Logan Ridge Finance Corp. - Quarter Report: 2014 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarter Ended September 30, 2014

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission
File Number

Exact name of registrants as specified in their charters, addresses of principal executive

offices, telephone numbers and states or other jurisdictions of incorporation or organization

I.R.S. Employer

Identification Number

814-01022

Capitala Finance Corp.

4201 Congress St., Suite 360

Charlotte, North Carolina

Telephone: (704) 376-5502

State of Incorporation: Maryland

90-0945675

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Capitala Finance Corp.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Capitala Finance Corp.

Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

Capitala Finance Corp.	Large accelerated filer	¨	Accelerated filer	¨

	Non-accelerated filer	x	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Capitala Finance Corp.

Yes ¨ No x

The number of shares of Capitala Finance Corp.’s common stock, $0.01 par value, outstanding as of November 10, 2014 was 12,974,420.

TABLE OF CONTENTS

		Page

PART I	FINANCIAL INFORMATION	3

Item 1.	Financial Statements	3

	Consolidated Statements of Assets and Liabilities as of September 30, 2014 (unaudited) and December 31, 2013	3

	Consolidated Statements of Operations for the three and nine months ended September 30, 2014 (unaudited) and September 30, 2013 (unaudited)	4

	Consolidated Statements of Changes in Net Assets for the nine months ended September 30, 2014 (unaudited) and September 30, 2013 (unaudited)	5

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 (unaudited) and September 30, 2013 (unaudited)	6

	Consolidated Schedules of Investments as of September 30, 2014 (unaudited) and December 31, 2013	7

	Notes to Consolidated Financial Statements as of September 30, 2014 (unaudited)	15

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	53

Item 4.	Controls and Procedures	54

PART II	OTHER INFORMATION	54

Item 1.	Legal Proceedings	54

Item 1A.	Risk Factors	54

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54

Item 3.	Defaults upon Senior Securities	54

Item 4.	Mine Safety Disclosures	54

Item 5.	Other Information	55

Item 6.	Exhibits	55

Signatures		56

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

Capitala Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except share and per share data)

	As of
	September 30, 2014			December 31, 2013
	(unaudited)
ASSETS

Investments at fair value
Non-control/non-affiliate investments (amortized cost of $158,338 and $84,138, respectively)	$	181,245		$	99,140
Affiliate investments (amortized cost of $161,730 and $159,104, respectively)		185,051			189,098
Control investments (amortized cost of $67,422 and $58,057, respectively)		78,830			76,481
Total investments at fair value (amortized cost of $387,490 and $301,299, respectively)		445,126			364,719
Cash and cash equivalents		107,576			101,622
Interest and dividend receivable		3,541			2,917
Due from related parties		541			1,645
Deferred financing fees (net of accumulated amortization of $2,873 and $2,216, respectively)		8,581			4,871
Prepaid expenses		47			654
Total assets	$	565,412		$	476,428

LIABILITIES
SBA debentures payable	$	192,200		$	202,200
Notes payable		113,438			-
Due to related parties		469			1,153
Incentive fee payable		-			1,525
Interest payable		968			2,723
Accounts payable and accrued expenses		221			157
Total liabilities	$	307,296		$	207,758

Commitments and contingencies (Note 2)

NET ASSETS
Common stock, par value $.01, 100,000,000 common shares authorized, 12,974,420 common shares issued and outstanding	$	130		$	130
Additional paid in capital		188,408			188,408
Accumulated undistributed net investment income		13,363			16,760
Accumulated undistributed net realized loss from investments		(1,421	)		(48	)
Net unrealized appreciation on investments		57,636			63,420
Total net assets		258,116			268,670

Total liabilities and net assets	$	565,412		$	476,428

Net asset value per share	$	19.89		$	20.71

See accompanying notes to consolidated financial statements.

Capitala Finance Corp.

Consolidated Statements of Operations

(in thousands, except share and per share data)

(unaudited)

	For the three months ended September 30,						For the nine months ended September 30,
	2014			2013			2014			2013
				(combined)						(combined)
INVESTMENT INCOME
Interest and fee income:
Non-control/Non-affiliate investments	$	4,104		$	2,061		$	10,170		$	6,110
Affiliate investments		4,790			2,796			12,415			8,981
Control investments		1,422			1,088			4,259			2,719
Total interest and fee income		10,316			5,945			26,844			17,810
Payment-in-kind interest and dividend income:
Non-control/Non-affiliate investments		202			45			626			132
Affiliate investments		334			114			956			268
Control investments		192			263			479			692
Total payment-in-kind interest and dividend income		728			422			2,061			1,092
Dividend income:
Non-control/Non-affiliate investments		152			2			1,666			2
Affiliate investments		29			29			745			86
Control investments		(61	)		2,127			4,734			2,586
Total dividend income		120			2,158			7,145			2,674
Other income		-			210			-			1,571
Interest income from cash and cash equivalents		3			66			17			141
Total investment income		11,167			8,801			36,067			23,288

EXPENSES
Interest expense and amortization of deferred financing fees		4,268			2,237			8,870			6,527
Management fees		2,536			980			6,830			2,994
Incentive fees		-			-			2,838			-
General and administrative expenses		857			147			2,870			382
Expenses before management fee waiver		7,661			3,364			21,408			9,903
Management fee waiver (See Note 5)		(38	)		-			(238	)		-
Total expenses net of management fee waiver		7,623			3,364			21,170			9,903

NET INVESTMENT INCOME		3,544			5,437			14,897			13,385

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain (loss) from investments:
Non-control/Non-affiliate investments		-			6,011			1,158			6,011
Affiliate investments		(3,055	)		(4,140	)		(2,704	)		(4,140	)
Control investments		-			-			173			364
Total realized gain (loss) from investments		(3,055	)		1,871			(1,373	)		2,235
Net unrealized appreciation (depreciation) on investments		(178	)		601			(5,784	)		6,442
Net gain/(loss) on investments		(3,233	)		2,472			(7,157	)		8,677

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS	$	311		$	7,909		$	7,740		$	22,062

NET INCREASE IN NET ASSETS PER SHARE RESULTING FROM OPERATIONS – BASIC AND DILUTED	$	0.02		$	0.61		$	0.60		$	1.70

WEIGHTED AVERAGE COMMON STOCK OUTSTANDING - BASIC AND DILUTED		12,974,420			12,974,420			12,974,420			12,974,420

N/A – Not Applicable

See accompanying notes to consolidated financial statements.

Capitala Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands, except share data)

(unaudited)

							Common Stock				Additional		Accumulated			Accumulated			Net Unrealized
	General			Limited			Number of		Par		Paid in		Undistributed Net			Undistributed Net			Appreciation (Depreciation) on
	Partner			Partners			Shares		Value		Capital		Investment Income			Realized Gains (Losses)			Investments			Total

BALANCE, December 31, 2012	$	282		$	77,358			-	$	-	$	-	$	8,560		$	-		$	56,233		$	142,433
Partners' capital contributions		-			24,852			-		-		-		-			-			-			24,852
Distribution to partners		-			-			-		-		-		(5,186	)		(2,235	)		-			(7,421	)
Formation Transactions		(282	)		(102,210	)		8,974,420		90		114,198		-			-			-			11,796
Public offering of common stock		-			-			4,000,000		40		74,210		-			-			-			74,250
Net investment income		-			-			-		-		-		13,385			-			-			13,385
Net realized gain on portfolio investments		-			-			-		-		-					2,235			-			2,235
Net change in unrealized appreciation on portfolio investments		-			-			-		-		-		-			-			6,442			6,442
BALANCE, September 30, 2013	$	-		$	-			12,974,420	$	130	$	188,408	$	16,759		$	-		$	62,675		$	267,972

BALANCE, December 31, 2013	$	-		$	-			12,974,420	$	130	$	188,408	$	16,760		$	(48	)	$	63,420		$	268,670
Net investment income		-			-			-		-		-		14,897			-			-			14,897
Net realized loss on portfolio investments		-			-			-		-		-		-			(1,373	)					(1,373	)
Net change in unrealized appreciation on portfolio investments		-			-			-		-		-		-						(5,784	)		(5,784	)
Dividends declared and paid		-			-			-		-		-		(18,294	)		-			-			(18,294	)
BALANCE, September 30, 2014	$	-		$	-			12,974,420	$	130	$	188,408	$	13,363		$	(1,421	)	$	57,636		$	258,116

See accompanying notes to consolidated financial statements.

Capitala Finance Corp.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	For the nine months ended September 30,
	2014			2013
				(combined)
CASH FLOWS FROM OPERATING ACTIVITIES
Net increase in net assets resulting from operations	$	7,740		$	22,062
Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:
Purchase of portfolio investments		(150,304	)		(75,817	)
Repayments of portfolio investments		64,833			50,209
Net realized (gain)/loss on portfolio investments		1,373			(2,235	)
(Increase) decrease in net unrealized appreciation on portfolio investments		5,784			(6,442	)
Payment-in-kind interest accrued, net of payments received		(2,061	)		(930	)
Accretion of original issue discount on portfolio investments		(32	)		(35	)
Amortization of deferred financing fees		656			522
Changes in assets and liabilities:
Interest and dividend receivable		(624	)		(398	)
Due from related parties		1,104			(288	)
Prepaid expenses		607			-
Due to related parties		(684	)		306
Incentive fee payable		(1,525	)		-
Interest payable		(1,755	)		(1,821	)
Accounts payable and accrued expenses		64			1,852
Other assets		-			(2	)
NET CASH USED IN OPERATING ACTIVITIES		(74,824	)		(13,017	)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of SBA-guaranteed debentures		-			25,000
Partners' capital contributions		-			24,852
Proceeds from IPO, net of underwriting expense		-			74,250
Paydowns on SBA-guaranteed debentures		(10,000	)		-
Issuance of notes		113,438			-
Dividends declared and paid		(18,294	)		(7,421	)
Deferred financing fees paid		(4,366	)		(606	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		80,778			116,075

NET INCREASE IN CASH AND CASH EQUIVALENTS		5,954			103,058
CASH AND CASH EQUIVALENTS, beginning of period		101,622			30,467
CASH AND CASH EQUIVALENTS, end of period	$	107,576		$	133,525

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest	$	9,964		$	7,828

SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING TRANSACTIONS
In-kind contribution of assets	$	-		$	11,796

See accompanying notes to consolidated financial statements.

Capitala Finance Corp.

Consolidated Schedule of Investments

(in thousands, except for units)

September 30, 2014

(unaudited)

Company ^(3, 4)	Industry	Investment Interest Rate / Maturity	Principal Amount		Cost		Fair Value		% of Net Assets

Non-control/Non-affiliated investments - 70.4%

AAE Acquisition, LLC	Industrial Equipment Rental	Senior Secured Term Debt (12% Cash, Due 5/6/15)	$	11,000	$	10,997	$	11,000		4.3	%

AAE Acquisition, LLC	Industrial Equipment Rental	Membership Units (14% fully diluted)		-		17		2,212		0.9	%

						11,014		13,212		5.2	%

A Wireless Holding Company	Cellular Device Retailer	Subordinated Debt (12% Cash, Due 9/09/19)		12,000		12,000		12,000		4.6	%

						12,000		12,000		4.6	%

American Exteriors, LLC ⁽¹⁾	Replacement Window Manufacturer	Senior Secured Debt (17% Cash, Due 6/30/15)		4,404		3,204		4,404		1.7	%

American Exteriors, LLC ⁽¹⁾	Replacement Window Manufacturer	Jr. Convertible Note (10% Cash, Due 6/30/16)		500		415		500		0.2	%

American Exteriors, LLC ⁽⁷⁾	Replacement Window Manufacturer	Common Stock Warrants (15% fully diluted)		-		-		-		0.0	%

						3,619		4,904		1.9	%

Boot Barn Holding Corporation	Western Wear Retail	Common Stock (2,400 shares)		-		2,400		9,202		3.6	%

						2,400		9,202		3.6	%

Caregiver Services, Inc.	In-Home Healthcare Services	Common Stock (293,186 shares)		-		258		193		0.1	%

Caregiver Services, Inc.⁽⁷⁾	In-Home Healthcare Services	Common Stock Warrants (655,908 units)		-		264		431		0.1	%

						522		624		0.2	%

Crowley Holdings, Inc.⁽⁵⁾	Transportation	Series A Income Preferred Shares (6,000 shares, 10% cash, 2% PIK dividend)		-		6,114		6,114		2.4	%

						6,114		6,114		2.4	%

CSM Bakery Solutions, LLC	Bakery Supplies Distributor	Subordinated Debt (L+7.75%, 1% Floor, Due 8/7/22)		17,000		16,628		17,000		6.6	%

						16,628		17,000		6.6	%

Immersive Media Tactical Solutions, LLC	Specialty Defense Contractor	Senior Secured Term Debt (13% Cash, Due 10/6/16)		2,000		2,000		2,000		0.8	%

Immersive Media Tactical Solutions, LLC	Specialty Defense Contractor	Common Unit Warrants (12% fully diluted)		-		-		-		0.0	%

						2,000		2,000		0.8	%

Kelle's Transport Service, LLC	Transportation	Senior Secured Debt (14% Cash, Due 3/31/19)		15,603		15,586		15,603		6.0	%

Kelle's Transport Service, LLC ⁽⁵⁾	Transportation	Preferred Units (1,000 units, 10% PIK Dividend)		-		2,732		2,732		1.1	%

Kelle's Transport Service, LLC	Transportation	Common Stock Warrants (15% fully diluted)		-		23		2,489		1.0	%

						18,341		20,824		8.1	%

Medical Depot, Inc. ⁽¹⁾	Medical Device Distributor	Subordinated Debt (14% Cash, Due 9/27/20)		4,667		4,667		4,667		1.8	%

Medical Depot, Inc.	Medical Device Distributor	Series C Convertible Preferred Stock (740 shares)		-		1,333		5,408		2.1	%

						6,000		10,075		3.9	%

Meritas Schools Holdings, LLC	Education Services	Subordinated Debt (L+9%, 1% Floor, Due 1/23/2021)		3,000		2,985		3,000		1.2	%

						2,985		3,000		1.2	%

Naples Lumber & Supply Co ⁽¹⁾	Building Supplies	Subordinated Debt (7% cash, Due 6/30/15)		2,109		1,309		2,109		0.8	%

Naples Lumber & Supply Co	Building Supplies	Common Stock Warrants (10% fully diluted)		-		-		700		0.3	%

						1,309		2,809		1.1	%

Nielsen & Bainbridge, LLC	Home Décor Manufacturer	Subordinated Debt (L+9.25%, 1% Floor, Due 8/15/21)		15,000		14,777		15,000		5.8	%

						14,777		15,000		5.8	%

Pickaway Plains Ambulance Services, Inc. ^{(1) (2)}	Medical Transportation Services	Senior Secured Term Debt (13% Cash, Due 12/31/15)		1,548		-		-		0.0	%

Pickaway Plains Ambulance Services, Inc.	Medical Transportation Services	Common Stock Warrants (5% fully diluted)		-		-		-		0.0	%

						-		-		0.0	%

Precision Manufacturing, LLC ⁽²⁾	Industrial Boiler Manufacturer	Subordinated Debt (14% PIK, Due 2/13/15)		219		200		128		0.0	%

Precision Manufacturing, LLC ⁽²⁾	Industrial Boiler Manufacturer	Subordinated Debt (14% Cash, Due 10/31/14)		300		300		192		0.1	%

Precision Manufacturing, LLC ⁽²⁾	Industrial Boiler Manufacturer	Subordinated Debt (6.5% Cash, 6.5% PIK, Due 2/10/17)		2,611		2,500		1,602		0.6	%

Precision Manufacturing, LLC	Industrial Boiler Manufacturer	Membership Unit Warrants (6.65% fully diluted)		-		-		-		0.0	%

						3,000		1,922		0.7	%

Sequoia Healthcare Management, LLC	Healthcare Management	Senior Secured Debt (12% cash, 4% PIK, due 7/17/2019)		12,604		12,365		12,604		4.9	%

						12,365		12,604		4.9	%

Sierra Hamilton, LLC	Oil & Gas Engineering and Consulting Services	Senior Secured Debt (12.25% Cash, Due 12/15/18)		15,000		15,000		15,491		6.0	%

						15,000		15,491		6.0	%

Southern Pump & Tank Company, LLC ⁽¹⁾	Petroleum Equipment Supplier	Senior Secured Term Debt (13% Cash, 6% PIK, Due 1/15/15)		4,235		3,436		3,802		1.5	%

Southern Pump & Tank Company, LLC	Petroleum Equipment Supplier	Common Stock Warrants (10% fully diluted)		-		-		-		0.0	%

						3,436		3,802		1.5	%

Stoddard Hill Media Holdings, LLC	IT Hosting Services	Class D Preferred Units (132,159 shares)		-		300		529		0.2	%

						300		529		0.2	%

Tenere, Inc.	Industrial Manufacturing	Senior Secured Term Debt (11% Cash, 2% PIK, Due 12/15/17)		3,487		3,487		3,487		1.4	%

						3,487		3,487		1.4	%

TGI Friday's, Inc.	Restaurant	Subordinated Debt (L+8.25%, 1% Floor, Due 7/15/21)		10,000		9,960		10,000		3.9	%

						9,960		10,000		3.9	%

U.S. Well Services, LLC	Oil & Gas Services	Senior Secured Debt (L+11.50%, 0.5% floor, Due 5/2/19)		4,883		4,781		4,883		1.9	%

						4,781		4,883		1.9	%

Velum Global Credit Management, LLC ⁽⁸⁾	Financial Services	Senior Secured Debt (15% Cash, Due 12/31/15)		8,300		8,300		8,300	3.2	%

						8,300		8,300	3.2	%

Worklife America, Inc.	Professional Employer Organization	Common Unit Warrants (3.84% ownership)		-		-		2,964	1.1	%

Worklife America, Inc.	Professional Employer Organization	Preferred Unit Warrants (3.84% ownership)		-		-		499	0.2	%

