Mill City Ventures III, Ltd - Quarter Report: 2021 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

or

Commission File Number 814-00991

MILL CITY VENTURES III, LTD.
(Exact name of registrant as specified in its charter)

(952) 479-1923

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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. x Yes    ¨ 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes    ¨ No

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes    x No

As of August 13, 2021, Mill City Ventures III, Ltd. had 10,790,413 shares of common stock, and no other classes of capital stock, outstanding.

MILL CITY VENTURES III, LTD.

Index to Form 10-Q

for the Quarter Ended June 30, 2021

PART I. FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

MILL CITY VENTURES III, LTD.

CONDENSED BALANCE SHEETS

See accompanying Notes to Financial Statements

MILL CITY VENTURES III, LTD.

CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)

See accompanying Notes to Financial Statements

MILL CITY VENTURES III, LTD.

CONDENSED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

See accompanying Notes to Financial Statements

MILL CITY VENTURES III, LTD.

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

See accompanying Notes to Financial Statements

MILL CITY VENTURES III, LTD.

CONDENSED SCHEDULE OF INVESTMENTS

JUNE 30, 2021

See accompanying Notes to the Financial Statements

MILL CITY VENTURES III, LTD.

SCHEDULE OF INVESTMENTS

DECEMBER 31, 2020

NOTE 1 – ORGANIZATION

In this report, we generally refer to Mill City Ventures III, Ltd. in the first person “we.” On occasion, we refer to our company in the third person as “Mill City Ventures” or the “Company.” The Company follows accounting and reporting guidance in Accounting Standards (“ASC”) 946.

We were incorporated in Minnesota in January 2006. Until December 13, 2012, we were a development-stage company that focused on promoting and placing a proprietary poker game online and into casinos and entertainment facilities nationwide. In 2013, we elected to become a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). We operated as a BDC until we withdrew our BDC election on December 27, 2019. As of the time of this filing, we remain a public reporting company that files periodic reports with the SEC. We offer short-term specialty finance solutions primarily to private businesses, small-cap public companies and high-net-worth individuals. To avoid regulation under the 1940 Act, we generally seek to structure our investments so they do not constitute “investment securities” for purposes of federal securities law, and we monitor our investments as a whole to ensure that no more than 40% of our total assets may consist of investment securities.

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation: The accompanying unaudited condensed financial statements of Mill City Ventures have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States (GAAP) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the quarter ended June 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.

The condensed balance sheet as of December 31, 2020 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information, refer to the financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2020.

Use of estimates: The preparation of financial statements in conformity with GAAP requires management and our Board of Directors to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of expenses during the reporting period. Actual results could differ from those estimates, and the differences could be material. For more information, see the “Valuation of portfolio investments” caption below, and “Note 4 – Fair Value of Financial Instruments” below. The Company is an investment company following accounting and reporting guidance in ASC 946.

Cash deposits: We maintain our cash balances in financial institutions and with regulated financial investment brokers. Cash on deposit in excess of FDIC and similar coverage is subject to the usual banking risk of funds in excess of those limits.

Valuation of investments: We carry our investments in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), issued by the Financial Accounting Standards Board (“FASB”), which defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. Fair value is generally based on quoted market prices provided by independent pricing services, broker or dealer quotations, or alternative price sources. In the absence of quoted market prices, broker or dealer quotations, or alternative price sources, investments are measured at fair value as determined by our Board of Directors, or by the Valuation Committee of our Board of Directors, based on, among other things, the input of our executive management, the Audit Committee of our Board of Directors, and any independent third-party valuation experts that may be engaged by management to assist in the valuation of our investments, but in all cases consistent with our written valuation policies and procedures.

Due to the inherent uncertainties of valuation, certain estimated fair values may differ significantly from the values that would have been realized had a ready market for these investments existed, and these differences could be material. In addition, such investments are generally less liquid than publicly traded securities. If we were required to liquidate an investment in a forced or liquidation sale, we could realize significantly less than the value at which we have recorded it.

Accounting guidance establishes a hierarchal disclosure framework that prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Observable inputs must be used when available. Observable inputs are inputs that market participants would use in valuing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability based upon the best information available. Assets and liabilities measured at fair value are to be categorized into one of the three hierarchy levels based on the relative observability of inputs used in the valuation. The three levels are defined as follows:

Our valuation policy and procedures: Under our valuation policies and procedures, we evaluate the source of inputs, including any markets in which our investments are trading, and then apply the resulting information in determining fair value. For our Level 1 investment assets, our valuation policy generally requires us to use a market approach, considering the last quoted closing price of a security we own that is listed on a securities exchange, and in a case where a security we own is listed on an over-the-counter market, to average the last quoted bid and ask price on the most active market on which the security is quoted. In the case of traded debt securities the prices for which are not readily available, we may value those securities using a present value approach, at their weighted-average yield to maturity.

