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**UNITED STATES** SECURITIES AND EXCHANGECOMMISSION

**WASHINGTON, DC 20549**

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**FORM 10-K**

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**(Mark One)**

 

**x****     ****ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIESEXCHANGE ACT OF 1934**

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**for thefiscal year ended September 30, 2009**

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**OR**

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**o****        ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THESECURITIES EXCHANGE ACT OF 1934**

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**for thetransition periodfrom              to              **

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**Commissionfile number 814-00237**

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**GLADSTONE CAPITALCORPORATION**

(Exactname of registrant as specified in its charter)

 

| **Maryland**                                                     | ** ** | **54-2040781**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **1521  Westbranch Drive, Suite 200  McLean, Virginia**     | ** ** | **22102**                             |
| (Address of principal  executive offices)                        |       | (Zip Code)                            |

** **

**(703) 287-5800**

(Registrant’stelephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: **Common Stock, $0.001 par value per share**

 

Securities registered pursuant to Section 12(g) of the Act: ** None**

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.  YES  o  NO x.

 

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. YES o NO x.

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days.   YES  x  NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this 10-Kor any amendment to this Form 10-K. x

 

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

 

| Large Accelerated filer  o |   | Accelerated filer  x    |
|--------------------------------------|--------|-----------------------------------|
|                                 |   |                              |
| Non-Accelerated filer  o   |   | Smaller reporting company o. |

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12 b-2of the Exchange Act). YES oNO x.

 

The aggregate market value of the voting stock held by non-affiliates ofthe Registrant on March 31, 2009, based on the closing price on that dateof $6.26 on the Nasdaq Global Select Market, was $123,940,569. For the purposesof calculating this amount only, all directors and executive officers of theRegistrant have been treated as affiliates.

 

There were 21,087,574 shares of the Registrant’s Common Stock, $0.001par value, outstanding as of November 23, 2009.

 

**Documents Incorporated by Reference.** Portions of the Registrant’sProxy Statement relating to the Registrant’s 2010 Annual Meeting ofStockholders are incorporated by reference into Part III of this Report.

 

 

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**GLADSTONECAPITAL CORPORATIONFORM 10-K FOR THE FISCAL YEAR ENDEDSEPTEMBER 30, 2009**

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**TABLE OF CONTENTS**

 
| PART I   |   | Item  1  | Business                                                                                                            | 2   |
|---------------|--------|----------|---------------------------------------------------------------------------------------------------------------------|-----|
|          |   | Item  1A | Risk  Factors                                                                                                       | 18  |
|          |   | Item 1B  | Unresolved  Staff Comments                                                                                          | 31  |
|          |   | Item  2  | Properties                                                                                                          | 31  |
|          |   | Item 3   | Legal Proceedings                                                                                                   | 31  |
|          |   | Item 4   | Submission  of Matters to a Vote of Security Holders                                                                | 31  |
| PART II  |   | Item 5   | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 31  |
|          |   | Item 6   | Selected  Financial Data                                                                                            | 32  |
|          |   | Item 7   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 33  |
|          |   | Item 7A  | Quantitative  and Qualitative Disclosures about Market Risk                                                         | 60  |
|          |   | Item 8   | Financial  Statements and Supplementary Data                                                                        | 62  |
|          |   | Item 9   | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                               | 99  |
|          |   | Item 9A  | Controls and  Procedures                                                                                            | 99  |
|          |   | Item 9B  | Other Information                                                                                                   | 99  |
| PART III |   | Item 10  | Directors,  Executive Officers and Corporate Governance                                                             | 99  |
|          |   | Item 11  | Executive  Compensation                                                                                             | 99  |
|          |   | Item 12  | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 99  |
|          |   | Item 13  | Certain  Relationships and Related Transactions, and Director Independence                                          | 100 |
|          |   | Item 14  | Principal  Accountant Fees and Services                                                                             | 100 |
| PART IV  |   | Item 15  | Exhibits and  Financial Statement Schedule                                                                          | 100 |
| SIGNATURES    |   |     |                                                                                                                | 102 |

 

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**FORWARD-LOOKING STATEMENTS**

 

*All statements contained herein, other thanhistorical facts, may constitute “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21 of the Securities Act of 1934, as amended (the “ExchangeAct”). These statements may relate to, among other things, future events or ourfuture performance or financial condition. In some cases, you can identifyforward-looking statements by terminology such as “may,” “might,” “believe,” “will,”“provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,”“should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or thenegative of such terms or comparable terminology. These forward-lookingstatements involve known and unknown risks, uncertainties and other factorsthat may cause our actual results, levels of activity, performance or achievementsto be materially different from any future results, levels of activity,performance or achievements expressed or implied by such forward-lookingstatements. Such factors include, among others: (1) further adversechanges in the economy and the capital markets; (2) risks associated withnegotiation and consummation of pending and future transactions; (3) theloss of one or more of our executive officers, in particular David Gladstone,Terry Lee Brubaker, or George Stelljes III; (4) changes in our businessstrategy; (5) availability, terms and deployment of capital; (6) changesin our industry, interest rates, exchange rates or the general economy; (7) thedegree and nature of our competition; and (8) those factors described inthe “Risk Factors” section of this Form 10-K. We caution readers notto place undue reliance on any such forward-looking statements. We undertake noobligation to publicly update or revise any forward-looking statements, whetheras a result of new information, future events or otherwise, after the date ofthis Form 10-K.*

 

**PART I**

**(Dollar amounts in thousands, unless otherwiseindicated)**

 

*In this Annual Report on Form 10-K, or Annual Report,the “Company,” “we,” “us,” and “our” refer to Gladstone Capital Corporation andits wholly-owned subsidiaries unless the context otherwise indicates.*

 

**Item 1. Business**

 

**Overview**

 

We were incorporatedunder the General Corporation Laws of the State of Maryland on May 30,2001 and completed our initial public offering on August 24, 2001. Weoperate as a closed-end, non-diversified management investment company, and wehave elected to be treated as a business development company (“BDC”) under theInvestment Company Act of 1940, as amended ( the “1940 Act”).  In addition, for tax purposes we have electedto be treated as a regulated investment company (“RIC”) under the InternalRevenue Code of 1986, as amended (the “Code”).

 

We seek to achieve a highlevel of current income by investing in debt securities, consisting primarilyof senior notes, senior subordinated notes and junior subordinated notes, ofestablished private businesses that are substantially owned by leveraged buyoutfunds, or individual investors or are family-owned businesses, with aparticular focus on senior notes. In addition, we may acquire from othersexisting loans that meet this profile. We also seek to provide our stockholders with long-term capital growththrough appreciation in the value of warrants or other equity instruments thatwe may receive when we make loans.

 

We seek to invest insmall and medium-sized private U.S. businesses that meet certain criteria,including some but not necessarily all of the following: the potential forgrowth in cash flow, adequate assets for loan collateral, experiencedmanagement teams with a significant ownership interest in the borrower,profitable operations based on the borrower’s cash flow, reasonablecapitalization of the borrower (usually by leveraged buyout funds or venturecapital funds) and the potential to realize appreciation and gain liquidity inour equity positions, if any.  Weanticipate that liquidity in our equity position will be achieved through amerger or acquisition of the borrower, a public offering of the borrower’sstock or by exercising our right to require the borrower to repurchase ourwarrants, though there can be no assurance that we will always have theserights.  We seek to lend to borrowersthat need funds to finance growth, restructure their balance sheets or effect achange of control.

 

We seek to investprimarily in three categories of debt of private companies:

 

·                  *Senior Notes.* We seek to invest a portion of our assets in senior notes ofborrowers.  Using its assets and cashflow as collateral, the borrower typically uses senior notes to cover a substantialportion of the funding needed to operate. Senior 

 

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lenders areexposed to the least risk of all providers of debt because they command asenior position with respect to scheduled interest and principal payments.  However, unlike senior subordinated andjunior subordinated lenders, these senior lenders typically do not receive anystock, warrants to purchase stock of the borrowers or other yieldenhancements.  As such, they generally donot participate in the equity appreciation of the value of the business. Seniornotes may include revolving lines of credit, senior term loans, seniorsyndicated loans and senior last-out tranche loans.

 

·                  *Senior Subordinated Notes. *We seek to invest a portion of our assets in seniorsubordinated notes, which include second lien notes.  Holders of senior subordinated notes aresubordinated to the rights of holders of senior debt in their right to receive principaland interest payments or, in the case of last out tranches of senior debt,liquidation proceeds from the borrower. As a result, senior subordinated notes are riskier than senior notes.  Although such loans are sometimes secured bysignificant collateral, the lender is largely dependent on the borrower’s cashflow for repayment.  Additionally,lenders may receive warrants to acquire shares of stock in borrowers or otheryield enhancements in connection with these loans.  Senior subordinated notes include second lienloans and syndicated second lien loans.

 

·                  *Junior Subordinated Notes.* We also seek to invest a small portion of our assets in juniorsubordinated notes, which include mezzanine notes.  Holders of junior subordinated notes aresubordinated to the rights of the holders of senior debt and seniorsubordinated debt in their rights to receive principal and interest paymentsfrom the borrower.  The risk profile ofjunior subordinated notes is high, which permits the junior subordinated lenderto obtain higher interest rates and more equity and equity-like compensation.

 

*InvestmentConcentrations*

 

At September 30,2009, we had aggregate investments in 48 portfolio companies, and approximately66.1% of the aggregate fair value of such investments was senior term debt,approximately 33.0% was senior subordinated term debt, no investments were injunior subordinated debt and approximately 0.9% was in equity securities.  The following table outlines our investmentsby type at September 30, 2009 and 2008:

 
| ** **                   | ** ** | **September 30, 2009** | ** **    | **September 30, 2008** | ** ** |
|------------------------------|------------|-----------------------------|---------------|-----------------------------|------------|
| ** **                   | ** ** | **Cost**                    | ** **    | **Fair Value**              | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior  Notes                |       | $                           |  240,172 |                        | $          |  212,290 |   | $ |  297,910 |   | $ |  265,297 |   |
| Senior  Subordinated Notes   |       | 118,743                     |          | 105,794                     |       | 157,927 |   | 140,676 |   |
| Junior  Subordinated Notes   |       | —                      |          | —                      |       | — |   | — |   |
| Preferred  Equity Securities |       | 2,028                       |          | —                      |       | 1,584 |   | — |   |
| Common  Equity Securities    |       | 3,450                       |          | 2,885                       |       | 3,449 |   | 1,960 |   |
|                         |       |                        |          |                        |       |   |   |   |   |
| Total  Investments           |       | $                           |  364,393 |                        | $          |  320,969 |   | $ |  460,870 |   | $ |  407,933 |   |

 

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Investmentsat fair value consisted of the following industry classifications as of September 30,2009 and 2008:

 
| ** **                                                          | ** ** | **September 30, 2009** | ** **  | **September 30, 2008** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------|-------------|-----------------------------|------------|
| ** **                                                          | ** ** | ** **                  | ** **  | **Percentage**              | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                                         | ** ** | **Fair Value**              | ** **  | **Total  Investments**      | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace &  Defense                                       |       | $                           |  1,857 |                        | 0.6        | % | 0.7 | % | $ |  4,192 |   | 1.0 | % | 1.6 | % |
| Automobile                                                          |       | 7,999                       |        | 2.5                         | %          | 3.2 | % | 5,055 |   | 1.2 | % | 1.9 | % |
| Broadcast  (TV & Radio)                                    |       | 43,403                      |        | 13.5                        | %          | 17.4 | % | 52,336 |   | 12.8 | % | 19.2 | % |
| Buildings &  Real Estate                                   |       | 12,882                      |        | 4.0                         | %          | 5.2 | % | 13,519 |   | 3.3 | % | 5.0 | % |
| Cargo  Transport                                                    |       | 5,427                       |        | 1.7                         | %          | 2.2 | % | 15,805 |   | 3.9 | % | 5.8 | % |
| Chemicals,  Plastics & Rubber                              |       | 15,884                      |        | 4.9                         | %          | 6.4 | % | 16,375 |   | 4.0 | % | 6.0 | % |
| Diversified/Conglomerate  Manufacturing                             |       | 1,236                       |        | 0.4                         | %          | 0.5 | % | 3,195 |   | 0.8 | % | 1.2 | % |
| Diversified  Natural Resources, Precious Metals & Minerals |       | 13,589                      |        | 4.2                         | %          | 5.5 | % | 12,936 |   | 3.2 | % | 4.8 | % |
| Electronics                                                         |       | 27,899                      |        | 8.7                         | %          | 11.2 | % | 35,208 |   | 8.6 | % | 13.0 | % |
| Farming &  Agriculture                                     |       | 9,309                       |        | 2.9                         | %          | 3.7 | % | 10,031 |   | 2.5 | % | 3.7 | % |
| Finance                                                             |       | —                      |        | —                      |       | — |   | 1,812 |   | 0.4 | % | 0.7 | % |
| Healthcare,  Education & Childcare                         |       | 58,054                      |        | 18.1                        | %          | 23.3 | % | 76,642 |   | 18.8 | % | 28.2 | % |
| Home &  Office Furnishings                                 |       | 16,744                      |        | 5.2                         | %          | 6.7 | % | 15,379 |   | 3.8 | % | 5.7 | % |
| Leisure,  Amusement, Movies & Entertainment                |       | 5,091                       |        | 1.6                         | %          | 2.0 | % | 8,097 |   | 2.0 | % | 3.0 | % |
| Machinery                                                           |       | 9,202                       |        | 2.9                         | %          | 3.7 | % | 9,834 |   | 2.4 | % | 3.6 | % |
| Mining,  Steel, Iron & Non-Precious Metals                 |       | 21,926                      |        | 6.8                         | %          | 8.8 | % | 25,095 |   | 6.2 | % | 9.2 | % |
| Personal &  Non-durable Consumer Products                  |       | 8,714                       |        | 2.7                         | %          | 3.5 | % | 9,703 |   | 2.4 | % | 3.6 | % |
| Printing &  Publishing                                     |       | 37,864                      |        | 11.8                        | %          | 15.2 | % | 60,440 |   | 14.8 | % | 22.2 | % |
| Retail  Stores                                                      |       | 23,669                      |        | 7.4                         | %          | 9.5 | % | 22,800 |   | 5.6 | % | 8.4 | % |
| Textiles &  Leather                                        |       | 220                         |        | 0.1                         | %          | 0.1 | % | 9,479 |   | 2.3 | % | 3.5 | % |
| **Total**                                                           |       | $                           | 320,969     |                        | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

Theinvestments at fair value were included in the following geographic regions ofthe United States at September 30, 2009 and 2008:

 
| ** **             | ** ** | **September 30, 2009** | ** ** | **September 30, 2008**  | ** ** |
|------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **             | ** ** | ** **                  | ** ** | **Percentage**               | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic  Region** | ** ** | **Fair Value**              | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** | **Fair Value** | ** ** | **Total********Investments** | ** ** | **Net********Assets** | ** ** |
| Midwest                |       | $                           | 172,263    |                         | 53.7       | % | 69.2 | % | $ | 206,271 |   | 50.6 | % | 75.9 | % |
| West                   |       | 65,678                      |       | 20.4                         | %          | 26.4 | % | 85,294 |   | 20.9 | % | 31.4 | % |
| Southeast              |       | 34,708                      |       | 10.8                         | %          | 13.9 | % | 49,374 |   | 12.1 | % | 18.2 | % |
| Mid-Atlantic           |       | 28,437                      |       | 8.9                          | %          | 11.4 | % | 50,807 |   | 12.4 | % | 18.7 | % |
| Northeast              |       | 14,170                      |       | 4.4                          | %          | 5.7 | % | 10,617 |   | 2.6 | % | 3.9 | % |
| U.S.  Territory        |       | 5,713                       |       | 1.8                          | %          | 2.3 | % | 5,570 |   | 1.4 | % | 2.0 | % |
|                   |       | $                           | 320,969    |                         | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

Thegeographic region indicates the location of the headquarters for our portfoliocompanies.  A portfolio company may havea number of other business locations in other geographic regions.

 

Our loans typically rangefrom $5 million to $20 million, generally mature in no more than seven yearsand accrue interest at a fixed or variable rate that exceeds the primerate.  Because the majority of the loansin our portfolio consist of term debt of private companies that typicallycannot or will not expend the resources to have their debt securities rated bya credit rating agency, we expect that most, if not all, of the debt securitieswe acquire will be unrated.  Accordingly,we cannot accurately

 

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predict what ratings theseloans might receive if they were in fact rated, and thus cannot determinewhether or not they could be considered “investment grade” quality.

 

We hold our loaninvestment portfolio through our wholly-owned subsidiary, Gladstone BusinessLoan, LLC (“Business Loan”).

 

**OurInvestment Adviser and Administrator**

 

Gladstone ManagementCorporation (our “Adviser”) is led by a management team which has extensiveexperience in our lines of business.  OurAdviser also has a wholly-owned subsidiary, Gladstone Administration, LLC (the “Administrator”)which employs our chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs. Excluding our chief financial officer, all of our executive officers areofficers or directors, or both, of our Adviser and our Administrator.

 

Our Adviser andAdministrator also provide investment advisory and administrative services,respectively, to our affiliates Gladstone Commercial Corporation (“GladstoneCommercial”), a publicly traded real estate investment trust; GladstoneInvestment Corporation (“Gladstone Investment”), a publicly traded businessdevelopment company; and Gladstone Land Corporation, a private agriculturalreal estate company owned by Mr. David Gladstone, our chairman and chiefexecutive officer. All of our directors and executive officers, with theexception of our chief financial officer, serve as either directors orexecutive officers, or both, of Gladstone Commercial and Gladstone Investment.  Our Adviser’s investment committee iscomposed of Mr. David Gladstone, Mr. Terry Brubaker, our vicechairman, chief operating officer and secretary, and Mr. George StelljesIII, our president and chief investment officer.  In the future, our Adviser may provideinvestment advisory and administrative services to other funds, both public andprivate, of which it is the sponsor.

 

We have been externallymanaged by our Adviser pursuant to a contractual investment advisoryarrangement since October 1, 2004. Our Adviser was organized as a corporation under the laws of the Stateof Delaware on July 2, 2002 and is a registered investment adviser underthe Investment Advisers Act of 1940, as amended.  Our Adviser and Administrator areheadquartered in McLean, Virginia, a suburb of Washington, D.C., and ourAdviser also has offices in New York, New Jersey, Illinois, Texas and Georgia.

 

**OurInvestment Strategy**

 

Our strategy is to makeloans at favorable interest rates to small and medium-sized businesses. OurAdviser uses the loan referral networks of Messrs. Gladstone, Stelljes andBrubaker and of its managing directors to identify and make senior andsubordinated loans to borrowers that need funds to finance growth, restructuretheir balance sheets or effect a change of control. We believe that ourbusiness strategy will enable us to achieve a high level of current income byinvesting in debt securities, consisting primarily of senior notes, seniorsubordinated notes and junior subordinated notes of established privatebusinesses that are backed by leveraged buyout funds, venture capital funds orothers. In addition, from time to time we might acquire existing loans thatmeet this profile from leveraged buyout funds, venture capital funds andothers. We also seek to provide our stockholders with long-term capital growththrough the appreciation in the value of warrants or other equity instrumentsthat we might receive when we make loans.

 

We target small andmedium-sized private businesses that meet certain criteria, including some butnot necessarily all of the following: the potential for growth in cash flow,adequate assets for loan collateral, experienced management teams with asignificant ownership interest in the borrower, profitable operations based onthe borrower’s cash flow, reasonable capitalization of the borrower (usually byleveraged buyout funds or venture capital funds) and the potential to realizeappreciation and gain liquidity in our equity position, if any. We may achieveliquidity in an equity position through a merger or acquisition of theborrower, a public offering of the borrower’s stock or by exercising our rightto require the borrower to repurchase our warrants, although we cannot assureyou that we will always have these rights. We can also achieve a similar effect by requiring the borrower to pay usconditional interest, which we refer to as a success fee, upon the occurrenceof certain events.  Success fees aredependent upon the success of the borrower and the occurrence of a triggeringevent, and are paid in lieu of warrants to purchase common stock of theborrower.

 

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**InvestmentProcess**

 

***Overviewof Loan Origination and Approval Process***

 

To originate loans, ourAdviser’s investment professionals use an extensive referral network comprisedprimarily of venture capitalists, leveraged buyout fund managers, investmentbankers, attorneys, accountants, commercial bankers and business brokers.  Our Adviser’s investment professionals reviewinformational packages from these and other sources in search of potentialfinancing opportunities.  If a potentialopportunity matches our investment objectives, the investment professionalswill seek an initial screening of the opportunity from our Adviser’s investmentcommittee which is composed of Mr. Gladstone, Mr. Brubaker and Mr. Stelljes.  If the prospective portfolio company passesthis initial screening, the investment professionals conduct a due diligenceinvestigation and create a detailed profile summarizing the prospectiveportfolio company’s historical financial statements, industry and managementteam and analyzing its conformity to our general investment criteria. Theinvestment professionals then present this profile to our Adviser’s investmentcommittee, which must approve each investment. Further, each financing is reviewed and approved by the members of ourBoard of Directors, a majority of whom are not “interested directors” as definedin Section 2(a)(19) of the 1940 Act.

 

***ProspectivePortfolio Company Characteristics***

 

We have identifiedcertain characteristics that we believe are important in identifying andinvesting in prospective portfolio companies. The criteria listed below provide general guideposts for our lending andinvestment decisions, although not all of these criteria may be met by eachportfolio company.

 

·                  *Value-and-Income Orientation andPositive Cash Flow.*    Ourinvestment philosophy places a premium on fundamental analysis from an investor’sperspective and has a distinct value-and-income orientation. In seeking value,we focus on companies in which we can invest at relatively low multiples ofearnings before interest, taxes, depreciation and amortization (“EBITDA”), andthat have positive operating cash flow at the time of investment. In seekingincome, we seek to invest in companies that generate relatively high and stablecash flow to provide some assurance that they will be able to service theirdebt and pay any required dividends on preferred stock. Typically, we do notexpect to invest in start-up companies or companies with speculative business plans.

 

·                  *Experienced Management. * Wegenerally require that our portfolio companies have an experienced  management team.  We also require the portfolio companies tohave in place proper incentives to induce management to succeed and act inconcert with our interests as investors, including having significant equity orother interests in the financial performance of their companies.

 

·                  *Strong Competitive Position in anIndustry.*    Weseek to invest in target companies that have developed strong market positionswithin their respective markets and that we believe are well-positioned tocapitalize on growth opportunities. We seek companies that demonstratesignificant competitive advantages versus their competitors, which we believewill help to protect their market positions and profitability.

 

·                  *Exit Strategy.* We seek to invest in companies that webelieve will provide a stable stream of cash flow that is sufficient to repaythe loans we make to them and to reinvest in their respective businesses. Weexpect that such internally generated cash flow, which will allow our portfoliocompanies to pay interest on, and repay the principal of, our investments, willbe a key means by which we exit from our investments over time. In addition, wealso seek to invest in companies whose business models and expected future cashflows offer attractive possibilities for capital appreciation on any equityinterests we may obtain or retain. These capital appreciation possibilitiesinclude strategic acquisitions by other industry participants or financialbuyers, initial public offerings of common stock, or other capital markettransactions.

 

·                  *Liquidation Value of Assets.* The prospective liquidation value of theassets, if any, collateralizing loans in which we invest is an important factorin our investment analysis.  We emphasizeboth tangible and intangible assets, such as accounts receivable, inventory,equipment, and real estate and intangible assets, such as intellectualproperty, customer lists, networks, databases, although the relative weight weplace on these assets will vary by company and industry.

 

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***ExtensiveDue Diligence***

 

Our Adviser conducts whatwe believe are extensive due diligence investigations of our prospectiveportfolio companies and investment opportunities.  Our due diligence investigation may beginwith a review of publicly available information, and will generally includesome or all of the following:

 

·                  a review of the prospective portfoliocompany’s borrower’s historical and projected financial information;

·                  visits to the prospective portfoliocompany’s business site(s);

·                  interviews with the prospective portfoliocompany’s management, employees, customers and vendors;

·                  review of all loan documents;

·                  background checks on the prospectiveportfolio company’s management team; and

·                  research on the prospective portfoliocompany’s products, services or particular industry.

 

Upon completion of a duediligence investigation and a decision to proceed with an investment, ourAdviser’s lending professionals who have primary responsibility for theinvestment present the investment opportunity to our Adviser’s investmentcommittee, which consists of Messrs. Gladstone, Brubaker and Stelljes. Theinvestment committee determines whether to pursue the potential investment.Additional due diligence of a potential investment may be conducted on ourbehalf by attorneys and independent accountants prior to the closing of theinvestment, as well as other outside advisers, as appropriate.

 

We also rely on thelong-term relationships that our Adviser’s professionals have with venturecapitalists, leveraged buyout fund managers, investment bankers, commercialbankers and business brokers, and on the extensive direct experiences of ourexecutive officers and managing directors in providing debt and equity capitalto small and medium-sized private businesses.

 

***InvestmentStructure***

 

We typically invest insenior, senior subordinated and junior subordinated loans. Our loans typicallyrange from $5 million to $20 million, although the size of ourinvestments may vary as our capital base changes.  Our loans generally mature within seven yearsand accrue interest at a variable rate that exceeds the LIBOR and primerates.  In the past, some of our loanshave had a provision that calls for some portion of the interest payments to bedeferred and added to the principal balance so that the interest is paid,together with the principal, at maturity. This form of deferred interest isoften called “paid in kind” (“PIK”) interest, and, when earned, we record PIKinterest as interest income and add the PIK interest to the principal balanceof the loans.  As of September 30,2009, two loans in our portfolio contained PIK provisions.

 

To the extent possible,our loans generally are collateralized by a security interest in the borrower’sassets.  In senior and subordinatedloans, we do not usually have the first claim on these assets. Interest paymentson loans we make will generally be made monthly or quarterly (except to theextent of any PIK interest) with amortization of principal generally beingdeferred for several years. The principal amount of the loans and any accruedbut unpaid interest will generally become due at maturity at five to sevenyears. We seek to make loans that are accompanied by warrants to purchase stockin the borrowers or other yield enhancement features, such as success fees. Anywarrants that we receive will typically have an exercise price equal to thefair value of the portfolio company’s common stock at the time of the loan andentitle us to purchase a modest percentage of the borrower’s stock.  Success fees are conditional interest that ispaid if the borrower is successful. The success fee is calculated as additionalinterest on the loan and is paid upon the occurrence of certain triggeringevents, such as the sale of the borrower. If the event or events do not occur, no success fee will be paid.

 

From time to time, a portfoliocompany may request additional financing, providing us with additional lendingopportunities. We will consider such requests for additional financing underthe criteria we have established for initial investments and we anticipate thatany debt securities we acquire in a follow-on financing will havecharacteristics comparable to those issued in the original financing. In somesituations, our failure, inability or decision not to make a follow-oninvestment may be detrimental to the operations or survival of a portfoliocompany, and thus may jeopardize our investment in that borrower.

 

As noted above, we expectto receive yield enhancements in connection with many of our loans, which mayinclude warrants to purchase stock or success fees. If a financing issuccessful, not only will our debt securities have been repaid with interest,but we will be in a position to realize a gain on the accompanying equityinterests or other yield enhancements. The opportunity to realize such gain mayoccur if the borrower is sold to new owners or if it makes a public offering ofits stock. In most cases, we will not have the right to require that a borrowerundergo an initial public offering by registering securities under theSecurities Act of 1933, as amended, (the “Securities Act”), but we generallywill have the right to sell our equity

 

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interests in anysubsequent public offering by the borrower. Even when we have the right toparticipate in a borrower’s public offering, the underwriters might insist,particularly if we own a large amount of equity securities, that we retain allor a substantial portion of our shares for a specified period of time.Moreover, we may decide not to sell an equity position even when we have theright and the opportunity to do so. Thus, although we expect to dispose of anequity interest after a certain time, situations may arise in which we holdequity securities for a longer period.

 

***RiskManagement***

 

We seek to limit thedownside risk of our investments by:

 

·                  making investments with an expected totalreturn (including both interest and potential equity appreciation) that webelieve compensates us for the credit risk of the investment;

 

·                  seeking collateral or superior positionsin the portfolio company’s capital structure where possible;

 

·                  incorporating put rights and callprotection into the investment structure where possible; and

 

·                  negotiating covenants in connection withour investments that afford our portfolio companies as much flexibility aspossible in managing their businesses, consistent with the preservation of ourcapital.

 

***TemporaryInvestments***

 

Pending investment inprivate companies, we invest our otherwise uninvested cash primarily in cash,cash items, government securities or high-quality debt securities maturing inone year or less from the time of investment, to which we refer collectively astemporary investments, so that 70% of our assets are “qualifying assets” forpurposes of the business development company provisions of the 1940 Act. Forinformation regarding regulations to which we are subject and the definition of“qualifying assets,” see “ — Regulation as a Business Development Company —Qualifying Assets.”

 

***HedgingStrategies***

 

Although it has not yethappened, nor do we expect this to happen in the near future, when one of ourportfolio companies goes public, we may undertake hedging strategies withregard to any equity interests that we may have in that company. We maymitigate risks associated with the volatility of publicly traded securities by,for instance, selling securities short or writing or buying call or putoptions. Hedging against a decline in the value of such investments in publiccompanies would not eliminate fluctuations in the values of such investments orprevent losses if the values of such investments decline, but would establishother investments designed to gain from those same developments. Therefore, byengaging in hedging transactions, we can moderate the decline in the value ofour hedged investments in public companies. However, such hedging transactionswould also limit our opportunity to gain from an increase in the value of ourinvestment in the public company. Hedging strategies can pose risks to us and our stockholders, however webelieve that such activities are manageable because they will be limited toonly a portion of our portfolio.

 

Section 12(a)(3) ofthe 1940 Act prohibits us from effecting a short sale of any security “incontravention of such rules and regulations or orders as the [SEC] mayprescribe as necessary or appropriate in the public interest or for theprotection of investors . . .” However, to date, the SEC has not promulgatedregulations under this statute. It is possible that such regulations could bepromulgated in the future in a way that would require us to change any hedgingstrategies that we may adopt.  Inaddition, our ability to engage in short sales may be limited by the 1940 Act’sleverage limitations.  We will onlyengage in hedging activities in compliance with applicable laws andregulations.

 

**CompetitiveAdvantages**

 

A large number ofentities compete with us and make the types of investments that we seek to makein small and medium-sized privately-owned businesses. Such competitors includeprivate equity funds, leveraged buyout funds, venture capital funds, investmentbanks and other equity and non-equity based investment funds, and otherfinancing sources, including traditional financial services companies such ascommercial banks. Many of our competitors are substantially larger than we areand have considerably greater funding sources that are not available to us. Inaddition, certain of our competitors may have higher risk tolerances ordifferent risk assessments, which could allow them to consider a wider varietyof investments, establish more relationships and build their market shares.Furthermore, many of these competitors are not subject to the

 

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regulatory restrictionsthat the 1940 Act imposes on us as a business development company.  However, we believe that we have thefollowing competitive advantages over other providers of financing to small andmid-sized businesses.

 

***ManagementExpertise***

 

David Gladstone, ourchairman and chief executive officer, is also the chairman and chief executiveofficer of our Adviser and its affiliated companies, which we refer to as theGladstone Companies, and has been involved in all aspects of the GladstoneCompanies’ investment activities, including serving as a member of our Adviser’sinvestment committee. Terry Lee Brubaker is our vice chairman, chief operatingofficer and secretary, and has substantial experience in acquisitions andoperations of companies. George Stelljes III is our president and chiefinvestment officer and has extensive experience in leveraged finance. Messrs. Gladstone,Brubaker and Stelljes have principal management responsibility for our Adviseras its senior executive officers. These individuals dedicate a significantportion of their time to managing our investment portfolio. Our seniormanagement has extensive experience providing capital to small and mid-sizedcompanies and has worked together for more than 10 years. In addition, we haveaccess to the resources and expertise of our Adviser’s investment professionalsand supporting staff who possess a broad range of transactional, financial,managerial and investment skills.

 

***IncreasedAccess to Investment Opportunities Developed Through Proprietary ResearchCapability and an Extensive Network of Contacts***

 

Our Adviser seeks toidentify potential investments both through active origination and duediligence and through its dialogue with numerous management teams, members ofthe financial community and potential corporate partners with whom our Adviser’sinvestment professionals have long-term relationships. We believe that ourAdviser’s investment professionals have developed a broad network of contactswithin the investment, commercial banking, private equity and investmentmanagement communities, and that their reputation in investment management enablesus to identify well-positioned prospective portfolio companies which provideattractive investment opportunities. Additionally, our Adviser expects togenerate information from its professionals’ network of accountants,consultants, lawyers and management teams of portfolio companies and othercompanies.

 

***Disciplined,Value and Income-Oriented Investment Philosophy with a Focus on Preservation ofCapital***

 

In making its investmentdecisions, our Adviser focuses on the risk and reward profile of each prospectiveportfolio company, seeking to minimize the risk of capital loss withoutforegoing the potential for capital appreciation. We expect our Adviser to usethe same value and income-oriented investment philosophy that its professionalsuse in the management of the other Gladstone Companies and to commit resourcesto management of downside exposure. Our Adviser’s approach seeks to reduce ourrisk in investments by using some or all of the following approaches:

 

·                  focusing on companies with good market positions,established management teams and good cash flow;

·                  investing in businesses with experiencedmanagement teams;

·                  engaging in extensive due diligence fromthe perspective of a long-term investor;

·                  investing at low price-to-cash flowmultiples; or

·                  adopting flexible transaction structuresby drawing on the experience of the investment professionals of our Adviser andits affiliates.

 

***LongerInvestment Horizon with Attractive Publicly Traded Model***

 

Unlike private equity andventure capital funds that are typically organized as finite-life partnerships,we are not subject to standard periodic capital return requirements. Thepartnership agreements of most private equity and venture capital fundstypically provide that these funds may only invest investors’ capital once andmust return all capital and realized gains to investors within a finite timeperiod, often seven to ten years. These provisions often force private equityand venture capital funds to seek returns on their investments by causing theirportfolio companies to pursue mergers, public equity offerings, or otherliquidity events more quickly than might otherwise be optimal or desirable,potentially resulting in both a lower overall return to investors and anadverse impact on their portfolio companies. We believe that our flexibility tomake investments with a long-term view and without the capital returnrequirements of traditional private investment vehicles provides us with theopportunity to achieve greater long-term returns on invested capital.

 

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***FlexibleTransaction Structuring***

 

We believe our managementteam’s broad expertise and its ability to draw upon many years of combinedexperience enables our Adviser to identify, assess, and structure investmentssuccessfully across all levels of a company’s capital structure and managepotential risk and return at all stages of the economic cycle. We are notsubject to many of the regulatory limitations that govern traditional lendinginstitutions such as banks. As a result, we are flexible in selecting andstructuring investments, adjusting investment criteria and transactionstructures, and, in some cases, the types of securities in which we invest. Webelieve that this approach enables our Adviser to identify attractiveinvestment opportunities that will continue to generate current income andcapital gain potential throughout the economic cycle, including duringturbulent periods in the capital markets. One example of our flexibility is ourability to exchange our publicly-traded stock for the stock of an acquisitiontarget in a tax-free reorganization under the Code. After completing anacquisition in such an exchange, we can restructure the capital of the smallcompany to include senior and subordinated debt.

 

***Leverage***

 

For the purpose of makinginvestments other than temporary investments and to take advantage of favorableinterest rates, we intend to issue senior debt securities (including borrowingsunder our current line of credit) up to the maximum amount permitted by the1940 Act. The 1940 Act currently permits us to issue senior debt securities andpreferred stock, to which we refer collectively as senior securities, inamounts such that our asset coverage, as defined in the 1940 Act, is at least200% after each issuance of senior securities. We may also incur suchindebtedness to repurchase our common stock. As a result of issuing seniorsecurities, we are exposed to the risks of leverage. Although borrowing moneyfor investments increases the potential for gain, it also increases the risk ofa loss. A decrease in the value of our investments will have a greater impacton the value of our common stock to the extent that we have borrowed money tomake investments. There is a possibility that the costs of borrowing couldexceed the income we receive on the investments we make with such borrowedfunds. In addition, our ability to pay dividends or incur additionalindebtedness would be restricted if asset coverage is less than twice ourindebtedness. If the value of our assets declines, we might be unable tosatisfy that test. If this happens, we may be required to liquidate a portionof our loan portfolio and repay a portion of our indebtedness at a time when asale may be disadvantageous. Furthermore, any amounts that we use to serviceour indebtedness will not be available for distributions to our stockholders.Our Board of Directors is authorized to provide for the issuance of preferredstock with such preferences, powers, rights and privileges as it deemsappropriate, provided that such an issuance adheres to the requirements of the1940 Act.  See “Regulation as a BusinessDevelopment Company—Asset Coverage” for a discussion of our leveragingconstraints.

 

**OngoingRelationships with and Monitoring of Portfolio Companies**

 

***Monitoring***

 

Our Adviser’s investmentprofessionals, led by Terry Lee Brubaker, our chief operating officer, monitorthe financial trends of each portfolio company on an ongoing basis to determineif each is meeting its respective business plans and to assess the appropriatecourse of action for each company.  Wemonitor the status and performance of each portfolio company and use it to evaluatethe overall performance of our portfolio.

 

Our Adviser employsvarious methods of evaluating and monitoring the performance of each of ourportfolio companies, which include some or all of following:

 

·                  assessment of success in the portfoliocompany’s overall adherence to its business plan and compliance with covenants;

·                  attendance at and participation inmeetings of the portfolio company’s board of directors;

·                  periodic contact, including formal updateinterviews with portfolio company management, and, if appropriate, thefinancial or strategic sponsor;

·                  comparison with other companies in theportfolio company’s industry; and

·                  review of monthly and quarterly financialstatements and financial projections for portfolio companies.

 

***ManagerialAssistance and Services***

 

As a business developmentcompany, we make available significant managerial assistance to our portfoliocompanies and provide other services to such portfolio companies. Neither wenor our Adviser currently receives fees in connection with managerialassistance. Our Adviser provides other services to our portfolio companies andreceives fees for these other services, certain of which are credited by 50%against the investment advisory fees that we pay our Adviser.

 

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***ValuationProcess***

 

The following is ageneral description of the steps we take each quarter to determine the value ofour investment portfolio. We value our investments in accordance with therequirements of the 1940 Act. We value securities for which market quotationsare readily available at their market value. We value all other securities andassets at fair value as determined in good faith by our Board of Directors. Indetermining the value of our investments, our Adviser has established aninvestment valuation policy (the “Policy”). The Policy has been approved by ourBoard of Directors and each quarter the Board of Directors reviews whether ourAdviser has applied the Policy consistently and votes whether or not to acceptthe recommended valuation of our investment portfolio. Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed. Investments for which market quotations are readilyavailable are recorded in our financial statements at such market quotations.With respect to any investments for which market quotations are not readilyavailable, we perform the following valuation process each quarter:

 

·                  Ourquarterly valuation process begins with each portfolio company or investmentbeing initially assessed by our Adviser’s investment professionals responsiblefor the investment, using the Policy.

 

·                  Preliminaryvaluation conclusions are then discussed with our management, and documented,along with any independent opinions of value provided by Standard &Poor’s Securities Evaluations, Inc. (“SPSE”), for review by our Board ofDirectors.

 

·                  OurBoard of Directors reviews this documentation and discusses the input of ourAdviser, management, and the opinions of value of SPSE to arrive at adetermination for the aggregate fair value of our portfolio of investments.

 

Our valuation policies,procedures and processes are more fully described under “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations — Critical Accounting Policies — Investment Valuation.”

 

**InvestmentAdvisory and Management Agreements**

 

We are externally managedpursuant to contractual arrangements with our Adviser and Administrator, underwhich our Adviser and Administrator employ all of our personnel and pay ourpayroll, benefits, and general expenses directly.  On October 1, 2006, we entered into anamended and restated investment advisory agreement with our Adviser (the “AdvisoryAgreement”) and an administration agreement with our Administrator (the “AdministrationAgreement”).  On July 8, 2009, ourBoard of Directors renewed the Advisory Agreement and the AdministrationAgreement through August 31, 2010. The management services and fees in effect under the Advisory Agreementare described below.  In addition to thefees described below, certain fees received by our Adviser from our portfoliocompanies were 100% credited, prior to April 1, 2007, or 50% creditedeffective April 1, 2007, against the investment advisory fee.  In addition, we pay our direct expensesincluding, but not limited to, directors’ fees, legal and accounting fees andstockholder related expenses under the Advisory Agreement.

 

***Managementservices and fees under the Advisory Agreement***

 

Under the AdvisoryAgreement, we pay our Adviser an annual base management fee of 2% of ouraverage gross assets, which is defined as total assets, including investmentsmade with proceeds of borrowings, less any uninvested cash or cash equivalentsresulting from borrowings, valued at the end of the two most recently completedcalendar quarters, and appropriately adjusted for any share issuances orrepurchases during the current calendar quarter.

 

We also pay our Adviser atwo-part incentive fee under the Advisory Agreement.  The first part of the incentive fee is anincome-based incentive fee which rewards our Adviser if our quarterly netinvestment income (before giving effect to any incentive fee) exceeds 1.75% ofour net assets (the “hurdle rate”). We pay our Adviser an income-basedincentive fee with respect to our pre-incentive fee net investment income ineach calendar quarter as follows:

 

·             no incentive fee in any calendar quarterin which our pre-incentive fee net investment income does not exceed the hurdlerate (7% annualized);

 

·             100% of our pre-incentive fee netinvestment income with respect to that portion of such pre-incentive fee netinvestment income, if any, that exceeds the hurdle rate but is less than2.1875% in any calendar quarter (8.75% annualized); and

 

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·             20% of the amount of our pre-incentivefee net investment income, if any, that exceeds 2.1875% in any calendar quarter(8.75% annualized).

 

*Quarterly Incentive Fee Based on NetInvestment Income*

 

**Pre-incentive fee net investmentincome(expressed as a percentage of the value of net assets)**

 

****

 

**Percentage of pre-incentive fee netinvestment incomeallocated to income-related portion of incentive fee**

 

The second part of theincentive fee is a capital gains-based incentive fee that is determined andpayable in arrears as of the end of each fiscal year (or upon termination ofthe Advisory Agreement, as of the termination date), equals 20% of our realizedcapital gains as of the end of the fiscal year. In determining the capital gains-based incentive fee payable to ourAdviser, we calculate the cumulative aggregate realized capital gains andcumulative aggregate realized capital losses since our inception, and theaggregate unrealized capital depreciation as of the date of the calculation, asapplicable, with respect to each of the investments in our portfolio. For thispurpose, cumulative aggregate realized capital gains, if any, equals the sum ofthe differences between the net sales price of each investment, when sold, andthe original cost of such investment since our inception. Cumulative aggregaterealized capital losses equals the sum of the amounts by which the net salesprice of each investment, when sold, is less than the original cost of suchinvestment since our inception. Aggregate unrealized capital depreciationequals the sum of the difference, if negative, between the valuation of eachinvestment as of the applicable calculation date and the original cost of suchinvestment. At the end of the applicable year, the amount of capital gains thatserves as the basis for our calculation of the capital gains-based incentivefee equals the cumulative aggregate realized capital gains less cumulativeaggregate realized capital losses, less aggregate unrealized capitaldepreciation, with respect to our portfolio of investments. If this number ispositive at the end of such year, then the capital gains-based incentive feefor such year equals 20% of such amount, less the aggregate amount of anycapital gains-based incentive fees paid in respect of our portfolio in allprior years.

 

Beginning in April 2006,our Board of Directors has accepted from the Adviser unconditional andirrevocable voluntary waivers on a quarterly basis to reduce the annual 2% basemanagement fee on senior syndicated loan participations to 0.5%, to the extentthat proceeds resulting from borrowings were used to purchase such syndicatedloan participations. These waivers were applied through September 30,2009, and any waived fees may not be recouped by our Adviser in the future.

 

When our Adviser receivesfees from our portfolio companies, such as investment banking fees, structuringfees or executive recruiting services fees, 50% of certain of these fees arecredited against the base management fee that we would otherwise be required topay to our Adviser.

 

In addition, our Adviserservices the loans held by Business Loan in return for which our Adviserreceives a 1.5% annual fee based on the monthly aggregate outstanding loanbalance of the loans pledged under our credit facility.  This fee directly reduces the amount of thefee payable under the Advisory Agreement. Loan servicing fees of $5,620 wereincurred for the fiscal year ended September 30, 2009, all of which weredirectly credited against the amount of the base management fee due to ourAdviser under the Advisory Agreement.

 

We pay our directexpenses including, but not limited to, directors’ fees, legal and accountingfees, stockholder-related expenses, and directors and officers insurance underthe Advisory Agreement.

 

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***AdministrationAgreement***

 

Under the AdministrationAgreement, we pay separately for administrative services. The AdministrationAgreement provides for payments equal to our allocable portion of theAdministrator’s overhead expenses in performing its obligations under theAdministration Agreement including, but not limited to, rent for employees ofthe Administrator and our allocable portion of the salaries and benefitsexpenses of our chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs. Our allocable portion of expenses is derived by multiplying ourAdministrator’s total expenses by the percentage of our average total assets(the total assets at the beginning and end of each quarter) in comparison tothe average total assets of all companies managed by our Adviser under similaragreements.

 

**MaterialU.S. Federal Income Tax Considerations**

 

***RegulatedInvestment Company Status***

 

In order to maintain thequalification for treatment as a RIC under Subchapter M of the Code, we mustdistribute to our stockholders, for each taxable year, at least 90% of ourinvestment company taxable income, which is generally our ordinary income plusshort-term capital gains. We refer to this as the annual distributionrequirement. We must also meet several additional requirements, including:

 

·                                          **Income source requirements.** At least 90% of our gross income foreach taxable year must be from dividends, interest, payments with respect tosecurities loans, gains from sales or other dispositions of securities or otherincome derived with respect to our business of investing in securities, and netincome derived from an interest in a qualified publicly traded partnership.

 

·                                          **Asset diversificationrequirements.** Asof the close of each quarter of our taxable year: (1) at least 50% of thevalue of our assets must consist of cash, cash items, U.S. governmentsecurities, the securities of other regulated investment companies and othersecurities to the extent that (a) we do not hold more than 10% of theoutstanding voting securities of an issuer of such other securities and (b) suchother securities of any one issuer do not represent more than 5% of our totalassets, and (2) no more than 25% of the value of our total assets may beinvested in the securities of one issuer (other than U.S. government securitiesor the securities of other regulated investment companies), or of two or moreissuers that are controlled by us and are engaged in the same or similar orrelated trades or businesses or in the securities of one or more qualifiedpublicly traded partnerships.

 

*Failureto Qualify as a RIC. *If we are unable to qualify for treatmentas a RIC, we will be subject to tax on all of our taxable income at regularcorporate rates. We would not be able to deduct distributions to stockholders,nor would we be required to make such distributions. Distributions would betaxable to our stockholders as ordinary dividend income to the extent of ourcurrent and accumulated earnings and profits. Subject to certain limitationsunder the Code, corporate distributees would be eligible for the dividendsreceived deduction. Distributions in excess of our current and accumulatedearnings and profits would be treated first as a return of capital to theextent of the stockholder’s tax basis, and then as a gain realized from thesale or exchange of property. If we fail to meet the RIC requirements for morethan two consecutive years and then seek to requalify as a RIC, we would berequired to recognize a gain to the extent of any unrealized appreciation onour assets unless we make a special election to pay corporate-level tax on anysuch unrealized appreciation recognized during the succeeding 10-year period.Absent such special election, any gain we recognized would be deemeddistributed to our stockholders as a taxable distribution.

 

*Qualificationas a RIC.*  If we qualify as a RIC and distribute tostockholders each year in a timely manner at least 90% of our investmentcompany taxable income, we will not be subject to federal income tax on theportion of our taxable income and gains we distribute to stockholders. Wewould, however, be subject to a 4% nondeductible federal excise tax if we donot distribute, actually or on a deemed basis, 98% of our income, includingboth ordinary income and capital gains. The excise tax would apply only to theamount by which 98% of our income exceeds the amount of income we distribute,actually or on a deemed basis, to stockholders. We will be subject to regular corporate income tax, currently at ratesup to 35%, on any undistributed income, including both ordinary income andcapital gains. We intend to retain some or all of our capital gains, but todesignate the retained amount as a deemed distribution. In that case, amongother consequences, we will pay tax on the retained amount, each stockholder willbe required to include its share of the deemed distribution in income as if ithad been actually distributed to the stockholder and the stockholder will beentitled to claim a credit or refund equal to its allocable share of the tax wepay on the retained capital gain. The amount of the deemed distribution net ofsuch tax will be added to the stockholder’s cost basis for its common stock.Since we expect to pay tax on any retained capital gains at our regular

 

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corporate capital gaintax rate, and since that rate is in excess of the maximum rate currentlypayable by individuals on long-term capital gains, the amount of tax thatindividual stockholders will be treated as having paid will exceed the tax theyowe on the capital gain dividend and such excess may be claimed as a credit orrefund against the stockholder’s other tax obligations. A stockholder that isnot subject to U.S. federal income tax or tax on long-term capital gains wouldbe required to file a U.S. federal income tax return on the appropriateform in order to claim a refund for the taxes we paid. In order to utilize thedeemed distribution approach, we must provide written notice to thestockholders prior to the expiration of 60 days after the close of therelevant tax year. We will also be subject to alternative minimum tax, but anytax preference items would be apportioned between us and our stockholders inthe same proportion that dividends, other than capital gain dividends, paid toeach stockholder bear to our taxable income determined without regard to thedividends paid deduction.

 

If we acquire debtobligations that were originally issued at a discount, which would generallyinclude loans we make that are accompanied by warrants, that bear interest atrates that are not either fixed rates or certain qualified variable rates orthat are not unconditionally payable at least annually over the life of theobligation, we will be required to include in taxable income each year aportion of the original issue discount (“OID”) that accrues over the life ofthe obligation. Such OID will be included in our investment company taxableincome even though we receive no cash corresponding to such discount amount. Asa result, we may be required to make additional distributions corresponding tosuch OID amounts in order to satisfy the annual distribution requirement and tocontinue to qualify as a RIC or to avoid the 4% excise tax. In this event, wemay be required to sell temporary investments or other assets to meet the RICdistribution requirements.  Through September 30,2009, we incurred no OID income.

 

**Taxationof Our U.S. Stockholders**

 

*Distributions. *For any period during which we qualify for treatmentas a RIC for federal income tax purposes, distributions to our stockholdersattributable to our investment company taxable income generally will be taxableas ordinary income to stockholders to the extent of our current or accumulatedearnings and profits. Any distributions in excess of our earnings and profitswill first be treated as a return of capital to the extent of the stockholder’sadjusted basis in his or her shares of common stock and thereafter as gain fromthe sale of shares of our common stock. Distributions of our long-term capitalgains, designated by us as such, will be taxable to stockholders as long-termcapital gains regardless of the stockholder’s holding period for its commonstock and whether the distributions are paid in cash or invested in additionalcommon stock. Corporate stockholders are generally eligible for the 70%dividends received deduction with respect to ordinary income, but not tocapital gains dividends to the extent such amount designated by us does notexceed the dividends received by us from domestic corporations. Any dividenddeclared by us in October, November or December of any calendar year,payable to stockholders of record on a specified date in such a month and actuallypaid during January of the following year, will be treated as if it werepaid by us and received by the stockholders on December 31 of the previousyear. In addition, we may elect to relate a dividend back to the prior taxableyear if we (1) declare such dividend prior to the due date for filing ourreturn for that taxable year, (2) make the election in that return, and (3) distributethe amount in the 12-month period following the close of the taxable year butnot later than the first regular dividend payment following the declaration.Any such election will not alter the general rule that a stockholder willbe treated as receiving a dividend in the taxable year in which thedistribution is made, subject to the October, November, December rule describedabove.