						-		3,463	1.3	%

Sub Total Non-control/Non-affiliated investments					$	158,338	$	181,245	70.4	%

Affiliate investments - 71.6%

Burgaflex Holdings, LLC	Automobile Part Manufacturer	Senior Subordinated Debt (14% cash, due 8/14/2019)	$	5,000	$	5,000	$	5,000	1.9	%

Burgaflex Holdings, LLC	Automobile Part Manufacturer	Junior Subordinated Debt (12% cash, due 8/14/2019)		7,225		7,225		7,225	2.8	%

Burgaflex Holdings, LLC	Automobile Part Manufacturer	Common Stock (11.54% Ownership)		-		2,104		2,314	0.9	%

						14,329		14,539	5.6	%

Chef'N Corporation	Culinary Products	Subordinated Debt (13%, 2% PIK at company's option, Due 5/16/18)		6,300		6,300		6,300	2.4	%

Chef'N Corporation	Culinary Products	Series A Preferred Stock (1,000,000 shares)		-		1,000		5,206	2.0	%

						7,300		11,506	4.4	%

City Gear, LLC	Footwear Retail	Subordinated Debt (13% Cash, Due 9/28/16)		8,231		8,231		8,231	3.2	%

City Gear, LLC ⁽⁵⁾	Footwear Retail	Preferred Membership Units (9% cash dividend)		-		1,269		1,269	0.5	%

City Gear, LLC	Footwear Retail	Membership Unit Warrants (14.15% fully diluted)		-		-		6,213	2.4	%

						9,500		15,713	6.1	%

Corporate Visions, Inc.	Sales & Marketing Services	Subordinated Debt (14% Cash, 2% PIK, Due 3/22/18)		11,344		11,344		11,344	4.4	%

Corporate Visions, Inc.	Sales & Marketing Services	Common Stock (2,216,463 shares)		-		2,576		11,082	4.3	%

Corporate Visions, Inc.	Sales & Marketing Services	Common Stock Warrant (403,257 shares)		-		-		2,016	0.8	%

						13,920		24,442	9.5	%

GA Communications, Inc. ⁽⁵⁾	Advertising & Marketing Services	Series A-1 Preferred Stock (1,998 shares, 8% PIK dividend)		-		2,145		2,510	1.0	%

GA Communications, Inc.	Advertising & Marketing Services	Series B-1 Common Stock (200,000 shares)		-		2		1,930	0.7	%

						2,147		4,440	1.7	%

Impresa Aerospace Holdings, LLC	Aerospace Parts Manufacturer	Class A Membership Units (1,006,621 units)		-		900		-	0.0	%

Impresa Aerospace Holdings, LLC	Aerospace Parts Manufacturer	Class C Membership Units (362,416 units)		-		362		-	0.0	%

Impresa Aerospace Holdings, LLC	Aerospace Parts Manufacturer	Class F Membership Units (604,504 units)		-		605		-	0.0	%

						1,867		-	0.0	%

J&J Produce Holdings, Inc.	Produce Distribution	Subordinated Debt (13% Cash, Due 7/16/18)		5,182		5,182		5,182	2.0	%

J&J Produce Holdings, Inc.	Produce Distribution	Common Stock (8,182 shares)		-		818		643	0.2	%

J&J Produce Holdings, Inc.	Produce Distribution	Common Stock Warrants (4,506 shares)		-		-		354	0.1	%

						6,000		6,179	2.3	%

LJS Partners, LLC	QSR Franchisor	Common Stock (1,500,000 shares)		-		1,500		2,959	1.1	%

						1,500		2,959	1.1	%

MJC Holdings, LLC	Specialty Clothing	Series A Preferred Units (2,000,000 units)		-		2,000		4,941	1.9	%

						2,000		4,941	1.9	%

MMI Holdings, LLC	Medical Device Distributor	Senior Secured Debt (12% Cash, Due 10/17/14)		2,600		2,600		2,600	1.0	%

MMI Holdings, LLC	Medical Device Distributor	Subordinated Debt (6% Cash, Due 8/15/15)		400		388		400	0.2	%

MMI Holdings, LLC ⁽⁵⁾	Medical Device Distributor	Preferred Units (1,000 units, 6% PIK dividend)		-		1,116		1,254	0.4	%

MMI Holdings, LLC	Medical Device Distributor	Common Units (45 units)		-		-		152	0.1	%

						4,104		4,406	1.7	%

MTI Holdings, LLC	Retail Display & Security Services	Subordinated Debt (12% Cash, Due 11/1/18)		8,000		8,000		8,000	3.1	%

MTI Holdings, LLC	Retail Display & Security Services	Capital Units (2,000,000 units)		-		2,000		4,392	1.7	%

						10,000		12,392	4.8	%

Source Capital ABUTEC, LLC	Environmental Services Products	Senior Secured Debt (12% Cash, 3% PIK, Due 12/28/17)		5,243		5,243		5,243	2.0	%

Source Capital ABUTEC, LLC	Environmental Services Products	Preferred Membership Units (10.8% fully diluted)		-		1,240		181	0.1	%

						6,483		5,424	2.1	%

Source Capital Penray, LLC	Automotive Chemicals & Lubricants	Subordinated Debt (13% Cash, Due 2/17/17)		2,500		2,500		2,500	1.0	%

Source Capital Penray, LLC	Automotive Chemicals & Lubricants	Common Stock Warrants (6.65% ownership)		-		-		512	0.2	%

Source Capital Penray, LLC	Automotive Chemicals & Lubricants	Membership Units (11.3% ownership)		-		750		727	0.3	%

						3,250		3,739	1.5	%

Source Capital SSCR, LLC	Personal Product Manufacturer	Senior Secured Term Debt (10% Cash, Due 6/12/17)		3,000		3,000		2,824	1.1	%

Source Capital SSCR, LLC	Personal Product Manufacturer	Subordinated Debt (14% Cash, Due 9/15/17)		17,125		17,125		13,613	5.3	%

Source Capital SSCR, LLC	Personal Product Manufacturer	Preferred Membership Units (15.8% ownership)		-		1,878		-	0.0	%

Source Capital SSCR, LLC	Personal Product Manufacturer	Membership Unit Warrant (0.31% ownership)		-		10		-	0.0	%

						22,013		16,437	6.4	%

Source Recycling, LLC ⁽²⁾	Metal Recycler	Subordinated Debt (13% Cash, Due 9/2/16)		5,000		5,000		4,150	1.6	%

Source Recycling, LLC	Metal Recycler	Membership Units (68,656 units)		-		1,590		-	0.0	%

Source Recycling, LLC	Metal Recycler	Membership Unit Warrants (1% fully diluted)		-		-		-	0.0	%

						6,590		4,150	1.6	%

Sparus Holdings, Inc. ⁽¹⁾	Energy Services	Senior Secured Debt (12% Cash, 2% PIK, Due 3/21/16)		12,078		12,078		11,715	4.5	%

Sparus Holdings, Inc.	Energy Services	Series B Preferred Stock (5,703 shares)		-		1,173		-	0.0	%

Sparus Holdings, Inc.	Energy Services	Common Stock Warrants (3,491 shares)		-		-		-	0.0	%

						13,251		11,715	4.5	%

STX Healthcare Management Services, Inc. ⁽¹⁾	Dental Practice Management	Subordinated Debt (14% Cash, Due 7/31/15)		7,425		7,425		7,425	2.9	%

STX Healthcare Management Services, Inc.	Dental Practice Management	Common Stock (1,200,000 shares)		-		1,200		710	0.3	%

STX Healthcare Management Services, Inc.	Dental Practice Management	Common Stock Warrants (1,154,254 shares)		-		218		683	0.3	%

						8,843		8,818	3.5	%

TCE Holdings, Inc.	Oil & Gas Services	Subordinated Debt (12% Cash, 2% PIK, Due 11/22/18)		12,273		12,273		12,273	4.8	%

TCE Holdings, Inc.	Oil & Gas Services	Subordinated Debt (12% Cash, 2% PIK, Due 2/1/19)		9,779		9,779		9,779	3.8	%

TCE Holdings, Inc.	Oil & Gas Services	Class A Common Stock (3,600 shares)		-		3,600		3,600	1.4	%

						25,652		25,652	10.0	%

V12 Holdings, Inc. ⁽¹⁾	Data Processing & Digital Marketing	Bridge Note (0% Cash, Due 12/31/14)		663		361		663	0.2	%

V12 Holdings, Inc. ⁽¹⁾	Data Processing & Digital Marketing	Tier 2 Note (0% Cash, Due 12/31/14)		81		44		81	0.0	%

V12 Holdings, Inc. ⁽¹⁾	Data Processing & Digital Marketing	Senior Subordinated Note (0% Cash, Due 12/31/14)		3,563		2,369		3,563	1.4	%

V12 Holdings, Inc. ⁽¹⁾	Data Processing & Digital Marketing	Tier 3 Note (0% Cash, Due 12/31/14)		299		207		299	0.1	%

V12 Holdings, Inc. ⁽¹⁾	Data Processing & Digital Marketing	Jr. Subordinated Note (0% Cash, Due 12/31/14)		2,750		-		2,750	1.1	%

V12 Holdings, Inc. ⁽¹⁾	Data Processing & Digital Marketing	Tier 4 Note (0% Cash, Due 12/31/14)		243		-		243	0.1	%

V12 Holdings, Inc.	Data Processing & Digital Marketing	Series A-1 Preferred Stock (255,102 shares)		-		-		-	0.0	%

V12 Holdings, Inc.	Data Processing & Digital Marketing	Series A-3 Preferred Stock (88,194 shares)		-		-		-	0.0	%

V12 Holdings, Inc.	Data Processing & Digital Marketing	Series A-5 Preferred Stock (20,530 shares)		-		-		-	0.0	%

V12 Holdings, Inc.	Data Processing & Digital Marketing	Common Stock Warrants (2,063,629 warrants)		-		-		-	0.0	%

						2,981		7,599	2.9	%

Sub Total Affiliate investments					$	161,730	$	185,051	71.6	%

Control investments - 30.5%

CableOrganizer Acquisition, LLC	Computer Supply Retail	Senior Secured Term Debt (12% Cash, 4% PIK, Due 5/24/18)	$	10,715	$	10,715	$	10,715	4.2	%

CableOrganizer Acquisition, LLC	Computer Supply Retail	Common Stock (1,125,000 shares)		-		1,125		1,366	0.5	%

						11,840		12,081	4.7	%

KBP Investments, LLC ^{(5) (6)}	QSR Franchisee	Class A Preferred Stock (8,270 shares, 10% Cash Dividend)		-		8,269		8,269	3.2	%

KBP Investments, LLC	QSR Franchisee	Class A Common Stock (380,413 shares)		-		-		11,735	4.5	%

						8,269		20,004	7.7	%

Market E's, LLC ⁽¹⁾	Online Travel Sales & Marketing	Senior Secured Debt (10% Cash, Due 5/31/15)		1,033		965		1,000	0.4	%

Market E's, LLC ^{(1) (2)}	Online Travel Sales & Marketing	Subordinated Debt (14% Cash, 3% PIK, Due 12/31/14)		2,897		2,833		750	0.3	%

Market E's, LLC	Online Travel Sales & Marketing	Class A Preferred Stock (600 shares)		-		240		-	0.0	%

Market E's, LLC	Online Travel Sales & Marketing	Class B Preferred Stock (2,411 shares)		-		965		-	0.0	%

Market E's, LLC	Online Travel Sales & Marketing	Class A Common Stock (600 shares)		-		-		-	0.0	%

						5,003		1,750	0.7	%

Micro Precision, LLC	Conglomerate	Subordinated Debt (10% Cash, Due 9/16/16)		1,862		1,862		1,862	0.7	%

Micro Precision, LLC	Conglomerate	Subordinated Debt (14% Cash, 4% PIK, Due 9/16/16)		3,655		3,655		3,655	1.4	%

Micro Precision, LLC	Conglomerate	Series A Preferred Units (47 units)		-		1,629		1,906	0.7	%

						7,146		7,423	2.8	%

Navis Holdings, Inc.	Textile Equipment Manufacturer	Senior Secured Term Debt (17% Cash, 3% PIK at Company's option, Due 2/1/16)		6,500		6,500		6,500	2.6	%

Navis Holdings, Inc. ⁽⁵⁾	Textile Equipment Manufacturer	Class A Preferred Stock (1,000 shares, 10% Cash Dividend)		-		1,000		1,000	0.3	%

Navis Holdings, Inc.	Textile Equipment Manufacturer	Common Stock (300,000 shares)		-		1		2,441	1.0	%

						7,501		9,941	3.9	%

On-Site Fuel Services, Inc.	Fuel Transportation Services	Subordinated Debt (14% Cash, 4% PIK, Due 12/19/16)		4,997		4,997		4,997	1.9	%

On-Site Fuel Services, Inc.	Fuel Transportation Services	Series A Preferred Stock (32,782 shares)		-		3,278		-	0.0	%

On-Site Fuel Services, Inc.	Fuel Transportation Services	Series B Preferred Stock (23,648 shares)		-		2,365		2,300	0.9	%

On-Site Fuel Services, Inc.	Fuel Transportation Services	Common Stock (33,107 shares)		-		33		-	0.0	%

						10,673		7,297	2.8	%

Print Direction, Inc.	Printing Services	Senior Secured Term Debt (15% Cash, Due 2/24/19)		14,000		14,000		14,000	5.4	%

Print Direction, Inc.	Printing Services	Common Stock (19,363 shares)		-		2,990		6,066	2.4	%

Print Direction, Inc.	Printing Services	Common Stock Warrants (3% fully diluted)		-		-		268	0.1	%

						16,990		20,334	7.9	%

Sub Total Control investments					$	67,422	$	78,830	30.5	%

TOTAL INVESTMENTS - 172.5%					$	387,490	$	445,126	172.5	%

(1) The maturity date of the original investment has been extended.

(2) Due to deterioration in credit quality, this investment is on non-accrual status.

(3) All debt investments are income producing. Equity and warrant investments are non-income producing, unless otherwise noted.

(4) Percentages are based on net assets of $258,116 as of September 30, 2014.

(5) The equity investment is income producing, based on rate disclosed.

(6) During the fourth quarter of 2013, the Company accepted a consent fee that waives its right to dividends through September 30, 2014.

(7) The equity investment has an exercisable put option.

(8) Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company's total assets at the time of acquisition of any additional non-qualifying assets.

See accompanying notes to consolidated financial statements.

Capitala Finance Corp.

Consolidated Schedule of Investments

(in thousands, except for units)

December 31, 2013

Company ^(4, 5)	Industry	Investment Interest Rate / Maturity	Principal Amount		Cost		Fair Value		% of Net Assets
Non-control/Non-affiliated investments - 36.9%
AAE Acquisition, LLC	Industrial Equipment Rental	Senior Secured Term Debt (12% Cash, Due 5/6/15)	$	19,000	$	18,992	$	19,000		7.1	%
AAE Acquisition, LLC	Industrial Equipment Rental	Membership Units (21% fully diluted)		-		25		3,500		1.3	%
						19,017		22,500		8.4	%
American Exteriors, LLC⁽¹⁾	Replacement Window Manufacturer	Senior Secured Debt (14.0% Cash, Due 6/30/14)		4,565		3,365		4,565		1.7	%
American Exteriors, LLC ⁽¹⁾	Replacement Window Manufacturer	Jr. Convertible Note (10.0% Cash, Due 6/30/15)		500		416		612		0.2	%
American Exteriors, LLC ⁽⁸⁾	Replacement Window Manufacturer	Common Stock Warrants (15% fully diluted)		-		-		1,106		0.4	%
						3,781		6,283		2.3	%
Boot Barn Holding Corporation	Western Wear Retail	Common Stock (2,400 shares)		-		2,400		4,774		1.8	%
						2,400		4,774		1.8	%
Caregiver Services, Inc.	In-Home Healthcare Services	Common Stock (293,186 shares)		-		258		231		0.1	%
Caregiver Services, Inc. ⁽⁸⁾	In-Home Healthcare Services	Common Stock Warrants (655,908 units)		-		264		517		0.2	%
						522		748		0.3	%
Crowley Holdings, Inc. ⁽⁶⁾	Transportation	Series A Income Preferred Shares (6,000 shares, 10% cash, 2% PIK dividend)		-		6,000		6,000		2.2	%
						6,000		6,000		2.2	%
Immersive Media Tactical Solutions, LLC	Specialty Defense Contractor	Senior Secured Term Debt (13% Cash, Due 10/6/16)		2,000		2,000		2,000		0.7	%
Immersive Media Tactical Solutions, LLC	Specialty Defense Contractor	Common Unit Warrants (12% fully diluted)		-		-		800		0.3	%
						2,000		2,800		1.0	%
Medical Depot, Inc.	Medical Device Distributor	Subordinated Debt (14% Cash, Due 10/11/16)		4,667		4,667		4,667		1.7	%
Medical Depot, Inc.	Medical Device Distributor	Series C Convertible Preferred Stock (740 shares)		-		1,333		2,129		0.8	%
	`
						6,000		6,796		2.5	%
Naples Lumber & Supply Co ⁽¹⁾	Building Supplies	Subordinated Debt (6% cash, Due 2/15/14)		2,109		1,309		2,109		0.8	%
Naples Lumber & Supply Co	Building Supplies	Common Stock Warrants (10% fully diluted)		-		-		400		0.1	%
						1,309		2,509		0.9	%
Pickaway Plains Ambulance Services, Inc. ^{(1, 2)}	Medical Transportation Services	Senior Secured Term Debt (13% Cash, Due 12/31/15)		1,548		-		-		0.0	%
Pickaway Plains Ambulance Services, Inc.	Medical Transportation Services	Common Stock Warrants (5% fully diluted)		-		-		-		0.0	%
						-		-		0.0	%
Precision Manufacturing, LLC ⁽²⁾	Industrial Boiler Manufacturer	Subordinated Debt (13% Cash, Due 2/10/17)		2,500		2,500		1,536		0.6	%
Precision Manufacturing, LLC	Industrial Boiler Manufacturer	Membership Unit Warrants (70,000 units)		-		-		-		0.0	%
						2,500		1,536		0.6	%
Sierra Hamilton, LLC	Oil & Gas Engineering and Consulting Services	Senior Secured Debt (12.25% Cash, 12/15/18)		15,000		15,000		15,000		5.6	%
						15,000		15,000		5.6	%

