UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 
 FORM 10-K 
  x

          

          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2011  o

          

          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to Commission File No. 814-00735 
 Kohlberg Capital Corporation (Exact name of Registrant as specified in its charter)  Delaware

          

          20-5951150(State or other jurisdiction of incorporation or organization)

          

          (I.R.S. Employer Identification Number)
 295 Madison Avenue, 6th FloorNew York, New York 10017 (Address of principal executive offices) (212) 455-8300 (Registrants telephone number, including area code) 
 Securities registered pursuant to Section 12(b) of the Act:  Title of each class

          

          Name of exchange on which registeredCommon Shares, par value $0.01 per share

          

          The NASDAQ Global Select Market
 Securities registered pursuant to Section 12(g) of the Act: None 
 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):  Large accelerated filer o

          

          Accelerated filer x

          

          Non-accelerated filer o(Do not check if a smaller reporting company)

          

          Smaller Reporting Company o
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of June 30, 2011 was approximately $152 million based upon a closing price of $7.95 reported for such date by The NASDAQ Global Select Market. Common shares held by each executive officer and director and by each person who owns 5% or more of the outstanding common shares have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of outstanding shares of common stock of the registrant as of March 1, 2012 was 23,009,963. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants definitive proxy statement for the annual meeting of stockholders to be held on or about June 15, 2012 (the Proxy Statement) are incorporated by reference into Part III of this report.
     TABLE OF CONTENTS NOTE ABOUT REFERENCES TO KOHLBERG CAPITAL CORPORATION In this Annual Report on Form 10-K (this Annual Report), the Company, we, us and our refer to Kohlberg Capital Corporation, its subsidiaries and its wholly-owned portfolio company, Katonah Debt Advisors, L.L.C., and its controlled affiliates (Katonah Debt Advisors or KDA), and related companies, unless the context otherwise requires. NOTE ABOUT TRADEMARKS Kohlberg Capital Corporation, our logo and other trademarks of Kohlberg Capital Corporation are the property of Kohlberg Capital Corporation. All other trademarks or trade names referred to in this Annual Report are the property of their respective owners. NOTE ABOUT FORWARD-LOOKING STATEMENTS This Annual Report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The matters discussed in this Annual Report, as well as in future oral and written statements by management of Kohlberg Capital Corporation, that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or
our future financial performance. We generally identify forward-looking statements by terminology such as may, will, should, expects, plans, anticipates, could, intends, target, projects, contemplates, believes, estimates, predicts, potential or continue or the negative of these terms or other similar words, although not all forward-looking statements include these words. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Annual Report should not be regarded as a representation by us that our plans or objectives will be
achieved. The forward-looking statements contained in this Annual Report include statements as to: 

          our future operating results; 

          our business prospects and the prospects of our existing and prospective portfolio companies; 

          the return or impact of current and future investments; 

          our contractual arrangements and other relationships with third parties; 

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

          the financial condition and ability of our existing and prospective portfolio companies to achieve their objectives; 

          our expected financings and investments; 

          our regulatory structure and tax treatment; 

          our ability to operate as a business development company and a registered investment company, including the impact of changes in laws or regulations governing our operations, the operations of KDA or the operations of our portfolio companies; 

          the adequacy of our cash resources and working capital; 

          the timing of cash flows, if any, from the operations of our portfolio companies, including Katonah Debt Advisors; 

          the impact of a protracted decline in the liquidity of credit markets on our business;
 i    TABLE OF CONTENTS 

          the impact of fluctuations in interest rates on our business; 

          the valuation of our investments in portfolio companies, particularly those having no liquid trading market; 

          our ability to recover unrealized losses; 

          market conditions and our ability to access additional capital; and 

          the timing, form and amount of any dividend distributions; For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this Annual Report, please see the discussion under Risk Factors in Item 1A. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Annual Report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this Annual Report.
 ii    TABLE OF CONTENTS TABLE OF CONTENTS  PagePart IItem 1.Business





1Item 1A.Risk Factors





41Item 1B.Unresolved Staff Comments





56Item 2.Properties





56Item 3.Legal Proceedings





56Item 4.Mine Safety Disclosures





57Part IIItem 5.Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities





58Item 6.Selected Financial Data





62Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations





63Item 7A.Quantitative and Qualitative Disclosures About Market Risk





73Item 8.Financial Statements and Supplementary Data





75Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure





75Item 9A.Controls and Procedures





75Item 9B.Other Information





76Part IIIItem 10.Directors, Executive Officers and Corporate Governance





77Item 11.Executive Compensation





77Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters





77Item 13.Certain Relationships and Related Transactions, and Director Independence





77Item 14.Principle Accountant Fees and Services





77Part IVItem 15.Exhibits and Financial Statement Schedules





78Signatures





79Financial Statements





F-1
 iii    TABLE OF CONTENTS PART I Item 1. Business KOHLBERG CAPITAL CORPORATION We are an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company (BDC) under the Investment Company Act of 1940, as amended (the 1940 Act). We originate, structure and invest in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies. We define the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization, which we refer to as EBITDA, of $10 million to $50 million and/or total debt of $25 million to $150 million. In
addition to our middle market investment business, our wholly-owned portfolio company, Katonah Debt Advisors and its controlled affiliates (collectively, Katonah Debt Advisors), manage collateralized loan obligation funds (CLO Funds) that invest in broadly syndicated loans, high-yield bonds and other corporate credit instruments. We acquired Katonah Debt Advisors and certain related assets prior to our initial public offering from affiliates of Kohlberg & Co., L.L.C. (Kohlberg & Co.), a leading private equity firm focused on middle market investing. As of December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of assets under management. Our investment objective is to generate current income and capital appreciation from our investments. We also expect to receive distributions of recurring fee income and to generate capital appreciation from our investment in the asset management business of Katonah Debt Advisors. Our investment portfolio as well as the investment portfolios of the CLO Funds in which we have invested and the investment portfolios of the CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments and other securities issued by corporations and do not include any asset-backed securities secured by commercial mortgages, residential mortgages or
other consumer borrowings. As a Regulated Investment Company (RIC), for U.S. federal tax purposes, we intend to distribute to our stockholders substantially all of our net taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, we generally will not have to pay corporate-level taxes on any income that we distribute in a timely manner to our stockholders. Our common stock is traded on The NASDAQ Global Select Market under the symbol KCAP. The net asset value per share of our common stock at December 31, 2011 was $7.85. On December 31, 2011, the last reported sale price of a share of our common stock on The NASDAQ Global Select Market was $6.31. CORPORATE HISTORY AND OFFICES We were formed in August 2006 as a Delaware limited liability company. In December 2006, we completed our initial public offering (IPO), which raised net proceeds of approximately $200 million after the exercise of the underwriters over-allotment option. In connection with our IPO, we issued an additional 3,484,333 shares of our common stock to affiliates of Kohlberg & Company in exchange for the ownership interests of Katonah Debt Advisors and in securities issued by CLO Funds managed by Katonah Debt Advisors and two other asset managers. Our principal executive offices are located at 295 Madison Avenue, 6th Floor, New York, New York 10017 and our telephone number is (212) 455-8300. Information about us may also be obtained from the website of the Securities and Exchange Commission (the SEC or the Commission) at http://www.sec.gov. We maintain a website on the Internet at http://www.kohlbergcapital.com. Information contained in our website is not incorporated by reference into this Annual Report, and that information should not be considered as part of this Annual Report. We make available free of charge on our website our Annual Report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.
 1    TABLE OF CONTENTS KEY QUANTITATIVE AND QUALITATIVE FINANCIAL MEASURES AND INDICATORS Net Asset Value Our net asset value (also referred to as NAV) per share was $7.85 and $8.21 as of December 31, 2011 and December 31, 2010, respectively. As we must report our assets at fair value for each reporting period, NAV also represents the amount of stockholders equity per share for the reporting period. Our NAV is comprised mostly of investment assets less debt and other liabilities:  December 31, 2011

          

          December 31, 2010Fair Value(1)

          

          per Share(1)

          

          Fair Value(1)

          

          per Share(1)Investments at fair value:Time deposits

          

          $

          229,152

          

          

          $

          0.01

          

          

          $

          720,225

          

          

          $

          0.03Money market account

          

          

          31,622,134

          

          

          

          1.38

          

          

          

          210,311

          

          

          

          0.01Debt securities

          

          

          114,673,506

          

          

          

          4.99

          

          

          

          91,042,928

          

          

          

          4.00CLO Fund securities

          

          

          46,412,000

          

          

          

          2.02

          

          

          

          53,031,000

          

          

          

          2.33Equity securities

          

          

          6,040,895

          

          

          

          0.26

          

          

          

          4,688,832

          

          

          

          0.21Asset manager affiliates

          

          

          40,814,000

          

          

          

          1.78

          

          

          

          41,493,000

          

          

          

          1.82Cash

          

          

          2,555,259

          

          

          

          0.10

          

          

          

          10,175,488

          

          

          

          0.45Restricted Cash

          

          

          

          

          

          

          

          

          

          

          67,023,170

          

          

          

          2.93Other assets

          

          

          5,786,715

          

          

          

          0.25

          

          

          

          11,437,732

          

          

          

          0.50Total Assets

          

          $

          248,133,661

          

          

          $

          10.79

          

          

          $

          279,822,686

          

          

          $

          12.28Borrowings

          

          $

          60,000,000

          

          

          $

          2.61

          

          

          $

          86,746,582

          

          

          $

          3.81Other liabilities

          

          

          7,607,719

          

          

          

          0.33

          

          

          

          6,150,437

          

          

          

          0.27Total Liabilities

          

          $

          67,607,719

          

          

          $

          2.94

          

          

          $

          92,897,019

          

          

          $

          4.08NET ASSET VALUE

          

          $

          180,525,942

          

          

          $

          7.85

          

          

          $

          186,925,667

          

          

          $

          8.21
  (1)

          Our balance sheet at fair value and resultant net asset value are calculated on a basis consistent with accounting principles generally accepted in the United States of America (GAAP). Our per share presentation of such amounts (other than NAV per share) is an internally derived non-GAAP performance measure calculated by dividing the applicable balance sheet amount by outstanding shares. We believe that the per share amounts for such balance sheet items are helpful in analyzing our balance sheet both quantitatively and qualitatively. Please refer to  Investment Portfolio below for a further description of our investment portfolio and the fair value thereof. Leverage We use borrowed funds, known as leverage, to make investments and to attempt to increase returns to our shareholders by reducing our overall cost of capital. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. We are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. As of December 31, 2011, we had approximately $60 million of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 401%, compliant with the minimum asset coverage level of 200% generally required for a BDC by the 1940 Act. We
may also borrow amounts of up to 5% of the value of our total assets for temporary purposes. At December 31, 2010, we had approximately $87 million of outstanding indebtedness through a secured credit facility. On January 31, 2011, we repaid in full the outstanding balance under this Facility. As a result, approximately $73 million of collateral previously securing the Facility was released to us and we also received a $2 million cash settlement from the lenders to settle litigation previously initiated by us against the lenders. In order to pay off the Facility, we utilized proceeds received from the paydown, amortization or sale of portfolio loan investments totaling approximately $133 million together with available cash.
 2    TABLE OF CONTENTS On March 16, 2011, we issued $55 million in aggregate principal amount of unsecured 8.75% convertible senior notes due 2016 (Convertible Senior Notes). On March 23, 2011, pursuant to an over-allotment option, we issued an additional $5 million of such Convertible Senior Notes for a total of $60 million in aggregate principal amount. The net proceeds for the Convertible Senior Notes, following underwriting expenses, were approximately $57.7 million. Interest on the Convertible Senior Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Notes mature on March 15, 2016
unless converted earlier. The Convertible Senior Notes are senior unsecured obligations of the Company. The Convertible Senior Notes are convertible into shares of Companys common stock based on an initial conversion rate of 118.5255 shares of common stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price of approximately $8.44 per share of common stock. The conversion rate will be subject to adjustment upon certain events. Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. As a result, we may seek to enter into a new agreement with other lenders or into other financing arrangements as market conditions permit. The weighted average daily debt balance for the years ended December 31, 2011 and 2010 was approximately $54 million and $155 million, respectively. On February 24, 2012, the Company entered into a Note Purchase Agreement (the Note Purchase Agreement) with Credit Suisse AG, Cayman Islands Branch (CS), Credit Suisse Securities (USA) LLC, as arranger, The Bank of New York Mellon Trust Company, National Association, as collateral administrator and collateral agent (BNYM), and KCAP Funding, a special-purpose bankruptcy remote wholly-owned subsidiary of the Company (KCAP Funding), whereby KCAP Funding purchased a portfolio of senior secured term loans (the Collateral Debt Obligations), the purchase of which was financed by the issuance of (a)
a senior note in an aggregate principal amount of $30.0 million, issued to CS in exchange for $30.0 million in cash and (b) a junior note in an aggregate principal amount of $12.5 million, issued to the Company in exchange for the sale by the Company to KCAP Funding of the Collateral Debt Obligations. Pursuant to the Note Purchase Agreement, the Company has agreed to act as Portfolio Manager on behalf of KCAP Funding and CS of the Collateral Debt Obligations, and has granted a security interest to KCAP Funding in all of the Companys right to receive certain management fees, and KCAP Funding granted to CS a security interest in, among other things, the Collateral Debt Obligations and its rights to receive the management fees pledged to it by the Company. Investment Portfolio Summary Attributes as of and for the Year Ended December 31, 2011 Our investment portfolio generates net investment income, which is generally used to pay principal and interest on our borrowings and to fund our dividends. Our investment portfolio consists of three primary components: debt securities, CLO fund securities and our investment in our wholly owned asset manager, Katonah Debt Advisors. We also have investments in equity securities of approximately $6 million, which comprises approximately 3% of our investment portfolio. Below are summary attributes for each of our primary investment portfolio components (see  Investment Portfolio and  Investments and Operations for a
more detailed description) as of and for the year ended December 31, 2011: Debt Securities 

          represent approximately 48% of total investment portfolio; 

          represent credit instruments issued by corporate borrowers; 

          no asset-backed securities such as those secured by commercial mortgages or residential mortgages and no consumer borrowings; 

          primarily senior secured and junior secured loans (39% and 41% of debt securities, respectively);
 3    TABLE OF CONTENTS 

          spread across 21 different industries and 44 different entities; 

          average balance per investment of approximately $3 million; 

          all but three issuers (representing less than 1% of total investments at fair value) are current on their debt service obligations; 

          weighted average interest rate of 8.4% on income producing debt investments. CLO Fund Securities (as of the last monthly trustee report prior to December 31, 2011 unless otherwise specified) 

          represent approximately 19% of total assets at December 31, 2011; 

          86% of CLO Fund Securities represent investments in subordinated securities or equity securities issued by CLO Funds and 14% of CLO Fund Securities are rated notes; 

          all CLO Funds invest primarily in credit instruments issued by corporate borrowers; 

          no asset-backed securities such as those secured by commercial mortgages or residential mortgages and no consumer borrowings; 

          nine different CLO Fund securities; six of such CLO Fund securities are managed by Katonah Debt Advisors; and 

          two CLO Fund securities, not managed by Katonah Debt Advisors, representing a fair value of $2,000, are not currently providing a dividend payment to the Company. Katonah Debt Advisors 

          represents approximately 17% of total investment portfolio; 

          represents our 100% ownership of the equity interest of a profitable CLO Fund manager focused on corporate credit investing; 

          has approximately $1.9 billion of assets under management; 

          receives contractual and recurring asset management fees based on par value of managed investments; 

          typically receives a one-time structuring fee upon completion of a new CLO Fund; 

          may receive an incentive fee upon liquidation of a CLO Fund provided that the CLO Fund achieves a minimum designated return on investment; 

          dividends paid by Katonah Debt Advisors are recognized as dividend income from affiliate asset manager on our statement of operations and are an additional source of income to pay our dividend; 

          for the year ended December 31, 2011, Katonah Debt Advisors had pre-tax net income of approximately $2 million; and 

          for the year ended December 31, 2011, Katonah Debt Advisors made distributions of $1.9 million to the Company in the form of a dividend which is recognized as current earnings to the Company. Time Deposits and Money Market Accounts 

          time deposits, represented by overnight Eurodollar deposits, were partially restricted under terms of the Facility prior to the payoff thereof on January 31, 2011; and 

          the money market account contains restricted cash held for employee flexible spending accounts.
 4    TABLE OF CONTENTS Revenue Revenues consist primarily of investment income from interest and dividends on our investment portfolio and various ancillary fees related to our investment holdings. Interest from Investments in Debt Securities.  We generate interest income from our investments in debt securities which consist primarily of senior and junior secured loans. Our debt securities portfolio is spread across multiple industries and geographic locations, and as such, we are broadly exposed to market conditions and business environments. As a result, although our investments are exposed to market risks, we continuously seek to limit concentration of exposure in any particular sector or issuer. Dividends from Investments in CLO Fund Securities.  We generate dividend income from our investments in the securities of CLO Funds (typically preferred shares or subordinated securities) managed by Katonah Debt Advisors and selective investments in securities issued by funds managed by other asset management companies. CLO Funds managed by Katonah Debt Advisors invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The Company distinguishes CLO Funds managed by Katonah Debt Advisors as CLO fund securities managed by affiliate. The underlying
assets in each of the CLO Funds in which we have an investment are generally diversified secured or unsecured corporate debt and exclude mortgage pools or mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset-backed securities), debt to companies providing mortgage lending and emerging markets investments. Our CLO Fund securities that are subordinated securities or preferred shares (junior securities) are subordinated to senior bond holders who typically receive a fixed rate of return on their investment. The CLO Funds are leveraged funds and any excess cash flow or excess spread (interest earned by the underlying securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is paid to the holders of the CLO Funds subordinated securities or preferred shares. The level of excess spread from CLO Fund securities can be impacted from the timing and level of the
resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund bond liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly. In addition, the failure of CLO Funds in which we invest to comply with certain financial covenants my lead to the temporary suspension or deferral of cash distributions to us. For non-junior class CLO Fund securities, such as our investment in the class B-2L notes of the Katonah 2007-1 CLO, interest is earned at a fixed spread relative to the LIBOR index. Dividends from Affiliate Asset Manager.  We generate dividend income from our investment in Katonah Debt Advisors, an asset management company, which is a wholly-owned portfolio company that manages CLO Funds that invest primarily in broadly syndicated non-investment grade loans, high yield bonds and other credit instruments issued by corporations. As a manager of CLO Funds, Katonah Debt Advisors receives contractual and recurring management fees as well as an expected one-time structuring fee from the CLO Funds for its management and advisory services. In addition, Katonah Debt Advisors may earn income related to net interest on
assets accumulated for future CLO issuances on which it has provided a first loss guaranty in connection with loan warehouse arrangements for its CLO Funds. Katonah Debt Advisors generates annual operating income equal to the amount by which its fee income exceeds it operating expenses. The annual management fees which Katonah Debt Advisors receives are generally based on a fixed percentage of the par value of assets under management and are recurring in nature for the term of the CLO Fund so long as Katonah Debt Advisors manages the fund. As a result, the annual management fees earned by Katonah Debt Advisors generally are not subject to market value fluctuations in the underlying collateral. In future years, Katonah Debt Advisors may receive incentive fees upon the liquidation of CLO Funds it manages, provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares. Capital Structuring Service Fees.  We may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities.
 5    TABLE OF CONTENTS Expenses We are internally managed and directly incur the cost of management and operations; as a result, we incur no management fees or other fees to an external advisor. Our expenses consist primarily of interest expense on outstanding borrowings, compensation expense and general and administrative expenses, including professional fees. Interest and Amortization of Debt Issuance Costs.  Interest expense is dependent on the average outstanding balance on our borrowings and the base index rate for the period. Debt issuance costs represent fees and other direct costs incurred in connection with the Companys borrowings. These amounts are capitalized and amortized ratably over the contractual term of the borrowing. Compensation Expense.  Compensation expense includes base salaries, bonuses, stock compensation, employee benefits and employer related payroll costs. The largest components of total compensation costs are base salaries and bonuses; generally, base salaries are expensed as incurred and annual bonus expenses are estimated and accrued. Our compensation arrangements with our employees contain a significant profit sharing and/or performance based bonus component. Therefore, as our net revenues increase, our compensation costs may also rise. In addition, our compensation expenses may also increase to reflect increased investment in
personnel as we grow our products and businesses. Professional Fees and General and Administrative Expenses.  The balance of our expenses include professional fees (primarily legal, accounting, valuation and other professional services), occupancy costs and general administrative and other costs. Net Change in Unrealized Depreciation on Investments During the year ended December 31, 2011, the Companys investments had net unrealized appreciation of $10 million. For the year ended December 31, 2011, the net increase of approximately $10 million in unrealized appreciation is primarily due to (i) one investment position with a cost basis of approximately $10.7 million and fair value of $250,000 as of March 31, 2011 that was written off which resulted in a decrease to unrealized depreciation on debt securities of approximately $10.5 million (additional fair value adjustments of approximately $4.5 million further increased the unrealized appreciation on debt securities for the period for a total of approximately $16 million); (ii) one CLO Fund security with a cost basis of approximately $3.2 million and a fair
value of $1.9 million as of March 31, 2011 that was sold which resulted in a decrease to unrealized depreciation on CLO Fund securities managed by non-affiliates of approximately $1.3 million, along with a decrease in unrealized appreciation of approximately $3.5 million on the remaining CLO Fund securities; (iii) an approximate decrease in unrealized depreciation of $1.7 million in equity securities; and (iv) a net decrease of approximately $2 million in the unrealized appreciation of Katonah Debt Advisors. The reduction in unrealized depreciation for the write off of the debt security and the sale of the CLO Fund security was offset by an increase to realized losses of approximately $12.0 million resulting in a net decrease in net asset value for the year ended December 31, 2011 of approximately $200,000. Net Change in Stockholders Equity Resulting From Operations The net change in stockholders equity resulting from operations for the year ended December 31, 2011 was an increase of approximately $8 million or an increase of $0.33 per share. Net Investment Income and Net Realized Gains (Losses) Net investment income and net realized gains (losses) represents the net change in stockholders equity before net unrealized appreciation or depreciation on investments. For the year ended December 31, 2011, net investment income and realized losses was approximately $2 million, or $0.11 per share. Net investment income represents the income earned on our investments less operating and interest expense before net realized gains or losses and unrealized appreciation or depreciation on investments. For the year ended December 31, 2011, net investment income was approximately $16 million, or $0.70 per share. Generally, we seek to fund our dividends from net investment income. For the year ended December 31, 2011, dividend distributions totaled $16 million, or $0.70 per share.
 6    TABLE OF CONTENTS Dividends We intend to continue to distribute quarterly dividends to our stockholders. To avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least equal to the sum of: 

          98.0% of our ordinary net taxable income for the calendar year; 

          98.2% of our capital gains, if any, in excess of capital losses for the one-year period ending on October 31 of the calendar year; and 

          any net ordinary income and net capital gains for the preceding year that were not distributed during such year. The amount of our declared dividends, as evaluated by management and approved by our Board of Directors, is based on our evaluation of both distributable income for tax purposes and GAAP net investment income (which excludes unrealized gains and losses). Generally, we seek to fund our dividends from GAAP current earnings, primarily from net interest and dividend income generated by our investment portfolio and without a return of capital or a high reliance on realized capital gains. The following table sets forth the quarterly dividends declared by us in the two most recently completed years, which represent an amount equal to our estimated net
investment income for the specified quarter, including income distributed from Katonah Debt Advisors received by the Company, plus a portion of any prior year undistributed amounts of net investment income distributed in subsequent years:  Dividend

          

          Declaration Date

          

          Record Date

          

          Pay Date2011:Fourth quarter

          

          $

          0.18

          

          

          

          12/12/2011

          

          

          

          12/23/2011

          

          

          

          1/27/2012Third quarter

          

          

          0.18

          

          

          

          9/15/2011

          

          

          

          10/10/2011

          

          

          

          10/28/2011Second quarter

          

          

          0.17

          

          

          

          6/13/2011

          

          

          

          7/8/2011

          

          

          

          7/29/2011First quarter

          

          

          0.17

          

          

          

          3/21/2011

          

          

          

          4/8/2011

          

          

          

          4/29/2011Total declared for 2011

          

          $

          0.702010:Fourth quarter

          

          $

          0.17

          

          

          

          12/13/2010

          

          

          

          12/24/2010

          

          

          

          1/29/2011Third quarter

          

          

          0.17

          

          

          

          9/20/2010

          

          

          

          10/8/2010

          

          

          

          10/29/2010Second quarter

          

          

          0.17

          

          

          

          6/23/2010

          

          

          

          7/7/2010

          

          

          

          7/29/2010First quarter

          

          

          0.17

          

          

          

          3/19/2010

          

          

          

          4/7/2010

          

          

          

          4/29/2010Total declared for 2010

          

          $

          0.68
 Due to our ownership of Katonah Debt Advisors and certain timing, structural and tax considerations, our dividend distributions may include a return of capital for tax purposes. For the year ended December 31, 2011, Katonah Debt Advisors had approximately $2 million of pre-tax net income and made distributions of $1.9 million to us, a portion of which represented undistributed earnings from prior years. For the year ended December 31, 2010, Katonah Debt Advisors had approximately $1 million of pre-tax net income and made distributions of $4.5 million to us. Dividends are recorded as declared (where declaration date represents ex-dividend date) by
Katonah Debt Advisors as income on our statement of operations. Please refer to Distributions and Certain United States Federal Income Tax Considerations for further information regarding our dividend distributions.
 7    TABLE OF CONTENTS INVESTMENT PORTFOLIO Investment Objective Our investment objective is to generate current income and capital appreciation from the investments made by our middle market business in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies, and from our investment in Katonah Debt Advisors. We intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. We primarily invest in first and second lien term loans which, because of their priority in a companys capital structure, we expect will have lower default rates and higher rates of recovery of principal if
there is a default and which we expect will create a stable stream of interest income. While our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, we may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. We may also receive warrants or options to purchase common stock in connection with our debt investments. In addition, we may also invest in debt and equity securities issued by CLO Funds managed by Katonah Debt Advisors or by other asset managers. However, our investment strategy is to limit the value of our investments in the debt or equity securities issued by CLO Funds to not more than 15% of the value of our total investment portfolio at the time of investment. We invest almost exclusively in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by commercial mortgages,
residential mortgages or other consumer borrowings. Our middle market investment business targets companies that have strong historical cash flows, experienced management teams and identifiable and defendable market positions in industries with positive dynamics. We seek to manage risk through a rigorous credit and investment underwriting process and an active portfolio monitoring program. We expect to continue to benefit from our ownership of Katonah Debt Advisors in four ways. First, by working with the investment professionals at Katonah Debt Advisors, we have multiple sources of investment opportunities. Second, the experienced team of credit analysts at Katonah Debt Advisors, the members of which also serve as officers of the Company, have specializations covering more than 20 industry groups and they assist us in reviewing potential investments and monitoring our portfolio. Third, we may continue to make investments in CLO Funds or other funds managed by Katonah Debt Advisors, which we believe will provide us with a current cash
investment return. Fourth, we expect to continue to receive distributions of recurring fee income and the potential to generate capital appreciation from our investment in Katonah Debt Advisors as the platform grows.
 8    TABLE OF CONTENTS The following table shows the Companys portfolio by security type at December 31, 2011 and December 31, 2010:  December 31, 2011

          

          December 31, 2010Security Type

          

          Cost

          

          Fair Value

          

          %(1)

          

          Cost

          

          Fair Value

          

          %(1)Time Deposits

          

          $

          229,152

          

          

          $

          229,152

          

          

          

          

          %

          

          $

          720,225

          

          

          $

          720,225

          

          

          

          

          %Money Market Account

          

          

          31,622,134

          

          

          

          31,622,134

          

          

          

          13

          

          

          

          210,311

          

          

          

          210,311

          

          

          

          Senior Secured Loan

          

          

          54,045,184

          

          

          

          45,259,328

          

          

          

          19

          

          

          

          34,183,551

          

          

          

          22,001,256

          

          

          

          12Junior Secured Loan

          

          

          58,936,728

          

          

          

          47,300,172

          

          

          

          20

          

          

          

          76,896,867

          

          

          

          63,944,003

          

          

          

          34Mezzanine Investment

          

          

          10,931,428

          

          

          

          11,588,115

          

          

          

          5

          

          

          

          10,744,496

          

          

          

          250,000

          

          

          

          Senior Subordinated Bond

          

          

          9,997,898

          

          

          

          10,125,891

          

          

          

          4

          

          

          

          4,320,596

          

          

          

          4,490,709

          

          

          

          2CLO Fund Securities

          

          

          65,209,809

          

          

          

          46,412,000

          

          

          

          19

          

          

          

          68,280,200

          

          

          

          53,031,000

          

          

          

          28Equity Securities

          

          

          16,559,610

          

          

          

          6,040,895

          

          

          

          3

          

          

          

          13,232,266

          

          

          

          4,437,871

          

          

          

          2Preferred

          

          

          400,000

          

          

          

          400,000

          

          

          

          

          

          

          

          650,961

          

          

          

          607,921

          

          

          

          Affiliate Asset Managers

          

          

          44,338,301

          

          

          

          40,814,000

          

          

          

          17

          

          

          

          44,532,329

          

          

          

          41,493,000

          

          

          

          22Total

          

          $

          292,270,244

          

          

          $

          239,791,687

          

          

          

          100

          %

          

          $

          253,771,802

          

          

          $

          191,186,296

          

          

          

          100

          %
  (1)