 

In general, the tax ratesapplicable to our dividends other than dividends designated as capital gaindividends will be the standard ordinary income tax rates, and not the lowerfederal income tax rate applicable to “qualified dividend income.” If wedistribute dividends that are attributable to actual dividend income receivedby us that is eligible to be, and is, designated by us as qualified dividendincome, such dividends would be eligible for such lower federal income taxrate. For this purpose, “qualified dividend income” means dividends received byus from United States corporations and qualifying foreign corporations,provided that both we and the stockholder recipient of our dividend satisfycertain holding period and other requirements in respect of our shares (in thecase of our stockholder) and the stock of such corporations (in our case).However, we do not anticipate receiving or distributing a significant amount ofqualified dividend income.

 

If a stockholderparticipates in our dividend reinvestment plan, any distributions reinvestedunder the plan will be taxable to the stockholder to the same extent, and withthe same character, as if the stockholder had received the distribution incash. The stockholder will have an adjusted basis in the additional commonshares purchased through the plan equal to the amount of the reinvesteddistribution. The additional shares will have a new holding period commencingon the day following the day on which the shares are credited to thestockholder’s account.

 

*Sale ofOur Shares.  * A U.S. stockholder generally will recognize taxable gain or lossif the U.S. stockholder sells or otherwise disposes of his, her or itsshares of our common stock. Any gain arising from such sale or dispositiongenerally will

 

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be treated as long-termcapital gain or loss if the U.S. stockholder has held his, her or itsshares for more than one year. Otherwise, it will be classified as short-termcapital gain or loss. However, any capital loss arising from the sale ordisposition of shares of our common stock held for six months or less will betreated as long-term capital loss to the extent of the amount of capital gaindividends received, or undistributed capital gain deemed received, with respectto such shares.  Under the tax laws ineffect as of the date of this filing, individual U.S. stockholders aresubject to a maximum federal income tax rate of 15% on their net capital gain (* i.e.* the excess of realized netlong-term capital gain over realized net short-term capital loss for a taxableyear) including any long-term capital gain derived from an investment in ourshares. Such rate is lower than the maximum rate on ordinary income currentlypayable by individuals. Corporate U.S. stockholders currently are subjectto federal income tax on net capital gain at the same rates applied to theirordinary income (currently up to a maximum of 35%). Capital losses are subjectto limitations on use for both corporate and non-corporate stockholders.

 

*BackupWithholding.  * We may be required to withhold federal income tax, or backupwithholding, currently at a rate of 28%, from all taxable distributions to anynon-corporate U.S. stockholder (1) who fails to furnish us with acorrect taxpayer identification number or a certificate that such stockholderis exempt from backup withholding, or (2) with respect to whom theInternal Revenue Service (“IRS”) notifies us that such stockholder has failedto properly report certain interest and dividend income to the IRS and torespond to notices to that effect. An individual’s taxpayer identificationnumber is generally his or her social security number. Any amount withheldunder backup withholding is allowed as a credit against theU.S. stockholder’s federal income tax liability, provided that properinformation is provided to the IRS.

 

**Regulationas a Business Development Company**

 

We are a closed-end,non-diversified management investment company that has elected to be regulatedas a business development company under Section 54 of the 1940 Act. Assuch, we are subject to regulation under the 1940 Act. The 1940 Act containsprohibitions and restrictions relating to transactions between businessdevelopment companies and their affiliates, principal underwriters andaffiliates of those affiliates or underwriters and requires that a majority ofthe directors be persons other than “interested persons,” as defined in the1940 Act. In addition, the 1940 Act provides that we may not change the natureof our business so as to cease to be, or to withdraw our election as, abusiness development company unless approved by a majority of our outstandingvoting securities.

 

We intend to conduct ourbusiness so as to retain our status as a business development company. Abusiness development  company may usecapital provided by public stockholders and from other sources to invest inlong-term private investments in businesses. A business development company provides stockholders the ability toretain the liquidity of a publicly traded stock while sharing in the possiblebenefits, if any, of investing in primarily privately owned companies.  In general, a business development companymust have been organized and have its principal place of business in the UnitedStates and must be operated for the purpose of making investments in assetsdescribed in Section 55(a) (1) — (3) of the 1940 Act.

 

***QualifyingAssets***

 

Under the 1940 Act, abusiness development company may not acquire any asset other than assets of thetype listed in Section 55(a) of the 1940 Act, which are referred toas qualifying assets, unless, at the time the acquisition is made, qualifyingassets, other than certain interests in furniture, equipment, real estate, orleasehold improvements (“operating assets”) represent at least 70% of thecompany’s total assets, exclusive of operating assets. The types of qualifyingassets in which we may invest under the 1940 Act include, but are not limitedto, the following:

 

(1)                                  Securities purchased in transactions notinvolving any public offering from the issuer of such securities, which issueris an eligible portfolio company. An eligible portfolio company is generallydefined in the 1940 Act as any issuer which:

 

(a)  is organized under the laws of, and has itsprincipal place of business in, any State or States in the United States;

 

(b)  is not an investment company(other than a small business investment company wholly owned by the businessdevelopment company); and

 

(c)  satisfies one of the following:

 

(i)  it does not have any class of securities withrespect to which a broker or dealer may extend margin credit;

 

(ii) it is controlled by the business developmentcompany and for which an affiliate of the business development company servesas a director;

 

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(iii)  it has total assets of not more than $4million and capital and surplus of not less than $2 million;

 

(iv)  it does not have any class of securitieslisted on a national securities exchange; or

 

(v)   it hasa class of securities listed on a national securities exchange, with anaggregate market value of outstanding voting and non-voting equity of less than$250 million.

 

(2)                                  Securities received in exchange for ordistributed on or with respect to securities described in (1) above, orpursuant to the exercise of options, warrants or rights relating to suchsecurities.

 

(3)                                  Cash, cash items, government securitiesor high quality debt securities maturing in one year or less from the time ofinvestment.

 

***AssetCoverage***

 

We are permitted, underspecified conditions, to issue multiple classes of indebtedness and one classof stock senior to our common stock if our asset coverage, as defined in the1940 Act, is at least 200% immediately after each such issuance. In addition,while senior securities are outstanding, we must make provisions to prohibitany distribution to our stockholders or the repurchase of such securities orshares unless we meet the applicable asset coverage ratios at the time of thedistribution or repurchase. We may also borrow amounts up to 5% of the value ofour total assets for temporary purposes. The 1940 Act requires, among otherthings, that (1) immediately after issuance and before any dividend ordistribution is made with respect to our common stock or before any purchase ofour common stock is made, the preferred stock, together with all other seniorsecurities, must not exceed an amount equal to 50% of our total assets afterdeducting the amount of such dividend, distribution or purchase price, as thecase may be, and (2) the holders of shares of preferred stock, if any areissued, must be entitled as a class to elect two directors at all times and toelect a majority of the directors if dividends on the preferred stock are inarrears by two years or more.

 

***SignificantManagerial Assistance***

 

A business developmentcompany generally must make available significant managerial assistance toissuers of certain of its portfolio securities that the business developmentcompany counts as a qualifying asset for the 70% test described above. Makingavailable significant managerial assistance means, among other things, anyarrangement whereby the business development company, through its directors,officers or employees, offers to provide, and, if accepted, does so provide,significant guidance and counsel concerning the management, operations orbusiness objectives and policies of a portfolio company. Significant managerialassistance also includes the exercise of a controlling influence over themanagement and policies of the portfolio company. However, with respect tocertain, but not all such securities, where the business development companypurchases such securities in conjunction with one or more other persons actingtogether, one of the other persons in the group may make available suchmanagerial assistance, or the business development company may exercise suchcontrol jointly.

 

***InvestmentPolicies***

 

We seek to achieve a highlevel of current income and capital gains through investments in debtsecurities and preferred and common stock that we acquired in connection withbuyout and other recapitalizations. The following investment policies, alongwith these investment objectives, may not be changed without the approval ofour Board of Directors:

 

·                  We will at all times conduct our businessso as to retain our status as a business development company. In order to bedeemed to be a business development company, we must be operated for thepurpose of investing in certain categories of qualifying assets.  In addition, we may not acquire any assets(other than non-investment assets necessary and appropriate to our operationsas a business development company or qualifying assets) if, after giving effectto such acquisition, the value of our “qualifying assets” is less than 70% ofthe value of our total assets. We anticipate that the securities we seek toacquire, as well as temporary investments, will generally be qualifying assets.

 

·                  We will at all times endeavor to conductour business so as to retain our status as a RIC under the Code. In order to doso, we must meet income source, asset diversification and annual distributionrequirements. We may issue senior securities, such as debt or preferred stock,to the extent permitted by the 1940 Act for the purpose of making investments,to fund share repurchases, or for temporary emergency or other purposes.

 

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With the exception of ourpolicy to conduct our business as a business development company, thesepolicies are not fundamental and may be changed without stockholder approval.

 

**Code ofEthics**

 

We and our Adviser haveeach adopted a code of ethics and business conduct applicable to our officers,directors and all employees of our Adviser and our Administrator that complieswith the guidelines set forth in Item 406 of Regulation S-K of the SecuritiesAct.  As required by the 1940 Act, thiscode establishes procedures for personal investments, restricts certaintransactions by our personnel and requires the reporting of certain transactionsand holdings by our personnel.  A copy ofthis code is available for review, free of charge, at our website atwww.GladstoneCapital.com.  We intend toprovide any required disclosure of any amendments to or waivers of theprovisions of this code by posting information regarding any such amendment orwaiver to our website within four days of its effectiveness.

 

**CompliancePolicies and Procedures**

 

We and our Adviser haveadopted and implemented written policies and procedures reasonably designed toprevent violation of the federal securities laws, and our Board of Directors isrequired to review these compliance policies and procedures annually to assesstheir adequacy and the effectiveness of their implementation.  We have designated a chief complianceofficer, John Dellafiora, Jr., who also serves as chief compliance officerfor our Adviser.

 

**Staffing**

 

We do not currently haveany employees and do not expect to have any employees in the foreseeablefuture.  Currently, services necessaryfor our business are provided by individuals who are employees of our Adviserand our Administrator pursuant to the terms of the Advisory Agreement and theAdministration Agreement, respectively. Excluding our chief financial officer, each of our executive officers isan employee or officer, or both, of our Adviser and our Administrator.  No employee of our Adviser or ourAdministrator will dedicate all of his or her time to us.  However, we expect that 25-30 full timeemployees of our Adviser and our Administrator will spend substantial time onour matters during the remainder of calendar year 2009 and all of calendar year2010.  To the extent we acquire moreinvestments, we anticipate that the number of employees of our Adviser and ourAdministrator who devote time to our matters will increase.

 

As of November 13,2009, our Adviser and our Administrator collectively had 54 full-timeemployees. A breakdown of these employees is summarized by functional area inthe table below:

 
| **Number of Individuals** | ** ** | **Functional Area**                                                          | ** ** |
|---------------------------|------------|------------------------------------------------------------------------------|------------|
| 12                        |       | Executive Management                                                         |       |
|                      |       |                                                                         |       |
| 34                        |       | Investment Management, Portfolio Management and Due  Diligence               |       |
|                      |       |                                                                         |       |
| 8                         |       | Administration, Accounting, Compliance, Human  Resources, Legal and Treasury |       |

 

**AvailableInformation**

 

Copies of our annualreport on Form 10-K, quarterly reports on Form 10-Q, current reportson Form 8-K, and amendments, if any, to those reports filed pursuant to Section 13(a) or15(d) of the Exchange Act are available free of charge through our websiteat www.GladstoneCapital.com.  A requestfor any of these reports may also be submitted to us by sending a writtenrequest addressed to Corporate Secretary, Gladstone Capital Corporation, 1521Westbranch Drive, Suite 200, McLean, VA 22102, or by calling our toll-freeinvestor relations line at 1-866-366-5745. The public may read and copy materials that we file with the SEC at theSEC’s Public Reference Room at 100 F Street, NE, Washington, DC20549.  Information on the operation ofthe Public Reference Room may be obtained by calling the SEC at1-800-SEC-0330.  The SEC also maintains awebsite that contains reports, proxy and information statements, and otherinformation regarding issuers that file electronically with the SEC atwww.sec.gov.

 

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**Item 1A. Risk Factors**

 

*Aninvestment in our securities involves a number of significant risks and otherfactors relating to our structure and investment objectives. As a result, wecannot assure you that we will achieve our investment objectives. You shouldconsider carefully the following information before making an investment in oursecurities.*

 

***Risks Related to the Economy***

 

*The current state of the economy and the capital marketsincreases the possibility of adverse effects on our financial position andresults of operations. Continued economic adversity could impair our portfoliocompanies’ financial positions and operating results and affect the industriesin which we invest, which could, in turn, harm our operating results.  Continued adversity in the capital marketscould impact our ability to raise capital and reduce our volume of newinvestments.*

 

##### The United States is in arecession. The recession generally, and the disruptions in the capital marketsin particular, have decreased liquidity and increased our cost of debt andequity capital, where available. The longer these conditions persist, thegreater the probability that these factors could continue to increase our costsof, and significantly limit our access to, debt and equity capital and, thus,have an adverse effect on our operations and financial results. Many of thecompanies in which we have made or will make investments are also susceptibleto the recession, which may affect the ability of one or more of our portfoliocompanies to repay our loans or engage in a liquidity event, such as a sale,recapitalization or initial public offering. The recession could alsodisproportionately impact some of the industries in which we invest, causing usto be more vulnerable to losses in our portfolio, which could cause the numberof our non-performing assets to increase and the fair market value of ourportfolio to decrease. The recession may also decrease the value of collateralsecuring some of our loans as well as the value of our equity investments whichwould decrease our ability to borrow under our credit facility or raise equitycapital, thereby further reducing our ability to make new investments.

#####  

The recession hasaffected the availability of credit generally and we have seen the withdrawalof Deutsche Bank AG as a committed lender and a reduction in committed fundingunder our credit facility from $162.0 million to $107.0 million,which will be further reduced to $102.0 million at January 1, 2010.  Our current credit facility limits ourdistributions to stockholders and as a result we recently decreased our monthlycash distribution rate by 50% starting with the April 2009 distributionsin an effort to more closely align our distributions to our net investmentincome. We do not know when market conditions will stabilize, if adverseconditions will intensify or the full extent to which the disruptions willcontinue to affect us. Also, it is possible that persistent instability of thefinancial markets could have other unforeseen material effects on our business.

 

*We may experience fluctuations inour quarterly and annual results based on the impact of inflation in the UnitedStates.*

 

The majority of ourportfolio companies are in industries that are directly impacted by inflation,such as consumer goods and services and manufacturing.  Our portfolio companies may not be able topass on to customers increases in their costs of operations which could greatlyaffect their operating results, impacting their ability to repay ourloans.  In addition, any projected futuredecreases in our portfolio companies’ operating results due to inflation couldadversely impact the fair value of those investments.  Any decreases in the fair value of ourinvestments could result in future unrealized losses and therefore reduce ournet assets resulting from operations.

 

***RisksRelated to Our External Management***

 

*We are dependent upon our key management personnel and thekey management personnel of our Adviser, particularly David Gladstone, GeorgeStelljes III and Terry Lee Brubaker, and on the continued operations ofour Adviser, for our future success.*

 

We have no employees. Ourchief executive officer, president and chief investment officer, chiefoperating officer and chief financial officer, and the employees of ourAdviser, do not spend all of their time managing our activities and ourinvestment portfolio. We are particularly dependent upon David Gladstone,George Stelljes III and Terry Lee Brubaker in this regard. Our executiveofficers and the employees of our Adviser allocate some, and in some cases amaterial portion, of their time to businesses and activities that are notrelated to our business. We have no separate facilities and are completelyreliant on our Adviser, which has significant discretion as to theimplementation and execution of our business strategies and risk managementpractices. We are subject to the risk of discontinuation of our Adviser’soperations or termination of the Advisory Agreement and the risk that, uponsuch event, no suitable replacement will be found. We believe that our success

 

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depends to a significantextent upon our Adviser and that discontinuation of its operations could have amaterial adverse effect on our ability to achieve our investment objectives.

 

*Ourincentive fee may induce our Adviser to make certain investments, includingspeculative investments.*

 

The managementcompensation structure that has been implemented under the Advisory Agreementmay cause our Adviser to invest in high-risk investments or take otherrisks.  In addition to its managementfee, our Adviser is entitled under the Advisory Agreement to receive incentivecompensation based in part upon our achievement of specified levels ofincome.  In evaluating investments andother management strategies, the opportunity to earn incentive compensationbased on net income may lead our Adviser to place undue emphasis on themaximization of net income at the expense of other criteria, such aspreservation of capital, maintaining sufficient liquidity, or management ofcredit risk or market risk, in order to achieve higher incentive compensation.  Investments with higher yield potential aregenerally riskier or more speculative. This could result in increased risk to the value of our investmentportfolio.

 

*We maybe obligated to pay our Adviser incentive compensation even if we incur a loss.*

 

The Advisory Agreemententitles our Adviser to incentive compensation for each fiscal quarter in anamount equal to a percentage of the excess of our investment income for thatquarter (before deducting incentive compensation, net operating losses andcertain other items) above a threshold return for that quarter. Whencalculating our incentive compensation, our pre-incentive fee net investmentincome excludes realized and unrealized capital losses that we may incur in thefiscal quarter, even if such capital losses result in a net loss on ourstatement of operations for that quarter. Thus, we may be required to pay ourAdviser incentive compensation for a fiscal quarter even if there is a declinein the value of our portfolio or we incur a net loss for that quarter. Foradditional information on incentive compensation under the Advisory Agreementwith our Adviser, see “Business — Investment Advisory and Management Agreements— Management services and fees under the Advisory Agreement.”

 

*OurAdviser’s failure to identify and invest in securities that meet our investmentcriteria or perform its responsibilities under the Advisory Agreement mayadversely affect our ability for future growth.*

 

Our ability to achieveour investment objectives will depend on our ability to grow, which in turnwill depend on our Adviser’s ability to identify and invest in securities thatmeet our investment criteria. Accomplishing this result on a cost-effective basis will be largely afunction of our Adviser’s structuring of the investment process, its ability toprovide competent and efficient services to us, and our access to financing onacceptable terms.  The senior managementteam of our Adviser has substantial responsibilities under the AdvisoryAgreement.  In order to grow, our Adviserwill need to hire, train, supervise, and manage new employeessuccessfully.  Any failure to manage ourfuture growth effectively could have a material adverse effect on our business,financial condition, and results of operations.

 

*There are significant potential conflicts of interest whichcould impact our investment returns.*

 

Our executive officersand directors, and the officers and directors of our Adviser, serve or mayserve as officers, directors, or principals of entities that operate in thesame or a related line of business as we do or of investment funds managed byour affiliates. Accordingly, they may have obligations to investors in thoseentities, the fulfillment of which might not be in the best interests of us orour stockholders. For example, Mr. Gladstone, our chairman and chiefexecutive officer, is the chairman of the board and chief executive officer ofour Adviser, Gladstone Investment and Gladstone Commercial. In addition, Mr. Brubaker,our vice chairman, chief operating officer and secretary is the vice chairman,chief operating officer and secretary of our Adviser, Gladstone Investment andGladstone Commercial. Mr. Stelljes, our president and chief investmentofficer, is also the president and chief investment officer of our Adviser andGladstone Commercial and vice chairman and chief investment officer ofGladstone Investment. Moreover, our Adviser may establish or sponsor otherinvestment vehicles which from time to time may have potentially overlappinginvestment objectives with those of ours and accordingly may invest in, whetherprincipally or secondarily, asset classes similar to those we target. While ourAdviser generally has broad authority to make investments on behalf of theinvestment vehicles that it advises, our Adviser has adopted investmentallocation procedures to address these potential conflicts and intends todirect investment opportunities to the Gladstone affiliate with the investmentstrategy that most closely fits the investment opportunity. Nevertheless, themanagement of our Adviser may face conflicts in the allocation of investmentopportunities to other entities managed by our Adviser. As a result, it ispossible that we may not be given the opportunity to participate in certaininvestments made by other members of the Gladstone Companies or investmentfunds managed by investment managers affiliated with our Adviser.

 

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In certaincircumstances, we may make investments in a portfolio company in which one ofour affiliates has or will have an investment, subject to satisfaction of anyregulatory restrictions and, where required, to the prior approval of our Boardof Directors. As of September 30, 2009, our Board of Directors hasapproved the following types of co-investment transactions:

 

·      Our affiliate, Gladstone Commercial, may leaseproperty to portfolio companies that we do not control under certain circumstances.We may pursue such transactions only if (i) the portfolio company is notcontrolled by us or any of our affiliates, (ii) the portfolio companysatisfies the tenant underwriting criteria of Gladstone Commercial, and (iii) thetransaction is approved by a majority of our independent directors and amajority of the independent directors of Gladstone Commercial. We expect thatany such negotiations between Gladstone Commercial and our portfolio companieswould result in lease terms consistent with the terms that the portfoliocompanies would be likely to receive were they not portfolio companies of ours.

 

·      We may invest simultaneously with our affiliateGladstone Investment in senior syndicated loans whereby neither we nor anyaffiliate has the ability to dictate the terms of the loans.

 

Certain of our officers,who are also officers of our Adviser, may from time to time serve as directorsof certain of our portfolio companies. If an officer serves in such capacitywith one of our portfolio companies, such officer will owe fiduciary duties toall shareholders of the portfolio company, which duties may from time to timeconflict with the interests of our stockholders.

 

In the course of ourinvesting activities, we will pay management and incentive fees to our Adviserand will reimburse our Administrator for certain expenses it incurs. As aresult, investors in our common stock will invest on a “gross” basis andreceive distributions on a “net” basis after expenses, resulting in, amongother things, a lower rate of return than one might achieve through ourinvestors themselves making direct investments. As a result of thisarrangement, there may be times when the management team of our Adviser hasinterests that differ from those of our stockholders, giving rise to aconflict.

 

*Our Adviser is not obligated to provide a waiver of the base managementfee, which could negatively impact our earnings and our ability to maintain ourcurrent level of distributions to our stockholders.*

 

The Advisory Agreementprovides for a base management fee based on our gross assets. Since our 2008fiscal year, our Board of Directors has accepted on a quarterly basisvoluntary, unconditional and irrevocable waivers to reduce the annual 2.0% basemanagement fee on senior syndicated loan participations to 0.5% to the extentthat proceeds resulting from borrowings were used to purchase such syndicatedloan participations, and any waived fees may not be recouped by our Adviser inthe future. However, our Adviser is not required to issue these or otherwaivers of fees under the Advisory Agreement, and to the extent our investmentportfolio grows in the future, we expect these fees will increase. If ourAdviser does not issue these waivers in future quarters, it could negativelyimpact our earnings and may compromise our ability to maintain our currentlevel of distributions to our stockholders, which could have a material adverseimpact on our stock price.

 

*Our business model is dependentupon developing and sustaining strong referral relationships with investmentbankers, business brokers and other intermediaries.*

 

We are dependent uponinformal relationships with investment bankers, business brokers andtraditional lending institutions to provide us with deal flow.  If we fail to maintain our relationship withsuch funds or institutions, or if we fail to establish strong referralrelationships with other funds, we will not be able to grow our portfolio ofloans and fully execute our business plan.

 

***RisksRelated to Our External Financing***

 

*Committed funding has been reduced from $162 millionunder our prior facility to $107 million under the new facility. Anyinability to expand the credit facility could adversely impact our liquidityand ability to find new investments or maintain distributions to ourstockholders.*

 

On May 15, 2009 we,through our wholly-owned subsidiary Gladstone Business Loan, LLC, enteredinto a third amended and restated credit agreement providing for a$127.0 million revolving line of credit (the “KEF Facility”), arranged byKey Equipment Finance Inc. (“KEF”) as administrative agent.  Branch Banking and Trust Company (“BB&T”)also joined the KEF Facility as a committed lender.   Committed funding under the KEF Facility wasreduced from $162.0 million under our prior credit facility and DeutscheBank AG, who was a committed lender under the prior facility, elected not toparticipate in

 

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the new facility andwithdrew its commitment.  The KEFFacility may be expanded up to $200.0 million through the addition ofother committed lenders to the facility. However, if additional lenders areunwilling to join the facility on its terms, we will be unable to expand thefacility and thus will continue to have limited availability to finance newinvestments under our line of credit. Furthermore, without the addition ofother committed lenders, the KEF Facility provides a total commitment of $102.0million from January 1, 2010 to May 11, 2010 and $77.0 millionthereafter.  As of September 30,2009, we had $44.0 million of availability to draw down borrowings underthe KEF Facility.

 

In October and November of2009, we reduced the size of the KEF Facility by $15.0 million and $5 million,respectively, from $127.0 million to $107.0 million. Under the KEF Facility thefirst $50.0 million of commitment reductions are applied against KEF’scommitment.  Therefore, the entire $20.0million was subtracted from KEF’s commitment, reducing it from $100.0 millionto $80.0 million and leaving BB&T’s commitment unchanged at $27.0million.  As a result of the manner inwhich our borrowing base is calculated under the KEF Facility, the reductionsdid not affect our availability under the KEF Facility.  The KEF Facility matures on May 14,2010, and if the facility is not renewed or extended by this date, allprincipal and interest will be due and payable within one year of maturity. Inaddition, if the facility is not renewed, our lenders have the right to applyall principal and interest collections to amounts outstanding under the KEFFacility.

 

There can be no guaranteethat we will be able to renew, extend or replace the KEF Facility upon itsmaturity on terms that are favorable to us, if at all. Our ability to expandthe KEF Facility, and to obtain replacement financing at the time of maturity,will be constrained by then-current economic conditions affecting the creditmarkets. In the event that we are not able to expand the KEF Facility, or torenew, extend or refinance the KEF Facility at the time of its maturity, thiscould have a material adverse effect on our liquidity and ability to fund newinvestments, our ability to make distributions to our stockholders and ourability to qualify as a RIC under the Code.

 

*Our business plan is dependent upon external financing,which is constrained by the limitations of the 1940 Act.*

 

Our business requires asubstantial amount of cash to operate and grow. We may acquire such additionalcapital from the following sources:

 

·      *Senior Securities. *We may issue debt securities, other evidences ofindebtedness (including borrowings under our line of credit) and possiblysenior common stock and preferred stock, up to the maximum amount permitted bythe 1940 Act. The 1940 Act currently permits us, as a business developmentcompany, to issue debt securities, senior common stock and preferred stock,which we refer to collectively as senior securities, in amounts such that ourasset coverage, as defined in the 1940 Act, is at least 200% after eachissuance of senior securities. As a result of issuing senior securities, wewill be exposed to the risks associated with leverage. Although borrowing moneyfor investments increases the potential for gain, it also increases the risk ofa loss. A decrease in the value of our investments will have a greater impacton the value of our common stock to the extent that we have borrowed money tomake investments. There is a possibility that the costs of borrowing couldexceed the income we receive on the investments we make with such borrowedfunds. In addition, our ability to pay distributions or incur additionalindebtedness would be restricted if asset coverage is not at least twice ourindebtedness. If the value of our assets declines, we might be unable tosatisfy that test. If this happens, we may be required to liquidate a portionof our loan portfolio and repay a portion of our indebtedness at a time when asale, to the extent possible given the limited market for many of ourinvestments, may be disadvantageous. Furthermore, any amounts that we use toservice our indebtedness will not be available for distributions to ourstockholders.

 

·      *Common Stock. *Because we are constrained in our ability to issuedebt for the reasons given above, we are dependent on the issuance of equity asa financing source. If we raise additional funds by issuing more common stockor senior securities convertible into or exchangeable for our common stock, thepercentage ownership of our stockholders at the time of the issuance woulddecrease and our common stock may experience dilution. In addition, anyconvertible or exchangeable securities that we issue in the future may haverights, preferences and privileges more favorable than those of our commonstock. In addition, under the 1940 Act, we will generally not be able to issueadditional shares of our common stock at a price below net asset value pershare to purchasers, other than to our existing stockholders, through a rightsoffering without first obtaining the approval of our stockholders and ourindependent directors. If we were to sell shares of our common stock below ourthen current net asset value per share, such sales would result in an immediatedilution to the net asset value per share. This dilution would occur as aresult of the sale of shares at a price below the then current net asset valueper share of our common stock and a proportionately greater decrease in astockholder’s interest in our earnings and assets and voting interest in usthan the increase in our assets resulting from such issuance. For example, ifwe sell an additional 10% of our common stock at a 5% discount from net assetvalue, a stockholder who

 

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does notparticipate in that offering for its proportionate interest will suffer netasset value dilution of up to 0.5% or $5 per $1,000 of net asset value.  This imposes constraints on our ability toraise capital when our common stock is trading at below net asset value, as ithas for the last year.

 

*A change in interest rates may adversely affect ourprofitability.*

 

We anticipate using acombination of equity and long-term and short-term borrowings to finance ourinvestment activities. As a result, a portion of our income will depend uponthe difference between the rate at which we borrow funds and the rate at whichwe loan these funds. Higher interest rates on our borrowings will decrease theoverall return on our portfolio.

 

Ultimately, we expectapproximately 80% of the loans in our portfolio to be at variable ratesdetermined on the basis of a London Interbank Offer Rate (“LIBOR”), andapproximately 20% to be at fixed rates. As of September 30, 2009, ourportfolio had approximately 11% of the total of the loan cost value at variablerates without a floor or ceiling, approximately 83% of the total loan costvalue at variable rates with floors, approximately 2% at variable rates with afloor and ceiling and approximately 4% of the total loan portfolio cost basisat fixed rates.

 

*Inaddition to regulatory limitations on our ability to raise capital, our creditfacility contains various covenants which, if not complied with, couldaccelerate our repayment obligations under the facility, thereby materially andadversely affecting our liquidity, financial condition, results of operationsand ability to pay distributions.*

 

We will have a continuingneed for capital to finance our loans. In order to maintain RIC status, we arerequired to distribute to our stockholders at least 90% of our ordinary incomeand short-term capital gains on an annual basis. Accordingly, such earningswill not be available to fund additional loans. Therefore, we are party to theKEF Facility, which provides us with a revolving credit line facility of$127.0 million, of which $44.0 million was available for borrowingsas of September 30, 2009. In October and November of 2009, wereduced the size of the KEF Facility by $15.0 million and $5 million,respectively, from $127.0 million to $107.0 million. The KEF Facility permitsus to fund additional loans and investments as long as we are within theconditions set out in the credit agreement. Current market conditions haveforced us to write down the value of a portion of our assets as required by the1940 Act and fair value accounting rules. These are not realized losses, butconstitute adjustment in asset values for purposes of financial reporting andfor collateral value for the KEF Facility. As assets are marked down in value,the amount we can borrow on the KEF Facility decreases.

 

As a result of the KEFFacility, we are subject to certain limitations on the type of loan investmentswe make, including restrictions on geographic concentrations, sectorconcentrations, loan size, dividend payout, payment frequency and status, andaverage life. The credit agreement also requires us to comply with otherfinancial and operational covenants, which require us to, among other things,maintain certain financial ratios, including asset and interest coverage and aminimum net worth. As of September 30, 2009, we were in compliance withthese covenants, however, our continued compliance with these covenants dependson many factors, some of which are beyond our control. In particular,depreciation in the valuation of our assets, which valuation is subject tochanging market conditions that remain very volatile, affects our ability tocomply with these covenants. During the year ended September 30, 2009, netunrealized appreciation on our investments was approximately $9.5 million,compared to $47.0 million unrealized depreciation during the prior fiscalyear. Given the continued deterioration in the capital markets, the cumulativeunrealized depreciation in our portfolio may increase in future periods andthreaten our ability to comply with the covenants under the KEF Facility.Accordingly, there are no assurances that we will continue to comply with thesecovenants. Under the KEF Facility, we are also required to maintain our statusas a BDC under the 1940 Act and as a RIC under the Code. Our failure to satisfythese covenants could result in foreclosure by our lenders, which wouldaccelerate our repayment obligations under the facility and thereby have amaterial adverse effect on our business, liquidity, financial condition,results of operations and ability to pay distributions to our stockholders.

 

***Risks Related to Our Investments***

 

*We operate in a highlycompetitive market for investment opportunities.*

 

A large number ofentities compete with us and make the types of investments that we seek to makein small and mid-sized companies. We compete with public and private buyoutfunds, commercial and investment banks, commercial financing companies, and, tothe extent they provide an alternative form of financing, hedge funds. Many ofour competitors are substantially larger and have considerably greaterfinancial, technical and marketing resources than we do. For example, somecompetitors may have a lower cost of funds and access to funding sources thatare not available to us. In addition, some of our competitors may have higherrisk tolerances or different risk assessments, which would allow them toconsider a wider

 

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variety of investmentsand establish more relationships than us. Furthermore, many of our competitorsare not subject to the regulatory restrictions that the 1940 Act imposes on usas a business development company. The competitive pressures we face could havea material adverse effect on our business, financial condition and results ofoperations. Also, as a result of this competition, we may not be able to takeadvantage of attractive investment opportunities from time to time and we canoffer no assurance that we will be able to identify and make investments thatare consistent with our investment objective. We do not seek to compete based on the interest rates we offer, and webelieve that some of our competitors may make loans with interest rates thatwill be comparable to or lower than the rates we offer.  We may lose investment opportunities if we donot match our competitors’ pricing, terms, and structure.  However, if we match our competitors’pricing, terms, and structure, we may experience decreased net interest incomeand increased risk of credit loss.

 

*Our investments in small andmedium-sized portfolio companies are extremely risky and could cause you tolose all or a part of your investment.*

 

Investments in small andmedium-sized portfolio companies are subject to a number of significant risksincluding the following:

 

·     *Small and medium-sized businessesare likely to have greater exposure to economic downturns than largerbusinesses.* Ourportfolio companies may have fewer resources than larger businesses, and thusthe current recession, and any further economic downturns or recessions aremore likely to have a material adverse effect on them. If one of our portfoliocompanies is adversely impacted by a recession, its ability to repay our loanor engage in a liquidity event, such as a sale, recapitalization or initial publicoffering would be diminished. Moreover, in light of our current near-termstrategy of preserving capital, our inability to make additional investments inour portfolio companies at a time when they need capital may increase theirexposure to the risks of the current recession and future economic downturns.

 

·     *Small and medium-sized businessesmay have limited financial resources and may not be able to repay the loans wemake to them.* Ourstrategy includes providing financing to portfolio companies that typically isnot readily available to them. While we believe that this provides anattractive opportunity for us to generate profits, this may make it difficultfor the portfolio companies to repay their loans to us upon maturity. Aborrower’s ability to repay its loan may be adversely affected by numerousfactors, including the failure to meet its business plan, a downturn in itsindustry, or negative economic conditions. A deterioration in a borrower’sfinancial condition and prospects usually will be accompanied by adeterioration in the value of any collateral and a reduction in the likelihoodof us realizing on any guarantees we may have obtained from the borrower’smanagement. Although we will sometimes seek to be the senior, secured lender toa borrower, in most of our loans we expect to be subordinated to a seniorlender, and our interest in any collateral would, accordingly, likely besubordinate to another lender’s security interest.  During the fiscal year ended September 30,2009, we converted three non-performing Non-Control/Non-Affiliate investmentsto Control investments (Clinton, Defiance and Lindmark) and as of September 30,2009, five investments were on non-accrual.  While we are working with theportfolio companies to improve their profitability and cash flows there can beno assurance that our efforts will prove successful.

 

·     *Small and medium-sized businessestypically have narrower product lines and smaller market shares than largebusinesses.*Because our target portfolio companies are smaller businesses, they will tendto be more vulnerable to competitors’ actions and market conditions, as well asgeneral economic downturns. In addition, our portfolio companies may faceintense competition, including competition from companies with greaterfinancial resources, more extensive development, manufacturing, marketing, andother capabilities and a larger number of qualified managerial, and technicalpersonnel.

 

·     *There is generally little or nopublicly available information about these businesses.* Because we seek to invest in privatelyowned businesses, there is generally little or no publicly available operatingand financial information about our potential portfolio companies. As a result,we rely on our officers, our Adviser, and its employees and consultants toperform due diligence investigations of these portfolio companies, theiroperations, and their prospects. We may not learn all of the material informationwe need to know regarding these businesses through our investigations.

 

·     *Small and medium-sized businessesgenerally have less predictable operating results.* We expect that our portfolio companiesmay have significant variations in their operating results, may from time totime be parties to litigation, may be engaged in rapidly changing businesseswith products subject to a substantial risk of obsolescence, may requiresubstantial additional capital to support their operations, to financeexpansion or to maintain their competitive position, may otherwise have a weakfinancial position, or may be adversely affected by changes in the businesscycle. Our

 

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portfoliocompanies may not meet net income, cash flow, and other coverage teststypically imposed by their senior lenders. A borrower’s failure to satisfyfinancial or operating covenants imposed by senior lenders could lead todefaults and, potentially, foreclosure on its senior credit facility, whichcould additionally trigger cross-defaults in other agreements. If this were tooccur, it is possible that the borrower’s ability to repay our loan would bejeopardized.

 

·     *Small and medium-sized businessesare more likely to be dependent on one or two persons.* Typically, the success of a small ormedium-sized business also depends on the management talents and efforts of oneor two persons or a small group of persons. The death, disability, orresignation of one or more of these persons could have a material adverseimpact on our borrower and, in turn, on us.

 

·     *Small and medium-sized businessesmay have limited operating histories.* While we intend to target stable companies withproven track records, we may make loans to new companies that meet our otherinvestment criteria. Portfolio companies with limited operating histories willbe exposed to all of the operating risks that new businesses face and may beparticularly susceptible to, among other risks, market downturns, competitivepressures and the departure of key executive officers.

 

*Because a large percentage of theloans we make and equity securities we receive when we make loans are notpublicly traded, there is uncertainty regarding the value of our privately heldsecurities that could adversely affect our determination of our net assetvalue.*

 

A large percentage of ourportfolio investments are, and we expect will continue to be, in the form ofsecurities that are not publicly traded. The fair value of securities and otherinvestments that are not publicly traded may not be readily determinable. OurBoard of Directors has established an investment valuation policy andconsistently applied valuation procedures used to determine the fair value ofthese securities quarterly. These procedures for the determination of value ofmany of our debt securities rely on the opinions of value submitted to us bySPSE, the use of internally developed discounted cash flow, or DCF, methodologies,or internal methodologies based on the total enterprise value, or TEV, of theissuer used for certain of our equity investments. SPSE will only evaluate thedebt portion of our investments for which we specifically request evaluation,and SPSE may decline to make requested evaluations for any reason in its solediscretion. However, to date, SPSE has accepted each of our requests forevaluation.

 

Our use of these fairvalue methods is inherently subjective and is based on estimates and assumptionsof each security.  In the event that we are required to sell a security,we may ultimately sell for an amount materially less than the estimated fairvalue calculated by SPSE, TEV or the DCF methodology.  We sold 13 of the24 syndicated loans that were held in our portfolio of investments at March 31,2009 to various investors in the syndicated loan market for an aggregate of$22.5 million in net proceeds.  The loanshad an aggregate cost value of approximately $30.4 million, or 7% of the costvalue of our total investments, and an aggregate fair value of approximately$22.5 million, or 6% of the fair value of our total investments, at March 31,2009.

 

Our procedures alsoinclude provisions whereby our Adviser will establish the fair value of anyequity securities we may hold where SPSE or third-party agent banks are unableto provide evaluations. The types of factors that may be considered indetermining the fair value of our debt and equity securities include some orall of the following:

 

·      the nature and realizable value of anycollateral;

·      the portfolio company’s earnings and cashflows and its ability to make payments on its obligations;

·      the markets in which the portfoliocompany does business;

·      the comparison to publicly tradedcompanies; and

·      discounted cash flow and other relevantfactors.

 

Because such valuations,particularly valuations of private securities and private companies, are notsusceptible to precise determination, may fluctuate over short periods of time,and may be based on estimates, our determinations of fair value may differ fromthe values that might have actually resulted had a readily available market forthese securities been available.

 

A portion of our assetsare, and will continue to be, comprised of equity securities that are valuedbased on internal assessment using our own valuation methods approved by ourBoard of Directors, without the input of SPSE or any other third-partyevaluator. We believe that our equity valuation methods reflect those regularlyused as standards by other professionals in our industry who value equitysecurities. However, determination of fair value for securities that are notpublicly traded, whether or not we use the recommendations of an independentthird-party evaluator, necessarily involves the

 

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exercise of subjectivejudgment. Our net asset value could be adversely affected if our determinationsregarding the fair value of our investments were materially higher than thevalues that we ultimately realize upon the disposal of such securities.

 

*The lack of liquidity of ourprivately held investments may adversely affect our business.*

 

We will generally makeinvestments in private companies whose securities are not traded in any publicmarket. Substantially all of the investments we presently hold and theinvestments we expect to acquire in the future are, and will be, subject tolegal and other restrictions on resale and will otherwise be less liquid thanpublicly traded securities. The illiquidity of our investments may make itdifficult for us to quickly obtain cash equal to the value at which we recordour investments if the need arises. This could cause us to miss importantinvestment opportunities. In addition, if we are required to liquidate all or aportion of our portfolio quickly, we may record substantial realized lossesupon liquidation.  For example, as aresult of the economic downturn, the availability of credit in the marketbecame scarce, and we were forced to sell 13 of the 24 syndicated loans thatwere held in our portfolio of investments at March 31, 2009 in order torepay amounts outstanding under our prior credit facility. These loans, inaggregate, had a cost value of approximately $30.4 million, or 7% of the costvalue of our total investments, and an aggregate fair market value ofapproximately $22.5 million, or 6% of the fair market value of our totalinvestments, at March 31, 2009.  Since then, we have sold additionalsyndicated loans and incurred a net realized loss of $26.4 million for thefiscal year ended September 30, 2009.  In addition, we may face otherrestrictions on our ability to liquidate an investment in a portfolio companyto the extent that we, our Adviser, or our respective officers, employees oraffiliates have material non-public information regarding such portfoliocompany.

 

Due to the uncertaintyinherent in valuing these securities, our determinations of fair value maydiffer materially from the values that could be obtained if a ready market forthese securities existed. Our net asset value could be materially affected ifour determinations regarding the fair value of our investments are materiallydifferent from the values that we ultimately realize upon our disposal of suchsecurities.

 

*Our financial results could be negatively affected if asignificant portfolio investment fails to perform as expected.*

 

Our total investment incompanies may be significant individually or in the aggregate. As a result, ifa significant investment in one or more companies fails to perform as expected,our financial results could be more negatively affected and the magnitude ofthe loss could be more significant than if we had made smaller investments inmore companies.

 

*When we are a debt or minorityequity investor in a portfolio company, which we expect will generally be thecase, we may not be in a position to control the entity, and its management maymake decisions that could decrease the value of our investment.*

 

We anticipate that mostof our investments will continue to be either debt or minority equityinvestments in our portfolio companies. Therefore, we are and will remain subject to risk that a portfoliocompany may make business decisions with which we disagree, and theshareholders and management of such company may take risks or otherwise act inways that do not serve our best interests. As a result, a portfolio company may make decisions that could decreasethe value of our portfolio holdings.  Inaddition, we will generally not be in a position to control any portfoliocompany by investing in its debt securities.

 

*Our portfolio companies may incurdebt that ranks equally with, or senior to, our investments in such companies.*

 

We invest primarily indebt securities issued by our portfolio companies.  In some cases portfolio companies will bepermitted to have other debt that ranks equally with, or senior to, the debtsecurities in which we invest.  By theirterms, such debt instruments may provide that the holders thereof are entitledto receive payment of interest and principal on or before the dates on which weare entitled to receive payments in respect of the debt securities in which weinvest.  Also, in the event ofinsolvency, liquidation, dissolution, reorganization, or bankruptcy of aportfolio company, holders of debt instruments ranking senior to our investmentin that portfolio company would typically be entitled to receive payment infull before we receive any distribution in respect of our investment.  After repaying such senior creditors, suchportfolio company may not have any remaining assets to use for repaying itsobligation to us.  In the case of debtranking equally with debt securities in which we invest, we would have to shareon an equal basis any distributions with other creditors holding such debt inthe event of an insolvency, liquidation, dissolution, reorganization, orbankruptcy of a portfolio company.

 

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*Prepayments of our investments byour portfolio companies could adversely impact our results of operations andreduce our return on equity.*

 

In addition to risksassociated with delays in investing our capital, we are also subject to therisk that investments that we make in our portfolio companies may be repaidprior to maturity. For the year ended September 30, 2009, we receivedprincipal payments prior to maturity of $25.2 million.  We will first use any proceeds fromprepayments to repay any borrowings outstanding on our credit facility. In theevent that funds remain after repayment of our outstanding borrowings, then wewill generally reinvest these proceeds in government securities, pending theirfuture investment in new debt and/or equity securities. These governmentsecurities will typically have substantially lower yields than the debtsecurities being prepaid and we could experience significant delays inreinvesting these amounts. As a result, our results of operations could bematerially adversely affected if one or more of our portfolio companies electsto prepay amounts owed to us. Additionally, prepayments could negatively impactour return on equity, which could result in a decline in the market price ofour common stock.

 

*Higher taxation of our portfolio companies may impact our quarterly andannual operating results.*

 

The recession’s adverseeffect on federal, state, and municipality revenues may induce these governmententities to raise various taxes to make up for lost revenues. Additionaltaxation may have an adverse affect on our portfolio companies’ earnings andreduce their ability to repay our loans to them, thus affecting our quarterlyand annual operating results.

 

*Our portfolio is concentrated ina limited number of companies and industries, which subjects us to an increasedrisk of significant loss if any one of these companies does not repay us or ifthe industries experience downturns.*

 

As of September 30, 2009 we had loansoutstanding to 48 portfolio companies.  Aconsequence of a limited number of investments is that the aggregate returns werealize may be substantially adversely affected by the unfavorable performanceof a small number of such loans or a substantial write-down of any oneinvestment. Beyond our regulatory and income tax diversification requirements,we do not have fixed guidelines for industry concentration and our investmentscould potentially be concentrated in relatively few industries. In addition,while we do not intend to invest 25.0% or more of our total assets in aparticular industry or group of industries at the time of investment, it ispossible that as the values of our portfolio companies change, one industry ora group of industries may comprise in excess of 25.0% of the value of our totalassets. As of September 30, 2009, 18.1% of our total assets were investedin healthcare, education and childcare companies, 13.5% were invested inbroadcast companies and 11.8% were invested in printing and publishingcompanies. As a result, a downturn in an industry in which we have invested asignificant portion of our total assets could have a materially adverse effecton us.

 

*Our investments are typicallylong term and will require several years to realize liquidation events.*

 

Since we generally makefive to seven year term loans and hold our loans and related warrants or otherequity positions until the loans mature, you should not expect realizationevents, if any, to occur over the near term. In addition, we expect that anywarrants or other equity positions that we receive when we make loans mayrequire several years to appreciate in value and we cannot give any assurancethat such appreciation will occur.

 

*We may not realize gains from ourequity investments and other yield enhancements.*

 

When we make asubordinated loan, we may receive warrants to purchase stock issued by theborrower or other yield enhancements, such as success fees (conditionalinterest). Our goal is to ultimately dispose of these equity interests andrealize gains upon our disposition of such interests. We expect that, overtime, the gains we realize on these warrants and other yield enhancements willoffset any losses we experience on loan defaults. However, any warrants wereceive may not appreciate in value and, in fact, may decline in value and anyother yield enhancements, such as success fees, may not be realized. Accordingly,we may not be able to realize gains from our equity interests or other yieldenhancements and any gains we do recognize may not be sufficient to offsetlosses we experience on our loan portfolio.

 

*Any unrealized depreciation we experience on our investment portfoliomay be an indication of future realized losses, which could reduce our incomeavailable for distribution.*

 

As a business developmentcompany we are required to carry our investments at market value or, if nomarket value is ascertainable, at fair value as determined in good faith by orunder the direction of our Board of Directors. Decreases in the

 

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market values or fairvalues of our investments will be recorded as unrealized depreciation. Sinceour inception, we have, at times, incurred a cumulative net unrealizeddepreciation of our portfolio. Any unrealized depreciation in our investmentportfolio could result in realized losses in the future and ultimately inreductions of our income available for distribution to stockholders in futureperiods.

 

***RisksRelated to Our Regulation and Structure***

 

*We will be subject tocorporate-level tax if we are unable to satisfy Code requirements for RICqualification.*

 

To maintain ourqualification as a RIC, we must meet income source, asset diversification, andannual distribution requirements. The annual distribution requirement issatisfied if we distribute at least 90% of our ordinary income and short-termcapital gains to our stockholders on an annual basis. Because we use leverage,we are subject to certain asset coverage ratio requirements under the 1940 Actand could, under certain circumstances, be restricted from making distributionsnecessary to qualify as a RIC. Warrants we receive with respect to debtinvestments will create “original issue discount,” which we must recognize asordinary income, increasing the amounts we are required to distribute tomaintain RIC status. Because such warrants will not produce distributable cashfor us at the same time as we are required to make distributions in respect ofthe related original issue discount, we will need to use cash from othersources to satisfy such distribution requirements. The asset diversificationrequirements must be met at the end of each calendar quarter. If we fail tomeet these tests, we may need to quickly dispose of certain investments toprevent the loss of RIC status. Since most of our investments will be illiquid,such dispositions, if even possible, may not be made at prices advantageous tous and, in fact, may result in substantial losses. If we fail to qualify as aRIC for any reason and become fully subject to corporate income tax, theresulting corporate taxes could substantially reduce our net assets, the amountof income available for distribution, and the actual amount distributed. Such afailure would have a material adverse effect on us and our shares. Foradditional information regarding asset coverage ratio and RIC requirements, see“Business—Competitive Advantages—Leverage” and “Business—Material U.S. FederalIncome Tax Considerations—Regulated Investment Company Status.”

 

*Changesin laws or regulations governing our operations, or changes in theinterpretation thereof, and any failure by us to comply with laws orregulations governing our operations may adversely affect our business.*

 

We and our portfoliocompanies are subject to regulation by laws at the local, state and federallevels. These laws and regulations, as well as their interpretation, may bechanged from time to time. Accordingly, any change in these laws orregulations, or their interpretation, or any failure by us or our portfoliocompanies to comply with these laws or regulations may adversely affect ourbusiness. For additional information regarding the regulations to which we aresubject, see “Material U.S. Federal Income Tax Considerations—RegulatedInvestment Company Status” and “Regulation as a Business Development Company.”

 

*We are subject to restrictionsthat may discourage a change of control. Certain provisions contained in ourarticles of incorporation and Maryland law may prohibit or restrict a change ofcontrol and adversely impact the price of our shares.*

 

OurBoard of Directors is divided into three classes, with the term of thedirectors in each class expiring every third year. At each annual meeting ofstockholders, the successors to the class of directors whose term expires atsuch meeting will be elected to hold office for a term expiring at the annualmeeting of stockholders held in the third year following the year of theirelection. After election, a director may only be removed by our stockholdersfor cause. Election of directors for staggered terms with limited rights toremove directors makes it more difficult for a hostile bidder to acquirecontrol of us. The existence of this provision may negatively impact the priceof our securities and may discourage third-party bids to acquire oursecurities. This provision may reduce any premiums paid to stockholders in achange in control transaction.

 

Certainprovisions of Maryland law applicable to us prohibit business combinationswith:

 

·      anyperson who beneficially owns 10% or more of the voting power of our commonstock (an “interested stockholder”);

·      anaffiliate of ours who at any time within the two-year period prior to the datein question was an interested stockholder; or

·      anaffiliate of an interested stockholder.