The estimated fair value of our Level 3 investment assets is determined on a quarterly basis by our Board of Directors, pursuant to our written Valuation Policy and Procedures. These policies and procedures generally require that we value our Level 3 equity investments at fair market value, unless circumstances warrant a different approach. Our Valuation Policy and Procedures provide examples of these circumstances, such as when a company in which we have invested has engaged in a subsequent financing of more than a de minimis size involving sophisticated investors (in which case we may use the price involved in that financing as a determinative input absent other known factors), or when a company is engaged in the process of a transaction that we determine is reasonably likely to occur (in which case we may use the price involved in the pending transaction as a determinative input absent other known factors). Other situations identified in our Valuation Policy and Procedures that may serve as input supporting a change in the valuation of our Level 3 equity investments include (i) a third-party valuation conducted by an independent and qualified professional, (ii) changes in the performance of long-term financial prospects of the company, (iii) a subsequent financing that changes the distribution rights associated with the equity security we hold, or (iv) sale transactions involving comparable companies, but only if further supported by a third-party valuation conducted by an independent and qualified professional.

When valuing preferred equity investments, we generally view intrinsic value as a key input. Intrinsic value means the value of any conversion feature (if the preferred investment is convertible) or the value of any liquidation or other preference. Discounts to intrinsic value may be applied in cases where the issuer’s financial condition is impaired or, in cases where intrinsic value relating to a conversion is determined to be a key input, to account for resale restrictions applicable to the securities issuable upon conversion.

When valuing warrants, our Valuation Policy and Procedures indicate that value will generally be the difference between closing price of the underlying equity security and the exercise price, after applying an appropriate discount for restriction, if applicable, in situations where the underlying security is marketable. If the underlying security is not marketable, then intrinsic value will be considered consistent with the principles described above. Generally, “out-of-the-money” warrants will be valued at cost or zero.

For non-traded (Level 3) debt investments with a residual maturity less than or equal to 60 days, the value will generally be based on a present value approach, considering the straight-line amortized face value of the debt unless justification for impairment exists. The fair value for short-term non-banking loans is determined as the present value of future contractual cash flows discounted at an interest rate that reflects the risks inherent to those cash flows. The discount ranges from 14% to 47% and approximate rates currently observed in publicly traded debt markets for debt of similar terms to companies with comparable credit risk.

On a quarterly basis, our management provides members of our Board of Directors with (i) valuation reports for each investment (which reports include our cost, the most recent prior valuation and any current proposed valuation, and an indication of the valuation methodology used, together with any other supporting materials); (ii) Mill City Ventures’ bank and other statements pertaining to our cash and cash equivalents; (iii) quarter- or period-end statements from our custodial firms holding any of our investments; and (iv) recommendations to change any existing valuations of our investments or hierarchy levels for purposes of determining the fair value of such investments based upon the foregoing. The board or committee then discusses these materials and, consistent with the policies and approaches outlined above, makes final determinations respecting the valuation and hierarchy levels of our investments.

We made no changes to our Valuation Policy and Procedures during the reporting period other than to have our entire Board of Directors involved in implementing and discharging those policies and procedures.

Income taxes:

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements.   Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement carrying amount and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine we would be able to realize our deferred income tax assets in the future in excess of their recorded amount, we would make an adjustment to the valuation allowance, which would reduce the provision for income taxes.

We file income tax returns in the U.S. Federal jurisdiction and various state jurisdictions.  The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months. Our evaluation was performed for the tax years ended December 31, 2017 through 2020, which are the tax years that remain subject to examination by major tax jurisdictions as of June 30, 2021.

Revenue recognition: Realized gains or losses on the sale of investments are calculated using the specific investment method.

Interest income, adjusted for amortization of premiums and accretion of discounts, is recorded on an accrual basis. Discounts from and premiums to par value on securities or other instruments purchased are accreted or amortized, as applicable, into interest income over the life of the related security using the effective-yield method. The amortized cost of investments represents the original cost, adjusted for the accretion of discounts and amortization of premiums, if any. Loans are generally placed on non-accrual status when principal or interest payments are past due 30 days or more, or when there is reasonable doubt that principal or interest will be collected in full. Loan origination fees are recognized when loans are issued. Accrued and unpaid interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past-due principal and interest is paid and, in management’s judgment, are likely to remain current. We may make exceptions to the policy described above if a loan has sufficient collateral value and is in the process of collection.

Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by a company in which we have invested and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private companies or on the ex-dividend date for publicly traded companies.

Certain investments may have contractual payment-in-kind (“PIK”) interest or dividends. PIK represents accrued interest or accumulated dividends that are added to the loan principal or stated value of the investment on the respective interest- or dividend-payment dates rather than being paid in cash, and generally becomes due at maturity or upon being repurchased by the issuer. PIK interest or dividends is recorded as interest or dividend income, as applicable. If at any point we believe that PIK interest or dividends is not expected be realized, the PIK-generating investment will be placed on non-accrual status. Accrued PIK interest or dividends are generally reversed through interest or dividend income, respectively, when an investment in placed on non-accrual status.

Allocation of net gains and losses: All income, gains, losses, deductions and credits for any investment are allocated in a manner proportionate to the shares owned.

Recently adopted accounting pronouncements

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740)—Simplifying the Accounting for Income Taxes. ASU 2019-12 is intended to simplify accounting for income taxes. It removes certain exceptions to the general principles in Topic 740 and amends existing guidance to improve consistent application. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years, which is fiscal 2021 for us, with early adoption permitted. The adoption of the ASU effective January 1, 2021 did not have a material impact on the Company’s financial statements.

NOTE 3 – INVESTMENTS

The following table shows the composition of our investments by major class, at amortized cost and fair value, as of June 30, 2021 (together with the corresponding percentage of the fair value of our total investments):

The following table shows the composition of our investments by major class, at amortized cost and fair value, as of December 31, 2020 (together with the corresponding percentage of the fair value of our total investments):

The following table shows the composition of our investments by industry grouping, based on fair value as of June 30, 2021:

The following table shows the composition of our investments by industry grouping, based on fair value as of December 31, 2020:

NOTE 4 – FAIR VALUE OF FINANCIAL INSTRUMENTS

Level 3 valuation information: Due to the inherent uncertainty in the valuation process, the estimate of the fair value of our investments as of June 30, 2021 may differ materially from values that would have been used had a readily available market for the securities or investments existed.

The following table presents the fair value measurements of our investments by major class, as of June 30, 2021, according to the fair value hierarchy:

The following table presents the fair value measurements of our investments by major class, as of December 31, 2020, according to the fair value hierarchy:

The following table presents a reconciliation of the beginning and ending fair value balances for our Level 3 investment assets for the six months ended June 30, 2021:

The net change in unrealized appreciation for the six months ended June 30, 2021 attributable to Level 3 investments still held as of June 30, 2021 is $0, and is included in net change in unrealized appreciation (depreciation) on investments on the statement of operations.

The following table lists our Level 3 investments held as of June 30, 2021 and the unobservable inputs used to determine their valuation:

The following table presents a reconciliation of the beginning and ending fair value balances for our Level 3 investment assets for the year ended December 31, 2020:

The net change in unrealized depreciation for the year ended December 31, 2020 attributable to Level 3 investments still held as of December 31, 2020 is $0, and is included in net change in unrealized appreciation (depreciation) on investments on the statement of operations.

The following table lists our Level 3 investments held as of December 31, 2020 and the unobservable inputs used to determine their valuation:

NOTE 5 – RELATED-PARTY TRANSACTIONS

We maintain a Code of Ethics and certain other policies relating to conflicts of interest and related-party transactions, as well as policies and procedures relating to what regulations applicable. Nevertheless, from time to time we may hold investments in portfolio companies in which certain members of our management, our Board of Directors, or significant shareholders of ours, are also directly or indirectly invested. Our Board of Directors has adopted a policy to require our disclosure of these instances in our periodic filings with the SEC. Our only related-party transaction requiring disclosure under this policy relates to an August 10, 2018 loan transaction we entered into with Elizabeth Zbikowski. Ms. Zbikowski, along with her husband Scott Zbikowski, owns approximately 1,765,000 shares of our common stock. In the transaction, we obtained a two-year promissory note in the principal amount of $250,000. The promissory note was subsequently amended such that it matures in August 2021. The note bears interest payable monthly at the rate of 10% per annum and is secured by the debtors’ pledge to us of 625,000 shares of our common stock. The pledged shares are held in physical custody for us by our custodial agent Millennium Trust Company.

NOTE 6 – INCOME TAXES

Presently, we are a C-Corporation for tax purposes and have booked an income tax provision for the periods described below.

