Business Context and Reporting Period
Company: Rand Capital Corporation (RAND)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2017
Business Overview: Rand is an internally managed Business Development Company (BDC) and Small Business Investment Company (SBIC) focused on making debt and equity investments in early or expansion-stage small companies, primarily in upstate New York. The company utilizes SBA leverage to fund investments. In 2017, Rand established a second SBIC subsidiary, Rand Capital SBIC II, L.P.
Key Financial Metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Total Assets | $40,133,913 | $42,418,530 |
| Total Liabilities | $8,215,228 | $9,789,167 |
| Net Assets | $31,918,685 | $32,629,363 |
| Net Asset Value (NAV) per Share | $5.05 | $5.16 |
| Investment Income | $1,454,782 | $1,031,858 |
| Total Expenses | $2,010,977 | $3,401,037 |
| Net Investment (Loss) Gain | ($19,298) | ($1,553,268) |
| Net Realized Gain on Investments | $88,684 | $8,864,653 |
| Net Unrealized Depreciation | ($780,064) | ($8,514,068) |
| Net Decrease in Net Assets from Operations | ($710,678) | ($1,202,683) |
| Cash and Cash Equivalents | $6,262,039 | $12,280,140 |
| Outstanding SBA Debentures | $8,000,000 | $8,000,000 |
Material Changes vs. Prior Period
- Net Asset Value: NAV per share decreased by $0.11 (2.1%) to $5.05, driven primarily by a net decrease in net assets from operations of $710,678.
- Investment Income: Increased 41% to $1.45 million, largely due to a 51% increase in interest income from portfolio companies resulting from new debt investments originated in 2017.
- Expenses: Total expenses decreased 41% to $2.01 million. This significant reduction was primarily due to the absence of a $1.38 million profit-sharing bonus paid in 2016 related to the sale of Gemcor II, LLC.
- Realized Gains: Net realized gains dropped significantly to $88,684 from $8.86 million in 2016. The 2016 figure was anomalously high due to the sale of Gemcor II, LLC. In 2017, the company realized a gain of $638,240 from the sale of Athenex shares but incurred a $500,000 loss on City Dining Cards (Loupe).
- Unrealized Depreciation: Net unrealized depreciation was $780,064, a substantial improvement over the $8.5 million depreciation recorded in 2016 (which included a reclassification of the Gemcor sale). Specific valuation decreases in 2017 affected SciAps, Teleservices, and Intrinsiq, while increases were recorded for Knoa and Carolina Skiff.
- Liquidity: Cash balances decreased by approximately $6 million to $6.26 million, primarily due to $5.4 million in new investments and funding of operating expenses.
Guidance, Outlook, and Risks
- Outlook: Management expects to continue adding new investments and reinvesting in existing portfolio companies. They anticipate potential new SBA leverage commitments in 2018 pending regulatory approval of an optimal structure.
- Capital Resources: The company believes cash on hand ($6.3 million) and scheduled interest payments are sufficient to meet 2018 needs. However, SBA debentures totaling $8 million mature between 2022 and 2025, requiring future funding sources if investment exits are insufficient.
- Valuation Risk: 100% of the investment portfolio consists of private securities (Level 3 assets) with no public market. Valuations are determined in good faith by management and are subject to significant judgment and potential volatility.
- Concentration Risk: The top five portfolio companies represented 37% of total assets at year-end. A default by any of these companies could materially impact net asset value.
- Regulatory Risk: As a BDC and SBIC, the company is subject to complex regulations from the SEC and SBA. Changes in these regulations could adversely affect operations.
Investor Verification Checklist
- Valuation Methodology: Verify the specific inputs and assumptions used by management to value Level 3 assets, particularly for companies with unrealized depreciation (e.g., SciAps, Teleservices).
- SBA Leverage Status: Confirm the status of the application for new SBA leverage commitments expected in 2018 and the impact on future capital deployment.
- Debt Maturity Profile: Review the plan for refinancing or repaying the $8 million in SBA debentures maturing from 2022 to 2025.
- Portfolio Performance: Monitor the operational progress of the top five portfolio companies (Genicon, eHealth, Rheonix, Tilson, Outmatch) which comprise a significant portion of assets.
- Profit Sharing Plan: Understand the impact of the profit-sharing plan on future expenses, as it is tied to net realized gains and can cause significant expense volatility.