Southern Pump & Tank Company, LLC ⁽¹⁾	Petroleum Equipment Supplier	Senior Secured Term Debt (13% Cash, 6% PIK, Due 6/15/14)		3,633		3,213		3,624	1.3	%
Southern Pump & Tank Company, LLC	Petroleum Equipment Supplier	Common Stock Warrants (10% fully diluted)		-		-		-	0.0	%
						3,213		3,624	1.3	%
Stoddard Hill Media Holdings, LLC	IT Hosting Services	Class D Preferred Units (132,159 shares)		-		300		453	0.2	%
						300		453	0.2	%
Tenere, Inc.	Industrial Manufacturing	Senior Secured Term Debt (11% Cash, 2% PIK, Due 12/17/17)		3,440		3,440		3,440	1.3	%
						3,440		3,440	1.3	%
Worklife America, Inc.	Professional Employer Organization	Senior Secured Debt (12% Cash, Due 12/28/16)		18,656		18,656		18,656	7.0	%
Worklife America, Inc.	Professional Employer Organization	Common Unit Warrants (3.84% ownership)		-		-		3,441	1.3	%
Worklife America, Inc.	Professional Employer Organization	Preferred Unit Warrants (3.84% ownership)		-		-		580	0.2	%
						18,656		22,677	8.5	%
Sub Total Non-control/Non-affiliated investments					$	84,138	$	99,140	36.9	%
Affiliate investments - 70.4%
Chef'N Corporation	Culinary Products	Subordinated Debt (15%, 3% PIK at company's option, Due 5/16/18)	$	6,300	$	6,300	$	6,300	2.3	%
Chef'N Corporation	Culinary Products	Series A Preferred Stock (1,000,000 shares)		-		1,000		4,002	1.5	%
						7,300		10,302	3.8	%
City Gear, LLC	Footwear Retail	Subordinated Debt (13% Cash, Due 9/28/16)		8,231		8,231		8,231	3.1	%
City Gear, LLC ⁽⁶⁾	Footwear Retail	Preferred Membership Units (2.78% fully diluted, 9% dividend)		-		1,269		1,269	0.5	%
City Gear, LLC	Footwear Retail	Membership Unit Warrants (11.37% fully diluted)		-		-		5,307	2.0	%
						9,500		14,807	5.6	%
Corporate Visions, Inc.	Sales & Marketing Services	Subordinated Debt (14% Cash, 2% PIK, Due 3/22/18)		11,174		11,174		11,174	4.2	%
Corporate Visions, Inc.	Sales & Marketing Services	Common Stock (2,216,463 shares)		-		2,576		9,797	3.6	%
Corporate Visions, Inc.	Sales & Marketing Services	Common Stock Warrant (403,257 shares)		-		-		1,782	0.7	%
						13,750		22,753	8.5	%
GA Communications, Inc.	Advertising & Marketing Services	Series A-1 Preferred Stock (1,998 shares)		-		1,998		2,370	0.9	%
GA Communications, Inc.	Advertising & Marketing Services	Series B-1 Common Stock (200,000 shares)		-		2		2,541	0.9	%
						2,000		4,911	1.8	%
Impresa Aerospace Holdings, LLC ⁽³⁾	Aerospace Parts Manufacturer	Subordinated Debt (4.1% Cash, Due 4/28/16)		13,274		12,258		10,064	3.7	%
Impresa Aerospace Holdings, LLC	Aerospace Parts Manufacturer	Class A Membership Units (1,006,621 units)		-		900		-	0.0	%
Impresa Aerospace Holdings, LLC	Aerospace Parts Manufacturer	Class C Membership Units (362,416 units)		-		362		-	0.0	%
Impresa Aerospace Holdings, LLC	Aerospace Parts Manufacturer	Class F Membership Units (604,504 units)		-		604		-	0.0	%
						14,124		10,064	3.7	%

Company ^{(4, 5)}	Industry	Investment Interest Rate / Maturity	Principal Amount		Cost		Fair Value		% of Net Assets
J&J Produce Holdings, Inc.	Produce Distribution	Subordinated Debt (13% Cash, Due 7/16/18)		5,182		5,182		5,182		2.0	%
J&J Produce Holdings, Inc.	Produce Distribution	Common Stock (8,182 Shares)		-		818		934		0.3	%
J&J Produce Holdings, Inc.	Produce Distribution	Common Stock Warrants (4,506 shares)		-		-		515		0.2	%
						6,000		6,631		2.5	%
LJS Partners, LLC	QSR Franchisor	Common Stock (1,500,000 shares)		-		1,500		14,622		5.4	%
						1,500		14,622		5.4	%
MJC Holdings, LLC	Specialty Clothing	Subordinated Debt (14%, 2% PIK at company's option, Due 1/16/18)		7,500		7,500		7,500		2.8	%
MJC Holdings, LLC	Specialty Clothing	Series A Preferred Units (2,000,000 units)		-		2,000		5,224		1.9	%
						9,500		12,724		4.7	%
MMI Holdings, LLC	Medical Device Distributor	Senior Secured Debt (12% Cash, Due 10/17/14)		2,600		2,600		2,600		1.1	%
MMI Holdings, LLC	Medical Device Distributor	Subordinated Debt (6% Cash, Due 8/15/15)		400		388		400		0.1	%
MMI Holdings, LLC	Medical Device Distributor	Preferred Units (1,000 units)		-		1,052		1,200		0.4	%
MMI Holdings, LLC	Medical Device Distributor	Common Units (45 units)		-		-		125		0.0	%
						4,040		4,325		1.6	%
MTI Holdings, LLC	Retail Display & Security Services	Subordinated Debt (12% Cash, Due 11/1/18)		8,000		8,000		8,000		3.0	%
MTI Holdings, LLC	Retail Display & Security Services	Capital Units (2,000,000 units)		-		2,000		2,823		1.1	%
						10,000		10,823		4.1	%
Source Capital ABUTEC, LLC	Environmental Services Products	Senior Secured Debt (12% Cash, 3% PIK, Due 12/28/17)		5,125		5,125		5,125		1.9	%
Source Capital ABUTEC, LLC	Environmental Services Products	Preferred Membership Units (15.5% fully diluted)		-		1,240		60		0.0	%
						6,365		5,185		1.9	%
Source Capital Penray, LLC	Automotive Chemicals & Lubricants	Subordinated Debt (13% Cash, Due 2/17/17)		2,500		2,500		2,500		0.9	%
Source Capital Penray, LLC	Automotive Chemicals & Lubricants	Membership Units (11.3% fully diluted)		-		750		810		0.3	%
Source Capital Penray, LLC	Automotive Chemicals & Lubricants	Common Stock Warrants (6.65% fully diluted)		-		-		576		0.2	%
						3,250		3,886		1.4	%
Source Capital SSCR, LLC	Personal Product Manufacturer	Senior Secured Term Debt (14% Cash, Due 7/6/17)		15,000		15,000		12,115		4.5	%
Source Capital SSCR, LLC	Personal Product Manufacturer	Senior Secured Term Debt (14% Cash, 5% PIK, Due 3/28/14)		2,079		2,079		1,958		0.7	%
Source Capital SSCR, LLC	Personal Product Manufacturer	Preferred Membership Units (14,718 units)		-		1,720		-		0.0	%
Source Capital SSCR, LLC	Personal Product Manufacturer	Membership Unit Warrants (0.987% fully diluted)		-		-		-		0.0	%
						18,799		14,073		5.2	%
Source Recycling, LLC ⁽²⁾	Metal Recycler	Subordinated Debt (13% Cash, Due 9/2/16)		5,000		5,000		3,950		1.5	%
Source Recycling, LLC	Metal Recycler	Membership Units (68,658 units)		-		1,590		-		0.0	%
Source Recycling, LLC	Metal Recycler	Membership Unit Warrants (1% fully diluted)		-		-		-		0.0	%
						6,590		3,950		1.5	%
Sparus Holdings, Inc.⁽¹⁾	Energy Services	Subordinated Debt (12% Cash, Due 3/21/16)		7,000		7,000		7,000		2.6	%

Sparus Holdings, Inc.	Energy Services	Series B Preferred Stock (5,703 shares)		-		1,173		1,479	0.6	%
Sparus Holdings, Inc.	Energy Services	Common Stock Warrants (3,491 shares)		-		-		304	0.1	%
						8,173		8,783	3.3	%
STX Healthcare Management Services, Inc. ⁽¹⁾	Dental Practice Management	Subordinated Debt (14% Cash, Due 7/31/15)		7,425		7,425		7,425	2.8	%
STX Healthcare Management Services, Inc.	Dental Practice Management	Common Stock (1,200,000 shares)		-		1,200		942	0.4	%
STX Healthcare Management Services, Inc.	Dental Practice Management	Common Stock Warrants (1,154,254 shares)		-		218		906	0.3	%
						8,843		9,273	3.5	%
Take 5 Oil Change, Inc.	Quick Lube Services	Common Stock (10,692 shares)		-		1,069		1,604	0.6	%
						1,069		1,604	0.6	%
TCE Holdings, Inc.	Oil & Gas Services	Subordinated Debt (12% Cash, 2% PIK, Due 11/22/18)		12,088		12,088		12,088	4.5	%
TCE Holdings, Inc.	Oil & Gas Services	Subordinated Debt (12% Cash, 2% PIK, Due 2/1/19)		9,633		9,633		9,633	3.6	%
TCE Holdings, Inc.	Oil & Gas Services	Class A Common Stock (3,600 shares)		-		3,600		3,600	1.3	%
						25,321		25,321	9.4	%
V12 Holdings⁽¹⁾	Data Processing & Digital Marketing	Bridge Note (0% Cash, Due 12/31/14)		663		361		663	0.3	%
V12 Holdings⁽¹⁾	Data Processing & Digital Marketing	Tier 2 Note (0% Cash, Due 12/31/14)		81		44		81	0.0	%
V12 Holdings⁽¹⁾	Data Processing & Digital Marketing	Senior Subordinated Note (0% Cash, Due 12/31/14)		3,563		2,369		3,598	1.3	%
V12 Holdings⁽¹⁾	Data Processing & Digital Marketing	Tier 3 Note (0% Cash, Due 12/31/14)		299		206		314	0.1	%
V12 Holdings⁽¹⁾	Data Processing & Digital Marketing	Jr. Subordinated Note (0% Cash, Due 12/31/14)		2,750		-		405	0.2	%
V12 Holdings⁽¹⁾	Data Processing & Digital Marketing	Tier 4 Note (0% Cash, Due 12/31/14)		243		-		-	0.0	%
V12 Holdings	Data Processing & Digital Marketing	Series A-1 Preferred Stock (255,102 shares)		-		-		-	0.0	%
V12 Holdings	Data Processing & Digital Marketing	Series A-3 Preferred Stock (88,194 shares)		-		-		-	0.0	%
V12 Holdings	Data Processing & Digital Marketing	Series A-5 Preferred Stock (20,530 shares)		-		-		-	0.0	%
V12 Holdings	Data Processing & Digital Marketing	Common Stock Warrants (2,063,629 warrants)		-		-		-	0.0	%
						2,980		5,061	1.9	%
Sub Total Affiliate investments					$	159,104	$	189,098	70.4	%
Control investments - 28.4%
CableOrganizer Acquisition, LLC	Computer Supply Retail	Senior Secured Debt (12% Cash, 4% PIK, Due 5/24/18)	$	6,585	$	6,585	$	6,585	2.5	%
CableOrganizer Acquisition, LLC	Computer Supply Retail	Common Stock (1,125,000 shares)		-		1,125		88	0.0	%
						7,710		6,673	2.5	%
KBP Investments, LLC ^{(6) (7)}	QSR Franchisee	Class A Preferred Stock (8,270 shares, 10% Dividend)		-		8,269		8,269	3.1	%
KBP Investments, LLC	QSR Franchisee	Class A Common Stock (380,413 shares)		-		-		16,518	6.1	%
						8,269		24,787	9.2	%
Market E’s, LLC	Online Travel Sales & Marketing	Senior Secured Debt (10% Cash, Due 12/31/14)		650		650		650	0.2	%
Market E’s, LLC ⁽¹⁾⁽²⁾	Online Travel Sales & Marketing	Senior Subordinated Debt (14% Cash, 3% PIK, Due 12/31/14)		3,014		2,832		988	0.4	%
Market E’s, LLC	Online Travel Sales & Marketing	Class A Preferred Stock (600 shares)		-		240		-	0.0	%

Market E’s, LLC	Online Travel Sales & Marketing	Class B Preferred Stock (2,411 shares)	-		965		-	0.0	%
Market E’s, LLC	Online Travel Sales & Marketing	Class A Common Stock (600 shares)	-		-		-	0.0	%
					4,687		1,638	0.6	%
Micro Precision, LLC	Conglomerate	Subordinated Debt (10% Cash, Due 9/16/16)	1,862		1,862		1,862	0.7	%
Micro Precision, LLC	Conglomerate	Subordinated Debt (14% Cash, 4% PIK, Due 9/16/16)	3,557		3,557		3,557	1.3	%
Micro Precision, LLC	Conglomerate	Common Stock (47 units)	-		1,629		2,210	0.8	%
					7,048		7,629	2.8	%
Navis Holdings, Inc.	Textile Equipment Manufacturer	Senior Secured Term Debt (17%, 3% PIK at company's option, Due 2/1/16)	6,753		6,753		6,753	2.5	%
Navis Holdings, Inc.	Textile Equipment Manufacturer	Class A Preferred Stock (1,000 shares)	-		1,000		1,200	0.5	%
Navis Holdings, Inc.	Textile Equipment Manufacturer	Common Stock (300,000 shares)	-		1		1,079	0.4	%
					7,754		9,032	3.4	%
On-Site Fuel Services, Inc.	Fuel Transportation Services	Subordinated Debt (14% Cash, 4% PIK, Due 12/19/16)	4,848		4,848		4,848	1.8	%
On-Site Fuel Services, Inc.	Fuel Transportation Services	Series A Preferred Stock (32,782 shares)	-		3,278		2,719	1.0	%
On-Site Fuel Services, Inc. ⁽⁶⁾	Fuel Transportation Services	Series B Preferred Stock (23,648 shares)	-		2,451		2,707	1.0	%
On-Site Fuel Services, Inc.	Fuel Transportation Services	Common Stock (33,107 shares)	-		33		-	0.0	%
					10,610		10,274	3.8	%
Print Direction, Inc. ⁽¹⁾	Printing Services	Subordinated Debt (12% Cash, 6% PIK, Due 7/25/2018)	4,424		4,389		4,424	1.6	%
Print Direction, Inc. ⁽¹⁾	Printing Services	Subordinated Debt (14% Cash, Due 7/31/18)	4,600		4,600		4,600	1.7	%
Print Direction, Inc.	Printing Services	Common Stock (19,363 shares)	-		2,990		7,110	2.7	%
Print Direction, Inc.	Printing Services	Common Stock Warrants (3% fully diluted)	-		-		314	0.1	%
					11,979		16,448	6.1	%
Sub Total Control investments				$	58,057	$	76,481	28.4	%
TOTAL INVESTMENTS - 135.7%				$	301,299	$	364,719	135.7	%

⁽¹⁾ The maturity date of the original investment has been extended.

⁽²⁾ Due to deterioration in credit quality, this investment is on non-accrual status.

⁽³⁾ The debt investment is accruing interest based on the terms of the forebearance agreement.

⁽⁴⁾ All debt investments are income producing. Equity and warrant investments are non-income producing, unless otherwise noted.

⁽⁵⁾ Percentages are based on net assets of $268,670 as of December 31, 2013.

⁽⁶⁾ The equity investment is income producing, based on cash rate disclosed.

⁽⁷⁾ During the fourth quarter of 2013, the Company accepted a consent fee that waives its right to dividends through September 30, 2014.

⁽⁸⁾ The equity investment has an exercisable put option.

See accompanying notes to consolidated financial statements.

CAPITALA FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(unaudited)

Note 1. Organization

Capitala Finance Corp. (the “Company”, “we”, “us”, and “our”) is an externally managed non-diversified closed-end management investment company incorporated in Maryland that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). We are an “emerging growth company” within the meaning of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and as such, are subject to reduced public company reporting requirements. We commenced operations on May 24, 2013 and completed our initial public offering (“IPO”) on September 30, 2013. The Company is managed by Capitala Investment Advisors, LLC (the “Investment Advisor”), an investment adviser that is registered as an investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), and Capitala Advisors Corp. (the “Administrator”) provides the administrative services necessary for us to operate. In addition, for U.S. federal income tax purposes, the Company intends to elect to be treated as a regulated investment company (“RIC”), under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”) commencing with our tax year ending August 31, 2014.

The Company was formed for the purpose of: (i) acquiring, through a series of transactions, an investment portfolio from the following entities: CapitalSouth Partners Fund I Limited Partnership (“Fund I”); CapitalSouth Partners Fund II Limited Partnership (“Fund II”); CapitalSouth Partners Fund III, L.P. (“Fund III Parent”); CapitalSouth Partners SBIC Fund III, L.P. (“Fund III”) and CapitalSouth Partners Florida Sidecar Fund I, L.P. (“Florida Sidecar” and, collectively with Fund I, Fund II, Fund III and Fund III Parent, the “Legacy Funds”); (ii) raising capital in the IPO; and (iii) continuing and expanding the business of the Legacy Funds by making additional debt and equity investments in smaller and lower middle market companies.

The Company’s investment objective is to generate both current income and capital appreciation through debt and equity investments. Both directly and through our subsidiaries that are licensed by the U.S. Small Business Administration (“SBA”) under the Small Business Investment Company (“SBIC”) Act, we offer customized financing to business owners, management teams and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. We invest primarily in traditional mezzanine, senior subordinated and unitranche debt, as well as senior and second-lien loans and, to a lesser extent, equity securities issued by smaller and lower middle-market companies.