As of June 30, 2021 and December 31, 2020, we have a deferred tax liability of $363,000 and $258,000, respectively. Our determination of the realizable deferred tax assets and liabilities requires the exercise of significant judgment, based in part on business plans and expectations about future outcomes. In the event the actual results differ from these estimates in future periods, we may need to adjust the valuation allowance, which could materially impact our financial position and results of operations. We will continue to assess the need for a valuation allowance in future periods.

As of June 30, 2021 and December 31, 2020 we had accrued income taxes of $920,000 and $13,722 respectively. We recorded income taxes of approximately $349,000 (28.9 percent effective tax rate) and $0 (0 percent effective tax rate) during the three months ended June 20, 2021 and June 30, 2020, respectively. We recorded income taxes of approximately $1,011,000 (28.8 percent effective tax rate) and $0 (0 percent effective tax rate) during the six months ended June 30, 2021 and June 30, 2020, respectively. Due to the full valuation allowances in periods prior to December 31, 2020, our effective tax rate was expected to be near zero percent, therefore income tax accruals and expense were not material for those prior periods presented.

As of December 31, 2020, we had a federal NOL of approximately $371,000. The federal NOL is expected to be completely used and offset taxable income by June 30, 2021. The federal NOL may be carried forward to offset future taxable income, subject to applicable provisions of the Internal Revenue Code. Due to tax reform enacted in 2017, NOLs created after 2017 carry forward indefinitely. The estimated federal NOL that does not expire included in the total above is $356,000. States may vary in their treatment of post-2017 NOLs. We lost some state NOL carryforwards when we filed final 2019 tax returns in several states. The remaining state NOLs are expected to be completely used and offset taxable income by June 30, 2021. The remaining state NOL carryforwards may expire in 2036 and 2037 if not used.

NOTE 7 – SHAREHOLDERS’ EQUITY

At June 30, 2021, we had 10,790,413 shares of common stock issued and outstanding.

On December 8, 2020 we announced that our Board of Directors had approved a cash dividend of $0.05 per common share. The dividend was paid on January 4, 2021 to shareholders of record as of the close of business on December 21, 2020.

NOTE 8 – PER-SHARE INFORMATION

Basic net gain per common share is computed by dividing net increase in net assets resulting from operations by the weighted-average number of common shares outstanding during the period. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net gain (loss) per common share is set forth below:

NOTE 9 – OPERATING LEASES

We are subject to two non-cancelable operating leases for office space expiring March 31, 2022. These leases do not have significant lease escalations, holidays, concessions, leasehold improvements, or other build-out clauses. Further, the leases do not contain contingent rent provisions. The leases do not include options to renew.

Because our lease does not provide an implicit rate, we use our incremental borrowing rate in determining the present value of the lease payments. The incremental borrowing rate represents an estimate of the interest rate we would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease. The weighted-average discount rate as of December 31, 2020 was 4.5% and the weighted-average remaining lease term is one year.

Under ASC 840, rent expense for office facilities for the three months ended June 30, 2021 and June 30, 2020 was $16,337 and $16,569, respectively.

The components of our operating lease were as follows for the three and six months ended June 30, 2021:

Supplemental balance sheet information consisted of the following at June 30, 2021:

Maturity analysis under lease agreements consisted of the following as of June 30, 2021:

NOTE 10 – FINANCIAL HIGHLIGHTS

The following is a schedule of financial highlights for the six months ended June 30, 2021 through 2017:

NOTE 11 – General Uncertainty

On March 11, 2020, the World Health Organization declared the outbreak of the coronavirus (COVID-19) a pandemic. As a result, economic uncertainties and market volatility have arisen which are likely to negatively impact our investment valuations and net increase or decrease in net assets resulting from operations. Other financial impacts could occur though such potential impact is difficult to determine at this time.

NOTE 12 – Subsequent Events

On August 2, 2021, Tailwind Real Estate, LLC pre-paid in full all of their obligations owing to us, including $3,000,000 of loan principal provided at March 31, 2021, and $18,500 of accrued but unpaid interest thereon.

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. In addition, unless expressly stated otherwise, the comparisons presented in this MD&A refer to the same period in the prior year. Our MD&A is presented in seven sections:

OVERVIEW

Mill City Ventures III, Ltd. was incorporated in the State of Minnesota on January 10, 2006. In this report, we generally refer to Mill City Ventures III, Ltd. in the first person “we.” On occasion, we refer to our company in the third person as “Mill City Ventures” or the “company.”

