference between their undistributed capital gains and their tax credit.

 

 

      * Unaudited

 

Financial information for the fiscal years ended October 31, 2006, 2005, 2004 and 2003 are derived from the consolidated financial statements, which have been audited by Ernst & Young LLP, the Fund’s current independent registered public accounting firm. The following selected financial data for the fiscal year ended October 31, 2002 are derived from the financial statements, which were audited by the Fund’s former independent public accountants. Quarterly financial information is derived from unaudited financial data, but in the opinion of management, reflects all adjustments (consisting only of normal recurring adjustments), which are necessary to present fairly the results for such interim periods. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 28 for more information.

 

Selected Consolidated Financial Data

 

 

 

 

 

This report contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Fund and its investment portfolio companies. Words such as may, will, expect, believe, anticipate, intend, could, estimate, might and continue, and the negative or other variations thereof or comparable terminology, are intended to identify forward-looking statements. Forward-looking statements are included in this report pursuant to the “Safe Harbor” provision of the Private Securities Litigation Reform Act of 1995. Such statements are predictions only, and the actual events or results may differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those relating to investment capital demand, pricing, market acceptance, the effect of economic conditions, litigation and the effect of regulatory proceedings, competitive forces, the results of financing and investing efforts, the ability to complete transactions and other risks identified below or in the Fund’s filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Fund undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. The following analysis of the financial condition and results of operations of the Fund should be read in conjunction with the Financial Statements, the Notes thereto and the other financial information included elsewhere in this report.

 

Overview

 

The Fund is an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a business development company under the 1940 Act. The Fund’s investment objective is to seek to maximize total return from capital appreciation and/or income.

 

On November 6, 2003, Mr. Tokarz assumed his positions as Chairman and Portfolio Manager of the Fund. He and the Fund’s investment professionals (who, effective November 1, 2006, provide their services to the Fund through the Fund’s investment adviser, TTG Advisers) are seeking to implement our investment objective (i.e., to maximize total return from capital appreciation and/or income) through making a broad range of private investments in a variety of industries.

 

The investments can include senior or subordinated loans, convertible debt and convertible preferred securities, common or preferred stock, equity interests, warrants or rights to acquire equity interests, and other private equity transactions. In the year ended October 31, 2005, we made six new investments and three additional investments in existing portfolio companies, committing capital totaling $53.8 million. In the year ended October 31, 2006, we made sixteen new investments and eight additional investments in existing portfolio companies, committing capital totaling $166.3 million.

Prior to the adoption of our current investment objective, the Fund’s investment objective had been to achieve long-term capital appreciation from venture capital investments in information technology companies. The Fund’s investments had thus previously focused on investments in equity and debt securities of information technology companies. As of October 31, 2006, 2.42% of the current fair value of our assets consisted of portfolio investments made by the Fund’s former management team pursuant to the prior investment objective. We are, however, seeking to manage these legacy investments to try and realize maximum returns. We generally seek to capitalize on opportunities to realize cash returns on these investments when presented with a potential “liquidity event,” i.e., a sale, public offering, merger or other reorganization.

 

Our new portfolio investments are made pursuant to our new objective and strategy. We are concentrating our investment efforts on small and middle-market companies that, in our view, provide opportunities to maximize total return from capital appreciation and/or income. Under our investment approach, we are permitted to invest, without limit, in any one portfolio company, subject to any diversification limits required in order for us to continue to qualify as a regulated investment company under Subchapter M of the Code.

 

We participate in the private equity business generally by providing privately negotiated long-term equity and/or debt investment capital to small and middle-market companies. Our financing is generally used to fund growth, buyouts, acquisitions, recapitalizations, note purchases, and/or bridge financings. We generally invest in private companies, though, from time to time, we may invest in public companies that may lack adequate access to public capital.

 

We may also seek to achieve our investment objective by establishing a subsidiary or subsidiaries that would serve as general partner or investment adviser to a private equity or other investment fund(s). In fact, during 2006, we established MVC Partners, LLC for this purpose. Additionally, we may also acquire a portfolio of existing private equity or debt investments held by financial institutions or other investment funds.

 

Operating Income

 

For the Years Ended October 31, 2006, 2005 and 2004.  Total operating income was $18.5 million for the fiscal year ended October 31, 2006 and $12.2 million for the fiscal year ended October 31, 2005, an increase of $6.3 million. For fiscal year 2005, operating income increased $8.2 million over 2004 operating income of $4.0 million.

 

For the Year Ended October 31, 2006

 

Total operating income was $18.5 million for the year ended October 31, 2006. The increase in operating income over last year was primarily due to the increase in the number of investments that provide the Fund with current income. For the years ended October 31, 2006 and 2005, the Fund made 24 and 9 investments in portfolio companies, respectively. The main components of operating income were the interest and dividend income earned on loans to portfolio companies and the receipt of closing and monitoring fees from certain portfolio companies by the Fund and MVCFS. During 2006, the Fund earned approximately $13.9 million in interest and dividend income from investments in portfolio companies. Of the $13.9 million recorded in interest/dividend income, approximately $2.2 million was payment in kind interest/dividends. The payment in kind interest/dividends are computed at the contractual rate specified in each investment agreement and added to the principal balance of each investment. During the year ended October 31, 2006, the Fund reclassified dividend income received from Vitality totaling approximately $900,000 to return of capital. The reclassification occurred due to the determination that Vitality did not have sufficient taxable earnings and profits for their fiscal year 2006. This reclassification to return of capital had limited impact on the Fund’s net asset value. The Fund’s investments yielded rates from 7% to 17%. Also, the Fund earned approximately $2.3 million in interest income on its cash equivalents and short-term investments. The Fund received fee income and other income from portfolio companies and other entities totaling approximately $3.8 million and $771,405, respectively. Included in other income is flow through income from limited liability companies and cash received from the Mentor Graphics Corp. (“Mentor Graphics”) multi-year earnout.

For the Year Ended October 31, 2005

 

Total operating income was $12.2 million for the year ended October 31, 2005. The increase in operating income over 2004 was primarily due to the increase in the number of investments that provide the Fund with current income. The main components of investment income were the interest and dividend income earned on loans to portfolio companies and the receipt of closing and monitoring fees from certain portfolio companies by the Fund and MVCFS. The Fund earned approximately $7.53 million in interest and dividend income from investments in portfolio companies. Of the $7.53 million recorded in interest/dividend income, approximately $1.37 million was “payment in kind” interest/dividends. The “payment in kind” interest/dividends are computed at the contractual rate specified in each investment agreement and added to the principal balance of each investment. The Fund’s yielding investments were paying interest to the Fund at various rates from 7% to 17%. Also, the Fund earned approximately $1.93 million in interest income on its cash equivalents and short-term investments. The Fund received fee income and other income from portfolio companies and other entities totaling approximately $1.81 million and $900,000 respectively. Included in other income is flow through income from limited liability companies, cash received from the Mentor Graphics multi-year earnout and a legal settlement of $473,968. See Note 12 “Legal Proceedings” for more information. Without the receipt of this settlement, other income earned for the year ended October 31, 2005, would have been $428,855.

 

For the Year Ended October 31, 2004

 

Total operating income was $4.0 million for the year ended October 31, 2004. The main components of operating income were the interest income earned on loans to portfolio companies and the receipt of closing and monitoring fees from certain portfolio companies by the Fund and MVCFS. The Fund earned approximately $2.3 million in interest income from investments in portfolio companies. Of the $2.3 million recorded in interest income, approximately $100,000 was “payment in kind” interest. The “payment in kind” interest is computed at the contractual rate specified in each investment agreement and added to the principal balance of each investment. The Fund’s yielding investments were paying interest to the Fund at various rates from 10% to 17%. Also, the Fund earned approximately $700,000 in interest income on its cash equivalents and short-term investments. The Fund received fee income and other income from portfolio companies totaling approximately $900,000 and $64,000 respectively.

 

Operating Expenses

 

For the Years Ended October 31, 2006, 2005 and 2004.  Operating expenses were $14.6 million for the fiscal year ended October 31, 2006 and $6.5 million for the fiscal year ended 2005, an increase of $8.1 million. For fiscal year ended October 31, 2005, operating expenses increased $2.2 million from $4.3 million for the fiscal year ended 2004.

 

For the Year Ended October 31, 2006

 

Operating expenses were $14.6 million or 6.78% of the Fund’s average net assets for the year ended October 31, 2006. Significant components of operating expenses for the year ended October 31, 2006, included an estimated provision for incentive compensation expense of approximately $6.1 million, salaries and benefits of approximately $3.5 million, interest and other borrowing costs of $1.6 million, legal fees of $685,396, facilities-related expenses of $603,328, and insurance premium expenses of $471,711,. The estimated provision for incentive compensation expense is a non-cash, not yet payable, provisional expense relating to Mr. Tokarz’s employment agreement with the Fund.

 

The $8.1 million increase in the Fund’s operating expenses for the year ended October 31, 2006 compared to the year ended October 31, 2005, was primarily due to: the $4.9 million increase in the provision for estimated incentive compensation; an increase in the number of employees needed to service the larger portfolio, which resulted in an increase of $1.2 million in salaries and benefits; and the Fund’s rent and other facility related expenses increased approximately $118,908 primarily due to the Fund’s procurement of larger office space to accommodate the Fund’s increased number of employees. See Note 10 “Commitments and Contingencies” for more information.

Finally, the increase of approximately $1.6 million compared to the year ended October 31, 2005 in the Fund’s interest expense and other borrowing costs was due to borrowings under the new Credit Facility II.

 

In February 2006, the Fund renewed its Directors & Officers/Professional Liability Insurance policies at an expense of approximately $459,000 which is amortized over the twelve month life of the policy. The prior policy premium was $517,000.

 

Pursuant to the terms of the Fund’s employment agreement with Mr. Tokarz, during the year ended October 31, 2006, the provision for estimated incentive compensation was increased by $6,055,024. The increase in the provision for incentive compensation resulted from the determination of the Valuation Committee to increase the fair value of six of the Fund’s portfolio investments: Baltic, Dakota, Ohio, Octagon, Turf, and Vitality, which are subject to the Fund’s employment agreement with Mr. Tokarz, by a total of $30,275,120. This reserve balance of $7,172,352 will remain unpaid until net capital gains are realized, if ever, by the Fund. Without this reserve for incentive compensation, operating expenses would have been approximately $8.51 million or 3.96% of average net assets when annualized as compared to 6.78% which is reported on the Consolidated Per Share Data and Ratios, for the year ended October 31, 2006. Pursuant to Mr. Tokarz’s employment agreement with the Fund, only after a realization event, may the incentive compensation be paid to him. Mr. Tokarz has determined to allocate a portion of his incentive compensation to certain employees of the Fund. During the years ended October 31, 2006 and October 31, 2005, Mr. Tokarz was paid no cash or other compensation. However, on October 2, 2006 and as discussed in “Realized Gains and Losses on Portfolio Securities,” the Fund realized a gain of $551,092 from the sale of a portion of the Fund’s LLC member interest in Octagon. This transaction triggered an incentive compensation payment obligation to Mr. Tokarz, which payment is not required to be made until the precise amount of the payment obligation is confirmed based on the Fund’s completed audited financials for the fiscal year 2006. Subject to confirmation following the audit, the payment obligation to Mr. Tokarz from this transaction is approximately $110,000 (which is expected to be paid during the first quarter of the Fund’s fiscal year 2007). Please see Note 5 “Incentive Compensation” for more information.

 

For the Year Ended October 31, 2005

 

Operating expenses were $6.5 million or 3.75% of average net assets for the year ended October 31, 2005. Significant components of operating expenses for the year ended October 31, 2005 included salaries and benefits of $2,336,242, estimated incentive compensation expense of $1,117,328, insurance premium expenses of $590,493, legal fees of $529,541 and facilities related expenses of $484,420. Estimated incentive compensation expense is a non-cash, not yet payable, provisional expense relating to Mr. Tokarz’s compensation arrangement with the Fund.

 

The increase in the Fund’s operating expenses in 2005 compared to 2004 was primarily due to an increase in employees needed to service the larger portfolio and work to continue to grow the Fund. Also, the Fund’s rent and other facility related expenses increased primarily due to the Fund’s procurement of larger office space to accommodate the Fund’s increased number of employees. See Note 10 “Commitments and Contingencies” for more information.

 

Pursuant to the terms of the Fund’s agreement with Mr. Tokarz, during the year ended October 31, 2005, the Fund created a provision for $1,117,328 of incentive compensation. This provision for incentive compensation resulted from the determination of the Valuation Committee to increase the fair value of five of the Fund’s portfolio investments: Baltic, Dakota, Octagon, Vestal and Vitality which are subject to the Fund’s agreement with Mr. Tokarz, by an aggregate amount of $5,586,638. This reserve balance of $1,117,328 will remain unpaid and not finally determined until net capital gains are realized, if ever, by the Fund. Pursuant to Mr. Tokarz’s agreement with the Fund, only after a realization event, will the incentive compensation be paid to him. Mr. Tokarz has determined to allocate a portion of his incentive compensation to certain employees of the Fund. During the year ended October 31, 2005, Mr. Tokarz was paid no cash or other compensation. Without this reserve for incentive compensation, operating expenses would have been approximately $5.4 million or 3.10% of average net assets. Please see Note 5 “Incentive Compensation” for more information.

 

In February 2005, the Fund renewed its Directors & Officers/Professional Liability Insurance policies at an expense of approximately $517,000 which is amortized over the twelve month life of the policy. The prior policy premium was $719,000.

During the year ended October 31, 2005, the Fund paid or accrued $529,541 in legal fees. This amount includes legal fees of $47,171 which were incurred while pursuing a claim against Federal Insurance Company. See Note 12 “Legal Proceedings” for more information. The Fund received $473,964 from the settlement of the legal action which was recorded as “other income.” After fees and expenses the cash received from the settlement was $426,797. Without the legal fees related to the legal action, the Fund would have paid or accrued $482,370 in legal fees.

 

For the Year Ended October 31, 2004

 

Operating expenses were $4.3 million or 3.68% of average net assets for the year ended October 31, 2004. Significant components of operating expenses for the year ended October 31, 2004 included insurance premium expenses of $959,570, salaries and benefits of $1,365,913, legal fees of $810,848, and facilities expense of $90,828.

 

In February 2003, the former management of the Fund (“Former Management”) entered into new Directors & Officers/Professional Liability Insurance policies with total premiums of approximately $1.4 million. The cost was amortized over the life of the policy, through February 2004, at which time at new policy was entered into with a premium of approximately $719,000. For the year ended October 31, 2004, the Fund expensed $959,570 in insurance premiums.