          Represents percentage of total portfolio at fair value. Investment Securities We invest in senior secured loans, mezzanine debt and, to a lesser extent, equity, of middle market companies in a variety of industries. We generally target companies that generate positive cash flows because we look to cash flows as the primary source for servicing debt. However, we may invest in other industries if we are presented with attractive opportunities. We employ a disciplined approach in the selection and monitoring of our investments. Generally, we target investments that will provide a current return through interest income to provide for stability in our net income and place less reliance on realized capital gains from our investments. Our investment philosophy is focused on preserving capital with an appropriate return profile relative to risk. Our investment due diligence and selection generally focuses on an underlying issuers net cash flow after capital expenditures to service its debt rather than on multiples of net income, valuations or other broad benchmarks which frequently miss
the nuances of an issuers business and prospective financial performance. We also generally avoid concentrations in any one industry or issuer. We manage risk through a rigorous credit and investment underwriting process and an active portfolio monitoring program. Our Board of Directors is ultimately and solely responsible for making a good faith determination of the fair value of portfolio investments on a quarterly basis. Debt and equity securities for which market quotations are readily available are generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued by the Board of Directors based on detailed analyses prepared by management, the Valuation Committee of the Board of Directors, and, in certain circumstances, third parties with valuation expertise. Valuations are conducted by management on 100% of the
investment portfolio at the end of each quarter. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ materially from the values that would have existed had a ready market existed for such investments. Further, such investments may be generally subject to legal and other restrictions on resale or otherwise less liquid than publicly traded securities. In addition, changes in the market environment and other events may occur over the life of the investments that may cause the value realized on such investments to be different from the currently assigned valuations. We derive fair value for our illiquid investments that do not have indicative fair values based upon active trades primarily by using a present value technique that discounts the estimated contractual cash flows for the underlying assets with discount rates imputed by broad market indices, bond spreads and yields for comparable issuers relative to the subject assets (the Market Yield Approach) and also consider recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt
security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a
 9    TABLE OF CONTENTS leveraged loan index and a high-yield bond index, at the valuation date. We have identified these two indices as benchmarks for broad market information related to our loan and debt investments. Because we have not identified any market index that directly correlates to the loan and debt investments held by us and therefore use the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Market Yield Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount
rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on
their relevancy. The appropriateness of specific valuation methods and techniques may change as market conditions and available data change. In January 2010, the Financial Accounting Standards Board (FASB) issued guidance that clarifies and requires new disclosures about fair value measurements. The clarifications and requirement to disclose the amounts and reasons for significant transfers between Level 1 and Level 2, as well as significant transfers in and out of Level III of the fair value hierarchy, were adopted by us in the first quarter of 2010. Note 4 to the financial statements reflects the amended disclosure requirements. The new guidance also requires that purchases, sales, issuances and settlements be presented gross in the Level 3 reconciliation and that
requirement is effective for fiscal years beginning after December 15, 2010 and for interim periods within those years, with early adoption permitted. Since this new guidance only amends the disclosures requirements, it did not impact our statements of financial position, statements of operations, or cash flow statements. In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurements: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements (ASU 2011-04). ASU 2011-04 amends Topic 820 to clarify existing fair value measurement disclosures to (1) specifically provide quantitative information about the significant unobservable inputs used for all level 3 measurements and (2) disclose any transfers between levels 1 and 2 of the fair value hierarchy, not just significant transfers. ASU 2011-04 also requires a number of additional disclosures regarding fair value measurements. Specifically, ASU 2011-04 requires
entities to disclose: (1) a qualitative discussion about the sensitivity of recurring level 3 measurements to changes in the unobservable inputs disclosed, including the interrelationship between inputs; (2) a description of our valuation processes surrounding level 3 measurements; (3) information about when the current use of a non-financial asset measured at fair value differs from its highest and best use; and (4) the hierarchy classification for items whose fair value is not recorded on the balance sheet but is disclosed in the notes. ASU 2011-04 amends Topic 820 to change the fair value measurement of financial instruments and the application of premiums and discounts in a fair value measurement. ASU 2011-04 also clarifies existing fair value measurement regarding the concepts of valuation premise, the application of the highest and best use, and the fair value measurement of an instrument classified in an entitys shareholders equity. The adoption of ASU 2011-04 is not
expected to have an effect on our current fair value measurements but is expected to have a significant impact on our disclosures related to the assets and liabilities of its consolidated investment products that are classified as level 3 assets within the fair value hierarchy. The amendments to Topic 820 made by ASU 2011-04 are effective for interim and annual periods beginning on or after December 15, 2011. As such, these disclosure changes will be required in our Form 10-Q for the three months ended March 31, 2012. Accounting Standards Codification Fair Value Measurements and Disclosures (Fair Value Measurements and Disclosure) requires the disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period.
 10    TABLE OF CONTENTS We engaged Valuation Research Corporation (VRC), an independent valuation firm, to provide third-party valuation estimates for approximately 8% of investments at fair value as of December 31, 2011. VRCs valuation estimates were considered as one of the relevant data inputs in the Companys determination of fair value. The Board of Directors did not engage VRC to provide valuation estimates for any of the assets in the Companys portfolio as of December 31, 2010. However, the Board of Directors engaged VRC to review our CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method
to determine CLO fair values, in the absence of Level 1 or Level 2 trading activity or observable market inputs for both the years ended December 31, 2011 and 2010. VRC concluded that our CLO model appropriately factored in all the necessary inputs required to build a CLO equity cash flow for fair value purposes and that the inputs were being employed correctly. The Board of Directors may engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of its valuation processes. The majority of our investment portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a valuation of each individual investment that considers multiple levels of market and asset specific inputs, including historical and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest rates and independent valuations and reviews. Loans and Debt Securities. To the extent that our investments are exchange traded and are priced or have sufficient price indications from normal course trading at or around the valuation date (financial reporting date), such pricing will determine fair value. Pricing service marks from third party pricing services may be used as an indication of fair value, depending on the volume and reliability of the marks, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading activity. However, most of our investments are illiquid investments with little or no trading activity. Further, we have been unable to identify directly
comparable market indices or other market guidance that correlate directly to the types of investments we own. As a result, for most of our assets, we determine fair value using alternative methodologies and models using available market data, as adjusted, to reflect the types of assets we own, their structure, qualitative and credit attributes and other asset specific characteristics. We derive fair value for our illiquid investments that do not have indicative fair values based upon active trades primarily by using the Market Yield Approach and also consider recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. We have identified these two indices as benchmarks for broad
market information related to our loan and debt investments. Because we have not identified any market index that directly correlates to the loan and debt investments held by us and therefore use the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Market Yield Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable
transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy.
 11    TABLE OF CONTENTS Equity and Equity-Related Securities. Our equity and equity-related securities in portfolio companies for which there is no liquid public market are carried at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including EBITDA, cash flows from operations less capital expenditures and other pertinent factors, such as recent offers to purchase a portfolio companys securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority ownership positions. The values of our equity and equity-related securities in public companies for which market
quotations are readily available are based upon the closing public market price on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security. The significant inputs used to determine the fair value of equity and equity-related securities include prices, earnings, EBITDA and cash flows after capital expenditures for similar peer comparables and the investment entity itself. Equity and equity-related securities are classified as Level III when there is limited activity or less transparency around inputs to the valuation given the lack of information related to such equity investments held in nonpublic companies. Significant assumptions observed for comparable companies as applied to relevant financial data for the specific investment. Such assumptions, such as model discount rates or
price/earnings multiples, vary by the specific investment, equity position and industry and incorporate adjustments for risk premiums, liquidity and company specific attributes. Such adjustments require judgment and may be material to the calculation of fair value. At December 31, 2011 and December 31, 2010, our investments in income producing loans and debt securities, excluding CLO Fund securities, had a weighted average interest rate of approximately 8.4% and 8.6%, respectively. The investment portfolio (excluding the Companys investment in asset manager affiliates and CLO Funds) at December 31, 2011 was spread across 21 different industries and 44 different entities with an average balance per entity of approximately $3 million. As of December 31, 2011, all but three of our portfolio companies were current on their debt service obligations. Our portfolio, including the CLO Funds in we invest, and the CLO Funds managed by Katonah Debt Advisors consist almost exclusively of credit instruments issued by corporations and do not include investments in asset-backed securities, such as those secured by commercial mortgages,
residential mortgages or other consumer borrowings. We may invest up to 30% of our investment portfolio in opportunistic investments in high-yield bonds, debt and equity securities of CLO Funds, distressed debt or equity securities of public companies. However, our investment strategy is to limit the value of our investments in the debt or equity securities issued by CLO Funds to not more than 15% of the value of our total investment portfolio at the time of investment. We expect that these public companies generally will have debt that is non-investment grade. We also may invest in debt of middle market companies located outside of the U.S., which investments are generally not anticipated to be in
excess of 10% of our investment portfolio at the time such investments are made. At December 31, 2011, approximately 21% of our investments were foreign assets (including our investments in CLO Funds, which are typically domiciled outside the U.S. and represent approximately 19% of our portfolio). We are generally prohibited from buying or selling any security from or to any portfolio company of a private equity fund managed by Kohlberg & Co. without the prior approval of the SEC. However, we may co-invest on a concurrent basis with Kohlberg & Co. or any of our affiliates, subject to compliance with existing regulatory guidance, applicable regulations and our allocation procedures. Certain types of negotiated co-investments may be made only if we receive an order from the SEC permitting us to do so. There can be no assurance that any such order will be applied for or, if applied for, obtained. At December 31, 2011, our ten largest portfolio companies represented approximately 62% of the total fair value of our investments. Our largest investment, Katonah Debt Advisors which is our wholly-owned portfolio company, represented 17% of the total fair value of our investments. Excluding Katonah Debt Advisors and CLO Fund securities, our ten largest portfolio companies represent approximately 26% of the total fair value of our investments. The characteristics of our investment securities at fair value, excluding CLO equity securities are presented in the following table as of each quarter end from March 31, 2010 through December 31, 2011.
 12    TABLE OF CONTENTS  4Q11

          

          3Q11

          

          2Q11

          

          1Q11Security Type ($ in millions)

          

          $

          

          %

          

          $

          

          %

          

          $

          

          %

          

          $

          

          %First Lien

          

          $

          45.3

          

          

          

          37

          %

          

          $

          47.0

          

          

          

          37

          %

          

          $

          31.9

          

          

          

          27

          %

          

          $

          23.3

          

          

          

          24

          %Second Lien/Mezzanine/Bond

          

          

          69.0

          

          

          

          57

          

          

          

          73.2

          

          

          

          58

          

          

          

          81.2

          

          

          

          68

          

          

          

          64.8

          

          

          

          68Equity

          

          

          6.0

          

          

          

          5

          

          

          

          6.0

          

          

          

          5

          

          

          

          6.7

          

          

          

          6

          

          

          

          7.4

          

          

          

          8Preferred

          

          

          0.4

          

          

          

          

          

          

          

          0.4

          

          

          

          

          

          

          

          0.4

          

          

          

          

          

          

          

          0.4

          

          

          

          Total

          

          $

          120.7

          

          

          

          99

          %

          

          $

          126.6

          

          

          

          100

          %

          

          $

          120.2

          

          

          

          101

          %

          

          $

          95.8

          

          

          

          100

          %
  4Q10

          

          3Q10

          

          2Q10

          

          1Q10Security Type ($ in millions)

          

          $

          

          %

          

          $

          

          %

          

          $

          

          %

          

          $

          

          %First Lien

          

          $

          22.0

          

          

          

          23

          %

          

          $

          95.7

          

          

          

          49

          %

          

          $

          123.3

          

          

          

          53

          %

          

          $

          143.3

          

          

          

          51

          %Second Lien/Mezzanine/Bond

          

          

          68.7

          

          

          

          72

          

          

          

          94.9

          

          

          

          48

          

          

          

          103.1

          

          

          

          44

          

          

          

          132.8

          

          

          

          47Equity

          

          

          4.4

          

          

          

          5

          

          

          

          5.7

          

          

          

          3

          

          

          

          6.2

          

          

          

          3

          

          

          

          5.6

          

          

          

          2Preferred

          

          

          0.6

          

          

          

          1

          

          

          

          0.6

          

          

          

          

          

          

          

          0.7

          

          

          

          

          

          

          

          0.7

          

          

          

          Total

          

          $

          95.7

          

          

          

          100

          %

          

          $

          196.9

          

          

          

          100

          %

          

          $

          233.3

          

          

          

          100

          %

          

          $

          282.4

          

          

          

          100

          %
 13    TABLE OF CONTENTS The industry concentrations, based on the fair value of the Companys investment portfolio as of December 31, 2011 and December 31, 2010, were as follows:  December 31, 2011

          

          December 31, 2010Industry Classification

          

          Cost

          

          Fair Value

          

          %(1)

          

          Cost

          

          Fair Value

          

          %(1)Aerospace and Defense

          

          $

          19,683,821

          

          

          $

          19,439,230

          

          

          

          8

          %

          

          $

          6,499,518

          

          

          $

          5,613,844

          

          

          

          2

          %Asset Management Companies(2)

          

          

          44,338,301

          

          

          

          40,814,000

          

          

          

          17

          

          

          

          44,532,329

          

          

          

          41,493,000

          

          

          

          22Beverage, Food and Tobacco

          

          

          9,892,274

          

          

          

          9,796,565

          

          

          

          4

          

          

          

          

          

          

          

          

          

          

          

          Buildings and Real Estate(3)

          

          

          18,591,674

          

          

          

          662,443

          

          

          

          

          

          

          

          32,845,509

          

          

          

          6,923,964

          

          

          

          4Cargo Transport

          

          

          4,374,350

          

          

          

          4,374,351

          

          

          

          2

          

          

          

          4,940,182

          

          

          

          4,940,182

          

          

          

          3Chemicals, Plastics and Rubber

          

          

          4,809,459

          

          

          

          4,614,828

          

          

          

          2

          

          

          

          

          

          

          

          

          

          

          

          CLO Fund Securities

          

          

          65,209,809

          

          

          

          46,412,000

          

          

          

          19

          

          

          

          68,280,200

          

          

          

          53,031,000

          

          

          

          28Containers, Packaging and Glass

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          3,009,682

          

          

          

          3,000,000

          

          

          

          2Diversified/Conglomerate Manufacturing

          

          

          6,905,447

          

          

          

          7,000,000

          

          

          

          3

          

          

          

          

          

          

          

          

          

          

          

          Diversified/Conglomerate Service

          

          

          2,870,642

          

          

          

          372,599

          

          

          

          

          

          

          

          10,384,036

          

          

          

          8,345,287

          

          

          

          4Electronics

          

          

          8,831,440

          

          

          

          9,026,186

          

          

          

          4

          

          

          

          3,006,137

          

          

          

          3,176,250

          

          

          

          2Healthcare, Education and Childcare

          

          

          20,956,582

          

          

          

          19,523,824

          

          

          

          8

          

          

          

          15,113,551

          

          

          

          15,037,936

          

          

          

          8Home and Office Furnishings, Housewares, and Durable Consumer Goods

          

          

          21,683,112

          

          

          

          20,604,850

          

          

          

          9

          

          

          

          9,654,903

          

          

          

          8,804,450

          

          

          

          5Insurance

          

          

          4,919,522

          

          

          

          3,753,000

          

          

          

          2

          

          

          

          4,890,322

          

          

          

          4,049,000

          

          

          

          2Leisure, Amusement, Motion Pictures, Entertainment

          

          

          2,290,892

          

          

          

          2,084,012

          

          

          

          1

          

          

          

          2,114,458

          

          

          

          1,983,619

          

          

          

          1Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

          

          

          3,483,174

          

          

          

          3,891,900

          

          

          

          2

          

          

          

          3,477,696

          

          

          

          3,864,600

          

          

          

          2Mining, Steel, Iron and Non-Precious Metals

          

          

          797,091

          

          

          

          438,913

          

          

          

          

          

          

          

          14,381,863

          

          

          

          14,430,312

          

          

          

          8Personal and Non Durable Consumer Products (Mfg. Only)

          

          

          5,000,000

          

          

          

          3,250,000

          

          

          

          1

          

          

          

          5,000,000

          

          

          

          3,435,000

          

          

          

          2Personal, Food and Miscellaneous Services

          

          

          2,872,500

          

          

          

          2,827,359

          

          

          

          1

          

          

          

          14,730,350

          

          

          

          4,090,000

          

          

          

          2Personal Transportation

          

          

          2,993,092

          

          

          

          2,983,648

          

          

          

          1

          

          

          

          

          

          

          

          

          

          

          

          Printing and Publishing

          

          

          1,044,539

          

          

          

          1,223,743

          

          

          

          1

          

          

          

          5,980,529

          

          

          

          5,669,716

          

          

          

          2Retail Stores

          

          

          1,885,086

          

          

          

          1,932,500

          

          

          

          1

          

          

          

          

          

          

          

          

          

          

          

          Telecommunications

          

          

          2,986,151

          

          

          

          2,776,950

          

          

          

          1

          

          

          

          

          

          

          

          

          

          

          

          Time Deposits and Money Market Account

          

          

          31,851,286

          

          

          

          31,851,286

          

          

          

          13

          

          

          

          930,537

          

          

          

          930,536

          

          

          

          Utilities

          

          

          4,000,000

          

          

          

          137,500

          

          

          

          

          

          

          

          4,000,000

          

          

          

          2,367,600

          

          

          

          1Total

          

          $

          292,270,244

          

          

          $

          239,791,687

          

          

          

          100

          %

          

          $

          253,771,802

          

          

          $

          191,186,296

          

          

          

          100

          %
  (1)

          Calculated as a percentage of total portfolio at fair value. (2)

          Represents Katonah Debt Advisors and other asset manager affiliates. (3)

          Buildings and real estate relate to real estate ownership, builders, managers and developers and excludes mortgage debt investments and mortgage lenders or originators. As of December 31, 2011 and December 31, 2010, the Company had no exposure to mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities) or companies providing mortgage lending.
 14    TABLE OF CONTENTS CLO Fund Securities We typically make a minority investment in the subordinated securities or preferred stock of CLO Funds raised and managed by Katonah Debt Advisors and may selectively invest in securities issued by CLO Funds managed by other asset management companies. As of December 31, 2011, we had approximately $46 million invested in CLO Fund securities, including those issued by funds managed by Katonah Debt Advisors. The CLO Funds managed by Katonah Debt Advisors invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which we have an investment are generally diversified secured or unsecured corporate debt. The underlying assets in our CLO Funds exclude mortgage pools or mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset-backed securities), debt to companies providing mortgage lending and emerging markets investments. Our CLO Fund investments as of December 31, 2011 and December 31, 2010 are as follows:  December 31, 2011

          

          December 31, 2010CLO Fund Securities

          

          Investment

          

          %(1)

          

          Cost

          

          Fair Value

          

          Cost

          

          Fair ValueGrant Grove CLO, Ltd.

          

          

          Subordinated Securities

          

          

          

          22.2

          %

          

          $

          4,724,303

          

          

          $

          2,730,000

          

          

          $

          4,720,982

          

          

          $

          3,150,000Katonah III, Ltd.

          

          

          Preferred Shares

          

          

          

          23.1

          

          

          

          4,500,000

          

          

          

          1,000

          

          

          

          4,500,000

          

          

          

          470,000Katonah IV, Ltd.

          

          

          Preferred Shares

          

          

          

          17.1

          

          

          

          

          

          

          

          

          

          

          

          3,150,000

          

          

          

          1,300,000Katonah V, Ltd.(3)

          

          

          Preferred Shares

          

          

          

          26.7

          

          

          

          3,320,000

          

          

          

          1,000

          

          

          

          3,320,000

          

          

          

          1,000Katonah VII CLO Ltd.(2)

          

          

          Subordinated Securities

          

          

          

          16.4

          

          

          

          4,500,000

          

          

          

          2,210,000

          

          

          

          4,500,000

          

          

          

          2,090,000Katonah VIII CLO Ltd.(2)

          

          

          Subordinated Securities

          

          

          

          10.3

          

          

          

          3,400,000

          

          

          

          1,800,000

          

          

          

          3,400,000

          

          

          

          1,690,000Katonah IX CLO Ltd.(2)

          

          

          Preferred Shares

          

          

          

          6.9

          

          

          

          2,000,000

          

          

          

          1,240,000

          

          

          

          2,000,000

          

          

          

          1,300,000Katonah X CLO Ltd.(2)

          

          

          Subordinated Securities

          

          

          

          33.3

          

          

          

          11,631,226

          

          

          

          8,320,000

          

          

          

          11,612,677

          

          

          

          8,820,000Katonah 2007-1 CLO Ltd.(2)

          

          

          Preferred Shares

          

          

          

          100

          

          

          

          30,027,384

          

          

          

          23,540,000

          

          

          

          29,987,959

          

          

          

          26,200,000Katonah 2007-1 CLO Ltd.(2)

          

          

          Class B-2L Notes

          

          

          

          100

          

          

          

          1,106,896

          

          

          

          6,570,000

          

          

          

          1,088,582

          

          

          

          8,010,000Total

          

          

          

          

          

          

          

          

          

          $

          65,209,809

          

          

          $

          46,412,000

          

          

          $

          68,280,200

          

          

          $

          53,031,000
  (1)

          Represents percentage of class held. (2)

          An affiliate CLO Fund managed by Katonah Debt Advisors. (3)

          As of December 31, 2011, this CLO Fund Security was not providing a dividend distribution. Our investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds that are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay down CLO Fund debt (or will begin to do so shortly), and for which there continue to be net cash distributions to the class of securities owned by us, or (ii) a discounted cash flow model for more recent CLO
Funds that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which we have invested. We recognize unrealized appreciation or depreciation on our investments in CLO Fund securities as comparable yields in the market change and/or based on changes in NAVs or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund investments. We determine the fair value of our investments in CLO Fund securities on an individual security-by-security basis. Due to the individual attributes of each CLO Fund security, they are classified as a Level III (as described in  Critical Accounting Policies  Valuation of Portfolio Investments below) investment unless specific trading activity can be identified at or near the valuation date. When available, Level II (as described in  Critical Accounting Policies  Valuation of Portfolio Investments below) market information will be identified, evaluated and weighted accordingly in the application of such data to the present value models and fair value determination. Significant assumptions
to the present value calculations include default rates,
 15    TABLE OF CONTENTS recovery rates, prepayment rates, investment/reinvestment rates and spreads and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterizations of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund securitys underlying assets, historic, current and prospective performance, vintage, and other quantitative and
qualitative factors that would be evaluated by market participants. We evaluate the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented. For bond rated tranches of CLO Fund securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds, and also considers other factors such as the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes. Such
adjustments require judgment and may be material to the calculation of fair value. The table below summarizes certain attributes of each CLO Fund as per their most recent trustee reports as of December 31, 2011:  CLO Fund Securities(1)

          

          Number of Securities

          

          Number of Issuers

          

          Number of Industries

          

          Average Security Position Size

          

          Average Issuer Position SizeGrant Grove CLO, Ltd.

          

          

          288

          

          

          

          235

          

          

          

          32

          

          

          $

          1,025,731

          

          

          $

          1,257,066Katonah III, Ltd.

          

          

          133

          

          

          

          76

          

          

          

          25

          

          

          

          1,370,298

          

          

          

          2,398,021Katonah V, Ltd.

          

          

          158

          

          

          

          84

          

          

          

          28

          

          

          

          453,668

          

          

          

          853,328Katonah VII CLO Ltd.

          

          

          208

          

          

          

          165

          

          

          

          32

          

          

          

          1,521,405

          

          

          

          1,917,892Katonah VIII CLO Ltd

          

          

          233

          

          

          

          189

          

          

          

          31

          

          

          

          1,524,747

          

          

          

          1,879,715Katonah IX CLO Ltd

          

          

          254

          

          

          

          205

          

          

          

          30

          

          

          

          1,551,079

          

          

          

          1,921,825Katonah X CLO Ltd

          

          

          248

          

          

          

          204

          

          

          

          29

          

          

          

          1,864,919

          

          

          

          2,267,157Katonah 2007-1 CLO Ltd

          

          

          213

          

          

          

          173

          

          

          

          31

          

          

          

          1,373,239

          

          

          

          1,690,751
  (1)

          All data from most recent trustee reports as of December 31, 2011 Katonah Debt Advisors Katonah Debt Advisors is our wholly-owned asset management company that manages CLO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments. The CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments issued by corporations and do not invest in asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. As of December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of par value of assets under management on which it earns management fees, and was valued at approximately $41 million. As a manager of the CLO Funds, Katonah Debt Advisors receives contractual and recurring management fees as well as an expected one-time structuring fee from the CLO Funds for its management and advisory services. In addition, Katonah Debt Advisors may also earn income related to net interest on assets accumulated for future CLO issuances on which it has provided a first loss guaranty in connection with loan warehouse arrangements for its CLO Funds. Katonah Debt Advisors generates annual operating income equal to the amount by which its fee income exceeds its operating expenses. The annual management fees which Katonah Debt Advisors receives are generally based on a fixed percentage of the par value of assets under management and are recurring in nature for the term of the CLO Fund so long as Katonah Debt Advisors manages the fund. As a result, the annual management fees earned by Katonah Debt Advisors are not subject to market value fluctuations in the underlying collateral. The annual management fees Katonah Debt Advisors receives have two components  a senior management fee and a subordinated management fee. During 2009, certain CLO funds managed by Katonah Debt Advisors were restricted from currently
paying their subordinated management fees as a result of the failure by those
 16    TABLE OF CONTENTS CLO Funds to satisfy certain restrictive covenants contained in their indenture agreements. At such time, those subordinated management fees continued to be accrued by the applicable CLO Fund to become payable to Katonah Debt Advisors when such CLO Fund becomes compliant with the applicable covenants. During the year ended December 31, 2010, all those CLO Funds which deferred payment of their subordinated management fees regained compliance with all applicable covenants in order to pay current subordinated management fees as well as all of their previously accrued subordinated management fees. During the year ended December 31, 2010, approximately $5
million of deferred subordinated management fees have been paid. Currently, all CLO Funds managed by Katonah Debt Advisors are paying both their senior and subordinated management fees on a current basis. In future years, Katonah Debt Advisors may receive accrued incentive fees upon the liquidation of CLO Funds it manages, provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares. Subject to market conditions, we expect to continue to make investments in CLO Funds managed by Katonah Debt Advisors, which we believe will provide us with a current cash investment return. We believe that these investments will provide Katonah Debt Advisors with greater opportunities to access new sources of capital which will ultimately increase Katonah Debt Advisors assets under management and resulting management fee income. We also expect to receive distributions of recurring fee income and, if debt markets stabilize and recover, to generate capital appreciation from our investment in the asset management business of Katonah Debt
Advisors. The revenue that Katonah Debt Advisors generates through the fees it receives for managing CLO Funds and after paying the expenses pursuant to an overhead allocation agreement with the Company associated with its operations, including compensation of its employees, may be distributed to Kohlberg Capital. Cash distributions of Katonah Debt Advisors net income are recorded as dividends from an affiliate asset manager when declared. As with all other investments, Katonah Debt Advisors fair value is periodically determined. Our investment in Katonah Debt Advisors is carried at fair value, which is determined after taking into consideration a
percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. Katonah Debt Advisors is classified as a Level III investment. Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation. Time Deposits and Money Market Accounts Cash time deposits primarily represent overnight Eurodollar investments of cash held in non-demand deposit accounts. Such time deposits are partially restricted under terms of the secured revolving credit facility. The money market account is restricted cash held for employee flexible spending accounts. INVESTMENTS AND OPERATIONS Overview We originate, structure and invest in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies. In addition to our middle market investment business, our wholly-owned portfolio company, Katonah Debt Advisors, manages CLO Funds, in which we also may make an investment, that invest in broadly syndicated loans, high-yield bonds and other corporate credit instruments. Our investment objective is to generate current income and capital appreciation from our investments. In the current economic environment, capital appreciation is difficult to achieve due to real or perceived credit concerns, illiquidity in the market and the resulting impact on fair values. However, we believe our longer-term investment horizon and quality of assets will allow us to generate current income and capital appreciation on discounted assets as they amortize and repay at par.
 17    TABLE OF CONTENTS As of December 31, 2011, we had total secured term loan, mezzanine debt, bond and equity investments of approximately $121 million, total investments in CLO Fund securities managed by our wholly-owned portfolio company Katonah Debt Advisors and three other asset managers of approximately $46 million, and total investment in 100% of Katonah Debt Advisors asset management company of approximately $41 million. As of December 31, 2011, we had a portfolio of investment securities that included first and second lien secured loans. Our investments generally averaged between $1 million to $10 million, although particular investments may be larger or smaller. The size of individual investments will vary according to their priority in a companys capital structure, with larger investments in more secure positions in an effort to maximize capital preservation. We expect that the size of our investments and maturity dates will vary as follows: 

          senior secured term loans from $10 to $20 million maturing in five to seven years; 

          second lien term loans from $5 to $20 million maturing in six to eight years; 

          senior unsecured loans $5 to $10 million maturing in six to eight years; 

          mezzanine loans from $5 to $10 million maturing in seven to ten years; and 

          equity investments from $1 to $5 million. When we extend senior secured term loans, we will generally take a security interest in the available assets of the portfolio company, including the equity interests of their subsidiaries, which we expect to help mitigate the risk that we will not be repaid. Nonetheless, there is a possibility that our lien could be subordinated to claims of other creditors. Structurally, mezzanine debt ranks subordinate in priority of payment to senior term loans and is often unsecured. Relative to equity, mezzanine debt ranks senior to common and preferred equity in a borrowers capital structure. Typically, mezzanine debt has elements of both debt and equity
instruments, offering the fixed returns in the form of interest payments associated with a loan, while providing an opportunity to participate in the capital appreciation of a borrower, if any, through an equity interest that is typically in the form of equity purchased at the time the mezzanine loan is repaid or warrants to purchase equity at a future date at a fixed cost. Mezzanine debt generally earns a higher return than senior secured debt due to its higher risk profile and usually less restrictive covenants. The warrants associated with mezzanine debt are typically detachable, which allows lenders to receive repayment of their principal on an agreed amortization schedule while retaining their equity interest in the borrower. Mezzanine debt also may include a put feature, which permits the holder to sell its equity interest back to the borrower at a price determined through an agreed formula. Investment Objective Our investment objective is to generate current income and capital appreciation from the investments made by our middle market business in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies, and from our investment in Katonah Debt Advisors. Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. We will primarily invest in first and second lien term loans which, because of their priority in a companys capital structure, we expect will have lower default rates
and higher rates of recovery of principal if there is a default and which we expect will create a stable stream of interest income. While our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, we may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. We may also receive warrants or options to purchase common stock in connection with our debt investments. In addition, we may also invest in debt and equity securities issued by CLO Funds managed by Katonah Debt Advisors or by other asset managers. However, our investment strategy is to limit the value of our investments in the debt or equity securities issued by CLO Funds to not more than 15% of the value of our total investment portfolio. We invest almost exclusively in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by
commercial or residential mortgages or other consumer borrowings.
 18    TABLE OF CONTENTS Credit and Investment Process We employ the same due diligence intensive investment strategy that our senior management team, Katonah Debt Advisors and Kohlberg & Co. have used over the past 23 years. Due to our ability to source transactions through multiple channels, we expect to maintain a substantial pipeline of opportunities to allow comparative risk return analysis and selectivity. By focusing on the drivers of revenue and cash flow, we develop our own underwriting cases, and multiple stress and event specific case scenarios for each company analyzed. We focus on lending and investing opportunities in: 

          companies with EBITDA of $10 to $50 million; 

          companies with financing needs of $25 to $150 million; 

          companies purchased by top tier equity sponsors; 

          non-sponsored companies with successful management and systems; 

          high-yield bonds and broadly syndicated loans to larger companies on a selective basis; and 

          equity co-investment in companies where we see substantial opportunity for capital appreciation. We expect to source investment opportunities from: 

          private equity sponsors; 

          regional investment banks for non-sponsored companies; 

          other middle market lenders with whom we can club loans; and 

          Katonah Debt Advisors with regard to high-yield bonds and syndicated loans. In our experience, good credit judgment is based on a thorough understanding of both the qualitative and quantitative factors which determine a companys performance. Our analysis begins with an understanding of the fundamentals of the industry in which a company operates, including the current economic environment and the outlook for the industry. We also focus on the companys relative position within the industry and its historical ability to weather economic cycles. Other key qualitative factors include the experience and depth of the management team and the financial sponsor, if any. Only after we have a comprehensive understanding of the qualitative factors do we focus on quantitative metrics. We believe that with the context provided by the qualitative analysis, we can gain a better understanding of a companys financial performance. We analyze a potential portfolio companys sales growth and margins in the context of its competition as well as its ability to manage its working capital requirements and its ability to generate consistent cash flow. Based upon this historical analysis, we develop a set of projections which represents a reasonable underwriting case of most likely outcomes for the company over the period
of our investment. Using our Maximum Reasonable Adversity model, we also look at a variety of potential downside cases to determine a companys ability to service its debt in a stressed credit environment. Elements of the qualitative analysis we use in evaluating investment opportunities include the following: 

          Industry fundamentals; 

          Competitive position and market share; 

          Past ability to work through historical down-cycles; 

          Quality of financial and technology infrastructure; 

          Sourcing risks and opportunities; 

          Labor and union strategy; 

          Technology risk; 

          Diversity of customer base and product lines;
 19    TABLE OF CONTENTS 

          Quality and experience of management; 

          Quality of financial sponsor (if applicable); and 

          Acquisition and integration history. Elements of the quantitative analysis we use in evaluating investment opportunities include the following: 

          Income statement analysis of growth and margin trends; 

          Balance sheet analysis of working capital efficiency; 

          Cash flow analysis of capital expenditures and free cash flow; 

          Financial ratio and market share standing among comparable companies; 

          Financial projections: underwriting versus stress case; 

          Event specific Maximum Reasonable Adversity credit modeling; 

          Future capital expenditure needs and asset sale plans; 

          Downside protection to limit losses in an event of default; 