We provide non-bank lending and specialty finance to companies and individuals on both a secured and unsecured basis. The significant majority by dollar amount of loans we provide typically have maturities that range from 9 to 12 months and may involve a pledge of collateral or, in the case of loans made to companies, personal guarantees by the principals of the borrower. Our loans may be made for real estate acquisitions, renovation and sale; other real estate projects; title loans; cash inventory needs: receivables financing (e.g., factoring or similar); inventory financing, or for other purposes. We intend to remain opportunistic, however, and may engage in transactions that involve other rights (such as stock, warrants or other equity-linked investments) or that are structured differently or uniquely. Our business objective is to generate revenues from the interest and fees we charge, and capital appreciation from any related investments we make.

Our principal sources of income are interest, dividends and other fees associated with lending such as origination fees, closing fees or exit fees. We may also receive reimbursement of legal costs associated with loan documentation. Our statement of operations also reflect increases and decreases in the carrying value of our asset and investments (i.e. unrealized appreciation and depreciation). Our principal expenses relate to operating expenses, the largest components of which are generally professional fees, payroll, occupancy, and insurance expenses.

Our MD&A should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2020, as well as our reports on Forms 10-Q and 8-K and other publicly available information. All amounts herein are unaudited. In addition, the discussion of our results of operations and financial condition should be read in the context of this overview. Furthermore, we are including a full description of our business in this report.

BUSINESS

Overview

Mill City Ventures III, Ltd, (the “Company” or “we”), is a Minnesota corporation that was incorporated in January 2006. From our inception until December 13, 2012, we were a development-stage company involved in the gaming and entertainment industry. In 2013, we elected to become a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). We operated as a BDC until we withdrew our BDC election on December 27, 2019. Since that time, we have engaged in the business of providing short-term specialty finance solutions primarily to private businesses, micro- and small-cap public companies and high-net-worth individuals. To avoid again becoming subject to regulation under the 1940 Act, we generally seek to structure our transactions so they do not constitute “investment securities” for purposes of federal securities law, and we monitor our holdings as a whole to ensure that no more than 40% of our total assets may consist of investment securities.

Descriptions

The principal specialty finance solutions we provide are high-interest short-term lending arrangements. On occasion, these lending arrangements involve us obtaining collateral as security for the borrower’s repayment of funds to us. In some circles, short-term high-interest collateralized lending is referred to as “hard-money lending.”

We believe we are generally able to charge high interest for our specialty finance solutions because (i) banks and other traditional providers of credit may have neither the expertise nor the infrastructure needed to evaluate creditworthiness and risks in a timeframe suitable for a potential borrower, preferring instead to process transactions and structures that present few novel issues or risks; and (ii) we will often be able to devote time and attention to transactions involving a smaller dollar amount than an institutional lender will view as worthwhile. These beliefs essentially explain why we refer to our business as “specialty finance”— financing that may involve structures that are unique, creative, and often bespoke; and that may involve dollar amounts that are not suitable for institutional lenders.

We generally provide specialty finance solutions that are short-term in nature. By this, we mean lending arrangements that mature or come due within nine months of the lending date. We view the provision of short-term finance as desirable for two principal reasons. First, short-term lending requires a potential borrower to identify for us a near-term source of repayment for the funds they borrow from us. This permits us to evaluate that source of repayment clearly and carefully, thus helping identify the potential risks involved in a particular transaction and how we may be able to include structural terms that mitigate these risks. Second, short-term lending permits us to avail ourselves of a court-recognized exception for treating promissory notes (evidencing a loan) as “investment securities” under federal securities law. In sum, this exception generally applies to promissory notes with short-term maturities of nine months. Our ability to avail ourselves of this exception, and to more generally structure our transactions in such a way as to avoid them being properly considered as “investment securities” under federal securities laws, is important to our ability to avoid once again becoming subject to regulation under the 1940 Act. Below we discuss our process for evaluating transactional terms and structures with a view to remaining outside of the regulatory regime of the 1940 Act (please refer to “Investment Process” below).

Examples of the kinds of the specialty finance solutions we have considered or provided to date, and may continue to provide in the future, include:

In addition, we are presently evaluating our ability to enter into other kinds of short-term specialty finance transactions. Examples include the expansion of our efforts to purchase adjudicated settlements, the purchase (at discounted rates) of receivables owing to professionals on account of certain workers’ compensation claim, and short-term consumer finance lending.