 

During the year ended October 31, 2004, the Fund paid or accrued $810,848 in legal fees (compared to $1.5 million in 2003). Legal expenses included fees of $124,787 incurred while pursuing action against the Fund’s former advisor, meVC Advisers, Inc. (the “Former Adviser”) for the reimbursement of management fees which were alleged to be excessive. See Note 12 “Legal Proceedings” for more information. The Fund received $370,000 from the settlement of the legal action which was recorded as other income. After fees and expenses the cash received from the settlement was $245,213. Without the legal fees related to this litigation, the Fund would have paid or accrued $686,061 in legal fees. The legal expenses for the year ended October 31, 2004, were reflective of a decreased need for legal counsel due to the redefinition of the Fund’s direction by Management.

 

On January 21, 2004, the Fund reached an agreement with the property manager at 3000 Sand Hill Road, Menlo Park, California to terminate its lease at such location. Under the terms of the agreement, the Fund bought-out its lease directly from the property manager, for an amount equal to $232,835. As a result, the Fund recovered approximately $250,000 of the remaining reserve established at October 31, 2003. Without the recovery of the reserve, the gross facilities expense for the year ended October 31, 2004 would have been approximately $340,828.

 

Realized Gains and Losses On Portfolio Securities

 

For the Years Ended October 31, 2006, 2005 and 2004.  Net realized gains for the year ended October 31, 2006 were $5.2 million and net realized losses for the year ended October 31, 2005 were $3.3 million, an increase of $8.5 million. Net realized losses for the year ended October 31, 2004 were $37.8 million which was $34.5 million more compared to fiscal year 2005.

 

For the Year Ended October 31, 2006

 

Net realized gains for the year ended October 31, 2006 were $5.2 million. The significant component of the Fund’s net realized gain for the year ended October 31, 2006 was primarily due to the gain on the sale of ProcessClaims Inc. (“Process Claims”), the escrow distribution from Sygate Technologies, Inc. (“Sygate”), and the sale of a portion of the Octagon equity interest, an investment made during Mr. Tokarz’s tenure as portfolio manager.

 

During the year ended October 31, 2006, the Fund sold its investment in ProcessClaims and realized a gain of approximately $5.5 million. The Fund was entitled to receive approximately $8.3 million in gross proceeds, of which approximately $400,000 or 5% of the proceeds will be deposited into a reserve account for one year. Due to the contingencies associated with the escrow, the Fund has not presently placed any value on the proceeds deposited in escrow and has therefore not factored such proceeds into the Fund’s increased NAV. The Fund received net proceeds of approximately $7.9 million.

On October 2, 2006, Octagon bought-back a total of 15% equity interest from non-service members. This resulted in a sale of a portion of the Fund’s LLC member interest to Octagon for proceeds of $1,020,018. The Fund realized a gain of $551,092 from this sale.

 

On October 17, 2006, the Fund received a $1.6 million escrow disbursement from the sale of Sygate on October 10, 2005. Due to the contingencies associated with the escrow, the Fund had not placed any value on the proceeds deposited in escrow. This resulted in an increase in NAV of $1.6 million.

 

The Fund received notification of the final dissolution of Yaga Inc. (“Yaga”). The Fund received no proceeds from the dissolution of this company and the investment has been removed from the Fund’s books. The Fund realized a loss of $2.3 million as a result of this dissolution. The fair value of Yaga was previously written down to zero and therefore, the net effect of the removal of Yaga from the Fund’s books on the Fund’s consolidated statement of operations and NAV was zero.

 

On April 7, 2006, the Fund sold its investment in Lumeta Corporation (“Lumeta”) for its then carrying value of $200,000. The Fund realized a loss on Lumeta of approximately $200,000. However, the Valuation Committee previously decreased the fair value of the Fund’s investment in this company to $200,000 and as a result, the realized loss was offset by a reduction in unrealized losses. Therefore, the net effect of the Fund’s sale of its investment in Lumeta on the Fund’s consolidated statement of operations and NAV was zero.

 

The Fund also received a payout related to a former portfolio company, Annuncio, of approximately $70,000.

 

For the Year Ended October 31, 2005

 

Net realized losses for the year ended October 31, 2005 were $3.3 million. The significant components of the Fund’s net realized loss for the year ended October 31, 2005 were realized gains on the Fund’s investments in Sygate, Mentor Graphics and BlueStar Solutions, Inc. (“BlueStar”) which were offset by realized losses on CBCA, Inc. (“CBCA”), Phosistor Technologies, Inc. (“Phosistor”) and ShopEaze Systems, Inc. (“ShopEaze”).

 

During the year ended October 31, 2005, the Fund sold its entire investment in Sygate and received net proceeds of $14.4 million. In addition, approximately $1.6 million or 10% of proceeds from the sale were deposited in an escrow account for approximately one year. Due to the contingencies associated with the escrow, the Fund did not place any value on the proceeds deposited in escrow and did not factor such proceeds into the Fund’s NAV. The realized gain from the $14.4 million in net proceeds received was $10.4 million. The Fund also sold 685,679 shares of Mentor Graphics receiving net proceeds of approximately $9.0 million and a realized gain on the shares sold of approximately $5.0 million. The Fund also received approximately $300,000 from the release of money held in escrow in connection with the Fund’s sale of its investment in BlueStar in 2004 (see below).

 

The Fund realized losses on CBCA of approximately $12.0 million, Phosistor of approximately $1.0 million and ShopEaze of approximately $6.0 million. The Fund received no proceeds from these companies and they have been removed from the Fund’s portfolio. The Valuation Committee previously decreased the fair value of the Fund’s investment in these companies to zero and as a result, the realized losses were offset by reductions in unrealized losses. Therefore, the net effect of the transactions on the Fund’s consolidated statement of operations and NAV was zero for the fiscal year ended October 31, 2005.

 

For the Year Ended October 31, 2004

 

Net realized losses for the year ended October 31, 2004 were $37.8 million. The significant components of the Fund’s realized losses for the year ended October 31, 2004 were transactions with PTS Messaging, Inc. (“PTS Messaging”), Ishoni Networks, Inc. (“Ishoni”), Synhrgy HR Technologies, Inc. (“Synhrgy”), BlueStar and DataPlay, Inc. (“DataPlay”).

 

The Fund had a return of capital from PTS Messaging with proceeds totaling approximately $102,000 from the initial and final disbursement of assets and a realized loss totaling approximately $11.6 million. As of October 31, 2004 the Fund no longer held an investment in PTS Messaging. The Valuation Committee previously decreased the fair value of the Fund’s investment in PTS Messaging to zero.

The Fund also realized a loss on Ishoni of approximately $10.0 million. The Fund received no proceeds from the dissolution of this company and the investment has been removed from the Fund’s portfolio. The Valuation Committee previously decreased the fair value of the Fund’s investment in Ishoni to zero.

 

There was a gain of $39,630 representing proceeds received from the cashless exercise of the Fund’s warrants of Synhrgy in conjunction with the early repayment by Synhrgy of the balance of Synhrgy’s credit facility.

 

On August 26, 2004, Affiliated Computer Services, Inc. (“ACS”) acquired the Fund’s portfolio company BlueStar in a cash transaction. The Fund received approximately $4.5 million for its investment in BlueStar. The amount received included up to $459,000 in contingent payments that were held in escrow. The carrying value of the BlueStar investment was $3.0 million. The Fund realized a loss of approximately $8.8 million, which was offset by a decrease in unrealized loss by the same amount. The effect of the transaction on the Fund was an increase in assets by $1.1 million. After the sale, the Fund no longer held an investment in BlueStar.

 

On August 29, 2004, the Fund entered into a transaction pursuant to which it received 602,131 Series A-1 preferred shares of DPHI, Inc. (“DPHI”), which purchased the assets of DataPlay out of bankruptcy in late 2003. The Fund’s legal fees in connection with the transaction were approximately $20,000. The shares of DPHI were received in exchange for the Fund’s seven promissory notes in DataPlay. The 2,500,000 shares of DataPlay Series D Preferred Stock were removed from the books of the Fund for a realized loss of $7.5 million. The unrealized loss had previously been recorded; therefore, the net effect of the transaction was zero.

 

Unrealized Appreciation and Depreciation of Portfolio Securities

 

For the Years Ended October 31, 2006, 2005 and 2004.  The Fund had a net change in unrealized appreciation on portfolio investments of $38.3 million for the year ended October 31, 2006. The Fund had a net change in unrealized appreciation on portfolio investments of $23.8 million and $49.4 million for the years ended October 31, 2005 and 2004, respectively.

 

For the Year Ended October 31, 2006

 

The Fund had a net change in unrealized appreciation on portfolio investments of $38.3 million for the year ended October 31, 2006. The change in unrealized appreciation on investment transactions for the year ended October 31, 2006 primarily resulted from the Valuation Committee’s decision to increase the fair value of the Fund’s investments in Baltic common stock by $11.6 million, Dakota common stock by approximately $2.6 million, Turf’s membership interest by approximately $2.0 million, Octagon’s membership interest by approximately $562,000, Ohio common stock by $9.2 million, ProcessClaims preferred stock by $4.8 million, Foliofn preferred stock by $5.0 million, Vendio Services, Inc. (“Vendio”) preferred stock by $700,000, and Vitality common stock and warrants by $3.5 million and $400,000, respectively. The Valuation Committee also decided to decrease the fair value of the Fund’s investment in Timberland common stock by $1.0 million. Other key components of the net change in unrealized appreciation were the $2.5 million depreciation reclassification from unrealized to realized caused by the removal of Yaga and Lumeta and the $4.8 million appreciation reclassification from the sale of ProcessClaims from the Fund’s books.

 

For the Year Ended October 31, 2005

 

The Fund had a net change in unrealized appreciation on portfolio investments of $23.8 million for the year ended October 31, 2005. The change in unrealized appreciation on investment transactions for the year ended October 31, 2005 primarily resulted from the Valuation Committee’s determinations to increase the fair value of the Fund’s investments in Baltic by $1.5 million, Dakota by $514,000, Octagon by $1,022,638, Sygate by $7.5 million, Vendio Services, Inc. (“Vendio”) by $1,565,999, Vestal by $1.85 million and Vitality by $700,000. The increase in the fair value of these portfolio investments resulted in a change in unrealized appreciation of approximately $14.7 million. Other key components were the realization of a $10.4 million gain on the sale of the Fund’s investment in Sygate, a $5.0 million gain on the sale of the Fund’s investment in Mentor Graphics, the $19.0 million depreciation reclassification from unrealized to realized caused by the removal of CBCA, Phosistor and ShopEaze from the Fund’s books and the $500,000 decrease in unrealized caused by repayment in full of the Arcot Systems, Inc. (“Arcot”) loan which was being carried below cost.

For the Year Ended October 31, 2004

 

Net change in unrealized appreciation for the year ended October 31, 2004 was $49.38 million. The net change in unrealized appreciation on investment transactions for the year ended October 31, 2004 resulted mainly from the $37.8 million reclassification from unrealized depreciation to realized loss caused by the sale or disbursement of assets from PTS Messaging, Ishoni, Synhrgy, BlueStar and DataPlay (See Realized Gains and Losses on Portfolio Securities). This net decrease also resulted from the determinations of the Valuation Committee to (i) increase the fair value of the Fund’s investments in 0-In Design Automation, Inc. (“0-In”) by $5 million, Sygate by $1.5 million, BlueStar by $1.5 million, Vendio by $634,000 and Integral Development Corp. (“Integral”) by $989,000 and (ii) decrease the fair value of the Fund’s investments in Actelis Networks, Inc. (“Actelis”) by $1,000,000, CBCA by $500,000, and Sonexis, Inc. (“Sonexis”) by $500,000.

 

The Fund also sold its investment in 0-In for 685,679 shares of Mentor Graphics in a tax-free exchange. Of these shares, 603,396 are freely tradable and valued daily at market price. As of October 31, 2004 these shares had an unrealized gain of approximately $3.0 million above the Fund’s cost basis in 0-In and $6.0 million above 0-In’s carrying value at October 31, 2003.

 

Portfolio Investments

 

For the Years Ended October 31, 2006 and 2005.  The cost of the portfolio investments held by the Fund at October 31, 2006 and at October 31, 2005 was $286.9 million and $171.6 million, respectively, an increase of $115.3 million. The aggregate fair value of portfolio investments at October 31, 2006 and at October 31, 2005 was $275.9 million and $122.3 million, respectively, an increase of $153.6 million. The cost and aggregated market value of short-term securities held by the Fund at October 31, 2006 and at October 31, 2005 was $0 and $51 million, respectively, a decrease of $51 million. The cost and aggregate market value of cash and cash equivalents held by the Fund at October 31, 2006 and at October 31, 2005 was $66.2 million and $26.3 million, respectively, an increase of approximately $39.9 million.

 

For the Year Ended October 31, 2006

 

During the year ended October 31, 2006, the Fund made sixteen new investments, committing capital totaling approximately $142.1 million. The investments were made in Turf ($11.6 million), SOI ($5.0 million), Henry ($5.0 million), BM Auto ($15.0 million), Storage Canada ($6.0 million), Phoenix ($8.0 million), Harmony ($200,000), Total Safety ($6.0 million), PreVisor ($6.0 million), Marine ($14.0 million), BP ($15.0 million), Velocitius ($66,290), Summit ($16.2 million), Octagon ($17.0 million), BENI ($2.0 million), and Innovative Brands ($15.0 million).

 

The Fund also made eight follow-on investments in existing portfolio companies committing capital totaling approximately $24.2 million. During the year ended October 31, 2006, the Fund invested approximately $879,000 in Dakota by purchasing an additional 172,104 shares of common stock at an average price of $5.11 per share. On December 22, 2005, the Fund made a follow-on investment in Baltic in the form of a $1.8 million revolving bridge note. Baltic immediately drew down $1.5 million from the note. On January 12, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note matured on January 31, 2006 and has been removed from the Fund’s books. On January 12, 2006, the Fund provided SGDA a $300,000 bridge loan. On March 28, 2006, the Fund provided Baltic a $2.0 million revolving bridge note. Baltic immediately drew down $2.0 million from the note. On April 5, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note matured on April 30, 2006 and has been removed from the Fund’s books. On April 6, 2006, the Fund invested an additional $2.0 million in SGDA in the form of a preferred equity security. On April 25, 2006, the Fund purchased an additional common equity security in SGDA for $23,000. On June 30, 2006, the Fund invested $2.5 million in Amersham in the form of a second lien loan. On August 4, 2006, the Fund invested $750,000 in Harmony in the form of common stock. On September 28, 2006, the Fund made another follow-on investment in Baltic in the form of a $1.0 million bridge loan and $2.0 million equity investment. On October 13, 2006, the Fund made a $10 million follow-on investment in SP. The $10 million was invested in the form of an additional $4.0 million in term loan B and $6.0 million in a mezzanine loan. On October 20, 2006, the Fund then assigned $5.0 million of SP’s $8.0 million term loan B to Citigroup Global Markets Realty Corp. On

October 24, 2006, the Fund invested an additional $3.0 million in SGDA in the form of a preferred equity security. On October 26, 2006, the Fund invested an additional $2.9 million in Velocitius in the form of common equity. The Fund also provided Velocitius a $260,000 revolving note on October 31, 2006. Velocitius immediately drew down $143,614 from the note.