          Risk adjusted returns and relative value analysis; and 

          Enterprise and asset valuations. The origination, structuring and credit approval processes are fully integrated. Our credit team is directly involved in all due diligence and analysis prior to the formal credit approval process. Credit Monitoring Our management team has significant experience monitoring portfolios of middle market investments and this is enhanced by the credit monitoring procedures of Katonah Debt Advisors. Along with origination and credit analysis, portfolio management is one of the key elements of our business. Most of our investments will not be liquid and, therefore, we must prepare to act quickly if potential issues arise so that we can work closely with the management and private equity sponsor, if applicable, of the portfolio company to take any necessary remedial action quickly. In addition, most of our senior management team, including the credit team at Katonah
Debt Advisors, have substantial workout and restructuring experience. In order to assist us in detecting issues with portfolio companies as early as possible, we perform a monthly financial analysis of each portfolio company. This analysis typically includes: 

          reviewing financial statements with comparisons to prior year financial statements, as well as the current budget including key financial ratios such as debt/EBITDA, margins and fixed charge coverage; 

          independently computing and verifying compliance with financial covenants; 

          reviewing and analyzing monthly borrowing base, if any; 

          a monthly discussion of MD&A with company management and the private equity sponsor, if applicable; 

          determining if current performance could cause future financial covenant default; 

          discussing prospects with the private equity sponsor, if applicable; 

          determining if a portfolio company should be added to our watch list (companies to be reviewed in more depth); 

          if a company is not meeting expectations, reviewing original underwriting assumptions and determining if either enterprise value or asset value has deteriorated enough to warrant further action; and 

          a monthly update to be reviewed by both the Chief Executive Officer and Chief Investment Officer.
 20    TABLE OF CONTENTS Investment Securities We invest in senior secured loans and mezzanine debt and, to a lesser extent equity capital, of middle market companies in a variety of industries. We generally target companies that generate positive cash flows because we look to cash flows as the primary source for servicing debt. As of December 31, 2011, together with our wholly-owned portfolio company Katonah Debt Advisors, we had a staff of 18 investment professionals who specialize in specific industries and generally seek to invest in companies about which we have direct expertise. However, we may invest in other industries if we are presented with attractive opportunities. For more
information regarding our investment securities, see  Investment Securities, above. CLO Fund Securities As of December 31, 2011, we had $46 million at fair value, invested in CLO Fund securities, including those issued by funds managed by Katonah Debt Advisors. CLO Funds managed by Katonah Debt Advisors invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which we have any investment are generally diversified secured or unsecured corporate debt and exclude mortgage pools or mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset-backed securities), debt to companies
providing mortgage lending and emerging markets investments. The CLO Funds are leveraged funds and any excess cash flow or excess spread (interest earned by the underlying securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is paid to us and the other holders of the CLO Funds subordinated securities or preferred shares based on the proportionate share of such class. The securities issued by CLO Funds managed by Katonah Debt Advisors are primarily held by third parties. As of December 31, 2011, we had $44 million invested at fair value in five Katonah Debt Advisors managed CLO Funds. We typically make a minority investment in the subordinated securities or preferred shares of CLO Funds raised and managed by Katonah Debt Advisors and may selectively invest in securities issued by CLO Funds managed by other asset management companies. For more information regarding our investment securities, see  Investment Portfolio  Investment in CLO Fund Securities. Katonah Debt Advisors Katonah Debt Advisors is our wholly-owned asset management company that manages CLO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments. The CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments issued by corporations and do not invest in asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. As of December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of assets under management, and was valued at approximately $41 million. As a manager of the CLO Funds, Katonah Debt Advisors receives contractual and recurring management fees as well as a one-time structuring fee from the CLO Funds for its management and advisory services. The annual management fees which Katonah Debt Advisors receives are generally based on a fixed percentage of the par value of assets under management and are recurring in nature for the term of the CLO Fund so long as Katonah Debt Advisors manages the fund. As a result, the annual management fees earned by Katonah Debt Advisors are not subject to market value fluctuations in the underlying collateral. Katonah Debt Advisors generates annual operating
income equal to the amount by which its fee income exceeds it operating expenses. The annual management fees which Katonah Debt Advisors receives are generally based on a fixed percentage of the par value of assets under management and are recurring in nature for the term of the CLO Fund so long as Katonah Debt Advisors manages the fund. As a result, the annual management fees earned by Katonah Debt Advisors are not subject to market value fluctuations in the underlying collateral. The annual management fees Katonah Debt Advisors receives have two components  a senior management fee and a subordinated management fee. During 2009, certain CLO Funds managed by Katonah Debt Advisors were restricted from currently
paying their subordinated management fees as a result of the failure by those CLO Funds to satisfy certain restrictive covenants contained in their indenture agreements. At such time, those subordinated management fees continued to be accrued by the applicable CLO Fund to become payable to
 21    TABLE OF CONTENTS Katonah Debt Advisors when such CLO Fund becomes compliant with the applicable covenants. During the year ended December 31, 2010, all those CLO Funds which deferred payment of their subordinated management fees regained compliance with all applicable covenants in order to pay current subordinated management fees as well as a portion of previously accrued subordinated management fees. During the year ended December 31, 2010, approximately $5 million of deferred subordinated management fees have been paid. Currently, all CLO Funds managed by Katonah Debt Advisors are paying both their senior and subordinated management fees on a current basis. In future years, Katonah Debt Advisors may receive accrued incentive fees upon the liquidation of CLO Funds it manages, provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares. Subject to market conditions, we expect to continue to make investments in CLO Funds managed by Katonah Debt Advisors, which we believe will provide us with a current cash investment return. We believe that these investments will provide Katonah Debt Advisors with greater opportunities to access new sources of capital which will ultimately increase Katonah Debt Advisors assets under management and resulting management fee income. We also expect to receive distributions of recurring fee income and, if debt markets stabilize and recover, to generate capital appreciation from our investment in the asset management business of Katonah Debt
Advisors. The revenue that Katonah Debt Advisors generates through the fees it receives for managing CLO Funds and after paying the expenses associated with its operations, including compensation of its employees, may be distributed to Kohlberg Capital Corporation. Cash distributions of Katonah Debt Advisors net income are recorded as dividends from affiliate asset manager when declared. As with all other investments, Katonah Debt Advisors fair value is periodically determined. Our investment in Katonah Debt Advisors is carried at fair value, which is determined after taking into consideration a percentage of assets under management and a
discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. Katonah Debt Advisors is classified as a Level III investment. Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation As a separately taxable corporation, Katonah Debt Advisors is taxed at normal corporate rates. For tax purposes, any distributions of taxable net income earned by Katonah Debt Advisors to us would generally need to be distributed to our stockholders. Katonah Debt Advisors taxable net income differs from GAAP net income due to both deferred tax timing adjustments and permanent tax adjustments. Deferred tax timing adjustments may include differences for the recognition and timing of depreciation, bonuses to employees, stock option expense, and interest rate caps. Permanent differences may include adjustments, limitations or disallowances for
meals and entertainment expenses, penalties and tax goodwill amortization. Goodwill amortizable for tax was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to our initial public offering in exchange for shares of our stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for GAAP purposes, such exchange was considered a taxable asset purchase under the Internal Revenue Code of 1986, as amended (Code). At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which will be amortized for tax purposes
on a straight-line basis over 15 years, resulting in an annual difference between GAAP income and taxable income of approximately $2 million per year over such period. On January 2, 2008, the Katonah Debt Advisors platform acquired substantially all of the assets of Scotts Cove Capital Management LLC (Scotts Cove), an asset manager focused on an event-driven credit long short investment strategy. On February 4, 2011, Katonah Debt Advisors entered to an Asset Purchase Agreement with a third-party buyer controlled by a former Katonah Debt Advisors employee to sell substantially all of the Scotts Cove assets for a purchase price of $25,000. The transaction closed on February 28, 2011. At closing, Katonah Debt Advisors and the buyer entered into a Services Agreement, pursuant to which the
buyer paid to Katonah Debt Advisors $225,000 for certain transitional services to be provided by Katonah Debt Advisors (including access to office space, secretarial services and information
 22    TABLE OF CONTENTS technology support) and agreed to pay an additional amount of $75,000 on each of the first and second anniversaries of the closing date (subject to, in the case of the first payment, deferment for up to one year under certain circumstances). Katonah Debt Advisors obligation to provide transitional services under the Services Agreement expired on June 30, 2011. At closing, Katonah Debt Advisors and the employees that formerly managed the Scotts Cove assets also entered into employee termination agreements, whereby they agreed to terminate their employment with Katonah Debt Advisors and to relinquish all claims against Katonah Debt Advisors
or its affiliates. Revenues We generate revenue in the form of interest income on debt securities and capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. In addition, we generate revenue in the form of commitment and facility fees and, to a lesser extent, due diligence fees. Any such fees are generated in connection with our investments and recognized as earned or, in some cases, recognized over the life of the loan. We expect our investments generally to have a term of between five and eight years and bear interest at various rates ranging from 2% to 10% over the prevailing market rates for Treasury securities.
Where applicable, we seek to collateralize our investments by obtaining security interests in our portfolio companies assets. Interest on debt securities will generally be payable monthly or quarterly, with amortization of principal typically occurring over the term of the security. In those limited instances where we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest will generally become due at the maturity date. We also generate dividend income from our investment in CLO equities. These subordinated securities are the most junior class of securities issued by the CLO Funds and are subordinated in priority of payment to each other class of securities issued by these CLO Funds. Dividends on CLO equities are generally paid quarterly. Expenses Because we are an internally managed BDC, we pay the costs associated with employing investment management professionals and other employees as well as running our operations. Our primary non-interest expenses include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing our investments and our related overhead charges and expenses, including rental expense and interest expense incurred in connection with borrowings. Because we are internally managed, we do not pay any management fees to any third party. Our Strategic Relationship with Kohlberg & Co. We believe that historically we have derived substantial benefits from our strategic relationship with Kohlberg & Co. Christopher Lacovara, a partner of Kohlberg & Co., is the Chairman of our Board of Directors and is also a member of our Investment Committee. Through such participation, we have access to the expertise of this individual in middle market and leveraged investing, which we believe enhances our capital raising, due diligence, investment selection and credit analysis activities. Kohlberg & Co. is a leading U.S. private equity firm which manages investment funds that acquire middle market companies. Because we are an internally managed BDC, we do not pay any fees to Kohlberg & Co. or any of its affiliates. Under the 1940 Act, we are generally prohibited from buying or selling any security from or to any portfolio company of a private equity fund managed by Kohlberg & Co. without the prior approval of the SEC. In addition, we may co-invest on a concurrent basis with Kohlberg & Co. or any of our affiliates, subject to compliance with existing regulatory guidance, applicable regulations and our allocation procedures. Certain types of negotiated co-investments may be made only if we receive an order from the SEC permitting us to do so.
There can be no assurance that any such order will be applied for or, if applied for, obtained.
 23    TABLE OF CONTENTS Our relationship with Kohlberg & Co., including our use of the Kohlberg name, is governed by the License and Referral Agreement between us and Kohlberg & Co. The initial term of the agreement expired on October 31, 2011, and there is no guarantee that the agreement will not be terminated and that we will continue to benefit from its provisions. See Risk Factors  Risks Related to Our Business  The initial term of the agreement governing our strategic relationship with Kohlberg & Co. expired on October 31, 2011 and such agreement may be terminated. LEVERAGE We use borrowed funds, known as leverage, to make investments and to attempt to increase returns to our shareholders by reducing our overall cost of capital. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. We are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. As of December 31, 2011, we had approximately $60 million of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 401%, compliant with the minimum asset coverage level of 200% generally required for a BDC by the 1940 Act. We
may also borrow amounts of up to 5% of the value of our total assets for temporary purposes. At December 31, 2010, we had approximately $87 million of outstanding indebtedness through a secured credit facility. On January 31, 2011, we repaid in full the outstanding balance under this facility. As a result, approximately $73 million of collateral previously securing the facility was released to us and we also received a $2 million cash settlement from the lenders to settle litigation previously initiated by us against the lenders. In order to pay off this facility, we utilized proceeds received from the paydown, amortization or sale of portfolio loan investments totaling approximately $133 million together with available cash. On March 16, 2011, we issued $55 million in aggregate principal amount of unsecured 8.75% convertible senior notes due 2016 (Convertible Senior Notes). On March 23, 2011, pursuant to an over-allotment option, we issued an additional $5 million of such Convertible Senior Notes for a total of $60 million in aggregate principal amount. The net proceeds for the Convertible Senior Notes, following underwriting expenses, were approximately $57.7 million. Interest on the Convertible Senior Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Notes mature on March 15, 2016
unless converted earlier. The Convertible Senior Notes are senior unsecured obligations of the Company. The Convertible Senior Notes are convertible into shares of Companys common stock based on an initial conversion rate of 118.5255 shares of common stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price of approximately $8.44 per share of common stock. The conversion rate will be subject to adjustment upon certain events. The weighted average daily debt balance for the years ended December 31, 2011 and 2010 was approximately $54 million and $155 million, respectively. On February 24, 2012, the Company entered into a Note Purchase Agreement with CS, Credit Suisse Securities (USA) LLC, as arranger, BNYM, as collateral administrator and collateral agent, and KCAP Funding, a special-purpose bankruptcy remote wholly-owned subsidiary of the Company, whereby KCAP Funding purchased a portfolio of Collateral Debt Obligations, the purchase of which was financed by the issuance of (a) a senior note in an aggregate principal amount of $30.0 million, issued to CS in exchange for $30.0 million in cash and (b) a junior note in an aggregate principal amount of $12.5 million, issued to the Company in exchange for the sale by the
Company to KCAP Funding of the Collateral Debt Obligations. Pursuant to the Note Purchase Agreement, the Company has agreed to act as Portfolio Manager on behalf of KCAP Funding and CS of the Collateral Debt Obligations, and has granted a security interest to KCAP Funding in all of the Companys right to receive certain management fees, and KCAP Funding granted to CS a security interest in, among other things, the Collateral Debt Obligations and its rights to receive the management fees pledged to it by the Company.
 24    TABLE OF CONTENTS COMPETITION Our primary competitors provide financing to prospective portfolio companies and include commercial banks, specialty finance companies, hedge funds, structured investment funds and investment banks. Many of these entities have greater financial and managerial resources than we have, and the 1940 Act imposes certain regulatory restrictions on us as a BDC to which many of our competitors are not subject. For additional information concerning the competitive risks we face, see Item 1A. Risk Factors  Risks Related to Our Business  We operate in a highly competitive market for investment opportunities. We believe that we provide a unique combination of an experienced middle market origination and credit team, an existing credit platform at Katonah Debt Advisors that includes experienced lenders with broad industry expertise and an Investment Committee that includes a partner of Kohlberg & Co., a leading experienced and successful middle market private equity firm. We believe that this combination of resources provides us with a thorough credit process and multiple sources of investment opportunities to enhance our asset selection process. COMPETITIVE ADVANTAGES We believe that we can successfully compete with other providers of capital in the markets in which we compete for the following reasons: 

          Internally managed structure and significant management resources.  We are internally managed by our executive officers under the supervision of our Board of Directors and do not depend on a third party investment advisor. As a result, we do not pay investment advisory fees and all of our income is available to pay our operating costs and to make distributions to our stockholders. 

          Multiple sourcing capabilities for assets.  We have multiple sources of loans, mezzanine investments and equity investments through our industry relationships and Katonah Debt Advisors. 

          Disciplined investment process.  We employ a rigorous credit review process and due diligence intensive investment strategy which our senior management has developed over more than 20 years of lending. For each analyzed company, we develop our own underwriting case and multiple stress case scenarios and an event-specific financial model reflecting company, industry and market variables. Generally, we have decided not to invest in highly leveraged or covenant light credit facilities. 

          Katonah Debt Advisors credit platform.  Katonah Debt Advisors serves as a source of our direct investment opportunities and cash flow, and certain credit analysts employed by Katonah Debt Advisors who also serve as officers of the Company serve as a resource for credit analysis. 

          Investments in a wide variety of portfolio companies in a number of different industries with no direct exposure to mortgage-backed securities.  Our investment portfolio (excluding our investments in Katonah Debt Advisors and CLO Fund securities) is spread across 21 different industries and 44 different entities with an average balance per investment of approximately $3 million. Our investment portfolio as well as the investment portfolios of the CLO Funds in which we have invested and the investment portfolios of the CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments and other securities issued by companies and do not include any asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. 

          Strategic relationship with Kohlberg & Co.  We believe that Kohlberg & Co. is one of the oldest and most well-known private equity firms focused on the middle market. We believe that we have historically derived substantial benefits from our strategic relationship with Kohlberg & Co. 

          Significant equity ownership and alignment of incentives.  Our senior management team and the senior management team of Katonah Debt Advisors together have a significant equity interest in the Company, ensuring that their incentives are strongly aligned with those of our stockholders.
 25    TABLE OF CONTENTS EMPLOYEES As of March 5, 2012, we had 26 employees. DETERMINATION OF NET ASSET VALUE We determine the net asset value per share of our common stock quarterly. The net asset value per share is equal to the value of our total assets minus liabilities and any preferred stock outstanding divided by the total number of shares of common stock outstanding. As of December 31, 2011, we did not have any preferred stock outstanding. Value, as defined in Section 2(a)(41) of 1940 Act, is (1) the market price for those securities for which a market quotation is readily available and (2) for all other securities and assets, fair value as determined in good faith by our Board of Directors pursuant to procedures approved by our Board of Directors. Our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment. Preliminary valuation conclusions are then documented and discussed with our senior management. The Valuation Committee of our Board of Directors reviews these
preliminary valuations and makes recommendations to our Board of Directors. Where appropriate, the Valuation Committee may utilize an independent valuation firm selected by our Board of Directors for an independent determination of fair value or certain other valuation related services. Our Board of Directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the recommendations of the Valuation Committee. Because of the inherent uncertainty of valuation, the Board of Directors determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material. We are, for GAAP purposes, an investment company under the AICPA Audit and Accounting Guide for Investment Companies. As a result, we reflect our investments on our balance sheet at their estimated fair value with unrealized gains and losses resulting from changes in fair value reflected as a component of unrealized gains or losses on our statements of operations. Fair value is the amount that would be received to sell the investments in an orderly transaction between market participants at the measurement date (i.e., the exit price). Additionally, we do not consolidate majority or wholly-owned and controlled investments. There is no single standard for determining fair value. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we must determine the fair value of each individual investment on a quarterly basis. We record unrealized depreciation on investments when we believe that an investment has decreased in value, including where collection of a loan or realization of an equity security is doubtful. Conversely, we record unrealized appreciation if we believe that our investment
has appreciated in value, for example, because the underlying portfolio company has appreciated in value. As a BDC, we invest primarily in illiquid securities, including loans to and warrants of private companies and interests in other illiquid securities, such as interests in the underlying CLO Funds. Our investments are generally subject to restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our valuation methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation. We have valued our investments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some investments little market activity may exist; managements determination of fair value is then based on the best information available in the circumstances, and may incorporate managements own assumptions and involves a significant degree of managements judgment.
 26    TABLE OF CONTENTS Fair values of our debt investments for which market prices are not observable are determined by reference to public market or private transactions or valuations for comparable companies or assets in the relevant asset class and or industry when such amounts are available. Generally these valuations are derived by multiplying a key performance metric of the investee company or asset (e.g., EBITDA) by the relevant valuation multiple observed for comparable companies or transactions, adjusted by management for differences between the investment and the referenced comparable. Such investments may also be valued at cost for a period of time after an
acquisition as the best indicator of fair value. If the fair value of such investments cannot be valued by reference to observable valuation measures for comparable companies, then the primary analytical method used to estimate the fair value is a discounted cash flow method and/or cap rate analysis. A sensitivity analysis is applied to the estimated future cash flows using various factors depending on the investment, including assumed growth rates (in cash flows), capitalization rates (for determining terminal values) and appropriate discount rates to determine a range of reasonable values or to compute projected return on investment. We derive fair value for our illiquid loan investments that do not have indicative fair values based upon active trades primarily by using the Market Yield Approach, and also consider recent loan amendments or other activity specific to the subject asset as described above. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments. Our Board of Directors may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with GAAP. The determination of fair value using this methodology takes into consideration a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance and financing transactions subsequent to the acquisition of the investment. This valuation methodology involves a significant degree of managements judgment. Our investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and the cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds which are approaching or past the end of their reinvestment period and therefore begin to sell assets and/or use principal repayments to pay-down CLO Fund debt, and for which there continue to be net cash distributions to the class of we securities own, or (ii) the net asset value of the CLO Fund for CLO Funds which are approaching or past the
end of their reinvestment period and therefore begin to sell assets and/or use principal repayments to pay-down CLO Fund debt, and for which there are negligible net cash distributions to the class of securities we own, or (iii) a discounted cash flow model for more recent CLO Funds that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested. We recognize unrealized appreciation or depreciation on our investments in CLO Fund securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in the
underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Investment. We determine the fair value of our investments in CLO Fund securities on an individual security-by-security basis. Our investment in Katonah Debt Advisors is carried at fair value, which is determined after taking into consideration a percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. Katonah Debt Advisors is classified as a Level III investment (as described below). Any change in value from period to period is recognized as net change in unrealized
appreciation or depreciation.
 27    TABLE OF CONTENTS ELECTION TO BE REGULATED AS A BUSINESS DEVELOPMENT COMPANY AND A REGULATED INVESTMENT COMPANY Our elections to be regulated as a BDC and to be treated as a RIC have a significant impact on our future operations: We report our investments at market value or fair value with changes in value reported through our statement of operations. We report all of our investments, including debt investments, at market value or, for investments that do not have a readily available market value, at their fair value as determined in good faith by our Board of Directors pursuant to procedures approved by our Board of Directors. Changes in these values are reported through our statement of operations under the caption of net unrealized appreciation (depreciation) on investments. See  Determination of Net Asset Value. Our ability to use leverage as a means of financing our portfolio of investments is limited. As a BDC, we are required to meet a coverage ratio of total assets to total senior securities of at least 200%. For this purpose, senior securities generally include all borrowings, guarantees of borrowings and any preferred stock we may issue in the future. Our ability to utilize leverage as a means of financing our portfolio of investments is limited by this asset coverage test. As of December 31, 2011, our total par debt outstanding was approximately $60 million and our asset coverage ratio was approximately 401%, above the minimum asset coverage level generally required for a BDC by the 1940 Act. See  Leverage above. We intend to distribute substantially all of our net taxable income to our stockholders. We generally will be required to pay U.S. federal income taxes only on the portion of our net taxable income and gains that we do not distribute to stockholders, although certain of our subsidiaries will be subject to corporate tax on their income. We have elected to be treated as a RIC for U.S. federal income tax purposes, commencing with our taxable year ended December 31, 2006. As a RIC, we intend to distribute to our stockholders substantially all of our net investment company income. In addition, we may retain certain net long-term capital gains and elect to treat such net capital gains as distributed to our stockholders. If this happens, you will be treated as if you received an actual distribution of the capital gains and reinvested the net after-tax proceeds in us. You also may be eligible to claim a tax credit against your U.S. federal income tax liability (or, in certain
circumstances, a tax refund) equal to your allocable share of the tax we pay on the deemed distribution. See  Certain United States Federal Income Tax Considerations. As a RIC, we generally are required to pay U.S. federal income taxes only on the portion of our net taxable income and gains that we do not distribute (actually or constructively). Katonah Debt Advisors, our wholly-owned taxable portfolio company, receives fee income earned with respect to its management services. We expect that we or Katonah Debt Advisors will form additional direct or indirect subsidiaries which will receive similar fee income. Some of these subsidiaries may be treated as corporations for U.S. federal income tax purposes, and as a result, such subsidiaries will be subject to income tax at regular corporate rates, for U.S. federal
and state purposes, although, as a RIC, dividends and distributions of capital received by us from our taxable subsidiaries and distributed to our stockholders will not subject us to U.S. federal income taxes. As a result, the net return to us on investments in or held by such subsidiaries will be reduced to the extent that the subsidiaries are subject to income taxes. In addition, due to the asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions. See  Regulation below. Also, restrictions and provisions governing our outstanding indebtedness may limit our ability to make distributions. See Item 1A. Risk Factors below. We are required to comply with the provisions of the 1940 Act applicable to BDCs. As a BDC, we are required to have a majority of directors who are not interested persons under the 1940 Act. In addition, we are required to comply with other applicable provisions of the 1940 Act, including those requiring the adoption of a code of ethics, fidelity bond and custody arrangements. See also  Regulation.
 28    TABLE OF CONTENTS REGULATION The following discussion is a general summary of some of the material prohibitions and restrictions governing BDCs generally. It does not purport to be a complete description of all the laws and regulations affecting BDCs. A BDC is a unique kind of investment company that primarily focuses on investing in or lending to private or relatively small publicly traded companies and making managerial assistance available to them. A BDC provides stockholders with the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits of investing in emerging-growth or expansion-stage privately-owned companies. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their directors and officers and principal underwriters and certain other related persons and requires that a majority of the directors be persons
other than interested persons, as that term is defined in the 1940 Act. In the ordinary course of business, we may enter into transactions with portfolio companies that may be considered related party transactions. We have implemented certain procedures, both written and unwritten, to ensure that we do not engage in any prohibited transactions with any persons affiliated with us. If such affiliations are found to exist, we seek Board and/or committee review and approval or exemptive relief for such transactions, as appropriate. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of (i) 67% or more of such companys shares present at a meeting or represented by proxy if more than 50% of the outstanding shares of such company are present or represented by proxy or (ii) more than 50% of the outstanding shares of such company. Qualifying Assets Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, or qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the companys total assets. The principal categories of qualifying assets relevant to our business are the following: 

          Securities of an eligible portfolio company purchased in transactions not involving any public offering. An eligible portfolio company is defined in the 1940 Act as any issuer which: (a)

          is organized under the laws of, and has its principal place of business in, the United States; (b)

          is not an investment company (other than a small business investment company wholly-owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and (c)

          satisfies any of the following: (i)

          does not have outstanding any class of securities with respect to which a broker or dealer may extend margin credit; (ii)

          is controlled by a BDC or a group of companies including a BDC and the BDC has an affiliated person who is a director of the eligible portfolio company; (iii)

          is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million; or (iv)

          does not have any class of securities listed on a national securities exchange (or, if it has a class of securities listed on a national securities exchange, has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million). 

          Securities of any eligible portfolio company that we control; 

          Securities purchased in a private transaction from a U.S. issuer that is not an investment company and is in bankruptcy and subject to reorganization;
 29    TABLE OF CONTENTS 

          Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the conversion of warrants or rights relating to such securities; 

          Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment; and 

          Under certain circumstances, securities of companies that were eligible portfolio companies at the time of the initial investment but that are not eligible portfolio companies at the time of the follow-on investment. Significant Managerial Assistance A BDC must be organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described above. However, to count portfolio securities as qualifying assets for the purpose of the 70% test discussed above, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where the BDC purchases such securities in conjunction with one or more other persons acting together, one of the other
persons in the group may make available such managerial assistance. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company through monitoring of portfolio company operations, selective participation in board and management meetings, consulting with and advising a portfolio companys officers or other organizational or financial guidance. Temporary Investments Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that at least 70% of our assets are qualifying assets. Typically, we invest in U.S. treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us,
of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements that are treated, under applicable tax rules, as being issued by a single counterparty, we would not meet the diversification tests imposed on us by the Code to qualify for tax treatment as a RIC for U.S. federal income tax purposes. Thus, we do not intend to enter into repurchase agreements treated as issued, under applicable tax rules, by a single counterparty in excess of this limit. We monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions. Senior Securities; Coverage Ratio We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, with respect to certain types of senior securities, we must make provisions to prohibit any dividend distribution to our stockholders or the repurchase of certain of our securities, unless we meet the applicable asset coverage ratios at the time of the dividend distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary purposes. For a
discussion of the risks associated with the resulting leverage, see Item 1A. Risk Factors  Risks Related to Our Business  The debt we incur could increase the risk of investing in our Company. As of December 31, 2011 our asset coverage ratio was 401%, above the minimum required asset coverage level of 200%.
 30    TABLE OF CONTENTS Code of Ethics We adopted and maintain a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the codes requirements. We may be prohibited under the 1940 Act from conducting certain transactions with our affiliates without the prior approval of our directors who are not interested persons and, in some cases, the prior approval of the SEC. A
copy of the code of ethics is available on the Corporate Governance section of the Companys website at www.kohlbergcap.com. Privacy Principles We are committed to maintaining the privacy of our stockholders and safeguarding their non-public personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties. Generally, we do not receive any non-public personal information relating to our stockholders, although some non-public personal information of our stockholders may become available to us. We do not disclose any non-public personal information about our stockholders or former stockholders to anyone, except as is necessary to service stockholder accounts, such as to a transfer agent, or as otherwise permitted by law. We restrict access to non-public personal information about our stockholders to our employees with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the non-public personal information of our stockholders. Proxy Voting Policy and Procedures Although most of the securities we hold are not voting securities, some of our investments may entitle us to vote proxies. We vote proxies relating to our portfolio securities in the best interest of our stockholders. We review on a case-by-case basis each proposal submitted to a stockholder vote to determine its impact on the portfolio securities held by us. Although we generally vote against proposals that we believe may have a negative impact on our portfolio securities, we may vote for such a proposal if we believe there exists a compelling long-term reason to do so. Our proxy voting decisions are made by our Investment Committee, which is responsible for monitoring each of our investments. To ensure that our vote is not the product of a conflict of interest, we require that (1) anyone involved in the decision making process disclose to our CCO any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (2) employees involved in the decision making process or vote administration are prohibited from revealing how we intend to vote on a proposal to reduce any attempted influence from interested parties. Other We will be periodically examined by the SEC for compliance with the 1940 Act. We will not concentrate our investments, that is, invest 25% or more of our assets in any particular industry (determined at the time of investment). We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from indemnifying any director or officer against any liability to our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such persons office. We are required to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws and to review these policies and procedures annually for their adequacy and the effectiveness of their implementation. We have a designated CCO who is responsible for administering these policies and procedures.
 31    TABLE OF CONTENTS CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS The following discussion is a general summary of certain material U.S. federal income tax considerations applicable to us and to an investment in our shares. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. For example, we have not described tax consequences that we assume to be generally known by investors or certain considerations that may be relevant to certain types of holders subject to special treatment under U.S. federal income tax laws, including stockholders subject to the alternative minimum tax, tax-exempt organizations, insurance companies, regulated investment
companies, dealers in securities, pension plans and trusts, and financial institutions. This summary assumes that investors hold our common stock as capital assets (within the meaning of the Code). The discussion is based upon the Code, Treasury regulations, and administrative and judicial interpretations, each as in effect as of the date of this filing and all of which are subject to change, possibly retroactively, which could affect the continuing validity of this discussion. This summary does not discuss any aspects of U.S. estate or gift tax or foreign, state or local tax. It does not discuss the special treatment under U.S. federal income tax laws that could result if we invested in tax-exempt securities or certain other investment assets in which we do not currently intend to invest. A U.S. stockholder generally is a beneficial owner of shares of our common stock who or which is for U.S. federal income tax purposes: 

          a citizen or individual resident of the United States including an alien individual who is a lawful permanent resident of the United States or meets the substantial presence test in Section 7701(b) of the Code; 

          a corporation or other entity taxable as a corporation, for U.S. federal income tax purposes, created or organized in or under the laws of the United States or any political subdivision thereof; 

          a trust over the administration of which a court in the U.S. has primary supervision or over which U.S. persons have control; or 