 

These prohibitionslast for five years after the most recent date on which the interestedstockholder became an interested stockholder. Thereafter, any businesscombination with the interested stockholder must be recommended by our board ofdirectors and approved by the affirmative vote of at least 80% of the votesentitled to be cast by holders of our outstanding

 

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shares of commonstock and two-thirds of the votes entitled to be cast by holders of our commonstock other than shares held by the interested stockholder. These requirementscould have the effect of inhibiting a change in control even if a change incontrol were in our stockholders’ interest. These provisions of Maryland law donot apply, however, to business combinations that are approved or exempted byour Board of Directors prior to the time that someone becomes an interestedstockholder.

 

Our articles ofincorporation permit our Board of Directors to issue up to 50,000,000 shares ofcapital stock. In addition, our Board of Directors, without any action by ourstockholders, may amend our articles of incorporation from time to time toincrease or decrease the aggregate number of shares or the number of shares ofany class or series of stock that we have authority to issue.  Our Board of Directors may classify orreclassify any unissued common stock or preferred stock and establish thepreferences, conversion or other rights, voting powers, restrictions,limitations as to distributions, qualifications and terms or conditions ofredemption of any such stock.  Thus, ourBoard of Directors could authorize the issuance of senior common stock orpreferred stock with terms and conditions that could have a priority as todistributions and amounts payable upon liquidation over the rights of theholders of our common stock.  SeniorCommon Stock or Preferred stock could also have the effect of delaying,deferring or preventing a change in control of us, including an extraordinarytransaction (such as a merger, tender offer or sale of all or substantially allof our assets) that might provide a premium price for holders of our commonstock.

 

***RisksRelated to an Investment in Our Common Stock***

 

*We may experience fluctuations inour quarterly and annual operating results.*

 

We may experiencefluctuations in our quarterly and annual operating results due to a number offactors, including, among others, variations in our investment income, theinterest rates payable on the debt securities we acquire, the default rates onsuch securities, the level of our expenses, variations in and the timing of therecognition of realized and unrealized gains or losses, the level of ourexpenses, the degree to which we encounter competition in our markets, andgeneral economic conditions, including the impacts of inflation. The majorityof our portfolio companies are in industries that are directly impacted byinflation, such as manufacturing and consumer goods and services. Our portfoliocompanies may not be able to pass on to customers increases in their costs ofproduction which could greatly affect their operating results, impacting theirability to repay our loans. In addition, any projected future decreases in ourportfolio companies’ operating results due to inflation could adversely impactthe fair value of those investments. Any decreases in the fair value of ourinvestments could result in future realized and unrealized losses and thereforereduce our net assets resulting from operations. As a result of these factors,results for any period should not be relied upon as being indicative ofperformance in future periods.

 

*There is a risk that you may notreceive distributions.*

 

Our current intention isto distribute at least 90% of our ordinary income and short-term capital gainsto our stockholders on a quarterly basis by paying monthly distributions. Weexpect to retain net realized long-term capital gains to supplement our equitycapital and support the growth of our portfolio, although our Board ofDirectors may determine in certain cases to distribute these gains. Inaddition, our credit facility restricts the amount of distributions we arepermitted to make.  We cannot assure youthat we will achieve investment results or maintain a tax status that willallow or require any specified level of cash distributions.

 

*Distributions by us have and mayin the future continue to include a return of capital.*

 

Our Board of Directorsdeclares monthly distributions based on estimates of net investment income foreach fiscal year, which may differ, and in the past have differed, from actualresults. Because our distributions are based on estimates of net investmentincome that may differ from actual results, future distributions payable to ourstockholders may also include a return of capital. Moreover, to the extent thatwe distribute amounts that exceed our accumulated earnings and profits, thesedistributions constitute a return of capital. A return of capital represents areturn of a stockholder’s original investment in shares of our stock and shouldnot be confused with a distribution from earnings and profits. Although returnof capital distributions may not be taxable, such distributions may increase aninvestor’s tax liability for capital gains upon the sale of our shares byreducing the investor’s tax basis for such shares. Such returns of capitalreduce our asset base and also adversely impact our ability to raise debtcapital as a result of the leverage restrictions under the 1940 Act, whichcould have a material adverse impact on our ability to make new investments.

 

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*The market price of our sharesmay fluctuate significantly.*

 

The trading price of ourcommon stock may fluctuate substantially. The extreme volatility and disruptionthat have affected the capital and credit markets for over a year have reachedunprecedented levels in recent months We have experienced greater than usualstock price volatility.

 

The market price andmarketability of our shares may from time to time be significantly affected bynumerous factors, including many over which we have no control and that may notbe directly related to us. These factors include, but are not limited to, thefollowing:

 
| · |   | general economic trends and other external factors;                                                                                                                                                                                    |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · |   | price and volume fluctuations in the stock market  from time to time, which are often unrelated to the operating performance of  particular companies;                                                                                 |
| · |   | significant volatility in the market price and  trading volume of shares of RICs, business development companies or other  companies in our sector, which is not necessarily related to the operating  performance of these companies; |
| · |   | changes in regulatory policies or tax guidelines,  particularly with respect to RICs or business development companies;                                                                                                                |
| · |   | loss of business development company status;                                                                                                                                                                                           |
| · |   | loss of RIC status;                                                                                                                                                                                                                    |
| · |   | changes in our earnings or variations in our  operating results;                                                                                                                                                                       |
| · |   | changes in the value of our portfolio of  investments;                                                                                                                                                                                 |
| · |   | any shortfall in our revenue or net income or any  increase in losses from levels expected by securities analysts;                                                                                                                     |
| · |   | departure of key personnel;                                                                                                                                                                                                            |
| · |   | operating performance of companies comparable to us;                                                                                                                                                                                   |
| · |   | short-selling pressure with respect to our shares or  business development companies generally;                                                                                                                                        |
| · |   | the announcement of proposed, or completed,  offerings of our securities, including a rights offering; and                                                                                                                             |
| · |   | loss of a major funding source.                                                                                                                                                                                                        |

 

Fluctuations in thetrading prices of our shares may adversely affect the liquidity of the tradingmarket for our shares and, if we seek to raise capital through future equityfinancings, our ability to raise such equity capital.

 

*The issuance of subscription rights to our existingstockholders may dilute the ownership and voting powers by existingstockholders in our common stock, dilute the net asset value of their sharesand have a material adverse effect on the trading price of our common stock.*

 

There are significantcapital raising constraints applicable to us under the 1940 Act when our stockis trading below its net asset value per share. In the event that we issuesubscription rights to our existing stockholders, there is a significantpossibility that the rights offering will dilute the ownership interest andvoting power of stockholders who do not fully exercise their subscriptionrights. Stockholders who do not fully exercise their subscription rights shouldexpect that they will, upon completion of the rights offering, own a smallerproportional interest in the Company than would otherwise be the case if theyfully exercised their subscription rights. In addition, because thesubscription price of the rights offering is likely to be less than the Company’smost recently determined net asset value per share, our stockholders are likelyto experience an immediate dilution of the per share net asset value of theirshares as a result of the offer. As a result of these factors, any futurerights offerings of our common stock, or our announcement of our intention toconduct a rights offering, could have a material adverse impact on the tradingprice of our common stock.

 

*Shares of closed-end investmentcompanies frequently trade at a discount from net asset value.*

 

Shares of closed-endinvestment companies frequently trade at a discount from net asset value. Since our inception, our common stock has at times traded above net assetvalue, and at times traded below net asset value. During the past year, ourcommon stock has traded consistently, and at times significantly, below netasset value. Subsequent to September 30, 2009, our stock has traded atdiscounts of up to 34% of our net asset value as of September 30,2009.  This characteristic of shares of closed-end investment companies isseparate and distinct from the risk that our net asset value per share willdecline.  As with any stock, the price of our shares will fluctuate withmarket conditions and other factors.  If shares are sold, the pricereceived may be more or less than the original investment.  Whetherinvestors will realize gains or losses upon the sale of our shares will notdepend directly upon our net asset value, but will depend upon the market priceof the shares at the time of

 

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sale.  Since themarket price of our shares will be affected by such factors as the relativedemand for and supply of the shares in the market, general market and economicconditions and other factors beyond our control, we cannot predict whether theshares will trade at, below or above our net asset value.  Under the 1940Act, we are generally not able to issue additional shares of our common stockat a price below net asset value per share to purchasers other than ourexisting stockholders through a rights offering without first obtaining theapproval of our stockholders and our independent directors. Additionally, attimes when our stock is trading below its net asset value per share, ourdividend yield may exceed the weighted average returns that we would expect torealize on new investments that would be made with the proceeds from the saleof such stock, making it unlikely that we would determine to issue additionalshares in such circumstances. Thus, for as long as our common stock tradesbelow net asset value we will be subject to significant constraints on ourability to raise capital through the issuance of common stock. Additionally, anextended period of time in which we are unable to raise capital may restrictour ability to grow and adversely impact our ability to increase or maintainour distributions.

 

*Stockholders may incur dilution if we sell shares of ourcommon stock in one or more offerings at prices below the then current netasset value per share of our common stock.*

 

At our most recent annualmeeting, our stockholders approved a proposal designed to allow us to accessthe capital markets in a way that we were previously unable to as a result ofrestrictions that, absent stockholder approval, apply to business developmentcompanies under the 1940 Act. Specifically, our stockholders approved a proposal that authorizes us tosell shares of our common stock below the then current net asset value pershare of our common stock in one or more offerings for a period of oneyear.  At the upcoming annualstockholders meeting scheduled for February 18, 2010, our stockholderswill again be asked to vote in favor of renewing this proposal for anotheryear.  During the past year, our commonstock has traded consistently, and at times significantly, below net assetvalue. Any decision to sell shares of our common stock below the then currentnet asset value per share of our common stock would be subject to thedetermination by our Board of Directors that such issuance is in our and ourstockholders’ best interests.

 

If we were to sell sharesof our common stock below net asset value per share, such sales would result inan immediate dilution to the net asset value per share. This dilution wouldoccur as a result of the sale of shares at a price below the then current netasset value per share of our common stock and a proportionately greaterdecrease in a stockholder’s interest in our earnings and assets and votinginterest in us than the increase in our assets resulting from such issuance.The greater the difference between the sale price and the net asset value pershare at the time of the offering, the more significant the dilutive impactwould be. Because the number of shares of common stock that could be so issuedand the timing of any issuance is not currently known, the actual dilutiveeffect, if any, cannot be currently predicted. However, if for example, we sold an additional 10% of our common stockat a 5% discount from net asset value, a stockholder who did not participate inthat offering for its proportionate interest would suffer net asset valuedilution of up to 0.5% or $5 per $1,000 of net asset value.

 

***OtherRisks***

 

*We could face losses and potential liability ifintrusion, viruses or similar disruptions to our technology jeopardize our confidentialinformation, whether through breach of our network security or otherwise.*

 

Maintaining our networksecurity is of critical importance because our systems store highlyconfidential financial models and portfolio company information. Although wehave implemented, and will continue to implement, security measures, ourtechnology platform is and will continue to be vulnerable to intrusion,computer viruses or similar disruptive problems caused by transmission fromunauthorized users. The misappropriation of proprietary information couldexpose us to a risk of loss or litigation.

 

*Terrorist attacks, acts of war,or national disasters may affect any market for our common stock, impact thebusinesses in which we invest, and harm our business, operating results, andfinancial conditions.*

 

Terrorist acts, acts ofwar, or national disasters have created, and continue to create, economic andpolitical uncertainties and have contributed to global economicinstability.  Future terroristactivities, military or security operations, or national disasters couldfurther weaken the domestic/global economies and create additionaluncertainties, which may negatively impact the businesses in which we investdirectly or indirectly and, in turn, could have a material adverse impact onour business, operating results, and financial condition.  Losses from terrorist attacks and nationaldisasters are generally uninsurable.

 

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**Item 1B. Unresolved Staff Comments**

 

None.

 

**Item 2. Properties**

 

We do not own anyreal estate or other physical properties materially important to ouroperations.  Gladstone ManagementCorporation is the current leaseholder of all properties in which weoperate.  We occupy these premisespursuant to our Advisory and Administration Agreements with our Adviser andAdministrator, respectively.  Our Adviserand Administrator are headquartered in McLean, Virginia and our Adviser alsohas operations in New York, New Jersey, Illinois, Texas and Georgia.

 

**Item 3. Legal Proceedings**

 

We are notcurrently subject to any material legal proceedings, nor, to our knowledge, isany material legal proceeding threatened against us.

 

**Item 4. Submission of Matters to a Vote ofSecurity Holders**

 

No matters weresubmitted to a vote of security holders during the fourth quarter of the fiscalyear ended September 30, 2009.

 

**PART II**

 

**Item 5. Market for Registrant’s Common Equity,Related Stockholder Matters and Issuer Purchases of Equity Securities**

 

Our common stock istraded on the Nasdaq Global Select Market under the symbol “GLAD.” Thefollowing table reflects, by quarter, the high and low closing prices per shareof our common stock on the Nasdaq Global Select Market, the closing sale priceas a percentage of net asset value (“NAV”) and quarterly dividends declared pershare for each fiscal quarter during the last two fiscal years.  Amounts presented for each fiscal quarter of2009 and 2008 represent the cumulative amount of the dividends declared for themonths composing such quarter.

 
| ** ** | ** ** | **Quarter** | ** ** | ** **  | ** ** | **Closing Sales Price** | ** ** | **Premium  (discount) of** | ** ** | **Premium  (discount) of** | ** ** | **Declared**      | ** ** |
|------------|------------|-------------|------------|-------------|------------|-------------------------|------------|----------------------------|------------|----------------------------|------------|-------------------|------------|
| ** ** | ** ** | **Ended**   | ** ** | **NAV (1)** | ** ** | **High**                | ** ** | **Low**                    | ** ** | **High to NAV(1)**         | ** ** | **Low to NAV(2)** | ** ** | **Dividends** | ** ** |
| FY  2009   | ** ** | 09/30/09    | ** ** | $           | 11.81      |                    | $          | 10.40                      |       | $                          | 7.17       | ** **        | (12        | )% | (39 | )% | $ | 0.210 |   |
|       |       | 06/30/09    |       | 11.86       |       | 7.80                    |       | 5.49                       |       | (34                        | )%         | (54               | )%         | 0.210 |   |
|       |       | 03/31/09    |       | 12.10       |       | 10.28                   |       | 5.01                       |       | (15                        | )%         | (59               | )%         | 0.420 |   |
|       |       | 12/31/08    |       | 12.04       |       | 15.38                   |       | 5.50                       |       | 28                         | %          | (54               | )%         | 0.420 |   |
| FY  2008   |       | 09/30/08    |       | $           | 12.89      |                    | $          | 18.65                      |       | $                          | 12.91      |              | 45         | % | 0 | % | $ | 0.420 |   |
|       |       | 06/30/08    |       | 13.97       |       | 19.31                   |       | 15.24                      |       | 38                         | %          | 9                 | %          | 0.420 |   |
|       |       | 03/31/08    |       | 14.27       |       | 19.22                   |       | 16.25                      |       | 35                         | %          | 14                | %          | 0.420 |   |
|       |       | 12/31/07    |       | 15.08       |       | 20.62                   |       | 17.01                      |       | 37                         | %          | 13                | %          | 0.420 |   |

 

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| (1)    |   | NAV per share is  determined as of the last day in the relevant quarter and therefore may not  reflect the NAV per share on the date of the high and low sales prices. The  NAVs shown are based on outstanding shares at the end of each period.                                                                                                        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                     |
| (2)    |   | The premiums  (discounts) set forth in these columns represent the high or low, as  applicable, closing price per share for the relevant quarter minus the net  asset value per share as of the end of such quarter, and therefore may not  reflect the premium (discount) to net asset value per share on the date of  the high and low closing prices. |

 

As of November 13,2009, there were approximately 80 stockholders of record of our common stock.

 

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**Distributions**

 

We currently intend todistribute in the form of cash dividends a minimum of 90% of our ordinaryincome and short-term capital gains, if any, on a quarterly basis to ourstockholders in the form of monthly dividends.

 

**Recent Salesof Unregistered Securities**

 

Therewere no unregistered sales of securities during the fiscal year ended September 30,2009.

 

**Item 6. Selected Financial Data**

 

The following selectedfinancial data for the fiscal years ended September 30, 2009, 2008, 2007,2006 and 2005 are derived from our audited consolidated financial statements.The data should be read in conjunction with our consolidated financialstatements and notes thereto and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” included elsewhere in thisreport.

 

**GLADSTONE CAPITAL CORPORATIONSELECTED FINANCIAL DATA**

**(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERUNIT DATA)**

** **
| ** **                                                       | ** ** | **Year  Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Statement of Operations Data:                                    |       |                               |       |   |   |   |   |   |   |   |   |
| Total Investment Income                                          |       | $                                  | 42,618     |   | $ | 45,725 |   | $ | 36,687 |   | $ | 26,900 |   | $ | 23,950 |   |
| Total Expenses                                                   |       | $                                  | 21,587     |   | $ | 19,172 |   | $ | 14,426 |   | $ | 7,447 |   | $ | 6,454 |   |
| Net Investment Income                                            |       | $                                  | 21,031     |   | $ | 26,553 |   | $ | 22,261 |   | $ | 19,351 |   | $ | 17,286 |   |
| Net Realized (Loss) Gain on Investments                          |       | $                                  | (26,411    | ) | $ | (787 | ) | $ | 44 |   | $ | (904 | ) | $ | 30 |   |
| Realized (Loss) Gain on Settlement of Derivative                 |       | $                                  | (304       | ) | $ | 7 |   | $ | 39 |   | $ | 15 |   | $ | — |   |
| Unrealized Appreciation (Depreciation) on  Derivative            |       | $                                  | 304        |   | $ | (12 | ) | $ | (38 | ) | $ | — |   | $ | (39 | ) |
| Net Unrealized Appreciation (Depreciation) on  Investments       |       | $                                  | 9,513      |   | $ | (47,023 | ) | $ | (7,354 | ) | $ | 5,968 |   | $ | (1,786 | ) |
| Net Unrealized Appreciation on Borrowings under  Line of Credit  |       | $                                  | (350       | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Net Increase (Decrease) in Net Assets Resulting  from Operations |       | $                                  | 3,783      |   | $ | (21,262 | ) | $ | 14,952 |   | $ | 24,430 |   | $ | 15,491 |   |
| Per Share Data (1):                                              |       |                               |       |   |   |   |   |   |   |   |   |
| Basic:                                                           |       | $                                  | 0.18       |   | $ | (1.08 | ) | $ | 1.13 |   | $ | 2.15 |   | $ | 1.37 |   |
| Diluted:                                                         |       | $                                  | 0.18       |   | $ | (1.08 | ) | $ | 1.13 |   | $ | 2.10 |   | $ | 1.33 |   |
| Cash Distributions Declared per share                            |       | $                                  | 1.260      |   | $ | 1.680 |   | $ | 1.680 |   | $ | 1.635 |   | $ | 1.515 |   |
| Statement of Assets and Liabilities Data:                        |       |                               |       |   |   |   |   |   |   |   |   |
| Total Assets                                                     |       | $                                  | 335,910    |   | $ | 425,698 |   | $ | 367,729 |   | $ | 225,783 |   | $ | 205,793 |   |
| Net Assets                                                       |       | $                                  | 249,076    |   | $ | 271,748 |   | $ | 220,959 |   | $ | 172,570 |   | $ | 151,611 |   |
| Net Asset Value Per Share                                        |       | $                                  | 11.81      |   | $ | 12.89 |   | $ | 14.97 |   | $ | 14.02 |   | $ | 13.41 |   |
| Common Shares Outstanding                                        |       | 21,087,574                         |       | 21,087,574 |   | 14,762,574 |   | 12,305,008 |   | 11,303,510 |   |
| Senior Securities Data:                                          |       |                               |       |   |   |   |   |   |   |   |   |
| Borrowings under line of credit (2)                              |       | $                                  | 83,350     |   | $ | 151,030 |   | $ | 144,440 |   | $ | 49,993 |   | $ | 53,034 |   |
| Asset coverage ratio (3) (4)                                |       | 399                                | %          | 286 | % | 259 | % | 466 | % | 402 | % |
| Asset coverage per unit (4)                                      |       | $                                  | 3,988      |   | $ | 2,860 |   | $ | 2,594 |   | $ | 4,657 |   | $ | 4,024 |   |
| Other Data:                                                      |       |                               |       |   |   |   |   |   |   |   |   |
| Number of Portfolio Companies at Year End                        |       | 48                                 |       | 63 |   | 56 |   | 32 |   | 28 |   |
| Principal Amount of Loan Originations                            |       | $                                  | 26,366     |   | $ | 176,550 |   | $ | 261,700 |   | $ | 135,955 |   | $ | 143,794 |   |
| Principal Amount of Loan Repayments and Investments  Sold        |       | $                                  | 96,693     |   | $ | 70,482 |   | $ | 121,818 |   | $ | 124,010 |   | $ | 88,019 |   |
| Weighted Average Yield on Investments (5):                  |       | 9.91                               | %          | 10.23 | % | 11.98 | % | 12.74 | % | 12.23 | % |
| Total Return (6)                                                 |       | (30.94                             | )%         | (13.90 | )% | (4.40 | )% | 5.21 | % | 5.93 | % |

 

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| (1) |   | Per share data for net  increase in net assets resulting from operations is based on the weighted  common stock outstanding for both basic and diluted.                                                                                                                                                                                                                 |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | See “Management’s  Discussion and Analysis of Financial Condition and Results of Operations” for  more information regarding our level of indebtedness.                                                                                                                                                                                                  |
| (3) |   | As a business  development company, we are generally required to maintain a ratio of 200% of  total assets, less all liabilities and indebtedness not represented by senior  securities, to total borrowings.                                                                                                                                                           |
| (4) |   | Asset coverage ratio is  the ratio of the carrying value of our total consolidated assets, less all  liabilities and indebtedness not represented by senior securities, to the  aggregate amount of senior securities representing indebtedness. Asset  coverage per unit is the asset coverage ratio expressed in terms of dollar  amounts per $1,000 of indebtedness. |
| (5) |   | Weighted average yield  on investments equals interest income on investments divided by the  annualized weighted average investment balance throughout the year.                                                                                                                                                                                                        |
| (6) |   | Total return equals the  increase of the ending market value over the beginning market value plus  monthly dividends divided by the monthly beginning market value.                                                                                                                                                                                                     |

 

**Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations*****(dollaramounts in thousands, unless otherwise indicated)***

 

*Thefollowing analysis of our financial condition and results of operations shouldbe read in conjunction with our financial statements and the notes theretocontained elsewhere in this Form 10-K.*

 

**OVERVIEW**

 

**General**

 

We were incorporatedunder the General Corporation Laws of the State of Maryland on May 30,2001. Our investment objectives are to achieve a high level of current incomeby investing in debt securities, consisting primarily of senior notes, seniorsubordinated notes and junior subordinated notes, of established privatebusinesses that are substantially owned by leveraged buyout funds, individualinvestors or are family-owned businesses, with a particular focus on seniornotes. In addition, we may acquire from others existing loans that meet thisprofile. We also seek to provide our stockholders with long-term capital growththrough the appreciation in the value of warrants or other equity instrumentsthat we may receive when we make loans. We operate as a closed-end, non-diversifiedmanagement investment company, and have elected to be treated as a businessdevelopment company under the Investment Company Act of 1940 (the “1940 Act”).  In addition, for tax purposes we have electedto be treated as a regulated investment company (“RIC”) under the InternalRevenue Code of 1986, as amended (the “Code”).

 

We seek out small andmedium-sized private U.S. businesses that meet certain criteria, including somebut not all of the following: the potential for growth in cash flow, adequateassets for loan collateral, experienced management teams with a significantownership interest in the borrower, profitable operations based on the borrower’scash flow, reasonable capitalization of the borrower (usually by leveragedbuyout funds or venture capital funds) and the potential to realizeappreciation and gain liquidity in our equity position, if any. We anticipatethat liquidity in our equity position will be achieved through a merger oracquisition of the borrower, a public offering of the borrower’s stock or byexercising our right to require the borrower to repurchase our warrants, thoughthere can be no assurance that we will always have these rights. We lend toborrowers that need funds to finance growth, restructure their balance sheetsor effect a change of control.

 

**BusinessEnvironment**

 

The current economicconditions generally and the disruptions in the capital markets in particularhave decreased liquidity and increased our cost of debt and equity capital,where available. The longer these conditions persist, the greater theprobability that these factors could continue to increase our cost andsignificantly limit our access to debt and equity capital, and thus have anadverse effect on our operations and financial results. Many of the companiesin which we have made or will make investments are also susceptible to theadverse economic environment, which may affect the ability of one or more ofour portfolio companies to repay our loans or engage in a liquidity event, suchas a sale, recapitalization or initial public offering. The recession couldalso disproportionately impact some of the industries in which we invest,causing us to be more vulnerable to losses in our portfolio. Therefore, thefair market value of our portfolio could continue to decrease during thecurrent economic situation, or future economic downturns.

 

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As aresult of the economic downturn, the availability of credit in the marketbecame scarce, and we were forced to sell 13 of the 24 syndicated loans thatwere held in our portfolio of investments at March 31, 2009 to variousinvestors in the syndicated loan market in order to repay amounts outstandingunder our prior credit facility, which matured in May 2009. These loans,in aggregate, had a cost value of approximately $30,427, or 7% of the costvalue of our total investments, and an aggregate fair market value of approximately$22,467, or 6% of the fair market value of our total investments, at March 31,2009.  Since then, we have soldadditional syndicated loans and incurred a net realized loss of $26,411 for thefiscal year ended September 30, 2009. We intend to sell the remaining syndicated loans in our portfolio assoon as practicable, which will likely result in further realized losses.

 

Challenges in the currentmarket are intensified for us by certain regulatory limitations under the Codeand the 1940 Act, as well as contractual restrictions under the agreementgoverning our credit facility that further constrain our ability to access thecapital markets.  To maintain ourqualification as a RIC, we must satisfy, among other requirements, an annualdistribution requirement to pay out at least 90% of our ordinary income andshort-term capital gains to our stockholders on an annual basis.  Because we are required to distribute ourincome in this manner, and because the illiquidity of many of our investmentsmakes it difficult for us to finance new investments through the sale ofcurrent investments, our ability to make new investments is highly dependentupon external financing.  Our externalfinancing sources include the issuance of equity securities, debt securities orother leverage such as borrowings under our line of credit.  Our ability to seek external debt financing,to the extent that it is available under current market conditions, is furthersubject to the asset coverage limitations of the 1940 Act, which require us tohave at least a 200% asset coverage ratio, meaning generally that for everydollar of debt, we must have two dollars of assets.

 

Recent market conditionshave also affected the trading price of our common stock and thus our abilityto finance new investments through the issuance of equity.  On November 13, 2009, the closing marketprice of our common stock was $7.98, which price represented a 32% discount toour September 30, 2009 net asset value (“NAV”) per share.  When our stock is trading below NAV, as ithas consistently traded for more than a year, our ability to issue equity isconstrained by provisions of the 1940 Act which generally prohibit the issuanceand sale of our common stock below NAV per share without stockholder approvalother than through sales to our then-existing stockholders pursuant to a rightsoffering.  At our annual meeting ofstockholders held on February 19, 2009, stockholders approved a proposalwhich authorizes us to sell shares of our common stock at a price below our thencurrent NAV per share for a period of one year from the date of approval,provided that our Board of Directors makes certain determinations prior to anysuch sale.  At the upcoming annualstockholders meeting scheduled for February 18, 2010, our stockholderswill again be asked to vote in favor of renewing this proposal for anotheryear.

 

The recession may alsocontinue to decrease the value of collateral securing some of our loans, aswell as the value of our equity investments, which has impacted and maycontinue to impact our ability to borrow under our credit facility.  Additionally, our credit facility containscovenants regarding the maintenance of certain minimum net worth requirementswhich are affected by the decrease in value of our portfolio.  Failure to meet these requirements wouldresult in a default which, if we are unable to obtain a waiver from ourlenders, would result in the acceleration of our repayment obligations underour credit facility.  As of September 30,2009, we were in compliance with all of the facility covenants.

 

We expect that, giventhese regulatory and contractual constraints in combination with current marketconditions, debt and equity capital may be costly or difficult for us to accessfor some time.  For so long as this isthe case, our near-term strategy will be focused primarily on retaining capitaland building the value of our existing portfolio companies to increase thelikelihood of maintaining potential future returns.  We will also, where prudent and possible,consider the sale of lower-yielding investments.  This has resulted, and may continue toresult, in significantly reduced investment activity, as our ability to makenew investments under these conditions is largely dependent on availability ofproceeds from the sale or exit of existing portfolio investments, which eventsmay be beyond our control.  As capitalconstraints improve, we intend to continue our strategy of making conservativeinvestments in businesses that we believe will weather the economy and that arelikely to produce attractive long-term returns for our stockholders.

 

**SyndicatedLoan Valuations**

 

Dueto the illiquidity in the market for syndicated loans during the three quartersprior to and including the quarter ended June 30, 2009, a discounted cashflow (“DCF”) methodology was used to value these investments during thoseperiods, following guidance provided under Financial AccountingStandards Board Accounting Standards Codification (“ASC”) 820, “Fair ValueMeasurements and Disclosures.”  However, in monitoring the market activityduring the quarter ended September 30, 2009, we noted changing marketsconditions indicating a return to liquidity and a better functioning secondary

 

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marketfor syndicated loans.  Therefore, inaccordance with ASC820, and following our valuation procedures which specify the use ofthird-party indicative bid quotes for valuing syndicated loans where there is aliquid public market for those loans and market pricing quotes are readilyavailable, a third-party bid quote was used to value the remaining syndicatedloans not sold during the year ended September 30, 2009.  In November 2009, we settled sales oftwo syndicated loans(Kinetek and Wesco). Those loans are included in our consolidated assets as of September 30,2009 and were valued as of September 30, 2009 at the respective saleprices.  The Wesco loan was sold subsequentto September 30, 2009 and the sale price was deemed to be an accuratereflection of the fair value as of September 30, 2009.

 

**Highlights**

 

*Registration Statement*

 

On October 20, 2009,we filed a registration statement on Form N-2 with the SEC.  If and when it is declared effective, it willpermit us to issue, through one or more transactions, up to an aggregate of$300,000 in securities, consisting of common stock, senior common stock,preferred stock, subscription rights, debt securities and warrants to purchasecommon stock, or a combination of these securities.

 

*PortfolioCompany Investment Activity*

 

*Purchases:*During the yearended September 30, 2009, we extended $26,366 of investments to existingportfolio companies through revolver draws or the additions of new term notes.

 

*Repayments:* During the year ended September 30,2009, we were repaid in full by three portfolio companies.  In addition, three portfolio companiesrefinanced their loans, one borrower made an unscheduled partial payoff, and weexperienced contractual amortization, revolver repayments and some principalpayments received ahead of schedule for total principal repayments of $47,490.

 

*Sales/Exits:* During the year ended September 30,2009, we exited from 12 companies and received an aggregate of $49,203 in netproceeds.

 

Since our initial publicoffering in August 2001, we have made 261 different loans to, orinvestments in, 126 companies for a total of approximately $952,348, beforegiving effect to principal repayments on investments and divestitures.

 

*FinancingActivity*

 

On May 15, 2009 we,through our wholly-owned subsidiary Gladstone Business Loan, LLC (“BusinessLoan”), entered into a third amended and restated credit agreement providingfor a $127,000 revolving line of credit arranged by Key Equipment Finance Inc.(“KEF”) as administrative agent, replacing Deutsche Bank AG as administrativeagent (the “KEF Facility”).  BranchBanking and Trust Company (“BB&T”) also joined the KEF Facility as acommitted lender.  In connection with enteringinto the KEF Facility, we borrowed $35,881 under the KEF Facility to make afinal payment to Deutsche Bank AG in satisfaction of all unpaid principal andinterest owed to Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to$200,000 through the addition of other committed lenders to the facility.  Without the addition of other committedlenders, the KEF Facility provides a total commitment of $102,000 from January 1,2010 to May 11, 2010, and $77,000 thereafter.

 

In October and November of2009, we reduced the size of the KEF Facility by $15,000 and $5,000,respectively, from $127,000 to $107,000.  Under the KEF Facility the first$50,000 of commitment reductions are applied against KEF’s commitment. Therefore, the entire $20,000 was subtracted from KEF’s commitment, reducing itfrom $100,000 to $80,000 and leaving BB&T’s commitment unchanged at$27,000.  As a result of the manner in which our borrowing base iscalculated under the KEF Facility, the reductions did not affect ouravailability under the KEF Facility.  TheKEF Facility matures on May 14, 2010, and if the facility is not renewedor extended by this date, all principal and interest will be due and payablewithin one year of maturity In addition, if the facility is not renewed, ourlenders have the right to apply all principal and interest collections toamounts outstanding under the KEF Facility. Advances under the KEF Facility will generally bear interest at the 30-dayLIBOR or commercial paper rate (subject to a minimum rate of 2%), plus 4% perannum, with a commitment fee of 0.75% per annum on undrawn amounts.  As of September 30, 2009, there was acost basis of approximately $83,000 of borrowings outstanding on the KEFFacility at an average rate of 7.36%, and the remaining borrowing capacityunder the KEF Facility was $44,000. Available borrowings are subject to various constraints imposed 

 

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under the KEF Facility,based on the aggregate loan balance pledged by Business Loan. Interest ispayable monthly during the term of the KEF Facility.

 

During the year ended September 30,2009, we elected to apply ASC 825, “FinancialInstruments,” specifically for the KEF Facility, which requires us toapply a fair value methodology to the KEF Facility as of September 30,2009.  The KEF Facility was fair valuedat $83,350 as of September 30, 2009.

 

**Investment Strategy**

 

Our loans typically rangefrom $5 million to $20 million, although this investment size may varyproportionately as the size of our capital base changes, generally mature in nomore than seven years and accrue interest at fixed or variable rates.  Some of our loans may contain a provisionthat calls for some portion of the interest payments to be deferred and addedto the principal balance so that the interest is paid, together with theprincipal, at maturity. This form of deferred interest is often called “paid inkind” (“PIK”) interest and, when earned, we record PIK interest as interestincome and add the PIK interest to the principal balance of the loans. We seekto avoid PIK interest with all potential investments under review. As of September 30,2009 one Control investment and one Non-Control/Non-Affiliate investment borePIK interest.

 

Because the majority ofour portfolio loans consist of term debt of private companies who typicallycannot or will not expend the resources to have their debt securities rated bya credit rating agency, we expect that most, if not all, of the debt securitieswe acquire will be unrated. We cannot accurately predict what ratings theseloans might receive if they were rated, and thus cannot determine whether ornot they could be considered “investment grade” quality.

 

To the extent possible,our loans generally are collateralized by a security interest in the borrower’sassets. Interest payments are generally made monthly or quarterly (except tothe extent of any PIK interest) with amortization of principal generally beingdeferred for several years. The principal amount of the loans and any accruedbut unpaid interest generally become due at maturity at five to seven years.When we receive a warrant to purchase stock in a borrower in connection with aloan, the warrant will typically have an exercise price equal to the fair valueof the portfolio company’s common stock at the time of the loan and entitle usto purchase a modest percentage of the borrower’s stock.

 

Original issue discount (“OID”)arises when we extend a loan and receive an equity interest in the borrower atthe same time.  To the extent that theprice paid for the equity is not at market value, we must allocate part of theprice paid for the loan, to the value of the equity.  Then the amount allocated to the equity, theOID, must be amortized over the life of the loan.  As with PIK interest, the amortization of OIDalso produces income that must be recognized for purposes of satisfying thedistribution requirements for a RIC under Subchapter M of the Code, whereas thecash is received, if at all, when the equity instrument is sold.  We seek to avoid OID with all potentialinvestments under review and from inception through September 30, 2009, wedid not hold any investments with OID income.

 

In addition, as abusiness development company under the 1940 Act, we are required to makeavailable significant managerial assistance to our portfolio companies. Ourinvestment adviser, Gladstone Management Corporation (the “Adviser”) providesthese services on our behalf through its officers who are also ourofficers.  Currently, neither we nor ourAdviser charges a fee for managerial assistance, however, if our Adviser doesreceive fees for managerial assistance, our Adviser will credit the managerialassistance fees to the base management fee due from us to our Adviser.

 

Our Adviser receives feesfor the other services it provides to our portfolio companies. These other feesare typically non-recurring, are recognized as revenue when earned and aregenerally paid directly to our Adviser by the borrower or potential borrowerupon the closing of the investment. The services our Adviser provides to ourportfolio companies vary by investment, but generally include a broad array of services,such as investment banking services, arranging bank and equity financing,structuring financing from multiple lenders and investors, reviewing existingcredit facilities, restructuring existing investments, raising equity and debtcapital from other investors, turnaround management, merger and acquisitionservices and recruiting new management personnel. When our Adviser receivesfees for these services, 50% of certain of those fees are credited against thebase management fee that we pay to our Adviser. Any services of this nature subsequent to closing would typicallygenerate a separate fee at the time of completion.

 

Our Adviser also receivesfees for monitoring and reviewing portfolio company investments. These fees arerecurring and are generally paid annually or quarterly in advance to ourAdviser throughout the life of the investment. Fees of this nature are recordedas revenue by our Adviser when earned and are not credited against the basemanagement fee.

 

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We may receive fees forthe origination and closing services we provide to portfolio companies throughour Adviser. These fees are paid directly to us and are recognized as revenueupon closing of the originated investment and are reported as fee income in theconsolidated statements of operations.

 

Prior to making aninvestment, we ordinarily enter into a non-binding term sheet with thepotential borrower. These non-binding term sheets are generally subject to anumber of conditions, including, but not limited to, the satisfactorycompletion of our due diligence investigations of the potential borrower’sbusiness, reaching agreement on the legal documentation for the loan, and thereceipt of all necessary consents. Upon execution of the non-binding termsheet, the potential borrower generally pays the Adviser a non-refundable feefor services rendered by the Adviser through the date of the non-binding termsheet. These fees are received by the Adviser and are offset against the basemanagement fee payable to the Adviser, which has the effect of reducing ourexpenses to the extent of any such fees received by the Adviser.

 

In the event that weexpend significant effort in considering and negotiating a potential investmentthat ultimately is not consummated, we generally will seek reimbursement fromthe proposed borrower for our reasonable expenses incurred in connection withthe transaction, including legal fees. Any amounts collected for expenses incurred by the Adviser in connectionwith unconsummated investments will be reimbursed to the Adviser.  Amounts collected for these expenses incurredby us will be reimbursed to us and will be recognized in the period in whichsuch reimbursement is received, however, there can be no guarantee that we willbe successful in collecting any such reimbursements.

 

**OurAdviser and Administrator**

 

Our Adviser is led by amanagement team which has extensive experience in our lines of business. OurAdviser is controlled by David Gladstone, our chairman and chief executiveofficer. Mr. Gladstone is also the chairman and chief executive officer ofour Adviser. Terry Lee Brubaker, our vice chairman, chief operating officer,secretary and director, is a member of the board of directors of our Adviserand its vice chairman and chief operating officer, George Stelljes III,our president, chief investment officer and director, is a member of the boardof directors of our Adviser and its president and chief investment officer. OurAdviser also has a wholly-owned subsidiary, Gladstone Administration, LLC (the “Administrator”),which employs our chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs.

 

Our Adviser andAdministrator also provide investment advisory and administrative services toour affiliates, Gladstone Commercial Corporation, a publicly traded real estateinvestment trust; Gladstone Investment Corporation, a publicly traded businessdevelopment company; and Gladstone Land Corporation, a private agriculturalreal estate company. With the exception of our chief financial officer, all ofour executive officers serve as either directors or executive officers, orboth, of our Adviser, our Administrator, Gladstone Commercial Corporation andGladstone Investment Corporation. In the future, our Adviser may provideinvestment advisory and administrative services to other funds, both public andprivate, of which it is the sponsor.

 

**Investment Advisory andManagement Agreement**

 

Under the amended andrestated investment advisory agreement (“Advisory Agreement”), we pay ourAdviser an annual base management fee of 2% of our average gross assets, whichis defined as total assets, including investments made with proceeds ofborrowings, less any uninvested cash or cash equivalents resulting fromborrowings, valued at the end of the two most recently completed calendarquarters and appropriately adjusted for any share issuances or repurchasesduring the current calendar quarter.

 

We also pay our Adviser atwo-part incentive fee under the Advisory Agreement.  The first part of the incentive fee is anincome-based incentive fee which rewards our Adviser if our quarterly netinvestment income (before giving effect to any incentive fee) exceeds 1.75% ofour net assets (the “hurdle rate”). The second part of the incentive fee is acapital gains-based incentive fee that is determined and payable in arrears asof the end of each fiscal year (or upon termination of the Advisory Agreement,as of the termination date), and equals 20% of our realized capital gains as ofthe end of the fiscal year. In determining the capital gains-based incentivefee payable to our Adviser, we will calculate the cumulative aggregate realizedcapital gains and cumulative aggregate realized capital losses since ourinception, and the aggregate unrealized capital depreciation as of the date ofthe calculation, as applicable, with respect to each of the investments in ourportfolio.  The Adviser did not earn thecapital gains portion of the incentive fee for the fiscal year ended September 30,2009.

 

We pay our directexpenses including, but not limited to, directors’ fees, legal and accountingfees, stockholder related expenses, and directors and officers insurance underthe Advisory Agreement.

 

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Beginning in April 2006,our Board of Directors has accepted from the Adviser, unconditional andirrevocable voluntarily waivers on a quarterly basis to reduce the annual 2.0%base management fee on senior syndicated loans to 0.5% to the extent thatproceeds resulting from borrowings were used to purchase such syndicated loanparticipations.  In addition to the basemanagement and incentive fees under the Advisory Agreement, 50% of certain feesreceived by the Adviser from our portfolio companies are credited against theinvestment advisory fee and paid to the Adviser.

 

The Adviser services ourloan portfolio pursuant to a loan servicing agreement with Gladstone BusinessLoan, LLC (“Business Loan”) in return for a 1.5% annual fee, based on themonthly aggregate outstanding loan balance of the loans pledged under ourcredit facility.

 

**Administration Agreement**

 

We have entered into anadministration agreement with our Administrator (the “Administration Agreement”),whereby we pay separately for administrative services. The AdministrationAgreement provides for payments equal to our allocable portion of theAdministrator’s overhead expenses in performing its obligations under theAdministration Agreement including, but not limited to, rent for employees ofthe Administrator, and our allocable portion of the salaries and benefitsexpenses of our chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs. Our allocable portion of expenses is derived by multiplying our Administrator’stotal expenses by the percentage of our average assets (the total assets at thebeginning of each quarter) in comparison to the average total assets of allcompanies managed by our Adviser under similar agreements.  On July 8, 2009, our Board of Directorsapproved the renewal of this Administration Agreement with our Administratorthrough August 31, 2010. We expect that the Board of Directors willconsider a further one year renewal in July 2010.

 

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**RESULTS OF OPERATIONS**

 

*COMPARISON OF THE FISCAL YEARS ENDEDSEPTEMBER 30, 2009 AND SEPTEMBER 30, 2008*

 

*A comparison of our operating results for thefiscal years ended September 30, 2009 and 2008 is below:*

 
| ** **                                                                                           | ** ** | **For the  year ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| INVESTMENT INCOME                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Interest income – non control/non affiliate  investments                                        |       | $                                          | 41,134     |   | $ | 44,733 |   | $ | (3,599 | ) | (8.0 | )% |
| Interest income – control investments                                                           |       | 933                                        |       | 64 |   | 869 |   | 1,357.8 | % |
| Interest income – cash                                                                          |       | 11                                         |       | 335 |   | (324 | ) | (96.7 | )% |
| Interest income – notes receivable from employees                                               |       | 468                                        |       | 471 |   | (3 | ) | (0.6 | )% |
| Prepayment fees and other income                                                                     |       | 72                                         |       | 122 |   | (50 | ) | (41.0 | )% |
| Total investment income                                                                              |       | 42,618                                     |       | 45,725 |   | (3,107 | ) | (6.8 | )% |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| EXPENSES                                                                                             |       |                                       |       |   |   |   |   |   |   |
| Interest expense                                                                                     |       | 7,949                                      |       | 8,284 |   | (335 | ) | (4.0 | )% |
| Loan servicing fee                                                                                   |       | 5,620                                      |       | 6,117 |   | (497 | ) | (8.1 | )% |
| Base management fee                                                                                  |       | 2,005                                      |       | 2,212 |   | (207 | ) | (9.4 | )% |
| Incentive fee                                                                                        |       | 3,326                                      |       | 5,311 |   | (1,985 | ) | (37.4 | )% |
| Administration fee                                                                                   |       | 872                                        |       | 985 |   | (113 | ) | (11.5 | )% |
| Professional fees                                                                                    |       | 1,586                                      |       | 911 |   | 675 |   | 74.1 | % |
| Amortization of deferred financing fees                                                              |       | 2,778                                      |       | 1,534 |   | 1,244 |   | 81.1 | % |
| Stockholder related costs                                                                            |       | 415                                        |       | 443 |   | (28 | ) | (6.3 | )% |
| Directors’ fees                                                                                 |       | 197                                        |       | 220 |   | (23 | ) | (10.5 | )% |
| Insurance expense                                                                                    |       | 241                                        |       | 227 |   | 14 |   | 6.2 | % |
| Other expenses                                                                                       |       | 278                                        |       | 325 |   | (47 | ) | (14.5 | )% |
| Expenses before credit from Adviser                                                                  |       | 25,267                                     |       | 26,569 |   | (1,302 | ) | (4.9 | )% |
| Credit to base management and incentive fees from  Adviser                                           |       | (3,680                                     | )          | (7,397 | ) | 3,717 |   | (50.3 | )% |
| Total expenses net of credit to base management and  incentive fees                                  |       | 21,587                                     |       | 19,172 |   | 2,415 |   | 12.6 | % |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| NET INVESTMENT INCOME                                                                                |       | 21,031                                     |       | 26,553 |   | (5,522 | ) | (20.8 | )% |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS,  DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT: |       |                                       |       |   |   |   |   |   |   |
| Net realized loss on investments                                                                     |       | (26,411                                    | )          | (787 | ) | (25,624 | ) | 3,255.9 | % |
| Realized (loss) gain on settlement of derivative                                                     |       | (304                                       | )          | 7 |   | (311 | ) | (4,442.9 | )% |
| Net unrealized appreciation (depreciation) on  derivative                                            |       | 304                                        |       | (12 | ) | 316 |   | (2,633.3 | )% |
| Net unrealized appreciation (depreciation) on  investments                                           |       | 9,513                                      |       | (47,023 | ) | 56,536 |   | (120.2 | )% |
| Net unrealized appreciation on borrowings under  line of credit                                      |       | (350                                       | )          | — |   | (350 | ) | — |   |
| Net loss on investments, derivative and borrowings  under line of credit                             |       | (17,248                                    | )          | (47,815 | ) | 30,567 |   | (63.9 | )% |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| NET INCREASE (DECREASE) IN NET ASSETS RESULTING  FROM OPERATIONS                                     |       | $                                          | 3,783      |   | $ | (21,262 | ) | 25,045 |   | (117.8 | )% |
|                                                                                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |

 

**Investment Income**

 

Investment income for theyear ended September 30, 2009 was $42,618 as compared to $45,725 for theyear ended September 30, 2008. Interest income from our aggregate investment portfolio decreased forthe year ended September 30, 2009 as compared to the prior year.  The level of interest income from investmentsis directly related to the balance, at cost, of the interest-bearing investmentportfolio outstanding during the year multiplied by the weighted averageyield.  The weighted average yield variesfrom year to year based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investmentsdecreased primarily due to the overall reduction in the cost basis of ourinvestments, resulting primarily from the exit of 15 investments during theyear ended September 30, 2009, as well as a slight decrease in theweighted average yield on our portfolio. The annualized weighted average yield on our portfolio was 9.9% for theyear ended September 30, 2009 as compared to 10.2% for the prior 

 

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year.  During the year ended September 30,2009, five investments were on non-accrual, for an aggregate of approximately$10,022 at cost, or 2.8% of the aggregate cost of our investment portfolio andduring the prior year, three investments were on non-accrual for an aggregateof approximately $13,098 at cost, or 2.8% of the aggregate cost of ourinvestment portfolio.

 

Interest income from Non-Control/Non-Affiliateinvestments decreased for the year ended September 30, 2009 as compared tothe prior year, primarily from an overall decrease in the aggregate cost basisof our Non-Control/Non-Affiliate investments during the year.  In addition, the success fees earned duringthe year ended September 30, 2009 totaled $387, compared to $998 earned inthe prior year.  Success fees earnedduring the year ended September 30, 2009 resulted from refinancings byActivStyle and It’s Just Lunch and an amendment by Interfilm.  Success fees earned during the year ended September 30,2008 resulted from refinancings by Defiance and Westlake Hardware and a fullrepayment from Express Courier.

 

Interest income fromControl investments increased for the year ended September 30, 2009 ascompared to the prior year.  The increasewas attributable to four additional Control investments held during the yearended September 30, 2009, which were converted fromNon-Control/Non-Affiliate investments.

 

The following table liststhe interest income from investments for the five largest portfolio companiesduring the respective years:

 

**Yearended September 30, 2009**

 
| **Company**               | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------|------------|
| Sunshine  Media           |       | $                    | 3,352      |            | 8.0        | % |
| Reliable  Biopharma       |       | 3,073                |       | 7.3             | %          |
| Westlake  Hardware        |       | 2,417                |       | 5.7             | %          |
| Clinton  Holdings         |       | 1,888                |       | 4.5             | %          |
| VantaCore                 |       | 1,696                |       | 4.0             | %          |
| **Subtotal**              | ** ** | **$**                | **12,426** | ** **      | **29.5**   | **%** |
| Other  companies          |       | 29,641               |       | 70.5            | %          |
| **Total interest income** | ** ** | **$**                | **42,067** | ** **      | **100.0**  | **%** |

 

**Yearended September 30, 2008**

 
| **Company**               | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------|------------|
| Sunshine  Media           |       | $                    | 2,939      |            | 6.6        | % |
| Reliable  Biopharma       |       | 2,870                |       | 6.4             | %          |
| Westlake  Hardware        |       | 2,852                |       | 6.4             | %          |
| Clinton  Holdings         |       | 1,902                |       | 4.2             | %          |
| Winchester  Electronics   |       | 1,399                |       | 3.1             | %          |
| **Subtotal**              | ** ** | **$**                | **11,962** | ** **      | **26.7**   | **%** |
| Other  companies          |       | 32,835               |       | 73.3            | %          |
| **Total interest income** | ** ** | **$**                | **44,797** | ** **      | **100.0**  | **%** |

 

Interest income frominvested cash decreased for the year ended September 30, 2009 as comparedto the prior year.  Interest income camefrom the following sources:

 
|                                                    |   | **Year ended**               |   |
|---------------------------------------------------------|--------|------------------------------|--------|
|                                                    |   | **September 30,  2009** |   | **September 30,  2008** |   |
|                                                    |   |                         |   |   |   |
| Interest  earned on Gladstone Capital account (1)       |   | $                            | — |   | $ | 50 |   |
| Interest  earned on Business Loan custodial account (2) |   | 10                           |   | 199 |   |
| Interest  earned on Gladstone Financial account (3)     |   | 1                            |   | 86 |   |
| Total  interest income from invested cash               |   | $                            | 11     |   | $ | 335 |   |

 

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(1)          Interest earned on our Gladstone Capital accountduring the year ended September 30, 2008 resulted from proceeds receivedfrom the equity offerings completed during the fiscal year that were held inthe account prior to being invested or used to pay down the line of credit.

(2)          Interest earned on our Business Loan custodial accountduring the year ended September 30, 2008 resulted from large cash amountsheld in the account prior to disbursement. During this fiscal year, we had $140,817 of originations to newportfolio companies.