 

At the beginning of the 2006 fiscal year, the revolving credit facility provided to SGDA had an outstanding balance of approximately $1.2 million. During December 2005, SGDA drew down an additional $70,600 from the credit facility. On April 28, 2006, the Fund increased the availability under the revolving credit facility by $300,000. The balance of the bridge loan mentioned above, which would have matured on April 30, 2006, was added to the revolving credit facility and the bridge loan was eliminated from the Fund’s books as a part of the refinancing.

 

On December 21, 2005, Integral prepaid its senior credit facility from the Fund in full. The Fund received approximately $850,000 from the prepayment. This amount included all outstanding principal and accrued interest. The Fund recorded no gain or loss as a result of the prepayment. Under the terms of the prepayment, the Fund returned its warrants to Integral for no consideration.

 

Effective December 27, 2005, the Fund exchanged $286,200, of the $3.25 million outstanding, of the Timberland junior revolving line of credit into 28.62 shares of common stock at a price of $10,000 per share. As a result, as of July 31, 2006, the Fund owned 478.62 common shares of Timberland and the funded debt under the junior revolving line of credit was reduced from $3.25 million to approximately $2.96 million.

 

Effective December 31, 2005, the Fund received 373,362 shares of Series E preferred stock of ProcessClaims, Inc. in exchange for its rights under a warrant issued by ProcessClaims that has been held by the Fund since May 2002. On January 5, 2006, the Valuation Committee increased the fair value of the Fund’s entire investment in ProcessClaims by $3.3 million to $5.7 million. Please see the paragraph below for more information on ProcessClaims.

 

On January 3, 2006, the Fund exercised its warrant ownership in Octagon which increased its existing membership interest. As a result, Octagon is now considered an affiliate of the Fund.

 

Due to the dissolution of Yaga, one of the Fund’s legacy portfolio companies, the Fund realized losses on its investment in Yaga totaling $2.3 million during the year ended October 31, 2006. The Fund received no proceeds from the dissolution of Yaga and the Fund’s investment in Yaga has been removed from the Fund’s books. The Valuation Committee previously decreased the fair value of the Fund’s investment in Yaga to zero and as a result, the Fund’s realized losses were offset by reductions in unrealized losses. Therefore, the net effect of the removal of Yaga from the Fund’s books on the Fund’s consolidated statement of operations and NAV at October 31, 2006, was zero.

 

On February 24, 2006, BP repaid its second lien loan from the Fund in full. The amount of the proceeds received from the prepayment was approximately $8.7 million. This amount included all outstanding principal, accrued interest, accrued monitoring fees and an early prepayment fee. The Fund recorded no gain or loss as a result of the repayment.

 

On April 7, 2006, the Fund sold its investment in Lumeta for its then carrying value of $200,000. The Fund realized a loss on Lumeta of approximately $200,000. However, the Valuation Committee previously decreased the fair value of the Fund’s investment in Lumeta to $200,000 and, as a result, the realized loss was offset by a reduction in unrealized losses. Therefore, the net effect of the Fund’s sale of its investment in Lumeta on the Fund’s consolidated statement of operations and NAV was zero.

 

On April 21, 2006, BM Auto repaid its bridge loan from the Fund in full. The amount of the proceeds received from the repayment was approximately $7.2 million. This amount included all outstanding principal, accrued interest and was net of foreign taxes withheld. The Fund recorded no gain or loss as a result of the repayment.

 

On May 4, 2006, the Fund received a working capital adjustment of approximately $250,000 related to the Fund’s purchase of a membership interest in Turf. As a result, the Fund’s cost basis in the investment was reduced.

 

On May 30, 2006, ProcessClaims, one of the Fund’s legacy portfolio companies, entered into a definitive agreement to be acquired by CCC Information Services Inc. (“CCC”). The acquisition by CCC closed on

June 9, 2006. As of June 9, 2006, the Fund received net proceeds of approximately $7.9 million. The gross proceeds were approximately $8.3 million of which approximately $400,000 or 5% of the gross proceeds were deposited into a reserve account for one year. Due to the contingencies associated with the escrow, the Fund has not presently placed any value on the proceeds deposited in escrow and has therefore not factored such proceeds into the Fund’s increased NAV. The Fund’s total investment in ProcessClaims was $2.4 million which resulted in a capital gain of approximately $5.5 million.

 

On July 27, 2006, SOI repaid their loan from the Fund in full. The amount of the proceeds received from the prepayment was approximately $4.5 million. This amount included all outstanding principal, accrued interest, and an early prepayment fee. The Fund recorded no gain or loss as a result of the prepayment.

 

On August 25, 2006, Harmony repaid their loan from the Fund in full. The amount of the proceeds received from the prepayment was $207,444. This amount included all outstanding principal and accrued interest. The Fund recorded no gain or loss as a result of the prepayment.

 

On August 25, 2006, SGDA’s revolving credit facility was added to the term loan, increasing the balance of the term loan by $1.6 million. The revolving credit facility was eliminated from the Fund’s books as a result of this refinancing.

 

Effective September 12, 2006, the Fund exchanged $409,091, of the $2.96 million outstanding, of the Timberland junior revolving line of credit into 40.91 shares of common stock at a price of $10,000 per share. Effective September 22, 2006, the Fund exchanged $225,000, of the $2.55 million outstanding, of the Timberland junior revolving line of credit into 22.5 shares of common stock at a price of $10,000 per share. On September 22, 2006, Timberland drew down $500,000 from the junior revolving line of credit. As a result of these transactions, as of October 31, 2006, the Fund owned 542.03 common shares of Timberland and the funded debt under the junior revolving line of credit was reduced from $2.96 million to approximately $2.83 million.

 

On October 2, 2006, Octagon bought-back a total of 15% equity interest from non-service members. This resulted in a sale of a portion of the Fund’s LLC member interest to Octagon for proceeds of $1,020,018. The Fund realized a gain of $551,092 from this sale.

 

On October 2, 2006, Octagon repaid their loan and revolving credit facility from the Fund in full. The amount of the proceeds received from the prepayment of the loan was approximately $5.4 million. This amount included all outstanding principal, accrued interest, and an unused fee on the revolving credit facility. The Fund recorded a gain as a result of these prepayments of approximately $429,000 from the acceleration of amortization of original issue discount.

 

On October 20, 2006, the Fund assigned $5.0 million of SP’s $8.0 million term loan B to Citigroup Global Markets Realty Corp.

 

On October 30, 2006, JDC repaid $160,116 of principal on the senior subordinated debt.

 

During the year ended October 31, 2006, the Valuation Committee increased the fair value of the Fund’s investments in Baltic common stock by $11.6 million, Dakota common stock by approximately $2.6 million, Turf’s membership interest by $2.0 million, Octagon’s membership interest by approximately $562,000, Ohio common stock by $9.2 million, Foliofn preferred stock by $5.0 million, Vendio preferred stock by $700,000, ProcessClaims preferred stock by $4.8 million and Vitality common stock and warrants by $3.5 million and $400,000, respectively. In addition, increases recorded to the cost basis and fair value of the loans to Amersham, BP, Impact, JDC, Phoenix, SP, Timberland, Turf, Marine, Summit and the Vitality and Marine preferred stock were due to the receipt of payment in kind interest/dividends totaling approximately $2.2 million. Also during the year ended October 31, 2006, the undistributed allocation of flow through income from the Fund’s equity investment in Octagon increased the cost basis and fair value of the Fund’s investment by approximately $279,000. During the year ended October 31, 2006, the Valuation Committee also decreased the fair value of the Fund’s equity investment in Timberland by $1 million. The increase in fair value from payment in kind interest/dividends and flow through income has been approved by the Fund’s Valuation Committee.

At October 31, 2006, the fair value of all portfolio investments, exclusive of short-term securities, was $275.9 million with a cost basis of $286.9 million. At October 31, 2005, the fair value of all portfolio investments, exclusive of short-term securities, was $122.3 million with a cost basis of $171.6 million.

 

For the Year Ended October 31, 2005

 

During the year ended October 31, 2005, the Fund made six new investments, committing capital totaling approximately $48.8 million. The investments were made in JDC, SGDA, SP, BP, Ohio and Amersham. The amounts invested were $3.0 million, $5.8 million, $10.5 million, $10 million, $17 million and $2.5 million respectively.

 

The Fund also made three follow-on investments in existing portfolio companies committing capital totaling approximately $5.0 million. In December 2004 and January 2005, the Fund invested a total of $1.25 million in Timberland in the form of subordinated bridge notes. On April 15, 2005, the Fund re-issued 146,750 shares of its treasury stock at the Fund’s NAV per share of $9.54 in exchange for 40,500 shares of common stock of Vestal. On July 8, 2005 the Fund extended Timberland a $3.25 million junior revolving note. According to the terms of the note, Timberland immediately drew $1.3 million from the revolving note and used the proceeds to repay the subordinated bridge notes in full. The repayment included all outstanding principal and accrued interest. On July 29, 2005, the Fund invested an additional $325,000 in Impact in the form of a secured promissory note.

 

In April 2005, Octagon drew $1.5 million from the senior secured credit facility provided to it by the Fund and repaid it in full during June 2005.

 

During 2005, SGDA drew approximately $1.2 million from the revolving credit facility provided to it by the Fund. As of October 31, 2005, all amounts drawn from the facility remained outstanding.

 

On July 14, 2005 and September 28, 2005, Timberland drew an additional $1.5 million and $425,000, respectively, from the revolving note mentioned above. As of October 31, 2005, the note was drawn in full and the balance of $3.25 million remained outstanding.

 

Also, during the year ended October 31, 2005, the Fund sold its entire investment in Sygate and received $14.4 million in net proceeds. In addition, approximately $1.6 million or 10% of proceeds from the sale were deposited in an escrow account for approximately one year. Due to the contingencies associated with the escrow, the Fund did not place any value on the proceeds deposited in escrow and did not factor such proceeds into the Fund’s NAV. The realized gain from the $14.4 million in net proceeds received was $10.4 million. The Fund also sold 685,679 shares of Mentor Graphics receiving net proceeds of approximately $9.0 million and a realized gain on the shares sold of approximately $5.0 million. The Fund also received approximately $300,000 from the escrow related to the 2004 sale of BlueStar.

 

The Fund realized losses on CBCA of approximately $12.0 million, Phosistor of approximately $1.0 million and ShopEaze of approximately $6.0 million. The Fund received no proceeds from these companies and they have been removed from the Fund’s portfolio. The Valuation Committee previously decreased the fair value of the Fund’s investments in these companies to zero. Therefore, the net effect of the transactions on the Fund’s consolidated statement of operations and NAV for the fiscal year ended October 31, 2005, was zero.

 

On December 21, 2004, Determine Software, Inc. (“Determine”) prepaid its senior credit facility from the Fund in full. The amount of proceeds the Fund received from the repayment was approximately $1.64 million. This amount included all outstanding principal and accrued interest. Under the terms of the early repayment, the Fund returned its 2,229,955 Series C warrants for no consideration.

 

On July 5, 2005, Arcot prepaid its senior credit facility from the Fund in full. The amount of proceeds the Fund received from the repayment was approximately $2.55 million. This amount included all outstanding principal and accrued interest. Under the terms of the early repayment, the Fund returned its warrants to Arcot for no consideration.

 

The Fund continued to receive principal repayments on the debt securities of Integral and BP. Integral made payments during the year ended October 31, 2005, according to its credit facility agreement totaling $1,683,336. BP

made two quarterly payments during the year ended totaling $833,333. Also, the Fund received a one time, early repayment on Vestal’s debt securities totaling $100,000.

 

During the year ended October 31, 2005, the Valuation Committee increased the fair value of the Fund’s investments in Baltic by $1.5 million, Dakota by $514,000, Octagon by $1,022,638, Sygate by $7.5 million (which was later realized), Vendio by $1,565,999, Vestal by $1,850,000 and Vitality by $700,000. In addition, increases in the cost basis and fair value of the Octagon loan, Impact loan, Timberland loan, Vitality Series A preferred stock, JDC loan and SP loans were due to the receipt of “payment in kind” interest/dividends totaling $1,370,777. Also during the year ended October 31, 2005, the undistributed allocation of flow through income from the Fund’s equity investment in Octagon increased the cost basis and fair value of the investment by $114,845.

 

At October 31, 2005, the fair value of all portfolio investments, exclusive of short-term securities, was $122.3 million with a cost of $171.6 million. At October 31, 2004, the fair value of all portfolio investments, exclusive of short-term securities, was $78.5 million with a cost of $151.6 million.

 

Portfolio Companies

 

During the year ended October 31, 2006, the Fund had investments in the following portfolio companies:

 

Actelis Networks, Inc.

 

Actelis Networks, Inc. (“Actelis”), Fremont, California, a legacy investment, provides authentication and access control solutions designed to secure the integrity of e-business in Internet-scale and wireless environments.

 

At October 31, 2005 and October 31, 2006, the Fund’s investment in Actelis consisted of 150,602 shares of Series C preferred stock at a cost of $5.0 million. The investment has been assigned a fair value of $0.

 

Amersham Corp.

 

Amersham Corp. (“Amersham”), Louisville, Colorado, is a manufacturer of precision machined components for the automotive, furniture, security and medical device markets.

 

During fiscal year 2005 the Fund made an investment in Amersham. The Fund’s investment in Amersham consists of $2.5 million in purchased notes, bearing annual interest at 10%. The notes have a maturity date of June 29, 2010. The notes have a principal face amount and cost basis of $2.5 million.

 

On June 30, 2006, the Fund made an additional investment in Amersham consisting of an additional $2.5 million note bearing annual interest at 16% from June 30, 2006 to June 30, 2008. The interest rate then steps down to 14% for the period July 1, 2008 to June 30, 2010, steps down to 13% for the period July 1, 2010 to June 30, 2012 and steps down again to 12% for the period July 1, 2012 to June 30, 2013. The note has a maturity date of June 30, 2013. The note has a principal face amount and cost basis of $2.6 million. The increase in the outstanding balance, cost and fair value of the loan, is due to the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

At October 31, 2006, the notes had a combined outstanding balance, cost and fair value of $5.1 million.