          an estate, the income of which is subject to U.S. federal income taxation regardless of its source. A Non-U.S. stockholder is a beneficial owner of shares of our common stock that is neither a U.S. stockholder nor a partnership for U.S. federal income tax purposes. If a partnership (including an entity treated as a partnership for U.S. federal income tax purposes) holds shares of our common stock, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. A prospective stockholder who is a partner of a partnership holding shares of our common stock should consult his, her or its tax advisors with respect to the purchase, ownership and disposition of
shares of our common stock. Tax matters are very complicated and the tax consequences to an investor of an investment in our shares will depend on the facts of his, her or its particular situation. We encourage investors to consult their tax advisors regarding the specific consequences of such an investment, including tax reporting requirements, the applicability of U.S. federal, state, local and foreign tax laws, eligibility for the benefits of any applicable tax treaty and the effect of any possible changes in the tax laws. Election to be Taxed as a Regulated Investment Company We have elected to be treated as a RIC under Subchapter M of the Code commencing with our taxable year ended December 31, 2006. As a RIC, we generally will not have to pay corporate-level taxes on any income or gains that we distribute to our stockholders as dividends in accordance with the timing requirements of the Code. To qualify for treatment as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to qualify for treatment as a RIC, we must distribute to our stockholders, for each taxable year, at least 90% investment company taxable income (also
previously referred to as net investment company income), which is generally the sum of our net investment income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses (the Annual Distribution Requirement), for such year.
 32    TABLE OF CONTENTS Taxation as a Regulated Investment Company For any taxable year in which we qualify as a RIC and satisfy the Annual Distribution Requirement, we generally will not be subject to U.S. federal income tax on the portion of our investment company taxable income and net capital gain (i.e., net realized long-term capital gains in excess of net realized short-term capital losses) we distribute to stockholders with respect to that year. We will be subject to U.S. federal income tax at the regular corporate rates on any net ordinary income or capital gain not distributed (or deemed distributed) to our stockholders. As a RIC, we will be subject to a 4% nondeductible U.S. federal excise tax on
certain net taxable undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the 1-year period ending October 31 in that calendar year, and (3) any net income realized, but not distributed, in the preceding year. For purposes of the required excise tax distribution, any ordinary gains and losses from the sale, exchange or other taxable disposition of property that would otherwise be taken into account after October 31 of a calendar year generally are treated as arising on January 1 of the following calendar year. We will not be subject to excise taxes on amounts on which we are required to pay corporate income tax (such as retained net capital gains). We currently intend to make sufficient distributions each taxable year and/or pay sufficient corporate income tax to avoid any excise tax liability, although we reserve the right to pay an
excise tax rather than make an additional distribution when circumstances warrant (e.g., the payment of an excise tax amount that we deem to be de minimis). To qualify for tax treatment as a RIC for U.S. federal income tax purposes, in addition to satisfying the Annual Distribution Requirement, we must, among other things: 

          have in effect at all times during each taxable year an election to be regulated as a BDC under the 1940 Act; 

          in each taxable year, derive at least 90% of our gross income from (a) dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities and (b) net income derived from an interest in a qualified publicly traded partnership (as defined by the Code) (all such income Qualifying Income); and 

          diversify our holdings so that at the end of each quarter of the taxable year: (i) at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and (ii) no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of (a) one issuer, (b) two or more issuers that are controlled, as determined under applicable tax rules, by us and that are engaged in the same or similar or related trades or businesses or (c) one or more qualified publicly traded partnerships (the Diversification Tests). We conduct the business of Katonah Debt Advisors through direct or indirect subsidiaries. Some of our subsidiaries are treated as corporations for U.S. federal income tax purposes. As a result, such subsidiaries will be subject to tax at regular corporate rates. We will recognize income from these subsidiaries to the extent that we receive dividends and distributions of capital from these subsidiaries. Some of the wholly-owned subsidiaries may be treated as disregarded entities for U.S. federal income tax purposes. As a result, we may directly recognize fee income earned by these subsidiaries. Fee income that we recognize directly through entities
that are treated as disregarded entities for U.S. federal tax purposes will generally not constitute Qualifying Income. We intend to monitor our recognition of fee income to ensure that at least 90% of our gross income in each taxable year is Qualifying Income. We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with non-cash payment in kind (PIK) interest or, in certain cases, with increasing interest rates or that are issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. Because any original issue discount accrued will be
 33    TABLE OF CONTENTS included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders to satisfy the Annual Distribution Requirement, even though we will not have received an amount of cash that corresponds with the income accrued. However, pursuant to guidance issued in 2009 and thereafter by the U.S. Internal Revenue Service (IRS), under certain circumstances it is possible for us to meet the Annual Distribution Requirement for 2009, 2010 and 2011, even though we limit how much cash (and other property which is not our stock) that we distribute in the aggregate to our stockholders (which limit can be as low as 10% of each qualifying distribution) when compared to how much cash (and other property which is not our stock) that we would need to distribute for us to meet the Annual Distribution Requirement without relying on such guidance (a qualifying
limited-cash distribution). The portion of a qualifying limited-cash distribution that does not consist of cash (and other property which is not our stock) will be in the form of shares of our stock (based on a market-price valuation method determined pursuant to such guidance). While we have not made any qualifying limited-cash distributions to date as permitted by the IRS guidance, we reserve the right to consider making such distributions in the future, subject to compliance with applicable tax requirements. The IRS guidance is in effect for distributions declared on or before December 31, 2012 with respect to taxable years ending on or before December 31, 2011. We could also be subject to a U.S. federal income tax (including interest charges) on distributions received from investments in passive foreign investment companies PFICs (defined below) or on proceeds received from the disposition of shares in PFICs, which tax cannot be eliminated by making distributions to our stockholders. A PFIC is any foreign corporation in which (i) 75% or more of the gross income for the taxable year is passive income, or (ii) the average percentage of the assets (generally by value, but by adjusted tax basis in certain cases) that produce or are held for the production of passive income is at least 50%.
Generally, passive income for this purpose means dividends, interest (including income equivalent to interest), royalties, rents, annuities, the excess of gains over losses from certain property transactions and commodities transactions, and foreign currency gains. Passive income for this purpose does not include rents and royalties received by the foreign corporation from an active business and certain income received from related persons. If we are in a position to treat and do treat a PFIC as a qualified electing fund (QEF) we will be required to include in income our share of the companys income and net capital gain annually, regardless of whether we receive any distribution from the company. Alternately, we may make an election to mark the gains (and to a limited extent losses) in such holdings to the market as though we had sold and repurchased our holdings in those PFICs on the last day of our taxable year. Such gains and losses are
treated as ordinary income and loss. The QEF and mark-to-market elections may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed for us to avoid taxation. We may also invest in controlled foreign corporations (CFCs). A non-U.S. corporation will be a CFC if U.S. Shareholders (i.e., each U.S. investor that owns (directly or by attribution) 10% or more of the interests in the non-U.S. corporation (by vote)) own (directly or by attribution) more than 50% (by vote or value) of the outstanding interests of the non-U.S. corporation. If we are a U.S. Shareholder with respect to a CFC, we will be required each year to include in income our pro rata share of the corporations Subpart F income (as defined in the Code). Therefore, investments in CFCs may
have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed for us to avoid taxation. We are authorized to borrow funds and to sell assets to satisfy the Annual Distribution Requirement and to avoid any excise tax liability. However, depending on the types of debt and equity securities we have outstanding, we may be prohibited under the 1940 Act from making distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain asset coverage tests are met. See Regulation  Senior Securities; Coverage Ratio. Moreover, our ability to dispose of assets to meet the Annual Distribution Requirement and to avoid any excise tax liability may be limited by
(1) the illiquid nature of our portfolio, or (2) other requirements relating to our tax treatment as a RIC, including the Diversification Tests. If we dispose of assets to meet the Annual Distribution Requirements and to avoid any excise tax liability, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
 34    TABLE OF CONTENTS Gain or loss realized by us from the sale or exchange of warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such gain or loss generally will be long-term or short-term, depending on how long we held a particular warrant. Our transactions in options, futures contracts, hedging transactions and forward contracts will be subject to special tax rules, the effect of which may be to accelerate income to us, defer losses, cause adjustments to the holding periods of our investments, convert long-term capital gains into short-term capital gains, convert short-term capital
losses into long-term capital losses or have other tax consequences. These rules could affect the amount, timing and character of distributions to stockholders. We do not currently intend to engage in these types of transactions. Capital losses in excess of capital gains (net capital losses) are not permitted to be deducted against a RICs net investment income. Instead, potentially subject to certain limitations, we may carry net capital losses from any taxable year forward to offset capital gains in future years, thereby reducing the amount we would otherwise be required to distribute in such future years to qualify for the special tax treatment accorded RICs and avoid a company-level tax. If we incur or have incurred net capital losses in a taxable year beginning on or before December 22, 2010 (pre-2011 losses), we are permitted to carry such
losses forward for eight taxable years, and in the year to which they are carried forward, such losses are treated as short-term capital losses that first offset short-term capital gains, and then offset long-term capital gains. A RIC is permitted to carry forward net capital losses it incurs in taxable years beginning after December 22, 2010 without expiration. Any such carryforward losses will retain their character as short-term or long-term; this may well result in larger distributions of short-term gains (taxed as ordinary income to individual shareholders) than would have resulted under the regime applicable to pre-2011 losses. We will also generally be required to use any such carryforward losses, which will not expire, before we use any pre-2011 losses. This may increase the likelihood that pre-2011 losses, if any, will expire unused. See Note 7  Distributable Taxable Income from our Notes to the Financial Statements included herein for information
relating to the amount and expiration date of our capital loss carryforwards. As a RIC we are not permitted to deduct expenses in excess of our investment company taxable income (which is, generally, ordinary income plus net short-term capital gains in excess of net long-term capital losses). If our expenses in a given year exceed investment company taxable income (e.g., as the result of large amounts of equity-based compensation), we would experience a net operating loss for that year. However, a RIC is not permitted to carry forward net operating losses to subsequent years. In addition, expenses can be used only to offset investment company taxable income, not net capital gain (that is, the excess of net
long-term capital gains over the net short-term capital losses). Due to these limits on the deductibility of expenses, we may for tax purposes have aggregate taxable income over a period of several years that we are required to distribute and that is taxable to our stockholders even if such income is greater than the net income we actually earned during those years in the aggregate. Such required distributions may be made from our cash assets or by liquidation of investments, if necessary. We may realize gains or losses from such liquidations. In the event we realize net capital gains from such transactions, you may receive a larger capital gain distribution than you would have received in the absence of such transactions. Assuming we qualify for tax treatment as a RIC, our corporate-level U.S. federal income tax should be substantially reduced or eliminated, and, as explained below in  Taxation of U.S. Stockholders, a portion of our distributions or deemed
distributions may be characterized as long-term capital gain in the hands of stockholders. Failure to Qualify as a Regulated Investment Company If we were to fail to meet the income or diversification requirements described above, we could in some cases cure such failure, including by paying a tax and, in the case of diversification failures, by disposing of certain assets. If we do not cure such a failure or otherwise fail to qualify for tax treatment as a RIC (including if our Board of Directors elected to temporarily or permanently revoke our RIC election), we would be subject to tax on all of our taxable income at regular corporate rates. We would not be able to deduct distributions to stockholders, nor would distributions be required to be made. Such distributions would be taxable to
our stockholders as dividend income to the extent of our current and accumulated earnings and profits and (if made during a taxable year beginning before January 1, 2013) provided certain holding period and other requirements were met, could potentially qualify for treatment as qualified dividend income in the
 35    TABLE OF CONTENTS hands of stockholders taxed as individuals eligible for the 15% maximum rate. Subject to certain limitations under the Code, corporate distributees may be eligible for the dividends received deduction with respect to our dividend distributions. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholders tax basis, and any remaining distributions would be treated as a capital gain. To requalify as a RIC in a subsequent taxable year, we would be required to satisfy the RIC qualification requirements for that year and distribute any earnings and profits
from any year in which we failed to qualify for tax treatment as a RIC. Subject to a limited exception applicable to RICs that qualified as such under Subchapter M of the Code for at least one year prior to disqualification and that requalify as a RIC no later than the second year following the nonqualifying year, we could be subject to tax on any unrealized net built-in gains in the assets held by us during the period in which we failed to qualify for tax treatment as a RIC that are recognized within the subsequent 10 years, unless we made a special election to pay corporate-level tax on such built-in gain at the time of our requalification as a RIC. Except as otherwise provided, the remainder of this discussion assumes that we qualify for tax treatment as a RIC and have satisfied the Annual Distribution Requirement. Taxation of U.S. Stockholders For U.S. federal income tax purposes, distributions by us generally are taxable to U.S. stockholders as ordinary income or capital gains. Distributions of our investment company taxable income (which is, generally, our ordinary income plus net realized short-term capital gains in excess of net realized long-term capital losses) will be taxable as ordinary income to U.S. stockholders to the extent of our current or accumulated earnings and profits, whether paid in cash or reinvested in additional common stock through our dividend reinvestment plan. For taxable years beginning before January 1, 2013, to the extent such distributions paid by
us are attributable to dividends from U.S. corporations and certain qualified foreign corporations, such distributions may be reported by us as qualified dividend income eligible to be taxed in the hands of non-corporate stockholders at the rates applicable to long-term capital gains, provided holding period and other requirements are met at both the stockholder and company levels. In this regard, it is anticipated that distributions paid by us generally will not be attributable to dividends and, therefore, generally will not be qualified dividend income. Distributions of our net capital gains (which is generally our realized net long-term capital gains in excess of realized net short-term capital losses) properly reported by us as capital gain dividends will be taxable to a U.S. stockholder as long-term capital gains (currently at a maximum rate of 15% in the case of individuals, trusts or estates), regardless of the U.S. stockholders holding period for
his, her or its common stock and regardless of whether paid in cash or reinvested in additional common stock. Distributions in excess of our current and accumulated earnings and profits first will reduce a U.S. stockholders adjusted tax basis in such stockholders common stock and, after the adjusted basis is reduced to zero, will constitute capital gains to such U.S. stockholder. We may retain some or all of our realized net long-term capital gains in excess of realized net short-term capital losses and designate the retained net capital gains as a deemed distribution. In that case, among other consequences, we will pay tax on the retained amount, each U.S. stockholder will be required to include his, her or its share of the deemed distribution in income as if it had been actually distributed to the U.S. stockholder, and the U.S. stockholder will be entitled to claim a credit equal to his, her or its allocable share of the tax paid thereon by us. The amount of the deemed distribution net of such tax will be added
to the U.S. stockholders cost basis for his, her or its common stock. Since we expect to pay tax on any retained net capital gains at our regular corporate tax rate, and since that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual stockholders will be treated as having paid and for which they will receive a credit will exceed the tax they owe on the retained net capital gain. Such excess generally may be claimed as a credit against the U.S. stockholders other federal income tax obligations or may be refunded to the extent it exceeds a stockholders liability for U.S. federal income tax. A stockholder that is not subject to U.S. federal income tax or otherwise required to file a U.S. federal income tax return would be required to file a U.S. federal income tax return on the appropriate form to claim a refund for the taxes we paid. To utilize the deemed distribution approach, we must
provide written notice to our stockholders prior to the expiration of 60 days after the close of the relevant taxable year. We cannot treat any of our investment company taxable income as a deemed distribution. We may also make actual distributions to our stockholders of some or all of realized net long-term capital gains in excess of realized net short-term capital losses.
 36    TABLE OF CONTENTS For purposes of determining (1) whether the Annual Distribution Requirement is satisfied for any year and (2) the amount of capital gain dividends paid for that year, we may, under certain circumstances, elect to treat a dividend that is paid during the following taxable year as if it had been paid during the taxable year in question. If we make such an election, the U.S. stockholder will still be treated as receiving the dividend in the taxable year in which the distribution is made. However, any dividend declared 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
actually paid during January of the following year, will be treated as if it had been received by our U.S. stockholders on December 31 of the year in which the dividend was declared. A U.S. stockholder generally will recognize taxable gain or loss if the U.S. stockholder sells or otherwise disposes of his, her or its shares of our common stock. Any gain arising from such sale or disposition generally will be treated as long-term capital gain or loss if the U.S. stockholder has held his, her or its shares for more than one year. Otherwise, it will be classified as short-term capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares. In addition, all or a portion of any loss recognized upon a disposition of shares of our
common stock may be disallowed if other shares of our common stock are purchased (whether through reinvestment of distributions or otherwise) within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss. For taxable years beginning before January 1, 2013, individual U.S. stockholders are subject to a maximum U.S. federal income tax rate of 15% on their net capital gain (i.e., the excess of realized net long-term capital gain over realized net short-term capital loss for a taxable year) including any long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary income currently payable by individuals. Corporate U.S. stockholders currently are subject to U.S. federal income tax on net capital gain at the maximum 35% rate also applied to ordinary income. Non-corporate stockholders with net
capital losses for a year (i.e., capital losses in excess of capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year ($1,500 for married individuals filing separately); any net capital losses of a non-corporate stockholder in excess of $3,000 ($1,500 for married individuals filing separately) generally may be carried forward and used in subsequent years as and to the extent provided in the Code. Corporate stockholders generally may not deduct any net capital losses for a year, but may carry back such losses for three years or carry forward such losses for five years. Distributions are taxable to stockholders even if they are paid from income or gains earned by us before a stockholders investment (and thus were included in the price the stockholder paid). If an investor purchases shares of our common stock shortly before the record date of a distribution, the price of the shares will include the value of the distribution and the investor will be subject to tax on the distribution even though economically, it may represent a return of his, her or its investment. Distributions are taxable whether stockholders receive them in cash or reinvest them in additional shares through the Dividend Reinvestment Plan. A stockholder whose distributions are reinvested in shares will be treated as having received a dividend equal to either (i) the fair market value of the shares issued to the stockholder (if we issue new shares), or (ii) the amount of cash allocated to the stockholder for the purchase of shares on its behalf (if we purchase shares on the open market). We will send to each of our U.S. stockholders, as promptly as possible after the end of each calendar year, a notice detailing, on a per share and per
distribution basis, the amounts includible in such U.S. stockholders taxable income for such year as ordinary income and as long-term capital gain. In addition, the U.S. federal tax status of each years distributions generally will be reported to the IRS (including the amount of dividends, if any, eligible for the 15% qualified dividend income rate). Distributions may also be subject to additional state, local and foreign taxes depending on a U.S. stockholders particular situation. Dividends distributed by us generally will not be eligible for the corporate dividends received deduction or the preferential rate applicable to qualified dividend income.
 37    TABLE OF CONTENTS We may be required to withhold U.S. federal income tax (backup withholding), currently at a rate of 28%, from all distributions to any non-corporate U.S. stockholder (1) who fails to furnish us with a correct taxpayer identification number, (2) who fails to furnish us with a certificate that such stockholder is exempt from backup withholding, or (3) with respect to whom the IRS notifies us that such stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individuals taxpayer identification number is his or her social security number. The 28% rate will
expire for amounts paid after December 31, 2012 and instead the backup withholding rate on such amounts will be 31% unless Congress enacts legislation providing otherwise. It is currently unclear whether such legislation will be enacted and, if enacted, what the terms of an extension will be. Backup withholding is not an additional tax. Any amount withheld under the backup withholding rules is allowed as a credit against the U.S. stockholders federal income tax liability, provided that proper information is provided to the IRS. Under Treasury regulations, if a stockholder recognizes a loss with respect to our shares of $2 million or more for an individual stockholder or $10 million for a corporate stockholder, the stockholder must file with the IRS a disclosure statement on Form 8886. Direct stockholders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, stockholders of a RIC are not excepted. Future guidance may extend the current exception from this reporting requirement to stockholders of most or all RICs. The fact that a loss is reportable under these regulations does not affect the legal determination of
whether a taxpayers treatment of the loss is proper. Stockholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances. Taxation of Non-U.S. Stockholders Whether an investment in the shares is appropriate for a non-U.S. stockholder will depend upon that persons particular circumstances. Non-U.S. stockholders should consult their tax advisors before investing in our common stock. In general, dividend distributions (other than certain distributions derived from net long-term capital gains, certain interest income and short term capital gains, as described below) paid by us to a non-U.S. stockholder are subject to withholding of U.S. federal income tax at a rate of 30% (or lower applicable treaty rate) even if they are funded by income or gains that, if paid to a non-U.S. stockholder directly,
would not be subject to withholding. If the distributions are effectively connected with a U.S. trade or business of the non-U.S. stockholder, (and, if an income tax treaty applies, attributable to a permanent establishment in the United States), we will not be required to withhold federal tax if the non-U.S. stockholder complies with applicable certification and disclosure requirements, although the distributions will be subject to U.S. federal income tax at the rates applicable to U.S. stockholders. (Special certification requirements apply to a non-U.S. stockholder that is a foreign partnership or a foreign trust and such entities are urged to consult their tax advisors.) For our taxable years beginning prior to January 1, 2012, except as provided below, we generally will not be required to withhold any amounts with respect to certain distributions of (1) U.S.-source interest income that meets certain requirements, and (2) net short-term capital gains in excess of net long-term
capital losses, in each case to the extent we properly report such distributions as such to stockholders. We intend to report to stockholders the portion of our distributions that are eligible for the interest-related dividend and short-term capital gain dividend withholding tax exemptions. In respect of distributions described in clause (1) above, however, we will be required to withhold amounts with respect to distributions to a non-U.S. stockholder: 

          that has not provided a satisfactory statement that the beneficial owner is not a U.S. person; 

          to the extent that the dividend is attributable to certain interest on an obligation if the non-U.S. stockholder is the issuer or is a 10% stockholder of the issuer; 

          that is within certain foreign countries that have inadequate information exchange with the United States; or 

          to the extent the dividend is attributable to interest paid by a person that is a related person of the non-U.S. stockholder and the non-U.S. stockholder is a controlled foreign corporation for U.S. federal income tax purposes.
 38    TABLE OF CONTENTS In the case of shares held through an intermediary, the intermediary may withhold even if we were to report a distribution as an interest-related or short-term capital gain dividend. Non-U.S. stockholders should contact their intermediaries regarding the application of these rules to their accounts. Actual or deemed distributions of our net capital gain to a non-U.S. stockholder, and gains realized by a non-U.S. stockholder upon the sale of our common stock, will not be subject to U.S. federal withholding tax and generally will not be subject to U.S. federal income tax unless the distributions or gain, as the case may be, are effectively connected with a U.S. trade or business of the non-U.S. stockholder (and, if an income tax treaty applies, are attributable to a permanent establishment maintained by the non-U.S. stockholder in the U.S.), or in the case of an individual stockholder, the stockholder is present in the U.S. for a period or periods
aggregating 183 days or more during the year of the sale or capital gain dividend and certain other conditions are met. If we distribute our net capital gain in the form of deemed rather than actual distributions, a non-U.S. stockholder will be entitled to a U.S. federal income tax credit or tax refund equal to the stockholders allocable share of the tax we pay on the capital gains deemed to have been distributed. To obtain the refund, the non-U.S. stockholder must obtain a U.S. taxpayer identification number and file a U.S. federal income tax return even if the non-U.S. stockholder would not otherwise be required to obtain a U.S. taxpayer identification number or file a U.S. federal income tax return. For a corporate non-U.S. stockholder, distributions (both actual and deemed), and gains realized upon the sale of our common stock that are effectively connected to a U.S. trade or business may, under certain circumstances, be subject to an additional branch profits tax
at a 30% rate (or at a lower rate if provided for by an applicable treaty). A non-U.S. stockholder who is a non-resident alien individual, and who is otherwise subject to withholding of U.S. federal tax, may be subject to information reporting and backup withholding of U.S. federal income tax on dividends unless the non-U.S. stockholder provides us or the dividend paying agent a properly completed and duly executed IRS Form W-8 (or an acceptable substitute or successor form) or otherwise meets documentary evidence requirements for establishing that it is a non-U.S. stockholder or otherwise establishes an exemption from backup withholding. Investment in the shares may not be appropriate for a non-U.S. stockholder. Non-U.S. persons should consult their tax advisors with respect to the U.S. federal income tax and withholding tax, and state, local and foreign tax consequences of an investment in the shares. Certain Additional Reporting and Withholding Requirements Rules enacted in March 2010 require the reporting to the IRS of direct and indirect ownership of foreign financial accounts and foreign entities by U.S. persons. Failure to provide this required information can result in a 30% withholding tax on certain payments (withholdable payments), beginning in 2014 or 2015, depending on the type of payment. Specifically, withholdable payments subject to this 30% withholding tax include payments of U.S.-source dividends and interest, made on or after January 1, 2014 and payments of gross proceeds from the sale or other disposal of property that can produce U.S.-source dividends or interest made on or
after January 1, 2015. The IRS has issued only very preliminary guidance with respect to these new rules; their scope remains unclear and potentially subject to material change. Pursuant to that guidance, it is possible that distributions and redemption payments made by us on or after the dates noted above (or such later dates as may be provided in future guidance) to a stockholder will be subject to the new 30% withholding requirement. Payments to a non-U.S. stockholder that is a foreign financial institution will generally be subject to withholding unless such stockholder enters into a timely agreement with the IRS. Payments to stockholders that are U.S.
persons or foreign individuals will generally not be subject to withholding, so long as such stockholders provide such certifications or other documentation as are required to comply with the new rules. Persons investing in us through an intermediary should contact their intermediaries regarding the application of the new reporting and withholding regime to their investments. Stockholders are urged to consult a tax advisor regarding this new reporting and withholding regime in light of their particular circumstances.
 39    TABLE OF CONTENTS DIVIDEND REINVESTMENT PLAN We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder elects to receive cash as provided below. As a result, if our Board of Directors authorizes, and we declare, a cash dividend, then our stockholders who have not opted out of our dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash. No action is required on the part of a registered stockholder to have such shareholders cash dividend reinvested in shares of our common stock. A registered stockholder may elect to receive an entire dividend in cash by notifying American Stock Transfer & Trust Company, the plan administrator and our transfer agent and registrar, in writing so that such notice is received by the plan administrator no later than the record date for dividends to stockholders. The plan administrator will set up an account for shares acquired through the plan for each stockholder who has not elected to receive dividends in cash and hold such shares in
non-certificated form. Upon request by a stockholder participating in the plan, received in writing not less than ten days prior to the record date, the plan administrator will, instead of crediting shares to the participants account, issue a certificate registered in the participants name for the number of whole shares of our common stock and a check for any fractional share. Those stockholders whose shares are held by a broker or other financial intermediary may receive dividends in cash by notifying their broker or other financial intermediary of their election. We intend to use primarily newly issued shares to implement the plan, whether our shares are trading at a premium or at a discount to net asset value. However, we reserve the right to purchase shares in the open market in connection with our implementation of the plan. The number of shares to be issued to a stockholder is determined by dividing the total dollar amount of the dividend payable to such stockholder by the market price per share of our common stock at the close of regular trading on The NASDAQ Global Select Market on the dividend payment date. Market price per share on that date will be the closing price for such shares on The NASDAQ
Global Select Market or, if no sale is reported for such day, at the average of their reported bid and asked prices. The number of shares of our common stock to be outstanding after giving effect to payment of the dividend cannot be established until the value per share at which additional shares will be issued has been determined and elections of our stockholders have been tabulated. There are no brokerage charges or other charges to stockholders who participate in the plan. The plan administrators fees under the plan are paid by us. If a participant elects by written notice to the plan administrator to have the plan administrator sell part or all of the shares held by the plan administrator in the participants account and remit the proceeds to the participant, the plan administrator is authorized to deduct a $15.00 transaction fee plus a $0.10 per share brokerage commission from the proceeds. If your dividends are reinvested, you will be required to pay tax on the distributions in the same manner as if the distributions were received in cash. The taxation of dividends will not be affected by the form in which you receive them. See Certain United States Federal Income Tax Considerations. Participants may terminate their accounts under the plan by notifying the plan administrator via its website at www.amstock.com, by filling out the transaction request form located at bottom of their statement and sending it to the plan administrator at the address set forth below or by calling the plan administrator at 1-866-668-8564. The plan may be terminated by us upon notice in writing mailed to each participant at least 30 days prior to any record date for the payment of any dividend by us. All correspondence concerning the plan should be directed to, and additional information about the plan may be obtained from, the plan administrator by mail at American Stock Transfer & Trust Company, Attn. Dividend Reinvestment Department, P.O. Box 922, Wall Street Station, New York, NY 10269-0560 or by telephone at 1-866-668-8564.
 40    TABLE OF CONTENTS Item 1A. Risk Factors Investing in our common stock involves a high degree of risk. The risks set forth below are not the only risks we face. If any of the following risks occur, our business, financial condition and results of our operations could be materially adversely affected. In such case, the net asset value and the trading price of our common stock could decline, and you may lose all or part of your investment. Risks Related to Our Business We are dependent upon senior management for our future success, and if we are unable to hire and retain qualified personnel or if we lose any member of our senior management team, our ability to achieve our investment objective could be significantly harmed. We depend on the members of our senior management as well as other key personnel for the identification, final selection, structuring, closing and monitoring of our investments. These employees have critical industry experience and relationships that we rely on to implement our business plan. Our future success depends on the continued service of our senior management team and our Board of Directors. The departure of any of the members of our senior management or a significant number of our senior personnel could have a material adverse effect on our ability to achieve our investment objective. As a result, we may not be able to operate our business
as we expect, and our ability to compete could be harmed, which could cause our operating results to suffer. We operate in a highly competitive market for investment opportunities. A large number of entities compete with us to make the types of investments that we plan to make in prospective portfolio companies. We compete with other BDCs, as well as a large number of investment funds, investment banks and other sources of financing, including traditional financial services companies, such as commercial banks and finance companies. Many of our competitors are substantially larger and have considerably greater financial, technical, marketing and other resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. This may enable some of our
competitors to make commercial loans with interest rates that are comparable to or lower than the rates we typically offer. We may lose prospective portfolio investments if we do not match our competitors pricing, terms and structure. If we do match our competitors pricing, terms or structure, we may experience decreased net interest income and increased risk of credit losses. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments, establish more relationships and build their market shares. Furthermore, many of our potential competitors have greater experience operating under, or are not subject to, the regulatory restrictions that the 1940 Act imposes on us as a BDC. As a result of this competition, there can be no assurance that we will be able to identify and take advantage of attractive investment opportunities or that we will be able to fully invest our
available capital. If we are not able to compete effectively, our business and financial condition and results of operations will be adversely affected. Although Kohlberg & Co. has agreed pursuant to the License and Referral Agreement with us to notify us of equity investment opportunities that are presented to Kohlberg & Co. but do not fit the investment profile of Kohlberg & Co. or its affiliates, no such referral to date has resulted in an investment by us or Katonah Debt Advisors and the initial term of the agreement expired on October 31, 2011, and, as a result, Kohlberg & Co. may terminate the agreement at any time in its sole discretion. If we are unable to source investments effectively, we may be unable to achieve our investment objective. Our ability to achieve our investment objective depends on our senior management teams ability to identify, evaluate, finance and invest in suitable companies that meet our investment criteria. Accomplishing this result on a cost-effective basis is largely a function of our marketing capabilities, our management of the investment process, our ability to provide efficient services and our access to financing sources on acceptable terms. In addition to monitoring the performance of our existing investments, members of our management team and our investment professionals may also be called upon to provide managerial assistance to our portfolio
companies. These demands on their time may distract them or slow the rate of investment. To grow, we need to continue to hire, train, supervise and manage new employees and to implement computer and
 41    TABLE OF CONTENTS other systems capable of effectively accommodating our growth. However, we cannot provide assurance that any such employees will contribute to the success of our business or that we will implement such systems effectively. Failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations. There is a risk that we may not make distributions. We intend to continue to make distributions on a quarterly basis to our stockholders. We may not be able to achieve operating results that will allow us to make distributions at historical or any specific levels or to increase the amount of these distributions from time to time. In addition, due to the asset coverage test applicable to us as a BDC, depending on the types of debt and equity securities we have outstanding, we may be limited in our ability to make distributions. See Item 1. Business  Leverage. Also, restrictions and provisions in our outstanding indebtedness may limit our ability to make distributions. If we
do not distribute a certain percentage of our income annually, we could fail to qualify for tax treatment as a RIC and we would be subject to corporate level U.S. federal income tax. Furthermore, in accordance with current IRS guidance, we may make distributions under special circumstances that would allow us to meet our annual RIC distribution requirement for 2009, 2010, and 2011 by distributing shares of our stock in lieu of a significant portion of the cash (or other property other than our stock) that we would otherwise be required to distribute to satisfy such distribution requirement. See Item 1. Business  Certain United States Federal Income Tax Considerations. We cannot ensure that we will make distributions at historical or any other specified levels or at all. We may have difficulty paying our required distributions if we recognize income before or without receiving cash equal to such income. In accordance with GAAP and the Code, we include in income certain amounts that we have not yet received in cash, such as contracted non-cash PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. In addition to the cash yields received on our loans, in some instances, certain loans may also include any of the following: end of term payments, exit fees, balloon payment fees or prepayment fees. The increases in loan balances as a result of contracted non-cash PIK arrangements are included in income for the period in which such non-cash PIK interest was received, which is often in advance of
receiving cash payment, and are separately identified on our statements of cash flows. We also may be required to include in income certain other amounts that we will not receive in cash. Any warrants that we receive in connection with our debt investments generally are valued as part of the negotiation process with the particular portfolio company. As a result, a portion of the aggregate purchase price for the debt investments and warrants is allocated to the warrants that we receive. This generally results in original issue discount for tax purposes, which we must recognize as ordinary income, increasing the amounts we are required to distribute to qualify as a RIC eligible for pass-through tax treatment. Because such original issue discount income might exceed the amount of cash received in a given year with respect to such investment, we might need to obtain cash from other sources to satisfy such distribution requirements. Other features of the debt instruments that we
hold may also cause such instruments to generate original issue discount, resulting in a dividend distribution requirement in excess of current cash received. Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. If we are unable to meet these distribution requirements, we will not qualify for tax treatment as a RIC or, even if such distribution requirement is satisfied, we may be subject to tax on the amount that is undistributed. Accordingly, we may have to sell some of our assets, raise additional debt or equity securities or reduce new investment originations to meet these distribution requirements and avoid tax. See Item 1. Business  Certain United States Federal Income Tax Considerations.
 42    TABLE OF CONTENTS We may incur losses as a result of first loss agreements into which we or Katonah Debt Advisors may enter in connection with warehousing credit arrangements which we put in place prior to raising a CLO Fund and pursuant to which we agree to reimburse credit providers for a portion of losses (if any) on warehouse investments. We and Katonah Debt Advisors have in the past entered, and may in the future enter, into first loss agreements in connection with warehouse credit lines to be established by Katonah Debt Advisors to fund the initial accumulation of loan investments for future CLO Funds that Katonah Debt Advisors will manage. Such agreements (referred to as first loss agreements or first loss obligations) frequently relate to (i) losses as a result of individual loan investments being ineligible for purchase by the CLO Fund (typically due to a payment default on such loan) when such fund formation is completed or, (ii) if the CLO
Fund has not been completed before the expiration of the warehouse credit line, the loss (if any, and net of any accumulated interest income) on the resale of such loans funded by the warehouse credit line. As a result, we may incur losses if loans and debt obligations that had been purchased in the warehouse facility become ineligible for inclusion in the CLO Fund or if a planned CLO Fund does not close. Any unrealized losses we experience on our loan portfolio may be an indication of future realized losses, which could reduce our income available for distribution. As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at the fair value as determined in good faith by our Board of Directors pursuant to a valuation methodology approved by our Board of Directors. Decreases in the market values or fair values of our investments will be recorded as unrealized losses. An unrealized loss in our loan portfolio could be an indication of a portfolio companys inability to meet its repayment obligations with respect to the affected loans. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in
future periods. We may experience fluctuations in our quarterly and annual operating results and credit spreads. We could experience fluctuations in our quarterly and annual operating results due to a number of factors, some of which are beyond our control, including our ability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the default rate on such securities, our level of expenses, variations in and timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in
future periods. We are exposed to risks associated with changes in interest rates and spreads. Changes in interest rates may have a substantial negative impact on our investments, the value of our securities and our rate of return on invested capital. A reduction in the interest spreads on new investments could also have an adverse impact on our net interest income. An increase in interest rates could decrease the value of any investments we hold which earn fixed interest rates, including mezzanine securities and high-yield bonds, and also could increase our interest expense, thereby decreasing our net income. An increase in interest rates due to an increase in credit spreads, regardless of general interest rate fluctuations, could also
negatively impact the value of any investments we hold in our portfolio. Also, an increase in interest rates available to investors could make investment in our common stock less attractive if we are not able to increase our dividend rate, which could reduce the value of our common stock. We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us. Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. We have issued senior securities, and in the future may borrow from, or issue additional senior securities (such as preferred or convertible securities or the senior debt securities) to, banks and other lenders and investors, including debt guaranteed by the Small Business Administration (SBA). Subject to prevailing market conditions, we intend to grow our portfolio of
 43    TABLE OF CONTENTS assets by raising additional capital, including through the prudent use of leverage available to us. Lenders and holders of such senior securities have fixed dollar claims on our consolidated assets that are superior to the claims of our common stockholders or any preferred stockholders. Leverage is generally considered a speculative investment technique. If the value of our consolidated assets increases, then leveraging would cause the net asset value per share of our common stock to increase more sharply than it would have had we not incurred leverage. Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset
value to decline more sharply than it otherwise would have had we not incurred leverage. Similarly, any increase in our consolidated income in excess of consolidated interest payable on our outstanding indebtedness would cause our net income to increase more than it would had we not incurred leverage, while any decrease in our consolidated income would cause net income to decline more sharply than it would have had we not incurred leverage. Such a decline could negatively affect our ability to make common stock dividend payments. There can be no assurance that our leveraging strategy will be successful. As of December 31, 2011, we had $60 million in aggregate principal amount of our 8.75% convertible senior notes due 2016 outstanding. We may incur additional indebtedness in the future, although there can be no assurance that we will be successful in doing so. Our ability to service our debt depends largely on our financial performance and is subject to prevailing economic conditions and competitive pressures. The amount of leverage that we employ at any particular time will depend on our managements and our Board of Directors assessment of market and other factors at the time of any proposed borrowing. On February 24, 2012, the Company incurred additional borrowings totaling $30 million to fund new investments. Such additional borrowings may exacerbate the risks defined above regarding leverage. Our convertible senior notes impose, and additional debt we may incur in the future will likely impose, financial and operating covenants that restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a RIC. A failure to add new debt facilities or issue additional debt securities or other evidences of indebtedness in lieu of or in addition to existing indebtedness could have a material adverse effect on our business, financial condition or results of operations. The following table illustrates the effect on return to a holder of our common stock of the leverage created by our use of borrowing at the convertible senior notes interest rate of 8.75% as of December 31, 2011, together with (a) total value of our assets of $248.1 million as of December 31, 2011, (b) $60 million of principal indebtedness outstanding as of December 31, 2011and (c) hypothetical annual returns on our portfolio of minus 15% to plus 15%.  Assumed Return on Portfolio (Net of Expenses)(1)