(3)          Interest earned on our Gladstone Financial accountduring the year ended September 30, 2008 resulted from the U.S. Treasurybill that was held with an original maturity of six months.

 

Interest income fromloans to our employees, in connection with the exercise of employee stockoptions, decreased slightly for the year ended September 30, 2009 ascompared to the prior year due to principal payments on the employee loansduring the current year.

 

Prepayment fees and otherincome decreased for the year ended September 30, 2009 as compared to theprior year.  The income for the prioryear consisted of prepayment penalty fees received upon the full repayment ofcertain loan investments 

 

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ahead of contractualmaturity and prepayment fees received upon the early unscheduled principalrepayments, which was based on a percentage of the outstanding principal amountof the loan at the date of prepayment.

 

**OperatingExpenses**

 

Operating expenses, netof credits from the Adviser for fees earned and voluntary irrevocable andunconditional waivers to the base management and incentive fees, increased forthe year ended September 30, 2009 as compared to the prior year primarilydue to an increase in professional fees and amortization of deferred financingfees incurred in connection with our previous credit facility with DeutscheBank AG (the “DB Facility”) and the new KEF Facility.

 

Interest expensedecreased for the year ended September 30, 2009 as compared to the prioryear due primarily to decreased borrowings under our line of credit during theyear ended September 30, 2009, partially offset by a higher weightedaverage annual interest cost, which is determined by using the annual statedinterest rate plus commitment and other fees, plus the amortization of deferredfinancing fees dividend by the weighted average debt outstanding.

 

Loan servicing feesdecreased for the year ended September 30, 2009 as compared to the prioryear.  These fees were incurred inconnection with a loan servicing agreement between Business Loan and ourAdviser, which is based on the size and mix of the portfolio.  The decrease was primarily due to thereduction in the size of our investment portfolio.  Due to voluntary, irrevocable andunconditional waivers in place during these years, senior syndicated loansincurred a 0.5% annual fee,  whereasproprietary loans incurred a 1.5% annual fee. All of these fees were reduced against the amount of the base managementfee due to our Adviser.

 

The base management feedecreased for the year ended September 30, 2009 as compared to the prioryear, which is reflective of fewer total assets held during the year ended September 30,2009.  Furthermore, due to theliquidation of the majority of our syndicated loans, the credit receivedagainst the gross base management fee for investments in syndicated loans hasalso been reduced. The base management fee is computed quarterly as describedunder *“Investment Advisory and Management Agreement”*in Note 4 to the accompanying consolidated financial statements, and issummarized in the table below:

 
| ** **                                                                                                               | ** ** | **Year ended**          | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                               | ** ** | **September  30, 2009** | ** ** | **September  30, 2008** | ** ** |
| Base  management fee (1)                                                                                                 |       | $                       | 2,005      |   | $ | 2,212 |   |
| Credit  for fees received by Adviser from the portfolio companies                                                        |       | (89                     | )          | (1,678 | ) |
| Fee  reduction for the voluntary, irrevocable and unconditional waiver of 2% fee  on senior syndicated loans to 0.5% (2) |       | (265                    | )          | (408 | ) |
| Net  base management fee                                                                                                 |       | $                       | 1,651      |   | $ | 126 |   |

 

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(1)          Base management fee is net of loanservicing fees per the terms of the Advisory Agreement.

(2)          The board of our Adviser voluntarily,irrevocably and unconditionally waived on a quarterly basis the annual 2.0%base management fee to 0.5% for senior syndicated loan participations for theyears ended September 30, 2009 and 2008,. Fees waived cannot be recouped by the Adviser in the future.

 

Incentive fee decreasedfor the year ended September 30, 2009 as compared to the prior year.  The board of our Adviser voluntarily,irrevocably and unconditionally waived on a quarterly basis the entireincentive fee for each quarter of the years ended September 30, 2009 and2008.  The incentive fee and associatedcredits are summarized in the table below:

 
| ** **                                                                                                | ** ** | **Year ended**          | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                | ** ** | **September  30, 2009** | ** ** | **September  30, 2008** | ** ** |
| Incentive  fee                                                                                            |       | $                       | 3,326      |   | $ | 5,311 |   |
| Credit  from voluntary, irrevocable and unconditional waiver issued by Adviser’s  board of directors |       | (3,326                  | )          | (5,311 | ) |
| Net  incentive fee                                                                                        |       | $                       | —     |   | $ | — |   |

 

Administration feedecreased for the year ended September 30, 2009 as compared to the prioryear, due to a decrease of administration staff and related expenses, as wellas a decrease in our total assets in comparison to the total assets of all

 

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companies managed by ourAdviser under similar agreements.  Thecalculation of the administrative fee is described in detail under *“Investment Advisory and Management Agreement”*in Note 4 of the notes to the accompanying consolidated financial statements.

 

Other operating expenses(including deferred financing fees, stockholder related costs, directors’ fees,insurance and other expenses) increased over the prior year driven byamortization of additional fees incurred with amending the DB Facility andentering into the new KEF Facility and legal fees incurred in connection withtroubled loans in the current year.

 

**Net Realized Loss on Investments**

 

The realized loss for theyear ended September 30, 2009 consisted of a $15,029 loss from the sale ofseveral syndicated loans and one non-syndicated loan, a $9,409 write-off of theBadanco loan, and a $2,000 write-off of a portion of the Greatwide second liensyndicated loan, partially offset by a $27 gain from the Country Roadpayoff.  Net realized loss on investmentsduring the year ended September 30, 2008 resulted from the partial sale ofthe senior subordinated term debt of Greatwide Logistics, as well as theunamortized investment acquisition costs related to the Anitox and Macfaddenloans, which were repaid in full during the year.

 

**Realized (Loss) Gain onSettlement of Derivative**

 

The realized loss for theyear ended September 30, 2009 was due to the expiration of our interestrate cap agreement in February 2009. We did not receive any interest rate cap agreement payments during theperiod from October 2008 through February 2009 as a result of theone-month LIBOR having a downward trend. During the year ended September 30, 2008, we received interest ratecap agreement payments of only $7 as a result of the one-month LIBOR having adownward trend.  We received paymentswhen the one-month LIBOR was over 5%.

 

**Net Unrealized Appreciation(Depreciation) on Derivative**

 

Net unrealizedappreciation (depreciation) on derivative is the net change in the fair valueof our interest rate cap during the year, including the reversal of previouslyrecorded unrealized appreciation or depreciation when gains and losses arerealized.  The unrealized appreciation onderivative during the year ended September 30, 2009 resulted from thereversal of previously recorded unrealized depreciation when the loss wasrealized during the three monthsended March 31, 2009.  For the yearended September 30, 2008, the unrealized depreciation was due to adecrease in the fair market value of our interest rate cap agreement.

 

**Net Unrealized Appreciation(Depreciation) on Investments**

 

Net unrealizedappreciation (depreciation) on investments is the net change in the fair valueof our investment portfolio during the year, including the reversal ofpreviously recorded unrealized appreciation or depreciation when gains andlosses are realized.  The net unrealizedappreciation on investments for the year ended September 30, 2009consisted of the following:

 
| · |   | Control investments                                                        |   | $       | 1,564  |   |
|--------|--------|----------------------------------------------------------------------------|--------|---------|--------|--------|
| · |   | Non-Control/Non-Affiliate  investments                                     |   | (16,582 | )      |
| · |   | Reversal of previously unrealized depreciation upon  realization of losses |   | 24,531  |   |
|   |   | Total                                                                      |   | $       | 9,513  |   |

 

We believe that ourinvestment portfolio was valued at a depreciated value due primarily to thegeneral instability of the loan markets. Although our investment portfolio has depreciated, our entire portfoliowas fair valued at 88% of cost as of September 30, 2009.  The cumulative unrealized depreciation of ourinvestments does not have an impact on our current ability to pay distributionsto stockholders; however, it may be an indication of future realized losses,which could ultimately reduce our income available for distribution.

 

**Net Unrealized Appreciation onBorrowings under Line of Credit**

 

Unrealizedappreciation on borrowings under line of credit is the net change in the fairvalue of our line of credit borrowings during the year, including the reversalof previously recorded unrealized appreciation or depreciation when gains andlosses are realized.  During the yearended September 30, 2009, we elected to apply ASC 825, “FinancialInstruments,” which 

 

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requiresthat we apply a fair value methodology to the KEF Facility.  We estimated the fair value of the KEFFacility using estimates of value provided by an independent third party and ourown assumptions in the absence of observable market data, including estimatedremaining life, current market yield and interest rate spreads of similarsecurities as of the measurement date. The KEF Facility was fair valued at $83,350 as of September 30,2009, and an unrealized appreciation of $350 was recorded for the year ended September 30,2009.

 

**Net Increase (Decrease) in Net Assets fromOperations**

 

For the year ended September 30, 2009, we realized a netincrease in net assets resulting from operations of $3,783 as a result of thefactors discussed above.  For the yearended September 30, 2008, we realized a net decrease in net assetsresulting from operations of $21,262.  Our net increase (decrease) in net assetsresulting from operations per basic and diluted weighted average common sharefor the years ended September 30, 2009 and 2008 were $0.18 and ($1.08),respectively.

 

*COMPARISONOF THE FISCAL YEARS ENDED SEPTEMBER 30, 2008 AND SEPTEMBER 30, 2007*

 

*A comparison of our operating results for thefiscal years ended September 30, 2008 and 2007 is below:*

 
| ** **                                                                                           | ** ** | **For the  year ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| INVESTMENT INCOME                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Interest income – non control/non affiliate  investments                                        |       | $                                          | 44,733     |   | $ | 35,413 |   | $ | 9,320 |   | 26.3 | % |
| Interest income – control investments                                                           |       | 64                                         |       | — |   | 64 |   | — |   |
| Interest income – cash                                                                          |       | 335                                        |       | 256 |   | 79 |   | 30.9 | % |
| Interest income – notes receivable from employees                                               |       | 471                                        |       | 526 |   | (55 | ) | (10.5 | )% |
| Prepayment fees and other income                                                                     |       | 122                                        |       | 492 |   | (370 | ) | (75.2 | )% |
| Total investment income                                                                              |       | 45,725                                     |       | 36,687 |   | 9,038 |   | 24.6 | % |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| EXPENSES                                                                                             |       |                                       |       |   |   |   |   |   |   |
| Interest expense                                                                                     |       | 8,284                                      |       | 7,226 |   | 1,058 |   | 14.6 | % |
| Loan servicing fee                                                                                   |       | 6,117                                      |       | 3,624 |   | 2,493 |   | 68.8 | % |
| Base management fee                                                                                  |       | 2,212                                      |       | 2,402 |   | (190 | ) | (7.9 | )% |
| Incentive fee                                                                                        |       | 5,311                                      |       | 4,608 |   | 703 |   | 15.3 | % |
| Administration fee                                                                                   |       | 985                                        |       | 719 |   | 266 |   | 37.0 | % |
| Professional fees                                                                                    |       | 911                                        |       | 523 |   | 388 |   | 74.2 | % |
| Amortization of deferred financing fees                                                              |       | 1,534                                      |       | 267 |   | 1,267 |   | 474.5 | % |
| Stockholder related costs                                                                            |       | 443                                        |       | 217 |   | 226 |   | 104.1 | % |
| Directors’ fees                                                                                 |       | 220                                        |       | 234 |   | (14 | ) | (6.0 | )% |
| Insurance expense                                                                                    |       | 227                                        |       | 249 |   | (22 | ) | (8.8 | )% |
| Other expenses                                                                                       |       | 325                                        |       | 328 |   | (3 | ) | (0.9 | )% |
| Expenses before credit from Adviser                                                                  |       | 26,569                                     |       | 20,397 |   | 6,172 |   | 30.3 | % |
| Credit to base management and incentive fees from  Adviser                                           |       | (7,397                                     | )          | (5,971 | ) | (1,426 | ) | 23.9 | % |
| Total expenses net of credit to base management and  incentive fees                                  |       | 19,172                                     |       | 14,426 |   | 4,746 |   | 32.9 | % |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| NET INVESTMENT INCOME                                                                                |       | 26,553                                     |       | 22,261 |   | 4,292 |   | 19.3 | % |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS,  DERIVATIVE AND BORROWINGS UNDER LINE OF CREDIT: |       |                                       |       |   |   |   |   |   |   |
| Net realized (loss) gain on investments                                                              |       | (787                                       | )          | 44 |   | (831 | ) | (1,888.6 | )% |
| Realized gain on settlement of derivative                                                            |       | 7                                          |       | 39 |   | (32 | ) | (82.1 | )% |
| Net unrealized depreciation on derivative                                                            |       | (12                                        | )          | (38 | ) | 26 |   | (68.4 | )% |
| Net unrealized depreciation on investments                                                           |       | (47,023                                    | )          | (7,354 | ) | (39,669 | ) | 539.4 | % |
| Net loss on investments and derivative                                                               |       | (47,815                                    | )          | (7,309 | ) | (40,506 | ) | 554.2 | % |
|                                                                                                 |       |                                       |       |   |   |   |   |   |   |
| NET (DECREASE) INCREASE IN NET ASSETS RESULTING  FROM OPERATIONS                                     |       | $                                          | (21,262    | ) | $ | 14,952 |   | (36,214 | ) | (242.2 | )% |
|                                                                                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |

 

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**Investment Income**

 

Interest income from ourinvestments in debt securities of private companies increased for the yearended September 30, 2008 as compared to the prior year.  The level of interest income from investmentsis directly related to the balance, at cost, of the interest-bearing investmentportfolio outstanding during the year multiplied by the weighted averageyield.  The weighted average yield variesfrom year to year based on the current stated interest rate on interest-bearinginvestments and the amounts of loans for which interest is not accruing.  Interest income from our investments increasedduring the year ended September 30, 2008 based on the overall growth inthe cost basis of our investments, offset by the decrease in the weightedaverage yield.  The success fees duringthe year ended September 30, 2008 and 2007 were $998 and $2,249 respectively.  The success fees for the year ended September 30,2008 resulted from refinancings by Westlake Hardware, Inc. and DefianceAcquisition Corp., and a full repayment by Express Courier International, whilethe success fees for the year ended September 30, 2007 resulted from arefinancing by Badanco Acquisition Corp. and full repayments by MistrasHoldings Corp., SCPH Holdings and Allied Extruders LLC.

 

·                  The interest-bearing investment portfoliohad an average cost basis of approximately $400,567 for the year ended September 30,2008, as compared to an average cost basis of $284,305 for the year ended September 30,2007.  The following table lists theinterest income from investments for the five largest portfolio companiesduring the respective years:

 

**Yearended September 30, 2008**

 
| **Company**               | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------|------------|
| Sunshine  Media           |       | $                    | 2,939      |            | 6.6        | % |
| Reliable  Biopharma       |       | 2,870                |       | 6.4             | %          |
| Westlake  Hardware        |       | 2,852                |       | 6.4             | %          |
| Clinton  Holdings         |       | 1,902                |       | 4.2             | %          |
| Winchester  Electronics   |       | 1,399                |       | 3.1             | %          |
| **Subtotal**              | ** ** | **$**                | **11,962** | ** **      | **26.7**   | **%** |
| Other  companies          |       | 32,835               |       | 73.3            | %          |
| **Total interest income** | ** ** | **$**                | **44,797** | ** **      | **100.0**  | **%** |

 

**Yearended September 30, 2007**

 
| **Company**               | ** ** | **Interest  Income** | ** ** | **% of  Total** | ** ** |
|---------------------------|------------|----------------------|------------|-----------------|------------|
| Westlake  Hardware        |       | $                    | 1,918      |            | 5.4        | % |
| Badanco                   |       | 1,905                |       | 5.4             | %          |
| Mistras  Holdings         |       | 1,356                |       | 3.8             | %          |
| Clinton  Holdings         |       | 1,321                |       | 3.7             | %          |
| Specialty  Coatings       |       | 1,285                |       | 3.7             | %          |
| **Subtotal**              | ** ** | **$**                | **7,785**  | ** **      | **22.0**   | **%** |
| Other  companies          |       | 27,628               |       | 78.0            | %          |
| **Total interest income** | ** ** | **$**                | **35,413** | ** **      | **100.0**  | **%** |

 

·                  The weighted average yield on ourportfolio, excluding cash and cash equivalents, for the year ended September 30,2008 was 10.2%, compared to 12.0% for the year ended September 30,2007.  The weighted average yields werenot materially impacted by the PIK interest, which was $62 and $0 for the yearended September 30, 2008 and 2007, respectively.  The decrease in the annualized weightedaverage yield primarily resulted from a reduction in the average LIBOR, whichwas 3.8% for the year ended September 30, 2008, compared to 5.3% in theprior year, as well as four investments being on non-accrual during the yearended September 30, 2008 (LocalTel, West Cost Yellow Pages, GreatwideLogistics and U.S. Healthcare) and none in the prior year.  As of September 30, 2008, threeinvestments were on non-accrual (Greatwide Logistics, LocalTel, and U.S.Healthcare).  West Coast Yellow Pages wasrestructured as a Control investment and was renamed Western Directories.

 

Interest income frominvested cash increased for the year ended September 30, 2008 as comparedto the prior year due to the amount of cash that was held in interest bearingaccounts and the interest earned on our custodial account prior todisbursement.

 

Interest income fromloans to our employees, in connection with the exercise of employee stockoptions, decreased for the year ended September 30, 2008 as compared tothe prior year due to the cancellation in full of one employee loan during thefourth quarter of the prior fiscal year, and full repayment of another employeeloan in the second quarter of the year ended September 30, 2008.

 

Prepayment fees and otherincome decreased for the year ended September 30, 2008 as compared to theprior year.  The income for the prioryear consisted of prepayment penalty fees received upon the full repayment ofcertain loan investments ahead of contractual maturity and prepayment feesreceived upon the early unscheduled principal repayments, which was based on apercentage of the outstanding principal amount of the loan at the date ofprepayment.

 

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** **

**OperatingExpenses**

 

Operating expenses, netof credits from the Adviser for fees earned and voluntary irrevocable andunconditional waivers to the base management and incentive fees, increased forthe year ended September 30, 2008 as compared to the prior year due to asignificant increase in interest expense, loan servicing fees and amortizationof deferred financing fees incurred in connection with certain amendments toour credit facility.

 

Interest expenseincreased for the year ended September 30, 2008 as compared to the prioryear due primarily to increased borrowings under our line of credit and anincrease in the interest rates on our borrowings.  The borrowings were partially used to financethe increase in our investment activity during the fiscal year ended September 30,2008.

 

Loan servicing feesincreased for the year ended September 30, 2008 as compared to the prioryear.  These fees were incurred inconnection with a loan servicing agreement between Business Loan and ourAdviser, which is based on the size and mix of the portfolio.  The average size of our investment portfolio,excluding equity investments and control investments, was approximately$375,563 for the year ended September 30, 2008 as compared toapproximately $281,313 for the year ended September 30, 2007.  In terms of portfolio mix, senior syndicatedloans comprised 7.3% and 10.7% of the portfolio during the year ended September 30,2008 and 2007, respectively.  Due tovoluntary, irrevocable and unconditional waivers in place during these years,senior syndicated loans incurred a 0.5% annual fee,  whereas proprietary loans incurred a 1.5%annual fee.  All of these fees werereduced against the amount of the base management fee due to our Adviser.

 

The base management feedecreased for the year ended September 30, 2008 as compared to the prioryear.  The base management fee iscomputed quarterly as described under *“Investment Advisory andManagement Agreement”* in Note 4 to the accompanying consolidatedfinancial statements, and is summarized in the table below:

 
| ** **                                                                                                               | ** ** | **Year ended**          | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                               | ** ** | **September  30, 2008** | ** ** | **September  30, 2007** | ** ** |
| Base  management fee (1)                                                                                                 |       | $                       | 2,212      |   | $ | 2,402 |   |
| Credit  for fees received by Adviser from the portfolio companies (2)                                                    |       | (1,678                  | )          | (1,660 | ) |
| Fee  reduction for the voluntary, irrevocable and unconditional waiver of 2% fee  on senior syndicated loans to 0.5% (3) |       | (408                    | )          | (481 | ) |
| Net  base management fee                                                                                                 |       | $                       | 126        |   | $ | 261 |   |

 

----

(1)          Base management fee is net of loan servicing fees perthe terms of the Advisory Agreement.

(2)          Effective April 1, 2007, the board of directorsof our Adviser reduced the amount of voluntary, irrevocable and unconditionalcredit for investment advisory fees received by our Adviser from 100% of thefees received to 50% of the fees received. Therefore, the year ended September 30, 2008 and the last sixmonths of the year ended September 30, 2007 reflect the reduced credit forfees received by our Adviser.

(3)          The board of our Adviser voluntarily, irrevocably andunconditionally waived, for the year ended September 30, 2008 and 2007,the annual 2.0% base management fee to 0.5% for senior syndicated loanparticipations.

 

Incentive fee increasedfor the year ended September 30, 2008 as compared to the prior year.  The board of our Adviser voluntarily,irrevocably and unconditionally waived on a quarterly basis the entireincentive fee for each quarter of the year ended September 30, 2008 and aportion of the incentive fee due for each quarter of the year ended September 30,2007.  The incentive fee and associatedcredits are summarized in the table below:

 
| ** **                                                                                                | ** ** | **Year ended**          | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                | ** ** | **September  30, 2008** | ** ** | **September  30, 2007** | ** ** |
| Incentive  fee                                                                                            |       | $                       | 5,311      |   | $ | 4,608 |   |
| Credit  from voluntary, irrevocable and unconditional waiver issued by Adviser’s  board of directors |       | (5,311                  | )          | (3,830 | ) |
| Net  incentive fee                                                                                        |       | $                       | —     |   | $ | 778 |   |

 

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Administration feeincreased for the year ended September 30, 2008 as compared to the prioryear, due to the addition of administration staff and related expenses.

 

Professional fees,consisting primarily of legal and audit fees, increased for the year ended September 30,2008 as compared to the prior year due primarily to legal fees incurred inconnection with converting troubled loans to control investments.

 

Amortization of deferredfinancing fees, in connection with our line of credit, increased for the yearended September 30, 2008 as compared to the prior year due to theamortization of additional fees incurred with certain amendments to our line ofcredit.  In February 2008, weincreased the DB Facility from $220 million to $250 million, and in April 2008,increased the DB Facility to $300 million and added BB&T as a committedlender.  In June 2008, we renewedthe DB Facility.  The fees incurred forthe above amendments are recorded in deferred financing fees on ourconsolidated statements of assets and liabilities, and amortized over the lifeof the DB Facility.

 

Stockholder related costsincreased for the year ended September 30, 2008 as compared to the prioryear.  Stockholder related costs includesuch recurring items as transfer agent fees, NASDAQ listing fees, costsassociated with SEC filings, and annual report printing and distributioncosts.  These fees increased during theyear ended September 30, 2008 due to the size and quantity of our annualreport and additional expenses for the annual stockholder meeting and proxycosts compared to the prior year.

 

Directors’ fees decreasedfor the year ended September 30, 2008 as compared to the prior year.  The fees consisted of amortization of thedirectors’ annual stipend and meeting stipends.

 

Insurance expensedecreased for the year ended September 30, 2008 as compared to the prioryear, due to a decrease in the amortization of our directors and officersinsurance policy premiums.

 

Other expenses decreasedslightly for the year ended September 30, 2008 as compared to the prioryear.  The expenses primarily representdirect expenses such as travel related specifically to our portfolio companies,loan evaluation services for our portfolio companies, press releases and backupservicer expenses.

 

**Net Realized (Loss) Gain onInvestments**

 

Net realized loss oninvestments during the year ended September 30, 2008 resulted from thepartial sale of the senior subordinated term debt of Greatwide Logistics, aswell as the unamortized investment acquisition costs related to the Anitox andMacfadden loans, which were repaid in full during the year, as compared to thenet realized gain on investments during the year ended September 30, 2007from the sale or repayment of 27 syndicated loan investments.

 

**Net Realized Gain on Settlementof Derivative**

 

During the years ended September 30,2008 and September 30, 2007, we received interest rate cap agreementpayments of $7 and $39, respectively, as a result of the one month LIBORexceeding 5%.

 

**Net Unrealized Depreciation onDerivative**

 

Net unrealizeddepreciation on derivative during the year ended September 30, 2008 wasdue to a decrease in the fair market value of our interest rate cap agreement.

 

**Net Unrealized Depreciation onInvestments**

 

The net unrealizeddepreciation on investments during the year ended September 30, 2008 wasmainly attributable to the decrease in fair value of our portfolio.  We believe that our investment portfolio wasvalued at a depreciated value due primarily to the general instability of theloan markets and, to a lesser extent, the use of a modified valuation procedurefor our non-control/non-affiliate investments. Previously, we valued the debt portion of bundled debt and equityinvestments in non-controlled companies in accordance with Board-approvedvaluation procedures, which valued the debt securities at the contractualprincipal balance, if it was determined total enterprise value was sufficientto cover the contractual principal balance. Consistent with the Board’s ongoing review and analysis of appropriatevaluation procedures, and in consideration of the fair value measurements ofASC 820, the Board of Directors modified our valuation procedure so that thedebt portion of bundled investments in non-controlled companies is primarilybased on opinions of value provided by

 

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SPSE.  This change in valuation estimate accountedfor $2,887, or 6.1%, of the net unrealized depreciation for the year.  Although our investment portfolio has depreciated,our entire portfolio was fair valued at 88.5% of cost as of September 30,2008.  The unrealized depreciation of ourinvestments does not have an impact on our current ability to pay distributionsto stockholders, however, it may be an indication of future realized losses,which could ultimately reduce our income available for distribution.

 

**Net (Decrease) Increase in Net Assets fromOperations**

 

For the year ended September 30, 2008, we realized a netdecrease in net assets resulting from operations of $21,262 as a result of thefactors discussed above.  For the yearended September 30, 2007, we realized a net increase in net assetsresulting from operations of $14,952.  Our net (decrease) increase in net assetsresulting from operations per basic and diluted weighted average common sharefor the years ended September 30, 2008 and 2007 were ($1.08) and $1.13,respectively.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

**OperatingActivities**

 

Net cash provided byoperating activities for the year ended September 30, 2009 was $95,521 andconsisted primarily of proceeds received from the syndicated loan sales and thenet loss realized on those sales and principal payments received from existinginvestments.  In contrast,  net cash used in operating activities for theyears ended September 30, 2008 and 2007 were $80,218 and $116,984,respectively, and consisted of the purchase of new investments, partiallyoffset by principal loan repayments.

 

At September 30,2009, we had investments in debt securities, or loans to or syndicatedparticipations in 48 private companies with a cost basis totaling$364,393.  At September 30, 2008, wehad investments in debt securities, or loans to or syndicated participations in63 private companies with a cost basis totaling $460,870.  At September 30, 2007, we hadinvestments in debt securities, or loans to or syndicated participations in 56private companies with a cost basis totaling approximately $355,759.

 

*Duringthe fiscal years ended September 30, 2009, 2008 and 2007, the following investmentactivity occurred during each quarter of the respective fiscal year:*

 
| **Quarter Ended**   | ** ** | **New  Investments (1)** | ** **    | **Principal  Repayments (2)** | ** ** | **Proceeds from  Sales/Exits (3)** | ** ** | **Net Gain (Loss)  on Disposal** | ** **   |
|--------------------------|------------|--------------------------|---------------|-------------------------------|------------|------------------------------------|------------|---------------------------------------|--------------|
| September 30,  2009 |       | $                        |  1,652   |                          | $          |  4,071                        |       | $                                     |  7,241  |   | $ | (12,086 | ) |
| June 30,  2009      |       | 7,582                    |          | 15,439                        |       | 39,750                             |       | (10,594                               | )            |
| March 31,  2009     |       | 8,430                    |          | 13,053                        |       | —                             |       | (2,000                                | )            |
| December 31,  2008  |       | 8,702                    |          | 14,927                        |       | 2,212                              |       | (1,731                                | )            |
| Total  fiscal year 2009  |       | $                        |  26,366  |                          | $          |  47,490                       |       | $                                     |  49,203 |   | $ | (26,411 | ) |
|                     |       |                     |          |                          |       |                               |       |                                  |         |
| September 30,  2008 |       | $                        |  39,048  |                          | $          |  21,381                       |       | $                                     |  1,299  |   | $ |  (701 | ) |
| June 30,  2008      |       | 43,678                   |          | 40,755                        |       | —                             |       | (86                                   | )            |
| March 31,  2008     |       | 20,483                   |          | 3,000                         |       | —                             |       | —                                |         |
| December 31,  2007  |       | 73,341                   |          | 4,047                         |       | —                             |       | —                                |         |
| Total  fiscal year 2008  |       | $                        |  176,550 |                          | $          |  69,183                       |       | $                                     |  1 ,299 |   | $ |  (787 | ) |
|                     |       |                     |          |                          |       |                               |       |                                  |         |
| September 30,  2007 |       | $                        |  7,972   |                          | $          |  22,015                       |       | $                                     |  — |   | $ |  (37 | ) |
| June 30,  2007      |       | 126,087                  |          | 20,913                        |       | 16,660                             |       | (5                                    | )            |
| March 31,  2007     |       | 75,330                   |          | 20,063                        |       | 18,200                             |       | 84                                    |         |
| December 31,  2006  |       | 52,311                   |          | 23,967                        |       | —                             |       | 2                                     |         |
| Total  fiscal year 2007  |       | $                        |  261,700 |                          | $          |  86,958                       |       | $                                     |  34,860 |   | $ |  44 |   |

 

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**(1)   New Investments:**

 
| ** **               | ** ** | **New Investments** | ** ** | **Disbursements  to  Existing Portfolio** | ** **   | **Total**     | ** ** |
|--------------------------|------------|---------------------|------------|-------------------------------------------|--------------|---------------|------------|
| **Quarter Ended**   | ** ** | **Companies**       | ** ** | **Investments**                           | ** **   | **Companies** | ** ** | **Disbursements** | ** ** |
| September 30,  2009 |       | —              |       | $                                         |  — |          | $          |  1,652 |   | $ |  1,652 |   |
| June 30,  2009      |       | —              |       | —                                    |         | 7,582         |       | 7,582 |   |
| March 31,  2009     |       | —              |       | —                                    |         | 8,430         |       | 8,430 |   |
| December 31,  2008  |       | —              |       | —                                    |         | 8,702         |       | 8,702 |   |
| Total  fiscal year 2009  |       | —              |       | $                                         |  — |          | $          |  26,366 |   | $ |  26,366 |   |
|                     |       |                |       |                                      |         |          |       |   |   |
| September 30,  2008 |       | 3                   | (a)        | $                                         |  33,375 |          | $          |  5,673 |   | $ |  39,048 |   |
| June 30,  2008      |       | 3                   | (b)        | 35,750                                    |         | 7,928         |       | 43,678 |   |
| March 31,  2008     |       | 1                   | (c)        | 13,700                                    |         | 6,783         |       | 20,483 |   |
| December 31,  2007  |       | 5                   | (d)        | 57,992                                    |         | 15,349        |       | 73,341 |   |
| Total  fiscal year 2008  |       | 12                  |       | $                                         | 140,817      |          | $          |  35,733 |   | $ |  176,550 |   |
|                     |       |                |       |                                      |         |          |       |   |   |
| September 30,  2007 |       | —              |       | $                                         |  — |          | $          |  7,972 |   | $ |  7,972 |   |
| June 30,  2007      |       | 20                  | (e)        | 112,709                                   |         | 13,378        |       | 126,087 |   |
| March 31,  2007     |       | 12                  | (f)        | 53,138                                    |         | 22,192        |       | 75,330 |   |
| December 31,  2006  |       | 20                  | (g)        | 48,827                                    |         | 3,484         |       | 52,311 |   |
| Total  fiscal year 2007  |       | 52                  |       | $                                         | 214,674      |          | $          |  47,026 |   | $ |  261,700 |   |

 

----

(a)          AKQA, VantaCore and Tulsa Welding School

(b)         Saunders, Legend and BAS Broadcasting

(c)          ACE Expediters

(d)         Interfilm,Reliable, Lindmark, GS Maritime and GFRC

(e)          Includesacquisition of loans in 16 companies from Wells Fargo Foothill in June 2007(totaling $63,259)

(f)            Most notably Clinton Holdings and Greatwide Logistics

(g)         Most notably Precision and Pinnacle Treatment Centers

 

**(2)****        ****Principal Repayments:**

 
| **Quarter Ended**        | ** ** | **Number of  Companies  Fully Exited** | ** ** | **Unscheduled  Principal  Repayments (*)** | ** **   | **Scheduled  Principal  Repayments** | ** ** | **Total Principal  Repayments** | ** ** |
|--------------------------|------------|----------------------------------------|------------|--------------------------------------------|--------------|--------------------------------------|------------|---------------------------------|------------|
| September 30,  2009 |       | —                                 |       | $                                          |  — |                                 | $          |  4,071                     |       | $ |  4,071 |   |
| June 30,  2009      |       | 1                                      | (a)        | 10,449                                     |         | 4,990                                |       | 15,439                          |       |
| March 31,  2009     |       | —                                 | (b)        | 7,813                                      |         | 5,240                                |       | 13,053                          |       |
| December 31,  2008  |       | 2                                      | (c)        | 6,966                                      |         | 7,961                                |       | 14,927                          |       |
| Total  fiscal year 2009  |       | 3                                      |       | $                                          | 25,228       |                                 | $          | 22,262                          |       | $ |  47,490 |   |
|                     |       |                                   |       |                                       |         |                                 |       |                            |       |
| September 30,  2008 |       | 2                                      | (d)        | $                                          | 12,797       |                                 | $          |  8,584                     |       | $ |  21,381 |   |
| June 30,  2008      |       | 3                                      | (e)        | 28,134                                     |         | 12,621                               |       | 40,755                          |       |
| March 31,  2008     |       | —                                 | (f)        | 500                                        |         | 2,500                                |       | 3,000                           |       |
| December 31,  2007  |       | —                                 |       | —                                     |         | 4,047                                |       | 4,047                           |       |
| Total  fiscal year 2008  |       | 5                                      |       | $                                          | 41,431       |                                 | $          | 27,752                          |       | $ |  69,183 |   |
|                     |       |                                   |       |                                       |         |                                 |       |                            |       |
| September 30,  2007 |       | 3                                      | (g)        | $                                          | 17,889       |                                 | $          |  4,126                     |       | $ |  22,015 |   |
| June 30,  2007      |       | 5                                      | (h)        | 17,061                                     |         | 3,852                                |       | 20,913                          |       |
| March 31,  2007     |       | 1                                      | (i)        | 17,785                                     |         | 2,278                                |       | 20,063                          |       |
| December 31,  2006  |       | 3                                      | (j)        | 20,860                                     |         | 3,107                                |       | 23,967                          |       |
| Total  fiscal year 2007  |       | 12                                     |       | $                                          | 73,595       |                                 | $          | 13,363                          |       | $ |  86,958 |   |

 

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(*)         Includes principalpayments due to excess cash flows, covenant violations, exits, refinancing,etc.

(a)          Full payoff fromMulti-Ag Media ($1,687), partial payoff from Saunders line of credit ($2,500)and refinancing from ActivStyle ($6,262).

(b)         Refinancing fromACE Expediters and Sunburst media.

(c)          Full payoff from Community Media and Country Road.

(d)         Full payoff from Express Courier International and MeteorHolding.

(e)          Full payoff from Macfadden Performing Arts, ReadingBroadcasting and SCS ($25,074) and partial payoff from Anitox Senior RealEstate Term Debt ($3,060).

(f)            Partial payoff from Risk Metrics Senior SubordinatedTerm Debt.

(g)         Full payoff from Advanced Homecare Management, FloridaCable and Ohmstede Acquisition.

(h)         Full payoff from Allied Extruders, Benetech,Consolidated Bedding SCPH Holdings and IPC.

(i)             Full payoff from Network Solutions ($4,455) andrefinancing from Badanco Acquisition Corp. ($13,330).

(j)             Full payoff from Fresh Start Bakeries, MistrasHoldings and Xspedius.

 

**(3)  Loan Sales / Exits:**

 
| **Quarter Ended**        | ** ** | **Number of  Companies  Fully Exited** | ** ** | **Proceeds  Received** | ** **   | **Position  (Principal)  Exited** | ** ** | **Unamortized  Loan Costs (*)** | ** ** | **Net (Loss)  Gain on Exit** | ** **   |
|--------------------------|------------|----------------------------------------|------------|------------------------|--------------|-----------------------------------|------------|---------------------------------|------------|------------------------------|--------------|
| September 30,  2009 |       | 3                                      | (a)        | $                      |  7,241  |                              | $          |  (19,321                   | )          | $                            |  (6     | ) | $ | (12,086 | ) |
| June 30,  2009      |       | 8                                      | (b)        | 39,750                 |         | (52,295                           | )          | 1,951                           |       | (10,594                      | )            |
| March 31,  2009     |       | 1                                      | (c)        | —                 |         | (2,000                            | )          | —                          |       | (2,000                       | )            |
| December 31,  2008  |       | —                                 | (d)        | 2,212                  |         | (3,950                            | )          | 7                               |       | (1,731                       | )            |
| Total  fiscal year 2009  |       | 12                                     |       | $                      | 49,203       |                              | $          | (77,566                         | )          | $                            | 1,952        |   | $ | (26,411 | ) |
|                     |       |                                   |       |                   |         |                              |       |                            |       |                         |         |
| September 30,  2008 |       | —                                 | (e)        | $                      |  1,299  |                              | $          |  (2,000                    | )          | $                            |  — |   | $ |  (701 | ) |
| June 30,  2008      |       | —                                 |       | —                 |         | —                            |       | (86                             | )          | (86                          | )            |
| March 31,  2008     |       | —                                 |       | —                 |         | —                            |       | —                          |       | —                       |         |
| December 31,  2007  |       | —                                 |       | —                 |         | —                            |       | —                          |       | —                       |         |
| Total  fiscal year 2008  |       | —                                 |       | $                      |  1,299  |                              | $          |  (2,000                    | )          | $                            |  (86    | ) | $ |  (787 | ) |
|                     |       |                                   |       |                   |         |                              |       |                            |       |                         |         |
| September 30,  2007 |       | —                                 |       | $                      |  — |                              | $          |  —                    |       | $                            |  (37    | ) | $ |  (37 | ) |
| June 30,  2007      |       | 9                                      | (f)        | 16,660                 |         | (16,660                           | )          | (5                              | )          | (5                           | )            |
| March 31,  2007     |       | 7                                      | (g)        | 18,200                 |         | (18,200                           | )          | 84                              |       | 84                           |         |
| December 31,  2006  |       | —                                 |       | —                 |         | —                            |       | 2                               |       | 2                            |         |
| Total  fiscal year 2007  |       | 16                                     |       | $                      | 34,860       |                              | $          | (34,860                         | )          | $                            |  44     |   | $ |  44 |   |

 

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(*)         Includes balanceof premiums, discounts and acquisition cost at time of exit.

(a)          Full sale of CHG and John Henry syndicatedloans, write-off of Badanco loan, and partial sale of Kinetek syndicated loan(senior subordinated debt).

(b)         Full sale of 8 loans (7 syndicated and 1 non-syndicated)and partial sale of CHG, GTM and Wesco syndicated loans (senior term debt).

(c)          Write-off ofGreatwide syndicated loan (senior subordinated term debt).

(d)         Partial sale of Greatwide Logistics syndicated loan(senior term debt).

(e)          Partial sale of Greatwide Logistics syndicated loan(senior subordinated term debt).

(f)            Full sale of nine syndicated loans, most notablyGenerac and Hudson Products.

(g)         Full sale of seven syndicated loans, most notably ACSMedia and West Corp.

 

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The following tablesummarizes the contractual principal repayment and maturity of our investmentportfolio by fiscal year, assuming no voluntary prepayments.

 

| ** **                                                                           | ** ** | **Amount** | ** **    |
|--------------------------------------------------------------------------------------|------------|------------|---------------|
| **Fiscal Year Ending September 30,**                                            |       |       |          |
| 2010                                                                                 |       | $          |  50,033  |   |
| 2011                                                                                 |       | 86,116     |          |
| 2012                                                                                 |       | 72,836     |          |
| 2013                                                                                 |       | 123,225    |          |
| 2014                                                                                 |       | 19,347     |          |
| Thereafter                                                                           |       | 6,851      |          |
| **Total Contractual Repayments**                                                     |       | 358,408    |          |
| Investments  in equity securities                                                    |       | 5,478      |          |
| Unamortized  premiums, discounts and investment acquisition costs on debt securities |       | 507        |          |
| **Total**                                                                            |       | $          |  364,393 |   |

 

**InvestingActivities**

 

Net cash provided byinvesting activities for the fiscal year ended September 30, 2008 was$2,484 for the redemption of a U.S. Treasury Bill with an original maturity ofsix months.  Net Cash used in investingactivities for the fiscal year ended September 30, 2007 was $2,484 for thepurchase of the U.S. Treasury Bill.  TheU.S. Treasury Bill was purchased with proceeds from our initial stock purchasein our wholly owned subsidiary, Gladstone Financial Corporation (previouslyknown as Gladstone SSBIC Corporation).

 

**FinancingActivities**

 

Net cash used infinancing activities for the fiscal year ended September 30, 2009 was $96,738and mainly consisted of net payments on our line of credit of $68,030,distribution payments of $26,570 and financing fees of $2,103 associated withthe KEF Facility which was entered into on May 15, 2009.

 

Net cash provided byfinancing activities for the fiscal year ended September 30, 2008 was$75,388 and mainly consisted of net borrowings on our line of credit of $6,590,proceeds of $105,374, net of offering costs, from the issuance of common stockand distribution payments of $33,379.

 

Net cash provided byfinancing activities for the fiscal year ended September 30, 2007 was$127,575 and mainly consisted of net borrowings on our line of credit of$94,447,  proceeds of $56,764, net ofoffering costs, from the issuance of common stock and distribution payments of$22,141.

 

**Distributions**

 

In order to qualify as aRIC and to avoid corporate level tax on the income we distribute to ourstockholders, we are required, under Subchapter M of the Code, to distribute atleast 90% of our ordinary income and short-term capital gains to ourstockholders on an annual basis. In accordance with these requirements, wedeclared and paid monthly cash dividends of $0.14 per common share for eachmonth from October 2008 through March 2009 and $0.07 per common sharefor each month from April 2009 through September 2009.  We declared and paid monthly cash dividendsof $0.14 per common share during each month of the fiscal years ended September 30,2008 and September 30, 2007.

 

For the year ended September 30,2009, our distribution payments of approximately $26,570 exceeded our netinvestment income by $5,539.  We declaredthese distributions based on our estimates of net investment income for thefiscal year.  Our investment pace wasslower than expected and, consequently, our net investment income was lowerthan our original estimates.  A portionof the distributions declared during fiscal 2009 is expected to be treated as areturn of capital to our stockholders.

 

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***Section 19(a) Disclosure– Unaudited***

 

The Company’s Board ofDirectors estimates the source of the distributions at the time of theirdeclaration as required by Section 19(a) of the 1940 Act.  On a monthly basis, if required under Section 19(a),the Company posts a Section 19(a) notice through the Depository TrustCompany’s Legal Notice System (“LENS”) and also sends to its registeredstockholders a written Section 19(a) notice along with the payment ofdividends for any payment which includes a dividend estimated to be paid fromany other source other than net investment income.  The estimates of the source of thedistribution are interim estimates based on GAAP that are subject to revision,and the exact character of the distributions for tax purposes cannot bedetermined until the final books and records of the Company are finalized forthe calendar year.  Following thecalendar year end, after definitive information has been determined by theCompany, if the Company has made distributions of taxable income (or return ofcapital), the Company will deliver a Form 1099-DIV to its stockholdersspecifying such amount and the tax characterization of such amount.  Therefore, these estimates are made solely inorder to comply with the requirements of Section 19(a) of the 1940Act and should not be relied upon for tax reporting or any other purposes andcould differ significantly from the actual character of distributions for taxpurposes.

 

The following GAAPestimates were made by the Board of Directors during the quarter ended September 30,2009:

 
| **Month Ended**          | ** ** | **Ordinary Income** | ** **  | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|--------------------------|------------|---------------------|-------------|-----------------------|------------|--------------------|------------|
| July 31,  2009      |       | $                   |  0.089 |                  | $          |  (0.019       | )          | $ |  0.070 |   |
| August 31,  2009    |       | 0.087               |        | (0.017                | )          | 0.070              |       |
| September 30,  2009 |       | 0.086               |        | (0.016                | )          | 0.070              |       |
|                          |            |                     |             |                       |            |                    |            |  |  |  |

 

Because the Board of Directors declares dividends atthe beginning of a quarter, it is difficult to estimate how much of the Company’smonthly dividends and distributions, based on GAAP, will come from ordinaryincome, capital gains and returns of capital. Subsequent to the quarter ended September 30, 2009, the followingcorrections were made to the above listed estimates for that quarter:

 
| **Month Ended**          | ** ** | **Ordinary Income** | ** **  | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|--------------------------|------------|---------------------|-------------|-----------------------|------------|--------------------|------------|
| July 31,  3009      |       | $                   |  0.099 |                  | $          |  (0.029       | )          | $ |  0.070 |   |
| August 31,  2009    |       | 0.057               |        | 0.013                 |       | 0.070              |       |
| September 30,  2009 |       | 0.041               |        | 0.029                 |       | 0.070              |       |
|                          |            |                     |             |                       |            |                    |            |  |  |  |

 

For dividends declared subsequent to quarter end, thefollowing estimates, based on GAAP, have been made pursuant to Section 19(a) ofthe 1940 Act:

 
| **Month Ended**         | ** ** | **Ordinary Income** | ** **  | **Return of Capital** | ** ** | **Total Dividend** | ** ** |
|-------------------------|------------|---------------------|-------------|-----------------------|------------|--------------------|------------|
| October 31,  2009  |       | $                   |  0.080 |                  | $          |  (0.010       | )          | $ |  0.070 |   |
| November 30,  2009 |       | 0.079               |        | (0.009                | )          | 0.070              |       |
| December 31,  2009 |       | 0.078               |        | (0.008                | )          | 0.070              |       |
|                         |            |                     |             |                       |            |                    |            |  |  |  |

 

***Tax Informationfor the Year Ended September 30, 2009 – Unaudited***

 

We are providing thisinformation as required by the Internal Revenue Code. The amounts shown maydiffer from those elsewhere in this report because of differences between taxand financial reporting requirements

 

Our distributions to stockholdersincluded $27 from long-term capital gains, subject to the 15% rate gainscategory.

 

For taxable non-corporatestockholders, none of our income represents qualified dividend income subjectto the 15% rate category.

 

**Issuance of Equity**

 

On October 20, 2009,we filed a registration statement with the SEC (the “Registration Statement”)which, if and when declared effective will permit us to issue, through one ormore transactions, up to an aggregate of $300,000 in securities, consisting ofcommon stock, senior common stock, preferred stock, subscription rights, debtsecurities, warrants to purchase common stock, or a combination of thesesecurities.

 

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We anticipate issuingequity securities to obtain additional capital in the future. However, wecannot determine the terms of any future equity issuances or whether we will beable to issue equity on terms favorable to us, or at all. Additionally, whenour common stock is trading below NAV, we will have regulatory constraintsunder the 1940 Act on our ability to obtain additional capital in this manner.  Generally, the 1940 Act provides that we maynot issue and sell our common stock at a price below our NAV per share, otherthan to our then existing stockholders pursuant to a rights offering, withoutfirst obtaining approval from our stockholders and our independentdirectors.  As of September 30,2009, our NAV per share was $11.81 and our closing market price was $8.93 pershare.  However, subsequent to that dateour stock has consistently traded at discounts of up to 34% of our September 30,2009 NAV per share.  On November 13,2009, our closing market price was $7.98 per share.  To the extent that our common stock trades ata market price below our NAV per share, we will generally be precluded fromraising equity capital through public offerings of our common stock, other thanpursuant to a rights offering.  The assetcoverage requirement of a BDC under the 1940 Act effectively limits our ratioof debt to equity to 1:1.  To the extentthat we are unable to raise capital through the issuance of equity, our abilityto raise capital through the issuance of debt may also be inhibited to theextent of our regulatory debt to equity ratio limits.

 

At our Annual Meeting ofStockholders held on February 19, 2009, our stockholders approved aproposal which authorizes us to sell shares of our common stock at a pricebelow our then current NAV per share for a period of one year, provided thatour Board of Directors makes certain determinations prior to any such sale. Atthe upcoming annual stockholders meeting scheduled for February 18, 2010,our stockholders will again be asked to vote in favor of renewing this proposalfor another year.

 

**Revolving Credit Facility**

 

On May 15, 2009 we,through our wholly-owned subsidiary Business Loan, entered into the KEFFacility.  BB&T also joined the KEFFacility as a committed lender.  Inconnection with entering into the KEF Facility, we borrowed $35,881 under theKEF Facility to make a final payment to Deutsche Bank AG in satisfaction of allunpaid principal and interest owed to Deutsche Bank under the prior creditagreement.  The KEF Facility may beexpanded up to $200,000 through the addition of other committed lenders to thefacility.  Without the addition of othercommitted lenders, the KEF Facility provides a total commitment of $102,000from January 1, 2010 to May 11, 2010, and $77,000 thereafter.  The KEF Facility matures on May 14,2010, and if the facility is not renewed or extended by this date, allprincipal and interest will be due and payable within one year of maturity. Inaddition, if the facility is not renewed, our lenders have the right to applyall principal and interest collections to amounts outstanding under the KEFFacility.

 

Advances under the KEFFacility will generally bear interest at the 30-day LIBOR or commercial paperrate (subject to a minimum rate of 2%), plus 4% per annum, with a commitmentfee of 0.75% per annum on undrawn amounts. As of September 30, 2009, there was a cost basis of approximately$83,000 of borrowings outstanding under the KEF Facility at an average rate of7.36%, and the remaining borrowing capacity under the KEF Facility was$44,000.  Available borrowings aresubject to various constraints imposed under the KEF Facility, based on theaggregate loan balance pledged by Business Loan. Interest is payable monthlyduring the term of the KEF Facility.

 

In October and November of2009, we reduced the size of the KEF Facility by $15,000 and $5,000,respectively, from $127,000 to $107,000.  Under the KEF Facility the first$50,000 of commitment reductions are applied against KEF’s commitment. Therefore, the entire $20,000 was subtracted from KEF’s commitment, reducing itfrom $100,000 to $80,000 and leaving BB&T’s commitment unchanged at$27,000.  As a result of the manner in which our borrowing base iscalculated under the KEF Facility, the reductions did not affect our borrowingcapacity under the KEF Facility at the time of the reductions.  As noted above, the size of the KEF Facilitywill be reduced by $5,000 effective January 1, 2010 to $102,000.

 

The KEF Facility containscovenants that require Business Loan to maintain its status as a separateentity, prohibit certain significant corporate transactions (such as mergers,consolidations, liquidations or dissolutions), and restrict material changes toour credit and collection policies.  Thefacility also limits payments of distributions. Further, the KEF Facilityrequires us to pay distributions only from estimated net investmentincome.  As of September 30, 2009, Business Loan was in compliancewith all of the facility covenants.

 

We elected to apply ASC 825, “Financial Instruments,” specificallyfor the KEF Facility, which was consistent with its application of ASC 820 toits investments.  ASC 825 requires that we apply a fair value methodology to theKEF Facility. We estimated the fair value of the KEF Facility using estimatesof value provided by an independent third party and our own assumptions in theabsence of observable market data, including estimated remaining life, currentmarket yield and interest 

 

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rate spreads of similarsecurities as of the measurement date. The following table presents the KEF Facility carried at fair value asof September 30, 2009, by caption on the accompanying consolidatedstatements of assets and liabilities for each of the three levels of hierarchyestablished by ASC 820-10:

** **
| ** **                           | ** ** | **As of September 30, 2009** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in** | ** ** |
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated  Statement of** | ** ** |
| ** **                           | ** ** | **Level 1**                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings  under Line of Credit (a) |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |
| Total                                |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |

 

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(a)     Unrealized appreciation of $350 isreported on the accompanying consolidated statements of operations for the yearended September 30, 2009.