Sourcing Transactions

We believe that our management’s strong combination of experience and contacts in the investment sector, including the experience and contacts of our independent directors, should be sufficient to continue attracting suitable prospective investment opportunities. To date, the network of contacts of our management and directors has been successful thus far in sourcing all of the transactions in which we have participated. Accordingly, we presently do not have any plans to hire any business development professionals to assist us with transactional volume.

Competition

The market for specialty finance is competitive, largely as a result of the participation of various types of professionally managed pooled investment funds (e.g., hedge funds, debt/mezzanine debt funds, private equity funds) seeking the high returns that are possible in specialty finance and hard-money lending.

Nevertheless, we believe we are well positioned to compete successfully due to our flexibility and creativity with our transactional structures and terms. We expect to continue to have significant flexibility in selecting and structuring our transactions. In part, this is because we will not be subject to many of the regulatory limitations that govern traditional or institutional lenders. We believe this will afford us broad latitude as to the nature of the transactions in which we may participate, and the specific terms to which we may agree. We believe that this flexible approach to structuring our transactions and investments will facilitate positive, long-term relationships with our borrowers. In addition, the freedom afforded to us through the lack of substantive regulation governing the types of transactions we enter into and our methods of operation in general permits us to allocate resources to those types of transactions that we believe may lead to the highest risk-adjusted returns or the steadiest stream of such returns.

The only significant limitation on our ability to flexibly structure transactions arises from our desire to remain outside the regulations of the 1940 Act. In order to meet this goal, we intend and aim to structure the vast majority of our transactions (by dollar amount) in ways such that they are not properly considered investment securities under federal securities laws, including the 1940 Act.

Finally, we believe we are able to manage the evaluation and due-diligence process swiftly and efficiently, largely as a result of our management team’s diverse experience in transactional finance.

Other Matters

We do not believe that we are dependent in any material way on any particular borrower, type of specialty finance transaction, or industry.

We do not own or use through license any patents, trademarks, or other intellectual properties and we do not believe that any such assets would be material to our business.

Sometimes the types of transactions we engage in are governed by particular laws, regulations, or rules. For example, lending transactions in which high-net-worth individuals are the borrower will nearly always involve state law usury limitations. Transactions in which we seek and obtain collateral as security for obligations owed to us involve legal issues arising under the Uniform Commercial Code or its various state law iterations. To date, we have not engaged in transactions that require us to obtain licensure or a permit prior to entering into the transaction—e.g., brokering transactions or engaging in licensed consumer finance activities.

Pending the consummation of transactions and deployment of cash, we generally keep the majority of our assets in cash, cash equivalents such as money-market investments, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.

Our Investment Process

We have identified several criteria that we believe are generally important guidelines for us to meet our financial objectives. These criteria are, however, only general guidelines for our investment decisions and, in the case of some transactions in which we invest, fewer than all—or even none—of these criteria will be met.

If we believe a potential transaction generally meets the characteristics described above or if we otherwise determine that a potential transaction may be desirable to enter into, we may perform a more rigorous due-diligence examination of the prospective borrower, the likely source or sources of liquidity for their repayment to us, and other aspects of the borrower or its assets (e.g., assets of the borrower that may serve as collateral security for the obligations that may be owing to us). Our due-diligence examination for each transaction will necessarily be unique and tailored to the specific transaction, but will generally be undertaken in light of the following facts and circumstances:

The assessments described above outlines our general approach for our investment decisions, although not all of such activities will be followed in each instance, or some may be stressed moreso than others depending on facts and circumstances. Upon successful completion of this preliminary evaluation, we will typically (1) evaluate our own regulatory concerns (i.e., to what extent the potential transaction may properly be considered an investment in an “investment security” for purposes of the 1940 Act and, if necessary, consider alternative structures to alleviate any risks to our company relating thereto), and (2) decide whether to move forward towards negotiating a letter of intent and, thereafter, definitive documentation for our transaction. Depending on timing, we may not use a letter of intent and will instead proceed directly to definitive documentation.

As indicated above, to avoid becoming subject to the regulatory requirements of the 1940 Act, we monitor our investment holdings as a whole to ensure that investments and other holdings which may be considered “investment securities” do not comprise more than 40% of our total assets. We undertake this analysis (1) on a quarterly basis and in connection with the review and preparation of our financial statements filed as part of our quarterly and annual reports with the U.S. Securities and Exchange Commission, and (2) at other times when we are considering how to structure a new transaction that is of a significant size (with “significance” largely based on the outcome of our most recent quarterly review). This review is generally undertaken by our Chief Financial Officer and may involve our outside legal counsel, in particular in a case where we are considering the structure of a potential new transaction.