 

Auto MOTOL BENI

 

Auto MOTOL BENI (“BENI”), consists of two leased Ford sales and service dealerships located in the western side of Prague, in the Czech Republic.

 

On October 10, 2006 the Fund made an investment in BENI by purchasing 200 shares of common stock at a cost of $2.0 million.

 

At October 31, 2006, the Fund’s investment in BENI was assigned a cost and fair value of $2.0 million.

 

Christopher Sullivan, a representative of the Fund, serves as a director for BENI.

Baltic Motors Corporation

 

Baltic Motors Corporation (“Baltic”), Purchase, New York, is a U.S. company focused on the importation and sale of Ford and Land Rover vehicles and parts throughout Latvia, a member of the European Union.

 

At October 31, 2005, the Fund’s investment in Baltic consisted of 54,947 shares of common stock at a cost of $6.0 million and a mezzanine loan with a cost basis of $4.5 million. The loan has a maturity date of June 24, 2007 and earns interest at 10% per annum.

 

At October 31, 2005, the investment in Baltic was assigned a fair value of $12.0 million.

 

On December 22, 2005, the Fund extended to Baltic a $1.8 million revolving bridge note. Baltic immediately drew down $1.5 million from the note. On January 12, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note ended on January 31, 2006 and has been removed from the Fund’s books.

 

On March 28, 2006, the Fund extended to Baltic a $2.0 million revolving bridge note. Baltic immediately drew down $2.0 million from the note. On April 5, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note ended on April 30, 2006 and has been removed from the Fund’s books.

 

On September 28, 2006, the Fund purchased an additional 5,737 shares of common stock at a cost of $2.0 million. The Fund also extended to Baltic a $1.0 million bridge loan. The loan bears annual interest at 12% with a maturity date of December 27, 2006.

 

During the year ended October 31, 2006, the Valuation Committee increased the fair value of the Fund’s equity investment in Baltic by $11.6 million. The fair value of the Fund’s equity investment at October 31, 2006 was $21.2 million.

 

At October 31, 2006, the Fund’s investment in Baltic was assigned a fair value of $26.7 million. Michael Tokarz, Chairman of the Fund, and Christopher Sullivan, a representative of the Fund, serve as directors for Baltic.

 

BP Clothing, LLC

 

BP Clothing, LLC (“BP”), Pico Rivera, California, is a company which designs, manufactures, markets and distributes, Baby Phat(R), a line of women’s clothing.

 

On June 3, 2005, the Fund made an initial investment in BP consisting of a $10 million second lien loan bearing annual interest at LIBOR plus 8% for the first year and variable interest rates for the remainder of the four year term. The loan has a $10.0 million principal face amount and was issued at a cost basis of $10.0 million. The loan’s cost basis was subsequently discounted to reflect loan origination fees received. The Fund is scheduled to receive quarterly principal repayments totaling $625,000 per quarter with the remaining principal balance due upon maturity.

 

On February 24, 2006, BP repaid its initial second lien loan from the Fund in full. The amount of the proceeds received from the prepayment was approximately $8.7 million. This amount included all outstanding principal, accrued interest, accrued monitoring fees and an early prepayment fee.

 

On July 19, 2006, the Fund extended to BP a subsequent $10 million second lien loan bearing annual interest at 14%. The loan has a $10.0 million principal face amount and was issued at a cost basis of $10.0 million. The loan’s cost basis was subsequently discounted to reflect loan origination fees received. The maturity date of the loan is July 18, 2012. The principal balance is due upon maturity.

 

On July 20, 2006, the Fund purchased at a discount $5 million in loan assignments in BP. The $3 million term loan A bears annual interest at LIBOR plus 4.25% or Prime Rate plus 3.25%. The $2 million term loan B bears annual interest at LIBOR plus 6.40% or Prime Rate plus 5.40%. The interest rate option on the loan assignments is at the borrower’s discretion. Both loans mature on July 18, 2011.

 

On September 29, 2006, the Fund received a quarterly principal payment for term loan A of $90,000. The increase in the outstanding balance, cost and fair value of the loans is due to the amortization of loan origination fees

and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

At October 31, 2006, the loans had a combined outstanding balance and cost basis of $14.7 million. The loan and loan assignments had a combined fair value of $14.9 million.

 

Dakota Growers Pasta Company, Inc.

 

Dakota Growers Pasta Company, Inc. (“Dakota”), Carrington, North Dakota, is the third largest manufacturer of dry pasta in North America and a market leader in private label sales. Dakota and its partners in DNA Dreamfields Company, LLC introduced a new process that is designed to reduce the number of digestible carbohydrates found in traditional pasta products.

 

At October 31, 2005, the Fund’s investment in Dakota consisted of 909,091 shares of common stock with a cost of $5.0 million and assigned fair value of $5.5 million.

 

During the year ended October 31, 2006, the Fund purchased an additional 172,104 shares of common stock at an average price of $5.11 per share or approximately $879,000.

 

Effective January 31, 2006 and April 30, 2006, the Valuation Committee increased the fair value of the newly purchased shares to the carrying value of the original shares or approximately $6.07. The increase in the fair value of the newly purchased shares over their cost was approximately $164,000.

 

Effective July 31, 2006, the Valuation Committee increased the fair value of the investment by approximately $900,000.

 

Effective October 31, 2006, the Valuation Committee increased the fair value of the investment by approximately $1.5 million.

 

At October 31, 2006, the Fund’s investment in Dakota consisted of 1,081,195 shares of common stock with a cost of $5.9 million and assigned fair value of $9 million.

 

Michael Tokarz, Chairman of the Fund, serves as a director of Dakota.

 

DPHI, Inc. (formerly DataPlay, Inc.)

 

DPHI, Inc. (“DPHI”), Boulder, Colorado, a legacy investment, is trying to develop new ways of enabling consumers to record and play digital content.

 

At October 31, 2005 and October 31, 2006, the Fund’s investment in DPHI consisted of 602,131 shares of Series A-1 preferred stock with a cost of $4.5 million. This investment has been assigned a fair value of $0.

 

Endymion Systems, Inc.

 

Endymion Systems, Inc. (“Endymion”), Oakland, California, a legacy investment, is a single source supplier for strategic, web-enabled, end-to-end business solutions designed to help its customers leverage Internet technologies to drive growth and increase productivity.

 

At October 31, 2005 and October 31, 2006, the Fund’s investment in Endymion consisted of 7,156,760 shares of Series A preferred stock with a cost of $7.0 million. The investment has been assigned a fair value of $0.

 

Foliofn, Inc.

 

Foliofn, Inc. (“Foliofn”), Vienna, Virginia, a legacy investment, is a financial services technology company that offers investment solutions to financial services firms and investors.

 

At October 31, 2005 and October 31, 2006, the Fund’s investment in Foliofn consisted of 5,802,259 shares of Series C preferred stock with a cost of $15.0 million. During the year ended October 31, 2006, the Valuation Committee increased the fair value of the Fund’s equity investment in Foliofn by $5.0 million. The fair value of the Fund’s equity investment at October 31, 2006 was $5.0 million.

Bruce Shewmaker, an officer of the Fund, serves as a director of Foliofn.

 

Harmony Pharmacy & Health Center, Inc.

 

Harmony Pharmacy & Health Center, Inc. (“Harmony Pharmacy”), Purchase, NY, plans to operate pharmacy and healthcare centers primarily in airports in the United States.

 

The Fund invested $200,000 in Harmony Pharmacy in the form of a demand note. The note bears annual interest at 10% and is callable anytime at the Fund’s discretion.

 

On August 4, 2006 the Fund purchased 750,000 shares of common stock at a cost of $750,000.

 

On August 25, 2006, Harmony repaid its demand note in full. The amount of the proceeds received from the prepayment was $207,444.44. This amount included all outstanding principal and accrued interest. There was no gain or loss as a result of the prepayment.

 

At October 31, 2006, the Fund’s investment in Harmony consisted of 2 million shares of common stock with a cost of $750,000 and was assigned a fair value of $750,000.

 

Michael Tokarz, Chairman of the Fund, serves as a director of Harmony.

 

Henry Company

 

Henry Company (“Henry”), Huntington Park, California, is a manufacturer and distributor of building products and specialty chemicals.

 

In January 2006, The Fund purchased the $5 million in loan assignments in Henry Company. The $3 million term loan A bears annual interest at LIBOR plus 3.5% and matures on April 6, 2011. The $2 million term loan B bears annual interest at LIBOR plus 7.75% and also matures on April 6, 2011.

 

At October 31, 2006, the loans had a combined outstanding balance, cost basis, and fair value of $5.0 million.

 

Impact Confections, Inc.

 

Impact Confections, Inc. (“Impact”), Roswell, New Mexico founded in 1981, is a manufacturer and distributor of children’s candies.

 

The Fund’s investment in Impact consists of 252 shares of common stock at a cost of $10,714.28 per share or $2.7 million and a loan to Impact in the form of a senior subordinated note with an outstanding balance of $5.0 million. The Fund’s common stock has a preferred status if there is a liquidation of the company. The loan bears annual interest at 17.0% and matures on July 30, 2009. The loan was issued at a cost basis of $5.0 million. The loan’s cost basis was then discounted to reflect loan origination fees received.

 

On July 29, 2005, the Fund made a $325,000 follow-on investment in Impact in the form of a secured promissory note which bears annual interest at LIBOR plus 4%. The promissory note has a three year term. The note has a $325,000 principal face amount and was issued at a cost basis of $325,000. The note’s cost basis was then discounted to reflect loan origination fees received.

 

At October 31, 2005, the Fund’s investment in Impact consisted of 252 shares of common stock at a cost of $2.7 million, the loan to Impact with an outstanding balance of $5.23 million and the secured promissory note with an outstanding balance of $325,000. The cost basis of the loan and promissory note at October 31, 2005 was approximately $5.13 million and $319,000, respectively. At October 31, 2005, the equity investment, loan and secured promissory note were assigned fair values of $2.7 million, $5.23 million and $325,000 respectively.

 

At October 31, 2006, the Fund’s investment in Impact consisted of 252 shares of common stock at a cost of $2.7 million, the loan to Impact with an outstanding balance of $5.5 million and the secured promissory note with a balance of $325,000. The cost basis of the loan and promissory note at October 31, 2006 were approximately $5.39 million and $321,000 respectively. At October 31, 2006, the equity investment, loan and secured promissory note were assigned fair values of $2.7 million, $5.5 million and $325,000, respectively. The increase in the

outstanding balance, cost and fair value of the loan is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

Puneet Sanan and Shivani Khurana, representatives of the Fund, serve as directors of Impact.

 

Innovative Brands, LLC

 

Innovative Brands, LLC (“Innovative Brands”), Phoenix, Arizona, is a consumer product company that manufactures and distributes personal care products.

 

The Fund purchased a $15 million loan assignment in Innovative Brands. The $15 million term loan bears annual interest at 11.125% and matures on September 25, 2011.

 

At October 31, 2006, the loan had an outstanding balance, cost basis, and was assigned a fair value of $15.0 million.

 

Integral Development Corporation

 

Integral Development Corporation (“Integral”), Mountain View, California, a legacy investment, is a developer of technology for financial institutions to expand, integrate and automate their capital markets businesses and operations.

 

At October 31, 2005, the Fund’s investment in Integral consisted of an outstanding balance on the loan of $1.12 million with a cost of $1.12 million. The investment had been assigned a fair value of $1.12 million.

 

During the year ended October 31, 2006, Integral prepaid its outstanding loan balance in full including all accrued interest. The Fund recorded no gain or loss as a result of the prepayment. Under the terms of the prepayment, the Fund returned its warrants to Integral for no consideration.

 

As of October 31, 2006, the Fund no longer held any investment in Integral.

 

JDC Lighting, LLC

 

JDC Lighting, LLC (“JDC”), New York, New York, is a distributor of commercial lighting and electrical products.

 

The Fund’s investment in JDC consists of a $3.0 million senior subordinated loan, bearing annual interest at 17% over a four year term. The loan has a $3.0 million principal face amount and was issued at a cost basis of $3.0 million. The loan’s cost basis was discounted to reflect loan origination fees received.

 

At October 31, 2005, the loan had an outstanding balance of $3.09 million with a cost of $3.03 million. The loan was assigned a fair value of $3.09 million.

 

On October 30, 2006, JDC repaid $160,116 of principal.

 

At October 31, 2006, the loan had an outstanding balance of $3.04 million with a cost of $2.99 million. The loan was assigned a fair value of $3.04 million. The increase in the outstanding balance, cost and fair value of the loan, is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

Lumeta Corporation

 

Lumeta Corporation (“Lumeta”), Somerset, New Jersey, a legacy investment, is a developer of network management, security, and auditing solutions. The company provides businesses with an analysis of their network security that is designed to reveal the vulnerabilities and inefficiencies of their corporate intranets.

 

At October 31, 2005 and January 31, 2006, the Fund’s investment in Lumeta consisted of 384,615 shares of Series A preferred stock and 266,846 shares of Series B preferred stock with a combined cost of approximately $406,000.

At October 31, 2005 the investments were assigned a fair value of $200,000, or approximately $0.11 per share of Series A preferred stock and approximately $0.59 per share of Series B preferred stock.

 

On April 7, 2006, the Fund sold its investment in Lumeta for its carrying value of $200,000. The Fund realized a loss on Lumeta of approximately $200,000. However, the Valuation Committee previously decreased the fair value of the Fund’s investment in this company to $200,000 and as a result, the realized loss was offset by a reduction in unrealized losses. Therefore, the net effect of the Fund’s sale of its investment in Lumeta on the Fund’s consolidated statement of operations and NAV was zero.

 

As of October 31, 2006, the Fund no longer held any investment in Lumeta.

 

Mainstream Data, Inc.

 

Mainstream Data, Inc. (“Mainstream”), Salt Lake City, Utah, a legacy investment, builds and operates satellite, internet, and wireless broadcast networks for information companies. Mainstream networks deliver text news, streaming stock quotations, and digital images to subscribers around the world.

 

At October 31, 2005 and October 31, 2006, the Fund’s investment in Mainstream consisted of 5,786 shares of common stock with a cost of $3.75 million. The investment has been assigned a fair value of $0.

 

Marine Exhibition Corporation

 

Marine Exhibition Corporation (“Marine”), Miami, Florida, owns and operates the Miami Seaquarium. The Seaquarium is a family-oriented entertainment park.