          

          

          -15

          %

          

          

          -10

          %

          

          

          -5

          %

          

          

          0

          %

          

          

          5

          %

          

          

          10

          %

          

          

          15

          %Corresponding Return to Common Stockholders(2)

          

          

          -17

          %

          

          

          -12

          %

          

          

          -7

          %

          

          

          -2

          %

          

          

          3

          %

          

          

          8

          %

          

          

          13

          %
  (1)

          The assumed portfolio return is required by SEC rules and is not a prediction of, and does not represent, our projected or actual performance. The table also assumes that we will maintain a constant level of leverage. The amount of leverage that we use will vary from time to time. Actual returns may be greater or smaller than those appearing in the table. (2)

          In order to compute the Corresponding Return to Common Stockholders, the Assumed Return on Portfolio is multiplied by the total value of our assets of $248.1 million at December 31, 2011to obtain an assumed return to us. From this amount, the interest expense (calculated by multiplying the convertible senior notes interest rate of 8.75% as of December 31, 2011 by the $60 million of principal indebtedness outstanding as of December 31, 2011) is subtracted to determine the return available to stockholders. The return available to stockholders is then divided by the total value of our net assets as of December 31, 2011 to determine the Corresponding Return to Common Stockholders.
 44    TABLE OF CONTENTS Our indebtedness could adversely affect our financial health and our ability to respond to changes in our business. With certain limited exceptions, we are only allowed to borrow amounts or issue senior securities such that our asset coverage, as defined in the 1940 Act, is at least 200% immediately after such borrowing or issuance. As of December 31, 2011, our asset coverage ratio was 401%. The amount of leverage that we employ in the future will depend on our managements and our Board of Directors assessment of market and other factors at the time of any proposed borrowing. There is no assurance that a leveraging strategy will be successful. As a result of the level of our leverage: 

          there is a likelihood of greater volatility of net asset value and market price of our common stock than without leverage; 

          our exposure to risk of loss is greater if we incur debt or issue senior securities to finance investments because a decrease in the value of our investments has a greater negative impact on our returns and, therefore, the value of our common stock than if we did not use leverage; 

          the decrease in our asset coverage ratio resulting from increased leverage and the covenants contained in documents governing our indebtedness (which may impose asset coverage or investment portfolio composition requirements that are more stringent than those imposed by the 1940 Act) limit our flexibility in planning for, or reacting to, changes in our business and industry, as a result of which we could be required to liquidate investments at an inopportune time; 

          we are required to dedicate a portion of our cash flow to interest payments, limiting the availability of cash for dividends and other purposes; and 

          our ability to obtain additional financing in the future may be impaired. If we have to sell assets at a loss to redeem or pay interest on our outstanding indebtedness or for other reasons, our net asset value will be reduced and may not fully recover. We cannot be sure that our leverage will not have a material adverse effect on us. In addition, we cannot be sure that additional financing will be available when required or, if available, will be on terms satisfactory to us. Further, even if we are able to obtain additional financing, we may be required to use some or all of the proceeds thereof to repay our outstanding indebtedness. Our stockholders may experience dilution upon the conversion of our convertible senior notes. Our 8.75% convertible senior notes due 2016 are convertible into shares of our common stock at any time prior to the end of business on the business day preceding the maturity date. Upon conversion, we will satisfy our conversion obligation by issuing shares of our common stock to the converting holder and, under certain limited circumstances, may elect to deliver cash in lieu of shares otherwise deliverable upon conversion to comply with certain listing standards of The NASDAQ Global Select Market. The current conversion price of the convertible senior is approximately 118.5255 shares of our common stock per $1,000 principal amount of the
convertible senior notes, equivalent to a conversion price of approximately $8.437 per share of our common stock. Our stockholders will experience dilution in their ownership percentage of common stock upon our issuance of common stock on any conversion of the convertible senior notes and any dividends paid on our common stock will also be paid on shares issued on any conversion. If market constraints prevent us from obtaining debt or additional equity capital, our liquidity could be adversely affected, our business prospects could be negatively impacted, we could lose key employees and our operating results could be negatively affected. Recent economic and capital market conditions in the U.S. have resulted in a severe reduction in the availability of debt and equity capital for the market as a whole, and financial services firms in particular. These conditions have constrained us and other companies in the financial services sector, limiting or completely preventing access to markets for debt and equity capital needed to maintain operations, continue investment originations and to grow. Reflecting concern about the stability of the financial markets, many lenders and institutional investors have reduced or ceased providing funding to borrowers. This market turmoil and tightening of
credit has led to increased market volatility and widespread reduction of business activity
 45    TABLE OF CONTENTS generally. If we are unable to obtain new debt or additional equity capital, our liquidity may be impacted. If these conditions continue for a prolonged period of time, or worsen in the future, we could lose key employees and our business prospects could be negatively impacted. Even if we are able to incur new debt, we may not be able to do so on favorable terms. In addition, the debt or equity capital that will be available, if at all, may be at a high cost and/or on unfavorable terms and conditions. Equity capital is, and may continue to be, difficult to raise because, subject to some limited exceptions, we are not generally able to issue and sell
our common stock at a price below NAV per share without stockholder approval. In addition, issuing equity at depressed stock prices can be dilutive to our stockholders. These events and our inability to raise capital have resulted in a reduction in new originations, curtailed our ability to grow and have had a negative impact on our liquidity and operating results. The continued inability to raise additional capital could further constrain our liquidity, negatively impact our business prospects, cause the departure of key employees and negatively impact our operating results. We obtained shareholder approval to sell our common stock at a price below net asset value at our 2011 annual meeting and such approval is effective for a period expiring on June 16, 2012, the one-year anniversary of the date of the shareholder approval. Because we intend to continue to distribute substantially all of our income and net realized capital gains to our stockholders, we will need additional capital to finance our growth. In order to qualify as a RIC, to avoid payment of excise taxes and to minimize or avoid payment of income taxes, we intend to continue to distribute to our stockholders substantially all of our net ordinary income and realized net capital gains except for certain net long-term capital gains (which we may retain, pay applicable income taxes with respect thereto, and elect to treat as deemed distributions to our stockholders). As a BDC, in order to incur new debt, we are generally required to meet a coverage ratio of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at
least 200%, as measured immediately after issuance of such security. This requirement limits the amount that we may borrow. Because we will continue to need capital to grow our loan and investment portfolio, this limitation may prevent us from incurring debt and require us to issue additional equity at a time when it may be disadvantageous to do so. We cannot assure you that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of such borrowings. If additional funds are not available to us, we could be forced to continue to curtail or cease new lending and investment activities, and our NAV could decline. If we sell common stock at a discount to our net asset value per share, stockholders who do not participate in such sale will experience immediate dilution in an amount that may be material. As a BDC, we are generally not permitted to issue equity securities priced below NAV without stockholder approval. We obtained stockholder approval to sell our common stock at a price below NAV at our 2011 annual stockholder meeting and such approval is effective for a period expiring on June 16, 2012, the one-year anniversary of the date of the stockholder approval. We may seek such approval for future periods, including for the one-year period starting at our 2012 annual stockholder meeting. The issuance or sale by us of shares of our common stock at a discount to net asset value poses a risk of dilution to our stockholders. In particular,
stockholders who do not purchase additional shares at or below the discounted price in proportion to their current ownership will experience an immediate decrease in NAV per share (as well as in the aggregate NAV of their shares if they do not participate at all). These stockholders will also experience a disproportionately greater decrease in their participation in our earnings and assets and their voting power than the increase we experience in our assets, potential earning power and voting interests from such issuance or sale. In addition, such sales may adversely affect the price at which our common stock trades.
 46    TABLE OF CONTENTS We may from time to time expand our business through acquisitions, which could disrupt our business, harm our financial condition and dilute current stockholders ownership interests in our Company. We may pursue potential acquisitions of, and investments in, businesses complementary to our business and from time to time engage in discussions regarding such possible acquisitions. For example, in February 2012, we completed the acquisition of Trimaran Advisors, L.L.C. (Trimaran). Such acquisition and any other acquisitions we may undertake involve a number of risks, including: 

          failure of the acquired businesses to achieve the results we expect; 

          substantial cash expenditures; 

          diversion of capital and management attention from operational matters; 

          our inability to retain key personnel of the acquired businesses; 

          incurrence of debt and contingent liabilities and risks associated with unanticipated events or liabilities; and 

          the potential disruption and strain on our existing business and resources that could result from our planned growth and continuing integration of our acquisitions. If we fail to properly evaluate acquisitions or investments, we may not achieve the anticipated benefits of such acquisitions, we may incur costs in excess of what we anticipate, and management resources and attention may be diverted from other necessary or valuable activities. Any acquisition, including the Trimaran acquisition, may not result in short-term or long-term benefits to us. If we are unable to integrate or successfully manage any business that we acquire, we may not realize anticipated cost savings, improved efficiencies or revenue growth, which may result in reduced profitability or operating losses. Moreover, acquisitions of businesses
may require the issuance of additional equity financing, which may result in dilution of our existing stockholders. Our Board of Directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval. Our Board of Directors has the authority to modify or waive certain of our operating policies and strategies without prior notice (except as required by the 1940 Act) and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and value of our stock. Nevertheless, the effects may adversely affect our business and impact our ability to make distributions. Recent regulatory changes impact the operations of Katonah Debt Advisors and our ownership thereof. Katonah Debt Advisors and its asset manager affiliates (together, the Advisers), our wholly-owned asset managers that manage CLO Funds, rely on an exemption from registration as investment advisers set forth in Section 203(b)(3) of the Investment Advisers Act of 1940, as amended (the Advisers Act), which provides generally that an investment adviser with fewer than 15 clients is not required to register with the SEC (i.e., the private adviser exemption). However, as a result of the elimination of the private adviser exemption by the Private Fund Investment Advisers Registration Act of 2010, we expect
that the Advisers will be required to register as investment advisers under the Advisers Act by March 31, 2012, and in that regard have filed to register as investment advisers with the SEC. Certain provisions of the 1940 Act applicable to BDCs may be interpreted to prohibit BDCs from owning any security issued by or any other interest in the business of a person who is a registered investment adviser. If the 1940 Act were so interpreted, the Company may be in violation of the 1940 Act unless the Commission grants the Company exemptive relief. The Company has applied for this exemptive relief [and the Commission has published notice of its intent to grant the relief](1); however, at this time the relief has not yet been granted and may not be granted on the terms expected. If the Company is not successful in obtaining such exemptive relief before the Advisers are required to register as investment advisers, or at all, then the Company may be in violation of the
1940 Act or the  (1)

          NTD: To be confirmed before filing.
 47    TABLE OF CONTENTS Advisers may be in violation of the Advisers Act until the Company is able to obtain the necessary exemptive relief or otherwise resolve the matter. The Company cannot guarantee that it will be able to obtain the necessary exemptive relief in the timeframe required, or at all. If the Company does receive such exemptive relief from the SEC, it may be subject to conditions that will limit the Companys or the Advisers ability to operate, structure or expand their businesses in the future. In addition, as registered investment advisers, the Advisers may be subject to increased regulatory risks, additional costs and expenses associated with operating as registered investment advisers. Our businesses may be adversely affected by litigation and regulatory proceedings, including those that are currently pending. From time to time, we may be subject to legal actions as well as various regulatory, governmental and law enforcement inquiries, investigations and subpoenas. In any such claims or actions, demands for substantial monetary damages may be asserted against us and may result in financial liability or an adverse effect on our reputation among investors. We may be unable to accurately estimate our exposure to litigation risk when we record balance sheet reserves for probable loss contingencies. As a result, any reserves we establish to cover any settlements or judgments may not be sufficient to cover our actual financial exposure, which may have a
material impact on our results of operations or financial condition. In regulatory enforcement matters, claims for disgorgement, the imposition of penalties and the imposition of other remedial sanctions are possible. We are currently parties in ongoing litigation and regulatory proceedings. As described in greater detail in Item 3. Legal Proceedings below, pending proceedings involving us and/or our directors and officers include three purported class action lawsuits filed by our stockholders and an SEC investigation, and a derivative action filed by a shareholder, which has been dismissed and in which the stockholder has appealed, all of which relate to the valuation methodology and procedures used by us to value our investments and the restatement to our financial statements for the year ended December 31, 2008 (and the quarterly periods included in
such year) and the quarterly periods ended March 31, 2009 and June 30, 2009. While we believe that we have meritorious defenses in these proceedings and that the outcomes should not materially impact us, we anticipate continued elevated legal and related costs as the ultimate outcomes of the matters are uncertain. In view of the inherent difficulty of predicting the outcome of legal actions and regulatory matters, we cannot provide assurance as to the outcome of any pending matter or, if resolved adversely, the costs associated with any such matter, particularly where the claimant seeks very large or indeterminate damages or where the matter presents novel legal theories, involves a large number of parties or is at a preliminary stage. The resolution of any such matters may be time consuming, expensive, and may distract management from the conduct of our business. The resolution of certain pending legal actions or regulatory matters, if unfavorable, could have
a material adverse effect on our results of operations for the quarter in which such actions or matters are resolved or a reserve is established. The initial term of the agreement governing our strategic relationship with Kohlberg & Co. expired on October 31, 2011 and such agreement may be terminated. Our strategic relationship with Kohlberg & Co. is governed by the License and Referral Agreement between us and Kohlberg & Co. We believe that we derive substantial benefits from this relationship, including our use of the Kohlberg name. The initial term of the agreement expired on October 31, 2011, and, as a result, Kohlberg & Co. may terminate the agreement at any time in its sole discretion. As a result, there is no guarantee that the agreement will not be terminated and that we will continue to benefit from its provisions. If the agreement is terminated, we will not, among other things, be able to use the
Kohlberg name, which may negatively adversely impact our brand and our business.
 48    TABLE OF CONTENTS Risks Related to Our Investments Our investments may be risky, and you could lose all or part of your investment. We invest primarily in senior secured term loans, mezzanine debt and selected equity investments issued by middle market companies. Secured Loans.  When we extend secured term loans, we generally take a security interest (either as a first lien position or as a second lien position) in the available assets of these portfolio companies, including the equity interests of their subsidiaries, which we expect to assist in mitigating the risk that we will not be repaid. However, there is a risk that the collateral securing our loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market conditions, including as a result of the inability of
the portfolio company to raise additional capital, and, in some circumstances, our lien could be subordinated to claims of other creditors. In addition, deterioration in a portfolio companys financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Consequently, the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to the loans terms, or at all, or that we will be able to collect on the loan should we be forced to exercise our remedies. Mezzanine Debt.  Our mezzanine debt investments generally are subordinated to senior loans and generally are unsecured. This may result in an above average amount of risk and volatility or loss of principal. These investments may entail additional risks that could adversely affect our investment returns. To the extent interest payments associated with such debt are deferred, such debt is subject to greater fluctuations in value based on changes in interest rates and such debt could subject us to phantom income. Since we generally do not receive any cash prior to maturity of the debt, the investment is of greater risk. Equity Investments.  We have made and expect to make selected equity investments. In addition, when we invest in senior secured loans or mezzanine debt, we may acquire warrants in the equity of the portfolio company. Our goal is ultimately to dispose of such equity interests and realize gains upon our disposition of such interests. However, the equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses
we experience. Risks Associated with Middle Market Companies.  Investments in middle market companies also involve a number of significant risks, including: 

          limited financial resources and inability to meet their obligations, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing the value of any guarantees we may have obtained in connection with our investment; 

          shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors actions and market conditions, as well as general economic downturns; 

          dependence on management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us; 

          less predictable operating results, being parties to litigation from time to time, engaging in rapidly changing businesses with products subject to a substantial risk of obsolescence and requiring substantial additional capital expenditures to support their operations, finance expansion or maintain their competitive position; 

          difficulty accessing the capital markets to meet future capital needs; and 

          generally less publicly available information about their businesses, operations and financial condition.
 49    TABLE OF CONTENTS Our portfolio investments for which there is no readily available market, including our investment in Katonah Debt Advisors and our investments in CLO Funds, are recorded at fair value as determined in good faith by our Board of Directors. As a result, there is uncertainty as to the value of these investments. Our investments consist primarily of securities issued by privately-held companies, the fair value of which is not readily determinable. In addition, we are not permitted to maintain a general reserve for anticipated loan losses. Instead, we are required by the 1940 Act to specifically value each investment and record an unrealized gain or loss for any asset that we believe has increased or decreased in value. We value these securities at fair value as determined in good faith by our Board of Directors pursuant to a valuation methodology approved by our Board of Directors. These valuations are initially prepared by our management and reviewed by our
Valuation Committee, which uses its best judgment in arriving at the fair value of these securities. However, the Board of Directors retains ultimate authority to determine the appropriate valuation for each investment. From time to time, our Board of Directors has used the services of an independent valuation firm to aid it in determining fair value, including in the case of our investments in CLO Funds and in Katonah Debt Advisors. Where applicable, an independent valuation firm provides third-party valuation consulting services, which typically consist of certain limited procedures that we identify and request an independent valuation firm to perform. The types of factors that may be considered in valuing our investments include the nature and realizable value of any collateral, the portfolio companys ability to make payments and its earnings, the markets in which the portfolio company does business, comparison to publicly-traded companies, discounted cash flow and other
relevant factors. Our investment in Katonah Debt Advisors is carried at fair value, which is determined after taking into consideration a percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain and may be based on estimates, our determinations of fair value may differ materially from the values that would be assessed if a ready market for these securities existed. Our NAV could be adversely affected if our determinations regarding the fair value of our illiquid investments were materially higher than the values that we ultimately realize upon the disposal of such
securities. We are subject to additional risks in light of the restatement of our prior period financial statements. We have previously restated our financial statements for the year ended December 31, 2008 (and the quarterly periods included in such year) as well as the quarterly periods ended March 31, 2009 and June 30, 2009. The restatement of our financial statements was due to errors in the application of accounting for the fair value of our illiquid investments and the revenue recognition for certain non-cash PIK investments, which errors impact the amount of unrealized gains (losses) reported for our illiquid investments, which affects the calculation of our net asset value and net income, and also impact net investment income as well as the cost basis and
the net change in unrealized appreciation on certain non-cash PIK investments. The error related to fair value measurements was identified through the use and weighting of additional valuation techniques and a broader consideration of secondary market inputs, and with regard to our financial statements for the periods noted above, resulted from the material weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements would not be prevented or detected on a timely basis. This restatement has exposed us to certain legal and regulatory actions described in Business  Legal Proceedings below and could expose us to additional legal or regulatory actions. In addition, the defense of any such actions could cause the
diversion of managements attention and resources, and we could be required to pay damages to settle such actions if any such actions are not resolved in our favor. Even if resolved in our favor, such actions could cause us to incur significant legal and other expenses. We believe that we addressed the material weaknesses through the adoption of the revised valuation procedures and the implementation of a review process in 2010. We may be the subject of negative publicity focusing on the restatement and negative reactions from shareholders and others with whom we do business.
 50    TABLE OF CONTENTS We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we may invest a significant portion of our assets in a relatively small number of issuers, which subjects us to a risk of significant loss if any of these issuers defaults on its obligations under any of its debt instruments or as a result of a downturn in the particular industry. We are classified as a non-diversified investment company within the meaning of the 1940 Act, and therefore we may invest a significant portion of our assets in a relatively small number of issuers in a limited number of industries. As of December 31, 2011, our largest investment, our 100% equity interest in Katonah Debt Advisors, equaled approximately 17% of the fair value of our investments. Beyond the asset diversification requirements associated with our qualification as a RIC (as described further in Item 1. Business  Certain United States Federal Income Tax Considerations), we do not have fixed guidelines for
diversification, and while we are not targeting any specific industries, relatively few industries may become significantly represented among our investments. In accordance with our current policy, we do not concentrate our investments, that is, invest 25% or more of our assets in any particular industry (determined at the time of investment). However, to the extent that we assume large positions in the securities of a small number of issuers, our NAV may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the markets assessment of the issuer or a downturn in any particular industry. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company. Economic recessions or downturns could negatively impact our portfolio companies and harm our operating results. Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay our loans during these periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions may also decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital
markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing investments and harm our operating results. Defaults by our portfolio companies could harm our operating results. A portfolio companys failure to satisfy financial or operating covenants imposed by us or other debt holders could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its secured assets. Such events could trigger cross-defaults under other agreements and jeopardize a portfolio companys ability to meet its obligations under the debt that we hold and the value of any equity securities we own. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. When we are a debt or minority equity investor in a portfolio company, which generally is the case, we may not be in a position to control the entity, and its management may make decisions that could decrease the value of our investment. Most of our investments are either debt or minority equity investments in our portfolio companies. Therefore, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and the stockholders and management of such company may take risks or otherwise act in ways that do not serve our interests. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings. In addition, we generally are not in a position to control any portfolio company by investing in its debt securities. Prepayments of our debt investments by our portfolio companies could negatively impact our operating results. We are subject to the risk that the investments we make in our portfolio companies may be repaid prior to maturity. When this occurs, we generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments typically have substantially lower
 51    TABLE OF CONTENTS yields than the debt being prepaid and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. Consequently, our results of operations could be materially adversely affected if one or more of our portfolio companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock. Our portfolio companies may incur debt that ranks equal with, or senior to, our investments in such companies. We invest primarily in debt securities issued by our portfolio companies. In some cases portfolio companies are permitted to have other debt that ranks equal with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders thereof are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that
portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equal with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company. There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims. Even though we may have structured certain of our investments as senior loans, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the size of our investment and the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. In addition, lenders can be subject to lender liability claims for actions taken by them where they become too involved in the borrowers business or exercise control over the borrower. It is possible that we
could become subject to a lenders liability claim, including as a result of actions taken in rendering significant managerial assistance. Our investments in equity securities involve a substantial degree of risk. We may purchase common stock and other equity securities, including warrants. Although equity securities have historically generated higher average total returns than fixed-income securities over the long term, equity securities have also experienced significantly more volatility in those returns. The equity securities we acquire may fail to appreciate and may decline in value or become worthless, and our ability to recover our investment depends on our portfolio companys success. Investments in equity securities involve a number of significant risks, including the risk of further dilution as a result of additional issuances, inability to
access additional capital and failure to pay current distributions. Investments in preferred securities involve special risks, such as the risk of deferred distributions, credit risk, illiquidity and limited voting rights. The lack of liquidity in our investments may adversely affect our business. We invest in securities issued by private companies. These securities may be subject to legal and other restrictions on resale or otherwise be less liquid than publicly-traded securities. The illiquidity of these investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. Our investments are usually subject to contractual or legal restrictions on resale or are otherwise illiquid because there is usually no established trading market for such
investments. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.
 52    TABLE OF CONTENTS We may not receive all or a portion of the income we expect to continue to receive from Katonah Debt Advisors. We expect to receive distributions of recurring fee income, after the payment of its expenses, from the asset management activities of Katonah Debt Advisors. However, the existing asset management agreements pursuant to which Katonah Debt Advisors receives such fee income from the CLO Funds for which it serves as manager may be terminated for cause by the holders of a majority of the most senior class of securities issued by such CLO Funds and the holders of a majority of the subordinated securities issued by such CLO Funds. Cause is defined in the asset management agreements to include a material breach by Katonah Debt
Advisors of the indenture governing the applicable CLO Fund, breaches by Katonah Debt Advisors of certain specified provisions of the indenture, material breaches of representations or warranties made by Katonah Debt Advisors, bankruptcy or insolvency of Katonah Debt Advisors, fraud or criminal activity on the part of Katonah Debt Advisors or an event of default under the indenture governing the CLO Funds. We expect that future asset management agreements will contain comparable provisions. Further, a significant portion of the asset management fees payable to Katonah Debt Advisors under the asset management agreements are subordinated to the prior payments of interest on the senior securities issued by the CLO Funds. If the asset management agreements are terminated or the CLO Funds do not generate enough income or otherwise have insufficient residual cash flow due to diversion of cash as a result of the failure by the CLO Funds to satisfy certain restrictive covenants contained in
their indenture agreements to pay the subordinated management fees, we will not receive the fee income that we expect to continue to receive from Katonah Debt Advisors, which will reduce income available to make distributions to our stockholders. At December 31, 2011, Katonah Debt Advisors was receiving all (senior and subordinate) management fees payable by the CLO Funds managed by it. The fair value of Katonah Debt Advisors may be negatively affected by the costs associated with preparing any separate financial statements of Katonah Debt Advisors that are required by Rule 3-09 of Regulation S-X or any separate summarized financial information of KDA that is required by Rules 10-01, 4-08(g) and 1-02(bb) of Regulation S-X, which could adversely affect our business and financial condition, including the financial condition of Katonah Debt Advisors and our net asset value, as well as the trading price of our common stock. Because the fair value of Katonah Debt Advisors is based on the cash flows of Katonah Debt Advisors available for distribution to the Company, the costs associated with the evaluation of the requirements of Rule 3-09 of Regulation S-X in respect of separate financial statements of Katonah Debt Advisors, the preparation of any required separate financial statements or separate summarized financial information of Katonah Debt Advisors in accordance with Rules 3-09, 10-01, 4-08(g) and 1-02(bb) of Regulation S-X, and any additional audit or review work required to be performed by our independent registered public accountants in respect of any such
separate financial statements or separate summarized financial information may reduce the fair value of Katonah Debt Advisors as reflected on the Companys financial statements, which could result in a reduction to our net asset value. Any such reduction in the fair value of Katonah Debt Advisors could adversely affect our business and financial condition and could result in a decline in the trading price of our common stock. We may not receive any return on our investment in the CLO Funds in which we have invested and we may be unable to raise additional CLO Funds. As of December 31, 2011, we had $41 million invested in the subordinated securities or preferred shares issued by CLO Funds managed by Katonah Debt Advisors and certain other third party asset managers. Subject to market conditions, we expect to continue to acquire subordinated securities in the future in CLO Funds managed by Katonah Debt Advisors and/or third party managers. These subordinated securities are the most junior class of securities issued by the CLO Funds and are subordinated in priority of payment to every other class of securities issued by these CLO Funds. Therefore, they only receive cash distributions if the CLO Funds have made all
cash interest payments to all other debt securities issued by the CLO Fund. The subordinated securities are also unsecured and rank behind all of the secured creditors, known or unknown, of the CLO Fund, including the holders of the senior securities issued by the CLO Fund. Consequently, to the extent that the value of a CLO Funds loan investments has been reduced as a result of conditions in the
 53    TABLE OF CONTENTS credit markets, or as a result of default loans or individual fund assets, the value of the subordinated securities at their redemption could be reduced. Additionally, we may not be able to continue to complete new CLO Funds due to prevailing CLO market conditions or other factors. Risks Related to Our Operation as a BDC A failure on our part to maintain our status as a business development company would significantly reduce our operating flexibility. If we do not continue to qualify as a business development company, we might be regulated as a registered closed-end investment company under the 1940 Act; our failure to qualify as a BDC would make us subject to additional regulatory requirements, which may significantly decrease our operating flexibility by limiting our ability to employ leverage and issue common stock. Our ability to enter into transactions with our affiliates is restricted. We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of our independent directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act, and we generally are prohibited from buying or selling any security from or to such affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits certain joint transactions with certain of our affiliates, which could include investments in the same portfolio company (whether
at the same or different times), without prior approval of our independent directors and, in some cases, the SEC. If a person acquires more than 25% of our voting securities, we are prohibited from buying or selling any security from or to such person or certain of that persons affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security from or to any portfolio company of our affiliates without the prior approval of the SEC. However, we may co-invest on a concurrent basis with any of our affiliates, subject to compliance with existing regulatory guidance, applicable regulations and our allocation procedures. Certain types of negotiated co-investments may be made only if we receive an order from the SEC permitting us to do
so. There can be no assurance that any such order will be applied for or, if applied for, obtained. Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital. Our business requires a substantial amount of additional capital. We may acquire additional capital from the issuance of senior securities or other indebtedness, the issuance of additional shares of our common stock or from securitization transactions. However, we may not be able to raise additional capital in the future on favorable terms or at all. We may issue debt securities or preferred securities, which we refer to collectively as senior securities, and we may borrow money from banks or other financial institutions, up to the maximum amount permitted by the 1940 Act. The 1940 Act permits us to issue senior securities or incur
indebtedness only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% immediately after such issuance or incurrence. With respect to certain types of senior securities, we must make provisions to prohibit any dividend distribution to our stockholders or the repurchase of certain of our securities, unless we meet the applicable asset coverage ratios at the time of the dividend distribution or repurchase. If the value of our assets declines, we may be unable to satisfy the asset coverage test. If that happens, we may be required to liquidate a portion of our investments and repay a portion of our indebtedness at a time when such sales may be disadvantageous. 

