RAND

Business Context and Reporting Period

Rand Capital Corporation (Rand) is a publicly traded Business Development Company (BDC) and operates a wholly-owned Small Business Investment Company (SBIC) subsidiary, Rand Capital SBIC, Inc. The company invests in a portfolio of private companies through debt, equity, and convertible instruments. This Form 10-Q covers the quarter ended March 31, 2011.

Key Financial Metrics

Material Changes vs. Prior Period

• Improved Operational Performance: The net decrease in net assets from operations improved significantly to $(221,660) in Q1 2011 compared to $(679,265) in Q1 2010. This improvement was driven by a reduction in net investment loss and a shift from a large unrealized loss in 2010 to a net unrealized gain in 2011.
• Investment Income Growth: Total investment income increased 21.1% to $228,140. This was primarily due to new debenture instruments from Chequed.com and Liazon Corporation, and a 195.7% increase in dividend income (driven by a $41,114 distribution from New Monarch Machine Tool, Inc.).
• Realized Losses: The company recognized a realized loss of $293,519 on Associates Interactive LLC, which ceased operations in Q1 2011. No realized gains or losses were recorded in the comparable 2010 period.
• Unrealized Appreciation: Net unrealized appreciation increased by $168,518 (net of tax $109,537) in Q1 2011, contrasting with a $800,000 unrealized loss in Q1 2010. The 2011 gain included a reclassification of the Associates Interactive loss and a write-down of the Niagara Dispensing investment.
• Liquidity: Cash and cash equivalents increased by approximately $3.5 million year-over-year, representing 48% of net assets at quarter-end.

Outlook, Risks, and Management Commentary

• Portfolio Valuation: All portfolio investments are classified as Level 3 assets (unobservable inputs) due to their private nature. Valuations are determined by management and approved by the Board. The portfolio fair value was $19.2 million, with a net unrealized appreciation of $5.96 million.
• Specific Investment Risks:
  • Niagara Dispensing Technologies: The investment was written down an additional $125,001 and is now valued at zero. The company is in discussions with a potential acquirer, but the transaction is complex and uncertain.
  • Associates Interactive: Ceased doing business, resulting in a full realized loss.
  • Interest Accruals: Interest accrual has ceased on G-Tec Natural Gas Systems (since 2004) and Niagara Dispensing (since 2010) due to collection doubts.
• Liquidity Outlook: Management expects current cash balances and scheduled portfolio payments to be sufficient to meet needs for the next 12 months. Future liquidity may increase through portfolio exits, though timing is uncertain.
• Regulatory Status: Rand SBIC is seeking SEC exemptions to operate as a BDC subsidiary, which would allow for consolidated reporting and specific asset coverage calculations. The company is currently open to IRS audit for tax years 2007 through 2010.

Investor Verification Checklist

• Valuation Methodology: Verify the assumptions used for Level 3 fair value measurements, particularly for the $19.2 million portfolio, as these are subjective and lack a ready market.
• Niagara Dispensing Status: Monitor the status of the potential acquisition of Niagara Dispensing, as the investment is currently valued at zero.
• SEC Exemption Application: Confirm the status of the SEC exemption application for Rand SBIC to operate as a BDC subsidiary, which impacts regulatory flexibility.
• Concentration Risk: Note that four portfolio companies (Gemcor II, Synacor, Microcision, and Carolina Skiff) represent approximately 70% of the portfolio's fair value.
• Subsequent Events: Review post-quarter activity, specifically the $500,000 repayment and $820,000 reinvestment in Liazon Corporation.