RAND

Business Context and Reporting Period

Company: Rand Capital Corporation (Rand)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2002
Business Overview: Rand is a publicly traded Business Development Company (BDC) and venture capital firm focused on early-stage and developing enterprises, primarily in Upstate New York. In 2002, Rand formed a wholly-owned subsidiary, Rand Capital SBIC, L.P., which was licensed by the Small Business Administration (SBA) in August 2002. The SBIC subsidiary is capitalized with $5 million in regulatory capital and is eligible to obtain SBA leverage up to a 2:1 ratio, though no leverage was drawn as of year-end.

Key Financial Metrics

Material Changes vs. Prior Period

• Asset Reduction: Total assets decreased by approximately 6% ($596,820) and net assets decreased by 5% ($453,650) compared to 2001. This decline was driven by a net investment loss of $738,046 and a net decrease in unrealized appreciation of $578,299, partially offset by a realized gain of $888,399.
• Portfolio Activity: The company made $3.3 million in new investments during 2002 ($1.1 million by the parent company and $2.2 million by the SBIC subsidiary). Investments at fair value increased to $6.08 million (63% of net assets) from $4.01 million (40% of net assets) in 2001.
• Realized Gains: The 2002 realized gain of $888,399 was primarily due to the sale of 61,051 shares of Advanced Digital Information Corporation (ADIC) stock for a net gain of $938,399, offset by a $50,000 write-off of the equity portion of the MemberWare Technologies investment. This contrasts with 2001, which saw a significantly larger realized gain of $3.29 million.
• Liquidity: Cash and cash equivalents dropped by approximately 48% to $3.09 million, reflecting the deployment of capital into new portfolio companies.
• Deferred Taxes: The company shifted from a net deferred tax liability of $150,000 in 2001 to a net deferred tax asset of $112,000 in 2002.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management believes current cash levels ($3.09 million) are sufficient to fund operations for the next 12 months. The primary objective remains long-term capital appreciation. The company intends to use the Rand SBIC subsidiary as its primary investment vehicle once SBA leverage is drawn.
• Dividends: Rand has not paid cash dividends in the last two fiscal years and has no present intention of paying them in the coming fiscal year.
• Key Risks:
  • Speculative Nature: Investments are in early-stage, privately held companies with high risk of loss and illiquidity.
  • Valuation Risk: A significant portion of the portfolio (63% of net assets) consists of securities with no public market, valued at "fair value" by the Board of Directors.
  • Regulatory Constraints: As a BDC and SBIC, the company faces strict limitations on asset types, leverage, and transactions with affiliates.
  • Key Personnel: Success is heavily dependent on two senior officers; the company does not maintain key man life insurance.
• Unusual Items: The company incurred $135,251 in organizational costs in 2002 related to the SBIC application and BDC restructuring. Additionally, the company repurchased 24,400 shares of its own stock for $25,704 during the year.

Investor Verification Checklist

• Valuation Methodology: Verify the Board's "good faith" fair value estimates for the $6.08 million portfolio, as these lack a public market and represent 63% of net assets.
• SBIC Leverage Status: Confirm whether Rand SBIC has successfully drawn any of the authorized SBA leverage (up to $10 million) to fund future investments, as none was drawn as of Dec 31, 2002.
• Cash Burn Rate: Assess the sustainability of the $3.09 million cash balance given the recurring net investment loss of $738,046 and reliance on asset sales to cover operating expenses.
• Portfolio Concentration: Review the specific performance and status of major holdings like Ultra-Scan Corporation and the new 2002 investments (Kionix, RAMSCO, Somerset Gas, Synacor, WineIsIt.com).
• Stock Repurchase Program: Monitor the remaining authorization for the stock repurchase program (up to 5% of outstanding stock) and its impact on share count.