On September 24, 2013, the Company acquired 100% of the limited partnership interests in Fund II, Fund III and Florida Sidecar and each of their respective general partners, as well as certain assets from Fund I and Fund III Parent, in exchange for an aggregate of 8,974,420 shares of the Company’s common stock (the “Formation Transactions”). Fund II, Fund III and Florida Sidecar became the Company’s wholly-owned subsidiaries. Fund II and Fund III retained their SBIC licenses and continue to hold their existing investments and continue to make new investments. The IPO consisted of the sale of 4,000,000 shares of the Company’s common stock at a price of $20.00 per share resulting in net proceeds to the Company of $74.25 million, after deducting underwriting fees and commissions totaling $4.0 million and offering expenses totaling $1.75 million. The other costs of the IPO were borne by the limited partners of the Legacy Funds. As of September 30, 2014, the Company had 12,974,420 shares of common stock outstanding.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited financial statements are presented in conformity with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with U.S. GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring adjustments necessary for the fair presentation of financial statements for the interim period, have been reflected in the unaudited consolidated financial statements. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year. Additionally, the unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto appearing in the Company’s annual report on Form 10-K for the period ended December 31, 2013, filed with the U.S Securities and Exchange Commission (“SEC”) on March 28, 2014. Financial statements prepared on a U.S. GAAP basis require management to make estimates and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

The consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries as described in the Formation Transactions presented in Note 1. The transactions related to Fund II, Fund III, and the Florida Sidecar constitute an exchange of shares between entities under common control and will be accounted for in accordance with the Accounting Standards Codification (“ASC”), Topic 805, Business Combinations (“ASC 805”). As such, the results of the Company’s operations and cash flows for the three and nine months ended September 30, 2013 have been presented on a combined basis in order to provide comparative information with respect to prior periods. The Formation Transactions also included an asset acquisition of certain assets in Fund I and Fund III Parent. In accordance with ASC 805, the assets acquired were recorded at fair value at the date of acquisition, September 24, 2013.

The Company’s financial position as of September 30, 2014 is presented on a consolidated basis. The effects of all intercompany transactions between the Company and its subsidiaries (Fund II, Fund III, and the Florida Sidecar) have been eliminated in consolidation. All financial data and information included in these consolidated financial statements have been presented on the basis described above. In the opinion of management, the consolidated financial statements reflect all adjustments that are necessary for the fair presentation of financial results as of and for the periods presented.

Use of Estimates in the Preparation of Financial Statements

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Segments

In accordance with ASC Topic 280 - Segment Reporting, the Company has determined that it has a single reporting segment and operating unit structure.

Cash and Cash Equivalents

The Company considers cash equivalents to be highly liquid investments with original maturities of three months or less at the date of purchase. Cash and cash equivalents include deposits in money market accounts. The Company deposits its cash in financial institutions and, at times, such balances may be in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limits.

Investment Classification

In accordance with the provisions of the 1940 Act, the Company classifies investment by level of control. As defined in the 1940 Act, “Control Investments” are investments in those companies that the Company is deemed to “Control.” “Affiliate Investments” are investments in those companies that are “Affiliated Companies” of the Company, as defined in the 1940 Act, other than Control Investments. “Non-Control/Non-Affiliate Investments” are those investments that are neither Control Investments nor Affiliate Investments. Generally under the 1940 Act, the Company is deemed to control a company in which it has invested if the Company owns more than 25% of the voting securities of such company and/or has greater than 50% representation on its board or has the power to exercise control over management or policies of such portfolio company. The Company is deemed to be an affiliate of a company in which the Company has invested if it owns between 5% and 25% of the voting securities of such company.

Valuation of Investments

The Company applies fair value accounting to all of its financial instruments in accordance with the 1940 Act and ASC Topic 820 - Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework used to measure fair value and requires disclosures for fair value measurements. In accordance with ASC 820, the Company has categorized its financial instruments carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy as discussed in Note 4.

In determining fair value, our board of directors (the “Board”) uses various valuation approaches, and engages a third-party valuation firm, which provides an independent review of certain investments. In accordance with U.S. GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Board. Unobservable inputs reflect the Boards’ assumptions about the inputs market participants would use in pricing the asset or liability developed based upon the best information available in the circumstances.

The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a market for the securities existed. Accordingly, the degree of judgment exercised by the Board in determining fair value is greatest for securities categorized in Level 3 (as defined below). In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls, is determined based on the lowest level input that is significant to the fair value measurement.

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. We use prices and inputs that are current as of the measurement date, including periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many securities. This condition could cause a security to be reclassified to a lower level within the fair value hierarchy.

Valuation Techniques

Senior and Subordinated Secured Loans

The Company’s portfolio primarily consists of private debt instruments (“Level 3 debt”). We consider our Level 3 debt to be performing loans if the borrower is not in default, the borrower is remitting payments in a timely manner, the loan is in covenant compliance or is otherwise not deemed to be impaired. In determining the fair value of the performing Level 3 debt, the Company’s Board considers fluctuations in current interest rates, the trends in yields of debt instruments with similar credit ratings (if applicable), the financial condition of the borrower, economic conditions and other relevant factors, both qualitative and quantitative. In the event that a Level 3 debt instrument is not performing, as defined above, the Board will evaluate the value of the collateral utilizing the same framework described above for a performing loan to determine the value of the Level 3 debt instrument.

This evaluation will be updated no less than quarterly for Level 3 debt instruments that are not performing, and more frequently for time periods where there are significant changes in the collateral or significant changes in the perceived performance of the underlying portfolio company. The collateral value will be analyzed on an ongoing basis using internal metrics, appraisals, third-party valuation agents and other data as may be acquired and analyzed by our management and Board.

Equity Investments in Private Companies

Our Board determines the fair value of its investments in private companies by incorporating valuations that consider the evaluation of financing and sale transactions with third-parties, expected cash flows and market-based information, including comparable transactions, and performance multiples, among other factors, and may use third-party valuation agents. Such non-public investments are included in Level 3 of the fair value hierarchy.

Warrants

Our Board will ascribe value to warrants based on valuation techniques that can include discounted cash flow analyses, option pricing models, comparable analyses and other techniques as deemed appropriate. Such warrants are included in Level 3 of the fair value hierarchy to the extent issued by non-public companies.

Revenue Recognition

The Company’s revenue recognition policies are as follows:

Interest Income and Paid-in Kind Interest Income: Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company has loans in the portfolio that contain a payment-in-kind (“PIK”) provision. PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at maturity, is recorded on the accrual basis to the extent that such amounts are expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to pay all principal and interest when due.

Non-accrual income: Generally, when interest and/or principal payments on a loan become materially past due, or if the Company otherwise does not expect the borrower to be able to service its debt and other obligations, the Company will place the loan on non-accrual status, and will generally cease recognizing interest income and PIK interest on that loan for financial reporting purposes. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. The Company writes off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. The company may elect to cease accruing PIK interest and continue accruing interest income in cases where a loan is currently paying its interest income but, in management’s judgment, there is a reasonable likelihood of principal loss on the loan. Non-accrual loans are returned to accrual status when the borrower’s financial condition improves such that management believes current interest and principal payments are expected to be collected.

Gains and Losses on investment sales and paydowns: Realized gains and losses on investments are recognized using the specific identification method.

Dividend Income and Paid-in-kind Dividends: Dividend income is recognized on the date dividends are declared. Dividend income may be reversed in the event that a previously declared dividend is no longer expected to be paid by the portfolio company. The Company holds preferred equity investments in the portfolio that contain a payment-in-kind dividend (“PIK dividends”) provision. PIK dividends, which represent contractually deferred dividends added to the equity balance, are recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company will typically cease accrual of PIK dividends when the fair value of the equity investment is less than the cost basis of the investment or when it is otherwise determined by management that collection of PIK dividends are unlikely to be collected. If management determines that a decline in fair value is temporary in nature and the PIK dividends are more likely than not to be collected, management may elect to continue accruing PIK dividends.

Other Income: Origination, amendment, consent, closing and/or commitment fees associated with investments in portfolio companies are recognized as income when the investment transaction closes. Prepayment penalties received by the Company for debt instruments repaid prior to maturity date are recorded as income upon receipt.

General and Administrative Expenses

General and administrative expenses are accrued as incurred. The Company’s general and administrative expenses include personnel expenses allocable to the Company under the Administration Agreement, legal and audit fees, director fees, director and officer insurance, and other expenses payable under the Administration Agreement.

Deferred Financing Fees

Costs incurred to issue the SBA-guaranteed debentures and notes payable are capitalized and are amortized over the term of the debt agreements under the effective interest method.

Commitments and Contingencies

As of September 30, 2014 and December 31, 2013, the Company had $1.2 million and $0 of outstanding unfunded commitments, respectively. The Company’s unfunded commitments are all related to debt agreements with existing portfolio companies.

In the ordinary course of its business, the Company may enter into contracts or agreements that contain indemnifications or warranties. Future events could occur that lead to the execution of these provisions against the Company. Based on its history and experience, management feels that the likelihood of such an event is remote.

In the ordinary course of business, the Company may directly or indirectly be a defendant or plaintiff in legal actions with respect to bankruptcy, insolvency or other types of proceedings. Such lawsuits may involve claims that could adversely affect the value of certain financial instruments owned by the Company. As of September 30, 2014, resolution of any outstanding claims is not expected to materially affect the Company’s business, financial position, results of operation, or liquidity.

Income Taxes

The Company intends to elect to be treated for federal income tax purposes, and intends to qualify annually thereafter, as a RIC under Subchapter M of the Code and, among other things, intends to make the requisite distributions to its stockholders which will relieve the Company from federal income taxes. Therefore, no provision has been recorded for federal income taxes.

In order to qualify as a RIC, among other requirements, the Company is required to timely distribute to its stockholders at least 90.0% of its investment company taxable income, as defined by the Code, for each fiscal tax year. The Company will be subject to a nondeductible U.S. federal excise tax of 4.0% on undistributed income if it does not distribute at least 98.0% of its ordinary income in any calendar year and 98.2% of its capital gain net income for each one-year period ending on October 31.

Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year dividend distributions into the next tax year and pay a 4.0% excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions for excise tax purposes, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned.

In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20.0% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock.

For income tax purposes, the Company has paid distributions on its common stock from ordinary income in the amount of $18.3 million during the tax year ended August 31, 2014. The tax character of the distributions is based on estimated taxable income for the tax year ended August 31, 2014. The tax character of the distributions based on actual taxable income for the tax year ended August 31, 2014 will be disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

ASC Topic 740, Income Taxes (“ASC 740”), provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the consolidated financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the current period. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the consolidated statements of operations. As of September 30, 2014 and December 31, 2013, there were no uncertain tax positions.

The Company is required to determine whether a tax position of the Company is more likely-than-not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that could have negatively impact the Company’s net assets.

U.S. GAAP provides guidance on thresholds, measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition that is intended to provide better financial statement comparability among different entities.

The Company has concluded that it was not necessary to record a liability for any such tax positions as of September 30, 2014 and December 31, 2013. However, the Company’s conclusions regarding this policy may be subject to review and adjustment at a later date based on factors including, but not limited to, ongoing analyses of, and changes to, tax laws, regulations and interpretations thereof.

The Company’s activities from commencement of operations remain subject to examination by U.S. federal, state, and local tax authorities. No interest expense or penalties have been assessed for the three and nine month periods ended September 30, 2014 and September 30, 2013. If the Company were required to recognize interest and penalties, if any, related to unrecognized tax benefits this would be recognized as income tax expense in the consolidated statement of operations.

Dividends

Dividends to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is approved by the Board. Net capital gains, if any, are generally distributed at least annually, although we may decide to retain such capital gains for reinvestment.

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a cash dividend or other distribution, each stockholder that has not “opted out” of our dividend reinvestment plan will have his/her dividends automatically reinvested in additional shares of our common stock rather than receiving cash dividends. Stockholders who receive distributions in the form of shares of common stock will be subject to the same federal, state and local tax consequences as if they received cash distributions.

Company Investment Risk, Concentration of Credit Risk, and Liquidity Risk

The Investment Advisor has broad discretion in making investments for the Company. Investments will generally consist of debt and equity instruments that may be affected by business, financial market or legal uncertainties. Prices of investments may be volatile, and a variety of factors that are inherently difficult to predict, such as domestic or international economic and political developments, may significantly affect the results of the Company’s activities and the value of its investments. In addition, the value of the Company’s portfolio may fluctuate as the general level of interest rates fluctuate.

The value of the Company’s investments in loans may be detrimentally affected to the extent, among other things, that a borrower defaults on its obligations, there is insufficient collateral and/or there are extensive legal and other costs incurred in collecting on a defaulted loan, observable secondary or primary market yields for similar instruments issued by comparable companies increase materially or risk premiums required in the market between smaller companies, such as our borrowers, and those for which market yields are observable increase materially.

The Investment Advisor may attempt to minimize this risk by maintaining low loan-to-liquidation values with each loan and the collateral underlying the loan.

The Company’s assets may, at any time, include securities and other financial instruments or obligations that are illiquid or thinly traded, making purchase or sale of such securities and financial instruments at desired prices or in desired quantities difficult. Furthermore, the sale of any such investments may be possible only at substantial discounts, and it may be extremely difficult to value any such investments accurately.

Note 3. Recent Accounting Pronouncements

In June 2013, the FASB issued ASU No. 2013-08, “Financial Services – Investment Companies (Topic 946), Amendments to the Scope, Measurement, and Disclosure Requirements.” The amendments in this accounting standards update affect the scope, measurement, and disclosure requirements for investment companies under U.S. GAAP, and clarify the characteristics of an investment company, provide comprehensive guidance for assessing whether an entity is an investment company, require that an investment company measure non-controlling ownership interests in other investment companies at fair value rather than using the equity method of accounting, and require additional disclosures. This standard is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013. The Company has adopted this standard and the required disclosures are presented in the consolidated financial statements.

Note 4. Investments

The Company’s investment objective is to generate both current income and capital appreciation through debt and equity investments. Both directly and through our subsidiaries that are licensed by the SBA under the SBIC Act, we offer customized financing to business owners, management teams and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. We invest primarily in traditional mezzanine, senior subordinated and unitranche debt, as well as senior and second-lien loans and, to a lesser extent, equity securities issued by smaller and lower middle-market companies. As of September 30, 2014, our portfolio consisted of investments in 50 portfolio companies with a fair value of approximately $445.1 million.

During the three months ended September 30, 2014, the Company made approximately $86.7 million of investments in new or existing portfolio companies and had approximately $44.7 million in exits and repayments resulting in net investments of approximately $42.0 million for the period. During the three months ended September 30, 2013, the Company made approximately $34.2 million of investments in new or existing portfolio companies and had approximately $23.1 million in exits and repayments resulting in net investments of approximately $11.1 million for the period.

During the nine months ended September 30, 2014, the Company made approximately $150.3 million of investments in new or existing portfolio companies and had approximately $64.8 million in exits and repayments resulting in net investments of approximately $85.5 million for the period. During the nine months ended September 30, 2013, the Company made approximately $75.8 million of investments in new or existing portfolio companies and had approximately $50.2 million in exits and repayments resulting in net investments of approximately $25.6 million for the period.

During the three and nine month periods ended September 30, 2014, all new investments were made to portfolio companies in which the Company was not previously contractually obligated to provide financial support. In addition to investing directly in portfolio companies, the Company may assist portfolio companies in securing financing from other sources by introducing portfolio companies to sponsors or by leading a syndicate of investors to provide the portfolio companies with financing. During the nine month period ended September 30, 2014, the Company did not lead any syndicates. During the three months ended September 30, 2014 the Company did not assist any portfolio companies in obtaining indirect financing. During the nine month period ended September 30, 2014, the Company helped Print Direction, Inc. obtain a $3.5 million senior revolving credit facility.

The composition of our investments as of September 30, 2014, at amortized cost and fair value were as follows (dollars in thousands):

	Investments at Amortized Cost		Amortized Cost Percentage of Total Portfolio			Investments at Fair Value		Fair Value Percentage of Total Portfolio
Senior Secured Debt	$	134,258		34.6	%	$	136,171		30.6	%
Subordinated Debt		187,842		48.5			186,483		41.9
Equity and Warrants		65,390		16.9			122,472		27.5
Total	$	387,490		100.0	%	$	445,126		100.0	%

The composition of our investments as of December 31, 2013, at amortized cost and fair value were as follows (dollars in thousands):

	Investments at Amortized Cost		Amortized Cost Percentage of Total Portfolio			Investments at Fair Value		Fair Value Percentage of Total Portfolio
Senior Secured Debt	$	103,457		34.3	%	$	102,071		28.0	%
Subordinated Debt		136,638		45.4			133,710		36.7
Equity and Warrants		61,204		20.3			128,938		35.3
Total	$	301,299		100.0	%	$	364,719		100.0	%

As noted above, the Company values all investments in accordance with ASC 820. ASC 820 requires enhanced disclosures about assets and liabilities that are measured and reported at fair value. As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

ASC 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.

Based on the observability of the inputs used in the valuation techniques, the Company is required to provide disclosures on fair value measurements according to the fair value hierarchy. The fair value hierarchy ranks the observability of the inputs used to determine fair values. Investments carried at fair value are classified and disclosed in one of the following three categories:

•

Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

•

Level 2—Valuations based on inputs other than quoted prices in active markets, which are either directly or indirectly observable.

•

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

In addition to using the above inputs in investment valuations, the Company continues to employ the valuation policy approved by the Board that is consistent with ASC 820 (See Note 2). Consistent with our Company’s valuation policy, we evaluate the source of inputs, including any markets in which our investments are trading, in determining fair value.

In estimating fair value of portfolio investments, the Company starts with the cost basis of the investment, which includes amortized original issue discount and PIK interest and dividends, if any. The transaction price is typically the best estimate of fair value at inception. When evidence supports a subsequent change to the carrying value from the original transaction price, adjustments are made to reflect the expected fair values.