 

On July 11, 2006, the Fund extended to Marine a $10 million senior secured loan bearing annual interest at 11%. The senior secured loan has a $10.0 million principal face amount and was issued at a cost basis of $10.0 million. The loan’s cost basis was subsequently discounted to reflect loan origination fees received. The maturity date of the loan is June 30, 2013. The Fund also extended a secured revolving note bearing interest at LIBOR plus 1%. The amount available to draw down at any time on the note is $2.0 million. The Fund also invested $2.0 million into Marine in the form of preferred stock, purchasing 2,000 shares. The dividend rate on the preferred stock is 12% per annum.

 

At October 31, 2006, the Fund’s senior secured loan had an outstanding balance of $10.1 million with a cost of $9.9 million. The senior secured loan was assigned a fair value of $10.1 million. The secured revolving note was not drawn upon. The preferred stock had been assigned a fair value of $2.0 million. The increase in the outstanding balance, cost and fair value of the loan and preferred stock, is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest/dividends. These increases were approved by the Fund’s Valuation Committee.

 

Octagon Credit Investors, LLC

 

Octagon Credit Investors, LLC (“Octagon”), is a New York-based asset management company that manages leveraged loans and high yield bonds through collateralized debt obligations (“CDO”) funds.

 

The Fund’s initial investment in Octagon consisted of a $5,000,000 senior subordinated loan, bearing annual interest at 15% over a seven year term. The loan has a $5,000,000 principal face amount and was issued at a discounted cost basis of $4,450,000. The loan included detachable warrants with a cost basis of $550,000. The Fund also provided a $5,000,000 senior secured credit facility to Octagon. This credit facility expires on May 7, 2009 and bears annual interest at LIBOR plus 4%. The Fund receives a 0.50% unused facility fee on an annual basis and a 0.25% servicing fee on an annual basis for maintaining the credit facility. The Fund also made a $560,000 equity investment in Octagon which provides the Fund a membership interest in Octagon.

 

At October 31, 2005, the loan had an outstanding balance of $5.15 million with a cost of $4.56 million. The loan was carried at a fair value of $4.66 million.

At October 31, 2005, the equity investment and detachable warrants had a cost basis of $724,857 and $550,000 respectively. The equity investment and detachable warrants were assigned a fair value of $1,228,083 and $1,069,457, respectively.

 

On January 3, 2006, the Fund exercised its warrant ownership in Octagon for no additional cost which increased its existing membership interest in Octagon. As a result, Octagon is now considered an affiliate under the definition of the 1940 Act.

 

Effective January 31, 2006, the Valuation Committee determined to increase the fair value of the Fund’s equity investment in Octagon by $562,291.

 

The cost basis and fair value of the equity investment was also increased by approximately $200,000 to account for the Fund’s allocated portion of the flow-through income, from its membership interest in Octagon, which was not distributed to members. This flow-through income is recorded by the Fund as “other income.”

 

On October 2, 2006, Octagon repaid the loan and credit facility in full. The amount of the proceeds received from the prepayment was approximately $5.4 million. This amount included all outstanding principal, accrued interest, and unused fee on the credit facility. The Fund recorded a gain as a result of these prepayments of approximately $429,000 from the acceleration of amortization of original issue discount. After this repayment, the Fund extended a $5 million term loan, cost discounted for loan fees, and a $12 million revolving line of credit to Octagon. Octagon immediately drew down $3.75 million from the revolving line of credit. The Fund received two distributions from Octagon on October 2, 2006, a return of capital of $191,258 and a one time incentive fee of $100,411. Also on October 2, 2006, Octagon repurchased a portion of the LLC membership interest for approximately $1.02 million. The Fund realized a capital gain of approximately $550,000 from this sale.

 

On October 30, 2006, Octagon repaid $500,000 of the outstanding balance on the revolving line of credit.

 

At October 31, 2006, the term loan had an outstanding balance of $5 million with a cost of $4.9 million. The loan was assigned a fair value of $5.0 million. The revolving line of credit had an outstanding balance of $3.25 million with a cost and fair value of $3.25 million.

 

At October 31, 2006, the equity investment had a cost basis of approximately $900,000 and was assigned a fair value of $1.93 million.

 

Ohio Medical Corporation

 

Ohio Medical Corporation (“Ohio”), Gurnee, Illinois, is a manufacturer and supplier of suction and oxygen therapy products, as well as medical gas equipment.

 

During fiscal year 2005, the Fund invested $17 million and sponsored the acquisition of General Electric’s Ohmeda Brand Suction and Oxygen Therapy business unit (“GE-SOT”), a leading global supplier of suction and oxygen therapy products. On July 14, 2005, in conjunction with this transaction, the Fund acquired GE-SOT’s largest supplier, Squire Cogswell/Aeros Instruments, Inc. and merged both businesses creating Ohio Medical Corporation.

 

The Fund’s investment in Ohio consists of 5,620 shares of common stock with a cost basis of $17 million.

 

As of October 31, 2005, the Fund’s investment was assigned a fair value of $17 million.

 

During the year ended October 31, 2006, the Valuation Committee increased the fair value of the Fund’s equity investment in Ohio by $9.2 million from $17.0 million to approximately $26.2 million.

 

As of October 31, 2006, the cost basis and fair value of the Fund’s investment in Ohio was $17.0 million and $26.2 million, respectively.

 

Michael Tokarz, Chairman of the Fund, Peter Seidenberg, Chief Financial Officer of the Fund and David Hadani, a representative of the Fund, serve as directors of Ohio.

Phoenix Coal Corporation

 

Phoenix Coal Corporation (“Phoenix”), Madisonville, KY, is engaged in the acquisition, development, production and sale of bituminous coal reserves and resources located primarily in the Illinois Basin. With offices in Madisonville, Kentucky and Champaign, Illinois, the company is focused on consolidating small and medium-sized coal mining projects and applying proprietary technology to increase efficiency and enhance profit margins.

 

On April 4, 2006, the Fund purchased 1 million shares of common stock of Phoenix for a purchase price of $500,000. On June 8, 2006, the Fund purchased an additional 666,667 shares of common stock of Phoenix for a purchase price of approximately $500,000.

 

Also, on June 8, 2006, the Fund committed to Phoenix $7.0 million in debt. The first $3.5 million second lien loan bears annual interest at 15%. The loan was discounted for the loan origination fees received.

 

On July 26, 2006 the Fund extended to Phoenix the remaining portion of the $7.0 million commitment. This $3.5 million second lien loan also bears annual interest at 15%. The maturity date for both loans is June 8, 2011.

 

At October 31, 2006, the second lien loan had an outstanding balance of $7.1 million with a cost of $7.0 million. The loan was assigned a fair value of $7.1 million. The increase in cost and fair value of the loan is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

At October 31, 2006, the equity investment had a cost basis of approximately $1.0 million and was assigned a fair value of $1.0 million.

 

Bruce Shewmaker, an officer of the Fund, serves as a director of Phoenix.

 

PreVisor, Inc.

 

PreVisor, Inc. (“PreVisor”), Roswell, Georgia, provides pre-employment testing and assessment solutions and related professional consulting services.

 

On May 31, 2006, the Fund invested $6 million in PreVisor in the form of common stock. Mr. Tokarz, our Chairman and Portfolio Manager, is a minority non-controlling shareholder of PreVisor. Our board of directors, including all of our directors who are not “interested persons” of the Fund, as defined by the 1940 Act (the “Independent Directors”), approved the transaction (Mr. Tokarz recused himself from making a determination or recommendation on this matter).

 

As of October 31, 2006, the common stock had been assigned a fair value of $6.0 million.

 

ProcessClaims, Inc.

 

ProcessClaims, Inc. (“ProcessClaims”), a legacy investment, Manhattan Beach, California, provides web-based solutions and value added services that streamline the automobile insurance claims process for the insurance industry and its partners.

 

At October 31, 2005, the Fund’s investments in ProcessClaims consisted of 6,250,000 shares of Series C preferred stock, 849,257 shares of Series D preferred stock, and 873,362 warrants to purchase 873,362 shares of Series E convertible preferred stock with a combined cost of $2.4 million. The investment in the Series C preferred stock was assigned a fair value of $2.0 million, the investment in the Series D preferred stock was assigned a fair value of $400,000, and the investment in the Series E warrants was assigned a fair value of $0.

 

Effective December 31, 2005, in a cashless transaction, the Fund received 373,362 shares of Series E preferred stock of ProcessClaims in exchange for its rights under a warrant issued by ProcessClaims that has been held by the Fund since May 2002.

 

On January 5, 2006, the Fund’s Valuation Committee determined to increase the fair value of the Fund’s entire investment in ProcessClaims by $3.3 million.

During March 2006, the Fund was granted and accepted 50,000 options to purchase shares of ProcessClaims common stock. Bruce Shewmaker, an officer of the Fund, serves as a director of ProcessClaims. The options were granted for Bruce Shewmaker’s service on ProcessClaims board of directors. The options vested immediately, have an exercise price of $0.32 per share and have an expiration date of ten years from the date of grant.

 

Effective April 30, 2006, the Fund’s Valuation Committee determined to increase the fair value of the Fund’s investment in ProcessClaims by approximately $760,000.

 

At April 30, 2006, the Fund’s investments in ProcessClaims consisted of 6,250,000 shares of Series C preferred stock, 849,257 shares of Series D preferred stock, 373,362 shares of Series E convertible preferred stock and 50,000 common stock options with a combined cost of $2.4 million. The investment in the Series C preferred stock was assigned a fair value of $5.2 million, the investment in the Series D preferred stock was assigned a fair value of $831,000, the investment in the Series E warrants was assigned a fair value of $446,000 and the options were fair valued at $9,000.

 

On May 30, 2006, ProcessClaims, one of the Fund’s legacy portfolio companies, entered into a definitive agreement to be acquired by CCC Information Services Inc. (“CCC”). The acquisition by CCC closed on June 9, 2006. As of June 9, 2006, the Fund received net proceeds of approximately $7.9 million. The gross proceeds were approximately $8.3 million of which approximately $400,000 or 5% of the gross proceeds were deposited into a reserve account for one year. Due to the contingencies associated with the escrow, the Fund has not presently placed any value on the proceeds deposited in escrow and has therefore not factored such proceeds into the Fund’s increased NAV. The Fund’s total investment in ProcessClaims was $2.4 million which resulted in a capital gain of approximately $5.5 million.

 

As of October 31, 2006, the Fund no longer held any investment in ProcessClaims.

 

SafeStone Technologies PLC

 

SafeStone Technologies PLC (“SafeStone”), Old Amersham, UK, a legacy investment, provides organizations with technology designed to secure access controls across the extended enterprise, enforcing compliance with security policies and enabling effective management of the corporate IT and e-business infrastructure.

 

At October 31, 2005 and October 31, 2006, the Fund’s investments in SafeStone consisted of 2,106,378 shares of Series A ordinary stock with a cost of $4.0 million. The investment has been assigned a fair value of $0 by the Fund’s Valuation Committee.

 

SGDA Sanierungsgesellschaft fur Deponien und Altasten mbH

 

SGDA Sanierungsgesellschaft fur Deponien und Altasten mbH (“SGDA”), Zella-Mehlis, Germany, is a company that is in the business of landfill remediation and revitalization of contaminated soil.

 

The Fund’s investment in SGDA consists of a $4.6 million term loan, bearing annual interest at 7% over a four and a half year term. The term loan has a $4.6 million principal face amount and was issued at a discounted cost basis of $4.3 million. The loan included a common equity ownership interest in SGDA with a cost basis of $315,000. The Fund also made available to SGDA a $1.3 million revolving credit facility that bears annual interest at 7%. The credit facility expires on August 25, 2006.

 

At October 31, 2005, the term loan had an outstanding balance of $4.58 million with a cost of $4.3 million. The term loan was carried at a fair value of $4.3 million. The increase in the cost and fair value of the loan is due to the accretion of the market discount of the term loan. The ownership interest in SGDA has been assigned a fair value of $315,000 which is its cost basis. As of October 31, 2005, SGDA had drawn $1,237,700 upon the revolving credit facility.

 

During December 2005, SGDA drew an additional $70,600 on the revolving line of credit. This brought the amount drawn under the line of credit to $1.3 million, the maximum available under the line of credit.

 

Also during December 2005, the Fund did not accrue, and therefore was not paid, approximately $23,000 in implied interest owed from the SGDA loan and revolving credit facility. This was due to a contractual agreement

(based on German tax provisions) to cap the interest paid by SGDA to Fund, in the aggregate, at 240,000 Euro in any given calendar year. Despite forgoing this interest management believes there is no credit risk associated with this portfolio company.

 

On January 12, 2006, the Fund extended to SGDA a $300,000 bridge loan. The loan bore annual interest at 7% and had a maturity date of April 30, 2006.

 

On April 6, 2006, the Fund invested an additional $2.0 million into SGDA in the form of a preferred equity interest. On April 25, 2006 the Fund purchased an additional common equity interest in SGDA for $23,551.

 

On April 28, 2006, the Fund increased the availability under the revolving credit facility by $300,000. The balance of the bridge loan mentioned above, which would have matured on April 30, 2006, was added to the revolving credit facility and the bridge loan was removed from the Fund’s books as a part of the refinancing. As of July 31, 2006, the entire $1.6 million facility was drawn in full.

 

On August 25, 2006 the revolving credit facility was added to the term loan balance assuming the same terms as the term loan.

 

On October 24, 2006, the Fund invested an additional $3 million into SGDA in the form of preferred equity interest.

 

At October 31, 2006, the term loan had an outstanding balance of $6.2 million with a cost of $6 million. The term loan was assigned a fair value of $6 million. The increase in the cost and fair value of the loan is due to the accretion of the market discount of the term loan. These increases were approved by the Fund’s Valuation Committee. The ownership interest in SGDA has been assigned a fair value of $338,551 which is its cost basis. The preferred stock has been assigned a fair value of $5.0 million.

 

Sonexis, Inc.

 

Sonexis, Inc. (“Sonexis”), Tewksbury, Massachusetts, a legacy investment, is the developer of a new kind of conferencing solution — Sonexis ConferenceManager — a modular platform that is designed to support a breadth of audio and web conferencing functionality to deliver rich media conferencing.

 

At October 31, 2005 and October 31, 2006, the Fund’s investment in Sonexis consisted of 131,615 shares of common stock with a cost of $10.0 million. The investment has been assigned a fair value of $0.

 

SIA BM Auto

 

SIA BM Auto (“BM Auto”), Riga, Latvia, is a company focused on the importation and sale of BMW vehicles and parts throughout Latvia, a member of the European Union.

 

The Fund’s investment in BM Auto consisted of 47,300 shares of common stock at a cost of $8 million and a sixty day bridge loan with a cost basis of $7.0 million. The loan was repaid in full, including all principal and accrued interest, on April 21, 2006.