 

In conjunction withentering into the KEF Facility, we amended a performance guaranty, whichremains substantially similar to the form under the previous facility.  The loan documents require us to maintain aminimum net worth of $200,000 plus 50% of all equity issuances after May 2009,to maintain “asset coverage” with respect to “senior securities representingindebtedness” of at least 200%, in accordance with Section 18 of the 1940Act, and to maintain our status as a BDC under the 1940 Act and as a RIC underthe Code.  As of September 30, 2009,we were in compliance with all covenants under the performance guaranty.

 

Our continued compliancewith these covenants, however, depends on many factors, some of which arebeyond our control.  In particular,depreciation in the valuation of our assets, which valuation is subject tochanging market conditions that are presently very volatile, affects ourability to comply with these covenants. Given the continued deterioration in the capital markets, net unrealizeddepreciation in our portfolio may occur in future periods and threaten ourability to comply with the covenants under our KEF Facility.  Accordingly, there are no assurances that wewill continue to comply with these covenants. Failure to comply with these covenants would result in a default which,if we are unable to obtain a waiver from the lenders, could accelerate ourrepayment obligations under the KEF Facility and thereby have a materialadverse impact on our liquidity, financial condition, results of operations andability to pay distributions.

 

There can be no guaranteethat we will be able to renew, extend or replace the KEF Facility on terms thatare favorable to us, or at all.  Ourability to obtain replacement financing will be constrained by current economicconditions affecting the credit markets. Consequently, any renewal, extension or refinancing of the KEF Facilitywill likely result in significantly higher interest rates and related chargesand may impose significant restrictions on the use of borrowed funds withregard to its ability to fund investments or maintain distributions.  For instance, in connection with theestablishment of the KEF Facility in May 2009, the size of the line wasreduced from $162,000 under our prior facility to $107,000 under the KEFFacility, and Deutsche Bank AG, who was a committed lender under our priorcredit facility elected not to participate in the KEF Facility and withdrew itscommitment.  If we are not able to renew,extend or refinance the KEF Facility, this would likely have a material adverseeffect on our liquidity and ability to fund new investments or paydistributions to our stockholders.  Ourinability to pay distributions could result in our failing to qualify as aRIC.  Consequently, any income or gainscould become taxable at corporate rates. If we are unable to secure replacement financing, we will be forced tosell certain assets on disadvantageous terms, which may result in realizedlosses such as those recently recorded in connection with the syndicated loansales, which resulted in a realized loss of approximately $26,411 during theyear ended September 30, 2009.  Suchrealized losses could materially exceed the amount of any unrealizeddepreciation on these assets as of our most recent balance sheet date, whichwould have a material adverse effect on its results of operations.  In addition to selling assets, or as an alternative,we may issue equity in order to repay amounts outstanding under the KEFFacility.  Based on the recent tradingprices of our stock, such an equity offering may have a substantial dilutiveimpact on our existing stockholders’ interest in our earnings and assets andvoting interest in it.

 

**Contractual Obligations**

 

As of September 30,2009, we were not party to any signed term sheets.

 

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**Off-BalanceSheet Arrangements**

 

We did not have anyoff-balance sheet arrangements as defined in Item 303(a)(4)(ii) ofSEC Regulation S-K as of September 30, 2009.

 

**CriticalAccounting Policies**

 

The preparation offinancial statements and related disclosures in conformity with generallyaccepted accounting principles in the United States requires management to makeestimates and assumptions that affect the reported consolidated amounts ofassets and liabilities, disclosure of contingent assets and liabilities at thedate of the financial statements, and revenues and expenses during the yearsreported. Actual results could materially differ from those estimates. Ouraccounting policies are more fully described in the “Notes to ConsolidatedFinancial Statements” contained elsewhere in this report. We have identifiedour investment valuation process as our most critical accounting policy.

 

**InvestmentValuation**

 

The most significantestimate inherent in the preparation of our consolidated financial statementsis the valuation of investments and the related amounts of unrealizedappreciation and depreciation of investments recorded.

 

*GeneralValuation Policy:*  We value our investments in accordance withthe requirements of the 1940 Act.  Asdiscussed more fully below, we value securities for which market quotations arereadily available and reliable at their market value.  We value all other securities and assets atfair value as determined in good faith by our Board of Directors.

 

We adopted guidance forfair value measurements on October 1, 2008. In part, this guidance definesfair value, establishes a framework for measuring fair value, and expandsdisclosures about assets and liabilities measured at fair value. The guidanceprovides a consistent definition of fair value that focuses on exit price inthe principal, or most advantageous, market and prioritizes, within ameasurement of fair value, the use of market-based inputs over entity-specificinputs. The guidance also establishes the following three-level hierarchy forfair value measurements based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date.

 

·                  *Level 1*—inputs to the valuation methodology arequoted prices (unadjusted) for identical assets or liabilities in activemarkets;

 

·                  *Level 2*—inputs to the valuation methodologyinclude quoted prices for similar assets and liabilities in active markets, andinputs that are observable for the asset or liability, either directly orindirectly, for substantially the full term of the financial instrument. Level2 inputs are in those markets for which there are few transactions, the pricesare not current, little public information exists or instances where pricesvary substantially over time or among brokered market makers; and

 

·                  *Level 3*—inputs to the valuation methodology areunobservable and significant to the fair value measurement. Unobservable inputsare those inputs that reflect our own assumptions that market participantswould use to price the asset or liability based upon the best availableinformation.

 

See Note 3, *“Investments”* in the notes to the consolidated financialstatements for additional information regarding fair value measurements.

 

We use generally acceptedvaluation techniques to value our portfolio unless we have specific informationabout the value of an investment to determine otherwise. From time to time wemay accept an appraisal of a business in which we hold securities. Theseappraisals are expensive and occur infrequently but provide a third-party valuationopinion that may differ in results, techniques and scopes used to value ourinvestments.  When these specificthird-party appraisals are engaged or accepted, we would use estimates of valueprovided by such appraisals and our own assumptions including estimatedremaining life, current market yield and interest rate spreads of similarsecurities as of the measurement date to value the investment we have in thatbusiness.

 

In determining the valueof our investments, our Adviser has established an investment valuation policy(the “Policy”).  The Policy has beenapproved by our Board of Directors, and each quarter the Board of Directorsreviews whether our Adviser has applied the Policy consistently and voteswhether or not to accept the recommended valuation of our investment portfolio.

 

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The Policy, which issummarized below, applies to the following categories of securities:

 

·                  Publicly-traded securities;

·                  Securities for which a limited market exists; and

·                  Securities for which no market exists.

 

*ValuationMethods:*

 

**Publicly-tradedsecurities:** Wedetermine the value of publicly-traded securities based on the closing pricefor the security on the exchange or securities market on which it is listed andprimarily traded on the valuation date. To the extent that we own restrictedsecurities that are not freely tradable, but for which a public marketotherwise exists, we will use the market value of that security adjusted forany decrease in value resulting from the restrictive feature.

 

**Securitiesfor which a limited market exists:**We value securities that are not traded on anestablished secondary securities market, but for which a limited market for thesecurity exists, such as certain participations in, or assignments of,syndicated loans, at the quoted bid price. In valuing these assets, we assess trading activity in an asset class,evaluate variances in prices and other market insights to determine if anyavailable quote prices are reliable.  Ifwe conclude that quotes based on active markets or trading activity may berelied upon, firm bid prices are requested; however, if a firm bid price isunavailable, we base the value of the security upon the indicative bid priceoffered by the respective originating syndication agent’s trading desk, orsecondary desk, on or near the valuation date. To the extent that we use the indicative bid price as a basis forvaluing the security, our Adviser may take further steps to consider additionalinformation to validate that price in accordance with the Policy.

 

In the event theselimited markets become illiquid such that market prices are no longer readilyavailable, we will value our syndicated loans using estimated net presentvalues of the future cash flows or discounted cash flows. The use of a DCFmethodology follows that prescribed by ASC 820, which provides guidance on theuse of a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant observable market data doesnot exist, the alternative outlined in ASC 820 is the use of valuing investmentsbased on DCF.  For the purposes of usingDCF to provide fair value estimates, we considere multiple inputs such as arisk-adjusted discount rate that incorporates adjustments that marketparticipants would make both for nonperformance and liquidity risks.  As such, we develop a modified discount rateapproach that incorporates risk premiums including, among others, increasedprobability of default, or higher loss given default, or increased liquidityrisk.  The DCF valuations applied to thesyndicated loans provide an estimate of what we believe a market participantwould pay to purchase a syndicated loan in an active market, therebyestablishing a fair value.  We willcontinue to apply the DCF methodology in illiquid markets until quoted pricesare available or are deemed reliable based on trading activity.

 

As of September 30,2009, we assessed trading activity in syndicated loan assets and determinedthat there had been a return to market liquidity and a better functioningsecondary market for these assets.  Thus,firm bid prices or indicative bids were used to fair value our remainingsyndicated loans at September 30, 2009.  However, for those syndicated loans where sales were completed after September 30,2009, we used the respective sales prices to value those syndicated loans.

 

**Securitiesfor which no market exists:** The valuation methodology for securities for which nomarket exists falls into three categories: (1) portfolio investmentscomprised solely of debt securities; (2) portfolio investments incontrolled companies comprised of a bundle of securities, which can includedebt and equity securities; and (3) portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities.

 

(1)          **Portfolio investments comprisedsolely of debt securities:** Debt securities that are not publicly traded on anestablished securities market, or for which a limited market does not exist (“Non-PublicDebt Securities”), and that are issued by portfolio companies where we have noequity or equity-like securities, are fair valued in accordance with the termsof the policy, which utilizes opinions of value submitted to us by Standard &Poor’s Securities Evaluations, Inc. (“SPSE”). We may also submit PIKinterest to SPSE for their evaluation when it is determined that PIK interestis likely to be received.

 

In the case of Non-PublicDebt Securities, we have engaged SPSE to submit opinions of value for our debtsecurities that are issued by portfolio companies in which we own no equity, orequity-like securities.  SPSE’s opinionsof value are based on the valuations prepared by our portfolio management teamas described below.  We request that SPSEalso evaluate and assign values to success fees (conditional interest includedin some loan securities) when we determine that 

 

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there is reasonableprobability of receiving a success fee on a given loan. SPSE will only evaluatethe debt portion of our investments for which we specifically requestevaluation, and may decline to make requested evaluations for any reason at itssole discretion. Upon completing our collection of data with respect to theinvestments (which may include the information described below under “---CreditInformation,” the risk ratings of the loans described below under “---LoanGrading and Risk Rating” and the factors described hereunder), this valuationdata is forwarded to SPSE for review and analysis. SPSE makes its independentassessment of the data that we have assembled and assesses its independent datato form an opinion as to what they consider to be the market values for thesecurities. With regard to its work, SPSE has issued the following paragraph:

 

SPSE provides evaluatedprice opinions which are reflective of what SPSE believes the bid side of themarket would be for each loan after careful review and analysis of descriptive,market and credit information. Each price reflects SPSE’s best judgment basedupon careful examination of a variety of market factors. Because of fluctuationin the market and in other factors beyond its control, SPSE cannot guaranteethese evaluations. The evaluations reflect the market prices, or estimatesthereof, on the date specified. The prices are based on comparable marketprices for similar securities. Market information has been obtained fromreputable secondary market sources. Although these sources are considered reliable,SPSE cannot guarantee their accuracy.

 

SPSE opinions of value ofour debt securities that are issued by portfolio companies where we have noequity or equity-like securities are submitted to our Board of Directors alongwith our Adviser’s supplemental assessment and recommendation regardingvaluation of each of these investments. Our Adviser generally accepts theopinion of value given by SPSE, however, in certain limited circumstances, suchas when our Adviser may learn new information regarding an investment betweenthe time of submission to SPSE and the date of the Board assessment our Adviser’sconclusions as to value may differ from the opinion of value delivered by SPSE.Our Board of Directors then reviews whether our Adviser has followed its establishedprocedures for determinations of fair value, and votes to accept or reject therecommended valuation of our investment portfolio. Our Adviser and ourmanagement recommended, and the Board of Directors voted to accept, theopinions of value delivered by SPSE on the loans in our portfolio as denoted onthe Schedule of Investments included in our accompanying consolidated financialstatements.

 

Because there is a delaybetween when we close an investment and when the investment can be evaluated bySPSE, new loans are not valued immediately by SPSE; rather, management makesits own determination about the value of these investments in accordance withour valuation policy using the methods described herein.

 

(2)          **Portfolio investments in controlledcompanies comprised of a bundle of investments, which can include debt andequity securities:**The fair value of these investments is determined based on the total enterprisevalue of the portfolio company, or issuer, utilizing a liquidity waterfallapproach.  For Non-Public Debt Securitiesand equity or equity-like securities (e.g. preferred equity, equity, or otherequity-like securities) that are purchased together as part of a package, wherewe have control or could gain control through an option or warrant security,both the debt and equity securities of the portfolio investment would exit inthe mergers and acquisitions market as the principal market, generally througha sale or recapitalization of the portfolio company. In accordance with ASC820-10, we apply the in-use premise of value which assumes the debt and equitysecurities are sold together. Under this liquidity waterfall approach, wecontinue to use the enterprise value methodology utilizing a liquiditywaterfall approach to determine the fair value of these investments under ASC820-10 if we have the ability to initiate a sale of a portfolio company as ofthe measurement date. Under this approach, we first calculate the totalenterprise value of the issuer by incorporating some or all of the followingfactors:

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  discounted cash flow or other pertinent factors.

 

In gathering the sales tothird parties of similar securities, we may reference industry statistics anduse outside experts. Once we have estimated the total enterprise value of theissuer, we subtract the value of all the debt securities of the issuer; whichare valued at the contractual principal balance. Fair values of these debtsecurities are discounted for any shortfall of total enterprise value over thetotal debt outstanding for the issuer. Once the values for all outstandingsenior securities (which include the debt securities) have been subtracted fromthe total enterprise value of the issuer, the remaining amount, if any, is usedto determine the value of the issuer’s equity or equity-like securities.  If, in our 

 

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Adviser’s judgment, theliquidity waterfall approach does not accurately reflect the value of the debtcomponent, our Adviser may recommend that we use a valuation by SPSE or, ifthat is unavailable, a DCF valuation technique.

 

(3)          **Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities:**We value Non-Public Debt Securities that are purchasedtogether with equity or equity-like securities from the same portfolio company,or issuer, for which we do not control or cannot gain control as of themeasurement date, using a hypothetical secondary market as our principalmarket. In accordance with ASC 820-10, we determine the fair value of thesedebt securities of non-control investments assuming the sale of an individualdebt security using the in-exchange premise of value. As such, we estimate thefair value of the debt component using estimates of value provided by SPSE andour own assumptions in the absence of observable market data, includingsynthetic credit ratings, estimated remaining life, current market yield andinterest rate spreads of similar securities as of the measurement date.Subsequent to June 30, 2009, for equity or equity-like securities ofinvestments for which we do not control or cannot gain control as of themeasurement date, we estimate the fair value of the equity using thein-exchange premise of value based on factors such as the overall value of theissuer, the relative fair value of other units of account including debt, orother relative value approaches. Consideration also is given to capitalstructure and other contractual obligations that may impact the fair value ofthe equity. Further, we may utilize comparable values of similar companies,recent investments and indices with similar structures and risk characteristicsor our own assumptions in the absence of other observable market data and mayalso employ DCF valuation techniques.

 

Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed, and the differences could be material. Additionally,changes in the market environment and other events that may occur over the lifeof the investments may cause the gains or losses ultimately realized on theseinvestments to be different than the valuations currently assigned. There is nosingle standard for determining fair value in good faith, as fair value dependsupon circumstances of each individual case. In general, fair value is theamount that we might reasonably expect to receive upon the current sale of thesecurity in an arms-length transaction in the security’s principal market.

 

*ValuationConsiderations: *From time to time, depending on certaincircumstances, the Adviser may use the following valuation considerations,including but not limited to:

 

·      the nature and realizable valueof the collateral;

·      the portfolio company’searnings and cash flows and its ability to make payments on its obligations;

·      the markets in which theportfolio company does business;

·      the comparison to publiclytraded companies; and

·      DCF and other relevant factors.

 

Because such valuations, particularly valuations ofprivate securities and private companies, are not susceptible to precisedetermination, may fluctuate over short periods of time, and may be based onestimates, our determinations of fair value may differ from the values thatmight have actually resulted had a readily available market for thesesecurities been available.

 

*CreditInformation:*  Our Adviser monitors a wide variety of keycredit statistics that provide information regarding our portfolio companies tohelp us assess credit quality and portfolio performance. We and our Adviserparticipate in the periodic board meetings of our portfolio companies in whichwe hold Control and Affiliate investments and also require them to provideannual audited and monthly unaudited financial statements. Using thesestatements or comparable information and board discussions, our Advisercalculates and evaluates the credit statistics.

 

*LoanGrading and Risk Rating:*  As part of our valuationprocedures above, we risk rate all of our investments in debt securities. Forsyndicated loans that have been rated by an NRSRO (as defined in Rule 2a-7under the 1940 Act), we use the NRSRO’s risk rating for such security. For allother debt securities, we use a proprietary risk rating system. Our risk ratingsystem uses a scale of 0 to 10, with 10 being the lowest probability ofdefault. This system is used to estimate the probability of default on debtsecurities and the probability of loss if there is a default. These types ofsystems are referred to as risk rating systems and are used by banks and ratingagencies. The risk rating system covers both qualitative and quantitativeaspects of the business and the securities we hold.

 

For the debt securitiesfor which we do not use a third-party NRSRO risk rating, we seek to have ourrisk rating system mirror the risk rating systems of major risk ratingorganizations, such as those provided by an NRSRO. While we seek to mirror theNRSRO systems, we cannot provide any assurance that our risk rating system willprovide the same risk rating as 

 

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an NRSRO for thesesecurities. The following chart is an estimate of the relationship of our riskrating system to the designations used by two NRSROs as they risk rate debtsecurities of major companies. Because our system rates debt securities ofcompanies that are unrated by any NRSRO, there can be no assurance that thecorrelation to the NRSRO set out below is accurate. We believe our risk ratingwould be significantly higher than a typical NRSRO risk rating because the riskrating of the typical NRSRO is designed for larger businesses. However, ourrisk rating has been designed to risk rate the securities of smaller businessesthat are not rated by a typical NRSRO. Therefore, when we use our risk ratingon larger business securities, the risk rating is higher than a typical NRSROrating. The primary difference between our risk rating and the rating of atypical NRSRO is that our risk rating uses more quantitative determinants andincludes qualitative determinants that we believe are not used in the NRSROrating. It is our understanding that most debt securities of medium-sizedcompanies do not exceed the grade of BBB on an NRSRO scale, so there would beno debt securities in the middle market that would meet the definition of AAA,AA or A. Therefore, our scale begins with the designation 10 as the best riskrating which may be equivalent to a BBB from an NRSRO, however, no assurancecan be given that a 10 on our scale is equal to a BBB on an NRSRO scale.

 
| **Company’s  System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone  Capital’s Description(a)**                                                          |
|----------------------------|------------|------------------|------------|-------------------|------------|-------------------------------------------------------------------------------------------------------|
| **>10**                 |       | Baa2             |       | BBB               |       | Probability of Default  (PD) during the next ten years is 4% and the Expected Loss (EL) is 1% or less |
| **10**                     |       | Baa3             |       | BBB-              |       | PD is 5% and the EL is  1% to 2%                                                                      |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10% and the EL is  2% to 3%                                                                     |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16% and the EL is  3% to 4%                                                                     |
| **7**                      |       | Ba3              |       | BB-               |       | PD is 17.8% and the EL  is 4% to 5%                                                                   |
| **6**                      |       | B1               |       | B+                |       | PD is 22% and the EL is  5% to 6.5%                                                                   |
| **5**                      |       | B2               |       | B                 |       | PD is 25% and the EL is  6.5% to 8%                                                                   |
| **4**                      |       | B3               |       | B-                |       | PD is 27% and the EL is  8% to 10%                                                                    |
| **3**                      |       | Caa1             |       | CCC+              |       | PD is 30% and the EL is  10% to 13.3%                                                                 |
| **2**                      |       | Caa2             |       | CCC               |       | PD is 35% and the EL is  13.3% to 16.7%                                                               |
| **1**                      |       | Caa3             |       | CC                |       | PD is 65% and the EL is  16.7% to 20%                                                                 |
| **0**                      |       | N/a              |       | D                 |       | PD is 85% or there is a  payment default and the EL is greater than 20%                               |

 

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(a)*                                 **The default rates setforth are for a ten year term debt security. If a debt security is less thanten years, then the probability of default is adjusted to a lower percentagefor the shorter period, which may move the security higher on our risk ratingscale.*

 

The above scale gives anindication of the probability of default and the magnitude of the loss if thereis a default. Our policy is to stop accruing interest on an investment if wedetermine that interest is no longer collectible. At September 30, 2009,one Non-Control/Non-Affiliate investments and four Control investments were onnon-accrual.  At September 30, 2008one Non-Control/Non-Affiliate investment and two Control investments were onnon-accrual.  Additionally, we do notrisk rate our equity securities.

 

The following table liststhe risk ratings for all non-syndicated loans in our portfolio at September 30,2009 and September 30, 2008, representing approximately 96% and 83%,respectively, of all loans in our portfolio at the end of each year:

 

| **Rating**        | ** ** | **Sept. 30, 2009** | ** ** | **Sept. 30, 2008** | ** ** |
|-------------------|------------|--------------------|------------|--------------------|------------|
| Average           | ** ** | 7.1                |       | 7.3                | ** ** |
| Weighted  Average | ** ** | 7.2                |       | 7.0                | ** ** |
| Highest           | ** ** | 9.0                |       | 9.0                | ** ** |
| Lowest            | ** ** | 3.0                |       | 5.0                | ** ** |

 

The following table liststhe risk ratings for all syndicated loans in our portfolio that were not ratedby an NRSRO at September 30, 2009 and September 30, 2008,representing approximately 2% and 6%, respectively, of all loans in ourportfolio at the end of each year:

 

| **Rating**        | ** ** | **Sept. 30, 2009** | ** ** | **Sept. 30, 2008** | ** ** |
|-------------------|------------|--------------------|------------|--------------------|------------|
| Average           | ** ** | 7.0                |       | 6.6                | ** ** |
| Weighted  Average | ** ** | 7.0                |       | 6.7                | ** ** |
| Highest           | ** ** | 7.0                |       | 7.0                | ** ** |
| Lowest            | ** ** | 7.0                |       | 6.0                | ** ** |

 

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For syndicated loans thatare currently rated by an NRSRO, we risk rate such loans in accordance with therisk rating systems of major risk rating organizations, such as those providedby an NRSRO. The following table lists the risk ratings for all syndicatedloans in our portfolio that were rated by an NRSRO at September 30, 2009and September 30, 2008, representing approximately 2% and 11%,respectively, of all loans in our portfolio at the end of each year:

 

| **Rating**       | ** ** | **Sept. 30,  2009** | ** ** | **Sept. 30,  2008** | ** ** |
|------------------|------------|---------------------|------------|---------------------|------------|
| Average          |       | CCC+/Caa1           |       | CCC+/Caa1           |       |
| Weighted Average |       | CCC+/Caa1           |       | CCC+/Caa1           |       |
| Highest          |       | B-/B3               |       | BB/Ba3              |       |
| Lowest           |       | D/C                 |       | CC/C                |       |

 

***Tax Status***

 

We intend to continue toqualify for treatment as a RIC under Subtitle A, Chapter 1 of Subchapter M ofthe Code. As a RIC, we are not subject to federal income tax on the portion ofour taxable income and gains distributed to stockholders. To qualify as a RIC,we must meet certain source-of-income, asset diversification, and annualdistribution requirements.  Under theannual distribution requirement, we are required to distribute to stockholdersat least 90% of our investment company taxable income, as defined by theCode.  We have a policy to pay out as adistribution up to 100% of that amount.

 

In an effort to avoidcertain excise taxes imposed on RICs, we currently intend to distribute duringeach calendar year, an amount at least equal to the sum of (1) 98% of ourordinary income for the calendar year, (2) 98% of our capital gains inexcess of capital losses for the one-year period ending on October 31 ofthe calendar year and (3) any ordinary income and net capital gains forpreceding years that were not distributed during such years.

 

***Revenue Recognition***

 

*InterestIncome Recognition*

 

Interest income, adjustedfor amortization of premiums and acquisition costs and for the accretion ofdiscounts, is recorded on the accrual basis to the extent that such amounts areexpected to be collected.  Generally, whena loan becomes 90 days or more past due or if our qualitative assessmentindicates that the debtor is unable to service its debt or other obligations,we will place the loan on non-accrual status and cease recognizing interestincome on that loan until the borrower has demonstrated the ability and intentto pay contractual amounts due.  However,we remain contractually entitled to this interest.  At September 30, 2009, oneNon-Control/Non-Affiliate investments and four Control investment were onnon-accrual with an aggregate cost basis of approximately $10,022 or 2.8% ofthe cost basis of all investments in our portfolio.  At September 30, 2008, oneNon-Control/Non-Affiliate investment and two Control investments were onnon-accrual with an aggregate cost basis of approximately $13,098 at September 30,2008, or 2.8% of the cost basis of all investments in our portfolio.  Conditional interest, or a success fee, isrecorded when earned or upon full repayment of a loan investment.

 

*Paid inKind Interest*

 

We may hold loans in ourportfolio which contain a PIK interest provision. The PIK interest, computed atthe contractual rate specified in each loan agreement, is added to theprincipal balance of the loan and recorded as interest income. To maintain ourstatus as a RIC, this non-cash source of income must be paid out tostockholders in the form of distributions, even though we have not yetcollected the cash.  As of September 30,2009, two loans in our portfolio bore PIK interest.

 

*ServicesProvided to Portfolio Companies*

 

As a business developmentcompany under the 1940 Act, we are required to make available significantmanagerial assistance to our portfolio companies. We provide these servicesthrough our Adviser, who provides these services on our behalf through itsofficers who are also our officers. Currently, neither we nor our Adviser charges a fee for managerialassistance, however, if our Adviser does receive fees for such managerialassistance, our Adviser will credit the managerial assistance fees to the basemanagement fee due from us to our Adviser.

 

Our Adviser receives feesfor the other services it provides to our portfolio companies.  These other fees are typically non-recurring,are recognized as revenue when earned and are generally paid directly to ourAdviser by the borrower or potential 

 

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borrower upon the closingof the investment. The services our Adviser provides to our portfolio companiesvary by investment, but generally include a broad array of services such asinvestment banking services, arranging bank and equity financing, structuringfinancing from multiple lenders and investors, reviewing existing creditfacilities, restructuring existing investments, raising equity and debtcapital, consulting, turnaround management, merger and acquisition services andrecruiting new management personnel. When our Adviser receives fees for these services, 50% of certain ofthose fees are voluntarily and irrevocably credited against the base managementfee that we pay to our Adviser, while others are reimbursements for costsassociated with the engagement.  Anyservices of this nature subsequent to the closing would typically generate aseparate fee at the time of completion.

 

Our Adviser also receivesfees for monitoring and reviewing portfolio company investments.  These fees are recurring and are generallypaid annually or quarterly in advance to our Adviser throughout the life of theinvestment.  Fees of this nature arerecorded as revenue by our Adviser when earned and are not credited against thebase management fee.

 

We may receive fees forthe origination and closing services we provide to portfolio companies throughour Adviser.  These fees are paiddirectly to us and are recognized as revenue upon closing of the originatedinvestment and are reported as fee income in the accompanying consolidatedstatements of operations.

 

**RecentAccounting Pronouncements**

 

Refer to Note 2 *Summary of Significant Accounting Policies* in the notes toour consolidated financial statements included elsewhere in this report.

 

**Item 7A.Quantitative and Qualitative Disclosures About Market Risk****(dollaramounts in thousands, unless otherwise indicated)**

 

Market risk includesrisks that arise from changes in interest rates, foreign currency exchangerates, commodity prices, equity prices and other market changes that affectmarket sensitive instruments.  The pricesof securities held by the us may decline in response to certain events,including those directly involving the companies whose securities are owned byus; conditions affecting the general economy; overall market changes; local,regional or global political, social or economic instability; and interest ratefluctuations.

 

The primary risk webelieve we are exposed to is interest rate risk.  Because we borrow money to make investments,our net investment is dependent upon the difference between the rate at whichwe borrow funds and the rate at which we invest those funds.  As a result, there can be no assurance that asignificant change in market interest rates will not have a material adverseeffect on our net investment income.  Weuse a combination of debt and equity capital to finance our investingactivities.  We may use interest raterisk management techniques to limit our exposure to interest ratefluctuations.  Such techniques mayinclude various interest rate hedging activities to the extent permitted by the1940 Act.  We have analyzed the potentialimpact of changes in interest rates on interest income net of interest expense.

 

While we expect thatultimately approximately 20% of the loans in our portfolio will be made atfixed rates, with approximately 80% made at variable rates, currentlysubstantially all of our investment portfolio is at variable rates.  At September 30, 2009, our portfolioconsisted of the following:

 
| 83  | % | variable  rates with a floor               |   |
|-----|---|--------------------------------------------|--------|
| 2   | % | variable  rates with a floor and ceiling   |   |
| 11  | % | variable  rates without a floor or ceiling |   |
| 4   | % | fixed  rate                                |   |
| 100 | % | total                                      |   |

 

All of our variable-rateloans have rates associated with either the current LIBOR or prime rate.

 

To illustrate the potential impact of changes ininterest rates on our net increase in net assets resulting from operations, wehave performed the following analysis, which assumes that our balance sheetremains constant and no further actions are taken to alter our existinginterest rate sensitivity.

 

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| **Basis  Point Change** | ** ** | **Increase  (Decrease) in  Interest Income** | ** ** | **Increase  (Decrease) in  Interest Expense** | ** ** | **Net  Increase (Decrease) in  Net Assets Resulting from  Operations** | ** ** |
|-------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------------------------|------------|
| Up 200 basis points     |       | $                                            | 668        |                                          | $          | 1,660                                                                  |       | $ | (992 | ) |
| Up 100 basis points     |       | 275                                          |       | 830                                           |       | (555                                                                   | )          |
| Down 100 basis points   |       | (156                                         | )          | (830                                          | )          | 674                                                                    |       |
| Down 200 basis points   |       | (263                                         | )          | (1,660                                        | )          | 1,397                                                                  |       |
|                         |            |                                              |            |                                               |            |                                                                        |            |  |  |  |

 

Although management believes that this analysis isindicative of our existing interest rate sensitivity, it does not adjust forpotential changes in credit quality, size and composition of our loan portfolioon the balance sheet and other business developments that could affect netincrease in net assets resulting from operations.  Accordingly, no assurances can be given thatactual results would not differ materially from the results under thishypothetical analysis.

 

We may also experiencerisk associated with investing in securities of companies with foreignoperations. We currently do not anticipate investing in debt or equity offoreign companies, however, some potential portfolio companies may haveoperations located outside the United States. These risks include, but are notlimited to, fluctuations in foreign currency exchange rates, imposition offoreign taxes, changes in exportation regulations and political and socialinstability.

 

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**Item 8.Financial Statements and Supplementary Data**

 

**Index toConsolidated Financial Statements**

 
| Report of Management on Internal Controls                                                                                                           |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent Registered Public Accounting  Firm                                                                                            |   |
| Consolidated Statements of Assets and Liabilities as  of September 30, 2009 and September 30, 2008                                        |   |
| Consolidated Schedules of Investments as of  September 30, 2009 and September 30, 2008                                                    |   |
| Consolidated Statements of Operations for the years  ended September 30, 2009, September 30, 2008 and September 30,  2007            |   |
| Consolidated Statements of Changes in Net Assets for  the years ended September 30, 2009, September 30, 2008 and  September 30, 2007 |   |
| Consolidated Statements of Cash Flows for the years  ended September 30, 2009, September 30, 2008 and September 30,  2007            |   |
| Financial  Highlights for the years ended September 30, 2009, September 30,  2008 and September 30, 2007                             |   |
| Notes to Consolidated Financial Statements                                                                                                          |   |

 

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### **Report of Management on Internal Controls**

###  

To the Stockholders and Board of Directors of Gladstone CapitalCorporation:

 

Our management is responsible for establishing and maintaining adequateinternal control over financial reporting as defined in Rule 13a-15(f) underthe Securities Exchange Act of 1934. Our internal control over financialreporting is designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles andinclude those policies and procedures that: (1) pertain to the maintenanceof records that in reasonable detail accurately and fairly reflect ourtransactions and the dispositions of our assets; (2) provide reasonableassurance that our transactions are recorded as necessary to permit preparationof financial statements in accordance with generally accepted accountingprinciples, and that our receipts and expenditures are being made only inaccordance with appropriate authorizations; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of our assets that could have a material effect on ourfinancial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Therefore, even thosesystems determined to be effective can provide only reasonable assurance withrespect to financial statement preparation and presentation.

 

Under the supervision and with the participation of our management, weassessed the effectiveness of our internal control over financial reporting asof September 30, 2009, using the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in Internal Control—IntegratedFramework. Based on its assessment, management has concluded that our internalcontrol over financial reporting was effective as of September 30, 2009.

 

Our management’s assessment of the effectiveness of our internalcontrol over financial reporting as of September 30, 2009 has been auditedby PricewaterhouseCoopers LLP, an independent registered public accountingfirm, as stated in their report which is included herein.

 

 

November 23, 2009

 

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### **Report of Independent Registered Public AccountingFirm**

###  

To the Stockholders and Board of Directors of Gladstone CapitalCorporation:

 

In our opinion,the accompanying consolidated statements of assets and liabilities, includingthe schedules of investments, and the related statements of operations, changesin net assets and cash flows and the financial highlights present fairly, inall material respects, the financial position of Gladstone Capital Corporationand its subsidiaries at September 30, 2009 and  2008, and the results of their operations and their cash flows for each of thethree years in the period ended September 30, 2009 in conformity with accounting principlesgenerally accepted in the United States of America.  In addition, in our opinion, the financialstatement schedule listed in the accompanying index under Item 15(a)(2) presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.  Also in our opinion, the Company maintained,in all material respects, effective internal control over financial reportingas of September 30, 2009, based on criteria established in *Internal Control - Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). TheCompany’s management is responsible for these financial statements andfinancial statement schedule, for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting, included in the accompanying Management’sReport on Internal Control over Financial Reporting. Our responsibility is toexpress opinions on these financial statements, on the financial statementschedule, and on the Company’s internal control over financial reporting basedon our integrated audits.  We conductedour audits in accordance with the standards of the Public Company AccountingOversight Board (United States).  Thosestandards require that we plan and perform the audits to obtain reasonableassurance about whether the financial statements are free of materialmisstatement and whether effective internal control over financial reportingwas maintained in all material respects. Our audits of the financial statements included examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation.  Our audit of internal control over financialreporting included obtaining an understanding of internal control overfinancial reporting, assessing the risk that a material weakness exists, andtesting and evaluating the design and operating effectiveness of internalcontrol based on the assessed risk.  Ouraudits also included performing such other procedures as we considerednecessary in the circumstances. We believe that our audits provide a reasonablebasis for our opinions.

 

A company’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.  A company’s internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

 

 

PricewaterhouseCoopers LLP

McLean, VA

November 23, 2009

 

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**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES**

**(DOLLARAMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)**

 
| ** **                                                                                                                                                                        | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **2009**               | ** ** | **2008**               | ** ** |
|                                                                                                                                                                              | ** ** | ** **             | ** ** | ** **             | ** ** |
| ASSETS                                                                                                                                                                            |       |                   |       |                   |       |
| Non-Control/Non-Affiliate  investments (Cost 9/30/09: $312,043; 9/30/08: $448,356)                                                                                                |       | $                      | 286,997    |                   | $          | 407,153 |   |
| Control  investments (Cost 9/30/09: $52,350; 9/30/08: $12,514)                                                                                                                    |       | 33,972                 |       | 780                    |       |
| Total  investments at fair value (Cost 9/30/09: $364,393; 9/30/08 $460,870)                                                                                                       |       | 320,969                |       | 407,933                |       |
| Cash                                                                                                                                                                              |       | 5,276                  |       | 6,493                  |       |
| Interest  receivable – investments in debt securities                                                                                                                        |       | 3,048                  |       | 3,588                  |       |
| Interest  receivable – employees (Refer to Note 4)                                                                                                                           |       | 85                     |       | 91                     |       |
| Due from  custodian                                                                                                                                                               |       | 3,059                  |       | 4,544                  |       |
| Due from Adviser  (Refer to Note 4)                                                                                                                                               |       | 69                     |       | —                 |       |
| Deferred  financing fees                                                                                                                                                          |       | 1,230                  |       | 1,905                  |       |
| Prepaid assets                                                                                                                                                                    |       | 341                    |       | 306                    |       |
| Other assets                                                                                                                                                                      |       | 1,833                  |       | 838                    |       |
| TOTAL ASSETS                                                                                                                                                                      |       | $                      | 335,910    |                   | $          | 425,698 |   |
|                                                                                                                                                                              |       |                   |       |                   |       |
| LIABILITIES                                                                                                                                                                       |       |                   |       |                   |       |
| Accounts payable                                                                                                                                                                  |       | $                      | 67         |                   | $          | 8 |   |
| Interest payable                                                                                                                                                                  |       | 378                    |       | 646                    |       |
| Fee due to  Administrator (Refer to Note 4)                                                                                                                                       |       | 216                    |       | 247                    |       |
| Due to Adviser  (Refer to Note 4)                                                                                                                                                 |       | 834                    |       | 457                    |       |
| Borrowings under  line of credit (Cost 9/30/09: $83,000; 9/30/08: $151,030)                                                                                                       |       | 83,350                 |       | 151,030                |       |
| Accrued expenses  and deferred liabilities                                                                                                                                        |       | 1,800                  |       | 1,328                  |       |
| Funds held in  escrow                                                                                                                                                             |       | 189                    |       | 234                    |       |
| TOTAL  LIABILITIES                                                                                                                                                                |       | 86,834                 |       | 153,950                |       |
| NET ASSETS                                                                                                                                                                        |       | $                      | 249,076    |                   | $          | 271,748 |   |
|                                                                                                                                                                              |       |                   |       |                   |       |
| ANALYSIS OF NET  ASSETS                                                                                                                                                           |       |                   |       |                   |       |
| Common stock,  $0.001 par value, 50,000,000 shares authorized and 21,087,574 shares issued  and outstanding at September 30, 2009 and September 30, 2008,  respectively |       | $                      | 21         |                   | $          | 21 |   |
| Capital in  excess of par value                                                                                                                                                   |       | 328,203                |       | 334,143                |       |
| Notes receivable  – employees (Refer to Note 4)                                                                                                                              |       | (9,019                 | )          | (9,175                 | )          |
| Net unrealized  depreciation on investments                                                                                                                                       |       | (43,425                | )          | (52,937                | )          |
| Net unrealized  depreciation on derivative                                                                                                                                        |       | —                 |       | (304                   | )          |
| Net unrealized  appreciation on borrowings under line of credit                                                                                                                   |       | (350                   | )          | —                 |       |
| Accumulated Net  Realized Losses                                                                                                                                                  |       | (26,354                | )          | —                 |       |
| TOTAL NET ASSETS                                                                                                                                                                  |       | $                      | 249,076    |                   | $          | 271,748 |   |
| NET ASSETS PER  SHARE                                                                                                                                                             |       | $                      | 11.81      |                   | $          | 12.89 |   |

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIALSTATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED SCHEDULE OF INVESTMENTS**

**SEPTEMBER 30, 2009**

**(DOLLARAMOUNTS IN THOUSANDS)**

 
| **Company (1)**                                         | ** **                                                       | **Industry**                                                   | ** ** | **Investment  (2)**                                                 | ** ** | **Cost**   | ** ** | **Fair  Value** | ** ** |
|---------------------------------------------------------|------------------------------------------------------------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|-----------------|------------|
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| **NON-CONTROL/NON-AFFILIATE  INVESTMENTS**              | ** **                                                       | ** **                                                     | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** **      | ** ** |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| ***Non-syndicated Loans:***                             |                                                             |                                                           |       |                                                                |       |       |       |            |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Access Television  Network, Inc.                   |                                                             | Service-cable airtime (infomercials)                           |       | Senior Term Debt (14.5%, Due 12/2009) (5) (9)                  |       | $          | 963        |            | $          | 868 |   |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| ACE Expediters,  Inc                                    |                                                             | Service-over-the-ground logistics                              |       | Senior Term Debt (13.5%, Due 9/2014) (5) (13)                  |       | 5,106      |       | 4,864           |       |
|                                                    |                                                             |                                                           |       | Common Stock Warrants (8)                                           |       | 200        |       | 564             |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| ActivStyle  Acquisition Co.                             |                                                             | Service-medical products distribution                          |       | Senior Term Debt (13.0%, Due 4/2014) (3) (5)                   |       | 4,000      |       | 3,940           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Allison  Publications, LLC                              |                                                             | Service-publisher of consumer oriented magazines               |       | Senior Term Debt (10.0%, Due 9/2012) (5)                            |       | 9,709      |       | 8,746           |       |
|                                                    | Senior Term Debt (13.0%, Due 12/2010) (5)                        |                                                           | 260        |                                                                | 246        |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Anitox  Acquisition Company                             |                                                             | Manufacturing-preservatives for animal feed                    |       | Line of Credit, $3,000 available (4.5%, Due 1/2010)  (5)            |       | 1,700      |       | 1,681           |       |
|                                                    | Senior Term Debt (8.5%, Due 1/2012) (5)                          |                                                           | 2,877      |                                                                | 2,823      |       |
|                                                    | Senior Term Debt (10.5%, Due 1/2012) (3) (5)                |                                                           | 3,688      |                                                                | 3,582      |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| BAS Broadcasting                                        |                                                             | Service-radio station operator                                 |       | Senior Term Debt (11.5%, Due 7/2013) (5)                            |       | 7,300      |       | 5,840           |       |
|                                                    |                                                             |                                                           |       | Senior Term Debt (12.0%, Due 7/2009)  (3) (5) (12)        |       | 950        |       | 475             |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| CCS, LLC                                                |                                                             | Service-cable TV franchise owner                               |       | Senior Term Debt (non-accrual, Due 8/2008)  (5) (10) (12) |       | 631        |       | 126             |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Chinese Yellow  Pages Company                      |                                                             | Service-publisher of Chinese language directories              |       | Line of Credit, $700 available (7.3%, Due 9/2010) (5)               |       | 450        |       | 427             |       |
|                                                    | Senior Term Debt (7.3%, Due 9/2010) (5)                          |                                                           | 518        |                                                                | 488        |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| CMI Acquisition,  LLC                                   |                                                             | Service-recycling                                              |       | Senior Subordinated Term Debt (10.3%, Due 11/2012)  (5)             |       | 6,233      |       | 5,890           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Doe &  Ingalls Management LLC                  |                                                             | Distributor-specialty chemicals                                |       | Senior Term Debt (6.8%, Due 11/2010) (5)                            |       | 2,300      |       | 2,266           |       |
|                                                    |                                                             |                                                           |       | Senior Term Debt (7.8%, Due 11/2010) (3) (5)                   |       | 4,365      |       | 4,267           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Finn Corporation                                        |                                                             | Manufacturing-landscape equipment                              |       | Common Stock Warrants (8)                                           |       | 37         |       | 1,223           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| GFRC Holdings LLC                                       |                                                             | Manufacturing-glass-fiber reinforced concrete                  |       | Line of Credit, $2,000 available (4.5%, Due 12/2010)                |       | —     |       | —          |       |
|                                                    | Senior Term Debt (9.0%, Due 12/2012) (5)                         |                                                           | 6,599      |                                                                | 6,450      |       |
|                                                    | Senior Subordinated Term Debt (11.5%, Due 12/2012)  (3) (5) |                                                           | 6,665      |                                                                | 6,432      |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Global Materials Technologies, Inc.                |                                                             | Manufacturing-steel wool products and metal fibers             |       | Senior Term Debt (13.0%, Due 6/2010) (3) (5)                   |       | 4,410      |       | 3,528           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Heartland  Communications Group                         |                                                             | Service-radio station operator                                 |       | Senior Term Debt (10.0%, Due 5/2011) (5)                            |       | 4,567      |       | 2,726           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Interfilm  Holdings, Inc.                          |                                                             | Service-slitter and distributor of plastic films               |       | Senior Term Debt (12.3%, Due 10/2012) (5)                           |       | 4,950      |       | 4,715           |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| International  Junior Golf Training Acquisition Company |                                                             | Service-golf training                                          |       | Line of Credit, $1,500 available (9.0%, Due 5/2010)  (5)            |       | 700        |       | 690             |       |
|                                                    | Senior Term Debt (8.5%, Due 5/2012) (5)                          |                                                           | 2,120      |                                                                | 2,036      |       |
|                                                    | Senior Term Debt (10.5%, Due 5/2012) (3) (5)                |                                                           | 2,500      |                                                                | 2,366      |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| KMBQ Corporation                                        |                                                             | Service-AM/FM radio broadcaster                                |       | Line of Credit, $200 available (11.0%, Due 3/2010)  (5)             |       | 153        |       | 69              |       |
|                                                    |                                                             |                                                           |       | Senior Term Debt (11.0%, Due 3/2010) (5)                            |       | 1,785      |       | 801             |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Legend  Communications of Wyoming LLC                   |                                                             | Service-operator of radio stations                             |       | Line of Credit, $500 available (12.0%, Due 6/2011)  (5)             |       | 497        |       | 450             |       |
|                                                    | Senior Term Debt (12.0%, Due 6/2013) (5)                         |                                                           | 9,373      |                                                                | 8,482      |       |
|                                                    |                                                             |                                                           |       |                                                                |       |       |       |            |       |
| Newhall  Holdings, Inc.                            |                                                             | Service-distributor of personal care products and  supplements |       | Line of Credit, $3,000 available (11.3%, Due 5/2010)  (5)           |       | 1,000      |       | 945             |       |
|                                                    | Senior Term Debt (5) (11.3%, Due 5/2012) (5)                |                                                           | 3,870      |                                                                | 3,657      |       |
|                                                    | Senior Term Debt (14.3%, Due 5/2012) (3) (5)                |                                                           | 4,410      |                                                                | 4,112      |       |
|                                                         |                                                                  |                                                                |            |                                                                     |            |            |            |                 |            |  |  |

 

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| **Company (1)**                                  | ** **                                              | **Industry**                                                    | ** ** | **Investment  (2)**                                       | ** ** | **Cost** | ** ** | **Fair  Value** | ** ** |
|--------------------------------------------------|---------------------------------------------------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------|------------|-----------------|------------|
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Northern  Contours, Inc.                    |                                                    | Manufacturing-veneer and laminate components                    |       | Senior Subordinated Term Debt (10.0%, Due 5/2010) (5)     |       | $        | 6,562      |            | $          | 5,414 |   |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Pinnacle  Treatment Centers, Inc.           |                                                    | Service-Addiction treatment centers                             |       | Line of Credit, $500 available (4.5%, Due 12/2009)        |       | —   |       | —          |       |
|                                             |                                                    |                                                            |       | Senior Term Debt (10.5%, Due 12/2011) (5)                 |       | 2,750    |       | 2,633           |       |
|                                             |                                                    |                                                            |       | Senior Term Debt (10.5%, Due 12/2011) (3) (5)        |       | 7,500    |       | 7,059           |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Precision  Acquisition Group Holdings, Inc. |                                                    | Manufacturing-consumable components for the aluminum  industry  |       | Equipment Note (8.5%, Due 10/2011) (5)                    |       | 1,000    |       | 988             |       |
|                                             | Senior Term Debt (8.5%, Due 10/2010) (5)                |                                                            | 4,250      |                                                      | 4,192      |     |
|                                             | Senior Term Debt (11.5%, Due 10/2010) (3) (5)      |                                                            | 4,074      |                                                      | 4,023      |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| PROFITSystems  Acquisition Co.                   |                                                    | Service-design and develop ERP software                         |       | Line of Credit, $350 available (4.5%, Due 7/2010)         |       | —   |       | —          |       |
|                                             | Senior Term Debt (8.5%, Due 7/2011) (5)                 |                                                            | 1,600      |                                                      | 1,468      |     |
|                                             | Senior Term Debt (10.5%, Due 7/2011) (3) (5)       |                                                            | 2,900      |                                                      | 2,632      |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| RCS Management  Holding Co.                      |                                                    | Service-healthcare supplies                                     |       | Senior Term Debt (8.5%, Due 1/2011) (3) (5)          |       | 2,437    |       | 2,383           |       |
|                                             |                                                    |                                                            |       | Senior Term Debt (10.5%, Due 1/2011) (4) (5)         |       | 3,060    |       | 2,949           |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Reliable Biopharmaceutical  Holdings, Inc.  |                                                    | Manufacturing-pharmaceutical and biochemical  intermediates     |       | Line of Credit, $5,000 available (9.0%, Due 10/2010)  (5) |       | 800      |       | 788             |       |
|                                             | Mortgage Note (9.5%, Due 10/2014) (5)                   |                                                            | 7,335      |                                                      | 7,261      |     |
|                                             | Senior Term Debt (9.0%, Due 10/2012) (5)                |                                                            | 1,530      |                                                      | 1,507      |     |
|                                             | Senior Term Debt (11.0%, Due 10/2012) (3) (5)      |                                                            | 11,813     |                                                      | 11,518     |     |
|                                             | Senior Subordinated Term Debt (12.0%, Due 10/2013)  (5) |                                                            | 6,000      |                                                      | 5,640      |     |
|                                             | Common Stock Warrants (8)                               |                                                            | 209        |                                                      | 282        |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Saunders &  Associates                  |                                                    | Manufacturing-equipment provider for frequency  control devices |       | Senior Term Debt (9.8%, Due 5/2013) (5)                   |       | 10,780   |       | 10,618          |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| SCI  Cable, Inc.                            |                                                    | Service-cable, internet, voice provider                         |       | Senior Term Debt (9.3%, Due 10/2008) (5) (12)        |       | 2,881    |       | 576             |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Sunburst Media -  Louisiana, LLC                 |                                                    | Service-radio station operator                                  |       | Senior Term Debt (10.5%, Due 6/2011) (5)                  |       | 6,411    |       | 5,817           |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Sunshine Media  Holdings                         |                                                    | Service-publisher regional B2B trade magazines                  |       | Senior Term Debt (11.0%, Due 5/2012) (5)                  |       | 16,948   |       | 15,973          |       |
|                                             | Senior Term Debt (13.5%, Due 5/2012) (3) (5)       |                                                            | 10,700     |                                                      | 9,978      |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Thibaut  Acquisition Co.                         |                                                    | Service-design and disbribute wall covering                     |       | Line of Credit, $1,000 available (9.0%, Due 1/2011)  (5)  |       | 1,000    |       | 933             |       |
|                                             | Senior Term Debt (8.5%, Due 1/2011) (5)                 |                                                            | 1,487      |                                                      | 1,387      |     |
|                                             | Senior Term Debt (12.0%, Due 1/2011) (3) (5)       |                                                            | 3,000      |                                                      | 2,745      |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Tulsa Welding  School                            |                                                    | Service-private welding school                                  |       | Line of credit, $750 available (9.5%, Due 9/2011)         |       | —   |       | —          |       |
|                                             |                                                    |                                                            |       | Senior Term Debt (9.5%, Due 9/2013) (5)                   |       | 4,144    |       | 4,144           |       |
|                                             |                                                    |                                                            |       | Senior Term Debt (12.8%, Due 9/2013) (5)                  |       | 7,960    |       | 7,950           |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| VantaCore                                        |                                                    | Service-acquisition of aggregate quarries                       |       | Senior Subordinated Term Debt (12.0%, Due 8/2013) (5)     |       | 13,726   |       | 13,589          |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Viapack, Inc.                               |                                                    | Manufacturing-polyethylene film                                 |       | Senior Real Estate Term Debt (10.0%, Due 3/2011) (5)      |       | 775      |       | 743             |       |
|                                             |                                                    |                                                            |       | Senior Term Debt (13.0%, Due 3/2011) (3) (5)         |       | 4,061    |       | 3,893           |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Visual Edge  Technology, Inc.               |                                                    | Service-office equipment distribution                           |       | Line of credit, $3,000 available (10.8%, Due 9/2011)  (5) |       | 2,981    |       | 2,340           |       |
|                                             | Senior Subordinated Term Debt (15.5%, Due 8/2011) (5)   |                                                            | 5,000      |                                                      | 3,925      |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Westlake  Hardware, Inc.                    |                                                    | Retail-hardware and variety                                     |       | Senior Subordinated Term Debt (9.0%, Due 1/2011) (5)      |       | 15,000   |       | 14,269          |       |
|                                             |                                                    |                                                            |       | Senior Subordinated Term Debt (10.3%, Due 1/2011) (5)     |       | 10,000   |       | 9,400           |       |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| Winchester  Electronics                          |                                                    | Manufacturing-high bandwidth connectors and cables              |       | Senior Term Debt (5.3%, Due 5/2013) (5)                   |       | 1,147    |       | 1,136           |       |
|                                             | Senior Term Debt (5.7%, Due 5/2013) (5)                 |                                                            | 1,690      |                                                      | 1,642      |     |
|                                             | Senior Subordinated Term Debt (14.0%, Due 6/2013) (5)   |                                                            | 9,925      |                                                      | 9,478      |     |
|                                             |                                                    |                                                            |       |                                                      |       |     |       |            |       |
| *Subtotal  - Non-syndicated loans*               |                                                    |                                                            |       |                                                      |       | 298,322  |       | 277,048         |       |
|                                                  |                                                         |                                                                 |            |                                                           |            |          |            |                 |            |  |  |