The following valuation methodologies are utilized by the company in estimating fair value and are summarized as follows:

Enterprise Value Waterfall Approach

The enterprise value waterfall approach determines an enterprise value based on earnings before interest, tax, depreciation and amortization (“EBITDA”) multiples of publicly traded companies that are considered similar to the subject portfolio company. The Company considers a variety of items in determining a reasonable pricing multiple, including operating results, budgeted projections, growth, size, risk, profitability, leverage, management depth, diversification, market position, supplier or customer dependence, asset utilization, liquidity metrics, and access to capital markets. EBITDA of the portfolio company is adjusted for non-recurring items in order to reflect a normalized level of earnings that is representative of future earnings. When available, the Company may assign a pricing multiple or value its equity investments based on the value of recent investment transactions in the subject portfolio company. The enterprise value is adjusted for financial instruments with seniority to the Company’s ownership and for the effect of any instrument which may dilute the Company’s investment in the portfolio company. The adjusted enterprise value is then apportioned based on the seniority and privileges of the Company’s investments within the portfolio company.

Income Approach

The income approach utilizes a discounted cash flow methodology in which the Company estimates fair value based on the present value of a stream of expected cash flows discounted at a market rate of interest. The determination of a discount rate, or required rate of return, takes into account the portfolio company’s fundamentals and perceived credit risk.

Asset Approach

The asset approach values an investment based on the greater of the enterprise value or the underlying collateral securing the investment. See discussion of determining enterprise value above. This approach is used when the debt is not performing in accordance with its contractual terms or when the Company has reason to believe that it will not collect all principal and interest in accordance with the contractual terms of the debt agreement.

The following table presents fair value measurements of investments, by major class, as of September 30, 2014 (dollars in thousands), according to the fair value hierarchy:

	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Senior Secured Debt	$	—	$	—	$	136,171	$	136,171
Subordinated Debt		—		—		186,483		186,483
Equity and Warrants		—		—		122,472		122,472
Total	$	—	$	—	$	445,126	$	445,126

The following table presents fair value measurements of investments, by major class, as of December 31, 2013 (dollars in thousands), according to the fair value hierarchy:

	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
Senior Secured Debt	$	—	$	—	$	102,071	$	102,071
Subordinated Debt		—		—		133,710		133,710
Equity and Warrants		—		—		128,938		128,938
Total	$	—	$	—	$	364,719	$	364,719

The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the nine months ended September 30, 2014 (dollars in thousands):

	Senior Secured Debt			Subordinated Debt			Equity and Warrants			Total
Balance as of January 1, 2014	$	102,071		$	133,710		$	128,938		$	364,719
Change in classification due to restructure		(7,073	)		7,073			—			—
Repayments		(36,300	)		(23,683	)		(4,850	)		(64,833	)
Purchases		76,345			69,069			4,890			150,304
Payment in-kind interest and dividends, net of payments received		809			792			460			2,061
Accretion of original issue discount		25			7			—			32
Realized gain/(loss) from investments		—			(5,059	)		3,686			(1,373	)
Increase/(decrease) in net unrealized appreciation		294			4,574			(10,652	)		(5,784	)
Balance as of September 30, 2014	$	136,171		$	186,483		$	122,472		$	445,126

The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the nine months ended September 30, 2013 (dollars in thousands):

	Senior Secured Debt			Subordinated Debt			Equity and Warrants			Total
Balance as of January 1, 2013	$	73,638		$	101,659		$	108,634		$	283,931
Change in classification due to restructure		6,735			(6,735	)		—			—
Repayments		(22,958	)		(20,004	)		(7,247	)		(50,209	)
Purchases		24,775			44,459			6,583			75,817
Purchase related to asset acquisition		5,601			2,353			3,842			11,796
Payment in-kind interest and dividends, net of payments received		362			568			—			930
Accretion of original issue discount		4			31			—			35
Realized gain/(loss) from investments		—			(2,597	)		4,832			2,235
Increase in net unrealized appreciation		75			3,899			2,468			6,442
Balance as of September 30, 2013	$	88,232		$	123,633		$	119,112		$	330,977

The net change in unrealized appreciation on investments held as of September 30, 2014 was a decrease of $7.4 million and is included in net unrealized depreciation on investments in the consolidated statements of operations for the nine months ended September 30, 2014. The net change in unrealized appreciation on investments held as of September 30, 2013 was $4.2 million and is included in net unrealized appreciation on investments in the consolidated statements of operations for the nine months ended September 30, 2014.

The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements of assets as of September 30, 2014 were as follows (dollars in thousands, except EBITDA amounts):

Fair Value

Valuation Approach

Level 3 Input

Range of Inputs

Weighted
Average

Subordinated debt and second lien notes

169,053

Income

Required Rate of Return
Leverage Ratio
Adjusted EBITDA

8.8% - 20.0%
1.4x – 9.9x
$2.3 million-$200.0 million

13.1%
4.4x
$41.3 million

Subordinated debt and second lien notes

17,430

Enterprise Value
Waterfall and Asset (1)

Adjusted EBITDA Multiple
Adjusted EBITDA

5.0x – 5.0x
$0.7 million - $2.8 million

5.4x
$2.3 million

Senior debt and first lien notes

136,171

Income and Asset (1)

Required Rate of Return
Leverage Ratio
Adjusted EBITDA

10.0% - 18.0%
1.0x – 9.9x
$0.6 million- $44.4 million

14.3%
4.3x
$10.2 million

Equity shares and warrants

122,472

Enterprise Value
Waterfall

Adjusted EBITDA Multiple
Adjusted EBITDA

4.5x – 11.0x
$1.6 million -$205.9 million

7.3x
$25.2 million

(1)

$14.4 million in subordinated notes and $9.3 million senior notes were valued using the asset approach.

The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements of assets as of December 31, 2013 were as follows (dollars in thousands, except EBITDA amounts):

Fair Value

Valuation Approach

Level 3 Input

Range of Inputs

Weighted
Average

Subordinated debt and second lien notes

111,711

Income

Required Rate of Return
Leverage Ratio
Adjusted EBITDA

7.0% - 18.0%
1.2x – 4.6x
$2.3 million-$25.8 million

14.1%
3.1x
$11.2 million

Subordinated debt and second lien notes

21,999

Enterprise Value
Waterfall and Asset (1)

Adjusted EBITDA Multiple
Adjusted EBITDA

4.3x – 11.5x
$1.3 million - $2.2 million

9.5x
$2.0 million

Senior debt and first lien notes

102,071

Income and Asset (1)

Required Rate of Return
Leverage Ratio
Adjusted EBITDA

10.0% - 24.5%
1.2x – 9.9x
$0.6 million- $29.7 million

15.2%
3.8x
$11.2 million

Equity shares and warrants

128,938

Enterprise Value
Waterfall

Adjusted EBITDA Multiple
Adjusted EBITDA
Transaction Price

1.6x – 9.5x
$1.4 million -$229.0 million
n/a

7.1x
$23.8 million
n/a

(1)

$15.0 million in subordinated notes and $3.6 million in senior notes were valued using the asset approach.

The significant unobservable inputs used in the valuation of the Company’s debt and equity investments are required rate of return, adjusted EBITDA, EBITDA multiples, leverage and transaction prices. Changes in any of these unobservable inputs could have a significant impact on the Company’s estimate of fair value. An increase (decrease) in required rate of return or leverage will result in a lower (higher) estimate of fair value while an increase (decrease) in adjusted EBITDA, EBITDA multiples, or transaction prices will result in a higher (lower) estimate of fair value.

Note 5. Agreements

On September 24, 2013, the Company entered into an investment advisory agreement (the “Investment Advisory Agreement”) with the Investment Advisor, which was approved by the Board of Directors of the Company on June 10, 2013. The initial term of the Investment Advisory Agreement is two years, with automatic, one-year renewals at the end of each year subject to certain approvals by our Board of Directors. The Investment Advisory Agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. Subject to the overall supervision of our Board of Directors, the Investment Advisor manages our day-to-day operations, and provides investment advisory and management services to us. Under the terms of our Investment Advisory Agreement, the Investment Advisor:

•

determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;

•

identifies, evaluates and negotiates the structure of the investments we make (including performing due diligence on our prospective portfolio companies);

•

closes and monitors the investments we make; and

•

provides us with other investment advisory, research and related services as we may from time to time require.

The Investment Advisor’s services under the Investment Advisory Agreement are not exclusive, and it is free to furnish similar services to other entities so long as its services to us are not impaired.

The Investment Advisory Agreement provides that, absent willful misfeasance, bad faith or negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, our Investment Advisor and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from the Company, for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our Investment Advisor’s services under the Investment Advisory Agreement or otherwise as Investment Advisor for the Company.

Pursuant to the Investment Advisory Agreement, we have agreed to pay the Investment Advisor a fee for investment advisory and management services consisting of two components — a base management fee and an incentive fee.

The base management fee is calculated at an annual rate of 1.75% of our gross assets, which is our total assets as reflected on our Consolidated Statements of Assets and Liabilities and includes any borrowings for investment purposes. Although we do not anticipate making significant investments in derivative financial instruments, the fair value of any such investments, which will not necessarily equal their notional value, will be included in our calculation of gross assets. For services rendered under the Investment Advisory Agreement, the base management fee is payable quarterly in arrears. The base management fee was initially calculated based on the value of our gross assets at the end of the first calendar quarter subsequent to our IPO, and thereafter based on the average value of our gross assets at the end of the two most recently completed calendar quarters, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter. For the first twelve months following our IPO, the Investment Advisor waived the portion of the base management fee payable on cash and cash equivalents held at the Company level, excluding cash and cash equivalents held by the Legacy Funds that were acquired by the Company in connection with the Formation Transactions.

Prior to the Formation Transactions, the management fee charged by each Legacy Fund for each fiscal quarter was the lesser of (a) an amount equal to an annual rate of .625% of the sum of (i) the Legacy Funds’ regulatory capital and (ii) the amount of an assumed two tiers of outstanding leverage based on such regulatory capital, or (b) an amount negotiated between the general partner and the management company. The management fee was reduced by certain fees ultimately received by the investment adviser to the Legacy Funds from the portfolio companies. Payments of the management fee were made quarterly in advance. Certain direct expenses such as legal, audit, tax, and limited partner expense were the responsibility of the Legacy Funds.

The incentive fee consists of the following two parts:

The first part of the incentive fee is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the Administration Agreement to our Administrator, and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net investment income does not include any realized capital gains, computed net of all realized capital losses or unrealized capital appreciation or depreciation. Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets at the end of the immediately preceding calendar quarter, is compared to a hurdle of 2.0% per quarter (8.0% annualized). Our net investment income used to calculate this part of the incentive fee is also included in the amount of our gross assets used to calculate the 1.75% base management fee. We pay the Investment Advisor an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:

•

no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the hurdle of 2.0%;

•

100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle but is less than 2.5% in any calendar quarter (10.0% annualized). We refer to this portion of our pre-incentive fee net investment income (which exceeds the hurdle but is less than 2.5%) as the “catch-up.” The “catchup” is meant to provide our Investment Advisor with 20% of our pre-incentive fee net investment income as if a hurdle did not apply if this net investment income exceeds 2.5% in any calendar quarter; and

•

20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.5% in any calendar quarter (10.0% annualized) is payable to our Investment Advisor (once the hurdle is reached and the catch-up is achieved, 20% of all pre-incentive fee investment income thereafter is allocated to the Investment Advisor).

The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date), and will equal 20% of our realized capital gains, if any, on a cumulative basis from inception through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees with respect to each of the investments in our portfolio.

We will defer cash payment of the portion of any incentive fee otherwise earned by our Investment Advisor that would, when taken together with all other incentive fees paid to our Investment Advisor during the most recent 12 full calendar month period ending on or prior to the date such payment is to be made, exceed 20% of the sum of (a) our pre-incentive fee net investment income during such period, (b) our net unrealized appreciation or depreciation during such period and (c) our net realized capital gains or losses during such period. Any deferred incentive fees will be carried over for payment in subsequent calculation periods to the extent such payment is payable under the Investment Advisory Agreement. Such deferred amounts will be calculated using a period of shorter than 12 full calendar months until 12 full calendar months have passed since completion of our IPO.

For the three months ended September 30, 2014 and 2013, we incurred $2.5 million and $1.0 million in base management fees, respectively. For the three months ended September 30, 2014 and 2013, our Investment Advisor waived $38 thousand and $0, respectively. For the three months ended September 30, 2014 and 2013, we incurred $0 million and $0, respectively, in incentive fees related to pre-incentive fee net investment income.

For the nine months ended September 30, 2014 and 2013, we incurred $6.8 million and $3.0 million in base management fees, respectively. For the nine months ended September 30, 2014 and 2013, our Investment Advisor waived $238 thousand and $0, respectively. For the nine months ended September 30, 2014 and 2013, we incurred $2.8 million and $0, respectively, in incentive fees related to pre-incentive fee net investment income.

On September 24, 2013, the Company entered into a separate administration agreement (the “Administration Agreement”) with Capitala Advisors Corp., our Administrator, pursuant to which our Administrator has agreed to furnish us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Our Administrator also performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for the financial records that we are required to maintain and preparing reports to our stockholders. In addition, our Administrator assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others.

Payments under the Administration Agreement are equal to an amount based upon our allocable portion of our Administrator’s overhead in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions and our allocable portion of the compensation of our chief financial officer, chief compliance officer and our allocable portion of the compensation of any administrative support staff. Under the Administration Agreement, our Administrator will also provide on our behalf managerial assistance to those portfolio companies that request such assistance. The Administration Agreement has an initial term of two years and may be renewed annually with the approval of our Board of Directors. The Administration Agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. To the extent that our Administrator outsources any of its functions, we will pay the fees associated with such functions on a direct basis without any incremental profit to our Administrator. Stockholder approval is not required to amend the Administration Agreement.

The Administration Agreement provides that, absent willful misfeasance, bad faith or negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, our Administrator and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from the Company, for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our Administrator’s services under the Administration Agreement or otherwise as Administrator for the Company.

Note 6. Related Party Transactions

At September 30, 2014 and December 31, 2013, the Company had the following receivables from (payables to) related parties relating to management fees, incentive fees, and reimbursable expenses (dollars in thousands):

	September 30, 2014		December 31, 2013
CapitalSouth Corporation	$	252	$	252
Shareholders/Limited Partners		270		267
CapitalSouth Fund III, L.P.		—		1,118
Capitala Investment Advisors, LLC		(450)		(2,670	)
Total	$	72	$	(1,033	)

These amounts are reflected in the accompanying statements of financial position under the captions, “Due from related parties”, “Incentive fee payable” and “Due to related parties.”

At times, the Company maintains deposit accounts and certificates of deposit with financial institutions that are shareholders of the Company. Total deposits with these financial institutions were approximately $34 thousand and $2.8 million at September 30, 2014 and December 31, 2013, respectively.

Note 7. Borrowings

SBA Debentures

The Company, through its two wholly-owned subsidiaries, uses debenture leverage provided through the SBA to fund a portion of its investment portfolio. As of September 30, 2014, the Company has issued $192.2 million of SBA-guaranteed debentures. The Company has issued all SBA-guaranteed debentures that were permitted under each of the Legacy Funds’ respective SBIC licenses (as applicable), and there are no unused SBA debenture commitments remaining. SBA-guaranteed debentures are secured by a lien on all assets of Fund II and Fund III. As of September 30, 2014, Fund II and Fund III had total assets of approximately $374.3 million. On June 10, 2014, the Company received an exemptive order from the SEC exempting the Company, Fund II and Fund III from certain provisions of the 1940 Act (including an exemptive order granting relief from the asset coverage requirements for certain indebtedness issued by Fund II and Fund III as SBICs) and from certain reporting requirements mandated by the Securities Exchange Act of 1934, as amended, with respect to Fund II and Fund III. The Company intends to comply with the conditions of the order.

For the three months ended September 30, 2014 and September 30, 2013, we recorded $2.1 million and $2.2 million, respectively, of interest, annual charges, and financing expenses related to the SBA guaranteed debentures, of which $1.9 million and $2.0 million, respectively, was attributable to interest expense and annual charges, and $0.2 million and $0.2 million, respectively, was attributable to amortization of commitment and upfront fees. For the nine months ended September 30, 2014 and September 30, 2013, we recorded $6.4 million and $6.5 million, respectively, of interest, annual charges, and financing expenses related to the SBA guaranteed debentures, of which $5.9 million and $6.0 million, respectively, was attributable to interest expense and annual charges, and $0.5 million and $0.5 million, respectively, was attributable to amortization of commitment and upfront fees. The weighted average interest rate for all SBA-guaranteed debentures as of September 30, 2014 and December 31, 2013 was 3.51% and 3.57%, respectively. In addition to the stated interest rate, the SBA also charges an annual fee on all SBA-guaranteed debentures issued, which is included in the Company’s interest expense. The weighted average annual fee for all SBA-guaranteed debentures as of September 30, 2014 and December 31, 2013 was 0.48% and 0.50%, respectively.

As of September 30, 2014 and December 31, 2013, the Company’s issued and outstanding SBA-guaranteed debentures mature as follows (dollars in thousands):

Date of Pooling	Fixed Maturity Date	Interest Rate			SBA Annual Charge			September 30, 2014		December 31, 2013
March 1, 2004	March 1, 2014		4.120	%		0.855	%	$	—	$	2,000
September 1, 2004	September 1, 2014		4.684	%		0.855	%		—		8,000
September 1, 2005	September 1, 2015		4.941	%		0.871	%		8,000		8,000
March 1, 2006	March 1, 2016		5.524	%		0.871	%		2,000		2,000
September 1, 2006	September 1, 2016		5.535	%		0.941	%		11,500		11,500
March 1, 2009	March 1, 2019		4.620	%		0.941	%		5,000		5,000
September 1, 2010	September 1, 2020		3.215	%		0.285	%		19,000		19,000
March 1, 2011	March 1, 2021		4.084	%		0.515	%		15,700		15,700
March 1, 2011	March 1, 2021		4.084	%		0.285	%		46,000		46,000
March 1, 2012	March 1, 2022		2.766	%		0.285	%		10,000		10,000
March 1, 2012	March 1, 2022		2.766	%		0.515	%		50,000		50,000
March 1, 2013	March 1, 2023		2.351	%		0.515	%		25,000		25,000
								$	192,200	$	202,200

ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. The Company estimates that the fair value of its SBA-guaranteed debentures is approximately $192.0 million and $200.7 million as of September 30, 2014 and December 31, 2013, respectively. The fair value estimate was based on future contractual cash payments discounted at market interest rates to borrow from the SBA as of the measurement date. Because the market interest rate is considered an unobservable input, SBA-guaranteed debentures are considered a level 3 financial instrument in the fair value hierarchy.