 

At October 31, 2006, the Fund’s investment in BM Auto was assigned a fair value of $8 million.

 

SP Industries, Inc.

 

SP Industries, Inc. (“SP”), Warminster, Pennsylvania, is a designer, manufacturer, and marketer of laboratory research and process equipment, glassware and precision glass components, and configured-to-order manufacturing equipment.

 

The Fund’s investment in SP consists of a $6.5 million mezzanine loan and a $4.0 million term loan. The mezzanine loan bears annual interest at 17% over a seven year term. The mezzanine loan has a $6.5 million principal face amount and was issued at a cost basis of $6.5 million. The mezzanine loan’s cost basis was discounted to reflect loan origination fees received. The term loan bears annual interest at LIBOR plus 10% over a five year term. The term loan has a $4.0 million principal face amount and was issued at a cost basis of $4.0 million. The term loan’s cost basis was discounted to reflect loan origination fees received by the Fund.

At October 31, 2005, the mezzanine loan and the term loan had outstanding balances of $6.65 million and $4.02 million respectively with cost basis of $6.4 million and $3.95 million, respectively. The mezzanine loan and term loan were assigned fair values of $6.65 million and $4.02 million, respectively.

 

On October 13, 2006 the Fund extended to SP $10 million in the form of an additional $4.0 million of term loan and an additional $6.0 million mezzanine loan. The interest rate and maturity date of the term loan was adjusted to LIBOR plus 8% and March 31, 2011. The interest rate of the mezzanine loan was adjusted to 16% with the maturity date remaining March 31, 2012.

 

On October 20, 2006 the Fund assigned $5.0 million of term loan to Citigroup Global Markets Realty.

 

At October 31, 2006, the mezzanine loan and the term loan had outstanding balances of $12.96 million and $3.06 million, respectively, with a cost basis of $12.65 million and $3.01 million, respectively. The mezzanine loan and term loan were assigned fair values of $12.96 million and $3.06 million, respectively. The increase in the outstanding balance, cost and fair value of the loan, is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

Strategic Outsourcing, Inc.

 

Strategic Outsourcing, Inc. (“SOI”), Charlotte, North Carolina, is a professional employer organization that provides services that enable small businesses to outsource their human resource function.

 

The Fund purchased a $5 million loan assignment in SOI. The loan has a 5 year term and bears annual interest at LIBOR plus 5.25%

 

On December 31, 2005, SOI repaid a portion of its outstanding loan. The Fund’s prorated share of the repayment was approximately $108,000.

 

On March 31, 2006, SOI repaid a portion of its outstanding loan. The Fund’s prorated share of the repayment was approximately $108,000.

 

On May 3, 2006, SOI repaid a portion of its outstanding loan. The Fund’s prorated share of the repayment was approximately $440,000.

 

On July 27, 2006, SOI repaid the loan assignment in full. The amount of the proceeds received from the prepayment was approximately $4.5 million. This amount included all outstanding principal, accrued interest, and an early prepayment fee.

 

As of October 31, 2006, the Fund no longer held any investment in SOI.

 

Storage Canada, LLC

 

Storage Canada, LLC (“Storage Canada”), Omaha, NE, is a real estate company that owns and develops self-storage facilities throughout the U.S. and Canada.

 

On March 30, 2006, the Fund provided a $6 million loan commitment to Storage Canada on which Storage Canada immediately borrowed $1.34 million. The commitment expires after one year, but may be renewed with the consent of both parties. The initial borrowing on the loan bears annual interest at 8.75% and has a maturity date of March 30, 2013. Any additional borrowings will mature seven years from the date of the subsequent borrowing. The Fund receives monthly principal payments. The Fund also receives a fee of 0.25% on the unused portion of the loan.

 

On October 6, 2006, Storage Canada borrowed $619,000. The borrowing bears annual interest at 8.75% and has a maturity date of October 6, 2013.

 

At October 31, 2006, the Fund’s investment in Storage Canada had an outstanding balance of $1.94 million and a cost basis of $1.95 million and was assigned a fair value of $1.94 million.

Summit Research Labs, Inc.

 

Summit Research Labs, Inc. (“Summit”), Huguenot, NY, is a specialty chemical company that manufactures antiperspirant actives.

 

On August 16, 2006, the Fund extended to Summit a $5 million second lien loan bearing annual interest at 14%. The second lien loan has a $5.0 million principal face amount and was issued at a cost basis of $5.0 million. The loan’s cost basis was subsequently discounted to reflect loan origination fees received. The maturity date of the loan is August 15, 2012. The Fund also invested $11.2 million into Summit in the form of preferred stock, purchasing 800 shares.

 

At October 31, 2006, the Fund’s second lien loan had an outstanding balance of $5.04 million with a cost of $4.95 million. The second lien loan was assigned a fair value of $5.04 million. The preferred stock had been assigned a fair value of $11.2 million. The increase in cost and fair value of the loan is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee.

 

Michael Tokarz, Chairman of the Fund, and Puneet Sanan and Shivani Khurana, representatives of the Fund, serve as directors of Summit.

 

Timberland Machines & Irrigation, Inc.

 

Timberland Machines & Irrigation, Inc. (“Timberland”), Enfield, Connecticut, is a distributor of landscaping outdoor power equipment and irrigation products.

 

The Fund’s investment in Timberland consists of a $6 million senior subordinated loan, bearing annual interest at 17% over a five year term. The note has a $6 million principal face amount and was issued at a cost basis of $6 million. The loan’s cost basis was then discounted to reflect loan origination fees received. The Fund also owns 450 shares of common stock for a $4.5 million equity investment in Timberland. The Fund has an option to purchase an additional 150 shares of common stock at a price of $10,000 per share. The Fund has also extended to Timberland a $3.25 million junior revolving note. The junior revolving note bears interest at 12.5% per annum and matures on July 7, 2007.

 

Timberland has a floor plan financing program administered by Transamerica Commercial Finance Corporation (“Transamerica”). As is typical in Timberland’s industry, under the terms of the dealer financing arrangement, Timberland guarantees the repurchase of product from Transamerica, if a dealer defaults on payment and the underlying assets are repossessed. The Fund has agreed to be a co-guarantor of this repurchase commitment, but its maximum potential exposure as a result of the guarantee is contractually limited to $0.5 million.

 

At October 31, 2005, the Fund’s mezzanine loan had an outstanding balance of $6.32 million with a cost of $6.23 million. The mezzanine loan was assigned a fair value of $6.32 million. The junior revolving note was fully drawn upon and assigned a fair value of $3.25 million. The common stock had been assigned a fair value of $4,500,000. The warrant was assigned a fair value of $0.

 

Effective December 27, 2005, the Fund converted $286,200 of the Timberland junior revolving line of credit into 28.62 shares of common stock at a price of $10,000 per share. As a result, as of July 31, 2006 the Fund owned 478.62 common shares and the funded debt under the junior revolving line of credit was reduced from $3.25 million to approximately $2.96 million.

 

During the quarter ended, April 30, 2006, Timberland had repaid an additional $500,000 on the note leaving the total amount outstanding at approximately $2.46 million.

 

On July 1, 2006, the Fund reduced the interest rate on the mezzanine loan from 17% to 14.426%.

 

During the quarter ended, July 31, 2006, Timberland repaid an additional $500,000 and drew down $1.0 million on the note leaving the total amount outstanding at approximately $2.96 million.

 

Effective September 12, 2006, the Fund converted $409,091 of the Timberland junior revolving line of credit into 40.91 shares of common stock at a price of $10,000 per share. Effective September 22, 2006, the Fund

converted $225,000 of the Timberland junior revolving line of credit into 22.50 shares of common stock at a price of $10,000 per share. Timberland then borrowed $500,000 from the junior revolving line of credit. As a result of these transactions, as of October 31, 2006 the Fund owned 542.03 common shares and the funded debt under the junior revolving line of credit was reduced from $3.25 million to approximately $2.83 million.

 

During the year ended October 31, 2006, the Valuation Committee decreased the fair value of the Fund’s equity investment in Timberland by $1 million from $5.42 million to approximately $4.42 million.

 

At October 31, 2006, the Fund’s mezzanine loan had an outstanding balance of $6.61 million with a cost of $6.55 million. The mezzanine loan was assigned a fair value of $6.61 million. The increase in the outstanding balance, cost and fair value of the loan is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee. The junior revolving note was assigned a fair value of $2.83 million. The common stock was assigned a fair value of $4.42 million. The warrant was assigned a fair value of $0.

 

Michael Tokarz, Chairman of the Fund, and Puneet Sanan, a representative of the Fund, serve as directors of Timberland.

 

Total Safety U.S., Inc.

 

Total Safety U.S., Inc. (“Total Safety”), Houston, Texas, is the leading provider of safety equipment and related services to the refining, petrochemical, and oil exploration and production industries.

 

The Fund purchased $6 million of loan assignments in Total Safety. The $5 million term loan A bears annual interest at LIBOR plus 4.5% and matures on December 31, 2010. The $1 million term loan B bears annual interest at LIBOR plus 8.5% and also matures on December 31, 2010.

 

On June 30, 2006, the Fund received a quarterly principal payment for each loan totaling $55,046.

 

On September 29, 2006, the Fund received a quarterly principal payment for each loan totaling $55,046.

 

At October 31, 2006, the loans had a combined outstanding balance and cost basis of $5.9 million. The loan assignments were assigned a fair value of $5.9 million.

 

Turf Products, LLC

 

Turf Products, LLC (“Turf”), Enfield, Connecticut, is a wholesale distributor of golf course and commercial turf maintenance equipment, golf course irrigation systems and consumer outdoor power equipment.

 

The Fund’s investment in Turf consists of senior subordinated loan, bearing interest at 15% per annum over a five year term. The note has a $7.5 million principal face amount and was issued at a cost basis of $7.5 million. The loan’s cost basis was then discounted to reflect loan origination fees received. The Fund also owns a membership interest from a $3.8 million equity investment in Turf. The Fund also has a warrant to purchase an additional 15% of the company.

 

During the year ended October 31, 2006, the Valuation Committee increased the fair value of the Fund’s equity investment in Turf by $2 million from $3.8 million to approximately $5.8 million.

 

At October 31, 2006, the Fund’s mezzanine loan had an outstanding balance of $7.68 million with a cost of $7.63 million. The loan was assigned a fair value of $7.68 million. The increase in the outstanding balance, cost and fair value of the loan is due to the amortization of loan origination fees and the capitalization of “payment in kind” interest. These increases were approved by the Fund’s Valuation Committee. The membership interest has been assigned a fair value of $5.8 million. The option was assigned a fair value of $0.

 

Michael Tokarz, Chairman of the Fund, and Puneet Sanan and Shivani Khurana, representatives of the Fund, serve as directors of Turf.

Velocitius B.V.

 

Velocitius B.V. (“Velocitius”), a Netherlands based company, manages Germany based wind farms through operating subsidiaries.

 

On May 10, 2006, the Fund made an equity investment of approximately $66,290 in Velocitius.

 

On October 26, 2006, the Fund made an additional equity investment of approximately $2.9 million.

 

On October 30, 2006, the Fund provided a $260,000 revolving line of credit to Velocitius on which Velocitius immediately borrowed approximately $143,614. The revolving line of credit expires on October 31, 2009. The note bears annual interest at 8%.

 

At October 31, 2006, the equity investment in Velocitius had a cost and was assigned a fair value of $2.97 million. The revolving line of credit had a cost and was assigned a fair value of $143,614.

 

Bruce Shewmaker, an officer of the Fund, serves as a director of Velocitius.

 

Vendio Services, Inc.

 

Vendio Services, Inc. (“Vendio”), San Bruno, California, a legacy investment, offers small businesses and entrepreneurs resources to build Internet sales channels by providing software solutions designed to help these merchants efficiently market, sell and distribute their products.

 

At October 31, 2005, the Fund’s investments in Vendio consisted of 10,476 shares of common stock and 6,443,188 shares of Series A preferred stock at a total cost of $6.6 million. The investments were assigned a fair value of $2.7 million, $0 for the common stock and $2.7 million for the Series A preferred stock.

 

During the year ended October 31, 2006, the Valuation Committee increased the fair value of the Fund’s equity investment in Vendio by $700,000 from $2.7 million to $3.4 million.

 

At October 31, 2006, the Fund’s investments in Vendio consisted of 10,476 shares of common stock and 6,443,188 shares of Series A preferred stock at a total cost of $6.6 million. The investments were assigned a fair value of $3.4 million, $0 for the common stock and $3.4 million for the Series A preferred stock.

 

Bruce Shewmaker, an officer of the Fund, serves as a director of Vendio.

 

Vestal Manufacturing Enterprises, Inc.

 

Vestal Manufacturing Enterprises, Inc. (“Vestal”), Sweetwater, Tennessee, is a market leader for steel fabricated products to brick and masonry segments of the construction industry. Vestal manufactures and sells both cast iron and fabricated steel specialty products used in the construction of single-family homes.

 

The Fund’s investment in Vestal consists of 81,000 shares of common stock at a cost of $1.85 million and a loan of $900,000 to Vestal in the form of a senior subordinated promissory note. The loan has a maturity date of April 29, 2011 and earns interest at 12% per annum.

 

At October 31, 2005, the senior subordinated promissory note had an outstanding balance, cost, and fair value of $900,000. The 81,000 shares of common stock of Vestal that had a cost basis of $1.85 million were assigned a fair value of $3.7 million.

 

On September 1, 2006, the Fund received a principal payment of approximately $100,000.

 

At October 31, 2006, the senior subordinated promissory note had an outstanding balance, cost, and fair value of $800,000. The 81,000 shares of common stock of Vestal that had a cost basis of $1.85 million were assigned a fair value of $3.7 million.

 

David Hadani and Ben Harris, representatives of the Fund, serve as directors of Vestal.

Vitality Foodservice, Inc.

 

Vitality Foodservice, Inc. (“Vitality”), Tampa, Florida, is a market leader in the processing and marketing of dispensed and non-dispensed juices and frozen concentrate liquid coffee to the foodservice industry. With an installed base of over 42,000 dispensers worldwide, Vitality sells its frozen concentrate through a network of over 350 distributors to such market niches as institutional foodservice, including schools, hospitals, cruise ships, hotels and restaurants.

 

The Fund’s investment in Vitality consists of 500,000 shares of common stock at a cost of $5 million and 1,000,000 shares of Series A convertible preferred stock at a cost of $10 million. The convertible preferred stock has a liquidation date of September 24, 2011 and has a yield of 13% per annum. The convertible preferred stock also has detachable warrants granting the Fund the right to purchase 211,243 shares of common stock at the price of $0.01 per share.