 

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| **Company (1)**                                   | ** **                                                               | **Industry**                                                | ** ** | **Investment  (2)**                                                         | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|---------------------------------------------------|--------------------------------------------------------------------------|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| ***Syndicated Loans:***                           |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| GTM  Holdings, Inc.                          |                                                                     | Manufacturing-socks                                         |       | Senior Subordinated Term Debt (11.8%, Due 4/2014) (6)                       |       | $          | 500         |            | $          | 220 |   |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Kinetek  Acquisition Corp.                        |                                                                     | Manufacturing-custom engineered motors &  controls |       | Senior Term Debt (3.6%, Due 11/2013) (7)                                    |       | 1,438      |        | 925             |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Puerto Rico Cable  Acquisition Company, Inc. |                                                                     | Service-telecommunications                                  |       | Senior Subordinated Term Debt (7.8%, Due 1/2012) (6)                        |       | 7,174      |        | 5,713           |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Wesco  Holdings, Inc.                        |                                                                     | Service-aerospace parts and distribution                    |       | Senior Subordinated Term Debt (6.0%, Due 3/2014) (7)                        |       | 2,264      |        | 1,856           |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| WP Evenflo Group  Holdings Inc.                   |                                                                     | Manufacturing-infant and juvenile products                  |       | Senior Term Debt (8.0%, Due 2/2013) (6)                                     |       | 1,901      |        | 1,235           |       |
|                                              | Senior Preferred Equity (8)                                              |                                                        | 333        |                                                                        | —     |       |
|                                              | Junior Preferred Equity (8)                                              |                                                        | 111        |                                                                        | —     |       |
|                                              | Common Stock (8)                                                         |                                                        | —     |                                                                        | —     |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| *Subtotal  - Syndicated loans*                    |                                                                     |                                                        |       |                                                                        |       | 13,721     |        | 9,949           |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| **Total  Non-Control/Non-Affiliate Investments**  | ** **                                                               | ** **                                                  | ** ** | ** **                                                                  | ** ** | **$**      | **312,043** | ** **      | **$**      | **286,997** | ** ** |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| **CONTROL  INVESTMENTS**                          |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| BERTL, Inc.                                  |                                                                     | Service-web-based evaluator of digital imaging  products    |       | Line of Credit, $842 available (non-accrual, Due  10/2009) (10)(13)(15)     |       | $          | 930         |            | $          | — |   |
|                                              | Common Stock (8) (15)                                               |                                                        | 424        |                                                                        | —     |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Clinton Holdings,  LLC                            |                                                                     | Distribution-aluminum sheets and stainless steel            |       | Senior Subordinated Term Debt (12.0%, Due 1/2013)  (5) (14)            |       | 15,500     |        | 12,013          |       |
|                                              | Escrow Funding Note (12.0%, Due 1/2013) (5) (14)                    |                                                        | 640        |                                                                        | 496        |       |
|                                              | Common Stock Warrants (8) (15)                                      |                                                        | 109        |                                                                        | —     |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Defiance  Integrated Technologies, Inc.      |                                                                     | Manufacturing-trucking parts                                |       | Senior Term Debt (11.0%, Due 4/2010) (3) (11)                          |       | 6,005      |        | 6,005           |       |
|                                              | Senior Term Debt (11.0%, Due 4/2010) (3) (11)                       |                                                        | 1,178      |                                                                        | 1,178      |       |
|                                              | Common Stock (8) (15)                                               |                                                        | 1          |                                                                        | 816        |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Lindmark  Acquisition, LLC                        |                                                                     | Service-advertising                                         |       | Senior Subordinated Term Debt (11.3%, Due 10/2012)  (15) (16)               |       | 12,000     |        | 10,410          |       |
|                                              |                                                                     |                                                        |       | Senior Subordinated Term Debt (13.0%, Due Upon  Demand) (15) (16)           |       | 1,553      |        | 1,049           |       |
|                                              |                                                                     |                                                        |       | Common Stock (8) (15)                                                  |       | 1          |        | —          |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| LYP Holdings  Corp.                               |                                                                     | Service-yellow pages publishing                        |       | Line of credit, $1,250 available (10.0%, Due 7/2010)  (15)                  |       | 1,168      |        | 1,168           |       |
|                                              |                                                                     |                                                        |       | Senior Term Debt (12.5%, Due 2/2012) (15)                                   |       | 325        |        | 325             |       |
|                                              |                                                                     |                                                        |       | Line of Credit, $3,000 available (non-accrual, Due  6/2010) (10) (15)  |       | 1,170      |        | 421             |       |
|                                              |                                                                     |                                                        |       | Senior Term Debt (non-accrual, Due 6/2011)  (10) (15)                  |       | 2,688      |        | —          |       |
|                                              |                                                                     |                                                        |       | Senior Term Debt (non-accrual, Due 6/2011)  (3) (10) (15)         |       | 2,750      |        | —          |       |
|                                              |                                                                     |                                                        |       | Common Stock Warrants (8) (15)                                         |       | —     |        | —          |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| U.S. Healthcare  Communications, Inc.        |                                                                     | Service-magazine publisher/operator                         |       | Line of credit, $200 available (non-accrual, Due  3/2010) (10) (15)    |       | 169        |        | 91              |       |
|                                              | Line of credit, $450 available (non-accrual, Due 3/2010)  (10) (15) |                                                        | 450        |                                                                        | —     |       |
|                                              | Common Stock (8) (15)                                               |                                                        | 2,470      |                                                                        | —     |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| Western  Directories, Inc.                   |                                                                     | Service-directory publisher                                 |       | Line of credit, $1,250 available (non-accrual, Due  12/2009) (10) (15) |       | 1,234      |        | —          |       |
|                                              |                                                                     |                                                        |       | Preferred Stock (8) (15)                                               |       | 1,584      |        | —          |       |
|                                              |                                                                     |                                                        |       | Common Stock (8) (15)                                                  |       | 1          |        | —          |       |
|                                              |                                                                     |                                                        |       |                                                                        |       |       |        |            |       |
| **Total  Control Investments**                    | ** **                                                               | ** **                                                  | ** ** | ** **                                                                  | ** ** | **$**      | **52,350**  | ** **      | **$**      | **33,972** | ** ** |
| ** **                                        | ** **                                                               | ** **                                                  | ** ** | ** **                                                                  | ** ** | ** ** | ** **  | ** **      | ** ** |
| **Total  Investments (17)**                       |                                                                     |                                                        |       |                                                                        | ** ** | **$**      | **364,393** | ** **      | **$**      | **320,969** | ** ** |

 

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(1)             Certain of the listed securities are issued byaffiliate(s) of the indicated portfolio company.

(2)             Percentage represents interest rates in effect at September 30,2009 and due date represents the contractual maturity date.

(3)             Last Out Tranche of senior debt, meaning if theportfolio company is liquidated, the holder of the Last Out Tranche is paidafter the senior debt.

(4)             Last Out Tranche of senior debt, meaning if theportfolio company is liquidated, the holder of the Last Out Tranche is paidafter the senior debt, however, the debt is also junior to another Last OutTranche.

(5)             Fair value was based on opinions of value submitted byStandard & Poor’s Securities Evaluations, Inc.

(6)             Security valued based on the indicative bid price onor near September 30, 2009, offered by the respective syndication agent’strading desk or secondary desk.

(7)             Security valued based on the transaction sale pricesubsequent to September 30, 2009 (see Note 12).

(8)             Security is non-income producing.

(9)             Access Television includes a success fee with a fairvalue of $1.

(10)       BERTL, CCS, U.S. Healthcare, Western Directories and aportion of LYP Holdings are currently past due on interest payments and are onnon-accrual.  BERTL’s loan matured in October 2009and the Company is actively working to recover amounts due under thisloan.  However, there is no assurancethat there will be any recovery of amounts past due.

(11)       Fair value of security estimated to be equal to costdue to recent recapitalization.

(12)       BAS Broadcasting’s loan matured in July 2009, CCS’loan matured in August 2008 and SCI Cable’s loan matured in October 2008.  The Company is actively working to recoveramounts due under these loans, however, there is no assurance that there willbe any recovery of amounts past due.

(13)       ACE Expediters’ interest and BERTL’s interest includepaid in kind (“PIK”) interest.  Pleaserefer to Note 2 “Summary of Significant Accounting Policies.”

(14)       Subsequent to September 30, 2009, ClintonAluminum’s senior subordinated term debt and escrow funding note were combinedinto one term note, with an interest rate of 12.0% and maturity date of January 2013.  In addition, a term loan was entered into for$320, with an interest rate of 12.0% and maturity date of January 2013.

(15)       Fair value was based on the total enterprise value ofthe portfolio company using a liquidity waterfall approach.

(16)       Lindmark’s loan agreement was amended in March 2009such that any unpaid current interest accrues at a conditional interestrate.  The conditional interest is not recorded until paid (see Note 2, “Summaryof Significant Accounting Policies — *Interest IncomeRecognition*”).

(17)       Aggregate gross unrealized depreciation for federalincome tax purposes is $45,863; aggregate gross unrealized appreciation forfederal income tax purposes is $2,439. Net unrealized depreciation is $43,424 based on a tax cost of $364,393.

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIALSTATEMENTS.*

 

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**GLADSTONE CAPITALCORPORATION**

**CONSOLIDATED SCHEDULEOF INVESTMENTS**

**AS OF SEPTEMBER 30,2008**

**(DOLLAR AMOUNTS INTHOUSANDS)**

 
| **Company (1)**                                         | ** **                                                       | **Industry**                                        | ** ** | **Investment  (2)**                                      | ** ** | **Cost**   | ** ** | **Fair  Value** | ** ** |
|---------------------------------------------------------|------------------------------------------------------------------|-----------------------------------------------------|------------|----------------------------------------------------------|------------|------------|------------|-----------------|------------|
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS**               | ** **                                                       | ** **                                          | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** **      | ** ** |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| ***Non-syndicated Loans:***                             |                                                             |                                                |       |                                                     |       |       |       |            |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Access  Television Network, Inc.                   |                                                             | Service-cable airtime  (infomercials)               |       | Senior Term Debt (10.5%,  Due 3/2009) (6)                |       | $          | 1,923      |            | $          | 1,774 |   |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| ACE  Expediters, Inc                                    |                                                             | Service-over-the-ground  logistics                  |       | Line of Credit, $850  available (6.0%, Due 1/2011)       |       | —     |       | —          |       |
|                                                    |                                                             |                                                |       | Senior Term Debt (9.8%,  Due 1/2012) (6)                 |       | 11,966     |       | 11,248          |       |
|                                                    |                                                             |                                                |       | Common Stock Warrants  (8)                               |       | 200        |       | 142             |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| ActivStyle  Acquisition Co.                             |                                                             | Service-medical products  distribution              |       | Line of Credit, $1,500  available (6.7%, Due 7/2009) (6) |       | 1,100      |       | 1,059           |       |
|                                                    | Senior Term Debt (8.5%,  Due 9/2012) (6)                         |                                                | 4,721      |                                                     | 4,543      |       |
|                                                    | Senior Term Debt (10.5%,  Due 9/2012) (3) (6)               |                                                | 4,435      |                                                     | 4,213      |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Allison  Publications, LLC                              |                                                             | Service-publisher of  consumer oriented magazines   |       | Line of Credit, $4,000  available (9.0%, Due 9/2010)     |       | —     |       | —          |       |
|                                                    | Senior Term Debt (9.0%,  Due 9/2012) (6)                         |                                                | 10,465     |                                                     | 9,568      |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Anitox  Acquisition Company                             |                                                             | Manufacturing-preservatives  for animal feed        |       | Line of Credit, $3,000  available (6.7%, Due 1/2010) (6) |       | 2,000      |       | 1,880           |       |
|                                                    | Senior Term Debt (8.5%,  Due 1/2012) (6)                         |                                                | 3,388      |                                                     | 3,185      |       |
|                                                    | Senior Term Debt (10.5%,  Due 1/2012) (3) (6)               |                                                | 3,688      |                                                     | 3,388      |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Badanco  Acquisition Corp.                              |                                                             | Service-luggage design  and distribution            |       | Senior Subordinated Term  Debt (11.5%, Due 7/2012) (6)   |       | 9,458      |       | 8,795           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| BAS  Broadcasting                                       |                                                             | Service-radio station  operator                     |       | Senior Term Debt (11.5%,  Due 7/2013) (5)                |       | 7,300      |       | 7,209           |       |
|                                                    |                                                             |                                                |       | Senior Term Debt (12.0%,  Due 7/2009) (3) (5)       |       | 1,000      |       | 988             |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| CCS,  LLC                                               |                                                             | Service-cable TV  franchise owner                   |       | Senior Term Debt (9.0%,  Due 8/2008) (6)                 |       | 728        |       | 364             |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Chinese  Yellow Pages Company                      |                                                             | Service-publisher of  Chinese language directories  |       | Line of Credit, $700  available (9.0%, Due 9/2010) (6)   |       | 575        |       | 529             |       |
|                                                    | Senior Term Debt (9.0%,  Due 9/2010) (6)                         |                                                | 702        |                                                     | 638        |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Clinton  Holdings, LLC                                  |                                                             | Distribution-aluminum  sheets and stainless steel   |       | Senior Subordinated Term  Debt (12.0%, Due 1/2013) (6)   |       | 15,500     |       | 14,880          |       |
|                                                    | Common Stock Warrants  (8)                                       |                                                | 109        |                                                     | —     |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| CMI  Acquisition, LLC                                   |                                                             | Service-recycling                                   |       | Senior Subordinated Term  Debt (10.2%, Due 11/2012) (6)  |       | 6,414      |       | 6,061           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Community  Media Corporation                            |                                                             | Service-publisher of  free weekly newspapers        |       | Senior Term Debt (7.0%,  Due 8/2012) (6)                 |       | 987        |       | 936             |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Defiance  Acquisition Corporation                       |                                                             | Manufacturing-trucking  parts                       |       | Senior Term Debt (11.0%,  Due 4/2010) (3) (6)       |       | 6,165      |       | 5,055           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Doe &  Ingalls Management LLC                  |                                                             | Distributor-specialty  chemicals                    |       | Senior Term Debt (6.8%,  Due 11/2010) (6)                |       | 3,100      |       | 2,945           |       |
|                                                    |                                                             |                                                |       | Senior Term Debt (7.8%,  Due 11/2010) (3) (6)       |       | 4,410      |       | 4,167           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Finn  Corporation                                       |                                                             | Manufacturing-landscape  equipment                  |       | Common Stock Warrants  (8)                               |       | 37         |       | 1,578           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| GFRC  Holdings LLC                                      |                                                             | Manufacturing-glass-fiber  reinforced concrete      |       | Line of Credit, $3,000  available (6.7%, Due 12/2010)    |       | —     |       | —          |       |
|                                                    | Senior Term Debt (9.3%,  Due 12/2012) (6)                        |                                                | 7,362      |                                                     | 7,105      |       |
|                                                    | Senior Subordinated Term  Debt (11.8%, Due 12/2012) (3) (6) |                                                | 6,716      |                                                     | 6,414      |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Global  Materials Technologies, Inc.               |                                                             | Manufacturing-steel wool  products and metal fibers |       | Senior Term Debt (13.0%,  Due 11/2009) (3) (6)      |       | 4,640      |       | 4,153           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Heartland  Communications Group, LLC                    |                                                             | Service-radio station  operator                     |       | Line of Credit, $500  available (10.0%, Due 12/2008) (6) |       | 105        |       | 79              |       |
|                                                    | Senior Term Debt (10.0%,  Due 5/2011) (6)                        |                                                | 4,523      |                                                     | 3,386      |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| Interfilm  Holdings, Inc.                          |                                                             | Service-slitter and  distributor of plastic films   |       | Senior Term Debt (10.5%,  Due 10/2012) (6)               |       | 5,000      |       | 4,750           |       |
|                                                    |                                                             |                                                |       |                                                     |       |       |       |            |       |
| International  Junior Golf Training Acquisition Company |                                                             | Service-golf training                               |       | Line of Credit, $1,500  available (9.2%, Due 5/2010) (6) |       | 1,400      |       | 1,288           |       |
|                                                    | Senior Term Debt (6.7%,  Due 5/2012) (6)                         |                                                | 2,551      |                                                     | 2,347      |       |
|                                                    | Senior Term Debt (10.5%,  Due 5/2012) (3) (6)               |                                                | 2,500      |                                                     | 2,288      |       |
|                                                         |                                                                  |                                                     |            |                                                          |            |            |            |                 |            |  |  |

 

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| **Company (1)**                                  | ** **                                                  | **Industry**                                                    | ** ** | **Investment  (2)**                                       | ** ** | **Cost** | ** ** | **Fair  Value** | ** ** |
|--------------------------------------------------|-------------------------------------------------------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------|------------|-----------------|------------|
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| It’s  Just Lunch International, LLC         |                                                        | Service-dating service                                          |       | Line of Credit, $750  available (6.5%, Due 6/2009) (6)    |       | $        | 550        |            | $          | 275 |   |
|                                             | Senior Term Debt (6.7%,  Due 6/2011) (6)                    |                                                            | 3,300      |                                                      | 1,650      |     |
|                                             | Senior Term Debt (10.5%,  Due 6/2011) (3) (6) (9) |                                                            | 500        |                                                      | 250        |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| KMBQ  Corporation                                |                                                        | Service-AM/FM radio  broadcaster                                |       | Line of Credit, $200  available (11.0%, Due 3/2010) (6)   |       | 153      |       | 137             |       |
|                                             |                                                        |                                                            |       | Senior Term Debt (11.0%,  Due 3/2010) (6)                 |       | 1,792    |       | 1,594           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Legend  Communications of Wyoming LLC            |                                                        | Service-operator of  radio stations                             |       | Line of Credit, $500  available (11.0%, Due 6/2011) (5)   |       | 397      |       | 392             |       |
|                                             | Senior Term Debt (11.0%,  Due 6/2013) (5)                   |                                                            | 9,250      |                                                      | 9,134      |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Lindmark  Outdoor Advertising LLC                |                                                        | Service-advertising                                             |       | Senior Subordinated Term  Debt (11.0%, Due 10/2012) (6)   |       | 11,421   |       | 9,651           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Multi-Ag  Media LLC                              |                                                        | Service-dairy magazine  publisher/information database          |       | Senior Term Debt (9.0%,  Due 12/2009) (6)                 |       | 2,072    |       | 1,853           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Newhall  Holdings, Inc.                     |                                                        | Service-distributor of  personal care products and supplements  |       | Line of Credit, $4,000  available (6.0%, Due 5/2010) (6)  |       | 2,100    |       | 1,880           |       |
|                                             | Senior Term Debt (8.3%,  Due 5/2012) (6)                    |                                                            | 4,230      |                                                      | 3,807      |     |
|                                             | Senior Term Debt (11.3%,  Due 5/2012) (3) (6)          |                                                            | 4,500      |                                                      | 4,016      |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Northern  Contours, Inc.                    |                                                        | Manufacturing-veneer and  laminate components                   |       | Senior Subordinated Term  Debt (10.0%, Due 5/2010) (6)    |       | 6,912    |       | 6,082           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Pinnacle  Treatment Centers, Inc.           |                                                        | Service-Addiction  treatment centers                            |       | Line of Credit, $500  available (6.7%, Due 12/2009)       |       | —   |       | —          |       |
|                                             |                                                        |                                                            |       | Senior Term Debt (8.5%,  Due 12/2011) (6)                 |       | 3,550    |       | 3,319           |       |
|                                             |                                                        |                                                            |       | Senior Term Debt (10.5%,  Due 12/2011) (3) (6)       |       | 7,500    |       | 6,938           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Precision  Acquisition Group Holdings, Inc. |                                                        | Manufacturing-consumable  components for the aluminum industry  |       | Equipment Note, $1,500  available (8.5%, Due 10/2011) (6) |       | 1,000    |       | 993             |       |
|                                             | Senior Term Debt (8.5%,  Due 10/2010) (6)                   |                                                            | 4,750      |                                                      | 4,714      |     |
|                                             | Senior Term Debt (11.5%,  Due 10/2010) (3) (6)         |                                                            | 4,158      |                                                      | 4,127      |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| PROFITSystems  Acquisition Co.                   |                                                        | Service-design and develop  ERP software                        |       | Line of Credit, $1,250  available (6.7%, Due 7/2009)      |       | —   |       | —          |       |
|                                             | Senior Term Debt (8.5%,  Due 7/2011) (6)                    |                                                            | 2,200      |                                                      | 2,027      |     |
|                                             | Senior Term Debt (10.5%,  Due 7/2011) (3) (6)          |                                                            | 2,900      |                                                      | 2,657      |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| RCS  Management Holding Co.                      |                                                        | Service-healthcare  supplies                                    |       | Senior Term Debt (8.5%,  Due 1/2011) (3) (6)         |       | 2,875    |       | 2,695           |       |
|                                             |                                                        |                                                            |       | Senior Term Debt (10.5%,  Due 1/2011) (4) (6)        |       | 3,060    |       | 2,815           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Reliable  Biopharmaceutical Holdings, Inc.  |                                                        | Manufacturing-pharmaceutical  and biochemical intermediates     |       | Line of Credit, $5,000  available (9.0%, Due 10/2010) (6) |       | 1,600    |       | 1,528           |       |
|                                             | Mortgage Note (9.5%, Due  10/2014) (6)                      |                                                            | 7,407      |                                                      | 7,147      |     |
|                                             | Senior Term Debt (9.0%,  Due 10/2012) (6)                   |                                                            | 1,800      |                                                      | 1,719      |     |
|                                             | Senior Term Debt (11.0%,  Due 10/2012) (3) (6)         |                                                            | 11,933     |                                                      | 11,352     |     |
|                                             | Senior Subordinated Term  Debt (12.0%, Due 10/2013) (6)     |                                                            | 6,000      |                                                      | 5,445      |     |
|                                             | Common Stock Warrants  (8)                                  |                                                            | 209        |                                                      | —     |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Saunders &  Associates                  |                                                        | Manufacturing-equipment  provider for frequency control devices |       | Line of Credit, $2,500  available (6.9%, Due 5/2009)      |       | —   |       | —          |       |
|                                             | Senior Term Debt (9.8%,  Due 5/2013) (6)                    |                                                            | 10,945     |                                                      | 10,740     |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| SCI  Cable, Inc.                            |                                                        | Service-cable, internet,  voice provider                        |       | Senior Term Debt (11.0%,  Due 10/2008) (6)                |       | 2,712    |       | 1,355           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Sunburst  Media - Louisiana, LLC                 |                                                        | Service-radio station  operator                                 |       | Senior Term Debt (9.5%,  Due 6/2011) (6)                  |       | 7,857    |       | 6,728           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Sunshine  Media Holdings                         |                                                        | Service-publisher  regional B2B trade magazines                 |       | Line of Credit, $3,000  available (11.0%, Due 5/2010) (6) |       | 700      |       | 627             |       |
|                                             | Senior Term Debt (11.0%,  Due 5/2012) (6)                   |                                                            | 17,000     |                                                      | 15,300     |     |
|                                             | Senior Term Debt (13.5%,  Due 5/2012) (3) (6)          |                                                            | 10,000     |                                                      | 8,750      |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Thibaut  Acquisition Co.                         |                                                        | Service-design and  disbribute wall covering                    |       | Line of Credit, $2,000  available (7.0%, Due 1/2011) (6)  |       | 2,000    |       | 1,838           |       |
|                                             | Senior  Term Debt (7.0%, Due 1/2011) (6)                    |                                                            | 2,013      |                                                      | 1,849      |     |
|                                             | Senior  Term Debt (10.5%, Due 1/2011) (3) (6)          |                                                            | 3,000      |                                                      | 2,685      |     |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| Tulsa  Welding School                            |                                                        | Service-private welding  school                                 |       | Line of credit, $2,000  available (9.5%, 9/2011)          |       | —   |       | —          |       |
|                                             |                                                        |                                                            |       | Senior Term Debt (9.5%,  9/2013) (5)                      |       | 4,000    |       | 4,000           |       |
|                                             |                                                        |                                                            |       | Senior Term Debt (12.8%,  9/2013) (5)                     |       | 8,000    |       | 8,000           |       |
|                                             |                                                        |                                                            |       |                                                      |       |     |       |            |       |
| VantaCore                                        |                                                        | Service-acquisition of  aggregate quarries                      |       | Senior Subordinated Term  Debt (12.0%, 8/2013) (6)        |       | 13,100   |       | 12,936          |       |
|                                                  |                                                             |                                                                 |            |                                                           |            |          |            |                 |            |  |  |

 

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| **Company (1)**                                   | ** **                                                             | **Industry**                                                | ** ** | **Investment  (2)**                                        | ** ** | **Cost** | ** **  | **Fair  Value** | ** ** |
|---------------------------------------------------|------------------------------------------------------------------------|-------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------|-------------|-----------------|------------|
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Viapack, Inc.                                |                                                                   | Manufacturing-polyethylene  film                            |       | Senior Real Estate Term  Debt (7.0%, Due 3/2011) (6)       |       | $        | 850         |            | $          | 780 |   |
|                                              |                                                                   |                                                        |       | Senior Term Debt (11.3%,  Due 3/2011) (3) (6)         |       | 4,091    |        | 3,733           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Visual  Edge Technology, Inc.                |                                                                   | Service-office equipment  distribution                      |       | Senior Subordinated Term  Debt (11.5%, Due 8/2011) (6)     |       | 5,000    |        | 2,925           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Westlake  Hardware, Inc.                     |                                                                   | Retail-hardware and  variety                                |       | Senior Subordinated Term  Debt (9.0%, Due 1/2011) (6)      |       | 15,000   |        | 13,800          |       |
|                                              |                                                                   |                                                        |       | Senior Subordinated Term  Debt (10.3%, Due 1/2011) (6)     |       | 10,000   |        | 9,000           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Winchester  Electronics                           |                                                                   | Manufacturing-high  bandwidth connectors and cables         |       | Senior Term Debt (8.0%,  Due 5/2013) (6)                   |       | 1,699    |        | 1,563           |       |
|                                              | Senior Subordinated Term  Debt (13.0%, Due 6/2013) (6)                 |                                                        | 9,950      |                                                       | 9,055      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| *Subtotal - Non-syndicated loans*                 |                                                                   |                                                        |       |                                                       |       | 371,204  |        | 340,816         |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| ***Syndicated Loans:***                           |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| AKQA  Holdings                                    |                                                                   | Service-market and  advertising                             |       | Senior Term Debt (7.7%,  Due 3/2013) (7)                   |       | $        | 8,273       |            | $          | 7,980 |   |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Bresnan  Communications, LLC                      |                                                                   | Service-telecommunications                                  |       | Senior Term Debt (4.8%,  Due 9/2013) (7)                   |       | 3,001    |        | 2,670           |       |
|                                              |                                                                   |                                                        |       | Senior Subordinated Term  Debt (7.6%, Due 3/2014) (7)      |       | 1,508    |        | 1,305           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| CHG  Companies, Inc.                         |                                                                   | Service-healthcare  staffing                                |       | Letter of Credit, $400  available (6.0%, Due 12/2012) (7)  |       | 400      |        | 356             |       |
|                                              |                                                                   |                                                        |       | Senior Term Debt (5.3%,  Due 12/2012) (7)                  |       | 1,572    |        | 1,399           |       |
|                                              |                                                                   |                                                        |       | Senior Subordinated Term  Debt (8.5%, Due 12/2013) (7)     |       | 500      |        | 425             |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Country  Road Communications LLC                  |                                                                   | Service-telecommunications                                  |       | Senior Subordinated Term  Debt (11.5%, Due 7/2013) (7)     |       | 5,973    |        | 5,880           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Emdeon  Business Services, Inc.              |                                                                   | Service-healthcare  technology solutions                    |       | Senior Term Debt (5.8%,  Due 11/2013) (7)                  |       | 2,359    |        | 2,027           |       |
|                                              | Senior Subordinated Term  Debt (8.8%, Due 5/2014) (7)                  |                                                        | 2,011      |                                                       | 1,720      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| GTM  Holdings, Inc.                          |                                                                   | Manufacturing-socks                                         |       | Senior Term Debt (8.5%,  Due 10/2013) (7)                  |       | 491      |        | 359             |       |
|                                              |                                                                   |                                                        |       | Senior Subordinated Term  Debt (11.8%, Due 4/2014) (7)     |       | 500      |        | 325             |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Greatwide  Logistics Services, Inc.          |                                                                   | Service-logistics and  transportation                       |       | Senior Term Debt  (non-accrual, Due 12/2013) (7) (10) |       | 3,950    |        | 2,765           |       |
|                                              | Senior Subordinated Term  Debt (non-accrual, Due 6/2014) (7) (10) |                                                        | 2,000      |                                                       | 700        |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Harrington  Holdings, Inc.                   |                                                                   | Service-healthcare  products distribution                   |       | Senior Term Debt (6.0%,  Due 1/2014) (7)                   |       | 2,463    |        | 2,192           |       |
|                                              | Senior Subordinated Term  Debt (9.7%, Due 1/2014) (7)                  |                                                        | 5,000      |                                                       | 3,750      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| John  Henry Holdings, Inc.                   |                                                                   | Manufacturing-packaging  products                           |       | Senior Subordinated Term  Debt (11.6%, Due 6/2011) (7)     |       | 8,000    |        | 7,600           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Kinetek  Acquisition Corp.                        |                                                                   | Manufacturing-custom  engineered motors & controls |       | Senior Term Debt (6.2%,  Due 11/2013) (7)                  |       | 1,478    |        | 1,326           |       |
|                                              | Senior Subordinated Term  Debt (9.2%, Due 5/2014) (7)                  |                                                        | 1,508      |                                                       | 1,275      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Puerto  Rico Cable Acquisition Company, Inc. |                                                                   | Service-telecommunications                                  |       | Senior Subordinated Term  Debt (11.3%, Due 1/2012) (7)     |       | 7,189    |        | 5,570           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| RedPrairie  Holding, Inc.                    |                                                                   | Service-design and  develop supply chain software           |       | Senior Term Debt (6.1%,  Due 7/2012) (7)                   |       | 4,412    |        | 4,014           |       |
|                                              | Senior Subordinated Term  Debt (9.3%, Due 1/2013) (7)                  |                                                        | 3,000      |                                                       | 2,550      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| RiskMetrics  Group Holdings, LLC                  |                                                                   | Service-develop risk and  wealth management solutions       |       | Senior Term Debt (5.8%,  Due 1/2014) (7)                   |       | 1,936    |        | 1,812           |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| United  Maritime Group, LLC                       |                                                                   | Service-cargo transport                                     |       | Senior Subordinated Term  Debt (11.2%, Due 12/2013) (7)    |       | 1,000    |        | 950             |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| Wesco  Holdings, Inc.                        |                                                                   | Service-aerospace parts  and distribution                   |       | Senior Term Debt (6.0%,  Due 9/2013) (7)                   |       | 2,451    |        | 2,212           |       |
|                                              | Senior Subordinated Term  Debt (9.5%, Due 3/2014) (7)                  |                                                        | 2,267      |                                                       | 1,980      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| WP  Evenflo Group Holdings Inc.                   |                                                                   | Manufacturing-infant and  juvenile products                 |       | Senior Term Debt (5.3%,  Due 2/2013) (7)                   |       | 1,910    |        | 1,595           |       |
|                                              | Senior Subordinated Term  Debt (8.8%, Due 2/2014) (7)                  |                                                        | 2,000      |                                                       | 1,600      |     |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| *Subtotal - Syndicated loans*                     |                                                                   |                                                        |       |                                                       |       | 77,152   |        | 66,337          |       |
|                                              |                                                                   |                                                        |       |                                                       |       |     |        |            |       |
| **Total Non-Control/Non-Affiliate Investments**   | ** **                                                             | ** **                                                  | ** ** | ** **                                                 | ** ** | **$**    | **448,356** | ** **      | **$**      | **407,153** | ** ** |

 

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| **Company (1)**                            | ** **                                                     | **Industry**                                             | ** ** | **Investment  (2)**                                                        | ** ** | **Cost**   | ** **  | **Fair  Value** | ** ** |
|--------------------------------------------|----------------------------------------------------------------|----------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|------------|-------------|-----------------|------------|
|                                       |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
| **CONTROL INVESTMENTS**                    |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
|                                       |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
| BERTL, Inc.                           |                                                           | Service-web-based  evaluator of digital imaging products |       | Line of Credit, $700  available (8.7%, Due 10/2009) (11) (12)              |       | $          | 742         |            | $          | — |   |
|                                       | Common Stock (8)                                               |                                                     | 424        |                                                                       | —     |       |
|                                       |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
| LYP  Holdings Corp.                        |                                                           | Service-yellow pages  publishing                         |       | Line of credit, $500  available (10.0%, 5/2009) (12)                       |       | 75         |        | —          |       |
|                                       |                                                           |                                                     |       | Line of Credit, $3,000  available (non-accrual, Due 6/2009) (10) (12) |       | 1,170      |        | —          |       |
|                                       |                                                           |                                                     |       | Senior Term Debt  (non-accrual, Due 6/2011) (10) (12)                 |       | 2,688      |        | —          |       |
|                                       |                                                           |                                                     |       | Senior Term Debt  (non-accrual, Due 6/2011) (3) (10) (12)        |       | 2,750      |        | —          |       |
|                                       |                                                           |                                                     |       | Common Stock Warrants  (8)                                                 |       | 1          |        | —          |       |
|                                       |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
| U.S.  Healthcare Communications, Inc. |                                                           | Service-magazine  publisher/operator                     |       | Line of credit, $200  available (non-accrual, Due 3/2010) (10)             |       | 90         |        | 90              |       |
|                                       | Line of credit, $450  available (non-accrual, Due 3/2010) (10) |                                                     | 450        |                                                                       | 450        |       |
|                                       | Common Stock (8)                                               |                                                     | 2,470      |                                                                       | 240        |       |
|                                       |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
| Western  Directories, Inc.            |                                                           | Service-directory  publisher                             |       | Line of credit, $1,000  available (10%, Due 8/2009) (12)                   |       | 69         |        | —          |       |
|                                       |                                                           |                                                     |       | Preferred Stock (8)                                                        |       | 1,584      |        | —          |       |
|                                       |                                                           |                                                     |       | Common Stock (8)                                                           |       | 1          |        | —          |       |
|                                       |                                                           |                                                     |       |                                                                       |       |       |        |            |       |
| **Total Control Investments**              | ** **                                                     | ** **                                               | ** ** | ** **                                                                 | ** ** | **$**      | **12,514**  | ** **      | **$**      | **780** | ** ** |
| ** **                                 | ** **                                                     | ** **                                               | ** ** | ** **                                                                 | ** ** | ** ** | ** **  | ** **      | ** ** |
| **Total Investments (13)**                 |                                                           |                                                     |       |                                                                       | ** ** | **$**      | **460,870** | ** **      | **$**      | **407,933** | ** ** |

 

----

(1)             Certain of the listed securities areissued by affiliate(s) of the indicated portfolio company.

(2)             Percentage represents interest rates ineffect at September 30, 2008 and due date represents the contractualmaturity date.

(3)             Last Out Tranche of senior debt, meaningif the company is liquidated, the holder of the Last Out Tranche is paid afterthe senior debt.

(4)             Last Out Tranche of senior debt, meaningif the company is liquidated, the holder of the Last Out Tranche is paid afterthe senior debt, however the debt is junior to another Last Out Tranche.

(5)             Investment estimated to be equal to costdue to recent acquisition.

(6)             Fair value was based on opinions of valuesubmitted by Standard & Poor’s Securities Evaluations, Inc.

(7)             Marketable securities, such as syndicatedloans, are valued based on the indicative bid price, as of September 30,2008, from the respective originating syndication agent’s trading desk.

(8)             Security is non-income producing.

(9)             It’s Just Lunch may borrow an additional$1,750 of the senior term debt facility, subject to certain conditionsincluding Gladstone Capital’s approval, borrowings of $500 were outstanding at September 30,2008.

(10)       Greatwide, LYP Holdings and U.S.Healthcare are currently past due on interest payments and are on non-accrual.

(11)       BERTL line of credit was overdrawn by $42as of September 30, 2008.  TheCompany is currently restructuring the line of credit.  BERTL interest is currently being capitalizedas paid in kind (“PIK”) interest.  Pleaserefer to Note 2 “Summary of Significant Accounting Policies.”

(12)       Fair value was based on the totalenterprise value of the issuer using a liquidity waterfall approach.

(13)       Aggregate gross unrealized depreciationfor federal income tax purposes is $54,477; aggregate gross unrealizedappreciation for federal income tax purposes is $1,540.  Net unrealized depreciation is $52,937 basedon a tax cost of $460,870.

 

*THE ACCOMPANYINGNOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONECAPITAL CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHAREDATA)**

 
| ** **                                                                                   | ** ** | **Year  ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| INVESTMENT INCOME                                                                            |       |                               |       |   |   |   |   |
| Interest income – non control/non affiliate  investments                                |       | $                                  | 41,134     |   | $ | 44,733 |   | $ | 35,413 |   |
| Interest income – control investments                                                   |       | 933                                |       | 64 |   | — |   |
| Interest income – cash                                                                  |       | 11                                 |       | 335 |   | 256 |   |
| Interest income – notes receivable from employees  (Refer to Note 4)                    |       | 468                                |       | 471 |   | 526 |   |
| Prepayment fees and other income                                                             |       | 72                                 |       | 122 |   | 492 |   |
| Total investment income                                                                      |       | 42,618                             |       | 45,725 |   | 36,687 |   |
|                                                                                         |       |                               |       |   |   |   |   |
| EXPENSES                                                                                     |       |                               |       |   |   |   |   |
| Interest expense                                                                             |       | 7,949                              |       | 8,284 |   | 7,226 |   |
| Loan servicing fee (Refer to Note 4)                                                         |       | 5,620                              |       | 6,117 |   | 3,624 |   |
| Base management fee (Refer to Note 4)                                                        |       | 2,005                              |       | 2,212 |   | 2,402 |   |
| Incentive fee (Refer to Note 4)                                                              |       | 3,326                              |       | 5,311 |   | 4,608 |   |
| Administration fee (Refer to Note 4)                                                         |       | 872                                |       | 985 |   | 719 |   |
| Professional fees                                                                            |       | 1,586                              |       | 911 |   | 523 |   |
| Amortization of deferred financing fees                                                      |       | 2,778                              |       | 1,534 |   | 267 |   |
| Stockholder related costs                                                                    |       | 415                                |       | 443 |   | 217 |   |
| Directors’ fees                                                                         |       | 197                                |       | 220 |   | 234 |   |
| Insurance expense                                                                            |       | 241                                |       | 227 |   | 249 |   |
| Other expenses                                                                               |       | 278                                |       | 325 |   | 328 |   |
| Expenses before credit from Adviser                                                          |       | 25,267                             |       | 26,569 |   | 20,397 |   |
| Credit to base management and incentive fees from  Adviser (Refer to Note 4)                 |       | (3,680                             | )          | (7,397 | ) | (5,971 | ) |
| Total expenses net of credit to base management and  incentive fees                          |       | 21,587                             |       | 19,172 |   | 14,426 |   |
|                                                                                         |       |                               |       |   |   |   |   |
| NET INVESTMENT INCOME                                                                        |       | 21,031                             |       | 26,553 |   | 22,261 |   |
|                                                                                         |       |                               |       |   |   |   |   |
| REALIZED AND UNREALIZED LOSS ON INVESTMENTS, DERIVATIVE  AND BORROWINGS UNDER LINE OF CREDIT |       |                               |       |   |   |   |   |
| Net realized (loss) gain on investments                                                      |       | (26,411                            | )          | (787 | ) | 44 |   |
| Realized (loss) gain on settlement of derivative                                             |       | (304                               | )          | 7 |   | 39 |   |
| Net unrealized appreciation (depreciation) on derivative                                     |       | 304                                |       | (12 | ) | (38 | ) |
| Net unrealized appreciation (depreciation) on  investments                                   |       | 9,513                              |       | (47,023 | ) | (7,354 | ) |
| Net unrealized appreciation on borrowings under  line of credit                              |       | (350                               | )          | — |   | — |   |
| Net loss on investments, derivative and borrowings  under line of credit                     |       | (17,248                            | )          | (47,815 | ) | (7,309 | ) |
|                                                                                         |       |                               |       |   |   |   |   |
| NET INCREASE (DECREASE) IN NET ASSETS RESULTING  FROM OPERATIONS                             |       | $                                  | 3,783      |   | $ | (21,262 | ) | $ | 14,952 |   |
|                                                                                         |       |                               |       |   |   |   |   |
| NET INCREASE (DECREASE) IN NET ASSETS RESULTING  FROM OPERATIONS PER COMMON SHARE            |       |                               |       |   |   |   |   |
| Basic and Diluted                                                                            |       | $                                  | 0.18       |   | $ | (1.08 | ) | $ | 1.13 |   |
| WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING                                          |       |                               |       |   |   |   |   |
| Basic and Diluted                                                                            |       | 21,087,574                         |       | 19,699,796 |   | 13,173,822 |   |

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OFTHESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**CONSOLIDATED STATEMENTS OF CHANGES INNET ASSETS**

**(DOLLAR AMOUNTS INTHOUSANDS)**

 
| ** **                                                      | ** ** | **Year ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                      | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| *Operations:*                                                   |       |                              |       |   |   |   |   |
| Net  investment income                                          |       | $                                 | 21,031     |   | $ | 26,553 |   | $ | 22,261 |   |
| Net  realized (loss) gain on sale of investments                |       | (26,411                           | )          | (787 | ) | 44 |   |
| Realized  (loss) gain on settlement of derivative               |       | (304                              | )          | 7 |   | 39 |   |
| Net  unrealized appreciation (depreciation) on derivative       |       | 304                               |       | (12 | ) | (38 | ) |
| Net  unrealized appreciation (depreciation) on investments      |       | 9,513                             |       | (47,023 | ) | (7,354 | ) |
| Net  unrealized appreciation on borrowings under line of credit |       | (350                              | )          | — |   | — |   |
| Net  increase (decrease) in net assets from operations          |       | 3,783                             |       | (21,262 | ) | 14,952 |   |
| *Distributions to stockholders from:*                           |       |                              |       |   |   |   |   |
| Net  investment income                                          |       | (20,795                           | )          | (25,945 | ) | (19,444 | ) |
| Gains                                                           |       | (27                               | )          | (285 | ) | (2,697 | ) |
| Tax  return on capital                                          |       | (5,748                            | )          | (7,149 | ) | — |   |
| Net decrease in net assets from distributions to  stockholders  |       | (26,570                           | )          | (33,379 | ) | (22,141 | ) |
| *Capital share transactions:*                                   |       |                              |       |   |   |   |   |
| Issuance  of common stock under shelf offering                  |       | —                            |       | 106,226 |   | 57,437 |   |
| Shelf  offering costs                                           |       | (41                               | )          | (852 | ) | (672 | ) |
| Repayment  of principal on employee notes                       |       | 6                                 |       | 56 |   | 301 |   |
| Reclassification  of principal on employee note                 |       | 150                               |       | — |   | — |   |
| Stock  surrendered in settlement of withholding tax             |       | —                            |       | — |   | (1,488 | ) |
| Net  increase in net assets from capital share transactions     |       | 115                               |       | 105,430 |   | 55,578 |   |
|                                                            |       |                              |       |   |   |   |   |
| Total  (decrease) increase in net assets                        |       | (22,672                           | )          | 50,789 |   | 48,389 |   |
| Net  assets at beginning of year                                |       | 271,748                           |       | 220,959 |   | 172,570 |   |
| Net  assets at end of year                                      |       | $                                 | 249,076    |   | $ | 271,748 |   | $ | 220,959 |   |

 

*THE ACCOMPANYINGNOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLAR AMOUNTS INTHOUSANDS)**

 
| ** **                                                                                                                           | ** ** | **Year ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                                                            |       |                              |       |   |   |   |   |
| Net increase (decrease) in net assets resulting  from operations                                                                     |       | $                                 | 3,783      |   | $ | (21,262 | ) | $ | 14,952 |   |
| Adjustments to reconcile net (decrease) increase in  net assets resulting from operations to net cash used in operating  activities: |       |                              |       |   |   |   |   |
| Purchase of investments                                                                                                              |       | (26,366                           | )          | (176,550 | ) | (261,700 | ) |
| Principal repayments on investments                                                                                                  |       | 47,490                            |       | 69,183 |   | 86,958 |   |
| Proceeds from sale of investments                                                                                                    |       | 49,203                            |       | 1,299 |   | 34,860 |   |
| Net amortization of premiums and discounts                                                                                           |       | (95                               | )          | 228 |   | 139 |   |
| Increase in investment balance due to payment in  kind interest                                                                      |       | (166                              | )          | (58 | ) | — |   |
| Amortization of deferred financing fees                                                                                              |       | 2,778                             |       | 1,534 |   | 267 |   |
| Realized loss on investments                                                                                                         |       | 26,411                            |       | 787 |   | 188 |   |
| Realized loss on settlement of derivative                                                                                            |       | 304                               |       | — |   | — |   |
| Unrealized (appreciation) depreciation on  derivative                                                                                |       | (304                              | )          | 12 |   | 38 |   |
| Change in net unrealized (appreciation)  depreciation on investments                                                                 |       | (9,513                            | )          | 47,023 |   | 7,354 |   |
| Change in net unrealized appreciation on borrowings  under line of credit                                                            |       | 350                               |       | — |   | — |   |
| Decrease (increase) in interest receivable                                                                                           |       | 546                               |       | (1,232 | ) | (1,015 | ) |
| Decrease (increase) in funds due from custodian                                                                                      |       | 1,485                             |       | (1,313 | ) | 357 |   |
| (Increase) decrease in prepaid assets                                                                                                |       | (35                               | )          | 31 |   | (111 | ) |
| Increase in due from affiliate                                                                                                       |       | (69                               | )          | — |   | — |   |
| Increase in other assets                                                                                                             |       | (845                              | )          | (490 | ) | (185 | ) |
| Increase in accounts payable                                                                                                         |       | 59                                |       | 2 |   | 2 |   |
| (Decrease) increase in interest payable                                                                                              |       | (268                              | )          | 59 |   | 340 |   |
| Increase in accrued expenses and deferred  liabilities                                                                               |       | 472                               |       | 537 |   | 69 |   |
| Increase (decrease) in fees due to affiliate (Refer  to Note 4)                                                                      |       | 377                               |       | (252 | ) | 468 |   |
| (Decrease) increase in administration fee due to  GladstoneAdministration  (Refer to Note 4)                                         |       | (31                               | )          | 10 |   | 238 |   |
| (Decrease) increase in funds held in escrow                                                                                          |       | (45                               | )          | 234 |   | (203 | ) |
| Net cash provided by (used in) operating activities                                                                                  |       | 95,521                            |       | (80,218 | ) | (116,984 | ) |
|                                                                                                                                 |       |                              |       |   |   |   |   |
| **CASH FLOW FROM INVESTING  ACTIVITIES**                                                                                             |       |                              |       |   |   |   |   |
| Redemption (purchase) of U.S. Treasury Bill                                                                                          |       | —                            |       | 2,484 |   | (2,484 | ) |
| Net cash provided by (used in) investing activities                                                                                  |       | —                            |       | 2,484 |   | (2,484 | ) |
|                                                                                                                                 |       |                              |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                                                                            |       |                              |       |   |   |   |   |
| Net proceeds from the issuance of common shares                                                                                      |       | —                            |       | 106,226 |   | 57,437 |   |
| Shelf offering costs                                                                                                                 |       | (41                               | )          | (852 | ) | (673 | ) |
| Borrowings from the line of credit                                                                                                   |       | 48,800                            |       | 200,618 |   | 305,600 |   |
| Repayments on the line of credit                                                                                                     |       | (116,830                          | )          | (194,028 | ) | (211,153 | ) |
| Distributions paid                                                                                                                   |       | (26,570                           | )          | (33,379 | ) | (22,141 | ) |
| Receipt of principal on notes receivable –  employees (Refer to Note 4)                                                         |       | 6                                 |       | 56 |   | 301 |   |
| Deferred financing fees                                                                                                              |       | (2,103                            | )          | (3,253 | ) | (308 | ) |
| Withholding tax obligation settlement                                                                                                |       | —                            |       | — |   | (1,488 | ) |
| Net cash (used in) provided by financing activities                                                                                  |       | (96,738                           | )          | 75,388 |   | 127,575 |   |
|                                                                                                                                 |       |                              |       |   |   |   |   |
| **NET (DECREASE) INCREASE IN CASH  AND CASH EQUIVALENTS**                                                                            |       | (1,217                            | )          | (2,346 | ) | 8,107 |   |
| **CASH, BEGINNING OF YEAR**                                                                                                          |       | 6,493                             |       | 8,839 |   | 732 |   |
| **CASH, END OF YEAR**                                                                                                                |       | $                                 | 5,276      |   | $ | 6,493 |   | $ | 8,839 |   |
| **CASH PAID DURING PERIOD FOR  INTEREST**                                                                                            |       | $                                 | 8,278      |   | $ | 8,226 |   | $ | 6,886 |   |
| **CASH PAID DURING PERIOD FOR TAXES**                                                                                                |       | $                                 | —     |   | $ | 7 |   | $ | — |   |
| **NON-CASH FINANCING ACTIVITIES**                                                                                                    |       |                              |       |   |   |   |   |
| Reclassification of  principal on employee note (Refer to Note 4)                                                                    |       | $                                 | 150        |   | $ | — |   | $ | — |   |
| Cancellation of employee  note receivable (Refer to Note 4)                                                                          |       | $                                 | —     |   | $ | — |   | $ | 717 |   |

 

*THE ACCOMPANYINGNOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATION**

**FINANCIAL HIGHLIGHTS**

**(DOLLAR AMOUNTS INTHOUSANDS, EXCEPT PER SHARE AND PER UNIT DATA)**

 
| ** **                                                      | ** ** | **Year ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                      | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Per Share Data (1)                                              |       |                              |       |   |   |   |   |
| Net asset value at beginning of period                          |       | $                                 | 12.89      |   | $ | 14.97 |   | $ | 14.02 |   |
| *Income from investment operations*(2)                          |       |                              |       |   |   |   |   |
| Net investment income                                           |       | 1.00                              |       | 1.35 |   | 1.69 |   |
| Net realized loss on the sale of investments                    |       | (1.25                             | )          | (0.04 | ) | — |   |
| Realized loss on settlement of derivative                       |       | (0.01                             | )          | — |   | — |   |
| Net unrealized appreciation on derivative                       |       | 0.01                              |       | — |   | — |   |
| Net unrealized (depreciation) appreciation on  investments      |       | 0.45                              |       | (2.39 | ) | (0.56 | ) |
| Net unrealized appreciation on borrowings under  line of credit |       | (0.02                             | )          | — |   | — |   |
| Total from investment operations                                |       | 0.18                              |       | (1.08 | ) | 1.13 |   |
| *Distributions to stockholders  from*(2)(3)                     |       |                              |       |   |   |   |   |
| Net investment income                                           |       | (0.99                             | )          | (1.31 | ) | (1.48 | ) |
| Gains                                                           |       | —                            |       | (0.01 | ) | (0.20 | ) |
| Tax return on capital                                           |       | (0.27                             | )          | (0.36 | ) | — |   |
| Total distributions                                             |       | (1.26                             | )          | (1.68 | ) | (1.68 | ) |
| *Capital share transactions*                                    |       |                              |       |   |   |   |   |
| Issuance of common stock under shelf offering                   |       | —                            |       | 0.72 |   | 1.55 |   |
| Offering costs                                                  |       | —                            |       | (0.04 | ) | (0.05 | ) |
| Repayment of principal on notes receivable                      |       | —                            |       | — |   | 0.06 |   |
| Stock surrendered to settle withholding tax  obligation         |       | —                            |       | — |   | (0.06 | ) |
| Total from capital share transactions                           |       | —                            |       | 0.68 |   | 1.50 |   |
| Net asset value at end of period                                |       | $                                 | 11.81      |   | $ | 12.89 |   | $ | 14.97 |   |
|                                                            |       |                              |       |   |   |   |   |
| Per share market value at beginning of period                   |       | $                                 | 15.24      |   | $ | 19.52 |   | $ | 22.01 |   |
| Per share market value at end of period                         |       | $                                 | 8.93       |   | $ | 15.24 |   | $ | 19.52 |   |
| Total return (4)                                                |       | (30.94                            | )%         | (13.90 | )% | (4.40 | )% |
| Shares outstanding at end of period                             |       | 21,087,574                        |       | 21,087,574 |   | 14,762,574 |   |
|                                                            |       |                              |       |   |   |   |   |
| Statement of Assets and Liabilities Data                        |       |                              |       |   |   |   |   |
| Net assets at end of period                                     |       | $                                 | 249,076    |   | $ | 271,748 |   | $ | 220,959 |   |
| Average net assets(5)                                           |       | $                                 | 253,316    |   | $ | 284,304 |   | $ | 189,732 |   |
| Senior Securities Data                                          |       |                              |       |   |   |   |   |
| Borrowing under line of credit                                  |       | $                                 | 83,350     |   | $ | 151,030 |   | $ | 144,440 |   |
| Asset coverage ratio (6)(7)                                     |       | 399                               | %          | 286 | % | 259 | % |
| Average coverage per unit (7)                                   |       | $                                 | 3,988      |   | $ | 2,860 |   | $ | 2,594 |   |
| Ratios/Supplemental Data                                        |       |                              |       |   |   |   |   |
| Ratio of expenses to average net assets (8)                     |       | 9.97                              | %          | 9.34 | % | 10.75 | % |
| Ratio of net expenses to average net assets (9)                 |       | 8.52                              | %          | 6.74 | % | 7.60 | % |
| Ratio of net investment income to average net  assets           |       | 8.30                              | %          | 9.34 | % | 11.73 | % |

 

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(1)   Basedon actual shares outstanding at the end of the corresponding period.