In general, our analysis starts with the length or duration of a potential new transaction. Although federal securities laws define “investment securities” in such a way as to include promissory notes, the U.S. Supreme Court held in Reves v. Ernst & Young, 110 S. Ct. 945 (1990), that certain kinds of promissory notes are not properly considered securities. Over time, court precedent has developed to identify these kinds of promissory notes as generally not constituting investment securities:

In addition to the types of financing arrangements noted above, court precedent indicates that there may be facts and circumstances surrounding the transaction that may cause other promissory notes to not be considered investment securities under federal securities laws. For example, it is presumed that a promissory note which matures in more than nine months is a “security,” but this presumption may be rebutted (with the conclusion that such a promissory note is not a properly considered a security) upon an evaluation of the following factors:

While the application of these factors can be helpful in some instances, often the factors and the proper manner of weighting them are unclear. As a result, the analyses we periodically undertake focuses on the more bright-line types of lending arrangements enumerated above—i.e., promissory notes maturing in nine months or less, etc.

Our Prior Business as a BDC

The analysis of our transactions and transactional holdings is undertaken with a view to ensuring that we do not become subject to the 1940 Act. Generally from 2013 through 2019, we were governed by the 1940 Act. During that time, we were a business development company under the 1940 Act, or “BDC,” primarily focused on investing in or lending to private and small-cap public companies and making managerial assistance available to such companies. As a BDC, our investments included stock of or membership interests (typically referred to as units) in private companies, small-cap public company stocks, and promissory notes. In some cases, the stock or membership interests we acquired were preferred stock or units, and in other cases the stock or membership interests acquired were common stock or units. In connection with our investments in promissory notes, we frequently obtained warrants to purchase common stock.

In our financial statements for the year ended December 31, 2019, revenues from our operations (as a BDC) relate to the earnings we received from our portfolio investments.

Our Management and Employees

Currently, Mr. Douglas M. Polinsky, the Chief Executive Officer and Chairman of our Board of Directors, and Joseph A. Geraci, II, our Chief Financial Officer and a director of the Company, serve as our senior management team. These are also the only two persons who are employees of the Company.

INVESTMENT ACTIVITY

During the six months ended June 30, 2021, we made $13,250,664 of investments and had $9,889,827 of redemptions and repayments, resulting in net investments at amortized cost of $11,864,762 at the end of the period.

During the six months ended June 30, 2020, we made $6,217,296 of investments and had $1,192,824 of redemptions and repayments, resulting in net investments at amortized cost of $7,200,566 at the end of the period.

Our investment composition by major class, based on fair value at June 30, 2021, was as follows:

RESULTS OF OPERATIONS

Our operating results for the three and six months ended June 30, 2021 and June 30, 2021 were as follows:

Investment Income

We generate revenue primarily in the form of interest income and capital gains, if any, on the debt instruments we own. We may also generate revenue from dividends and capital gains on equity investments we make, if any, or on warrants or other equity interests that we may acquire. In some cases, the interest on our investments may accrue or be paid in the form of additional debt. The principal amount of the debt instruments, together with any accrued but unpaid interest thereon, will generally become due at the maturity date of those debt instruments. We may also generate revenue in the form of commitment, origination, structuring, diligence, or consulting fees. Any such fees will be recognized as earned.

For the three and six months ended June 30, 2021, our total investment income was $675,549 and $1,222,391, respectively. For the three and six months ended June 30, 2020, our total investment income was $283,456 and $468,435, respectively. The increase is due to the change in our business structure which now focuses on short-term non-bank lending. Our loan portfolio generates interest income, with an average rate on the loans of 25%.

Professional Fees

For the three and six months ended June 30, 2021, we had $77,539 and $220,347 professional fees expense, respectively. For the three and six months ended June 30, 2020, we had $90,529 and $74,297 professional fees expense, respectively The increase for the six months in 2021 is due to legal costs incurred to close on several new short-term banking loans. In 2020, we received a refund during the first quarter of $59,957 relating to certain audit expenses incurred during 2018 and 2019.

Net Realized Gain from Investments

For the three and six months ended June 30, 2021, we had $4,853,170 and $9,889,827, respectively, of sales of investments, resulting in $621,600 and $3,529,599, respectively, of realized gains. For the three and six months ended June 30, 2020, we had $971,044 and $1,192,824, respectively, of sales of investments, resulting in $175,222 and $199,724, respectively, of realized gains.