Notes

In June 2014, the Company issued $113.4 million in aggregate principal amount of 7.125% fixed-rate notes due 2021 (the “Notes”). The Notes will mature on June 16, 2021, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after June 16, 2017 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest will be payable quarterly beginning September 16, 2014.

As of September 30, 2014, the carrying amount and fair value of the Notes was $113.4 million and $115.0 million, respectively. The fair value of the Notes, which are publicly traded, is based upon closing market quotes as of the measurement date. Because the fair value is determined by quoted prices for the Notes, the Notes are considered a level 1 financial instrument in the fair value hierarchy. As of September 30, 2014, $4.4 million of financing costs related to the Notes have been capitalized and are being amortized over the term of the Notes. For the three months ended September 30, 2014, the Company has recorded $2.0 million of interest expense and $0.1 million of amortization of deferred financing costs related to the Notes. For the nine months ended September 30, 2014, the Company has recorded $2.4 million of interest expense and $0.1 million of amortization of deferred financing costs related to the Notes.

Note 8. Directors Fees

Our independent directors receive an annual fee of $50,000. They also receive $5,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each board meeting, and also receive $5,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting. In addition, the chairman of the audit committee receives an annual fee of $10,000 and each chairman of any other committee receives an annual fee of $5,000 for their additional services, if any, in these capacities. For the three and nine months ended September 30, 2014, the Company recognized director fee expense of $90,000 and $278,250, respectively. For the three and nine months ended September 30, 2013, the Company recognized director fee expense of $0 and $0, respectively. No compensation is expected to be paid to directors who are “interested persons” of the Company, as such term is defined in Section 2(a)(19) of the 1940 Act.

Note 9. Stockholders’ Equity

On September 24, 2013, we issued 8,974,420 shares of common stock to the limited partners of the Legacy Funds, in exchange for 100% of their membership interests or certain investment assets of such Legacy Fund, as the case may be. On September 30, 2013, we issued 4,000,000 shares of common stock in connection with the closing of our IPO. The shares issued in the IPO were priced at $20.00 per share. We received proceeds of $74.25 million in the IPO, net of underwriters’ discounts and commissions totaling $4.0 million and offering expenses totaling $1.75 million. The Legacy Funds bore the other expenses associated with the offering. As of September 30, 2014, the Company had 12,974,420 shares of common stock outstanding.

Note 10. Summarized Financial Information of Our Unconsolidated Subsidiaries

The Company holds a control interest, as defined by the 1940 Act, in four majority owned portfolio companies that are not consolidated in the Company’s consolidated financial statements. Below is a brief description of each portfolio company, along with summarized financial information as of September 30, 2014 and December 31, 2013, and for the nine month period ended September 30, 2014 and September 30, 2013.

Print Direction, Inc.

Print Direction, Inc., incorporated in Georgia on May 11, 2006, is a professional printing services firm serving customers, particular fast food, retail, and other similar chains, throughout the United States. Print Direction, Inc. also provides warehousing and distribution services for these customers. The income the Company generated from Print Direction, Inc., which includes all interest, dividends, PIK interest and dividends, fees, and unrealized appreciation/depreciation, was $3.9 million and $3.2 million for the nine months ended September 30, 2014 and September 30, 2013, respectively.

Navis Holdings, Inc.

Navis Holdings, Inc., incorporated in Delaware on December 21, 2010, designs and manufactures leading machinery for the global knit and woven finishing textile industries. The income the Company generated from Navis Holdings, Inc., which includes all interest, dividends, PIK interest and dividends, fees, and unrealized appreciation, was $3.3 million and $1.6 million for the nine months ended September 30, 2014 and September 30, 2013, respectively.

On-Site Fuel Service, Inc.

On-Site Fuel Service, Inc. is a 100% owned subsidiary of On-Site Fuel Holdings, Inc., which was incorporated in Delaware on December 19, 2011. On-Site Fuel Service, Inc. provides fueling services for commercial and government vehicle fleets throughout the southeast United States. The loss the Company generated from On-Site Fuel Service, Inc., which includes all interest, dividends, PIK interest and dividends, fees, and unrealized depreciation, was $2.5 million for the nine months ended September 30, 2014. The income the Company generated from On-Site Fuel Service, Inc. which includes all interest, dividends, PIK interest and dividends, fees, and unrealized appreciation was $1.8 million for the nine months ended September 30, 2013.

CableOrganizer Holdings, LLC

CableOrganizer Holdings, LLC, a Delaware limited liability company that began operations on April 23, 2013, is a leading online provider of cable and wire management products. The income the Company generated from CableOrganizer Holdings, LLC, which includes all interest, dividends, PIK interest and dividends, fees, and unrealized appreciation, was $2.4 million and $0.3 million for the nine months ended September 30, 2014 and September 30, 2013, respectively.

The summarized financial information of our unconsolidated subsidiaries was as follows (dollars in thousands):

	As of
Balance Sheet - Print Direction, Inc.	September 30, 2014			December 31, 2013
Current assets	$	4,889		$	5,738
Noncurrent assets		5,481			5,955
Total assets	$	10,370		$	11,693

Current liabilities	$	3,146		$	3,828
Noncurrent liabilities		14,510			10,496
Total liabilities	$	17,656		$	14,324

Total equity	$	(7,286	)	$	(2,631	)

	Nine Months Ended
Statements of Operations - Print Direction, Inc.	September 30, 2014		September 30, 2013
Net sales	$	16,763	$	18,919
Cost of goods sold		6,629		8,174
Gross profit	$	10,134	$	10,745

Other expenses	$	9,997	$	9,493
Income before income taxes		137		1,252
Income tax provision		58		551
Net income	$	79	$	701

	As of
Balance Sheet - Navis Holdings, Inc.	September 30, 2014			December 31, 2013
Current assets	$	4,574		$	5,216
Noncurrent assets		5,399			5,333
Total assets	$	9,973		$	10,549

Current liabilities	$	3,441		$	1,761
Noncurrent liabilities		6,897			7,053
Total liabilities	$	10,338		$	8,814

Total equity	$	(365	)	$	1,735

	Nine Months Ended
Statements of Operations - Navis Holdings, Inc.	September 30, 2014		September 30, 2013
Net sales	$	10,642	$	10,895
Cost of goods sold		6,630		7,442
Gross profit	$	4,012	$	3,453

Other expenses	$	3,713	$	3,469
Income (loss) before income taxes		299		(16	)
Income tax provision (benefit)		124		(4	)
Net income	$	175	$	(12	)

	As of
Balance Sheet – On-Site Fuel Service, Inc.	September 30, 2014		December 31, 2013
Current assets	$	16,695	$	15,578
Noncurrent assets		17,375		18,124
Total assets	$	34,070	$	33,702

Current liabilities	$	14,572	$	12,666
Noncurrent liabilities		11,284		11,442
Total liabilities	$	25,856	$	24,108

Total equity	$	8,214	$	9,594

	Nine Months Ended
Statements of Operations - On-Site Fuel Service, Inc.	September 30, 2014			September 30, 2013
Net sales	$	158,709		$	179,465
Cost of goods sold		150,540			170,904
Gross profit	$	8,169		$	8,561

Other expenses	$	9,548		$	8,818
Loss before income taxes		(1,379	)		(257	)
Income tax provision		—			—
Net loss	$	(1,379	)	$	(257	)

	As of
Balance Sheet – CableOrganizer Holdings, LLC	September 30, 2014		December 31, 2013
Current assets	$	3,641	$	2,441
Noncurrent assets		12,659		8,469
Total assets	$	16,300	$	10,910

Current liabilities	$	1,804	$	1,299
Noncurrent liabilities		10,925		6,585
Total liabilities	$	12,729	$	7,884

Total equity	$	3,571	$	3,026

	Nine Months Ended
Statements of Operations - CableOrganizer Holdings, LLC	September 30, 2014		September 30, 2013
Net sales	$	18,191	$	12,178
Cost of goods sold		11,585		7,295
Gross profit	$	6,606	$	4,883

Other expenses	$	5,893	$	3,863
Income before income taxes		713		1,020
Income tax provision		—		—
Net loss	$	713	$	1,020

Note 11. Earnings Per Share

In accordance with the provisions of ASC 260, Earnings per Share, basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. As of September 30, 2014, there were no dilutive shares.

The following information sets forth the computation of the weighted average basic and diluted net increase in net assets per share from operations for the three and nine months ended September 30, 2014 and September 30, 2013 (dollars in thousands except share and per share data):

	For the three months ended				For the nine months ended
Basic and diluted	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Net increase in net assets from operations	$	311	$	7,909	$	7,740	$	22,062
Weighted average common shares outstanding		12,974,420		12,974,420		12,974,420		12,974,420
Net increase in net assets per share from operations-basic and diluted	$	0.02	$	0.61	$	0.60	$	1.70

Note 12. Dividend

The Company’s dividends and distributions are recorded on the record date. Shareholders have the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and common stock.

The following table summarizes the Company’s dividend declarations and distributions for the nine months ended September 30, 2014:

Date Declared	Record Date	Payment Date	Amount Per Share
February 27, 2014	March 14, 2014	March 26, 2014	$	0.47
May 8, 2014	June 9, 2014	June 26, 2014		0.47
August 7, 2014	September 12, 2014	September 26, 2014		0.47
		Total Dividends Declared	$	1.41

Note 13. Financial Highlights

The following is a schedule of financial highlights for the nine months ended September 30, 2014 and 2013 (dollars in thousands, except share and per share data):

	September 30, 2014			September 30, 2013
Per share data:
Net asset value at beginning of period(1)	$	20.71		$	17.74

Net investment income(2)		1.15			1.03
Net realized gain (loss) on investments		(0.10	)		0.17
Net increase (decrease) in unrealized appreciation on investments		(0.45	)		0.50

Net increase in stockholders’ equity		0.60			1.70

Capital contributions from partners		—			1.92
Dividends declared and paid from accumulated net investment income		(1.41	)		—
Capital distributions to partners		—			(0.57	)

Net asset value at end of period	$	19.89		$	20.79
Net assets at end of period	$	258,116		$	269,722
Shares outstanding at end of period		12,974,420			12,974,420
Per share market value at end of period	$	17.72		$	19.20
Total return based on market value(3)		(4.12	)%		(4.00	)%
Ratio/Supplemental data:
Ratio of net investment income to average net assets(1)(5)		7.55	%		7.14	%
Ratio of incentive fee to average net assets(1)(5)		1.44	%		—	%
Ratio of debt related expenses to average net assets(1)(5)		4.50	%		3.48	%
Ratio of other operating expenses, net of management fee waiver to average net assets(1)(5)(8)		4.80	%		1.80	%
Ratio of total expenses to average net assets(1)(5)		10.74	%		5.29	%
Portfolio turnover rate(4)		16.14	%		2.27	%
Average Debt Outstanding(6)	$	238,293		$	186,797
Average Debt Outstanding per common share	$	18.37		$	14.40
Asset Coverage ratio per unit(7)	$	1,845		$	2,268

(1)	Net asset value as of January 1, 2013 and average net assets for the nine months ended September 30, 2013 are presented as if the IPO and Formation Transactions had occurred on January 1, 2013. See Note 2 for a further description of the basis of presentation of the Company’s financial statements.
(2)	Net investment income per share is calculated using the weighted average shares outstanding during the period.
(3)	Total investment return is calculated assuming a purchase of common shares at the current market value on the first day and a sale at the current market value on the last day of the period reported. Dividends and distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the Company’s dividend reinvestment plan. Total investment return does not reflect brokerage commissions. Total investment returns covering less than a full period are not annualized. Portfolio turnover rates that cover less than a full period are not annualized.
(4)	Portfolio turnover rate is calculated using the lesser of year-to-date sales or year-to-date purchases over the average of the invested assets at fair value.
(5)	Ratios are annualized.
(6)	Based on daily weighted average balance of debt outstanding during the period.
(7)	Asset coverage per unit is the ratio of the carrying value of our total consolidated assets, less all liabilities and indebtness not represented by senior securities, to the aggregate amount of senior securities representing indebtness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtness.
(8)	The ratio of waived management fees to average net assets was .09% for the nine months ended September 30, 2014. For the period ended September 30, 2013, there was no management fee waiver.

Note 14. Subsequent Events

Management has evaluated subsequent events through the date of issuance of the consolidated financial statements included herein. There have been no subsequent events that occurred during such period that would be required to be recognized in the consolidated financial statements as of and for the nine month period ended September 30, 2014.

Distributions

On October 3, 2014, the Company announced that it has declared distributions for the months of October, November, and December of 2014. The Company converted to monthly distributions, effective October 2014. Accordingly, on October 2, 2014, the Company’s Board of Directors declared the following distributions:

Record Date	Payment Date	Amount Per Share
10/22/14	10/30/14	$	0.1567
11/21/14	11/28/14	$	0.1567
12/19/14	12/30/14	$	0.1567

Credit Facility

On October 17, 2014, the Company entered into a senior secured revolving credit agreement (the “Credit Facility”) with ING Capital, LLC, as administrative agent, arranger, and bookrunner, and the lenders party thereto. The Credit Facility initially provides for borrowings up to $50,000,000 and may be increased up to $150,000,000 pursuant to its “accordion” feature. The Credit Facility matures on October 17, 2018.

Borrowings under the Credit Facility bear interest, at the Company’s election, at a rate per annum equal to (i) the one, two, three or six month LIBOR as applicable, plus 3.00% or (ii) 2.00% plus the highest of (A) a prime rate, (B) the Federal Funds rate plus 0.5% and (C) three month LIBOR plus 1.0%. The Company’s ability to elect LIBOR indices with various tenors (e.g., one, two, three or six month LIBOR) on which the interest rates for borrowings under the Credit Facility are based provides the company with increased flexibility to manage interest rate risks as compared to a borrowing arrangement that does not provide for such optionality. Once a particular LIBOR rate has been selected, the interest rate on the applicable amount borrowed will reset after the applicable tenor period and be based on the then applicable selected LIBOR rate (e.g., borrowings for which the Company has elected the one month LIBOR rate will reset on the one month anniversary of the period based on the then selected LIBOR rate). For any given borrowing under the Credit Facility, the Company intends to elect what it believes to be an appropriate LIBOR rate taking into account the Company’s needs at the time as well as the Company’s view of future interest rate movements. The Company will also pay an unused commitment fee at a rate of 2.50% per annum on the amount (if positive) by which 40% of the aggregate commitments under the Credit Facility exceeds the outstanding amount of loans under the Credit Facility and 0.50% per annum on any remaining unused portion of the Credit Facility.

Portfolio Activity

On October 23, 2014, the Company invested $5.0 million in the first lien senior debt (LIBOR plus 5.75%, 1.00% floor) of Flavors Holdings, Inc. On November 4, 2014, the Company invested an additional $3.0 million in the first lien senior debt (LIBOR plus 5.75%, 1.00% floor) of Flavors Holdings, Inc. On October 27, 2014, the Company invested $12.0 million in the subordinated debt (LIBOR plus 10.00%/1.00% floor) of Flavors Holdings, Inc.

On October 30, 2014, Boot Barn Inc. completed an initial public offering (“IPO”) and began trading on the NYSE under the ticker symbol BOOT. Based on a 25:1 stock conversion at IPO, the Company now owns 600,000 shares of common stock in Boot Barn, which priced at $16 per share in an all primary offering.

On October 31, 2014, the Company received $2.8 million from Naples Lumber & Supply Co., representing full repayment of the investment, generating a gain of $1.4 million.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q.

Except as otherwise specified, references to “we,” “us,” “our” or the “Company”, refer to Capitala Finance Corp.

This Quarterly Report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about the Company, our current and prospective portfolio investments, our industry, our beliefs, and our assumptions. Words such as “anticipates,” “expects,” “intends,” “plans,” “will,” “may,” “continue,” “believes,” “seeks,” “estimates,” “would,” “could,” “should,” “targets,” “projects,” and variations of these words and similar expressions are intended to identify forward-looking statements.

The forward-looking statements contained in this Quarterly Report on Form 10-Q involve risks and uncertainties, including statements as to:

•

our future operating results;

•

our business prospects and the prospects of our portfolio companies;

•

the impact of investments that we expect to make;

•

our contractual arrangements and relationships with third parties;

•

the dependence of our future success on the general economy and its impact on the industries in which we invest;

•

the ability of our portfolio companies to achieve their objectives;

•

our expected financings and investments;

•

the adequacy of our cash resources and working capital; and

•

the timing of cash flows, if any, from the operations of our portfolio companies.

These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements, including without limitation:

•

an economic downturn could impair our portfolio companies’ ability to continue to operate or repay their borrowings, which could lead to the loss of some or all of our investments in such portfolio companies;

•

a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities;

•

interest rate volatility could adversely affect our results, particularly if we use leverage as part of our investment strategy; and

•

the risks, uncertainties and other factors we identify in “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. Important assumptions include our ability to originate new loans and investments, certain margins and levels of profitability and the availability of additional capital. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described or identified in “Risk Factors” in our Annual Report on Form 10-K. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or U.S. Securities and Exchange Commission (“SEC”) rule or regulation.

OVERVIEW

We are a Maryland corporation that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). We are an emerging growth company within the meaning of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and as such, are subject to reduced public company reporting requirements. Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We are managed by Capitala Investment Advisors, LLC (the “Investment Advisor”), and Capitala Advisors Corp. (the “Administrator”) provides the administrative services necessary for us to operate.