 

At October 31, 2005, the investment in Vitality consisted of 500,000 shares of common stock at a cost of $5 million and 1,000,000 shares of Series A convertible preferred stock at a cost of $10.52 million. The common stock, Series A convertible preferred stock and warrants were assigned fair values of $5 million, $10.52 million and $700,000, respectively.

 

Effective January 31, 2006, the Valuation Committee determined to increase the fair value of the common stock and warrants in Vitality by $3.5 million and $400,000, respectively.

 

During the year ended October 31, 2006, the Fund reclassified dividend income received from Vitality totaling approximately $900,000 to return of capital. The reclassification occurred due to Vitality’s determination that it will not have taxable earnings and profits for their fiscal year 2006. This reclassification to return of capital had no impact on the Fund’s net asset value.

 

At October 31, 2006, the investment in Vitality consisted of 500,000 shares of common stock at a cost of $5 million and 1,000,000 shares of Series A convertible preferred stock at a cost of $9.66 million. The increase in the cost and fair value of the Series A convertible preferred stock is due to the capitalization of “payment in kind” dividends. These increases were approved by the Fund’s Valuation Committee. The common stock, Series A convertible preferred stock and warrants were assigned fair values of $8.5 million, $11.05 million and $1.1 million, respectively.

 

David Hadani, a representative of the Fund, serves as a director of Vitality.

 

Yaga, Inc.

 

Yaga, Inc. (“Yaga”), San Francisco, California, a legacy investment, provided a hosted application service provider (ASP) platform that is designed to address emerging revenue and payment infrastructure needs of online businesses. Yaga’s payment and accounting application supports micropayments, aggregated billing and stored value accounts while also managing royalty/affiliate accounting and split payments.

 

At October 31, 2005, the Fund’s investment in Yaga consisted of 300,000 shares of Series A preferred stock and 1,000,000 shares of Series B with a combined cost of $2.3 million. The investments had been assigned a fair value of $0.

 

During the quarter ended January 31, 2006, the Fund received notification of the final dissolution of Yaga. The Fund received no proceeds from the dissolution of this company and the investment has been removed from the Fund’s books. The fair value of Yaga was previously written down to zero and therefore, the net effect of the removal of Yaga from the Fund’s books on the Fund’s consolidated statement of operations and NAV was zero.

 

At October 31, 2006, the Fund no longer held any investment in Yaga.

 

Liquidity and Capital Resources

 

At October 31, 2006, the Fund had investments in portfolio companies totaling $275.9 million. Also, at October 31, 2006, the Fund had investments in cash equivalents totaling approximately $66.2 million. The Fund

considers all money market and other cash investments purchased with an original maturity of less than three months to be cash equivalents. U.S. government securities and cash equivalents are highly liquid.

 

During the year ended October 31, 2006, the Fund made sixteen new investments, committing capital totaling approximately $142.1 million. The investments were made in Turf, SOI, Henry, BM Auto, Storage Canada, Phoenix, Harmony Pharmacy, Inc., Total Safety, PreVisor, Marine, BP, Velocitius, Summit, Octagon, BENI, and Innovative Brands. The amounts invested were $11.6 million, $5.0 million, $5.0 million, $15.0 million, $6.0 million, $8.0 million, $200,000, $6.0 million, $6.0 million, $14.0 million, $15.0 million, $66,290, $16.2 million, $17.0 million, $2.0 million and $15.0 million, respectively.

 

The Fund also made eight follow-on investments in existing portfolio companies committing capital totaling approximately $24.2 million. During the year ended October 31, 2006, the Fund invested approximately $879,000 in Dakota by purchasing an additional 172,104 shares of common stock at an average price of $5.11 per share. On December 22, 2005, the Fund made a follow-on investment in Baltic in the form of a $1.8 million revolving bridge note. Baltic immediately drew down $1.5 million from the note. On January 12, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note matured on January 31, 2006 and has been removed from the Fund’s books. On January 12, 2006, the Fund provided SGDA a $300,000 bridge loan. On March 28, 2006, the Fund provided Baltic a $2.0 million revolving bridge note. Baltic immediately drew down $2.0 million from the note. On April 5, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note matured on April 30, 2006 and has been removed from the Fund’s books. On April 6, 2006, the Fund invested an additional $2.0 million in SGDA in the form of a preferred equity security. On April 25, 2006, the Fund purchased an additional common equity security in SGDA for $23,000. On June 30, 2006, the Fund invested $2.5 million in Amersham in the form of a second lien loan. On August 4, 2006, the Fund invested $750,000 in Harmony in the form of common stock. On September 28, 2006, the Fund made another follow-on investment in Baltic in the form of a $1.0 million bridge loan and $2.0 million equity investment. On October 13, 2006, the Fund made a $10 million follow-on investment in SP. The $10 million was invested in the form of an additional $4.0 million in term loan B and $6.0 million in a mezzanine loan. On October 20, 2006, the Fund then assigned $5.0 million of SP’s $8.0 million term loan B to Citigroup Global Markets Realty Corp. On October 24, 2006, the Fund invested an additional $3.0 million in SGDA in the form of a preferred equity security. On October 26, 2006, the Fund invested an additional $2.9 million in Velocitius in the form of common equity. The Fund also provided Velocitius a $260,000 revolving note on October 31, 2006. Velocitius immediately drew down $143,614 from the note.

 

Commitments to/for Portfolio Companies:

 

At October 31, 2006, the Fund’s commitments to portfolio companies consisted of the following:

 

Open Commitments of MVC Capital, Inc.

 

 

On May 7, 2004, the Fund provided a $5,000,000 senior secured credit facility to Octagon. This credit facility expires on May 6, 2007 and can be automatically extended until May 6, 2009. The credit facility bears annual interest at LIBOR plus 4%. The Fund receives a 0.50% unused facility fee on an annual basis and a 0.25% servicing fee on an annual basis for maintaining the credit facility. On February 1, 2006, Octagon drew $250,000 from the credit facility. The credit facility was repaid in full including, all accrued interest on February 23, 2006. This credit facility was refinanced on October 12, 2006.

 

During February 2005, the Fund made available to SGDA, a $1,308,300 revolving credit facility that bears annual interest at 7%. The credit facility expired on August 25, 2006. During fiscal year 2006, SGDA drew down

$70,600 from the credit facility. On April 28, 2006, the Fund increased the availability under the revolving credit facility by $300,000. The balance of the Fund’s bridge loan to SDGA, which would have matured on April 30, 2006, was added to the revolving credit facility and the bridge loan was removed from the Fund’s books.

 

On June 30, 2005, the Fund pledged its common stock of Ohio to Guggenheim to collateralize a loan made by Guggenheim to Ohio.

 

On July 8, 2005 the Fund extended Timberland a $3.25 million junior revolving note that bears interest at 12.5% per annum and expires on July 7, 2007. The Fund also receives a fee of 0.25% on the unused portion of the note. As of October 31, 2005, the total amount outstanding on the note was $3.25 million. On December 27, 2005, the Fund exchanged $286,200 of the Timberland junior revolving line of credit for 28.62 shares of common stock at a price of $10,000 per share. As of January 31, 2006, the Fund owned 478.62 common shares and the funded debt under the junior revolving line of credit has been reduced from $3.25 million to approximately $2.96 million. On April 21, 2006, Timberland repaid $500,000 on the note. On May 18, 2006, Timberland repaid an additional $500,000 on the note. On July 10, 2006, Timberland drew down $1.0 million leaving the total amount on the note outstanding at July 31, 2006 approximately $2.96 million. On September 12, 2006, the Fund converted $409,091 of the Timberland junior revolving line of credit into 40.91 shares of common stock at a price of $10,000 per share. Effective September 22, 2006, the Fund converted $225,000 of the Timberland junior revolving line of credit into 22.50 shares of common stock at a price of $10,000 per share. Timberland then borrowed $500,000 from the junior revolving line of credit. As a result of these transactions, as of October 31, 2006 the Fund owned 542.03 common shares and the funded debt under the junior revolving line of credit was reduced from $3.25 million to approximately $2.83 million.

 

On December 22, 2005, the Fund extended to Baltic a $1.8 million revolving bridge note. The note bears interest at 12% per annum and had a maturity date of January 31, 2006. Baltic immediately drew $1.5 million from the note. On January 12, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The revolver matured on January 31, 2006 and has been removed from the Fund’s books.

 

On March 28, 2006, the Fund extended to Baltic a $2.0 million revolving bridge note. Baltic immediately drew down $2.0 million from the note. On April 5, 2006, Baltic repaid the amount drawn from the note in full including all unpaid interest. The note matured on April 30, 2006 and has been removed from the Fund’s books.

 

On March 30, 2006, the Fund provided a $6 million loan commitment to Storage Canada and the company immediately borrowed $1.34 million. The commitment expires after one year, but may be renewed with the consent of both parties. The initial borrowing on the loan bears annual interest at 8.75% and has a maturity date of March 30, 2013. Any additional borrowings will mature seven years from the date of the subsequent borrowing. The Fund also receives a fee of 0.25% on the unused portion of the loan. On October 6, 2006, Storage Canada borrowed an additional $619,000. The borrowing bears annual interest at 8.75% and has a maturity date of October 6, 2013.

 

On July 11, 2006, the Fund extended to Marine a $2.0 million secured revolving note. The note bears annual interest at LIBOR plus 1%. The Fund also receives a fee of 0.50% of the unused portion of the loan. There was no amount drawn on the revolving note as of October 31, 2006.

 

On August 25, 2006, SGDA’s revolving credit facility was added to the term loan, increasing the balance of the term loan by $1.6 million. The revolving credit facility was eliminated from the Fund’s books as a result of this refinancing.

 

On October 12, 2006, the Fund provided a $12.0 million revolving credit facility to Octagon in replacement of the senior secured credit facility provided on May 7, 2004. This credit facility expires on December 31, 2011. The credit facility bears annual interest at LIBOR plus 4.25%. The Fund receives a 0.50% unused facility fee on an annual basis and a 0.25% servicing fee on an annual basis for maintaining the credit facility. On October 12, 2006, Octagon drew $3.75 million from the credit facility. Octagon repaid $500,000 of the credit facility on October 30, 2006. As of October 31, 2006, there was $3.25 million outstanding.

 

On October 30, 2006, the Fund provided a $260,000 revolving line of credit to Velocitius on which Velocitius immediately borrowed $143,614. The revolving line of credit expires on October 31, 2009. The note bears annual interest at 8%.

Timberland also has a floor plan financing program administered by Transamerica. As is typical in Timberland’s industry, under the terms of the dealer financing arrangement, Timberland guarantees the repurchase of product from Transamerica, if a dealer defaults on payment and the underlying assets are repossessed. The Fund has agreed to be a limited co-guarantor for up to $500,000 on this repurchase commitment.

 

Commitments of the Fund:

 

On October 28, 2004, the Fund entered into a one-year, cash collateralized, $20 million revolving credit facility (“Credit Facility I”) with LaSalle Bank National Association (the “Bank”). On July 20, 2005, the Fund amended Credit Facility I. The maximum aggregate loan amount under Credit Facility I was increased from $20 million to $30 million. Additionally, the maturity date was extended from October 31, 2005 to August 31, 2006. All other material terms of Credit Facility I remained unchanged. On January 27, 2006, the Fund borrowed $10 million under Credit Facility I. The $10 million borrowed under Credit Facility I was repaid in full by February 3, 2006. Borrowings under Credit Facility I bear interest, at the Fund’s option, at either a fixed rate equal to the LIBOR rate (for one, two, three or six months), plus 1.00% per annum, or at a floating rate equal to the Bank’s prime rate in effect from time to time, minus 1.00% per annum. Credit Facility I expired on August 31, 2006.

 

On February 16, 2005, the Fund entered into a sublease (the “Sublease”) for a larger space in the building in which the Fund’s current executive offices are located. Effective November 1, 2006, the Fund subleased its principal executive office to TTG Advisers. The Sublease is scheduled to expire on February 28, 2007. Future payments under the Sublease for TTG Advisers total approximately $75,000 in fiscal year 2007. The Fund’s previous lease was terminated effective March 1, 2005, without penalty. The building in which the Fund’s executive offices are located, 287 Bowman Avenue, is owned by Phoenix Capital Partners, LLC, an entity which is 97% owned by Mr. Tokarz. See Note 4 “Management” for more information on Mr. Tokarz.

 

On April 27, 2006, the Fund and MVCFS, as co-borrowers entered into a new four-year, $100 million revolving credit facility (“Credit Facility II”) with Guggenheim as administrative agent to the lenders. On April 27, 2006, the Fund borrowed $45 million ($27.5 million drawn from the revolving credit facility and $17.5 million in term debt) under Credit Facility II. The $27.5 million drawn from the revolving credit facility was repaid in full on May 2, 2006. On July 28, 2006, the Fund borrowed $57.5 million ($45.0 million drawn from the revolving credit facility and $12.5 million in term debt) under Credit Facility II. On August 2, 2006, the Fund repaid $45.0 million borrowed on the revolving credit facility. On August 31, 2006, the Fund borrowed $5.0 million in term debt under Credit Facility II. On October 27, 2006, the Fund borrowed $4.0 million from the revolving credit under Credit Facility II. On October 30, 2006, the Fund borrowed $61 million under Credit Facility II, $15 million in term debt and $46 million drawn from the revolving credit facility. As of October 31, 2006, there was $50.0 million in term debt and $50.0 million on the revolving credit facility outstanding. The proceeds from borrowings made under Credit Facility II are expected to be used to fund new and existing portfolio investments, pay fees and expenses related to the financing and for general corporate purposes. Credit Facility II will expire on April 27, 2010, at which time all outstanding amounts under Credit Facility II will be due and payable. Borrowings under Credit Facility II will bear interest, at the Fund’s option, at a floating rate equal to either (i) the LIBOR rate (for one, two, three or six months), plus a spread of 2.00% per annum, or (ii) the Prime rate in effect from time to time, plus a spread of 1.00% per annum. The Fund paid a closing fee, legal and other costs associated with this transaction. These costs will be amortized evenly over the life of the facility. The prepaid expenses on the Balance Sheet include the unamortized portion of these costs. Borrowings under Credit Facility II will be secured, by among other things, cash, cash equivalents, debt investments, accounts receivable, equipment, instruments, general intangibles, the capital stock of MVCFS, and any proceeds from all the aforementioned items, as well as all other property except for equity investments made by the Fund.

 

The Fund enters into contracts with portfolio companies and other parties that contain a variety of indemnifications. The Fund’s maximum exposure under these arrangements is unknown. However, the Fund has not experienced claims or losses pursuant to these contracts and believes the risk of loss related to indemnifications to be remote.