Net Change in Unrealized Appreciation (Depreciation) on Investments

For the three and six months ended June 30, 2021, our investments had $83,100 of unrealized appreciation and $430,150 of unrealized depreciation, respectively. For the three and six months ended June 30, 2020, our investments had $348,602 of unrealized appreciation and $37,405 of unrealized depreciation, respectively.

Changes in Net Assets from Operations

For the three and six months ended June 30, 2021, we recorded a net increase in net assets from operations of $781,506 and $2,526,548, respectively. Based on the weighted-average number of shares of common stock outstanding for the three and six months ended June 30, 2021, our per-share net increase in net assets from operations was $0.07 and $0.23, respectively. For the three and six months ended June 30, 2020, we recorded a net increase in net assets from operations of $593,370 and $311,452, respectively. Based on the weighted-average number of shares of common stock outstanding for the three and six months ended June 30, 2020, our per-share net increase in net assets from operations was $0.05 and $0.03, respectively.

Cash Flows for the Six Months Ended June 30, 2021 and 2020

The level of cash flows used in or provided by operating activities is affected by the purchases of investments, redemptions and repayments of investments, among other factors. For the six months ended June 30, 2021, net cash used in operating activities was $3,401,681. Cash flows used in operating activities for the six months ended June 30, 2021 were primarily related to purchases of investments of $13,250,664, offset mostly by redemptions and repayments of investments totaling $9,889,827. For the six months ended June 30, 2020, net cash used in operating activities was $3,457,399. Cash flows provided in operating activities for the six months ended June 30, 2020 were primarily related to purchases of investments of $6,217,296, offset mostly by redemptions and repayments of investments totaling $1,192,824.

FINANCIAL CONDITION

As of June 30, 2021, we had cash of $1,515,005, a decrease of $3,925,574 from December 31, 2020. The primary use of our existing funds and any funds raised in the future is expected to be for investments, cash distributions to our shareholders or for other general corporate purposes, including paying for operating expenses or debt service to the extent we borrow or issue senior securities. Pending investment, our investments may consist of cash, cash equivalents, U.S. government securities or high quality debt securities maturing in one year or less from the time of investment.

To the extent our Board of Directors determines in the future, based on our financial condition and capital market conditions, that additional capital would allow us to take advantage of additional investment opportunities, we may seek to raise additional equity capital or to engage in borrowing.

CRITICAL ACCOUNTING ESTIMATES

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, or U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods.

In preparing the financial statements, management will make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. In preparing the financial statements, management also will utilize available information, including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results will almost certainly differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As our expected operating results occur, we will describe additional critical accounting policies in the notes to our financial statements. Our most critical accounting policies relate to the valuation of our investments and revenue recognition. For more information, refer to our Annual Report on Form 10-K for the year ended December 31, 2020.

OFF-BALANCE-SHEET ARRANGEMENTS

During the six months ended June 30, 2021, we did not engage in any off-balance sheet arrangements as described in Item 303(a)(4) of Regulation S-K.

FORWARD-LOOKING STATEMENTS

Some of the statements made in this section of our report are forward-looking statements based on our management’s current expectations for our company. These expectations involve assumptions and are subject to substantial risks and uncertainties that could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance, and can ordinarily be identified by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “targets,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. Important assumptions include our ability to identify and consummate new investments, achieve certain margins and levels of profitability, the availability of any needed additional capital, and the ability to maintain compliance with regulations applicable to us. Some of the forward-looking statements contained in this report relate to, and are based our current assumptions regarding, the following:

The foregoing list is not exhaustive. For a more complete summary of the risks and uncertainties facing our company and its business and relating to our forward-looking statements, please refer to our Annual Report on Form 10-K filed on March 10, 2021 (related to our year ended December 31, 2020) and in particular the section thereof entitled “Risk Factors.” Because of the significant uncertainties inherent in forward-looking statements pertaining to our company, the inclusion of those statements should not be regarded as a representation or warranty by us or any other person that our objectives, plans, expectations or projections that are contained in this filing will be achieved in any specified time frame, if ever. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this filing. The forward-looking statements made in this report relate only to events as of the date on which the statements are made, and are excluded from the safe harbor protection provided by Section 21E of the Securities Exchange Act of 1934.

We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934 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. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance the objectives of the control system are met.

As of June 30, 2021, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as such term is defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded our disclosure controls and procedures are effective as of June 30, 2021.

There were no significant changes in our internal controls over financial reporting that occurred during the fiscal quarter covered by this report that materially affected, or were reasonably likely to materially affect such controls.

PART II. OTHER INFORMATION

* Filed herewith

SIGNATURES

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