(2)   Basedon weighted average basic per share data.

(3)   Distributions are determined based ontaxable income calculated in accordance with income tax regulations which maydiffer from amounts determined under accounting principles generally acceptedin the United States of America.

 

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(4)   Totalreturn equals the change in the ending market value of the Company’s commonstock from the beginning of the period taking into account dividends reinvestedin accordance with the terms of its dividend reinvestment plan. Total returndoes not take into account dividends that may be characterized as a return ofcapital. For further information on estimated character of the Company’sdividends please refer to Note 9.

(5)   Averagenet assets are computed using the average of the balance of net assets at theend of each month of the reporting period.

(6)   As a business development company, theCompany is generally required to maintain a ratio of at least 200% of totalassets, less all liabilities and indebtedness not represented by senior securities,to total borrowings.

(7)   Asset coverage ratio is the ratio of thecarrying value of the Company’s total consolidated assets, less all liabilitiesand indebtedness not represented by senior securities, to the aggregate amountof senior securities representing indebtedness. Asset coverage per unit is theasset coverage ratio expressed in terms of dollar amounts per $1,000 ofindebtedness.

8)     Ratioof expenses to average net assets is computed using expenses before creditsfrom Adviser to the base management and incentive fees and including income taxexpense.

(9)   Ratioof net expenses to average net assets is computed using total expenses net ofcredits from Adviser to the base management and incentive fees and includingincome tax expense.

 

*THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OFTHESE CONSOLIDATED FINANCIAL STATEMENTS.*

 

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**GLADSTONE CAPITAL CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30,2009**

**(DOLLAR AMOUNTS INTHOUSANDS, EXCEPT PER SHARE DATA AND AS OTHERWISE INDICATED)**

 

**Note 1.Organization**

 

GladstoneCapital Corporation (the “Company”) was incorporated under the GeneralCorporation Laws of the State of Maryland on May 30, 2001.  The Company is a closed-end, non-diversifiedmanagement investment company that has elected to be treated as a businessdevelopment company (“BDC”) under the Investment Company Act of 1940, asamended (the “1940 Act”).  In addition,the Company has elected to be treated for tax purposes as a regulatedinvestment company (“RIC”) under the Internal Revenue Code of 1986, as amended(the “Code”).  The Company’s investmentobjectives are to achieve a high level of current income by investing in debtsecurities, consisting primarily of senior notes, senior subordinated notes andjunior subordinated notes, of established private businesses that aresubstantially owned by leveraged buyout funds, individual investors or arefamily-owned businesses, with a particular focus on senior notes. In addition,the Company may acquire from others existing loans that meet this profile.

 

GladstoneBusiness Loan, LLC (“Business Loan”), a wholly-owned subsidiary of the Company,was established on February 3, 2003 for the purpose of holding the Company’sportfolio of loan investments.  GladstoneCapital Advisers, Inc. is also a wholly-owned subsidiary of the Company,which was established on December 30, 2003.

 

GladstoneSBIC, LP (“Gladstone SBIC”) and Gladstone SBIC GP, LLC, the general partner ofGladstone SBIC, were established on December 4, 2008 as wholly-ownedsubsidiaries of the Company for the purpose of applying for and holding alicense to enable the Company, through Gladstone SBIC, to make investments inaccordance with the United States Small Business Administration guidelines forsmall business investment companies.

 

GladstoneFinancial Corporation (“Gladstone Financial”), a wholly-owned subsidiary of theCompany, was established on November 21, 2006 for the purpose of holding alicense to operate as a Specialized Small Business Investment Company.  Gladstone Financial (previously known asGladstone SSBIC Corporation) acquired this license in February 2007.  This will enable the Company, through thissubsidiary, to make investments in accordance with the United States SmallBusiness Administration guidelines for specialized small business investmentcompanies.

 

Thefinancial statements of the subsidiaries are consolidated with those of theCompany.

 

TheCompany is externally managed by Gladstone Management Corporation (the “Adviser”),an unconsolidated affiliate of the Company.

 

**Note 2.Summary of Significant Accounting Policies**

 

*Basisof Presentation*

 

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries. All significant intercompany balances andtransactions have been eliminated.

 

*Consolidation*

 

Under Article 6 ofRegulation S-X under the Securities Act of 1933, as amended, and theauthoritative accounting guidance provided by the AICPA Audit and AccountingGuide for Investment Companies, the Company is not permitted to consolidate anysubsidiary or other entity that is not an investment company.

 

*Use ofEstimates*

 

The consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) thatrequire management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Actual results maydiffer from those estimates.

 

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*Cashand Cash Equivalents*

 

Cash and cash equivalentsconsist of demand deposits and highly liquid investments with originalmaturities of three months or less when purchased. Cash is carried at costwhich approximated fair value as of September 30, 2009 and September 30,2008.  There were no cash equivalents asof September 30, 2009 and September 30, 2008.

 

*Concentrationof Credit Risk*

 

The Company places itscash and cash equivalents with financial institutions and, at times, cash heldin accounts may exceed the Federal Deposit Insurance Corporation insuredlimit.  The Company seeks to mitigatethis risk by depositing funds with major financial institutions.

 

*Classificationof Investments*

 

The1940 Act requires classification of the Company’s investments by its respectivelevel of control.  As defined in the 1940Act, “Control Investments” are investments in those portfolio companies thatthe Company is deemed to “Control.”  “AffiliateInvestments” are investments in those portfolio companies that are “AffiliatedCompanies” of the Company, as defined in the 1940 Act, other than ControlInvestments.  “Non-Control/Non-AffiliateInvestments” are those that are neither Control Investments nor AffiliateInvestments.  In general, the 1940 Actprescribes that the Company has control over a portfolio company if it ownsgreater than 25% of the voting securities of the portfolio company.  The Company is deemed to be an affiliate of aportfolio company if it owns between 5% and 25% of the voting securities ofsuch portfolio company or has one or more seats on the affiliated company’sboard of directors.  However, if theCompany holds 50% or more contractual representation on a portfolio company’sboard of directors, the Company will be deemed to have control over theportfolio company.

 

*InvestmentValuation Policy*

 

The Company carries itsinvestments at market value to the extent that market quotations are readilyavailable and reliable, and otherwise at fair value, as determined in goodfaith by its Board of Directors.  Indetermining the fair value of the Company’s investments, the Adviser hasestablished an investment valuation policy (the “Policy”).  The Policy is approved by the Company’s Boardof Directors and each quarter the Board of Directors reviews whether theAdviser has applied the Policy consistently and votes whether or not to acceptthe recommended valuation of the Company’s investment portfolio.

 

The Company usesgenerally accepted valuation techniques to value its portfolio unless theCompany has specific information about the value of an investment to determineotherwise. From time to time the Company may accept an appraisal of a businessin which the Company holds securities. These appraisals are expensive and occurinfrequently but provide a third-party valuation opinion that may differ inresults, techniques and scopes used to value the Company’s investments.  When these specific third-party appraisalsare engaged or accepted, the Company uses estimates of value provided by suchappraisals and its own assumptions including estimated remaining life, currentmarket yield and interest rate spreads of similar securities as of themeasurement date to value the investment the Company has in that business.

 

The Policy, which issummarized below, applies to publicly-traded securities, securities for which alimited market exists, and securities for which no market exists.

 

**Publicly-tradedsecurities:** TheCompany determines the value of publicly-traded securities based on the closingprice for the security on the exchange or securities market on which it islisted and primarily traded on the valuation date.  To the extent that the Company owns restrictedsecurities that are not freely tradable, but for which a public marketotherwise exists, the Company will use the market value of that securityadjusted for any decrease in value resulting from the restrictive feature.

 

**Securitiesfor which a limited market exists:** The Company values securities that are not traded onan established secondary securities market, but for which a limited market forthe security exists, such as certain participations in, or assignments of,syndicated loans, at the quoted bid price. In valuing these assets, the Company assesses trading activity in anasset class and evaluates variances in prices and other market insights todetermine if any available quote prices are reliable.  If the Company concludes that quotes based onactive markets or trading activity may be relied upon, firm bid prices arerequested; however, if a firm bid price is unavailable, the Company bases thevalue of the security upon the indicative bid price offered by the respectiveoriginating syndication agent’s trading desk, or secondary desk, on or near thevaluation date. 

 

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To the extent that theCompany uses the indicative bid price as a basis for valuing the security, theAdviser may take further steps to consider additional information to validatethat price in accordance with the Policy.

 

In the event theselimited markets become illiquid such that market prices are no longer readilyavailable, the Company will value its syndicated loans using estimated netpresent values of the future cash flows or discounted cash flows (“DCF”). Theuse of a DCF methodology follows that prescribed by the Financial AccountingStandards Board (“FASB”) AccountingStandards Codification (“ASC”) 820,“Fair Value Measurements and Disclosures,” which provides guidance onthe use of a reporting entity’s own assumptions about future cash flows andrisk-adjusted discount rates when relevant observable inputs, such as quotes inactive markets, are not available. When relevant observable market data doesnot exist, the alternative outlined in ASC820 is the use of valuing investments based on DCF.  For the purposes of using DCF to provide fairvalue estimates, the Company considers multiple inputs such as a risk-adjusteddiscount rate that incorporates adjustments that market participants would makeboth for nonperformance and liquidity risks. As such, the Company develops a modified discount rate approach thatincorporates risk premiums including, among others, increased probability ofdefault, or higher loss given default, or increased liquidity risk. The DCFvaluations applied to the syndicated loans provide an estimate of what theCompany believes a market participant would pay to purchase a syndicated loanin an active market, thereby establishing a fair value.  The Company will apply the DCF methodology inilliquid markets until quoted prices are available or are deemed reliable basedon trading activity.

 

As of September 30,2009, the Company assessed trading activity in its syndicated loan assets anddetermined that there had been a return to market liquidity and a betterfunctioning secondary market for these assets. Thus, firm bid prices or indicative bids were used to fair value theCompany’s remaining syndicated loans at September 30, 2009.   However, for those syndicated loans wheresales were completed after September 30, 2009, the Company used therespective sales prices to value those syndicated loans.

 

**Securitiesfor which no market exists:** The valuation methodology for securities for which nomarket exists falls into three categories: (1) portfolio investmentscomprised solely of debt securities; (2) portfolio investments in controlledcompanies comprised of a bundle of securities, which can include debt andequity securities, or both; and (3) portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities.

 

**(1)****        ****Portfolio investments comprisedsolely of debt securities:** Debt securities that are not publicly-traded on anestablished securities market, or for which a limited market does not exist (“Non-PublicDebt Securities”), and that are issued by portfolio companies where the Companyhas no equity or equity-like securities, are fair valued in accordance with theterms of the Policy, which utilizes opinions of value submitted to the Companyby Standard & Poor’s Securities Evaluations, Inc. (“SPSE”). TheCompany may also submit paid in kind (“PIK”) interest to SPSE for theirevaluation when it is determined the PIK interest is likely to be received.

 

**(2)****        ****Portfolio investments in controlledcompanies comprised of a bundle of investments, which can include debt and equitysecurities:** Thefair value of these investments is determined based on the total enterprisevalue of the portfolio company, or issuer, utilizing a liquidity waterfallapproach, for the Company’s Non-Public Debt Securities and equity orequity-like securities (e.g. preferred equity, equity, or other equity-likesecurities) that are purchased together as part of a package, where the Companyhas control or could gain control through an option or warrant security, boththe debt and equity securities of the portfolio investment would exit in themergers and acquisition market as the principal market, generally through asale or recapitalization of the portfolio company. In accordance with ASC820-10, the Company applies the in-use premise of value which assumes the debtand equity securities are sold together. Under this liquidity waterfallapproach, the Company first calculates the total enterprise value of the issuerby incorporating some or all of the following factors to determine the totalenterprise value of the issuer:

 

·                  the issuer’s ability to make payments;

·                  the earnings of the issuer;

·                  recent sales to third parties of similar securities;

·                  the comparison to publicly traded securities; and

·                  DCF or other pertinent factors.

 

In gathering the sales tothird parties of similar securities, the Company may reference industrystatistics and use outside experts. Once the Company has estimated the totalenterprise value of the issuer, the Company will subtract the value of all thedebt securities of the issuer , which are valued at the contractual principalbalance. Fair values of these debt securities are discounted for any shortfallof total enterprise value over the total debt outstanding for the issuer. Oncethe 

 

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values for alloutstanding senior securities (which include the debt securities) have beensubtracted from the total enterprise value of the issuer, the remaining amount,if any, is used to determine the value of the issuer’s equity or equity likesecurities.  If, in the Adviser’sjudgment, the liquidity waterfall approach does not accurately reflect thevalue of the debt component, the Adviser may recommend that the Company use avaluation by SPSE, or if that is unavailable, a DCF valuation technique.

 

**(3)****        ****Portfolio investments innon-controlled companies comprised of a bundle of investments, which caninclude debt and equity securities:**The Company values Non-Public Debt Securities that arepurchased together with equity and equity-like securities from the sameportfolio company, or issuer, for which the Company does not control or cannotgain control as of the measurement date, using a hypothetical secondary marketas the Company’s principal market. In accordance with ASC 820-10, the Companydetermines its fair value of these debt securities of non-control investmentsassuming the sale of an individual debt security using the in-exchange premiseof value. As such, the Company estimates the fair value of the debt componentusing estimates of value provided by SPSE and its own assumptions in theabsence of observable market data, including synthetic credit ratings,estimated remaining life, current market yield and interest rate spreads ofsimilar securities as of the measurement date. Subsequent to June 30,2009, for equity or equity-like securities of investments for which the Companydoes not control or cannot gain control as of the measurement date, the Companyestimates the fair value of the equity using the in-exchange premise of valuebased on factors such as the overall value of the issuer, the relative fairvalue of other units of account including debt, or other relative valueapproaches. Consideration also is given to capital structure and othercontractual obligations that may impact the fair value of the equity. Further,the Company may utilize comparable values of similar companies, recentinvestments and indices with similar structures and risk characteristics or itsown assumptions in the absence of other observable market data and may alsoemploy DCF valuation techniques.

 

Due to the uncertaintyinherent in the valuation process, such estimates of fair value may differsignificantly from the values that would have been obtained had a ready marketfor the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains or losses ultimately realizedon these investments to be different than the valuations currently assigned.There is no single standard for determining fair value in good faith, as fairvalue depends upon circumstances of each individual case. In general, fairvalue is the amount that the Company might reasonably expect to receive uponthe current sale of the security in an arms-length transaction in the security’sprincipal market.

 

Refer to Note 3 foradditional information regarding fair value measurements and the Company’s adoptionof ASC 820-10.

 

*InterestIncome Recognition*

 

Interestincome, adjusted for amortization of premiums and acquisition costs and for theaccretion of discounts, is recorded on the accrual basis to the extent thatsuch amounts are expected to be collected. Generally, when a loan becomes 90 days or more pastdue or if the Company’s qualitative assessment indicates that the debtor isunable to service its debt or other obligations, the Company will place theloan on non-accrual status and cease recognizing interest income on that loanuntil the borrower has demonstrated the ability and intent to pay contractualamounts due.  However, the Companyremains contractually entitled to this interest.  At September 30,2009, one Non-Control/Non-Affiliate investment and four Control investmentswere on non-accrual with an aggregate cost basis of approximately $10,022, or2.8% of the cost basis of all loans in the Company’s portfolio.  At September 30, 2008, oneNon-Control/Non-Affiliate investment and two Control investments were onnon-accrual with a cost basis of approximately $13,098 at September 30,2008, or 2.8% of the cost basis of all loans in the Company’s portfolio.  Conditionalinterest, or a success fee, is recorded when earned or upon full repayment of aloan investment.

 

*Paid inKind Interest*

 

The Company has two loansin its portfolio which contain PIK provisions. The PIK interest, computed atthe contractual rate specified in each loan agreement, is added to theprincipal balance of the loan and recorded as income. To maintain the Company’sstatus as a RIC, this non-cash source of income must be paid out tostockholders in the form of dividends, even though the Company has not yetcollected the cash.   For the fiscal yearended September 30, 2009, the Company recorded PIK income of $162.  For the fiscal year ended September 30,2008, the Company recorded PIK income of $62. There was no PIK income recorded during the fiscal year ended September 30,2007.

 

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*ServicesProvided to Portfolio Companies*

 

As a business developmentcompany under the 1940 Act, the Company is required to make availablesignificant managerial assistance to its portfolio companies.  The company provides these services throughits Adviser, who provides these services on the Company’s behalf through itsofficers, who are also the Company’s officers.  Currently, neither the Company nor the Adviser receives fees inconnection with managerial assistance.

 

The Adviser receives feesfor other services it provides to the Company’s portfolio companies.  These other fees are typically non-recurring,are recognized as revenue when earned and are generally paid directly to theAdviser by the borrower or potential borrower upon closing of theinvestment.  The services the Adviserprovides to portfolio companies vary by investment, but generally include abroad array of services, such as investment banking services, arranging bankand equity financing, structuring financing from multiple lenders andinvestors, reviewing existing credit facilities, restructuring existinginvestments, raising equity and debt capital, consulting turnaround management,merger and acquisition services and recruiting new management personnel.  When the Adviser receives fees for theseservices, 50% of certain of those fees are credited against the base managementfee that the Company pays to its Adviser, while others are reimbursements forcosts associated with the engagement. Any services of this nature subsequent to the closing would typicallygenerate a separate fee at the time of completion.

 

The Adviser also receivesfees for monitoring and reviewing portfolio company investments.  These fees are recurring and are generallypaid annually or quarterly in advance to the Adviser throughout the life of theinvestment.  Fees of this nature arerecorded as revenue by the Adviser when earned and are not credited against thebase management fee.

 

The Company may receivefees for non-recurring consulting or origination and closing services itprovides to portfolio companies through its Adviser. These fees are paiddirectly to the Company and are recognized as revenue upon closing of the servicesprovided and are reported as fee income in the consolidated statements ofoperations.

 

As of September 30,2009 and 2008, Other Assets in the accompanying consolidated statements ofassets and liabilities included $1,529 and $560, respectively, of reimbursementsfor non-recurring costs incurred on behalf of the portfolio companies.

 

*Realized Gain or Loss andUnrealized Appreciation or Depreciation of Portfolio Investments*

 

Gains or losses on thesale of investments are calculated by using the specific identificationmethod.  Realized gain or loss is recognized when an investment is disposed ofand is computed as the difference between the Company’s cost basis in theinvestment at the disposition date and the net proceeds received from suchdisposition.  Unrealized appreciation ordepreciation displays the difference between the fair market value of theinvestment and the cost basis of such investment.  Unlike banks, the Company is notpermitted to provide a general reserve for anticipated loan losses.  Instead, the Company must determine the fairvalue of each individual investment on a quarterly basis and record changes infair value as unrealized appreciation or depreciation in its consolidatedstatement of operations.

 

*Deferred Finance Costs*

 

Costs associated with theCompany’s line ofcredit facility with Key Equipment Finance Inc. are deferred and amortized overthe life of the credit facility, generally for a period of one year.  These costs are amortized in the consolidatedstatement of operations as amortization of deferred financing fees using thestraight line method, which closely approximates the effective interest method.

 

*InvestmentAdvisory and Management Agreement with Gladstone Management Corporation*

 

The Company is externallymanaged pursuant to contractual arrangements with its Adviser and awholly-owned subsidiary of the Adviser, Gladstone Administration, LLC (the “Administrator”),under which its Adviser and Administrator employ all of the Company’s personneland pay its payroll, benefits, and general expenses directly.  On October 1, 2006, the Company enteredinto an amended and restated investment advisory agreement (the “AdvisoryAgreement”) with the Adviser and an administration agreement (the “AdministrationAgreement”) with the Administrator. (Please refer to Note 4. Related Party Transactions ).

 

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Under the AdvisoryAgreement, the Company pays a 2% annual base management fee computed on thebasis of the Company’s average gross assets, which are total assets, includinginvestments made with the proceeds of borrowings, less any uninvested cash orcash equivalents resulting from borrowings, valued at the end of the two mostrecently completed calendar quarters, and appropriately adjusted for any shareissuances or repurchases during the current calendar quarter.  During the fiscal year ended September 30,2007, the Adviser’s board of directors waived the amount of the fee on seniorsyndicated loans from an annual rate of 2% to 0.5%.  Effective April 1, 2007, when theCompany’s Adviser receives fees from the Company’s portfolio companies, such asinvestment banking fees, structuring fees or executive recruiting servicesfees, 50%  of certain of these fees will be credited against the basemanagement fee that the Company would otherwise be required to pay to theCompany’s Adviser.  Prior to April 1,2007, certain of such fees were 100% credited against the 2% base managementfee.

 

In addition, the Company’sAdviser services the loans held by Business Loan, in return for which theAdviser receives a 1.5% annual fee based on the monthly aggregate balance ofloans held by Business Loan.  Since theCompany owns these loans, all loan servicing fees paid to the Adviser are alsocredited directly against the 2% base management fee.

 

The incentive feeconsists of two parts: an income-based incentive fee and a capital gains-basedincentive fee. The income-based incentive fee rewards the Adviser if theCompany’s quarterly net investment income (before giving effect to theincentive fee) exceeds 1.75% of the Company’s net assets.  The Adviser will receive an annual capitalgains-based incentive fee of 20% of the Company’s realized capital gains (netof realized capital losses and unrealized capital depreciation).

 

Beginning in April 2006,the Company’s Board of Directors has accepted from the Adviser unconditionaland irrevocable voluntary waivers on a quarterly basis to reduce the annual2.0% base management fee on senior syndicated loan participations to 0.5%, tothe extent that proceeds resulting from borrowings were used to purchase suchsyndicated loan participations. These waivers were applied through September 30,2009, and any waived fees may not be recouped by the Adviser in the future.

 

*AdministrationAgreement with Gladstone Administration, LLC*

 

The Company has enteredinto the Administration Agreement with the Administrator, a wholly ownedsubsidiary of the Adviser, which is controlled by the Company’s chairman andchief executive officer. Pursuant to the Administration Agreement, theAdministrator furnishes the Company with office facilities, equipment andclerical, bookkeeping and record keeping services at such facilities andperforms, or oversees the performance of the Company’s required administrativeservices. Such required administrative services include, among other things,being responsible for the financial records which the Company is required tomaintain and preparing reports to the Company’s stockholders and reports filedwith the Securities and Exchange Commission.

 

The AdministrationAgreement requires the Company to reimburse the Administrator for theperformance of its obligations under the Administration Agreement. Thereimbursement is based upon the allocable portion of the Administrator’soverhead, including, but not limited to, rent and the allocable portion ofsalaries and benefits of the Company’s chief financial officer, controller, chiefcompliance officer, internal counsel, treasurer and their respective staff.

 

*FederalIncome Taxes*

 

The Company intends to continue to qualify fortreatment as a RIC under subchapter M of the Code. As a RIC, the Company willnot be subject to federal income tax on the portion of its taxable income andgains distributed to stockholders. To qualify as a RIC, the Company must meetcertain source-of-income, asset diversification, and annual distributionrequirements.  Under the annualdistribution requirement, the Company is required to distribute at least 90% ofits investment company taxable income, as defined by the Code. The Companyintends to distribute at least 90% of its ordinary income, and as a result, noincome tax provisions have been recorded. The Company may, but does not intendto, pay out a return of capital.

 

ASC 740-10, “Income Taxes” requires the evaluation oftax positions taken or expected to be taken in the course of preparing theCompany’s tax returns to determine whether the tax positions are “more-likely-than-not”of being sustained by the applicable tax authorities.  Tax positions not deemed to satisfy the “more-likely-than-not”threshold would be recorded as a tax benefit or expense in the currentyear.  As of September 30, 2009 taxyears 2006, 2007, 2008 and 2009 were open. The Company has evaluated the implications of ASC 870, for all open taxyears and in all major tax jurisdictions, and determined that there is nomaterial impact on the consolidated financial statements.

 

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*Dividends*

 

Distributions tostockholders are recorded on the ex-dividend date. The Company is required topay out at least 90% of its ordinary income and short-term capital gains foreach taxable year as a dividend to its stockholders in order to maintain itsstatus as a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code. It isthe policy of the Company to pay out as a dividend up to 100% of those amounts.The amount to be paid out as a dividend is determined by the Board of Directorseach quarter and is based on the annual earnings estimated by the management ofthe Company. Based on that estimate, a dividend is declared each quarter and ispaid out monthly over the course of the respective quarter. At year-end theCompany may pay a bonus dividend, in addition to the monthly dividends, toensure that it has paid out at least 90% of its ordinary income and short-termcapital gains for the year. The Company may retain long-term capital gains, ifany, and not pay them out as dividends. If the Company decides to retain long-term capital gains, the portion ofthe retained capital gains will be subject to a 35% tax.

 

*RecentAccounting Pronouncements*

 

On July 1, 2009, theFASB issued FASB Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy ofGenerally Accepted Accounting Principles,” which has been codified asASC 105-10, “Generally Accepted AccountingPrinciples” (“ASC 105-10”) (the “Codification”).  ASC 105-10 establishes the exclusiveauthoritative reference for U.S. GAAP for use in financial statements, exceptfor SEC rules and interpretive releases, which are also authoritative GAAPfor SEC registrants. The Codification does not change current U.S. GAAP but isintended to simplify user access to all authoritative U.S. GAAP by providingall the authoritative literature related to a particular topic in oneplace.  All existing accounting standard documents have beensuperseded and all other accounting literature not included in the Codificationis considered non-authoritative.   The Codification was effective forthe Company during the year ended September 30, 2009 and did not havean impact on its financial condition or results ofoperations.  The Company has included the references to theCodification, as appropriate, in these consolidated financial statements.

 

ASC320, “Investments-Debt and Equity Securities” was issued to make the guidanceon other-than-temporary impairment more operational and to improve thepresentation and disclosure of other-than-temporary impairments on debt andequity securities in the financial statements. ASC 320-10  requires significantadditional disclosures for both annual and interim periods, including theamortized cost basis of available-for-sale and held-to-maturity debt, themethodology and key inputs used to measure the credit portion ofother-than-temporary impairment, and a roll forward of amounts recognized inearnings for securities by major security type. ASC 320-10 requires that entities identify major security classesconsistent with how the securities are managed based on the nature and risks ofthe security, and also expands, for disclosure purposes, the list of majorsecurity types identified in ASC 320. ASC 320-10 is effective for interim andannual reporting periods ending after June 15, 2009.  The Company’s adoption of this pronouncementdid not have a material impact on the consolidated financial statements.

 

ASC 820, “Fair ValueMeasurements and Disclosures,” defines fair value, establishes a framework formeasuring fair value in GAAP and expands disclosures about fair valuemeasurements.  ASC 820-10 is effective for financial statements issued forfiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years.  The Company’s adoption of this pronouncement did nothave a material impact on the consolidated financial statements.

 

ASC 820-10-35-15A, “FairValue Measurements and Disclosures,” further clarifies the application of thestandard in a market that is not active. More specifically, ASC 820-10-35-51Estates that significant judgment should be applied to determine if observabledata in a dislocated market represents forced liquidations or distressed salesand are not representative of fair value in an orderly transaction.  ASC 820-10-35-55A provides further guidancethat the use of a reporting entity’s own assumptions about future cash flowsand appropriately risk-adjusted discount rates is acceptable when relevantobservable inputs are not available.  Inaddition, ASC 820-10-35-55B provides guidance on the level of reliance ofbroker quotes or pricing services when measuring fair value in a non activemarket stating that less reliance should be placed on a quote that does notreflect actual market transactions and a quote that is not a bindingoffer.  The guidance is effective uponissuance for all financial statements that have not been issued and any changesin valuation techniques as a result of applying the guidance are accounted foras a change in accounting estimate. The Company’s adoption of thispronouncement did not have a material impact on the consolidated financialstatements.

 

ASC 820-10-35-51A, “FairValue Measurements and Disclosures,” provides additional guidance forestimating fair value when the volume and level of activity for the asset orliability have significantly decreased when compared with normal marketactivity for the asset or liability.  ASC 820-10-35-51E provides guidanceon identifying circumstances that indicate 

 

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when a transaction is notorderly.  ASC 820-10-35-51D emphasizes that the fair value is the pricethat would be received to sell an asset or paid to transfer a liability in anorderly transaction (not a forced liquidation or distressed sale) betweenmarket participants at the measurement date under current marketconditions.  The guidance is effective for interim and annual periodsending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. TheCompany’s adoption of this pronouncement did not have a material impact on theconsolidated financial statements.

 

ASC 825, “FinancialInstruments,” requires disclosures about fair value of financial instrumentsfor interim reporting periods of publicly traded companies as well as in annualfinancial statements, whether recognized or not recognized in the statement offinancial position. The guidance in ASC 825 is effective for interim periodsending after June 15, 2009. The Company adopted this pronouncement duringthe quarter ended June 30, 2009, and the adoption had no material impacton the Company’s consolidated financial statements .

 

ASC855-10-50, “Subsequent Events,” was issued in an effort to incorporateaccounting guidance that originated as auditing standards into the body ofauthoritative literature issued by the FASB. Moving the accounting requirements out of the auditing literature andinto the accounting literature is consistent with the FASB’s objective tocodify all authoritative U.S. accounting guidance related to a particular topicin one place.  It also provided anopportunity to consider international convergence issues.  The FASB has established general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued.  Although there is new terminology, thestandard is based on the same principles as those that previously existed inthe auditing standards.  The newstandard, which includes a required disclosure of the date through which anentity has evaluated subsequent events, is effective for interim or annualperiods ending after June 15, 2009. The Company’s adoption of this pronouncement did not have a materialimpact on the consolidated financial statements.

 

ASC860, “Transfers and Servicing,” removes the concept of a qualifyingspecial-purpose entity (“QSPE”) and removes the exception from applying tovariable interest entities that are QSPEs. This statement also clarifies therequirements for isolation and limitations on portions of financial assets thatare eligible for sale accounting. This statement is effective for fiscal yearsbeginning after November 15, 2009, and is effective for the Company’sfiscal year beginning October 1, 2010. The Company is currently evaluatingthe impact of adopting this standard on the consolidated financial statements.

 

ASC845, “Variable Interest Entities” amends the accounting and disclosurerequirements for the consolidation of variable interest entities (“VIEs”). Theelimination of the concept of a QSPE, as discussed above, removes the exceptionfrom applying the consolidation guidance within this amendment. This amendmentrequires an enterprise to perform a qualitative analysis when determiningwhether or not it must consolidate a VIE. The amendment also requires anenterprise to continuously reassess whether it must consolidate a VIE.Additionally, the amendment requires enhanced disclosures about an enterprise’sinvolvement with VIEs and any significant change in risk exposure due to thatinvolvement, as well as how its involvement with VIEs impacts the enterprise’sfinancial statements. Finally, an enterprise will be required to disclosesignificant judgments and assumptions used to determine whether or not to consolidatea VIE. This amendment is effective for financial statements issued for fiscalyears beginning after November 15, 2009. The Company is currentlyevaluating the impact of adopting this standard on the consolidated financialstatements.

 

**Note 3.Investments**

 

The Company adoptedguidance for fair value measurements on October 1, 2008. In part, thisguidance defines fair value, establishes a framework for measuring fair valueand expands disclosures about assets and liabilities measured at fair value.The guidance provides a consistent definition of fair value that focuses onexit price in the principal, or most advantageous, market and prioritizes,within a measurement of fair value, the use of market-based inputs overentity-specific inputs. The guidance also establishes the following three-levelhierarchy for fair value measurements based upon the transparency of inputs tothe valuation of an asset or liability as of the measurement date.

 

·                  *Level 1* — inputs to the valuation methodologyare quoted prices (unadjusted) for identical assets or liabilities in activemarkets;

 

·                  *Level 2***— inputs to the valuation methodologyinclude quoted prices for similar assets and liabilities in active markets, andinputs that are observable for the asset or liability, either directly orindirectly, for substantially the full term of the financial instrument. Level2 inputs are in those markets for which there are few transactions, the pricesare not current, 

 

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little public information exists or instances whereprices vary substantially over time or among brokered market makers; and

 

·                  *Level 3*— inputs to the valuation methodology areunobservable and significant to the fair value measurement. Unobservable inputsare those inputs that reflect the Company’s own assumptions that marketparticipants would use to price the asset or liability based upon the bestavailable information.

 

As of September 30,2009, all of the Company’s assets were valued using Level 3 inputs.

 

The following tablepresents the financial instruments carried at fair value as of September 30,2009, by caption on the accompanying consolidated statements of assets andliabilities for each of the three levels of hierarchy:

 
| ** **                       | ** ** | **As of September 30, 2009** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|
| ** **                       | ** ** | **Level 1**                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total Fair Value  Reported in  Consolidated Statements of  Assets and Liabilities** | ** ** |
| Senior  Term Debt                |       | $                                 | —     |   | $ | — |   | $ | 213,106 |   | $ | 213,106 |   |
| Senior  Subordinated Term Debt   |       | —                            |       | — |   | 105,794 |   | 105,794 |   |
| Preferred  Equity Securities     |       | —                            |       | — |   | — |   | — |   |
| Common  Equity Securities        |       | —                            |       | — |   | 2,069 |   | 2,069 |   |
| Total  investments at fair value |       | $                                 | —     |   | $ | — |   | $ | 320,969 |   | $ | 320,969 |   |

 

*Changesin Level 3 Fair Value Measurements*

 

The following tableprovides a roll-forward in the changes in fair value during the year from September 30,2008 to September 30, 2009 for all investments for which the Companydetermines fair value using unobservable (Level 3) factors. When adetermination is made to classify a financial instrument within Level 3 of thevaluation hierarchy, the determination is based upon the significance of theunobservable factors to the overall fair value measurement. However, Level 3financial instruments typically include, in addition to the unobservable orLevel 3 components, observable components (that is, components that areactively quoted and can be validated by external sources). Accordingly, thelosses in the table below include changes in fair value due in part toobservable factors that are part of the valuation methodology.

 

**Fairvalue measurements using unobservable data inputs (Level 3)**

 
| ** **                                                | ** ** | **Non-Control/  Non-Affiliate  Investments** | ** ** | **Control  Investments** | ** ** | **Derivative** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------|------------|----------------|------------|-----------|------------|
| Fair  value as of September 30, 2008                 |       | $                                            | 407,153    |                     | $          | 780            |       | $         | —     |   | $ | 407,933 |   |
| Realized  losses (a)                                      |       | (26,411                                      | )          | —                   |       | (304           | )          | (26,715   | )          |
| Reversal  of prior period depreciation on realization (b) |       | 24,531                                       |       | —                   |       | 304            |       | 24,835    |       |
| Unrealized  (depreciation) appreciation (b)               |       | (16,582                                      | )          | 1,564                    |       | —         |       | (15,018   | )          |
| New  investments, repayments, and settlements, net (c)    |       | (101,694                                     | )          | 31,628                   |       | —         |       | (70,066   | )          |
| Transfers  in (out) of Level 3                            |       | —                                       |       | —                   |       | —         |       | —    |       |
| Fair  value as of September 30, 2009                 |       | $                                            | 286,997    |                     | $          | 33,972         |       | $         | —     |   | $ | 320,969 |   |

 

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(a)          Included in net realized loss on investments andrealized gain on settlement of derivative on the accompanying consolidatedstatement of operations for the year ended September 30, 2009.

(b)         Included in unrealized appreciation (depreciation) oninvestments on the accompanying consolidated statement of operations for theyear ended September 30, 2009.

(c)          Includes increases in the cost basis of investmentsresulting from new portfolio investments, the amortization of discounts,premiums and closing fees as well as decreases in the cost basis of investmentsresulting from principal repayments or sales.

 

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*Non-Control/Non-AffiliateInvestments*

 

At September 30,2009 and 2008, the Company held Non-Control/Non-Affiliate investments in theaggregate of approximately $286,997 and $407,153, at fair value, respectively.

 

*Control and Affiliate Investments*

 

At September 30, 2009and September 30, 2008, the Company held Control investments in theaggregate of approximately $33,972 and $780, at fair value, respectively.  At September 30, 2009, the Controlinvestments were comprised of BERTL, Inc. (“BERTL”), Clinton Holdings, LLC(“Clinton”), Defiance Integrated Technologies, Inc. (“Defiance”), LindmarkAcquisition, LLC (“Lindmark”), LYP Holdings Corp. (“LYP Holdings”), U.S.Healthcare Communications, Inc. (“U.S. Healthcare”) and WesternDirectories, Inc. (“Western Directories”).

 

·                  *BERTL:*The Company originally purchased a pastdue debt instrument in MCA Communications, LLC, and the Company accepted a deedin lieu of foreclosure in satisfaction of BERTL’s obligations under the debtinstrument in September 2007.  BERTLis a web-based evaluator of digital imaging products.

 

·                  *Clinton:* In September 2009, the Company tookcontrol of certain Clinton entities by exercising contractual rights under theinvestment documents.  Clinton is a distributor of aluminum sheets andstainless steel.

 

·                  *Defiance:* In July 2009, the Company acquiredfrom the previous owner certain assets of Defiance Acquisition Corp.,consisting of tangible and intangible personal property.  The Company acquired these assets through anewly formed subsidiary, Defiance, and intends to continue the business underits control.  Defiance is a manufacturerof trucking parts.

 

·                  *Lindmark:* In March 2009, the Company acquiredfrom the previous owner certain assets of Lindmark Outdoor Advertising, LLC,consisting of all tangible and intangible personal property.  The Company acquired these assets through anewly formed subsidiary, Lindmark, and intends to continue the business underits control.  Lindmark is a billboardadvertising company.

 

·                  *LYP Holdings:*In July 2008, the Company acquiredfrom the previous owner certain assets of LocalTel, Inc., consisting ofall tangible and intangible personal property. The Company acquired these assets through a newly formed subsidiary, LYPHoldings, and intends to continue the business under its control.  LYP Holdings is a publisher of communityyellow page directories.

 

·                  *U.S. Healthcare:* The Company offered at public salecertain assets of U.S. Healthcare Communications, LLC in January 2008,consisting generally of all fixtures of tangible and intangible personalproperty.  The Company acquired theseassets in the sale through a newly formed subsidiary, U.S. Healthcare, andintends to continue the business under its control.  U.S. Healthcare is a trade magazine operator.

 

·                  *Western Directories:* In August 2008, the Companyacquired from the previous owner certain assets of West Coast Yellow Pages, Inc.,consisting of all tangible and intangible personal property.  The Company acquired these assets through anewly formed subsidiary, Western Directories, and intends to continue thebusiness under its control.  WesternDirectories is a publisher of community yellow page directories.

 

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*Investment Concentrations*

 

At September 30,2009, the Company had aggregate investments in 48 portfolio companies andapproximately 66.1% of the aggregate fair value of such investments was seniorterm debt, approximately 33.0% was senior subordinated term debt, noinvestments were in junior subordinated debt and approximately 0.9% was inequity securities.  The following tableoutlines the Company’s investments by type at September 30, 2009 and September 30,2008:

 
| ** **                     | ** ** | **September 30, 2009** | ** ** | **September 30, 2008** | ** ** |
|--------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **Cost**                    | ** ** | **Fair Value**              | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Senior  Term Debt              |       | $                           | 240,172    |                        | $          | 212,290 |   | $ | 297,910 |   | $ | 265,297 |   |
| Senior  Subordinated Term Debt |       | 118,743                     |       | 105,794                     |       | 157,927 |   | 140,676 |   |
| Preferred  Equity Securities   |       | 2,028                       |       | —                      |       | 1,584 |   | — |   |
| Common  Equity Securities      |       | 3,450                       |       | 2,885                       |       | 3,449 |   | 1,960 |   |
|                           |       |                        |       |                        |       |   |   |   |   |
| Total  Investments             |       | $                           | 364,393    |                        | $          | 320,969 |   | $ | 460,870 |   | $ | 407,933 |   |

 

Investments at fair valueconsisted of the following industry classifications as of September 30,2009 and September 30, 2008:

 
| ** **                                                        | ** ** | **September 30, 2009** | ** **  | **September 30, 2008** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------|-------------|-----------------------------|------------|
| ** **                                                        | ** ** | ** **                  | ** **  | **Percentage**              | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Industry Classification**                                       | ** ** | **Fair Value**         | ** **  | **Total  Investments**      | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Aerospace &  Defense                                     |       | $                           |  1,857 |                        | 0.6        | % | 0.7 | % | $ |  4,192 |   | 1.0 | % | 1.6 | % |
| Automobile                                                        |       | 7,999                       |        | 2.5                         | %          | 3.2 | % | 5,055 |   | 1.2 | % | 1.9 | % |
| Broadcast  (TV & Radio)                                  |       | 43,403                      |        | 13.5                        | %          | 17.4 | % | 52,336 |   | 12.8 | % | 19.2 | % |
| Buildings &  Real Estate                                 |       | 12,882                      |        | 4.0                         | %          | 5.2 | % | 13,519 |   | 3.3 | % | 5.0 | % |
| Cargo  Transport                                                  |       | 5,427                       |        | 1.7                         | %          | 2.2 | % | 15,805 |   | 3.9 | % | 5.8 | % |
| Chemicals,  Plastics & Rubber                            |       | 15,884                      |        | 4.9                         | %          | 6.4 | % | 16,375 |   | 4.0 | % | 6.0 | % |
| Diversified/Conglomerate  Manufacturing                           |       | 1,236                       |        | 0.4                         | %          | 0.5 | % | 3,195 |   | 0.8 | % | 1.2 | % |
| Diversified  Natural Resources, Precious Metals & Minerals    |       | 13,589                      |        | 4.2                         | %          | 5.5 | % | 12,936 |   | 3.2 | % | 4.8 | % |
| Electronics                                                       |       | 27,899                      |        | 8.7                         | %          | 11.2 | % | 35,208 |   | 8.6 | % | 13.0 | % |
| Farming &  Agriculture                                   |       | 9,309                       |        | 2.9                         | %          | 3.7 | % | 10,031 |   | 2.5 | % | 3.7 | % |
| Finance                                                           |       | —                      |        | —                      |       | — |   | 1,812 |   | 0.4 | % | 0.7 | % |
| Healthcare,  Education & Childcare                       |       | 58,054                      |        | 18.1                        | %          | 23.3 | % | 76,642 |   | 18.8 | % | 28.2 | % |
| Home &  Office Furnishings                               |       | 16,744                      |        | 5.2                         | %          | 6.7 | % | 15,379 |   | 3.8 | % | 5.7 | % |
| Leisure,  Amusement, Movies &    Entertainment |       | 5,091                       |        | 1.6                         | %          | 2.0 | % | 8,097 |   | 2.0 | % | 3.0 | % |
| Machinery                                                         |       | 9,202                       |        | 2.9                         | %          | 3.7 | % | 9,834 |   | 2.4 | % | 3.6 | % |
| Mining,  Steel, Iron & Non-Precious Metals               |       | 21,926                      |        | 6.8                         | %          | 8.8 | % | 25,095 |   | 6.2 | % | 9.2 | % |
| Personal &  Non-durable Consumer Products                |       | 8,714                       |        | 2.7                         | %          | 3.5 | % | 9,703 |   | 2.4 | % | 3.6 | % |
| Printing &  Publishing                                   |       | 37,864                      |        | 11.8                        | %          | 15.2 | % | 60,440 |   | 14.8 | % | 22.2 | % |
| Retail  Stores                                                    |       | 23,669                      |        | 7.4                         | %          | 9.5 | % | 22,800 |   | 5.6 | % | 8.4 | % |
| Textiles &  Leather                                      |       | 220                         |        | 0.1                         | %          | 0.1 | % | 9,479 |   | 2.3 | % | 3.5 | % |
| **Total**                                                         |       | $                           | 320,969     |                        | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

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Theinvestments at fair value consisted of the following geographic regions of theUnited States as of September 30, 2009 and September 30, 2008:

 
| ** **             | ** ** | **September 30, 2009** | ** ** | **September 30, 2008** | ** ** |
|------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **             | ** ** | ** **                  | ** ** | **Percentage**              | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **Geographic  Region** | ** ** | **Fair Value**         | ** ** | **Total  Investments**      | ** ** | **Net  Assets** | ** ** | **Fair Value** | ** ** | **Total  Investments** | ** ** | **Net  Assets** | ** ** |
| Midwest                |       | $                           | 172,263    |                        | 53.7       | % | 69.2 | % | $ | 206,271 |   | 50.6 | % | 75.9 | % |
| West                   |       | 65,678                      |       | 20.5                        | %          | 26.4 | % | 85,294 |   | 20.9 | % | 31.4 | % |
| Southeast              |       | 34,708                      |       | 10.8                        | %          | 13.9 | % | 49,374 |   | 12.1 | % | 18.2 | % |
| Mid-Atlantic           |       | 28,437                      |       | 8.9                         | %          | 11.4 | % | 50,807 |   | 12.4 | % | 18.7 | % |
| Northeast              |       | 14,170                      |       | 4.4                         | %          | 5.7 | % | 10,617 |   | 2.6 | % | 3.9 | % |
| U.S.  Territory        |       | 5,713                       |       | 1.8                         | %          | 2.3 | % | 5,570 |   | 1.4 | % | 2.0 | % |
|                   |       | $                           | 320,969    |                        | 100.0      | % |   |   | $ | 407,933 |   | 100.0 | % |   |   |

 

Thegeographic region depicts the location of the headquarters for the Company’sportfolio companies.  A portfolio companymay have a number of other locations in other geographic regions.

 

*Investment Principal Repayment*

 

The following tablesummarizes the contractual principal repayment and maturity of the Company’sinvestment portfolio by fiscal year, assuming no voluntary prepayments:

 
| **Fiscal Year Ending  September 30,**                                           | ** ** | **Amount** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|
| 2010                                                                                 |       | $          | 50,033     |   |
| 2011                                                                                 |       | 86,116     |       |
| 2012                                                                                 |       | 72,836     |       |
| 2013                                                                                 |       | 123,225    |       |
| 2014                                                                                 |       | 19,347     |       |
| Thereafter                                                                           |       | 6,851      |       |
| **Total Contractual Repayments**                                                     |       | 358,408    |       |
| Investments  in equity securities                                                    |       | 5,478      |       |
| Unamortized  premiums, discounts and investment acquisition costs on debt securities |       | 507        |       |
| **Total**                                                                            |       | $          | 364,393    |   |

 

**Note 4.Related Party Transactions**

 

*Loansto Employees*

 

TheCompany provided loans to employees of the Adviser, who at the time of theloans were joint employees of the Company and either the Adviser, or theCompany’s previous investment adviser, Gladstone Capital Advisers, Inc.,for the exercise of options under the Company’s Amended and Restated 2001 EquityIncentive Plan (the “2001 Plan”), which has since been terminated and is nolonger in operation.  The loans requirethe quarterly payment of interest at the market rate in effect at the date ofissue, have varying terms not exceeding ten years and have been recorded as areduction of net assets.  The loans areevidenced by full recourse notes that are due upon maturity or 60 daysfollowing termination of employment, and the shares of common stock purchasedwith the proceeds of the loan are posted as collateral.  No new loans were issued during the fiscalyears ended September 30, 2009 and 2008, and the Company received $6, $56and $301 of principal repayments during the fiscal years ended September 30,2009, 2008 and 2007, respectively.  TheCompany recognized interest income from all employee stock option loans of$468, $471 and $526, respectively, for the fiscal years ended September 30,2009, 2008 and 2007.  The outstandingprincipal balances due on all employee stock option loans at September 30,2009 and 2008 were $9,019 and $9,175, respectively.