          Senior Securities.  As a result of issuing senior securities, we would also be exposed to typical risks associated with leverage, including an increased risk of loss. If we issue preferred securities they would rank senior to common stock in our capital structure. Preferred stockholders would have separate voting rights and may have rights, preferences or privileges more favorable than those of our common stock. Furthermore, the issuance of preferred securities could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for our common stockholders or otherwise be in your best interest.
 54    TABLE OF CONTENTS 

          Additional Common Stock.  Our Board of Directors may decide to issue common stock to finance our operations rather than issuing debt or other senior securities. As a BDC, we are generally not able to issue our common stock at a price below NAV without first obtaining required approvals from our stockholders and our independent directors. In any such case, the price at which our securities are to be issued and sold may not be less than a price, that in the determination of our Board of Directors, closely approximates the market value of such securities (less any commission or discount). We may also make rights offerings to our stockholders at prices per share less than the NAV per share, subject to the 1940 Act. If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our stockholders at that time would decrease, and you
may experience dilution. 

          Securitization.  In addition to issuing securities to raise capital as described above, we may securitize a portion of the loans we may obtain to generate cash for funding new investments. If we are unable to successfully securitize our loan portfolio our ability to grow our business and fully execute our business strategy and our earnings (if any) may be adversely affected. Moreover, even successful securitization of our loan portfolio might expose us to losses, as the residual loans in which we do not sell interests tend to be those that are riskier and more apt to generate losses. Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws or regulations, could negatively affect the profitability of our operations. Changes in the laws or regulations or the interpretations of the laws and regulations that govern BDCs, RICs or non-depository commercial lenders, could significantly affect our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and are subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured transactions, collection and foreclosure procedures and other trade practices. If these laws, regulations or decisions change, or if we expand our
business into jurisdictions that have adopted more stringent requirements than those in which we currently conduct business, we may have to incur significant expenses in order to comply or we might have to restrict our operations. In addition, if we do not comply with applicable laws, regulations and decisions, we may lose licenses needed for the conduct of our business and be subject to civil fines and criminal penalties, any of which could have a material adverse effect upon our business, results of operations or financial condition. If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to qualify as a BDC or be precluded from investing according to our current business strategy. As a BDC, we may not acquire any assets other than qualifying assets for purposes of the 1940 Act unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. See Item 1. Business  Regulation. We believe that most of the senior loans and mezzanine investments that we acquire constitute qualifying assets. However, investments in the equity securities of CLO Funds generally do not constitute qualifying assets, and we may invest in other assets that are not qualifying assets. If we do not invest a sufficient portion of our assets in qualifying assets, we may be precluded from investing in what we believe are attractive investments or could lose our status as a BDC, which would have a material adverse effect on our business, financial condition and results of operations. These restrictions could
also prevent us from making investments in the equity securities of CLO Funds, which could limit Katonah Debt Advisors ability to organize new CLO Funds. Similarly, these rules could prevent us from making follow-on investments in existing portfolio companies (which could result in the dilution of our position) or could require us to dispose of investments at inappropriate times in order to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it would be difficult to dispose of such investments on favorable terms. For example, we may have difficulty in finding a buyer and, even if we do find a buyer, we may have to sell the investments at a substantial loss.
 55    TABLE OF CONTENTS If we are unable to qualify as a RIC under Subchapter M of the Code, we will generally be subject to corporate-level U.S. federal income tax, which will adversely affect our results of operations and financial condition. Provided we qualify as a RIC, we will generally not be subject to corporate-level U.S. federal income taxes on income distributed to our stockholders as dividends in accordance with the timing requirements of the Code. We generally will not continue to qualify for pass-through tax treatment as a RIC, and thus will be subject to corporate-level U.S. federal income taxes, if we are unable to comply with the source-of-income, asset diversification and distribution requirements contained in the Code, or if we fail to maintain our election to be regulated as a BDC under the 1940 Act. Failure to meet the requirements for tax treatment as a RIC would
subject us to taxes, which would reduce the return on your investment. As such, our failure to qualify for tax treatment as a RIC would have a material adverse effect on us, the NAV of our common stock and the total return obtainable from your investment in our common stock. We may, from time to time, organize and conduct the business of our wholly-owned portfolio company, Katonah Debt Advisors, through additional direct or indirect wholly-owned subsidiaries which may, in some cases, be taxable as corporations. For additional information see Item 1. Business  Regulation and Item 1. Business  Certain United States Federal Income Tax Considerations. Item 1B. Unresolved Staff Comments None. Item 2. Properties We do not own any real estate or other real property. Our wholly-owned portfolio company, Katonah Debt Advisors, is the lessee for our principal headquarters at 295 Madison Avenue, 6th Floor, New York, New York 10017. We have entered into an Overhead Allocation Agreement with Katonah Debt Advisors which provides for the sharing of the expenses under the lease agreement. Item 3. Legal Proceedings Class Actions against the Company and Certain Directors and Officers The Company and certain directors and officers were named as defendants in three putative class actions pending in the Southern District of New York brought by stockholders of the Company and filed in December 2009 and January 2010. The complaints in these three actions alleged violations of Sections 10 and 20 of the Exchange Act based on the Companys disclosures of its year-end 2008 and first- and second-quarter 2009 financial statements. The federal court consolidated the three lawsuits and appointed a lead plaintiff under the Private Securities Litigation Reform Act on March 21, 2011, and lead plaintiff filed a consolidated amended complaint
on May 11, 2011. The Company moved to dismiss the consolidated amended complaint. On July 28, 2011, the Court granted that motion and dismissed the consolidated amended complaint, giving the plaintiff until August 22, 2011 to file any further amended complaint. Lead plaintiff filed a second amended consolidated class action complaint on August 22, 2011, which defendants moved to dismiss. The Court dismissed that complaint with prejudice on October 7, 2011. The time for that Lead plaintiff to appeal the dismissal has now passed. SEC Investigation On January 11, 2010, the staff of the SECs Division of Enforcement informed the Company that it was conducting an informal inquiry. The focus of the inquiry concerns the valuation methodology and procedures used by the Company to value its investments. On April 30, 2010, the SEC Staff advised the Company that a formal order of private investigation had been issued and that the informal inquiry was now a formal investigation. A subpoena has been issued to the Company in connection with the formal investigation. The subpoena requests that the Company produce documents that primarily relate to the valuation methodology and procedures used by the
Company to value its investments. Since January 2010, the Company has been providing documents in response to the informal inquiry and the subpoena, and the SEC Staff has taken testimony from Company representatives. The Company is cooperating fully with the SEC Staffs investigation. The Company cannot predict the outcome of, or the time frame for, the conclusion of this investigation.
 56    TABLE OF CONTENTS Except as set forth above, neither the Company, nor any of its subsidiaries, is currently a party to any material legal proceedings, other than routine litigation and administrative proceedings arising in the ordinary course of business. Such proceedings are not expected to have a material adverse effect on the business, financial condition, or results of the Companys operations. Item 4. Mine Safety Disclosures Not applicable.
 57    TABLE OF CONTENTS PART II Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities PRICE RANGE OF COMMON STOCK Our common stock is quoted on The NASDAQ Global Select Market under the symbol KCAP. We completed our initial public offering on December 11, 2006 at an initial public offering price of $15.00 per share. Prior to such date there was no public market for our common stock. The following table sets forth the range of high and low closing sales prices per share of our common stock as reported on The NASDAQ Global Select Market in respect of the periods indicated. The stock quotations are interdealer quotations and do not include markups, markdowns or commissions and may not necessarily represent actual transactions. Quarterly Stock Prices for 2011 and 2010  High

          

          Low

          

          Close

          

          NAV(1)2011:Fourth quarter

          

          $

          6.85

          

          

          $

          5.65

          

          

          $

          6.31

          

          

          $

          7.85Third quarter

          

          $

          8.26

          

          

          $

          5.33

          

          

          $

          5.85

          

          

          $

          8.29Second quarter

          

          $

          8.16

          

          

          $

          7.12

          

          

          $

          7.95

          

          

          $

          8.52First quarter

          

          $

          8.58

          

          

          $

          6.70

          

          

          $

          8.26

          

          

          $

          8.642010:Fourth quarter

          

          $

          7.10

          

          

          $

          6.34

          

          

          $

          6.97

          

          

          $

          8.21Third quarter

          

          $

          6.69

          

          

          $

          4.55

          

          

          $

          6.69

          

          

          $

          8.84Second quarter

          

          $

          5.88

          

          

          $

          4.43

          

          

          $

          5.01

          

          

          $

          9.20First quarter

          

          $

          5.71

          

          

          $

          3.79

          

          

          $

          5.66

          

          

          $

          9.62
  (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 closing sales prices. We began paying quarterly dividends in our first full quarter of operations following our IPO. See Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 7   Distributable Tax Income from our Notes to the Financial Statements included herein. The table below provides information relating to dividends we paid in respect of the periods indicated. Dividend Declarations  Dividend

          

          Declaration Date

          

          Record Date

          

          Pay Date2011:Fourth quarter

          

          $

          0.18

          

          

          

          12/12/2011

          

          

          

          12/23/2011

          

          

          

          1/27/2012Third quarter

          

          

          0.18

          

          

          

          9/15/2011

          

          

          

          10/10/2011

          

          

          

          10/28/2011Second quarter

          

          

          0.17

          

          

          

          6/13/2011

          

          

          

          7/8/2011

          

          

          

          7/29/2011First quarter

          

          

          0.17

          

          

          

          3/21/2011

          

          

          

          4/8/2011

          

          

          

          4/29/2011Total declared for 2011

          

          $

          0.702010:Fourth quarter

          

          $

          0.17

          

          

          

          12/13/2010

          

          

          

          12/24/2010

          

          

          

          1/29/2011Third quarter

          

          

          0.17

          

          

          

          9/20/2010

          

          

          

          10/8/2010

          

          

          

          10/29/2010Second quarter

          

          

          0.17

          

          

          

          6/23/2010

          

          

          

          7/7/2010

          

          

          

          7/29/2010First quarter

          

          

          0.17

          

          

          

          3/19/2010

          

          

          

          4/7/2010

          

          

          

          4/29/2010Total declared for 2010

          

          $

          0.68
 58    TABLE OF CONTENTS Performance Graph The following graph compares the return on our common stock with that of the Russell 2000 Index and the Nasdaq Financial 100 Index (IXF), for the period December 11, 2006 (the date of our initial public offering) to December 31, 2011. The graph assumes that, on December 11, 2006, a person invested $100 in each of our common stock and the Russell 2000 Index. The graph measures total shareholder return, which takes into account both changes in stock price and dividends. It assumes that dividends are reinvested. Shareholder Return Performance Graph Cumulative Total Return Since Initial Public Offering(1) (Through December 31, 2011) [GRAPHIC MISSING]  (1)

          Total return includes reinvestment of dividends through December 31, 2011. The IXF is an index of diversified financial sector stocks and, as such, the Company believes that it is representative of our industry. The Russell 2000 is a broad based equity market index that tracks companies with a market capitalization that the Company believes are comparable to Kohlberg Capital. HOLDERS As of December 31, 2011, there were 20 shareholders of record of our common stock and approximately 9,644 beneficial shareholders of the Company. SALES OF UNREGISTERED SECURITIES We did not sell any securities during the period covered by this report that were not registered under the Securities Act. However, we issued 141,278 shares of common stock pursuant to a dividend reinvestment plan. See Note 9, Stockholders Equity, of our Notes to the Consolidated Financial Statements included herein. ISSUER PURCHASES OF EQUITY SECURITIES In November 2008, the Board of Directors approved a $5 million share repurchase plan. Any share repurchases are subject to timing restrictions and other applicable regulations. We did not repurchase any shares of our common stock during the year ended December 31, 2011.
 59    TABLE OF CONTENTS DIVIDEND POLICY We intend to continue to distribute quarterly dividends to our stockholders. Our quarterly dividends, if any, will be determined by our Board of Directors. To maintain our RIC status, we must timely distribute an amount equal to at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses, out of the assets legally available for distribution, for each year. To avoid certain excise taxes imposed on RICs, we are generally required to distribute during each calendar year an amount at least equal to the sum of (1) 98% of our ordinary income for the
calendar year, (2) 98.2% of our capital gains in excess of capital losses for the one-year period ending on October 31 of the calendar year and (3) any ordinary income and net capital gains for preceding years that were not distributed during such years. If this requirement is not met, we will be required to pay a nondeductible excise tax equal to 4% of the amount by which the required distribution amount exceeds the actual distribution for the year. The taxable income on which an excise tax is paid is generally carried forward and distributed to stockholders in the next tax year. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required. We cannot assure you that we will achieve results that will permit the payment of any cash distributions and, if we incur public indebtedness or issue public senior securities, we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. We maintain an opt out dividend reinvestment plan for our common stockholders. As a result, if we declare a dividend, then stockholders cash dividends will be automatically reinvested in additional shares of our common stock, unless they specifically opt out of the dividend reinvestment plan so as to receive cash dividends.
 60    TABLE OF CONTENTS EQUITY COMPENSATION PLAN INFORMATION The following table summarizes certain information regarding the Amended and Restated 2006 Equity Incentive Plan and the Amended and Restated Non-Employee Director Plan as of December 31, 2011:  Plan Category

          

          Number of Securities to Be Issued Upon Exercise of Outstanding Options, Warrants and Rights

          

          Weighted Average Exercise Price of Outstanding Options, Warrants and Rights

          

          Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))(a)

          

          (b)

          

          (c)Equity Compensation Plans Approved by Security Holders(1)

          

          

          60,000

          

          

          $

          7.24

          

          

          

          1,426,539

          (2)(3)Equity Compensation Plans Not Approved by Security Holders

          

          

          

          

          

          

          

          

          

          

          Total

          

          

          60,000

          

          

          

          7.24

          

          

          

          1,426,539
  (1)

          The Companys Amended and Restated 2006 Equity Incentive Plan and Amended and Restated Non-Employee Director Plan. (2)

          Subject to the following additional limitations: The aggregate number of shares of restricted stock that may be issued under the Amended and Restated 2006 Equity Incentive Plan may not exceed 10% of the outstanding shares on June 13, 2008, the effective date of the Amended and Restated 2006 Equity Incentive Plan, plus 10% of the number of shares issued or delivered by the Company (other than pursuant to compensation plans) during the term of the Amended and Restated 2006 Equity Incentive Plan. No one person may be granted more than 25% of the shares of restricted stock reserved for issuance under the Amended and Restated 2006 Equity Incentive Plan. In addition, the amount of voting securities that would result from the exercise of all of the Companys outstanding warrants, options and rights, together with any restricted stock issued by the Company, at the time of issuance may not exceed 25% of the outstanding voting securities of the
Company, except that if the amount of voting securities that would result from the exercise of all the Companys outstanding warrants, options and rights issued to the Companys directors, officers and employees, together with any restricted stock issued by the Company, would exceed 15% of the outstanding voting securities of the Company, the total amount of voting securities that would result from the exercise of all outstanding warrants, options and rights, together with any restricted stock issued by the Company, at the time of issuance may not exceed 20% of the outstanding voting securities of the Company. (3)

          The 1,390,539 shares issuable under the Companys Amended and Restated 2006 Equity Incentive Plan may be issued in the form of options, restricted stock or other stock-based awards. The 36,000 shares issuable under the Companys Amended and Restated Non-Employee Director Plan may currently be issued in the form of options. As further described below, the Company is seeking approval of an amendment to the Amended and Restated Non-Employee Director Plan at the Meeting to, among other things, permit the Company to grant shares of restricted stock to Non-Employee Directors.
 61    TABLE OF CONTENTS Item 6. Selected Financial Data The following selected financial and other data for the years ended December 31, 2011, 2010, 2009, 2008, and 2007 is derived from our financial statements. The data should be read in conjunction with our financial statements and notes thereto and Managements Discussion and Analysis of Financial Condition and Results of Operations, which are included in this Annual Report. KOHLBERG CAPITAL CORPORATION SELECTED FINANCIAL DATA  Year Ended December 31, 2011

          

          Year Ended December 31, 2010

          

          Year Ended December 31, 2009

          

          Year Ended December 31, 2008

          

          Year Ended December 31, 2007(1)Income Statement Data:Interest and related portfolio income:Interest and Dividends

          

          $

          24,010,467

          

          

          $

          24,638,631

          

          

          $

          33,497,213

          

          

          $

          46,208,978

          

          

          $

          37,219,713Fees and other income

          

          

          86,057

          

          

          

          215,233

          

          

          

          399,338

          

          

          

          1,653,232

          

          

          

          759,301Dividends from affiliate asset manager

          

          

          1,910,000

          

          

          

          4,500,000

          

          

          

          

          

          

          

          1,350,000

          

          

          

          500,000Other Income

          

          

          2,000,000

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          Total interest and related portfolio income

          

          

          28,006,524

          

          

          

          29,353,864

          

          

          

          33,896,551

          

          

          

          49,212,210

          

          

          

          38,479,014Expenses:Interest and amortization of debt issuance costs

          

          

          4,588,482

          

          

          

          7,088,202

          

          

          

          9,276,563

          

          

          

          10,925,624

          

          

          

          7,229,597Compensation

          

          

          3,907,900

          

          

          

          3,322,895

          

          

          

          3,222,604

          

          

          

          3,940,638

          

          

          

          4,104,761Other

          

          

          3,490,939

          

          

          

          7,045,648

          

          

          

          3,066,729

          

          

          

          3,640,031

          

          

          

          4,385,707Total operating expenses

          

          

          11,987,321

          

          

          

          17,456,745

          

          

          

          15,565,896

          

          

          

          18,506,293

          

          

          

          15,720,065Net Investment Income

          

          

          16,019,203

          

          

          

          11,897,119

          

          

          

          18,330,655

          

          

          

          30,705,917

          

          

          

          22,758,949Realized and unrealized gains (losses) on investments:Net realized gains (losses)

          

          

          (18,476,608

          )

          

          

          (17,862,984

          )

          

          

          (15,782,121

          )

          

          

          (575,179

          )

          

          

          266,317Net change in unrealized gains (losses)

          

          

          10,106,949

          

          

          

          (8,322,812

          )

          

          

          31,854,736

          

          

          

          (93,414,146

          )

          

          

          3,116,719Total net gains (losses)

          

          

          (8,369,659

          )

          

          

          (26,185,796

          )

          

          

          16,072,615

          

          

          

          (93,989,325

          )

          

          

          3,383,036Net increase (decrease) in net assets resulting from operations

          

          $

          7,649,544

          

          

          $

          (14,288,677

          )

          

          $

          34,403,270

          

          

          $

          (63,283,408

          )

          

          $

          26,141,985Per Share:Earnings per common share  basic

          

          $

          0.33

          

          

          $

          (0.63

          )

          

          $

          1.56

          

          

          $

          (3.09

          )

          

          $

          1.45Earnings per common share  diluted

          

          $

          0.33

          

          

          $

          (0.63

          )

          

          $

          1.56

          

          

          $

          (3.09

          )

          

          $

          1.45Net investment income per share  basic

          

          $

          0.70

          

          

          $

          0.53

          

          

          $

          0.83

          

          

          $

          1.50

          

          

          $

          1.27Net investment income per share  diluted

          

          $

          0.70

          

          

          $

          0.53

          

          

          $

          0.83

          

          

          $

          1.50

          

          

          $

          1.27Dividends declared per common share

          

          $

          0.70

          

          

          $

          0.68

          

          

          $

          0.92

          

          

          $

          1.44

          

          

          $

          1.40Balance Sheet Data:Investment assets at fair value

          

          $

          239,791,687

          

          

          $

          191,186,296

          

          

          $

          409,105,621

          

          

          $

          460,509,190

          

          

          $

          521,006,947Total assets

          

          $

          248,133,661

          

          

          $

          279,822,686

          

          

          $

          439,416,057

          

          

          $

          469,156,229

          

          

          $

          533,141,959Total debt outstanding

          

          $

          60,000,000

          

          

          $

          86,746,582

          

          

          $

          218,050,363

          

          

          $

          261,691,148

          

          

          $

          255,000,000Stockholders' equity

          

          $

          180,525,942

          

          

          $

          186,925,667

          

          

          $

          213,895,724

          

          

          $

          196,566,018

          

          

          $

          259,068,164Net asset value per common share

          

          $

          7.85

          

          

          $

          8.21

          

          

          $

          9.56

          

          

          $

          9.03

          

          

          $

          14.38Common shares outstanding at end of year

          

          

          22,992,211

          

          

          

          22,767,130

          

          

          

          22,363,281

          

          

          

          21,771,186

          

          

          

          18,017,699Other Data:Investments funded(2)

          

          

          85,541,809

          

          

          

          11,245,300

          

          

          

          23,482,349

          

          

          

          109,442,643

          

          

          

          373,852,286Principal collections related to investment repayments or sales(2)

          

          

          81,681,314

          

          

          

          223,103,170

          

          

          

          84,503,183

          

          

          

          72,345,600

          

          

          

          104,037,559Number of portfolio investments at year end(2)

          

          

          68

          

          

          

          58

          

          

          

          124

          

          

          

          149

          

          

          

          145Weighted average yield of income producing debt investments(3)

          

          

          8.4

          %

          

          

          8.6

          %

          

          

          6.5

          %

          

          

          7.0

          %

          

          

          9.5

          %
  (1)

          Certain prior year amounts have been reclassified to conform to current year presentation. (2)

          Does not include investments in time deposits or money markets. (3)

          Weighted average yield of income producing debt investments is calculated as the average yield to par outstanding balances for investments in loans and mezzanine debt. The yields on CLO equities and investment in our wholly-owned portfolio manager, Katonah Debt Advisors, are excluded.
 62    TABLE OF CONTENTS Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this Annual Report. In addition to historical information, the following discussion and other parts of this Annual Report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Item 1A. Risk Factors and Note about Forward-Looking Statements appearing elsewhere herein. OVERVIEW We are an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company (BDC) under the Investment Company Act of 1940, as amended (the 1940 Act). We originate, structure and invest in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies. We define the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization, which we refer to as EBITDA, of $10 million to $50 million and/or total debt of $25 million to $150 million. In
addition to our middle market investment business, our wholly-owned portfolio company, Katonah Debt Advisors and its affiliates (collectively, Katonah Debt Advisors), manage collateralized loan obligation funds (CLO Funds) that invest in broadly syndicated loans, high-yield bonds and other corporate credit instruments. We acquired Katonah Debt Advisors and certain related assets prior to our initial public offering from affiliates of Kohlberg & Co., L.L.C. (Kohlberg & Co.), a leading private equity firm focused on middle market investing. As of December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of assets under management. Our investment objective is to generate current income and capital appreciation from our investments. We also expect to receive distributions of recurring fee income and, when debt markets stabilize and recover, to generate capital appreciation from our investment in the asset management business of Katonah Debt Advisors. Our investment portfolio as well as the investment portfolios of the CLO Funds in which we have invested and the investment portfolios of the CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments and other securities issued by corporations and do not include any asset-backed securities secured by
commercial mortgages, residential mortgages or other consumer borrowings. As a regulated investment company (RIC), we intend to distribute to our stockholders substantially all of our net taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, we generally will not have to pay corporate-level taxes on any income that we distribute in a timely manner to our stockholders. Our common stock is traded on The NASDAQ Global Select Market under the symbol KCAP. The net asset value per share of our common stock at December 31, 2011 was $7.85. On December 31, 2011, the last reported sale price of a share of our common stock on The NASDAQ Global Select Market was $6.31. CRITICAL ACCOUNTING POLICIES The financial statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require managements most difficult, complex, or subjective judgments. Our critical accounting policies are those applicable to the basis of presentation, valuation of investments, and certain revenue recognition matters as discussed below. Basis of Presentation The accompanying financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States. The financial statements reflect all adjustments and reclassifications which, in the opinion of management, are necessary for the fair presentation of our results of operations and financial condition for the periods presented. Furthermore, the
 63    TABLE OF CONTENTS financial statements are based on the selection and application of critical accounting policies which may require management to make significant estimates and assumptions. Actual results could differ from those estimates. Critical accounting policies are those that are important to the presentation of our financial condition and results of operations that require managements most difficult, complex or subjective judgments. Accounting Standards Codification.  In June 2009, the Financial Accounting Standards Board (FASB) issued a pronouncement establishing the FASB Accounting Standards Codification (ASC) as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with GAAP. The ASC reorganized existing U.S. accounting and reporting standards issued by the FASB and other related private sector standard setters into a single source of authoritative accounting principles arranged by topic. The standard explicitly recognizes rules and interpretive
releases of the SEC under federal securities laws as authoritative GAAP for SEC registrants. The ASC supersedes all existing U.S. accounting standards; all other accounting literature not included in the ASC (other than Securities and Exchange Commission guidance for publicly-traded companies) is considered non-authoritative. The ASC was effective on a prospective basis for interim and annual reporting periods ending after September 15, 2009. The adoption of the ASC changed our references to U.S. GAAP accounting standards but did not impact our results of operations, financial position or liquidity. Valuation of Portfolio Investments The most significant estimate inherent in the preparation of our financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded. Value, as defined in Section 2(a)(41) of 1940 Act, is (1) the market price for those securities for which a market quotation is readily available and (2) for all other securities and assets, fair value as determined in good faith by our Board of Directors pursuant to procedures approved by our Board of Directors. Our valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio based on the nature of the security, the market for the security and other considerations including the financial performance and enterprise value of the portfolio company. Because of the inherent uncertainty of valuation, the Board
of Directors determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material. We are, for GAAP purposes, an investment company under the AICPA Audit and Accounting Guide for Investment Companies. As a result, we reflect our investments on our balance sheet at their estimated fair value with unrealized gains and losses resulting from changes in fair value reflected as a component of unrealized gains or losses on our statements of operations. Fair value is the amount that would be received to sell the investments in an orderly transaction between market participants at the measurement date (i.e., the exit price). Additionally, we do not consolidate majority or wholly-owned and controlled investments. Effective January 1, 2008 we adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (Fair Value Measurements and Disclosures), which among other things, requires enhanced disclosures about financial instruments carried at fair value. See Note 4 to the financial statements for the additional information about the level of market observability associated with investments carried at fair value. We have valued our investments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some investments little market activity may exist; managements determination of fair value is then based on the best information available in the circumstances, and may incorporate managements own assumptions and involves a significant degree of managements judgment. Our investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and the cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds which are approaching or past the end of their reinvestment period and therefore begin to sell assets and/or use principal repayments to pay-down CLO Fund debt, and for which there continue to be net cash distributions to the class of we securities own, or (ii) the net asset value of the CLO Fund for CLO Funds which are approaching or past the
end of their reinvestment period and therefore begin to sell assets and/or use principal repayments to pay-down CLO Fund debt, and for which there are negligible net cash distributions to the class of securities
 64    TABLE OF CONTENTS we own, or (iii) a discounted cash flow model for more recent CLO Funds that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested. We recognize unrealized appreciation or depreciation on our investments in CLO Fund securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each
investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Investment. We determine the fair value of our investments in CLO Fund securities on an individual security-by-security basis. Our investment in Katonah Debt Advisors is carried at fair value, which is determined after taking into consideration a percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. Katonah Debt Advisors is classified as a Level III investment (as described below). Any change in value from period to period is recognized as net change in unrealized
appreciation or depreciation. Fair values of other investments for which market prices are not observable are determined by reference to public market or private transactions or valuations for comparable companies or assets in the relevant asset class and or industry when such amounts are available. Generally these valuations are derived by multiplying a key performance metric of the investee company or asset (e.g., EBITDA) by the relevant valuation multiple observed for comparable companies or transactions, adjusted by management for differences between the investment and the referenced comparable. Such investments may also be valued at cost for a period of time after an
acquisition as the best indicator of fair value. If the fair value of such investments cannot be valued by reference to observable valuation measures for comparable companies, then the primary analytical method used to estimate the fair value is a discounted cash flow method and/or cap rate analysis. A sensitivity analysis is applied to the estimated future cash flows using various factors depending on the investment, including assumed growth rates (in cash flows), capitalization rates (for determining terminal values) and appropriate discount rates to determine a range of reasonable values or to compute projected return on investment. We derive fair value for our illiquid loan investments that do not have indicative fair values based upon active trades primarily by using the Market Yield Approach, and also consider recent loan amendments or other activity specific to the subject asset as described above. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments. Our Board of Directors may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with GAAP. The determination of fair value using this methodology takes into consideration a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance and financing transactions subsequent to the acquisition of the investment. This valuation methodology involves a significant degree of managements judgment. After our adoption of Fair Value Measurements and Disclosures, investments measured and reported at fair value are classified and disclosed in one of the following categories: 

          Level I  Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by Fair Value Measurements and Disclosures, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.
 65    TABLE OF CONTENTS 

          Level II  Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid corporate loans and bonds and less liquid, privately held or restricted equity securities for which some level of recent trading activity has been observed. 