We provide capital to smaller and lower middle-market companies in the United States, with a non-exclusive emphasis on the Southeast, Southwest and Mid-Atlantic regions. We invest primarily in companies with a history of earnings growth and positive cash flow, proven management teams, product or service with competitive advantages and industry-appropriate margins. We primarily invest in companies with between $5 million and $30 million in trailing twelve month earnings before interest, tax, depreciation and amortization (“EBITDA”).

We invest in mezzanine and senior subordinated debt investments that are secured by subordinated liens on all of our borrowers’ assets and, to a lesser extent, in senior, cash flow-based “unitranche” securities. Most of our debt investments are coupled with equity interests, whether in the form of detachable “penny” warrants or equity co-investments made pari passu with our borrowers’ financial sponsors.

As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” including securities of private or thinly traded public U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less. In addition, we are only allowed to borrow money such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing, with certain limited exceptions. To maintain our regulated investment company (“RIC”) status, we must meet specified source-of-income and asset diversification requirements. To maintain our RIC tax treatment under subchapter M for U.S. federal income tax purposes, we must distribute at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, for the taxable year.

Corporate History

We commenced operations on May 24, 2013 and completed our initial public offering (“IPO”) on September 30, 2013. The Company was formed for the purpose of (i) acquiring, through a series of transactions, an investment portfolio from the following entities: CapitalSouth Partners Fund I Limited Partnership (“Fund I”); CapitalSouth Partners Fund II Limited Partnership (“Fund II”); CapitalSouth Partners Fund III, L.P. (“Fund III Parent”); CapitalSouth Partners SBIC Fund III, L.P. (“Fund III”) and CapitalSouth Partners Florida Sidecar Fund I, L.P. (“Florida Sidecar” and, collectively with Fund I, Fund II, Fund III and Fund III Parent, the “Legacy Funds”); (ii) raising capital in the IPO and (iii) continuing and expanding the business of the Legacy Funds by making additional debt and equity investments in smaller and lower middle market companies.

On September 24, 2013, the Company acquired 100% of the limited partnership interests in Fund II, Fund III and Florida Sidecar and each of their respective general partners, as well as certain assets from Fund I and Fund III Parent, in exchange for an aggregate of 8,974,420 shares of the Company’s common stock (the “Formation Transactions”). Fund II, Fund III and Florida Sidecar became the Fund’s wholly-owned subsidiaries. Fund II and Fund III retained their SBIC licenses and continue to hold their existing investments and continue to make new investments. The IPO consisted of the sale of 4,000,000 shares of the Company’s common stock at a price of $20.00 per share resulting in net proceeds to the Company of $74.25 million, after deducting underwriting fees and commissions totaling $4.0 million and offering expenses totaling $1.75 million. The other costs of the IPO were borne by the limited partners of the Legacy Funds. As of September 30, 2014, the Company had 12,974,420 shares of common stock outstanding.

At the time of the Formation Transactions, our portfolio consisted of: (i) approximately $326.3 million in investments; (ii) an aggregate of approximately $67.1 million in cash, interest receivable and other assets; and (iii) liabilities of approximately $202.2 million of SBA-guaranteed debt payable. We have two SBIC-licensed subsidiaries that have elected to be regulated as BDCs under the 1940 Act. We may also seek other forms of leverage and borrow funds to make investments, including before we have fully invested the proceeds of this offering.

Basis of Presentation

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”). The consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries as described in the Formation Transactions presented in Note 1 to our Consolidated Financial Statements. The transactions related to Fund II, Fund III, and the Florida Sidecar constitute an exchange of shares between entities under common control and will be accounted for in accordance with the Accounting Standards Codification (“ASC”), Topic 805, Business Combinations (“ASC 805”). As such, the results of the Company’s operations and cash flows for the three and nine months ended September 30, 2013 have been presented on a combined basis in order to provide comparative information with respect to prior periods. The Formation Transactions also included an asset acquisition of certain assets in Fund I and Fund III Parent. In accordance with ASC 805, the assets acquired were recorded at fair value at the date of acquisition, September 24, 2013.

The Company’s financial position as of September 30, 2014 is presented on a consolidated basis. The effects of all intercompany transactions between the Company and its subsidiaries (Fund II, Fund III, and the Florida Sidecar) have been eliminated in consolidation. All financial data and information included in these financial statements have been presented on the basis described above. In the opinion of management, the financial statements reflect all adjustments that are necessary for the fair presentation of financial results as of and for the periods presented.

Revenues

We generate revenue primarily from the periodic cash interest we will collect on our debt investments. In addition, most of our debt investments offer the opportunity to participate in a borrower’s equity performance through warrant participation, direct equity ownership or otherwise, which we expect to result in revenue in the form of dividends and/or capital gains. Further, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting fees and performance-based fees. These fees will be recognized as they are earned.

Expenses

Our primary operating expenses include the payment of investment advisory fees to our Investment Advisor, our allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations under the Administration Agreement and other operating expenses as detailed below. Our investment advisory fee will compensate our Investment Advisor for its work in identifying, evaluating, negotiating, closing, monitoring and servicing our investments. We will bear all other expenses of our operations and transactions, including (without limitation):

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the cost of our organization;

•

the cost of calculating our net asset value, including the cost of any third-party valuation services;

•

the cost of effecting sales and repurchases of our shares and other securities;

•

interest payable on debt, if any, to finance our investments;

•

fees payable to third parties relating to, or associated with, making investments, including fees and expenses associated with performing due diligence reviews of prospective investments and advisory fees;

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transfer agent and custodial fees;

•

fees and expenses associated with marketing efforts;

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costs associated with our reporting and compliance obligations under the 1940 Act, the Securities Exchange Act of 1934 (the “Exchange Act”), other applicable federal and state securities laws and ongoing stock exchange listing fees;

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federal, state and local taxes;

•

independent directors’ fees and expenses;

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brokerage commissions;

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costs of proxy statements, stockholders’ reports and other communications with stockholders;

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fidelity bond, directors’ and officers’ liability insurance, errors and omissions liability insurance and other insurance premiums;

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direct costs and expenses of administration, including printing, mailing, telephone and staff;

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fees and expenses associated with independent audits and outside legal costs; and

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all other expenses incurred by either our Administrator or us in connection with administering our business, including payments under the Administration Agreement that will be based upon our allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing compliance functions, and our allocable portion of any costs of compensation and related expenses of our chief compliance officer and our chief financial officer and any administrative support staff.

Critical Accounting Policies and Use of Estimates

In the preparation of our consolidated financial statements and related disclosures, we have adopted various accounting policies that govern the application of U.S. GAAP. Our significant accounting policies are described in Note 2 to our Consolidated Financial Statements. While all of these policies are important to understanding our consolidated financial statements, certain accounting policies and estimates are considered critical due to their impact on the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses for the periods covered by such financial statements. We have identified investment valuation, revenue recognition, and income taxes as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. Because of the nature of the judgment and assumptions we make, actual results could materially differ from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

Valuation of Investments

In determining fair value, our board of directors (the “Board”) uses various valuation approaches, and engages a third-party independent valuation firm, which provides positive assurance on the investments they review. In accordance with U.S. GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.

Level 1 – Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 securities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a market for the securities existed. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls, is determined based on the lowest level input that is significant to the fair value measurement.

Valuation Techniques

Senior and Subordinated Secured Loans

Equity Investments in Private Companies

Warrants

Revenue Recognition

The Company’s revenue recognition policies are as follows:

Interest Income and Paid-in Kind Interest Income: Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. The company has loans in the portfolio that contain a payment-in-kind (“PIK”) provision. PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at maturity, is recorded on the accrual basis to the extent that such amounts are expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to pay all principal and interest when due.

Non-accrual income: Generally, when interest and/or principal payments on a loan become materially past due, or if the Company otherwise does not expect the borrower to be able to service its debt and other obligations, the Company will place the loan on non-accrual status, and will generally cease recognizing interest income and PIK on that loan for financial reporting purposes. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. The Company writes off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. The company may elect to cease accruing PIK and continue accruing interest income in cases where a loan is currently paying interest income but, in management’s judgment, there is a reasonable likelihood of principal loss on the loan. Non-accrual loans are returned to accrual status when the borrower’s financial condition improves such that management believes current interest and principal payments are expected to be collected.

Gains and Losses on investment sales and paydowns: Realized gains and losses on investments are recognized using the specific identification method.

Income Taxes

Prior to the Formation Transactions, the Legacy Funds were treated as partnerships for U.S. federal, state and local income tax purposes and, therefore, no provision has been made in the accompanying consolidated financial statements for federal, state or local income taxes. In accordance with the partnership tax law requirements, each partner would include their respective components of the Legacy Funds' taxable profits or losses, as shown on their Schedule K-1s in their respective tax or information returns. The Legacy Funds are disregarded entities for tax purposes prior to and post the Formation Transactions.

In accordance with certain applicable treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20.0% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock.

For income tax purposes, we have paid distributions on our common stock from ordinary income in the amount of $18.3 million during the tax year ended August 31, 2014. The tax character of the distributions is based on estimated taxable income for the tax year ended August 31, 2014. The tax character of the distributions based on actual taxable income for the tax year ended August 31, 2014 will be disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Portfolio and Investment Activity

As of September 30, 2014, our portfolio consisted of investments in 50 portfolio companies with a fair value of approximately $445.1 million.

During the three months ended September 30, 2014, we made approximately $86.7 million of investments in new or existing portfolio companies and had approximately $44.7 million in exits and repayments resulting in net investments of approximately $42.0 million for the period. During the three months ended September 30, 2013, we made approximately $34.2 million of investments in new or existing portfolio companies and had approximately $23.1 million in exits and repayments resulting in net investments of approximately $11.1 million for the period.

During the nine months ended September 30, 2014, we made approximately $150.3 million of investments in new or existing portfolio companies and had approximately $64.8 million in exits and repayments resulting in net investments of approximately $85.5 million for the period. During the nine months ended September 30, 2013, we made approximately $75.8 million of investments in new or existing portfolio companies and had approximately $50.2 million in exits and repayments resulting in net investments of approximately $25.6 million for the period.

As of September 30, 2014, our average portfolio company investment and our largest portfolio company investment at amortized cost and fair value was approximately $7.7 million and $8.9 million, and $25.7 million and $25.7 million, respectively. As of September 30, 2014, the Company had approximately $107.6 million of cash and cash equivalents. As of December 31, 2013, our average portfolio company investment and our largest portfolio company investment at amortized cost and fair value was approximately $7.3 million and $8.9 million, and $25.3 million and $25.3 million, respectively. As of December 31, 2013, the Company had $101.6 million of cash and cash equivalents.

The following table summarizes the amortized cost and the fair value of investments and cash and cash equivalents as of September 30, 2014 (dollars in thousands):

	Investments at Amortized Cost		Amortized Cost Percentage of Total Portfolio			Investments at Fair Value		Fair Value Percentage of Total Portfolio
Senior Secured Debt	$	134,258		27.1	%	$	136,171		24.6	%
Subordinated Debt		187,842		38.0			186,483		33.7
Equity and Warrants		65,390		13.2			122,472		22.2
Cash and Cash Equivalents		107,576		21.7			107,576		19.5
Total	$	495,066		100.0	%	$	552,702		100.0	%

The following table summarizes the amortized cost and the fair value of investments and cash and cash equivalents as of December 31, 2013 (dollars in thousands):

	Investments at Amortized Cost		Amortized Cost Percentage of Total Portfolio			Investments at Fair Value		Fair Value Percentage of Total Portfolio
Senior Secured Debt	$	103,457		25.7	%	$	102,071		21.9	%
Subordinated Debt		136,638		33.9			133,710		28.7
Equity and Warrants		61,204		15.2			128,938		27.6
Cash and Cash Equivalents		101,622		25.2			101,622		21.8
Total	$	402,921		100.0	%	$	466,341		100.0	%

As of September 30, 2014, our income-bearing investment portfolio, which represented nearly 73% of our total portfolio, had a weighted average yield of approximately 12.8%. As of September 30, 2014, 85% of our income-bearing investment portfolio was bearing a fixed rate of interest. As of December 31, 2013, our income-bearing investment portfolio, which represented nearly 65% of our total portfolio, had a weighted average yield of approximately 13.7% all bearing a fixed rate of interest.

The following table shows the portfolio composition by industry grouping at fair value (dollars in thousands):

	September 30, 2014					December 31, 2013
	Investments at Fair Value		Percentage of Total Portfolio			Investments at Fair Value		Percentage of Total Portfolio
Oil & Gas Services	$	30,535		6.8	%	$	25,321		7.0	%
Transportation		26,938		6.1			6,000		1.6
Sales & Marketing Services		24,442		5.5			22,753		6.3
Printing Services		20,334		4.6			16,448		4.5
QSR Franchisee		20,004		4.5			24,787		6.8
Bakery Supplies Distributor		17,000		3.8			—		—
Personal Product Manufacturer		16,437		3.7			14,073		3.9
Footwear Retail		15,713		3.5			14,807		4.1
Oil & Gas Engineering and Consulting Services		15,491		3.5			15,000		4.1
Home Décor Manufacturer		15,000		3.4			—		—
Automobile Part Manufacturer		14,539		3.3			—		—
Medical Device Distributor		14,481		3.3			11,121		3.0
Industrial Equipment Rental		13,212		3.0			22,500		6.2
Healthcare Management		12,604		2.8			—		—
Retail Display & Security Services		12,392		2.8			10,823		3.0
Computer Supply Retail		12,081		2.7			6,673		1.8
Wireless Communication Retailer		12,000		2.7			—		—
Energy Services		11,715		2.6			8,783		2.4
Culinary Products		11,506		2.6			10,302		2.8
Restaurant		10,000		2.2			—		—
Textile Equipment Manufacturer		9,941		2.2			9,031		2.5
Western Wear Retail		9,202		2.1			4,774		1.3
Dental Practice Management		8,818		2.0			9,273		2.6
Financial Services		8,300		1.9			—		—
Data Processing & Digital Marketing		7,599		1.7			5,061		1.4
Conglomerate		7,423		1.7			7,630		2.1
Fuel Transportation Services		7,297		1.6			10,274		2.8
Produce Distribution		6,179		1.4			6,631		1.8
Environmental Services Products		5,424		1.2			5,185		1.4
Specialty Clothing		4,941		1.1			12,724		3.5
Replacement Window Manufacturer		4,904		1.1			6,284		1.7
Advertising & Marketing Services		4,440		1.0			4,911		1.3
Metal Recycler		4,150		0.9			3,950		1.1
Petroleum Equipment Supplier		3,802		0.9			3,624		1.0
Automotive Chemicals & Lubricants		3,739		0.8			3,886		1.1
Industrial Manufacturing		3,487		0.8			3,440		0.9
Professional Employer Organization		3,463		0.8			22,677		6.2
Education Services		3,000		0.7			—		—
QSR Franchisor		2,959		0.7			14,622		4.0
Building Supplies		2,809		0.6			2,509		0.7
Specialty Defense Contractor		2,000		0.4			2,799		0.8
Industrial Boiler Manufacturer		1,922		0.4			1,536		0.4
Online Travel Sales & Marketing		1,750		0.4			1,638		0.4
In-Home Healthcare Services		624		0.1			748		0.2
IT Hosting Services		529		0.1			453		0.1
Aerospace Parts Manufacturer		—		—			10,064		2.8
Quick Lube Services		—		—			1,604		0.4
Medical Transportation Services		—		—			—		—
Total	$	445,126		100.0	%	$	364,719		100.0	%

With the exception of an $8.3 million investment in an internationally headquartered company, all investments made by the Company as of September 30, 2014 and December 31, 2013 were made in portfolio companies located in the United States. The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business. The following table shows the portfolio composition by geographic region at fair value as of September 30, 2014 and December 31, 2013 (dollars in thousands):

	September 30, 2014					December 31, 2013
	Investments at Fair Value		Percentage of Total Portfolio			Investments at Fair Value		Percentage of Total Portfolio
South	$	279,720		62.8	%	$	254,143		69.7	%
West		85,020		19.1			66,637		18.3
Northeast		41,851		9.4			23,436		6.4
Midwest		30,235		6.8			20,503		5.6
International		8,300		1.9			—		—
Total	$	445,126		100.0	%	$	364,719		100.0	%

In addition to various risk management tools, our investment adviser also uses an investment rating system to characterize and monitor our expected level of return on each investment in our portfolio.

As part of our valuation procedures, we risk rate all of our investments. In general, our investment rating system uses a scale of 1 to 5, with 1 being the lowest probability of default and principal loss. Our internal rating is not an exact system, but it is used internally to estimate the probability of: (i) default on our debt securities and (ii) loss of our debt principal, in the event of a default. In general, our internal rating system may also assist our valuation team in its determination of the estimated fair value of equity securities or equity-like securities. Our internal risk rating system generally encompasses both qualitative and quantitative aspects of our portfolio companies.

Our internal investment rating system incorporates the following five categories:

Investment Rating		Definition

1		In general, the investment may be performing above our internal expectations. Full return of principal and interest is expected. Capital gain is expected.

2		In general, the investment may be performing within our internal expectations, and potential risks to potential risks to the applicable investment are considered to be neutral or favorable compared to any potential risks at the time of the original investment. All new investments are initially given this rating.

3		In general, the investment may be performing below our internal expectations and therefore, investments in this category may require closer internal monitoring; however, the valuation team believes that no loss of investment return (interest and/or dividends) or principal is expected. The investment also may be out of compliance with certain senior or senior subordinated debt financial covenants.

4		In general, the investment may be performing below internal expectations and quantitative or qualitative risks may have increased substantially since the original investment. Loss of some or principal is expected.

5		In general, the investment may be performing substantially below our internal expectations and a number of quantitative or qualitative risks may have increased substantially since the original investment. Loss of some or all principal is expected.

Our Investment Advisor will monitor and, when appropriate, change the investment ratings assigned to each investment in our portfolio. In connection with our valuation process, our investment adviser will review these investment ratings on a quarterly basis, and our Board of Directors will affirm such ratings. The investment rating of a particular investment should not, however, be deemed to be a guarantee of the investment’s future performance.

