RAND

Business Context and Reporting Period

Company: Rand Capital Corporation (RAND), an internally managed Business Development Company (BDC) and Small Business Investment Company (SBIC).

Reporting Period: Quarter ended March 31, 2015.

Overview: The company invests in small and medium-sized U.S. companies through debt and equity instruments. It operates primarily through its subsidiary, Rand Capital SBIC, Inc., which is licensed by the SBA. As of March 31, 2015, the company held 6,328,538 shares of common stock outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability: The company reported a net increase in net assets from operations of $179,548, a significant improvement from a net decrease of $169,613 in the prior year quarter. This turnaround was driven by a net realized gain of $84,593 compared to a net realized loss of $501,495 in Q1 2014.
• Investment Income: Total investment income increased 23.9% to $641,747. Dividend and other investment income rose 40.6% to $441,519, largely due to distributions from Gemcor II, LLC ($412,151). Conversely, interest income from portfolio companies decreased slightly by 3.7% due to principal repayments.
• Operating Expenses: Total operating expenses increased 15.7% to $440,385. This increase was attributed to higher professional fees due to the regulatory environment and increased SBA interest expense.
• Portfolio Composition: Investments at fair value increased 7.9% to $32.7 million. New investments totaling $2.66 million were made in companies including HealthTeacher, Inc. and Tilson Technology Management, Inc. The portfolio is heavily weighted toward Manufacturing (46.4%) and Software (21.3%).
• Liquidity: Cash balances decreased from $13.2 million at year-end 2014 to $7.9 million at March 31, 2015, reflecting active deployment of capital into new investments.

Outlook, Risks, and Management Commentary

• Outlook: Management expressed confidence in the ability to grow the portfolio, citing improving U.S. economic conditions and low costs of capital. With approximately $7.9 million in cash on hand, the company intends to continue adding new investments while reinvesting in existing portfolio companies.
• Valuation Risks: Approximately 99% of the investment portfolio consists of Level 3 assets (restricted securities with no active market). Valuations are determined in good faith by management based on unobservable inputs, creating a risk that fair values may differ significantly from actual liquidation proceeds.
• Concentration Risk: Five portfolio companies (Gemcor II, Rheonix, Microcision, Carolina Skiff, and SciAps) represented 54% of the fair value of the investment portfolio as of March 31, 2015.
• Regulatory Compliance: As a BDC, the company must invest at least 70% of assets in qualifying assets. It also faces SBA leverage requirements and potential automatic default remedies if certain conditions are not met.
• Unusual Items: The company ceased accruing interest income on Mezmeriz, Inc. in 2014 due to performance concerns. In Q1 2015, the company recognized a realized gain on the sale of Synacor, Inc. shares.

Investor Verification Checklist

• Cash Deployment: Verify the rate of capital deployment given the reduction in cash from 41% to 24% of net assets over the quarter.
• Valuation Methodology: Review the specific unobservable inputs (e.g., EBITDA multiples, revenue multiples) used to value the 99% Level 3 portfolio, as these are highly subjective.
• Portfolio Concentration: Assess the financial health of the top five holdings, which comprise over half the portfolio's value.
• SBA Leverage: Confirm the status of the $8 million SBA debentures and the company's compliance with SBA leverage and reporting requirements.
• Dividend Sustainability: Analyze the source of dividend income, noting the heavy reliance on distributions from specific LLCs (e.g., Gemcor) to cover operating expenses and potential distributions to shareholders.