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 debt and equity securities of private companies. This Form 10-Q covers the quarterly and six-month periods ended June 30, 2011.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Portfolio: Total investments at fair value increased by 3.6% to $20.07 million, driven by a $2.16 million increase in net unrealized appreciation. However, the cost basis of investments decreased by 10.8% due to realized losses and repayments.
• Realized Losses: The company recognized a net realized loss of $1.32 million for the six months ended June 30, 2011, compared to zero in the prior year. This was primarily due to the sale of Niagara Dispensing Technologies, Inc. (loss of $1.78 million) and the liquidation of Associates Interactive (loss of $0.29 million).
• Unrealized Gains: Significant unrealized appreciation of $2.16 million was recorded, largely due to reclassifications of previously unrealized losses on Niagara Dispensing and Associates to realized losses, and a valuation increase in Liazon Corporation following a new equity financing.
• Liquidity: Cash and cash equivalents increased significantly to $10.79 million (47% of net assets) from $5.85 million in the prior year period, providing a strong liquidity buffer.
• Operating Expenses: Total expenses remained relatively flat at approximately $865,000 for both periods, with interest on SBA obligations being a major component.

Guidance, Outlook, and Risks

• Outlook: Management notes that while the economy continues to improve, the recovery may be prolonged due to a weak labor market and tight credit conditions for small businesses. The company anticipates most future investments will be originated through its SBIC subsidiary.
• Valuation Risk: All portfolio investments are classified as Level 3 assets (unobservable inputs). Valuations are determined in good faith by management and approved by the Board. These estimates may differ materially from values realized upon actual liquidation.
• Concentration Risk: Four portfolio companies (Gemcor II, Synacor, Microcision, and Carolina Skiff) represented 30%, 21%, 8%, and 7% respectively of the portfolio's fair value as of June 30, 2011.
• Profit Sharing: The company has a profit sharing plan for executive officers based on net realized capital gains of the SBIC subsidiary. No contributions were made in the first half of 2011, though $568,694 accrued in 2010 was paid during this period.
• Regulatory Status: The company is seeking SEC exemptions to operate its SBIC subsidiary as a BDC, which would allow for consolidated reporting and asset coverage calculations.

Investor Verification Checklist

• Realized Losses: Verify the details of the Niagara Dispensing sale and the $1.78 million realized loss, including the valuation of the retained royalty interest ($73,500).
• Valuation Methodology: Review the specific assumptions used to increase the valuation of Liazon Corporation and the reclassification of unrealized losses to realized losses.
• Liquidity Coverage: Confirm that the $10.8 million cash balance is sufficient to cover the $10 million SBA debenture interest obligations and operating expenses for the next 12 months without new capital raises.
• Portfolio Concentration: Assess the financial health of the top four holdings (Gemcor, Synacor, Microcision, Carolina Skiff) which comprise over 60% of the portfolio value.
• SEC Exemption Status: Monitor the status of the pending SEC exemption application regarding the SBIC subsidiary's BDC election.