The following table shows the distribution of our investments on the 1 to 5 investment performance rating scale at fair value as of September 30, 2014 (dollars in thousands):

Investment Performance Rating	Investments at Fair Value		Percentage of Total Investments
1	$	160,818		36.1	%
2		219,308		49.3
3		57,178		12.8
4		7,822		1.8
5		—		—
Total	$	445,126		100.0	%

The following table shows the distribution of our investments on the 1 to 5 investment performance rating scale at fair value as of December 31, 2013 (dollars in thousands):

Investment Performance Rating	Investments at Fair Value		Percentage of Total Investments
1	$	183,194		50.2	%
2		129,721		35.5
3		44,680		12.3
4		7,124		2.0
5		—		—
Total	$	364,719		100.0	%

As of September 30, 2014, the Company had debt investments in four portfolio companies on non-accrual status with a total principal amount of $13.5 million, amortized cost of $11.8 million and a fair value of $7.8 million, which represented 3.7%, 3.0%, and 1.8% of the investment portfolio, respectively. As of December 31, 2013, the Company had debt investments in four portfolio companies on non-accrual status with a total principal amount of $12.1 million, amortized cost of $10.3 million and a fair value of $6.5 million representing 3.3%, 2.8% and 1.8% of the investment portfolio, respectively.

Results of Operations

Operating results for the three and nine months ended September 30, 2014 and September 30, 2013 are as follows (dollars in thousands):

	For the three months ended					For the nine months ended
	September 30, 2014			September 30, 2013		September 30, 2014			September 30, 2013
Total investment income	$	11,167		$	8,801	$	36,067		$	23,288
Total expenses, net		7,623			3,364		21,170			9,903
Net investment income		3,544			5,437		14,897			13,385
Net realized gain (loss) from investments		(3,055	)		1,871		(1,373	)		2,235
Net increase (decrease) in unrealized appreciation		(178	)		601		(5,784	)		6,442
Net increase in net assets resulting from operations	$	311		$	7,909	$	7,740		$	22,062

Investment income

The composition of our investment income for the three and nine months ended September 30, 2014 and September 30, 2013 was as follows (dollars in thousands):

	For the three months ended				For the nine months ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Interest and fee income	$	10,316	$	5,945	$	26,844	$	17,810
Payment-in-kind interest and dividend income		728		422		2,061		1,092
Dividend income		120		2,158		7,145		2,674
Other income		—		210		—		1,571
Interest from cash and cash equivalents		3		66		17		141
Total Investment Income	$	11,167	$	8,801	$	36,067	$	23,288

For the three months ended September 30, 2014, total investment income increased $2.4 million, or 26.9%, compared to the three months ended September 30, 2013. The increase from the prior period related primarily to higher interest and PIK income as the result of an increasing investment portfolio, partially offset by lower dividend income for the current period. For the nine months ended September 30, 2014, total investment income increased $12.8 million, or 54.9%, compared to the nine months ended September 30, 2013. The increase from the prior period relates to higher dividend income mostly from recapitalizations of control investments, and higher loan interest and fee income resulting from an increasing investment portfolio.

Operating expenses

The composition of our expenses for the three and nine months ended September 30, 2014 and September 30, 2013 was as follows (dollars in thousands):

	For the three months ended				For the nine months ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Interest expense and amortization of deferred financing fees	$	4,268	$	2,237	$	8,870	$	6,527
Management fees, net of management fee waiver		2,498		980		6,592		2,994
Incentive fees		—		—		2,838		—
General and administrative expenses		857		147		2,870		382
Total expenses	$	7,623	$	3,364	$	21,170	$	9,903

For the three months ended September 30, 2014, operating expenses increased $4.3 million, or 126.6%, compared to the three months ended September 30, 2013. For the nine months ended September 30, 2014, operating expenses increased $11.3 million, or 113.8%, compared to the nine months ended September 30, 2013. The increase from the prior period is attributable to incentive and management fees under the Advisory Agreement along with increased general and administrative expenses due to regulatory and reporting costs subsequent to our IPO on September 30, 2013, and an increase in interest expense as a result of our June 2014 $113.4 million offering of 7.125% fixed rate notes due 2021 (“the Notes”). It should be noted that the three months ended September 30, 2013 was the first quarter of operations for the Company following the IPO, but did not include a full allocation of operating expenses and management fees since the IPO was completed on the last day of the reporting period.

Net realized gains/losses on sales of investments

During the three and nine months ended September 30, 2014, we recognized $3.1 million and $1.4 million, respectively, of net realized losses on our portfolio investments. Gross losses for the third quarter of 2014 totaling $5.2 million related to the exit of Impresa Aerospace Holdings, LLC debt were partially offset by a $2.1 million gain on the exit of Take 5 Oil Change, Inc. During the three and nine months ended September 30, 2013, we recognized $1.9 million and $2.2 million, respectively, of net realized gains on portfolio investments.

Net unrealized appreciation/depreciation on investments

Net change in unrealized appreciation on investments reflects the net change in the fair value of our investment portfolio. For the three months ended September 30, 2014, we had a $0.2 million decrease in unrealized appreciation on portfolio investments. For the nine months ended September 30, 2014, we had a $5.8 million decrease in unrealized appreciation on portfolio investments. For the three and nine months ended September 30, 2013, we had a $0.6 million and $6.4 million, respectively, increase in unrealized appreciation on portfolio investments.

Changes in net assets resulting from operations

For the three and nine months ended September 30, 2014, we recorded a net increase in net assets resulting from operations of $0.3 million and $7.7 million, respectively. Based on the weighted average shares of common stock outstanding for the three and nine months ended September 30, 2014, our per share net increase in net assets resulting from operations was $0.02 and $0.60, respectively. For the three and nine months ended September 30, 2013, we recorded a net increase in net assets resulting from operations of $7.9 million and $22.1 million, respectively. Based on the weighted average shares of common stock outstanding for the three and nine months ended September 30, 2013 our per share net increase in net assets resulting from operations was $0.61 and $1.70, respectively.

Financial Condition, Liquidity and Capital Resources

In addition to cash flows generated from operations, including earnings on investments in our portfolio and future investments, as well as interest earned from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less, we intend to continue to seek capital through future equity and debt capital raises. In addition to the $74.25 million in net proceeds received from our IPO on September 30, 2014, the Company issued $113.4 million in aggregate principal amount of 7.125% fixed-rate notes in June of 2014. The Notes will mature on June 16, 2021, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after June 17, 2017 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. The notes will bear interest at a rate of 7.125% per year payable quarterly on March 16, June 16, September 16, and December 16 of each year, beginning September 16, 2014. The Notes are listed on the New York Stock Exchange under the trading symbol “CLA” with a par value $25.00 per share.

In addition to our existing SBA-guaranteed debentures, we may, if permitted by regulation, seek to issue additional SBA-guaranteed debentures as well as other forms of leverage and borrow funds to make investments. On June 10, 2014, we received an exemptive order from the SEC exempting us, Fund II and Fund III from certain provisions of the 1940 Act (including an exemptive order granting relief from the asset coverage requirements for certain indebtedness issued by Fund II and Fund III as SBICs) and from certain reporting requirements mandated by the Securities Exchange Act of 1934, as amended, with respect to Fund II and Fund III. We intend to comply with the conditions of the order.

As of September 30, 2014, we had $107.6 million in cash and cash equivalents, and our net assets totaled $258.1 million.

Contractual obligations

We have entered into two contracts under which we have material future commitments, the Investment Advisory Agreement, pursuant to which the Investment Advisor serves as our investment adviser, and the Administration Agreement, pursuant to which our Administrator agrees to furnish us with certain administrative services necessary to conduct our day-to-day operations. Payments under the Investment Advisory Agreement in future periods will be equal to: (1) a percentage of the value of our gross assets; and (2) an incentive fee based on our performance. Payments under the Administration Agreement will occur on an ongoing basis as expenses are incurred on our behalf by our Administrator.

The Investment Advisory Agreement and the Administration Agreement are each terminable by either party without penalty upon 60 days’ written notice to the other. If either of these agreements is terminated, the costs we incur under new agreements may increase. In addition, we will likely incur significant time and expense in locating alternative parties to provide the services we expect to receive under both our Investment Advisory Agreement and our Administration Agreement. Any new Investment Advisory Agreement would also be subject to approval by our stockholders.

A summary of the Company’s significant contractual payment obligations as of September 30, 2014 is as follows (dollars in thousands):

	Contractual Obligations Payments Due by Period
	Less Than 1 Year		1 - 3 Years		3 - 5 Years		More Than 5 Years		Total
SBA-Guaranteed Debentures	$	8,000	$	13,500	$	5,000	$	165,700	$	192,200
Note Obligations		—		—		—		113,438		113,438
Total Contractual Obligations	$	8,000	$	13,500	$	5,000	$	279,138	$	305,638

Distributions

In order to qualify as a RIC and to avoid U.S. federal corporate level income tax on the income we distribute to our stockholders, we are required to distribute at least 90% of our net ordinary income and our net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Additionally, we must distribute an amount at least equal to the sum of 98% of our net ordinary income (during the calendar year) plus 98.2% of our net capital gain income (during each 12-month period ending on October 31) plus any net ordinary income and capital gain net income for preceding years that were not distributed during such years and on which we paid no U.S. federal income tax to avoid a U.S. federal excise tax. To the extent that we have income available, we intend to make quarterly distributions to our stockholders for the first four full quarters subsequent to our IPO and then make monthly distributions thereafter. Our monthly stockholder distributions, if any, will be determined by our Board on a quarterly basis. Any distribution to our stockholders will be declared out of assets legally available for distribution.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of our distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage requirements applicable to us as a BDC under the 1940 Act. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including the possible loss of our qualification as a RIC. We cannot assure stockholders that they will receive any distributions.

To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a return of capital to our stockholders for U.S. federal income tax purposes. Thus, the source of a distribution to our stockholders may be the original capital invested by the stockholder rather than our income or gains. Stockholders should read any written disclosure accompanying any stockholder distribution carefully and should not assume that the source of any distribution is our ordinary income or capital gains.

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a distribution, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock unless a stockholder specifically “opts out” of our dividend reinvestment plan. If a stockholder opts out, that stockholder will receive cash distributions. Although distributions paid in the form of additional shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, stockholders participating in our dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes.

Related Parties

We have entered into the Investment Advisory Agreement with the Investment Advisor. Mr. Alala, our chief executive officer, president and chairman of our Board, is the managing partner and chief investment officer of our Investment Advisor, and Mr. Broyhill, a member of our Board, has an indirect controlling interest in the Investment Advisor.

In addition, the Investment Advisor’s investment team also manages Fund IV, a private investment limited partnership providing financing solutions to smaller and lower middle-market companies that had its first closing in March 2013 and obtained SBA approval for its SBIC license in April 2013. In addition to Fund IV, affiliates of the Investment Advisor may manage several affiliated funds whereby institutional limited partners in Fund IV, have the opportunity to co-invest with Fund IV in portfolio investments. The Investment Advisor and its affiliates may also manage other funds in the future that may have investment mandates that are similar, in whole and in part, with ours. The Investment Advisor and its affiliates may determine that an investment is appropriate for us and for one or more of those other funds. In such event, depending on the availability of such investment and other appropriate factors, the Investment Advisor or its affiliates may determine that we should invest side-by-side with one or more other funds. Any such investments will be made only to the extent permitted by applicable law and interpretive positions of the SEC and its staff, and consistent with the Investment Advisor’s allocation procedures. We do not expect to make co-investments, or otherwise compete for investment opportunities, with Fund IV because its focus and investment strategy differ from our own.

We have entered into a license agreement with the Investment Advisor, pursuant to which the Investment Advisor has agreed to grant us a non-exclusive, royalty-free license to use the name “Capitala.”

We have entered into the Administration Agreement with our Administrator. Pursuant to the terms of the Administration Agreement, our Administrator provides us with the office facilities and administrative services necessary to conduct our day-to-day operations. Mr. Alala, our chief executive officer, president and chairman of our Board, is the chief executive officer, president and a director of our Administrator, and Mr. Broyhill, a member of our Board, is the trustee of a trust that has a controlling interest in our Adminstrator.

Off-balance sheet arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Recent Developments

Distributions

On October 3, 2014, we announced that we have declared distributions for the months of October, November, and December of 2014. The Company converted to monthly distributions, effective October 2014. Accordingly, on October 2, 2014, the Company’s Board of Directors declared the following distributions:

Record Date	Payment Date	Amount Per Share
10/22/14	10/30/14	$	0.1567
11/21/14	11/28/14	$	0.1567
12/19/14	12/30/14	$	0.1567

Credit Facility

On October 17, 2014, we entered into a senior secured revolving credit agreement (the “Credit Facility”) with ING Capital LLC, as administrative agent, arranger and bookrunner, and the lenders party thereto. The Credit Facility initially provides for borrowings of up to $50,000,000 and may be increased up to $150,000,000 pursuant to its “accordion” feature. The Credit Facility matures on October 17, 2018.

Portfolio Activity

On October 23, 2014, we invested $5.0 million in the first lien senior debt (LIBOR plus 5.75%, 1.00% floor) of Flavors Holdings, Inc. On November 4, 2014, we invested an additional $3.0 million in the first lien senior debt (LIBOR plus 5.75%, 1.00% floor) of Flavors Holdings, Inc. On October 27, 2014, we invested $12.0 million in the subordinated debt (LIBOR plus 10.00%/1.00% floor) of Flavors Holdings, Inc.

On October 30, 2014, Boot Barn Inc. completed an initial public offering (“IPO”) and began trading on the NYSE under the ticker symbol BOOT. Based on a 25:1 stock conversion at IPO, we now own 600,000 shares of common stock in Boot Barn, which priced at $16per share in an all primary offering.

On October 31, 2014, we received $2.8 million from Naples Lumber & Supply Co., representing full repayment of the investment, generating a gain of $1.5 million.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments and cash and cash equivalents. We may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contracts subject to the requirements of the 1940 Act. For the three and nine months ended September 30, 2014, we did not engage in hedging activities.

As of September 30, 2014, the Company held 5 securities at a cost of $49.1 million bearing a variable rate of interest. The Company’s variable rate investments represent approximately 15% of the fair market value of total interest earning investments. All variable rate securities are London Interbank Offered Rate-based (“LIBOR”) and are subject to interest rate floors. As of and for the three and nine month periods ended September 30, 2014, all variable rate securities are yielding interest at a rate equal to the established interest rate floor. As of September 30, 2014, all of our interest paying liabilities, consisting of $192.2 million in SBA-guaranteed debentures and $113.4 million in notes payable, bear interest at a fixed rate.

Item 4. Controls and Procedures

(a)

Evaluation of Disclosure Controls and Procedures

As of September 30, 2014 (the end of the period covered by this report), we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended). Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of such possible controls and procedures.

(b)

Changes in Internal Controls Over Financial Reporting

Management has not identified any change in the Company’s internal control over financing reporting that occurred during the third quarter of 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None of us, our Investment Advisor or Administrator or any of the Legacy Funds, is currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us, or against our Investment Advisor or Administrator. From time to time, we, our Investment Advisor or Administrator, or any of the Legacy Funds may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties are not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2013.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the quarter ended September 30, 2014, we issued 5,995 shares of common stock under our dividend reinvestment plan. The issuances were not subject to the registration requirements under the Securities Act of 1933, as amended. The cash paid for shares of common stock issued under our dividend reinvestment plan during the quarter ended September 30, 2014 was approximately $110 thousand. Other than the shares issued under our dividend reinvestment plan during the quarter ended September 30, 2014, we did not sell any unregistered equity securities and we did not repurchase any of our equity securities.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:

Exhibit
Number		Description of Document
3.1		Articles of Amendment and Restatement(1)
3.4		Bylaws(1)
4.1		Form of Common Stock Certificate(1)
4.2		Form of Base Indenture(2)
4.3		Form of First Supplemental Indenture(2)
4.4		Form of Global Note (included as Exhibit A to the Form of First Supplemental Indenture)(2)
10.1		Form of Dividend Reinvestment Plan(1)
10.2		Form of Investment Advisory Agreement by and between Registrant and Capitala Investment Advisors, LLC(1)
10.3		Form of Custodian Agreement(1)
10.4		Form of Administration Agreement by and between Registrant and Capitala Advisors Corp.(1)
10.5		Form of Indemnification Agreement by and between Registrant and each of its directors(1)
10.6 10.7 10.8		Form of Trademark License Agreement by and between Registrant and Capitala Investment Advisors, LLC(1) Form of Senior Secured Revolving Credit Agreement dated October 17, 2014, among Capitala Finance Corp., as Borrower, the lenders party thereto, and ING Capital LLC, as Administrative Agent, Arranger and Bookrunner(3) Form of Guarantee, Pledge and Security Agreement dated October 17, 2014, among Capitala Finance Corp., as Borrower, the subsidiary guarantors party thereto, ING Capital LLC, as Revolving Administrative Agent for the Revolving Lenders and as Collateral Agent, and each Financing Agent and Designated Indebtedness Holder party thereto(3)
11.1		Computation of Per Share Earnings (included in the notes to the consolidated financial statements contained in this report)
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1		Certification of Chief Executive Officer 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.2		Certification of Chief Financial Officer 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
(1)		Previously filed in connection with the Pre-Effective Amendment No. 1 to Capitala Finance Corp.’s registration statement on Form N-2 (File No. 333-188956) filed on September 9, 2013.
(2) (3)		Previously filed in connection with Pre-Effective Amendment No. 2 to Capitala Finance Corp.’s registration statement on Form N-2 (File No. 333-193374) filed on May 21, 2014. Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on October 21, 2014.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 10, 2014	By	/s/ Joseph B. Alala III
		Joseph B. Alala III
		Chief Executive Officer
		(Principal Executive Officer)
		Capitala Finance Corp.

Date: November 10, 2014	By	/s/ Stephen A. Arnall
		Stephen A. Arnall
		Chief Financial Officer
		(Principal Financial and Accounting Officer)
		Capitala Finance Corp.