 

Subsequent Events

 

Effective November 1, 2006, pursuant to the Advisory Agreement, the Fund is externally managed by TTG Advisers, which serves as the Fund’s investment adviser. Under the terms of the Advisory Agreement,

TTG Advisers will determine, consistent with the Fund’s investment strategy, the composition of the Fund’s portfolio, the nature and timing of the changes to the Fund’s portfolio and the manner of implementing such changes, identify, and negotiate the structure of the Fund’s investments (including performing due diligence on prospective portfolio companies), close and monitor the Fund’s investments, determine the securities and other assets purchased, retain or sell and oversee the administration, recordkeeping and compliance functions of the Fund and/or third parties performing such functions for the Fund. TTG Advisers’ services under the Advisory Agreement are not exclusive, and it may furnish similar services to other entities. Pursuant to the Advisory Agreement, the Fund is required to pay TTG Advisers a fee for investment advisory and management services consisting of two components — a base management fee and an incentive fee. The base management fee shall be 2.0% per annum of the Fund’s total assets excluding cash. The incentive fee will consist of two parts: (i) one part will be based on our pre-incentive fee net operating income; and (ii) the other part will be based on the capital gains realized on our portfolio of securities acquired after November 1, 2003. For a detailed description of the Advisory Agreement, please refer to the Definitive Proxy Statement on Schedule 14A (as filed with the SEC on August 3, 2006).

 

On November 1, 2006, Timberland borrowed $420,291 from the secured junior revolving note.

 

On November 2, 2006, the Fund repaid $54.5 million borrowed on the revolving credit facility under Credit Facility II.

 

On November 7, 2006, the Fund made an additional $100,000 equity investment into SGDA.

 

On November 7, 2006, the Fund repaid $5.5 million borrowed on the revolving credit facility under Credit Facility II.

 

On November 21, 2006, consistent with the contemplated spin-off identified in the Advisory Agreement (and which is depicted in the Registration Statement), the Fund formed MVC Partners, a private equity firm. On December 5, 2006, MVC Partners’ subsidiary, MVC Europe LLC, arrived at an agreement to co-own BPE Management Ltd. (“BPE”) with Parex Asset Management IPAS, a management investment company and subsidiary of the Parex Bank. BPE will pursue investments in businesses throughout the Baltic region.

 

In addition, on November 21, 2006, MVC Partners established its MVC Global LLC division, which pursues investments in foreign operating companies.

 

On November 22, 2006, the Fund invested $3.2 million in Westwood Chemical Corporation, a manufacturer of antiperspirant actives and water treatment chemicals, consisting of a $1.6 million bridge loan and $1.6 million in equity.

 

On November 27, 2006, the Fund increased the amount available to draw down on the Timberland secured junior revolving note from $3.25 million to $4.0 million. Timberland then borrowed $750,000 from the secured junior revolver.

 

On November 29, 2006, the Fund filed Post-Effective Amendment No. 2 to its Registration Statement on Form N-2 (the “Registration Statement”).

 

On December 6, 2006, the Fund borrowed $10.0 million on the revolving credit facility under Credit Facility II. The revolving credit facility now has a balance of $15.0 million and the term loan has a balance of $35.0 million.

 

On December 8, 2006, Total Safety repaid term loan A and term loan B in full including all accrued interest and fees. The total amount received in repayment for term loan A was $5,043,775 and for term loan B was $1,009,628.

 

On December 12, 2006, the Fund invested $10 million in Levlad Arbonne International LLC, a marketer of personal care products, in the form of a $10 million second lien loan. The loan bears annual interest of LIBOR plus 6.5% and the maturity date is December 19, 2013.

 

On December 13, 2006, the Fund made an investment in Total Safety by extending a $3.5 million second lien loan and a $1.0 million first lien loan. The second lien loan has an annual interest rate of LIBOR plus 6.5% and a maturity date of December 8, 2013. The first lien loan has an annual interest rate of LIBOR plus 3.0% and a maturity date of December 8, 2012.

On December 14, 2006, the Fund’s Board of Directors declared a $0.12 per share dividend for the first quarter of fiscal 2007. The Board of Directors also declared an additional cash dividend of $0.06 per share. The dividends are payable on January 5, 2007 to shareholders of record on December 28, 2006. The ex-dividend date is December 26, 2006.

 

On December 18, 2006, the Fund extended the maturity date on the $1 million Baltic bridge loan from December 22, 2006 to January 5, 2007. This note was then repaid in full on January 5, 2007, including principal and all accrued interest.

 

On December 22, 2006, the Fund invested $564,716 in Vitality in the form of common stock.

 

On January 3, 2007, the Fund borrowed $3.0 million on the revolving credit facility under Credit Facility II. The revolving credit facility now has a balance of $18.0 million and the term loan has a balance of $35.0 million.

 

On January 4, 2007, the Fund’s Valuation Committee determined to increase the fair values of the Fund’s investments in the following portfolio companies by an aggregate amount of approximately $20.8 million^*: SIA BM Auto, Baltic Motors Corporation, Dakota Growers Pasta Company, Inc., Octagon Credit Investors, LLC, SGDA Sanierungsgesellschaft für Deponien und Altlasten mbH, Vendio Services, Inc., and Vitality Foodservice, Inc.

 

Subject to confirmation following the audit, the payment obligation to Mr. Tokarz resulting from the sale of a portion of the Fund’s LLC membership interest in Octagon is expected to be approximately $110,000 (which is expected to be paid during the first quarter of the Fund’s fiscal year 2007).

 

Historically the Fund has invested in small companies, and its investments in these companies are considered speculative in nature. The Fund’s investments often include securities that are subject to legal or contractual restrictions on resale that adversely affect the liquidity and marketability of such securities. As a result, the Fund is subject to risk of loss which may prevent our shareholders from achieving price appreciation, dividend distributions and return of capital.

 

Financial instruments that subjected the Fund to concentrations of market risk consisted principally of equity investments, subordinated notes, and debt instruments, which represent approximately 69.34% of the Fund’s total assets at July 31, 2006. As discussed in Note 5 “Portfolio Investments,” these investments consist of securities in companies with no readily determinable market values and as such are valued in accordance with the Fund’s fair value policies and procedures. The Fund’s investment strategy represents a high degree of business and financial risk due to the fact that the investments (other than cash equivalents) are generally illiquid, in small and middle market companies, and include entities with little operating history or entities that possess operations in new or developing industries. These investments, should they become publicly traded, would generally be: (i) subject to restrictions on resale, if they were acquired from the issuer in private placement transactions; and (ii) susceptible to market risk. At this time, the Fund’s investments in short-term securities are in 90-day Treasury Bills, which are federally guaranteed securities, or other high quality, highly liquid investments. The Fund’s cash balances, if not large enough to be invested in 90-day Treasury Bills or other high quality, highly liquid investments, are swept into designated money market accounts.

 

In addition, the following risk factors relate to market risks impacting the Fund.

 

Investing in private companies involves a high degree of risk.

 

Our investment portfolio generally consists of loans to, and investments in, private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative. There is generally very little publicly available information about the companies in which we invest, and we rely significantly on the due diligence of the Fund’s investment team to obtain appropriate information in connection with our investment decisions.

 

Our investments in portfolio companies are generally illiquid.

 

We generally acquire our investments directly from the issuer in privately negotiated transactions. Most of the investments in our portfolio (other than cash or cash equivalents) are typically subject to restrictions on resale or

 

 

^*  Unaudited.

otherwise have no established trading market. We may exit our investments when the portfolio company has a liquidity event, such as a sale, recapitalization or initial public offering. The illiquidity of our investments may adversely affect our ability to dispose of equity and debt securities at times when it may be otherwise advantageous for us to liquidate such investments. In addition, if we 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 fair value of such investments.

 

Substantially all of our portfolio investments are recorded at “fair value” and, as a result, there is a degree of uncertainty regarding the carrying values of our portfolio investments.

 

Pursuant to the requirements of the 1940 Act, because our portfolio company investments do not have readily ascertainable market values, we record these investments at fair value in accordance with Valuation Procedures adopted by our board of directors.

 

At October 31, 2006, approximately 79.50% of our total assets represented portfolio investments recorded at fair value. 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 we make. We specifically value each individual investment and record unrealized depreciation for an investment that we believe has become impaired, including where collection of a loan or realization of an equity security is doubtful. Conversely, we will record unrealized appreciation if we have an indication (based on an objective development) that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value, where appropriate. Without a readily ascertainable market value and because of the inherent uncertainty of fair valuations, fair value of our investments may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

 

Pursuant to our Valuation Procedures, our Valuation Committee (which is currently comprised of three Independent Directors) reviews, considers and determines fair valuations on a quarterly basis (or more frequently, if deemed appropriate under the circumstances). Any changes in valuation are recorded in the statements of operations as “Net change in unrealized appreciation (depreciation) on investments.”

 

Economic recessions or downturns could impair our portfolio companies and harm our operating results.

 

Many of the companies in which we have made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may affect the ability of a company to engage in a liquidity event. These conditions could lead to financial losses in our portfolio and a decrease in our revenues, net income and assets.

 

Our overall business of making private equity investments may be affected by current and future market conditions. The absence of an active mezzanine lending or private equity environment may slow the amount of private equity investment activity generally. As a result, the pace of our investment activity may slow, which could impact our ability to achieve our investment objective. In addition, significant changes in the capital markets could have an effect on the valuations of private companies and on the potential for liquidity events involving such companies. This could affect the amount and timing of any gains realized on our investments.

 

Our borrowers may default on their payments, which may have an effect on our financial performance.

 

We may make long-term unsecured, subordinated loans, which may involve a higher degree of repayment risk than conventional secured loans. We primarily invest in companies that may have limited financial resources and that may be unable to obtain financing from traditional sources. In addition, numerous factors may adversely affect a portfolio company’s ability to repay a loan we make to it, including the failure to meet a business plan, a downturn in its industry or operating results, or negative economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in any related collateral.

Our investments in mezzanine and other debt securities may involve significant risks.

 

Our investment strategy contemplates investments in mezzanine and other debt securities of privately held companies. “Mezzanine” investments typically are structured as subordinated loans (with or without warrants) that carry a fixed rate of interest. We may also make senior secured and other types of loans or debt investments. Our debt investments are typically not rated by any rating agency, but we believe that if such investments were rated, they would be below investment grade quality (rated lower than “Baa3” by Moody’s or lower than “BBB−” by Standard & Poor’s, commonly referred to as “junk bonds”). Loans of below investment grade quality have predominantly speculative characteristics with respect to the borrower’s capacity to pay interest and repay principal. Our debt investments in portfolio companies may thus result in a high level of risk and volatility and/or loss of principal.

 

We may not realize gains from our equity investments.

 

When we invest in mezzanine and senior debt securities, we may acquire warrants or other equity securities as well. We may also invest directly in various equity securities. Our goal is ultimately to dispose of such equity interests and realize gains upon our disposition of such interests. However, the equity interests we receive or invest in may not appreciate in value and, in fact, may decline in value. In addition, the equity securities we receive or invest in may be subject to restrictions on resale during periods in which it would be advantageous to resell. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.

 

Our investments in small and middle-market privately-held companies are extremely risky and you could lose your entire investment.

 

Investments in small and middle-market privately-held companies are subject to a number of significant risks including the following:

 

 

 

Investments in foreign debt or equity may involve significant risks in addition to the risks inherent in U.S. investments.

 

Our investment strategy may result in some investments in debt or equity of foreign companies (subject to applicable limits prescribed by the 1940 Act). Investing in foreign companies can expose us to additional risks not typically associated with investing in U.S. companies. These risks include exchange rates, changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility.

 

The market for private equity investments can be highly competitive. In some cases, our status as a regulated business development company may hinder our ability to participate in investment opportunities.

 

We face competition in our investing activities from private equity funds, other business development companies, investment banks, investment affiliates of large industrial, technology, service and financial companies, small business investment companies, wealthy individuals and foreign investors. As a regulated business development company, we are required to disclose quarterly the name and business description of portfolio companies and the value of any portfolio securities. Many of our competitors are not subject to this disclosure requirement. Our obligation to disclose this information could hinder our ability to invest in certain portfolio companies. Additionally, other regulations, current and future, may make us less attractive as a potential investor to a given portfolio company than a private equity fund not subject to the same regulations. Furthermore, some of our competitors have greater resources than we do. Increased competition would make it more difficult for us to purchase or originate investments at attractive prices. As a result of this competition, sometimes we may be precluded from making certain investments.

 

Our common stock price can be volatile.

 

The trading price of our common stock may fluctuate substantially. The price of the common stock may be higher or lower than the price you pay for your shares, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include the following:

 

 

 

We are subject to market discount risk.

 

As with any stock, the price of our shares will fluctuate with market conditions and other factors. If shares are sold, the price received may be more or less than the original investment. Whether investors will realize gains or losses upon the sale of our shares will not depend directly upon our NAV, but will depend upon the market price of the shares at the time of sale. Since the market price of our shares will be affected by such factors as the relative demand for and supply of the shares in the market, general market and economic conditions and other factors beyond our control, we cannot predict whether the shares will trade at, below or above our NAV. Although our shares have recently traded at a premium to our NAV, historically, our shares, as well as those of other closed-end investment companies, have frequently traded at a discount to their NAV, which discount often fluctuates over time.

 

Changes in interest rates may affect our cost of capital and net operating income.

 

Because we have and may continue to borrow money to make investments, our net operating income before net realized and unrealized gains or losses, or net investment income, may be dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net operating income. In periods of sharply rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. We may utilize our short-term credit facilities as a means to bridge to long-term financing. Our long-term fixed-rate investments are financed primarily with equity and long-term fixed-rate debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.

 

The war with Iraq, terrorist attacks, the Middle East crisis and other acts of violence or war may affect any market for our common stock, impact the businesses in which we invest and harm our operations and our profitability.

 

The war with Iraq, its aftermath and the continuing occupation of Iraq are likely to have a substantial impact on the U.S. and world economies and securities markets. The nature, scope and duration of the war and occupation cannot be predicted with any certainty. Furthermore, terrorist attacks may harm our results of operations and your investment. We cannot assure you that there will not be further terrorist attacks against the United States or U.S. businesses. Such attacks and armed conflicts in the United States or elsewhere may impact the businesses in which we invest directly or indirectly, by undermining economic conditions in the United States. Losses resulting from terrorist events are generally uninsurable.

CONSOLIDATED FINANCIAL STATEMENTS

 

MVC Capital, Inc.

 

Consolidated Balance Sheets

 

 

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

MVC Capital, Inc.

 

Consolidated Schedule of Investments
October 31, 2006

 

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

 

MVC Capital, Inc.

 

Consolidated Schedule of Investments — (Continued)
October 31, 2006