RAND

Business Context and Reporting Period

Company: Rand Capital Corporation (RAND), a publicly traded Business Development Company (BDC) and Small Business Investment Company (SBIC).

Reporting Period: Quarter and six months ended June 30, 2007.

Overview: The Corporation invests in small to medium-sized private companies through a mix of debt and equity instruments. It operates a wholly-owned SBIC subsidiary (Rand Capital SBIC, L.P.) to access SBA leverage. As of June 30, 2007, the company held 5,718,934 shares of common stock outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Surge: Total investment income increased 106.6% to $856,140. This was driven by a 1,348.4% increase in dividend and other investment income (primarily distributions from LLCs like Gemcor II and Carolina Skiff) and a 713.9% increase in interest from other investments due to higher cash balances and yields.
• Portfolio Interest Decline: Interest from portfolio companies decreased 5.2% to $334,196. This was due to the repayment or conversion of four debenture instruments (Concentrix, Innov-X, UStec, and Synacor) that were active in the prior year.
• Expense Growth: Total expenses rose 16% to $812,239. Key drivers included a 15% increase in SBA interest expense (due to the full $8.1M drawdown) and a 54% increase in directors' fees due to a revised fee structure.
• Realized Losses: The company recorded a net realized loss of $38,796, primarily due to a $39,236 loss on the UStec debenture settlement, contrasting with a $226,894 gain in the prior year.
• Unrealized Gains: Net unrealized appreciation increased by $119,121, significantly lower than the $829,048 increase in the prior year, which was heavily influenced by Minrad valuations.

Outlook, Risks, and Contingencies

• Liquidity and Capital: The company holds $4.36 million in cash, representing approximately 25% of net assets. It has reserved $10 million in SBA leverage, with $8.1 million currently drawn. Management expects to draw the remaining $1.9 million in 2008.
• Legal Proceedings: In June 2007, Rand and Rand SBIC were named as defendants in a New York Supreme Court complaint seeking $10 million in damages related to an alleged breach of a letter agreement regarding the sale of a portfolio company's assets. Management believes the suit is without merit and intends to defend vigorously.
• Regulatory Restructuring: The company is in discussions with the SEC and SBA regarding the reorganization of its SBIC subsidiary from a limited partnership to a corporate subsidiary to comply with regulatory requirements. This is expected to be finalized in late 2007.
• Subsequent Events: Following the quarter-end, the company made two new investments totaling $750,000.
• Risk Factors: Significant risks include the illiquidity of private portfolio investments, valuation subjectivity (99% of the portfolio is restricted securities), and dependence on key management personnel.

Investor Verification Checklist

• Legal Exposure: Verify the status and potential financial impact of the $10 million lawsuit filed in June 2007.
• Portfolio Valuation: Review the Board's fair value determinations for restricted securities, which comprise 99% of the portfolio and lack public market quotations.
• Interest Accruals: Confirm the status of investments where interest accrual has ceased (Contract Staffing, G-Tec, Ustec, WineIsIt.com) and the likelihood of recovery.
• Regulatory Compliance: Monitor the progress of the SBIC subsidiary reorganization to ensure no disruption to SBA leverage access.
• Cash Deployment: Assess the strategy for deploying the $4.36 million cash balance and the timing of the remaining $1.9 million SBA drawdown.