 

Duringthe three months ended September 30, 2009, $150 of an employee stockoption loan to a former employee of the Adviser was transferred from notesreceivable — employees to other assets in connection with the termination ofhis employment with the Adviser and the later amendment of the loan. The interest on the loan from the time the employee stopped working for theAdviser is included in other income on the consolidated statement of operations.

 

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In July 2007, a loan to an employee,and the shares pledged as collateral under the loan under a related pledgeagreement, were cancelled due to an event of default which was triggeredby a stop loss provision in the employee’s promissory note and pledgeagreement.  The provision specified that in the event that theaggregate value of the shares pledged under the note, as determined by theintra-day trading price of the shares on Nasdaq, became less than orequal to the aggregate outstanding principal amount of the note, the note wouldbecome immediately due and collectible through cancellation of the shares underthe terms of the pledge agreement.  The Company cancelled 37,109shares which, in turn, cancelled via a non-cash transaction the remainingoutstanding principal of the note of approximately $717.

 

*InvestmentAdvisory and Management Agreement*

 

TheCompany is externally managed by the Adviser, which is controlled by ourchairman and chief executive officer, under a contractual investment advisoryagreement.  On October 1, 2006, theCompany entered into the Advisory Agreement. Under the Advisory Agreement, the Company pays the Adviser an annualbase management fee of 2% of its average total assets, which is defined astotal assets less cash and cash equivalents pledged to creditors calculated asof the end of the two most recently completed fiscal quarters and also consistsof a two-part incentive fee.

 

Thefirst part of the incentive fee is an income-based incentive fee which rewardsthe Adviser if the Company’s quarterly net investment income (before givingeffect to any incentive fee) exceeds 1.75% of the Company’s net assets (the “hurdlerate”). The Company pays the Adviser an income incentive fee with respect toits pre-incentive fee net investment income in each calendar quarter asfollows:

 

·             no incentive fee in any calendar quarter in which itspre-incentive fee net investment income does not exceed the hurdle rate (7%annualized);

·             100% of pre-incentive fee net investment income withrespect to that portion of such pre-incentive fee net investment income, ifany, that exceeds the hurdle rate but is less than 2.1875% in any calendarquarter (8.75% annualized); and

·             20% of the amount of pre-incentive fee net investmentincome, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized).

 

Thesecond part of the incentive fee is a capital gains-based incentive fee that isdetermined and payable in arrears as of the end of each fiscal year (or upontermination of the Advisory Agreement, as of the termination date) and equals20% of the Company’s realized capital gains as of the end of the fiscal year.In determining the capital gains-based incentive fee payable to the Adviser,the Company calculates the cumulative aggregate realized capital gains andcumulative aggregate realized capital losses since the Company’s inception, andthe aggregate unrealized capital depreciation as of the date of thecalculation, as applicable, with respect to each of the investments in itsportfolio.

 

TheAdviser’s board of directors voluntarily waived, for the fiscal quarters withinthe fiscal year ended September 30, 2009, the annual 2.0% base managementfee to 0.5% for senior syndicated loan participations and also waived in itsentirety the incentive fee due for the quarter ended September 30, 2009.

 

Inaddition to the base management and incentive fees under the AdvisoryAgreement, certain fees received by the Adviser from the Company’s portfoliocompanies are paid by the Adviser and credited under the AdvisoryAgreement.  Effective April 1, 2007,50% of certain of the fees received by the Adviser are credited against thebase management fee, whereas prior to such date 100% of those fees werecredited against the base management fee. In addition, the Company continues to pay its direct expenses including,but not limited to, directors’ fees, legal and accounting fees, stockholderrelated expenses, and directors and officers insurance under the AdvisoryAgreement.

 

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Thefollowing tables summarize the management fees, incentive fees and associatedcredits reflected in the accompanying consolidated statements of operations:

 
| ** **                                                                                                       | ** ** | **Year Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                       | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Base  management fee (1)                                                                                         |       | $                                 | 2,005      |   | $ | 2,212 |   | $ | 2,402 |   |
| Credit  for fees received by Adviser from the portfolio companies                                                |       | (89                               | )          | (1,678 | ) | (1,660 | ) |
| Fee  reduction for the voluntary, irrevocable waiver of 2% fee on senior  syndicated loans to 0.5% per annum (2) |       | (265                              | )          | (408 | ) | (481 | ) |
| Net  base management fee                                                                                         |       | $                                 | 1,651      |   | $ | 126 |   | $ | 261 |   |
|                                                                                                             |       |                              |       |   |   |   |   |
| Incentive  fee                                                                                                   |       | $                                 | 3,326      |   | $ | 5,311 |   | $ | 4,608 |   |
| Credit  from voluntary, irrevocable waiver issued by Adviser’s board of directors                           |       | (3,326                            | )          | (5,311 | ) | (3,830 | ) |
| Net  incentive fee                                                                                               |       | $                                 | —     |   | $ | — |   | $ | 778 |   |
|                                                                                                             |       |                              |       |   |   |   |   |
| Credit  for fees received by Adviser from the portfolio companies                                                |       | $                                 | (89        | ) | $ | (1,678 | ) | $ | (1,660 | ) |
| Fee  reduction for the voluntary, irrevocable waiver of 2% fee on senior  syndicated loans to 0.5% per annum     |       | (265                              | )          | (408 | ) | (481 | ) |
| Incentive  fee credit                                                                                            |       | (3,326                            | )          | (5,311 | ) | (3,830 | ) |
| Credit  to base management and incentive fees from Adviser                                                       |       | $                                 | (3,680     | ) | $ | (7,397 | ) | $ | (5,971 | ) |

 

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(1)          Base management fee is net of loanservicing fees per the terms of the Advisory Agreement.

(2)          The board of our Adviser voluntarily,irrevocably and unconditionally waived, for the year ended September 30,2009 and 2008, the annual 2.0% base management fee to 0.5% for seniorsyndicated loan participations.  Feeswaived cannot be recouped by the Adviser in the future.

 

Overall,the base management fee due to the Adviser cannot exceed 2.0% of total assets(as reduced by cash and cash equivalents pledged to creditors) during any givenfiscal year.  Amounts included in Due toAdviser in the accompanying consolidated statements of assets and liabilitieswere as follows:

 
| ** **                            | ** ** | **September 30,********2009** | ** ** | **September 30,  2008** | ** ** |
|---------------------------------------|------------|------------------------------------|------------|------------------------------|------------|
| Unpaid base management fee to Adviser |       | $                                  | 617        |                         | $          | 83 |   |
| Unpaid loan servicing fees to Adviser |       | 217                                |       | 374                          |       |
| Total Due to Adviser                  |       | $                                  | 834        |                         | $          | 457 |   |

 

Asof September 30, 2009, Due from Adviser totaled $69, which includedreimbursements for non-recurring costs incurred on behalf of the portfoliocompanies.

 

*LoanServicing and Portfolio Company Fees*

 

TheAdviser also services the loans held by Business Loan, in return for which itreceives a 1.5% annual fee based on the monthly aggregate outstanding balanceof the loans pledged under the Company’s line of credit.  Since the Company owns these loans, all loanservicing fees paid to the Adviser have been and continue to be treated asreductions directly against the 2% management fee, under the AdvisoryAgreement.  For fiscal years ended September 30,2009 and 2008, these loan servicing fees totaled $5,620 and $6,117,respectively, all of which were deducted against the 2% base management fee inorder to derive the base management fee, which is presented as the line itemBase management fee in the accompanying consolidated statements ofoperations.  As of September 30,2009 and 2008, the Company owed $217 and $374, respectively, of unpaid loanservicing fees to the Adviser, which are recorded in Fees due to Adviser in theaccompanying consolidated statements of assets and liabilities.

 

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*AdministrationAgreement*

 

Underthe Administration Agreement, the Company pays separately for administrativeservices.  The Administration Agreementprovides for payments equal to the Company’s allocable portion of theAdministrator’s overhead expenses in performing its obligations under theAdministration Agreement, including, but not limited to, rent for employees ofthe Administrator, and the allocable portion of salaries and benefits expensesof the Company’s chief financial officer, chief compliance officer, internalcounsel, treasurer and their respective staffs. For the fiscal years ended September 30, 2009 and 2008, the Companyrecorded administration fees of $872 and $985, respectively.  As of September 30, 2009 and 2008, theCompany owed $216 and $247, respectively, of unpaid administration fees to theAdviser, which is recorded in the Fee due to Administrator in the accompanyingconsolidated statements of assets and liabilities.  On July 8, 2009, the Company’s Board ofDirectors approved the renewal of its Administration Agreement with theAdministrator through August 31, 2010.

 

**Note 5.Line of Credit**

 

On May 15, 2009, theCompany, through its wholly-owned subsidiary, Gladstone Business Loan, LLC,entered into a third amended and restated credit agreement providing for a$127,000 revolving line of credit arranged by Key Equipment Finance Inc. “(KEF”)as administrative agent, replacing Deutsche Bank AG as administrative agent(the “KEF Facility”).  Branch Banking andTrust Company (“BB&T”) also joined the KEF Facility as a committedlender.  In connection with entering intothe KEF Facility, the Company borrowed $35,881 under the KEF Facility to make afinal payment to Deutsche Bank AG in satisfaction of all unpaid principal andinterest owed to Deutsche Bank under the prior credit agreement.  The KEF Facility may be expanded up to$200,000 through the addition of other committed lenders to the facility.  Without the addition of other committed lenders,the KEF Facility provides a total commitment of $127,000 through December 31,2009, $102,000 from January 1, 2010 to May 11, 2010 and $77,000thereafter.  The KEF Facility matures on May 14,2010 and, if the facility is not renewed or extended by this date, allprincipal and interest will be due and payable within one year of maturity. Inaddition, if the facility is not renewed, the Company’s lenders have the rightto apply all principal and interest collections to amounts outstanding underthe KEF Facility.  Advances under the KEFFacility will generally bear interest at the 30-day LIBOR or the commercialpaper rate (subject to a minimum rate of 2%), plus 4% per annum, with acommitment fee of 0.75% per annum on undrawn amounts.  As of September 30, 2009, there was acost basis of approximately $83,000 of borrowings outstanding under the KEFFacility at an average rate of 7.36%, and the remaining borrowing capacityunder the KEF Facility was $44,000. Available borrowings are subject to various constraints imposed underthe KEF Facility, based on the aggregate loan balance pledged by Business Loan.Interest is payable monthly during the term of the KEF Facility.

 

In October and November of2009, the Company reduced the size of the KEF Facility by $15,000 and $5,000,respectively, from $127,000 to $107,000.  See further discussion in Note12, *Subsequent Events*.

 

The KEF Facility containscovenants that require Business Loan to maintain its status as a separateentity, prohibit certain significant corporate transactions (such as mergers,consolidations, liquidations or dissolutions), and restrict material changes tothe Company’s credit and collection policies. The facility also limits payments of distributions. Further, the KEFFacility requires the Company to pay distributions only from estimated netinvestment income.  As a result of that change from its prior creditfacility, the Company reduced its distribution from 14 cents per share permonth to 7 cents per share per month. As of September 30, 2009, BusinessLoan was in compliance with all of the facility covenants.

 

The Company elected toapply ASC 825, “Financial Instruments,”specifically for the KEF Facility, which was consistent with itsapplication of ASC 820 to its investments. ASC 825 requires thatthe Company apply a fair value methodology to the KEF Facility. The Companyestimated the fair value of the KEF Facility using estimates of value providedby an independent third party and its own assumptions in the absence ofobservable market data, including estimated remaining life, current marketyield and interest rate spreads of similar securities as of the measurementdate.  The following table presents theKEF Facility carried at fair value as of September 30, 2009, by caption onthe accompanying consolidated statements of assets and liabilities for each ofthe three levels of hierarchy established by ASC 820-10:

 

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| ** **                           | ** ** | **As of September 30, 2009** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Total Fair Value** | ** ** |
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Reported in** | ** ** |
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated  Statement of** | ** ** |
| ** **                           | ** ** | **Level 1**                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Assets and Liabilities** | ** ** |
| Borrowings  under Line of Credit (a) |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |
| Total                                |       | $                                 | —     |   | $ | — |   | $ | 83,350 |   | $ | 83,350 |   |

 

----

(a)          Unrealizedappreciation of $350 is reported on the accompanying consolidated statements ofoperations for the year ended September 30, 2009.

 

In conjunction withentering into the KEF Facility, the Company amended a performance guaranty,which remains substantially similar to the form under the previousfacility.  The loan documents require theCompany to maintain a minimum net worth of $200,000 plus 50% of all equityissuances after May 2009, to maintain “asset coverage” with respect to “seniorsecurities representing indebtedness” of at least 200%, in accordance with Section 18of the 1940 Act, and to maintain its status as a BDC under the 1940 Act and asa RIC under the Code.  As of September 30,2009, the Company was in compliance with all covenants under the performanceguaranty.

 

The Company’s continuedcompliance with these covenants, however, depends on many factors, some ofwhich are beyond the Company’s control. In particular, depreciation in the valuation of its assets, whichvaluation is subject to changing market conditions that are presently veryvolatile, affects the Company’s ability to comply with these covenants.  Given the continued deterioration in thecapital markets, net unrealized depreciation in the Company’s portfolio mayoccur in future periods and threaten the Company’s ability to comply with thecovenants under the KEF Facility. Accordingly, there are no assurances that the Company will continue tocomply with these covenants.  Failure tocomply with these covenants would result in a default which, if the Company isunable to obtain a waiver from the lenders, could accelerate the Company’srepayment obligations under the KEF Facility and thereby have a materialadverse impact on its liquidity, financial condition, results of operations andability to pay distributions.

 

There can be no guaranteethat the Company will be able to renew, extend or replace the KEF Facility onterms that are favorable to the Company, or at all.  The Company’s ability to obtain replacementfinancing will be constrained by current economic conditions affecting thecredit markets.  Consequently, anyrenewal, extension or refinancing of the KEF Facility will likely result insignificantly higher interest rates and related charges and may imposesignificant restrictions on the use of borrowed funds with regard to itsability to fund investments or maintain distributions.  For instance, in connection with theestablishment of the Company’s KEF Facility in May 2009, the size of theline was reduced from $162,000 under its prior facility to $127,000 under itsKEF Facility and Deutsche Bank AG, who was a committed lender under its priorcredit facility elected not to participate in the KEF Facility and withdrew itscommitment.  If the Company is not ableto renew, extend or refinance the KEF Facility, this would likely have amaterial adverse effect on its liquidity and ability to fund new investments orpay distributions to its stockholders. The Company’s inability to pay distributions could result in it failingto qualify as a RIC.  Consequently, anyincome or gains could become taxable at corporate rates.  If the Company is unable to secure replacementfinancing, it will be forced to sell certain assets on disadvantageous terms,which may result in realized losses such as those recently recorded in connection with the syndicatedloan sales, which resulted in a realized loss of approximately $26,411 duringthe year ended September 30,2009.  Such realized losses couldmaterially exceed the amount of any unrealized depreciation on these assets asof the Company’s most recent balance sheet date, which would have a materialadverse effect on its results of operations. In addition to selling assets, or as an alternative, the Company mayissue equity in order to repay amounts outstanding under the KEF Facility.  Based on the recent trading prices of itsstock, such an equity offering may have a substantial dilutive impact on theCompany’s existing stockholders’ interest in the Company’s earnings and assetsand voting interest in it.

 

**Note 6.Interest Rate Cap Agreement**

 

Pursuant to its previousrevolving credit facility (the “DB Facility”), the Company had an interest ratecap agreement, with an initial notional amount of $35,000 at a cost of $304that effectively limited the interest rate on a portion of the borrowings underthe line of credit.  The interest ratecap agreement expired in February 2009.

 

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At September 30,2008, the interest rate cap agreement had a nominal fair market value, which isrecorded in other assets on the Company’s consolidated statement of assets andliabilities.  The Company recordedchanges in the fair market value of the interest rate cap agreement monthlybased on the current market valuation at month end as unrealized depreciation orappreciation on derivative on the Company’s consolidated statement ofoperations. The agreement provided that the Company’s floating interest rate orcost of funds on a portion of the portfolio’s borrowings would be capped at 5%when the LIBOR was in excess of 5%. During the year ended September 30, 2009, the Company recorded $304of loss from the interest rate cap agreement, recorded as a realized loss onthe settlement of derivative on the Company’s consolidated statements ofoperations.  During the year ended September 30,2008, the Company recorded $7 of income from the interest rate cap agreement,recorded as a realized gain on the settlement of derivative on the Company’sconsolidated statements of operations.

 

**Note 7.Common Stock Transactions**

 

Transactionsin common stock were as follows:

 
| ** **                                              | ** ** | **Shares** | ** ** | **Total Value** | ** ** |
|---------------------------------------------------------|------------|------------|------------|-----------------|------------|
| Balance as of  September 30, 2007                  |       | 14,762,574 |       | $               | 235,922    |   |
| Issuance of common  stock under shelf offerings (1)     |       | 6,325,000  |       | 105,374         |       |
| Return of capital  statement of position adjustment (2) |       | —     |       | (7,132          | )          |
| Balance as of  September 30, 2008                  |       | 21,087,574 |       | $               | 334,164    |   |
| Shelf offering costs                                    |       | —     |       | (41             | )          |
| Return of capital  statement of position adjustment (2) |       | —     |       | (5,899          | )          |
| Balance as of  September 30, 2009                  |       | 21,087,574 |       | $               | 328,224    |   |

 

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(1)   On October 19, 2007, the Company completed an offeringof  2,500,000 shares of its common stockat a price of $18.70 per share, less an underwriting discount of $1.03 pershare, or 6%.  On November 19, 2007,the underwriter exercised its over-allotment option and the Company sold anadditional 375,000 shares of common stock at the same price.

 

On February 5, 2008, the Company completed an offeringof  3,000,000 shares of its common stockat a price of $17.00 per share, less an underwriting discount of $0.935 pershare, or 6%.  On February 26, 2008,the underwriter exercised its over-allotment option and the Company sold anadditional 450,000 shares of common stock at the same price.

 

(2)   The timing and characterizationof certain income and capital gains distributions are determined annually inaccordance with federal tax regulations which may differ from GAAP.  These differences primarily relate to itemsrecognized as income for financial statement purposes and realized gains fortax purposes.  As a result, netinvestment income and net realized gain (loss) on investment transactions for areporting period may differ significantly from distributions during suchperiod.  Accordingly, the Company made areclassification among certain of its capital accounts without impacting the netasset value of the Company.

 

**Note 8.Net Increase (Decrease) in Net Assets Resulting from Operations per Share**

 

The following table setsforth the computation of basic and diluted net increase (decrease) in netassets resulting from operations per share for the fiscal years ended September 30,2009, 2008 and 2007:

 
| ** **                                                                                                  | ** ** | **Year ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                  | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator  for basic and diluted net increase (decrease) in net assets resulting from  operations per share |       | $                                 | 3,783      |   | $ | (21,262 | ) | $ | 14,952 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Denominator  for basic and diluted shares                                                                   |       | 21,087,574                        |       | 19,699,796 |   | 13,173,822 |   |
| Basic  net increase (decrease) in net assets resulting from operations per common  share                    |       | $                                 | 0.18       |   | $ | (1.08 | ) | $ | 1.13 |   |

 

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**Note 9.Distributions**

 

***Distributions***

 

TheCompany is required to pay out as a dividend 90% of its ordinary income andshort-term capital gains for each taxable year in order to maintain its statusas a RIC under Subtitle A, Chapter 1 of Subchapter M of the Code.  It is the policy of the Company to pay out asa dividend up to 100% of those amounts. The amount to be paid out as a dividend is determined by the Board of Directorseach quarter and is based on the annual earnings estimated by the management ofthe Company.  Based on that estimate,three monthly dividends are declared each quarter.  At year-end the Company may pay a bonusdividend, in addition to the monthly dividends, to ensure that it has paid outat least 90% of its ordinary income and realized net short-term capital gainsfor the year.  Long-term capital gainsare composed of success fees, prepayment fees and gains from the sale ofsecurities held for one year or more. The Company may decide to retainlong-term capital gains from the sale of securities, if any, and not pay themout as dividends, however, the Board of Directors may decide to declare and payout capital gains during any fiscal year. If the Company decides to retain long-term capital gains, the portion ofthe retained capital gains will be subject to a 35% tax.  The tax characteristics of all dividends willbe reported to stockholders on Form 1099 at the end of each calendaryear.  The following table lists the pershare dividends paid for the fiscal years ended September 30, 2009 and2008:

 
| **Fiscal  Year** | ** ** | **Record Date**     | ** ** | **Payment Date**    | ** ** | **Dividend per  Share** | ** ** |
|------------------|------------|--------------------------|------------|--------------------------|------------|------------------------------|------------|
| 2009             |       | October 23,  2008   |       | October 31,  2008   |       | $                            | 0.140      |   |
|             |       | November 19,  2008  |       | November 28,  2008  |       | 0.140                        |       |
|             |       | December 22,  2008  |       | December 31,  2008  |       | 0.140                        |       |
|             |       | January 22,  2009   |       | January 31,  2009   |       | 0.140                        |       |
|             |       | February 19,  2009  |       | February 27,  2009  |       | 0.140                        |       |
|             |       | March 23,  2009     |       | March 30,  2009     |       | 0.140                        |       |
|             |       | April 27,  2009     |       | May 8, 2009         |       | 0.070                        |       |
|             |       | May 29,  2009       |       | June 11, 2009       |       | 0.070                        |       |
|             |       | June 22,  2009      |       | June 30,  2009      |       | 0.070                        |       |
|             |       | July 23,  2009      |       | July 31,  2009      |       | 0.070                        |       |
|             |       | August 21,  2009    |       | August 31,  2009    |       | 0.070                        |       |
|             |       | September 22,  2009 |       | September 30,  2009 |       | 0.070                        |       |
|             |       |                     |       | Annual  Total:           |       | $                            | 1.260      |   |
|             |       |                     |       |                     |       |                         |       |
| 2008             |       | October 23,  2007   |       | October 31,  2007   |       | $                            | 0.140      |   |
|             |       | November 21,  2007  |       | November 30,  2007  |       | 0.140                        |       |
|             |       | December 20,  2007  |       | December 31,  2007  |       | 0.140                        |       |
|             |       | January 23,  2008   |       | January 31,  2008   |       | 0.140                        |       |
|             |       | February 21,  2008  |       | February 29,  2008  |       | 0.140                        |       |
|             |       | March 21,  2008     |       | March 31,  2008     |       | 0.140                        |       |
|             |       | April 22,  2008     |       | April 30,  2008     |       | 0.140                        |       |
|             |       | May 21,  2008       |       | May 30,  2008       |       | 0.140                        |       |
|             |       | June 20,  2008      |       | June 30,  2008      |       | 0.140                        |       |
|             |       | July 23,  2008      |       | July 31,  2008      |       | 0.140                        |       |
|             |       | August 21,  2008    |       | August 29,  2008    |       | 0.140                        |       |
|             |       | September 22,  2008 |       | September 30,  2008 |       | 0.140                        |       |
|             |       |                     |       | Annual  Total:           |       | $                            | 1.680      |   |

 

Aggregate distributionsdeclared and paid for the 2009 and 2008 fiscal years were approximately $26,570and $33,379, respectively, which were declared based on an estimate of netinvestment income for each year.

 

**Distribution of Income andGains **Net investmentincome of the Company is declared and distributed to stockholders monthly.  Net realized gains from investmenttransactions, in excess of available capital loss carryforwards, would betaxable to the Company if not distributed, and, therefore, generally will bedistributed at least annually.

 

The timing andcharacterization of certain income and capital gains distributions aredetermined annually in accordance with federal tax regulations which may differfrom GAAP.  These differences primarilyrelate to items recognized as income for 

 

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financial statementpurposes and realized gains for tax purposes. As a result, net investment income and net realized gain (loss) oninvestment transactions for a reporting period may differ significantly fromdistributions during such period. Accordingly, the Company may periodically make reclassifications amongcertain of its capital accounts without impacting the net asset value of theCompany.

 

The Company’s componentsof net assets on a tax-basis were as follows:

 
| ** **                  | ** ** | **Year Ended September 30,** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| Post-October tax  loss |       | $                                 | (26,354    | ) | $ | — |   |
|                             |            |                                   |            |  |  |  |  |

 

In addition, the taxcharacter of distributions paid to stockholders by the Company is summarized asfollows:

 
| ** **                                  | ** ** | **Year Ended September 30,** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Distributions  from Ordinary Income         |       | $                                 | 20,795     |   | $ | 26,110 |   | $ | 19,444 |   |
| Distributions  from Long Term Capital Gains |       | 27                                |       | 120 |   | 2,697 |   |
| Distributions  from Tax Return on Capital   |       | 5,748                             |       | 7,149 |   | — |   |
| Total  Distributions                        |       | $                                 | 26,570     |   | $ | 33,379 |   | $ | 22,141 |   |

 

**Note 10.Commitments and Contingencies**

 

As of September 30,2009, the Company was not party to any signed and non-binding term sheets forpotential investments.

 

**Note 11.Federal and State Income Taxes**

 

TheCompany has historically operated, and intends to continue to operate, in amanner to qualify for treatment as a RIC under Subchapter M of the Code.  As a RIC, the Company is not subject tofederal or state income tax on the portion of its taxable income and gainsdistributed to stockholders.  To qualifyas a RIC, the Company is required to distribute to its stockholders at least90% of investment company taxable income, as defined by the Code and as such noincome tax provisions have been recorded for the individual companies ofGladstone Capital Corporation and Gladstone Business Loan, LLC.

 

**Note 12.  Subsequent Events**

 

The Company evaluated allevents that have occurred subsequent to September 30, 2009 through thedate of the filing of this Form 10-K on November 23, 2009.

 

*Distributions*

 

On October 6, 2009,the Company’s Board of Directors declared the following monthly cashdistributions:

 
| **Record Date**         | ** ** | **Payment Date**       | ** ** | **Dividend per Share** | ** ** |
|-------------------------|------------|------------------------|------------|------------------------|------------|
| October 22,  2009  |       | October 30, 2009  |       | $                      | 0.07       |   |
| November 19,  2009 |       | November 30, 2009 |       | $                      | 0.07       |   |
| December 22,  2009 |       | December 31, 2009 |       | $                      | 0.07       |   |

 

*Investment Activity*

 

Subsequent to September 30,2009, the Company extended $1,556 in revolver draws and additional investmentsto existing portfolio companies.  TheCompany also received $7,839 in scheduled and unscheduled loan repayments.

 

The Company entered intoan agreement to sell the Kinetek and Wesco syndicated loans that were held inits portfolio of investments at September 30, 2009 to investors in thesyndicated loan market.  The loans had anaggregate cost value of approximately $3,702 and aggregate fair value of $2,781as of September 30, 2009.  On November 23,2009, the Company 

 

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closed the sale of theloans for $2,781 in net proceeds.  Theloans are included in the Company’s consolidated assets as of September 30,2009 and the loans are valued at the respective sales prices.

 

*Line of Credit*

 

On October 9, 2009and November 9, 2009, the Company reduced the size of the KEF Facility by$15,000 and $5,000, respectively, from $127,000 to $107,000.  Under theKEF Facility the first $50,000 of commitment reductions are applied against KEF’scommitment.  Therefore, the entire $20,000 was subtracted from KEF’scommitment, reducing it from $100,000 to $80,000 and leaving BB&T’scommitment unchanged at $27,000.  As a result of the manner in which theCompany’s borrowing base is calculated under the KEF Facility, the reductionsdid not affect the Company’s availability under the KEF Facility.

 

*RegistrationStatement*

 

On October 20, 2009,the Company filed a registration statement on Form N-2 with the SEC.  If and when it is declared effective, it willpermit the Company to issue, through one or more transactions, up to anaggregate of $300,000 in securities, consisting of common stock, senior common stock,preferred stock, subscription rights, debt securities and warrants to purchasecommon stock, or a combination of these securities.

 

**Note 13.Selected Quarterly Data (Unaudited)**

 
| ** **                                                       | ** ** | **Year Ended September 30, 2009** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Quarter  Ended  December 31,  2008**           | ** ** | **Quarter  Ended  March 31,  2009** | ** ** | **Quarter  Ended  June 30,  2009** | ** ** | **Quarter  Ended  September 30,  2009** | ** ** |
|                                                             |       |                                                  |       |   |   |   |   |   |   |
| Total  Investment Income                                         |       | $                                                     | 11,808     |   | $ | 10,929 |   | $ | 10,598 |   | $ | 9,283 |   |
| Net  Investment Income                                           |       | 5,881                                                 |       | 5,555 |   | 5,435 |   | 4,160 |   |
| Net  (Decrease) Increase in Net Assets Resulting From Operations |       | (9,103                                                | )          | 10,280 |   | (788 | ) | 3,394 |   |
|                                                             |       |                                                  |       |   |   |   |   |   |   |
| Basic  and Diluted Earnings per Weighted Average Common Share    |       | $                                                     | (0.43      | ) | $ | 0.48 |   | $ | (0.04 | ) | $ | 0.17 |   |

 
| ** **                                                       | ** ** | **Year Ended September 30, 2008** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Quarter  Ended  December 31,  2007**           | ** ** | **Quarter  Ended  March 31,  2008** | ** ** | **Quarter  Ended  June 30,  2008** | ** ** | **Quarter  Ended  September 30,  2008** | ** ** |
|                                                             |       |                                                  |       |   |   |   |   |   |   |
| Total  Investment Income                                         |       | $                                                     | 11,402     |   | $ | 11,350 |   | $ | 11,420 |   | $ | 11,553 |   |
| Net  Investment Income                                           |       | 7,303                                                 |       | 6,442 |   | 6,697 |   | 6,110 |   |
| Net  Increase (Decrease) in Net Assets Resulting From Operations |       | 1,900                                                 |       | (11,904 | ) | 2,809 |   | (14,068 | ) |
|                                                             |       |                                                  |       |   |   |   |   |   |   |
| Basic  and Diluted Earnings per Weighted Average Common Share    |       | $                                                     | 0.11       |   | $ | (0.61 | ) | $ | 0.13 |   | $ | (0.67 | ) |

 

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**Item9. Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure**

 

Not applicable.

 

**Item9A. Controls and Procedures.**

 

a)  Disclosure Controls and Procedures

 

As of September 30,2009 (the end of the period covered by this report), we, including our ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness anddesign and operation of our disclosure controls and procedures.  Based on that evaluation, our management,including the Chief Executive Officer and Chief Financial Officer, concludedthat our disclosure controls and procedures were effective in timely alertingmanagement, including the Chief Executive Officer and Chief Financial Officer,of material information about us required to be included in periodic SECfilings.  However, in evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

b)Management’s Annual Report on Internal Control Over Financial Reporting

 

Refer to the Management’sReport on Internal Control over Financial Reporting located in Item 8 of this Form 10-K.

 

c)Attestation Report of the Registered Public Accounting Firm

 

Referto the Report of Independent Registered Public Accounting Firm located in Item8 of this Form 10-K.

 

d)Change in Internal Control over Financial Reporting

 

Therewere no changes in internal controls for the fiscal quarter ended September 30,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**Item9B. Other Information.**

 

Notapplicable.

 

**PART III**

 

We will file adefinitive Proxy Statement for our 2010 Annual Meeting of Stockholders (the “2010Proxy Statement”) with the SEC, pursuant to Regulation 14A, not later than120 days after the end of our fiscal year. Accordingly, certaininformation required by Part III has been omitted under GeneralInstruction G(3) to Form 10-K. Only those sections of the 2010 ProxyStatement that specifically address the items set forth herein are incorporatedby reference.

 

**Item10. Directors, Executive Officers and Corporate Governance**

 

The information requiredby Item 10 is hereby incorporated by reference from our 2010 Proxy Statementunder the captions “Election of Directors” and “Section 16(a) BeneficialOwnership Reporting Compliance.”

 

**Item11. Executive Compensation**

 

The information requiredby Item 11 is hereby incorporated by reference from our 2010 Proxy Statementunder the captions “Executive Compensation” and “Director Compensation”

 

**Item12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

 

The information requiredby Item 12 is hereby incorporated by reference from our 2010 Proxy Statementunder the caption “Security Ownership of Certain Beneficial Owners andManagement.”

 

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**Item13. Certain Relationships and Related Transactions and Director Independence**

 

The information requiredby Item 13 is hereby incorporated by reference from our 2010 Proxy Statementunder the captions “Certain Transactions” and “Director Independence.”

 

**Item14. Principal Accountant Fees and Services.**

 

The information requiredby Item 14 is hereby incorporated by reference from our 2010 Proxy Statementunder the caption “Independent Registered Public Accounting Firm Fees.”

 

**PART IV**

 

**Item15. Exhibits and Financial Statement Schedules**

 

**a.****                                       DOCUMENTSFILED AS PART OF THIS REPORT**

 

1.                                       Thefollowing financial statements are filed herewith:

 
| Report of Management on Internal Controls                                                                                                           |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| Report of Independent Registered Public Accounting  Firm                                                                                            |
| Consolidated Statements of Assets and Liabilities as  of September 30, 2009 and September 30, 2008                                        |
| Consolidated Schedule of Investments as of  September 30, 2009                                                                            |
| Consolidated Schedule of Investments as of  September 30, 2008                                                                            |
| Consolidated Statements of Operations for the years  ended September 30, 2009, September 30, 2008 and September 30,  2007            |
| Consolidated Statements of Changes in Net Assets for  the years ended September 30, 2009, September 30, 2008 and  September 30, 2007 |
| Consolidated Statements of Cash Flows for the years  ended September 30, 2009, September 30, 2008 and September 30,  2007            |
| Financial Highlights for the years ended  September 30, 2009, September 30, 2008 and September 30, 2007                              |
| Notes to Consolidated Financial Statements                                                                                                          |

 

2.                                       Financialstatement schedules

 

·                  Schedule12-14 Investments in and Advances to Affiliates

 

No other financialstatement schedules are filed herewith because (1) such schedules are notrequired or (2) the information has been presented in the aforementionedfinancial statements.

 

·                  Exhibits

 

The followingexhibits are filed as part of this report or are hereby incorporated byreference to exhibits previously filed with the SEC:

 
| 3.1 |   | Articles of Amendment and Restatement of the  Articles of Incorporation, incorporated by reference to Exhibit a.2 to  Pre-Effective Amendment No. 1 to the Registration Statement on  Form N-2 (File No. 333-63700), filed July 27, 2001.                                                                                                                  |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2 |   | By-laws, incorporated by reference to Exhibit b  to Pre-Effective Amendment No. 1 to the Registration Statement on  Form N-2 (File No. 333-63700), filed July 27, 2001.                                                                                                                                                                                    |
| 3.3 |   | Amendment to By-laws, incorporated by reference to  Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended December 31, 2003 (File No. 814-00237), filed  February 17, 2004.                                                                                                                                               |
| 3.4 |   | Second amendment to By-laws, incorporated by  reference to Exhibit 99.1 to the Company’s Current Report on  Form 8-K (File No. 814-00237), filed July 10, 2007.                                                                                                                                                                                            |
| 4.1 |   | Form of Direct Registration Transaction Advice  for the Company’s common stock, par value $0.001 per share, the rights of  holders of which are defined in exhibits 3.1 and 3.2, incorporated by  reference to Exhibit d to Pre-Effective Amendment No. 1 to the  Registration Statement on Form N-2 (File No. 333-63700), filed  July 27, 2001. |

 

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| 4.2   |   | Specimen Stock Certificate, incorporated by  reference to Exhibit d.2 to Pre-Effective Amendment No. 3 to the  Registration Statement on Form N-2 (File No. 333-63700), filed  August 23, 2001.                                                                                                                                                                                                                                                                                    |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1  |   | Promissory Note of David Gladstone in favor of the  Company, dated August 23, 2001, incorporated by reference to  Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the  period ended June 30, 2001, filed October 4, 2001.                                                                                                                                                                                                                                     |
| 10.2  |   | Promissory Note of Terry Brubaker in favor of the  Company, dated August 23, 2001, incorporated by reference to  Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the  period ended June 30, 2001, filed October 4, 2001.                                                                                                                                                                                                                                      |
| 10.3* |   | Joint Directors  Nonqualified Excess Plan of Gladstone Commercial Corporation, Gladstone  Capital Corporation and Gladstone Investment Corporations, dated as of  July 11, 2006, incorporated by reference to Exhibit 10.1 to the  Company’s Current Report on Form 8-K (File No. 814-00237), filed on  July 12, 2006.                                                                                                                                                        |
| 10.4  |   | Custodian  Agreement between Gladstone Capital Corporation and The Bank of New York,  dated as of May 5, 2006, incorporated by reference to Exhibit 10.3  to the Company’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2006 (File No. 814-00237), filed August 1, 2006.                                                                                                                                                                                |
| 10.5* |   | Amended and Restated Investment Advisory and  Management Agreement between Gladstone Capital Corporation and Gladstone  Management Corporation, dated as of October 1, 2006 incorporated by reference to  Exhibit 99.1 to the Company’s Current Report on Form 8-K (File  No. 814-00237), filed on October 5, 2006 (renewed on July 8,  2009).                                                                                                                           |
| 10.6* |   | Administration Agreement between Gladstone Capital Corporation  and Gladstone Administration, LLC, dated as of October 1, 2006  incorporated by reference to Exhibit 99.1 to the Company’s Current  Report on Form 8-K (File No. 814-00237), filed on October 5,  2006 (renewed on July 8, 2009).                                                                                                                                                                        |
| 10.7  |   | Third Amended and Restated Credit Agreement dated as  of May 15, 2009 by and among Gladstone Business Loan, LLC as Borrower,  Gladstone Management Corporation as Servicer, the Committed Lenders named  therein, the CP Lenders named therein, the Managing Agents named therein, and  Key Equipment Finance Inc. as Administrative Agent, incorporated by reference  to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File  No. 814-00237), filed May 19, 2009. |
| 11    |   | Computation of Per Share Earnings (included in the  notes to the audited financial statements contained in this report).                                                                                                                                                                                                                                                                                                                                                                                    |
| 21    |   | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 23    |   | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1  |   | Certification of Chief Executive Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                   |
| 31.2  |   | Certification of Chief Financial Officer pursuant to  section 302 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                   |
| 32.1  |   | Certification of Chief Executive Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                   |
| 32.2  |   | Certification of Chief Financial Officer pursuant to  section 906 of The Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                   |

 

----

*                                         Denotesmanagement contract or compensatory plan or arrangement.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| ** **                   | **GLADSTONE CAPITAL CORPORATION** |
|------------------------------|-----------------------------------|
| ** **                   | ** **                        |
| Date: November 23, 2009 | By:                               | /s/ GRESFORD GRAY |
|                         |                              | Gresford Gray |
|                         |                              | Chief Financial Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacity and on the dates indicated.

 
| Date: November 23, 2009 | By:    | /s/ DAVID GLADSTONE                                                                           |
|------------------------------|--------|-----------------------------------------------------------------------------------------------|
|                         |   | David Gladstone                                                                               |
|                         |   | Chief Executive Officer and Chairman of the Board of  Directors (principal executive officer) |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ TERRY LEE BRUBAKER                                                                        |
|                         |   | Terry Lee Brubaker                                                                            |
|                         |   | Vice Chairman, Chief Operating Officer  and Director                                     |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ GEORGE STELLJES III                                                                       |
|                         |   | George Stelljes III                                                                           |
|                         |   | President, Chief Investment Officer and Director                                              |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ DAVID A.R. DULLUM                                                                         |
|                         |   | David A.R. Dullum                                                                             |
|                         |   | Director                                                                                      |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ GRESFORD GRAY                                                                             |
|                         |   | Gresford Gray                                                                                 |
|                         |   | Chief Financial Officer (principal financial and  accounting officer)                         |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ ANTHONY W. PARKER                                                                         |
|                         |   | Anthony W. Parker                                                                             |
|                         |   | Director                                                                                      |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ MICHELA A. ENGLISH                                                                        |
|                         |   | Michela A. English                                                                            |
|                         |   | Director                                                                                      |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ PAUL ADELGREN                                                                             |
|                         |   | Paul Adelgren                                                                                 |
|                         |   | Director                                                                                      |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ MAURICE COULON                                                                            |
|                         |   | Maurice Coulon                                                                                |
|                         |   | Director                                                                                      |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ JOHN OUTLAND                                                                              |
|                         |   | John Outland                                                                                  |
|                         |   | Director                                                                                      |
|                         |   |                                                                                          |
| Date: November 23, 2009 | By:    | /s/ GERARD MEAD                                                                               |
|                         |   | Gerard Mead                                                                                   |
|                         |   | Director                                                                                      |

 

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**SCHEDULE12-14**

 

**GLADSTONECAPITAL CORPORATIONINVESTMENTS IN AND ADVANCES TO AFFILIATES**

** **
| **Name of Issuer (1)**                       | ** **       | **Title  of Issue or Nature of  Indebtedness** | ** ** | **Number  of Shares or  Principal Amount of  Indebtedness Held at  September 30, 2009** | ** ** | **Interest  Earned for  the year Ended  September 30, 2009** | ** ** | **Equity  in Net Profit  (Loss) for the year ended  September 30, 2009 (3)** | ** ** | **Value  at  September 30,  2009** | ** ** |
|----------------------------------------------|------------------|------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| **CONTROL INVESTMENTS**                      | ** **       |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| BERTL, Inc.                             |             | Line of Credit                                 |       | $                                                                                            | 930        |                                                              | 56         |                                                                              | —     |                                    | $          | — |   |
|                                         |             | Common Stock (2)                               |       | 424                                                                                          |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| Clinton  Holdings, LLC                       |             | Senior Subordinated Term  Debt                 |       | 15,500                                                                                       |       | —                                                            |       | —                                                                            |       | 12,013                                  |       |
|                                         |             | Escrow Funding Note                            |       | 640                                                                                          |       | —                                                            |       | —                                                                            |       | 496                                     |       |
|                                         |             | Common Stock Warrants  (2)                     |       | 109                                                                                          |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| Defiance  Integrated Technologies, Inc. |             | Senior Term Debt                               |       | 6,005                                                                                        |       | 185                                                               |       | —                                                                            |       | 6,005                                   |       |
|                                         | Senior Term Debt |                                           | 1,178      |                                                                                         | —     |                                                              | —     |                                                                              | 1,178      |                                    |
|                                         |             | Common Stock (2)                               |       | 1                                                                                            |       | —                                                            |       | —                                                                            |       | 816                                     |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| Lindmark  Acquisition, LLC                   |             | Senior Subordinated Term  Debt                 |       | 12,000                                                                                       |       | 344                                                               |       | —                                                                            |       | 10,410                                  |       |
|                                         |             | Senior Subordinated Term  Debt                 |       | 1,553                                                                                        |       | —                                                            |       | —                                                                            |       | 1,049                                   |       |
|                                         |             | Common Stock (2)                               |       | 1                                                                                            |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| LYP  Holdings Corp.                          |             | Line of Credit                                 |       | 1,168                                                                                        |       | 57                                                                |       | —                                                                            |       | 1,168                                   |       |
|                                         |             | Senior Term Debt                               |       | 325                                                                                          |       | 20                                                                |       |                                                                              |       | 325                                     |       |
|                                         |             | Line of Credit                                 |       | 1,170                                                                                        |       | 24                                                                |       | —                                                                            |       | 421                                     |       |
|                                         |             | Senior Term Debt                               |       | 2,688                                                                                        |       | 95                                                                |       | —                                                                            |       | —                                  |       |
|                                         |             | Senior Term Debt                               |       | 2,750                                                                                        |       | 120                                                               |       | —                                                                            |       | —                                  |       |
|                                         |             | Common Stock Warrants  (2)                     |       | —                                                                                       |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| U.S.  Healthcare Communications, Inc.   |             | Line of Credit                                 |       | 169                                                                                          |       | —                                                            |       | —                                                                            |       | 91                                      |       |
|                                         | Line of Credit   |                                           | 450        |                                                                                         | —     |                                                              | —     |                                                                              | —     |                                    |
|                                         |             | Common Stock (2)                               |       | 2,470                                                                                        |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                         |             |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| Western  Directories, Inc.              |             | Line of Credit                                 |       | 1,234                                                                                        |       | 32                                                                |       | —                                                                            |       | —                                  |       |
|                                         |             | Preferred Stock (2)                            |       | 1,584                                                                                        |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                         |             | Common Stock (2)                               |       | 1                                                                                            |       | —                                                            |       | —                                                                            |       | —                                  |       |
| ** **                                   | ** **       | ** **                                     | ** ** | ** **                                                                                   | ** ** | ** **                                                        | ** ** | ** **                                                                        | ** ** | ** **                              | ** ** |
| **Total Control Investments**                | ** **       | ** **                                     | ** ** | **$**                                                                                        | **52,350** | ** **                                                        | **$**      | **933**                                                                           | ** ** | **$**                                   | **—** | ** ** | **$** | **33,972** | ** ** |
|                                              |                  |                                                |            |                                                                                              |            |                                                                   |            |                                                                                   |            |                                         |            |  |  |  |  |

 
| **Name of Issuer (1)**                     | ** **     | **Title  of Issue or Nature of  Indebtedness** | ** ** | **Number  of Shares or  Principal Amount of  Indebtedness Held at  September 30, 2008** | ** ** | **Interest  Earned for  the year Ended  September 30, 2008** | ** ** | **Equity  in Net Profit  (Loss) for the year ended  September 30, 2008 (3)** | ** ** | **Value  at  September 30,  2008** | ** ** |
|--------------------------------------------|----------------|------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| **CONTROL INVESTMENTS**                    | ** **     |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
|                                       |           |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| BERTL, Inc.                           |           | Line of Credit                                 |       | $                                                                                            | 742        |                                                              | 62         |                                                                              | —     |                                    | $          | — |   |
|                                       |           | Common Stock (2)                               |       | 424                                                                                          |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                       |           |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| LYP  Holdings Corp.                        |           | Line of Credit                                 |       | 75                                                                                           |       | 1                                                                 |       | —                                                                            |       | —                                  |       |
|                                       |           | Line of Credit                                 |       | 1,170                                                                                        |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                       |           | Senior Term Debt                               |       | 2,688                                                                                        |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                       |           | Senior Term Debt                               |       | 2,750                                                                                        |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                       |           | Common Stock Warrants  (2)                     |       | —                                                                                       |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                       |           |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| U.S.  Healthcare Communications, Inc. |           | Line of Credit                                 |       | 90                                                                                           |       | —                                                            |       | —                                                                            |       | 90                                      |       |
|                                       | Line of Credit |                                           | 450        |                                                                                         | —     |                                                              | —     |                                                                              | 450        |                                    |
|                                       |           | Common Stock (2)                               |       | 2,470                                                                                        |       | —                                                            |       | —                                                                            |       | 240                                     |       |
|                                       |           |                                           |       |                                                                                         |       |                                                              |       |                                                                              |       |                                    |       |
| Western  Directories, Inc.            |           | Line of Credit                                 |       | 70                                                                                           |       | 1                                                                 |       | —                                                                            |       | —                                  |       |
|                                       |           | Preferred Stock (2)                            |       | 1,584                                                                                        |       | —                                                            |       | —                                                                            |       | —                                  |       |
|                                       |           | Common Stock (2)                               |       | 1                                                                                            |       | —                                                            |       | —                                                                            |       | —                                  |       |
| ** **                                 | ** **     | ** **                                     | ** ** | ** **                                                                                   | ** ** | ** **                                                        | ** ** | ** **                                                                        | ** ** | ** **                              | ** ** |
| **Total Control Investments**              | ** **     | ** **                                     | ** ** | **$**                                                                                        | **12,514** | ** **                                                        | **$**      | **64**                                                                            | ** ** | **$**                                   | **—** | ** ** | **$** | **780** | ** ** |
|                                            |                |                                                |            |                                                                                              |            |                                                                   |            |                                                                                   |            |                                         |            |  |  |  |  |

 

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(1)          Certain of the listed securities are issued by affiliates(s) of theindicated portfolio company

(2)          Security is non-income producing.

(3)          In accordance with Regulation S-X, rule 6-03(c)(i), the Companydoes not consolidate its portfolio investments. Therefore, no equity in netprofit (loss) was recorded as of September 30, 2009.

 

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Tableof Contents

 
| **Name of Issuer (1)**                       | ** **       | **Title  of Issue or Nature of  Indebtedness** | ** ** | **Value  of Each Item at  September 30, 2008** | ** ** | **Gross    Additions** | ** ** | **Gross  Reductions** | ** ** | **Value  of Each Item at  September 30, 2009** | ** ** |
|----------------------------------------------|------------------|------------------------------------------------|------------|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|-----------------------------------------------------|------------|
| **CONTROL INVESTMENTS**                      | ** **       |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| BERTL, Inc.                             |             | Line of Credit                                 |       | $                                                   | —     |                   | —     |                  | —     |                                                | $          | — |   |
|                                         |             | Common Stock (2)                               |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| Clinton  Holdings, LLC                       |             | Senior Subordinated Term  Debt                 |       | —                                              |       | 12,013                 |       | —                |       | 12,013                                              |       |
|                                         |             | Escrow Funding Note                            |       | —                                              |       | 496                    |       | —                |       | 496                                                 |       |
|                                         |             | Common Stock Warrants  (2)                     |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| Defiance  Integrated Technologies, Inc. |             | Senior Term Debt                               |       | —                                              |       | 6,005                  |       | —                |       | 6,005                                               |       |
|                                         | Senior Term Debt |                                           | —     |                                                | 1,178      |                   | —     |                  | 1,178      |                                                |
|                                         |             | Common Stock (2)                               |       | —                                              |       | 816                    |       | —                |       | 816                                                 |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| Lindmark  Acquisition, LLC                   |             | Senior Subordinated Term  Debt                 |       | —                                              |       | 10,410                 |       | —                |       | 10,410                                              |       |
|                                         |             | Senior Subordinated Term  Debt                 |       | —                                              |       | 1,049                  |       | —                |       | 1,049                                               |       |
|                                         |             | Common Stock (2)                               |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| LYP  Holdings Corp.                          |             | Line of Credit                                 |       | —                                              |       | 1,168                  |       | —                |       | 1,168                                               |       |
|                                         |             | Senior Term Debt                               |       | —                                              |       | 325                    |       |                  |       | 325                                                 |       |
|                                         |             | Line of Credit                                 |       | —                                              |       | 421                    |       | —                |       | 421                                                 |       |
|                                         |             | Senior Term Debt                               |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             | Senior Term Debt                               |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             | Common Stock Warrants  (2)                     |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| U.S. Healthcare  Communications, Inc.   |             | Line of Credit                                 |       | 90                                                  |       | 1                      |       | —                |       | 91                                                  |       |
|                                         | Line of Credit   |                                           | 450        |                                                | —     |                   | (450       | )                     | —     |                                                |
|                                         |             | Common Stock (2)                               |       | 240                                                 |       | —                 |       | (240                  | )          | —                                              |       |
|                                         |             |                                           |       |                                                |       |                   |       |                  |       |                                                |       |
| Western  Directories, Inc.              |             | Line of Credit                                 |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             | Preferred Stock (2)                            |       | —                                              |       | —                 |       | —                |       | —                                              |       |
|                                         |             | Common Stock (2)                               |       | —                                              |       | —                 |       | —                |       | —                                              |       |
| ** **                                   | ** **       | ** **                                     | ** ** | ** **                                          | ** ** | ** **             | ** ** | ** **            | ** ** | ** **                                          | ** ** |
| **Total Control Investments**                | ** **       | ** **                                     | ** ** | **$**                                               | **780**    | ** **             | **$**      | **33,882**            | ** ** | **$**                                               | **(690**   | **)** | **$** | **33,972** | ** ** |
|                                              |                  |                                                |            |                                                     |            |                        |            |                       |            |                                                     |            |  |  |  |  |

 

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(1)          Certain of the listed securities are issued by affiliates(s) of theindicated portfolio company

(2)          Security is non-income producing.

 

104

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