          Level III  Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Companys own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investments level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and it considers factors specific to the investment. Substantially all of our investments are classified as Level III. Our Board of Directors may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with GAAP. Interest Income Interest income, adjusted for amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We generally place a loan on non-accrual status and cease recognizing interest income on such loan or security when a loan or security becomes 90 days or more past due or if we otherwise do not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of December 31, 2011, three issuers representing less than 1%
of our total investments at fair value were on non-accrual status. As of December 31, 2010, five issuers representing 4.1% of our total investments at fair value were on non-accrual status. Dividend Income from CLO Fund Securities We generate dividend income from our investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by Katonah Debt Advisors and selective investments in securities issued by funds managed by other asset management companies. Our CLO Fund securities are subordinate to senior bond holders who typically receive a fixed rate of return on their investment. The CLO Funds are leveraged funds and any excess cash flow or excess spread (interest earned by the underlying securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is
paid to the holders of the CLO Funds subordinated securities or preferred shares. The level of excess spread from CLO Fund securities can be impacted from the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund bond liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly. In addition, the failure of CLO Funds in which we invest to comply with certain financial covenants may lead to the temporary suspension or deferral of cash distributions to us. We make estimated interim accruals of such dividend income based on recent historical distributions and CLO Fund performance and adjust such accruals on a quarterly basis to reflect actual distributions.
 66    TABLE OF CONTENTS For non-junior class CLO Fund securities, such as our investment in the class B-2L notes of Katonah 2007-1 CLO, interest is earned at a fixed spread relative to the LIBOR index. Dividends from Affiliate Asset Manager The Company records dividend income from its affiliate asset manager on the declaration date, which represents the ex-dividend date. Payment-in-Kind Interest We may have loans in our portfolio that contain a payment-in-kind (PIK) provision. PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain our RIC status, this non-cash source of income must be paid out to stockholders in the form of dividends, even though the Company has not yet collected the cash. Fee Income Fee income includes fees, if any, for due diligence, structuring, commitment and facility fees, and fees, if any, for transaction services and management services rendered by us to portfolio companies and other third parties. Commitment and facility fees are generally recognized as income over the life of the underlying loan, whereas due diligence, structuring, transaction service and management service fees are generally recognized as income when the services are rendered. Management Compensation We may, from time to time, issue stock options or restricted stock under the Kohlberg Capital Corporation 2006 Equity Incentive Plan as amended (our Equity Incentive Plan) to officers and employees for services rendered to us. We follow Statement of Financial Accounting Standards No. 123R (revised 2004), Accounting for Stock-Based Compensation, a method by which the fair value of options or restricted stock is determined and expensed. We use a Binary Option Pricing Model (American, call option) as its valuation model to establish the expected value of all stock option grants. We are internally managed and therefore do not incur management fees payable to third parties. United States Federal Income Taxes The Company has elected and intends to continue to qualify for the tax treatment applicable to RICs under Subchapter M of the Code and, among other things, intends to make the required distributions to its stockholders as specified therein. In order to qualify as a RIC, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent
required. Dividends Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is generally based upon the earnings estimated by management for the period and year. We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder opts out of the plan to receive cash in lieu of having their cash dividends automatically reinvested in additional shares of our common stock.
 67    TABLE OF CONTENTS Recent Accounting Pronouncements Improved Disclosures Regarding Fair Value Measurements.  In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Improving Disclosures About Fair Value Measurements (Topic 820),which provides for improving disclosures about fair value measurements, primarily significant transfers in and out of Levels I and II, and activity in Level III fair value measurements. The new disclosures and clarifications of existing disclosures are effective for the interim and annual reporting periods beginning after December 15, 2009, while the disclosures about the purchases, sales, issuances, and
settlements in the roll forward activity in Level 3 fair value measurements are effective for fiscal years beginning after December 15, 2010 and for the interim periods within those fiscal years. Except for certain detailed Level III disclosures, which are effective for fiscal years beginning after December 15, 2010 and interim periods within those years, the new guidance became effective for the Companys fiscal 2010 second quarter. The adoption of this disclosure-only guidance is included in Note 4  Investments and did not have a material impact on the Companys financial results. In May 2011, the FASB issued FASB Accounting Standards Update (ASU) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and IFRS. The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and IFRS. The amendments
in this ASU are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011. Management currently believes that the adoption of this ASU will not have a material impact on the Companys operating results, financial position or cash flows. PORTFOLIO AND INVESTMENT ACTIVITY Our primary business is lending to and investing in middle-market businesses through investments in senior secured loans, junior secured loans, subordinated/mezzanine debt investments, CLO equity investments and other equity-based investments, which may include warrants. Total portfolio investment activity (excluding activity in time deposit and money market investments) for the years ended December 31, 2011, December 31, 2010, and December 31, 2009 was as follows:  Debt Securities

          

          CLO Fund Securities

          

          Equity Securities

          

          Affiliate Asset Managers

          

          Total PortfolioFair Value at December 31, 2008

          

          $

          353,859,007

          

          

          $

          34,640,000

          

          

          $

          5,089,365

          

          

          $

          54,734,812

          

          

          $

          448,323,1842009 Activity:Purchases/originations/draws

          

          $

          1,509,987

          

          

          $

          1,076,250

          

          

          $

          8,625,627

          

          

          $

          4,018,309

          

          

          $

          15,230,173Pay-downs/pay-offs/sales

          

          

          (72,227,405

          )

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (72,227,405

          )Net accretion of discount

          

          

          964,724

          

          

          

          742,204

          

          

          

          

          

          

          

          

          

          

          

          1,706,928Net realized losses

          

          

          (12,050,370

          )

          

          

          

          

          

          

          (1,516,682

          )

          

          

          (2,215,069

          )

          

          

          (15,782,121

          )Increase (decrease) in fair value

          

          

          25,300,586

          

          

          

          12,512,546

          

          

          

          (7,485,064

          )

          

          

          1,526,668

          

          

          

          31,854,736Fair Value at December 31, 2009

          

          $

          297,356,529

          

          

          $

          48,971,000

          

          

          $

          4,713,246

          

          

          $

          58,064,720

          

          

          $

          409,105,4952010 Activity:Purchases/originations/draws

          

          $

          9,981,426

          

          

          $

          

          

          

          $

          1,927,366

          

          

          $

          3,780,817

          

          

          $

          15,689,609Pay-downs/pay-offs/sales

          

          

          (208,820,374

          )

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (208,820,374

          )Net accretion of discount

          

          

          381,677

          

          

          

          85,150

          

          

          

          

          

          

          

          

          

          

          

          466,827Net realized losses

          

          

          (17,053,242

          )

          

          

          

          

          

          

          (809,742

          )

          

          

          

          

          

          

          (17,862,984

          )Increase (decrease) in fair value

          

          

          9,196,912

          

          

          

          3,974,850

          

          

          

          (1,142,038

          )

          

          

          (20,352,537

          )

          

          

          (8,322,813

          )Fair Value at December 31, 2010

          

          $

          91,042,928

          

          

          $

          53,031,000

          

          

          $

          4,688,832

          

          

          $

          41,493,000

          

          

          $

          190,255,7602011 Activity:Purchases/originations/draws

          

          $

          81,815,921

          

          

          $

          

          

          

          $

          3,218,151

          

          

          $

          (194,027

          )

          

          $

          84,840,045Pay-downs/pay-offs/sales

          

          

          (56,944,765

          )

          

          

          (1,935,000

          )

          

          

          (141,769

          )

          

          

          

          

          

          

          (59,021,534

          )Net accretion of discount

          

          

          156,180

          

          

          

          79,609

          

          

          

          

          

          

          

          

          

          

          

          235,789Net realized losses

          

          

          (17,261,608

          )

          

          

          (1,215,000

          )

          

          

          

          

          

          

          

          

          

          

          (18,476,608

          )Increase (decrease) in fair value

          

          

          15,864,850

          

          

          

          (3,548,609

          )

          

          

          (1,724,319

          )

          

          

          (484,973

          )

          

          

          10,106,949Fair Value at December 31, 2011

          

          $

          114,673,506

          

          

          $

          46,412,000

          

          

          $

          6,040,895

          

          

          $

          40,814,000

          

          

          $

          207,940,401
 68    TABLE OF CONTENTS The level of investment activity for investments funded and principal repayments for our investments can vary substantially from period to period depending on the number and size of investments that we invest in or divest of, and many other factors, including the amount and competition for the debt and equity securities available to middle market companies, the level of merger and acquisition activity for such companies and the general economic environment. RESULTS OF OPERATIONS The principal measure of our financial performance is the net increase (decrease) in stockholders equity resulting from operations which includes net investment income (loss) and net realized and unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, dividends, fees, and other investment income and our operating expenses. Net realized gain (loss) on investments, is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net change in unrealized appreciation (depreciation) on investments is the net change in the fair value
of our investment portfolio. Set forth below is a discussion of our results of operations for the the years ended December 31, 2011, 2010, and 2009. Investment Income Investment income for the years ended December 31, 2011, 2010, and 2009 was approximately $28 million, $29 million, and $34 million, respectively. Of this amount, approximately $9 million, $14 million and $24 million, respectively, was attributable to interest income on our loan and bond investments. A portion of such interest income is attributable to net interest earned on assets accumulated for future CLO issuance on which Katonah Debt Advisors entered into a first loss agreement in connection with loan warehouse arrangements for Katonah Debt Advisors CLO Funds. For the years ended December 31, 2011 and December 31, 2010 no income related to first
loss arrangements was earned. For the year ended December 31, 2009, approximately $107,000 of such net interest related to the first loss arrangements previously accrued was written off. For the years ended December 31, 2011, 2010, and 2009, approximately $15 million, $10 million and $9 million, respectively, of investment income was attributable to investments in CLO fund securities. During the three months ended March 31, 2011, we received a $2 million cash settlement to settle litigation previously initiated by us against the lenders related to our secured credit facility which we fully repaid on January 31, 2011. Upon receipt, this settlement was recognized as other income during the three months ended March 31, 2011. Investment income is primarily dependent on the composition and credit quality of our investment portfolio. Generally, our debt securities portfolio is expected to generate predictable, recurring interest income in accordance with the contractual terms of each loan. Corporate equity securities may pay a dividend and may increase in value for which a gain may be recognized; generally such dividend payments and gains are less predictable than interest income on our loan portfolio. Dividends from CLO Fund securities are dependent on the performance of the underlying assets in each CLO Fund; interest payments, principal amortization and prepayments of the underlying loans in each CLO Fund are primary factors which determine the level of income on our CLO Fund securities. The level of excess spread from CLO Fund securities can be impacted by the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund bond liabilities (which reset at each quarterly distribution date); in periods of short-term and
volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly.
 69    TABLE OF CONTENTS Dividends from Affiliate Asset Manager As of December 31, 2011, our investment in Katonah Debt Advisors was approximately $41 million. For the year ended December 31, 2011 and 2010, Katonah Debt Advisors had GAAP net income of approximately $2 million and $1 million, respectively. During the year ended December 31, 2011 distributions from Katonah Debt Advisors totaled approximately $1.9 million. For the year ended December 31, 2010 distributions from Katonah Debt Advisors totaled approximately $4.5 million, a portion of which represented undistributed earnings from prior years. Distributions of Katonah Debt Advisors net income are recorded as dividends from affiliate asset manager. The Company intends to distribute the accumulated undistributed net income of Katonah Debt Advisors in the future. For purposes of calculating distributable tax income for required quarterly dividends as a RIC, Katonah Debt Advisors net income is further reduced by approximately $2 million per annum for tax goodwill amortization resulting from its acquisition by us prior to our initial public offering. As a result, the amount of our declared dividends, as evaluated by management and approved by our Board of Directors, is based on our
evaluation of both distributable income for tax purposes and GAAP net investment income (which excludes unrealized gains and losses). Expenses Interest and compensation expense are generally expected to be our largest expenses each period. Interest expense is dependent on the average outstanding principal balance of our borrowings and the applicable interest rate for the period. Compensation expense includes base salaries, bonuses, stock compensation, employee benefits and employer related payroll costs. The largest components of total compensation costs are base salaries and bonuses; generally, base salaries are expensed as incurred and bonus expenses are estimated and accrued since bonuses are paid annually. Total expenses for the years ended December 31, 2011, 2010, and 2009 were approximately $12 million, $17 million, and $16 million, respectively. Interest expense and amortization on debt issuance costs for the period, which includes facility and program fees on the unused loan balance, was approximately $5 million, $7 million, and $9 million, respectively, on average debt outstanding of $54 million, $155 million, and $236 million, respectively. For the years ended December 31, 2011, 2010, and 2009 approximately $4 million, $3 million, and $3 million respectively, of expenses were attributable to employment compensation, including salaries, bonuses and stock option expense. For the year ended December 31, 2011, professional fees and insurance expenses totaled approximately $3 million. For the year ended December 31, 2010 and December 31, 2009, professional fees and insurance expenses totaled approximately $6 million, and $2 million, respectively. For the year ended December 31, 2011, administrative and other costs totaled approximately $987,000. For the year ended December 31, 2010 and
December 31, 2009, administrative and other costs totaled approximately $1 million and $991,000, respectively. These costs include occupancy expense, technology and other office expenses. Professional fee expenses for the year ended December 31, 2011 are significantly lower by approximately $3 million relative to the same prior year period. This decrease in professional fees is primarily related to legal proceedings and our complaint against our lenders and additional legal, accounting and valuation costs related to the restatement (and defense on the related class-action and SEC investigation net of reimbursable legal fees covered by directors and officers insurance) of our year-end 2008 and first-and second- quarter 2009 financial statements.
 70    TABLE OF CONTENTS Net Unrealized Appreciation (Depreciation) on Investments During the year ended December 31, 2011, our total investments had net unrealized appreciation of approximately $10 million. During the years ended December 31, 2010 and December 31, 2009, our total investments had net unrealized depreciation of approximately $8 million, and net unrealized appreciation of $32 million, respectively. The $10 million of unrealized gains during the year ended December 31, 2011 are due to unrealized gains of $11 million on debt securities, equity securities and CLO Fund securities in our investment portfolio, and a $485,000 decrease in the value of Katonah Debt Advisors. The $8 million of unrealized loss during the year ended December 31, 2010 were primarily due to unrealized gains of approximately $9 million and $4 million on debt securities and CLO Fund securities, respectively, in our investment portfolio, offset in part by approximately a $1 million unrealized loss on equity securities, and an approximate decrease of $20 million in the value of Katonah Debt Advisors. The $31 million of unrealized gains during the year ended December 31, 2009 were primarily due to unrealized gains of $25 million and $13 million on debt securities and CLO Fund securities, respectively, in our investment portfolio, as well as an
approximate unrealized loss on equity of $7 million and an approximate $2 million unrealized loss on Katonah Debt Advisors. Net Change in Stockholders Equity Resulting From Operations The net increase in stockholders equity resulting from operations for the year ended December 31, 2011 was an approximately $8 million, or $0.33 per share. The net decrease in stockholders equity resulting from operations for the year ended December 31, 2010 was $14 million, or $0.64 per share, and the net increase in stockholders equity resulting from operations for the year ended December 31, 2009 was approximately $34 million, or $1.56 per share. FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay dividends to our stockholders and other general business needs. We recognize the need to have funds available for operating our business and to make investments. We seek to have adequate liquidity at all times to cover normal cyclical swings in funding availability and to allow us to meet abnormal and unexpected funding requirements. We plan to satisfy our liquidity needs through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds. In addition to the traditional sources of available funds (issuance of new equity, debt or undrawn warehouse facility capacity), we also have the ability to raise additional cash funds through the securitization of assets on our balance sheet through our wholly-owned asset manager, Katonah Debt Advisors. Such a securitization would provide cash for new investments on our balance sheet as well as additional management fee income and potentially increased value (as a result of increased assets under management) for Katonah Debt Advisors. No new securitizations by Katonah Debt Advisors have closed since January 2008. As a BDC, we are limited in the amount of leverage we can incur to finance our investment portfolio. In order to incur new debt, we are required to meet a coverage ratio of total assets to total senior securities of at least 200%. For this purpose, senior securities include all borrowings and any preferred stock. As a result, our ability to utilize leverage as a means of financing our portfolio of investments is limited by this asset coverage test. As of December 31, 2011, we had $60 million of outstanding borrowings and our asset coverage was 401%, which is above the minimum asset coverage level generally required by the 1940 Act for a BDC to incur
new debt. See Item 1. Business  Leverage.
 71    TABLE OF CONTENTS As of December 31, 2011 and December 31, 2010 the fair value of investments and cash were as follows:  Investments at Fair ValueSecurity Type

          

          December 31, 2011

          

          December 31, 2010Cash

          

          $

          2,555,259

          

          

          $

          10,175,488Time Deposits

          

          

          229,152

          

          

          

          720,225Money Market Account

          

          

          31,622,134

          

          

          

          210,311Senior Secured Loan

          

          

          45,259,328

          

          

          

          22,001,256Junior Secured Loan

          

          

          47,300,172

          

          

          

          63,944,003Mezzanine Investment

          

          

          11,588,115

          

          

          

          250,000Senior Subordinated Bond

          

          

          10,125,891

          

          

          

          4,490,709CLO Fund Securities

          

          

          46,412,000

          

          

          

          53,031,000Equity Securities

          

          

          6,040,895

          

          

          

          4,437,871Preferred

          

          

          400,000

          

          

          

          607,921Affiliate Asset Managers

          

          

          40,814,000

          

          

          

          41,493,000Total

          

          $

          242,346,946

          

          

          $

          201,361,784
 We use borrowed funds, known as leverage, to make investments and to attempt to increase returns to our shareholders by reducing our overall cost of capital. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. We are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. As of December 31, 2011, we had approximately $60 million of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 401%, compliant with the minimum asset coverage level of 200% generally required for a BDC by the 1940 Act. We
may also borrow amounts of up to 5% of the value of our total assets for temporary purposes. As of January 31, 2011, we had repaid in full the outstanding balance of our borrowings and we are currently operating fully unlevered. At December 31, 2010, we had approximately $87 million of outstanding indebtedness through a secured credit facility. On January 31, 2011, we repaid in full the outstanding balance under this facility. On March 16, 2011, we issued $55 million in aggregate principal amount of unsecured 8.75% convertible senior notes due 2016 (Convertible Senior Notes). On March 23, 2011, pursuant to an over-allotment option, we issued an additional $5 million of such Convertible Senior Notes for a total of $60 million in aggregate principal amount. As of December 31, 2011, we had total outstanding indebtedness of $60 million at a fixed rate of interest of 8.75%. As of December 31, 2011, we had cash, time deposits, and money market accounts of approximately $34 million which will fund future investments and operational needs. On February 24, 2012, the Company entered into a Note Purchase Agreement with CS, Credit Suisse Securities (USA) LLC, as arranger, BNYM, as collateral administrator and collateral agent, and KCAP Funding, a special-purpose bankruptcy remote wholly-owned subsidiary of the Company, whereby KCAP Funding purchased a portfolio of Collateral Debt Obligations, the purchase of which was financed by the issuance of (a) a senior note in an aggregate principal amount of $30.0 million, issued to CS in exchange for $30.0 million in cash and (b) a junior note in an aggregate principal amount of $12.5 million, issued to the Company in exchange for the sale by the
Company to KCAP Funding of the Collateral Debt Obligations. Pursuant to the Note Purchase Agreement, the Company has agreed to act as Portfolio Manager on behalf of KCAP Funding and CS of the Collateral Debt Obligations, and has granted a security interest to KCAP Funding in all of the Companys right to receive certain management fees, and KCAP Funding granted to CS a security interest in, among other things, the Collateral Debt Obligations and its rights to receive the management fees pledged to it by the Company.
 72    TABLE OF CONTENTS Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. As a result, we may seek to enter into a new agreement with other lenders or into other financing arrangements as market conditions permit. Such financing arrangements may include a new secured and/or unsecured credit facility, the issuance of preferred securities or debt guaranteed by the SBA. We also believe that our current cash position, certain loan investments and cash income earned by our investment portfolio are adequate for our current liquidity needs. OFF-BALANCE SHEET ARRANGEMENTS We are a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Companys investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on our balance sheet. Prior to extending such credit, we attempt to limit our credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of December 31, 2011 and December 31, 2010, we had committed to make a total of approximately $2 million and
$2 million, respectively, of investments in various revolving senior secured loans, of which none was funded as of December 31, 2011 and $1 million was funded as of December 31, 2010. As of December 31, 2011 and December 31, 2010, we had committed to make no investments in delayed draw senior secured loans. CONTRACTUAL OBLIGATIONS The following table summarizes our contractual cash obligations and other commercial commitments as of December 31, 2011:  Payments Due by PeriodContractual Obligations

          

          Total

          

          Less than one year

          

          1  3 years

          

          3  5 years

          

          More than 5 yearsOperating lease obligations

          

          $

          4,671,981

          

          

          $

          335,445

          

          

          $

          1,073,220

          

          

          $

          369,432

          

          

          $

          2,893,884Long-term debt obligations

          

          

          60,000,000

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          60,000,000Unused lending commitments(1)

          

          

          2,000,000

          

          

          

          2,000,000

          

          

          

          

          

          

          

          

          

          

          

          Total

          

          $

          66,671,981

          

          

          $

          2,335,445

          

          

          $

          1,073,220

          

          

          $

          369,432

          

          

          $

          62,893,884
  (1)

          Represents the unfunded lending commitment in connection with revolving lines of credit or delayed funding draws on loans made to portfolio companies. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Our business activities contain elements of market risks. We consider our principal market risks to be fluctuations in interest rates and the valuations of our investment portfolio. Managing these risks is essential to our business. Accordingly, we have systems and procedures designed to identify and analyze our risks, to establish appropriate policies and thresholds and to continually monitor these risks and thresholds by means of administrative and information technology systems and other policies and processes. Interest Rate Risk Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest earning assets and our interest expense incurred in connection with our interest bearing debt and liabilities. Changes in interest rates can also affect, among other things, our ability to acquire and originate loans
and securities and the value of our investment portfolio. Our investment income is affected by fluctuations in various interest rates, including LIBOR and prime rates. As of December 31, 2011, approximately 75% of our loans at fair value in our portfolio were at floating rates with a spread to an interest rate index such as LIBOR or the prime rate. We generally expect that future portfolio investments will predominately be floating rate investments. As of December 31, 2011, we had $60 million of borrowings outstanding at a fixed rate of 8.75%.
 73    TABLE OF CONTENTS Because we borrow money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising or lowering interest rates, our current cost of debt would remain the same at 8.75% given that our debt is at a fixed rate. We would expect that an increase in the base rate index for our floating rate investment assets would increase our net investment income and that a
decrease in the base rate index for such assets would decrease our net investment income (in either case, such increase/decrease may be limited by interest rate floors/minimums for certain investment assets). We have analyzed the potential impact of changes in interest rates on interest income net of interest expense. Assuming that our balance sheet at December 31, 2011 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical increase of a 1% change in interest rates would correspondingly increase net interest income proportionately by approximately $700,000 over a one-year period. Conversely, a hypothetical decrease of a 1% change in interest rates would correspondingly decrease net interest income proportionately by approximately $700,000 over a one-year period. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect a net change in assets resulting from operations or net income. Accordingly, no assurances can be given that actual results would not materially differ from the potential outcome simulated by this estimate. We did not hold any derivative financial instruments for hedging purposes as of December 31, 2011. Portfolio Valuation We carry our investments at fair value, as determined in good faith by our Board of Directors pursuant to a valuation methodology approved by our Board of Directors. Investments for which market quotations are generally readily available are generally valued at such market quotations. Investments for which there is not a readily available market value are valued at fair value as determined in good faith by our Board of Directors under a valuation policy and consistently applied valuation process. However, due to the inherent uncertainty of determining the fair value of investments that cannot be marked to market, the fair value of our investments may
differ materially from the values that would have been used had a ready market existed for such investments. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the value realized on these investments to be different than the valuations that are assigned. The types of factors that we may take into account in fair value pricing of our investments include, as relevant, the nature and realizable value of any collateral, third party valuations, the portfolio companys ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly-traded securities, recent sales of or offers to buy comparable companies, and other relevant factors. In 2011 and 2010, we engaged an independent valuation firm, to provide a third-party review of our CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine CLO fair values, in the absence of Level 1 or Level 2 trading activity or observable market inputs. The independent valuation firm concluded that our CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow for fair value purposes and that the inputs were being employed correctly. Beginning with the period ending June 30, 2011, the Company has engaged an independent valuation firm to provide third party valuation consulting services to the Companys Board of Directors. Each quarter, the independent valuation firm will perform third party valuations on the Companys investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. Third party valuations were performed on approximately 8% of investments at fair value as of December 31, 2011. These third party valuation estimates were considered as one of the relevant data inputs in the Companys determination of fair
value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.
 74    TABLE OF CONTENTS Item 8. Financial Statements and Supplementary Data Our financial statements are annexed to this Annual Report beginning on page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure On January 12, 2010, Kohlberg Capital dismissed Deloitte as its registered public accounting firm. The Company took this action after discussions with the Staff of the SEC regarding the provisions in the 1940 Act relating to the selection and termination of a BDCs independent public accountants and the circumstances surrounding Deloitte and the Company, including the fact that on January 5, 2010, Deloitte informed the Company that, as a result of and in response to a communication from the Company on January 4, 2010, Deloitte had concluded that it was not currently independent with respect to the Company. Both the Board of Directors of the
Company and the Boards Audit Committee approved the decision to dismiss Deloitte. Prior to Deloittes dismissal, the Company and Deloitte disagreed with respect to the appropriateness of the methodology and procedures used by the Company under Fair Value Measurements and Disclosures to value the Companys investments for the year ended December 31, 2008 (and the quarterly periods included in such year) and the interim periods ended March 31, 2009 and June 30, 2009. The Company does not believe that Deloitte, prior to this dismissal, provided its definitive views to the Company on the application of Fair Value Measurements and Disclosures to the valuation of the Companys investments, and, as a result,
the Company is unable to describe the effect on its financial statements had the accounting methodology that Deloitte apparently would have concluded was required been followed. Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures. The Companys management, under the supervision and with the participation of various members of management, including its Chief Executive Officer (CEO) and its Chief Financial Officer (CFO), has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Companys CEO and CFO have concluded that the Companys disclosure controls and procedures are effective as of the end of the period covered by this report. Managements Report on Internal Control Over Financial Reporting. General.  The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) of the Exchange Act. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Scope of Managements Report on Internal Control Over Financial Reporting.  The Companys internal control over financial reporting includes those policies and procedures that: 

          Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; 

          Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Companys receipts and expenditures are being made only in accordance with authorizations of the Companys management and directors; and 

          Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the Companys financial statements.
 75    TABLE OF CONTENTS Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In addition, as the Company does not have the legal or contractual right or authority to assess the internal controls of the CLO Funds that are consolidated into KDA in accordance with Accounting Standards Codification Topic 810, Consolidation and are included in KDAs
separate financial statements, which are included in this report, and also lacks the practical ability to make such assessment, it has not evaluated the internal controls of such CLO Funds. Accordingly, managements conclusion regarding the effectiveness of the Companys internal control over financial reporting does not extend to the internal controls of such CLO Funds due to the fact that the Company does not have the ability to dictate or modify the controls of such CLO Funds and does not have the practical ability to evaluate those controls. Conclusion.  Management, including the Companys CEO and CFO, assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on managements assessment, management concluded, subject to the limitations described under  Scope of Managements Report on Internal Control Over Financial Reporting above, that the Company maintained effective internal control over
financial reporting as of December 31, 2011. Attestation Report of the Independent Registered Public Accounting Firm. The Companys independent registered public accounting firm has audited and issued a report on the Companys internal control over financial reporting, which appears in Item 15 of this report. Changes in Internal Control Over Financial Reporting. During the quarter ended December 31, 2011, the Company was not able to determine on a timely basis whether separate summarized financial information of KDA was required to be included in its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2011 pursuant to Rules 10-01, 4-08(g) and 1-02(bb) of Regulation S-X and to prepare and include any required separate summarized financial information in such report on a timely basis, as required by the rules of the SEC and the Nasdaq Stock Market. Subsequent to the filing of such report, the Companys management concluded that, in accordance with Rule 3-09 of Regulation S-X,
separate financial statements of KDA were required to be filed with respect the fiscal year ended December 31, 2010 and separate summarized financial information of KDA was required to be filed with respect to the quarterly periods in fiscal 2011. On March 15, 2012, the Company filed an amended Quarterly Report on Form 10-Q/A for the quarterly period ended September 30, 2011 that included the required separate summarized financial information of KDA and this Annual Report on Form 10-K includes the required separate financial statements of KDA with respect to the fiscal years ended December 31, 2010 and 2011 as well as the separate summarized financial information of KDA for the quarterly periods ended March 31, 2011 and June 30, 2011. We continue to strive to improve our processes to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the applicable time periods. Item 9B. Other Information None.
 76    TABLE OF CONTENTS PART III Item 10. Directors, Executive Officers and Corporate Governance The information required by this item will be contained in the Proxy Statement under the headings Proposal 1: Election of Directors, Control Persons and Principal Stockholders and Corporate Governance Principles and Director Information, to be filed with the Securities and Exchange Commission on or prior to April 30, 2012, and is incorporated herein by reference. We have adopted a Code of Ethics that applies to directors and officers of the Company and a Sarbanes-Oxley Code of Ethics that applies to directors, officers and employees of the Company. Both of these codes of conduct are published on our website at www.kohlbergcap.com. We intend to disclose any future amendments to, or waivers from, these codes of conduct within four business days of the waiver or amendment through a website posting. Item 11. Executive Compensation The information required by this item will be contained in the Proxy Statement under the headings Proposal 1: Election of Directors, Executive Compensation, Compensation Committee Interlocks and Insider Participation and Compensation Committee Report, to be filed with the Securities and Exchange Commission on or prior to April 30, 2012, and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this item will be contained in the Proxy Statement under the headings Executive Compensation and Control Persons and Principal Stockholders, to be filed with the Securities and Exchange Commission on or prior to April 30, 2012, and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions, and Director Independence The information required by this item will be contained in the Proxy Statement under the headings Transactions with Related Persons and Proposal 1: Election of Directors, to be filed with the Securities and Exchange Commission on or prior to April 30, 2012, and is incorporated herein by reference. Item 14. Principal Accountant Fees and Services The information required by this item will be contained in the Proxy Statement under the heading Proposal 2: Ratification of Independent Registered Public Accounting Firm, to be filed with the Securities and Exchange Commission on or prior to April 30, 2012, and is incorporated herein by reference.
 77    TABLE OF CONTENTS PART IV Item 15. Exhibits and Financial Statement Schedules (a)  Documents filed as part of this report: 1.  For a list of the consolidated financial information included herein, see Index to the Consolidated Financial Statements on page F-1. 2.  For a list of the other financial statements and financial statement schedules included herein, see Index to Other Financial Statements and Financial Statement Schedules on page S-1. 3.  For a list of other exhibits included herein, see Exhibit List on page E-1. (b)  Exhibits required by Item 601of Regulation S-K.  Reference is made to the Exhibit List filed as a part of this report beginning on page E-1. Each of such exhibits is incorporated by reference herein. (c)  Other financial statements and financial statement schedules.  Reference is made to the Index to Other Financial Statements and Financial Statement Schedules on page S-1. Each of such documents is incorporated by reference herein.
 78    TABLE OF CONTENTS SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  Kohlberg Capital CorporationDate: March 15, 2012

          

          By/s/ Dayl W. PearsonDayl W. PearsonPresident and Chief Executive Officer
 * * * * * Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.  Signature

          

          Title

          

          Date/s/ Dayl W. PearsonDayl W. Pearson

          

          President and Chief Executive Officer (principal executive officer) and Member of the Board of Directors

          

          March 15, 2012/s/ Michael I. WirthMichael I. Wirth

          

          Chief Financial Officer, Secretary and Treasurer (principal financial and accounting officer)

          

          March 15, 2012/s/ Christopher LacovaraChristopher Lacovara

          

          Member of the Board of Directors

          

          March 15, 2012/s/ Gary CademartoriGary Cademartori

          

          Member of the Board of Directors

          

          March 15, 2012/s/ C. Michael JacobiC. Michael Jacobi

          

          Member of the Board of Directors

          

          March 15, 2012/s/ Albert G. PastinoAlbert G. Pastino

          

          Member of the Board of Directors

          

          March 15, 2012/s/ C. Turney Stevens, Jr.C. Turney Stevens, Jr.

          

          Member of the Board of Directors

          

          March 15, 2012/s/ Jay R. BloomJay R. Bloom

          

          Member of the Board of Directors

          

          March 15, 2012/s/ Dean C. KehlerDean C. Kehler

          

          Member of the Board of Directors

          

          March 15, 2012
 79    TABLE OF CONTENTS INDEX TO FINANCIAL STATEMENTS  Reports of Independent Registered Public Accounting Firm





F-2Balance Sheets as of December 31, 2011 and December 31, 2010





F-4Statements of Operations for the years ended December 31, 2011, December 31, 2010 and December 31, 2009





F-5Statements of Changes in Net Assets for the years ended December 31, 2011, December 31, 2010, and December 31, 2009





F-6Statements of Cash Flows for the years ended December 31, 2011, December 31, 2010, and December 31, 2009





F-7Schedules of Investments as of December 31, 2011 and December 31, 2010





F-8Financial Highlights for the years ended December 31, 2011, December 31, 2010 and December 31, 2009





F-18Notes to Financial Statements





F-19
 F-1    TABLE OF CONTENTS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders ofKohlberg Capital Corporation We have audited the accompanying balance sheets, including the schedule of investments, of Kohlberg Capital Corporation and subsidiary (collectively, the Company) (a Delaware corporation) as of December 31, 2011 and 2010, and the related statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2011 and financial highlights for each of the five years in the period ended December 31, 2011. These financial statements and financial highlights are the responsibility of the Companys management. Our responsibility is to express an opinion on the financial statements and
financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of investments owned as of
December 31, 2011 and 2010. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Kohlberg Capital Corporation and subsidiary as of December 31, 2011 and 2010, and the results of their operations, changes in their net assets and their cash flows for each of the three years in the period ended December 31, 2011 and the financial highlights for each of the five years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Kohlberg Capital Corporation and subsidiarys internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2012 expressed an unqualified opinion. /s/ GRANT THORNTON LLP New York, New York March 15, 2011
 F-2    TABLE OF CONTENTS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders ofKohlberg Capital Corporation We have audited Kohlberg Capital Corporation and subsidiarys (collectively, the Company) (a Delaware Corporation) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for maintaining effective internal control over financial reporting for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control Over
Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances.
We believe that our audit provides a reasonable basis for our opinion. A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Kohlberg Capital Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control   Integrated Framework issued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying balance sheets of the Company, including the schedule of investments as of December 31, 2011 and 2010, and the related statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2010 and financial highlights for each of the five years in the period ended December 31, 2011, and our report dated March 15, 2012 expressed an unqualified opinion. /s/ GRANT THORNTON LLP New York, New York March 15, 2011
 F-3    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   BALANCE SHEETS  As of December 31, 2011

          

          As of December 31, 2010ASSETSInvestments at fair value:Time deposits (cost: 2011  $229,152; 2010  $720,225)

          

          $

          229,152

          

          

          $

          720,225Money market account (cost: 2011  $31,622,134; 2010  $210,311)

          

          

          31,622,134

          

          

          

          210,311Debt securities (cost: 2011  $134,311,238; 2010  $126,545,510)

          

          

          114,673,506

          

          

          

          91,042,928CLO fund securities managed by non-affiliates (cost: 2011  $12,544,303; 2010  $15,690,983)

          

          

          2,732,000

          

          

          

          4,921,000CLO fund securities managed by affiliate (cost: 2011  $52,665,506; 2010  $52,589,217)

          

          

          43,680,000

          

          

          

          48,110,000Equity securities (cost: 2011  $16,559,610; 2010  $13,483,227)

          

          

          6,040,895

          

          

          

          4,688,832Asset manager affiliates (cost: 2011  $44,338,301; 2010  $44,532,329)

          

          

          40,814,000

          

          

          

          41,493,000Total Investments at fair value

          

          

          239,791,687

          

          

          

          191,186,296Cash

          

          

          2,555,259

          

          

          

          10,175,488Restricted cash

          

          

          

          

          

          

          67,023,170Interest and dividends receivable

          

          

          2,548,895

          

          

          

          2,574,115Receivable for open trades

          

          

          

          

          

          

          7,681,536Accounts Receivable

          

          

          859,156

          

          

          

          851,020Due from affiliates

          

          

          3,517

          

          

          

          Other assets

          

          

          2,375,147

          

          

          

          331,061Total assets

          

          $

          248,133,661

          

          

          $

          279,822,686LIABILITIESBorrowings

          

          $

          

          

          

          $

          86,746,582Convertible Senior Notes

          

          

          60,000,000

          

          

          

          Accounts payable and accrued expenses

          

          

          3,527,682

          

          

          

          2,337,767Dividend payable

          

          

          4,080,037

          

          

          

          3,812,670Total liabilities

          

          $

          67,607,719

          

          

          $

          92,897,019STOCKHOLDERS' EQUITYCommon stock, par value $0.01 per share, 100,000,000 common shares authorized; 22,992,211 and 22,767,130 common shares issued and outstanding at December 31, 2011 and December 31, 2010, respectively.

          

          $

          226,648

          

          

          $

          224,274Capital in excess of par value

          

          

          284,571,466

          

          

          

          282,794,025Accumulated undistributed net investment income

          

          

          1,008,783

          

          

          

          818,664Accumulated net realized losses

          

          

          (52,802,400

          )

          

          

          (34,325,792

          )Net unrealized depreciation on investments

          

          

          (52,478,555

          )

          

          

          (62,585,504

          )Total stockholders' equity

          

          $

          180,525,942

          

          

          $

          186,925,667Total liabilities and stockholders' equity

          

          $

          248,133,661

          

          

          $

          279,822,686NET ASSET VALUE PER COMMON SHARE

          

          $

          7.85

          

          

          $

          8.21
 See accompanying notes to financial statements.
 F-4    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   STATEMENTS OF OPERATIONS  For the Year Ended December 31,2011

          

          2010

          

          2009Investment Income:Interest from investments in debt securities

          

          $

          9,438,493

          

          

          $

          14,409,069

          

          

          $

          24,157,213Interest from cash and time deposits

          

          

          21,938

          

          

          

          21,531

          

          

          

          17,956Dividends from investments in CLO fund securities managed by non-affiliates

          

          

          1,984,177

          

          

          

          1,837,024

          

          

          

          1,296,349Dividends from investments in CLO fund securities managed by affiliate

          

          

          12,565,859

          

          

          

          8,371,007

          

          

          

          8,025,695Dividends from affiliate asset manager

          

          

          1,910,000

          

          

          

          4,500,000

          

          

          

          Capital structuring service fees

          

          

          86,057

          

          

          

          215,233

          

          

          

          399,338Other Income

          

          

          2,000,000

          

          

          

          

          

          

          

          Total investment income

          

          

          28,006,524

          

          

          

          29,353,864

          

          

          

          33,896,551Expenses:Interest and amortization of debt issuance costs

          

          

          4,588,482

          

          

          

          7,088,202

          

          

          

          9,276,563Compensation

          

          

          3,907,900

          

          

          

          3,322,895

          

          

          

          3,222,604Professional fees

          

          

          2,010,253

          

          

          

          5,411,499

          

          

          

          1,691,832Insurance

          

          

          493,305

          

          

          

          419,942

          

          

          

          359,062Administrative and other

          

          

          987,381

          

          

          

          1,214,207

          

          

          

          990,835Total expenses

          

          

          11,987,321

          

          

          

          17,456,745

          

          

          

          15,540,896Net Investment Income before Income Tax Expense

          

          

          16,019,203

          

          

          

          11,897,119

          

          

          

          18,355,655Excise taxes

          

          

          

          

          

          

          

          

          

          

          (25,000

          )Net Investment Income

          

          

          16,019,203

          

          

          

          11,897,119

          

          

          

          18,330,655Realized And Unrealized Gains (Losses) On Investments:Net realized gain loss from investment transactions

          

          

          (18,476,608

          )

          

          

          (17,862,984

          )

          

          

          (15,782,121

          )Net change in unrealized appreciation (depreciation) on:Debt securities

          

          

          15,864,850

          

          

          

          9,196,912

          

          

          

          25,300,586Equity securities

          

          

          (1,724,319

          )

          

          

          (1,142,038

          )

          

          

          (7,485,064

          )CLO fund securities managed by affiliate

          

          

          (4,506,289

          )

          

          

          3,079,974

          

          

          

          12,986,453CLO fund securities managed by non-affiliates

          

          

          957,680

          

          

          

          894,877

          

          

          

          (473,907

          )Affiliate asset manager investments

          

          

          (484,973

          )

          

          

          (20,352,537

          )

          

          

          1,526,668Net realized and unrealized appreciation (depreciation) on investments

          

          

          (8,369,659

          )

          

          

          (26,185,796

          )

          

          

          16,072,615Net Increase (Decrease) In Stockholders Equity Resulting From Operations

          

          $

          7,649,544

          

          

          $

          (14,288,677)

          

          

          $

          34,403,270Net Increase (Decrease) in Stockholders' Equity Resulting from Operations per Common Share:Basic:

          

          $

          0.33

          

          

          $

          (0.64

          )

          

          $

          1.56Diluted:

          

          $

          0.33

          

          

          $

          (0.64

          )

          

          $

          1.56Net Investment Income Per Common Share:Basic:

          

          $

          0.70

          

          

          $

          0.53

          

          

          $

          0.83Diluted:

          

          $

          0.70

          

          

          $

          0.53

          

          

          $

          0.83Weighted Average Shares of Common Stock Outstanding  Basic

          

          

          22,868,648

          

          

          

          22,283,088

          

          

          

          22,105,800Weighted Average Shares of Common Stock Outstanding  Diluted

          

          

          22,880,674

          

          

          

          22,283,088

          

          

          

          22,105,800
 See accompanying notes to financial statements.
 F-5    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   STATEMENTS OF CHANGES IN NET ASSETS  Year Ended December 31,2011

          

          2010

          

          2009Operations:Net investment income

          

          $

          16,019,203

          

          

          $

          11,897,119

          

          

          $

          18,330,655Net realized gain loss from investment transactions

          

          

          (18,476,608

          )

          

          

          (17,862,984

          )

          

          

          (15,782,121

          )Net change in unrealized gain (loss) on investments

          

          

          10,106,949

          

          

          

          (8,322,812

          )

          

          

          31,854,736Net increase (decrease) in net assets resulting from operations

          

          

          7,649,544

          

          

          

          (14,288,677

          )

          

          

          34,403,270Shareholder distributions:Dividends from net investment income to common stockholders

          

          

          (15,802,712

          )

          

          

          (11,897,119

          )

          

          

          (18,330,654

          )Dividends from net investment income to restricted stockholders

          

          

          (26,373

          )

          

          

          (55,404

          )

          

          

          (125,053

          )Common Stock Dividends in excess of net investment income

          

          

          

          

          

          

          (3,269,688

          )

          

          

          (1,747,018

          )Net decrease in net assets resulting from stockholder distributions

          

          

          (15,829,085

          )

          

          

          (15,222,211

          )

          

          

          (20,202,725

          )Capital share transactions:Issuance of common stock for:Dividend reinvestment plan

          

          

          1,006,205

          

          

          

          1,621,074

          

          

          

          2,218,818Vesting of restricted stock

          

          

          961

          

          

          

          647

          

          

          

          1,223Stock based compensation

          

          

          772,650

          

          

          

          919,111

          

          

          

          909,119Net increase in net assets resulting from capital share transactions

          

          

          1,779,816

          

          

          

          2,540,832

          

          

          

          3,129,160Net assets at beginning of period

          

          

          186,925,667

          

          

          

          213,895,723

          

          

          

          196,566,018Net assets at end of period (including accumulated undistributed net investment income of $1,008,783, $818,664, and $1,326,380 in 2011, 2010, and 2009, respectively.

          

          $

          180,525,942

          

          

          $

          186,925,667

          

          

          $

          213,895,723Net asset value per common share

          

          $

          7.85

          

          

          $

          8.21

          

          

          $

          9.56Common shares outstanding at end of period

          

          

          22,992,211

          

          

          

          22,767,130

          

          

          

          22,363,281
 See accompanying notes to financial statements.
 F-6    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   STATEMENTS OF CASH FLOWS  Year Ended December 31,2011

          

          2010

          

          2009OPERATING ACTIVITIES:Net increase (decrease) in stockholders equity resulting from operations

          

          $

          7,649,544

          

          

          $

          (14,288,677

          )

          

          $

          34,403,270Adjustments to reconcile net increase (decrease) in stockholders equity resulting from operations to net cash provided by operations:Net realized losses on investment transactions

          

          

          18,476,608

          

          

          

          17,862,984

          

          

          

          15,782,121Net change in unrealized (appreciation) depreciation on investments

          

          

          (10,106,949

          )

          

          

          8,322,812

          

          

          

          (31,854,736

          )Net accretion of discount on securities and loans

          

          

          (235,789

          )

          

          

          (466,826

          )

          

          

          (1,706,928

          )Amortization of debt issuance cost

          

          

          22,908

          

          

          

          595,614

          

          

          

          824,695Amortization of convertible notes offering cost

          

          

          375,597

          

          

          

          

          

          

          

          Purchases of investments

          

          

          (115,976,563

          )

          

          

          (12,018,942

          )

          

          

          (13,581,354

          )Capital contribution to (from) affiliate asset manager

          

          

          194,027

          

          

          

          (3,780,817

          )

          

          

          (3,600,016

          )Payment-in-kind interest income

          

          

          (469,329

          )

          

          

          (820,262

          )

          

          

          (3,801

          )Proceeds from sale and redemption of investments

          

          

          67,194,142

          

          

          

          204,092,344

          

          

          

          81,459,787Stock based compensation expense

          

          

          772,650

          

          

          

          919,112

          

          

          

          909,121Changes in operating assets and liabilities:Decrease in interest and dividends receivable

          

          

          25,219

          

          

          

          1,261,916

          

          

          

          332,567Increase in accounts receivable

          

          

          (8,135

          )

          

          

          

          

          

          

          (Increase) Decrease in other assets

          

          

          (72,137

          )

          

          

          (286,473

          )

          

          

          251,550(Increase) Decrease in due from affiliates

          

          

          (3,517

          )

          

          

          44,274

          

          

          

          346,315Increase (decrease) in accounts payable and accrued expenses

          

          

          1,189,915

          

          

          

          (1,570,996

          )

          

          

          (6,661

          )Net cash provided by (used in) operating activities

          

          

          (30,971,809

          )

          

          

          199,866,063

          

          

          

          83,555,930FINANCING ACTIVITIES:Issuance of stock (net of offering costs)

          

          

          

          

          

          

          647

          

          

          

          1,223Dividends paid in cash

          

          

          (14,554,554

          )

          

          

          (14,200,702

          )

          

          

          (19,451,339

          )Cash paid on repayment of debt

          

          

          (86,746,582

          )

          

          

          (131,303,781

          )

          

          

          (43,640,786

          )Convertible notes offering costs

          

          

          (2,370,454

          )

          

          

          

          

          

          

          Issuance of Convertible Senior Notes

          

          

          60,000,000

          

          

          

          

          

          

          

          (Increase) Decrease in restricted cash

          

          

          67,023,170

          

          

          

          (48,327,147

          )

          

          

          (16,576,032

          )Net cash provided by (used in) financing activities

          

          

          23,351,580

          

          

          

          (193,830,983

          )

          

          

          (79,666,934

          )CHANGE IN CASH

          

          

          (7,620,229

          )

          

          

          6,035,080

          

          

          

          3,888,996CASH, BEGINNING OF YEAR

          

          

          10,175,488

          

          

          

          4,140,408

          

          

          

          251,412CASH, END OF YEAR

          

          $

          2,555,259

          

          

          $

          10,175,488

          

          

          $

          4,140,408Supplemental Information:Interest paid during the year

          

          $

          2,745,968

          

          

          $

          7,195,181

          

          

          $

          8,297,586Non-cash dividends paid during the year under the dividend reinvestment plan

          

          $

          1,007,164

          

          

          $

          1,621,074

          

          

          $

          2,218,818
 See accompanying notes to financial statements.
 F-7    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   SCHEDULE OF INVESTMENTS As of December 31, 2011 Debt Securities Portfolio  Portfolio Company/Principal Business

          

          InvestmentInterest Rate(1)/Maturity

          

          Principal

          

          Cost

          

          Value(2)Advanced Lighting Technologies, Inc.Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Senior Secured Loan  Revolving Loan .5% Cash, Due 6/13

          

          

          $

          

          

          

          $

          

          

          

          $

          Advanced Lighting Technologies, Inc.Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Junior Secured Loan  Second Lien Term Loan Note 6.3% Cash, Due 6/14

          

          

          

          5,000,000

          

          

          

          4,997,622

          

          

          

          4,965,000Alaska Communications Systems Holdings, Inc.Telecommunications

          

          

          Senior Secured Loan  Term Loan5.5% Cash, Due 10/16

          

          

          

          2,970,000

          

          

          

          2,986,151

          

          

          

          2,776,950Avis Budget Car Rental, LLCPersonal Transportation

          

          

          Senior Secured Loan  Extended Term Loan 5.8% Cash, Due 4/14

          

          

          

          2,974,338

          

          

          

          2,993,092

          

          

          

          2,983,648Bankruptcy Management Solutions, Inc.Diversified/Conglomerate Service

          

          

          Junior Secured Loan  Loan (Second Lien)1.4% Cash, 7.0% PIK, Due 8/15

          

          

          

          1,291,447

          

          

          

          1,217,438

          

          

          

          39,822Bankruptcy Management Solutions, Inc.Diversified/Conglomerate Service

          

          

          Senior Secured Loan  Term Loan B 6.5% Cash, 1.0% PIK, Due 8/14

          

          

          

          1,442,478

          

          

          

          1,434,611

          

          

          

          331,777Bicent Power LLCUtilities

          

          

          Junior Secured Loan  Advance (Second Lien) 4.6% Cash, Due 12/14

          

          

          

          4,000,000

          

          

          

          4,000,000

          

          

          

          137,500Burger King CorporationPersonal, Food and Miscellaneous Services

          

          

          Senior Secured Loan  Tranche B Term Loan4.5% Cash, Due 10/16

          

          

          

          2,872,500

          

          

          

          2,872,500

          

          

          

          2,827,359Caribe Media Inc. (fka Caribe Information Investments Incorporated)Printing and Publishing

          

          

          Senior Secured Loan  Loan 10.0% Cash, Due 11/14

          

          

          

          684,774

          

          

          

          684,774

          

          

          

          684,774CoActive Technologies LLC (fka CoActive Technologies, Inc.)Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

          

          

          Junior Secured Loan  Term Loan (Second Lien) 7.3% Cash, Due 1/15

          

          

          

          2,000,000

          

          

          

          1,983,174

          

          

          

          1,552,200Del Monte Foods CompanyBeverage, Food and Tobacco

          

          

          Senior Secured Loan  Initial Term Loan 4.5% Cash, Due 3/18

          

          

          

          2,985,000

          

          

          

          2,991,687

          

          

          

          2,843,212eInstruction CorporationHealthcare, Education and Childcare

          

          

          Junior Secured Loan  Term Loan (Second Lien)11.5% Cash, Due 7/14

          

          

          

          10,000,000

          

          

          

          10,000,000

          

          

          

          9,489,000Freescale Semiconductor, Inc.Electronics

          

          

          Senior Subordinated Bond   10.125%  12/2016  35687MAP210.3% Cash, Due 12/16

          

          

          

          3,000,000

          

          

          

          3,007,007

          

          

          

          3,135,000Ginn LA Conduit Lender, Inc.(8)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  First Lien Tranche A Credit-Linked Deposit7.8% Cash, Due 6/11

          

          

          

          1,257,143

          

          

          

          1,224,101

          

          

          

          91,142Ginn LA Conduit Lender, Inc.(8)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  First Lien Tranche B Term Loan 7.8% Cash, Due 6/11

          

          

          

          2,694,857

          

          

          

          2,624,028

          

          

          

          195,377Ginn LA Conduit Lender, Inc.(8)Buildings and Real Estate(4)

          

          

          Junior Secured Loan  Loan (Second Lien)11.8% Cash, Due 6/12

          

          

          

          3,000,000

          

          

          

          2,715,997

          

          

          

          15,000
 F-8    TABLE OF CONTENTS Portfolio Company/Principal Business

          

          InvestmentInterest Rate(1)/Maturity

          

          Principal

          

          Cost

          

          Value(2)HMSC Corporation (aka Swett and Crawford)Insurance

          

          

          Junior Secured Loan  Loan (Second Lien)5.8% Cash, Due 10/14

          

          

          $

          5,000,000

          

          

          $

          4,919,522

          

          

          $

          3,753,000Hunter Defense Technologies, Inc.Aerospace and Defense

          

          

          Junior Secured Loan  Term Loan (Second Lien)7.3% Cash, Due 2/15

          

          

          

          5,000,000

          

          

          

          4,916,872

          

          

          

          5,000,000Hunter Fan CompanyHome and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Junior Secured Loan  Loan (Second Lien)7.0% Cash, Due 10/14

          

          

          

          3,000,000

          

          

          

          3,000,000

          

          

          

          2,724,300International Architectural Products, Inc.(8)Mining, Steel, Iron and Non-Precious Metals

          

          

          Senior Secured Loan  Term Loan12.0% Cash, 3.3% PIK, Due 5/15

          

          

          

          530,803

          

          

          

          504,240

          

          

          

          437,913Jones Stephens Corp.Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Senior Secured Loan  Term Loan7.0% Cash, Due 9/15

          

          

          

          4,889,912

          

          

          

          4,889,912

          

          

          

          4,889,912Kaseman Holdings and Sallyport HoldingsAerospace and Defense

          

          

          Mezzanine Investment  Mezzanine Notes14.5% Cash, Due 6/17

          

          

          

          11,250,597

          

          

          

          10,931,428

          

          

          

          11,588,115KIK Custom Products Inc.Personal and Non Durable Consumer Products (Mfg. Only)

          

          

          Junior Secured Loan  Loan (Second Lien)5.3% Cash, Due 12/14

          

          

          

          5,000,000

          

          

          

          5,000,000

          

          

          

          3,250,000LBREP/L-Suncal Master I LLC(8)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  Term Loan (First Lien)7.5% Cash, Due 1/10

          

          

          

          3,401,921

          

          

          

          3,401,921

          

          

          

          359,923Legacy Cabinets, Inc.Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Senior Secured Loan  Term Loan1.0% Cash, 6.3% PIK, Due 5/14

          

          

          

          492,944

          

          

          

          463,380

          

          

          

          253,817Merisant CompanyBeverage, Food and Tobacco

          

          

          Senior Secured Loan  Loan 7.5% Cash, Due 1/14

          

          

          

          5,049,291

          

          

          

          5,030,584

          

          

          

          5,043,232Metropolitan Health Networks, Inc.Healthcare, Education and Childcare

          

          

          Junior Secured Loan  Term Loan (Second Lien) 13.5% Cash, Due 10/17

          

          

          

          5,000,000

          

          

          

          4,903,929

          

          

          

          5,000,000Michael Foods Group, Inc. (f/k/a M-Foods Holdings, Inc.)Beverage, Food and Tobacco

          

          

          Senior Secured Loan  Term B Facility4.3% Cash, Due 2/18

          

          

          

          1,925,767

          

          

          

          1,870,004

          

          

          

          1,910,120Neiman Marcus Group Inc., TheRetail Stores

          

          

          Senior Secured Loan  Term Loan4.8% Cash, Due 5/18

          

          

          

          2,000,000

          

          

          

          1,885,086

          

          

          

          1,932,500Pegasus Solutions, Inc.Leisure, Amusement, Motion Pictures, Entertainment

          

          

          Senior Subordinated Bond  Senior Subordinated Second Lien PIK Notes 13.0% Cash, Due 4/14

          

          

          

          1,490,892

          

          

          

          1,490,892

          

          

          

          1,490,892Perseus Holding Corp.(6)Leisure, Amusement, Motion Pictures, Entertainment

          

          

          Preferred Stock  Preferred Stock14.0% PIK

          

          

          

          400,000

          

          

          

          400,000

          

          

          

          400,000Potters Holdings, II, L.P.Diversified/Conglomerate Manufacturing

          

          

          Junior Secured Loan  Term B Loan (Second Lien)10.3% Cash, Due 11/17

          

          

          

          7,000,000

          

          

          

          6,905,447

          

          

          

          7,000,000Trinseo Materials Operating S.C.A. (fka Styron S.A.R.L)(3)Chemicals, Plastics and Rubber

          

          

          Senior Secured Loan  Term Loan6.0% Cash, Due 8/17

          

          

          

          1,989,950

          

          

          

          1,824,534

          

          

          

          1,728,779TriZetto Group, Inc. (TZ Merger Sub, Inc.)Electronics

          

          

          Senior Secured Loan  Term Loan 4.8% Cash, Due 5/18

          

          

          

          1,979,757

          

          

          

          1,898,410

          

          

          

          1,950,554TUI University, LLCHealthcare, Education and Childcare

          

          

          Senior Secured Loan  Term Loan (First Lien) 3.5% Cash, Due 10/14

          

          

          

          3,040,242

          

          

          

          2,978,384

          

          

          

          2,626,161
 F-9    TABLE OF CONTENTS Portfolio Company/Principal Business

          

          InvestmentInterest Rate(1)/Maturity

          

          Principal

          

          Cost

          

          Value(2)Twin-Star International, Inc.Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Senior Subordinated Bond  Senior Subordinated Note 13.0% Cash, Due 4/14

          

          

          $

          5,500,000

          

          

          $

          5,500,000

          

          

          $

          5,500,000Univar Inc.Chemicals, Plastics and Rubber

          

          

          Senior Secured Loan  Term B Loan5.0% Cash, Due 6/17

          

          

          

          2,984,925

          

          

          

          2,984,925

          

          

          

          2,886,049Vantiv, LLC (fka Fifth Third Processing Solutions, LLC)Electronics

          

          

          Senior Secured Loan  Term B-1 Loan (First Lien)4.5% Cash, Due 11/16

          

          

          

          1,989,975

          

          

          

          1,992,299

          

          

          

          1,988,482Vertafore, Inc.Electronics

          

          

          Senior Secured Loan  Term Loan (First Lien) 5.3% Cash, Due 7/16

          

          

          

          1,989,956

          

          

          

          1,933,723

          

          

          

          1,952,147Walker Group Holdings LLCCargo Transport

          

          

          Junior Secured Loan  Term Loan B13.3% Cash, Due 12/13

          

          

          

          416,737

          

          

          

          416,737

          

          

          

          416,737Walker Group Holdings LLCCargo Transport

          

          

          Junior Secured Loan  Term Loan B13.3% Cash, Due 12/13

          

          

          

          3,957,614

          

          

          

          3,957,614

          

          

          

          3,957,614Warner Chilcott Company, LLCHealthcare, Education and Childcare

          

          

          Senior Secured Loan  Term B-2 Loan4.3% Cash, Due 3/18

          

          

          

          454,851

          

          

          

          455,921

          

          

          

          449,450Warner Chilcott CorporationHealthcare, Education and Childcare

          

          

          Senior Secured Loan  Term B-1 Loan4.3% Cash, Due 3/18

          

          

          

          909,703

          

          

          

          911,841

          

          

          

          898,900WC Luxco S.A.R.L. (Warner Chilcott)(3)Healthcare, Education and Childcare

          

          

          Senior Secured Loan  Term B-3 Loan4.3% Cash, Due 3/18

          

          

          

          625,421

          

          

          

          626,891

          

          

          

          617,994Wesco Aircraft Hardware Corp.Aerospace and Defense

          

          

          Senior Secured Loan  Tranche B Term Loan4.3% Cash, Due 4/17

          

          

          

          2,590,244

          

          

          

          2,584,560

          

          

          

          2,599,154Total Investment in Debt Securities (64% of net asset value at fair value)

          

          

          

          

          

          $

          136,034,039

          

          

          $

          134,311,238

          

          

          $

          114,673,506
 Equity Portfolio  Portfolio Company/Principal Business

          

          Investment

          

          Percentage Interest/Shares

          

          Cost

          

          Value(2)Aerostructures Holdings L.P.(6)Aerospace and Defense

          

          

          Partnership Interests

          

          

          

          1.2

          %

          

          $

          1,000,000

          

          

          $

          1,000Aerostructures Holdings L.P.(6)Aerospace and Defense

          

          

          Series A Preferred Interests

          

          

          

          1.2

          %

          

          

          250,961

          

          

          

          250,961Bankruptcy Management Solutions, Inc.(6)Diversified/Conglomerate Service

          

          

          Common Stock

          

          

          

          1.2

          %

          

          

          218,592

          

          

          

          1,005Bankruptcy Management Solutions, Inc.(6)Diversified/Conglomerate Service

          

          

          Warrants

          

          

          

          0.1

          %

          

          

          

          

          

          

          Coastal Concrete Holding II, LLC(6)Buildings and Real Estate(4)

          

          

          Class A Units

          

          

          

          10.8

          %

          

          

          8,625,626

          

          

          

          1,000eInstruction Acquisition, LLC(6)Healthcare, Education and Childcare

          

          

          Membership Units

          

          

          

          1.1

          %

          

          

          1,079,617

          

          

          

          442,319FP WRCA Coinvestment Fund VII, Ltd.(3),(6)Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

          

          

          Class A Shares

          

          

          

          1,500

          

          

          $

          1,500,000

          

          

          

          2,339,700International Architectural Products, Inc.(6)Mining, Steel, Iron and Non-Precious Metals

          

          

          Common

          

          

          

          2.5

          %

          

          

          292,851

          

          

          

          1,000Legacy Cabinets, Inc.(6)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Equity

          

          

          

          4.0

          %

          

          

          115,580

          

          

          

          1,000
 F-10    TABLE OF CONTENTS Portfolio Company/Principal Business

          

          Investment

          

          Percentage Interest/Shares

          

          Cost

          

          Value(2)Perseus Holding Corp.(6)Leisure, Amusement, Motion Pictures, Entertainment

          

          

          Common

          

          

          

          0.2

          %

          

          $

          400,000

          

          

          $

          193,120Plumbing Holdings Corporation(6)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Common

          

          

          

          7.8

          %

          

          

          

          

          

          

          Plumbing Holdings Corporation(6)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Preferred Stock

          

          

          

          9.0

          %

          

          

          2,716,618

          

          

          

          2,270,821Caribe Media Inc. (fka Caribe Information Investments Incorporated)(6)

          

          

          Common

          

          

          

          1.3

          %

          

          

          359,765

          

          

          

          538,969Total Investment in Equity Securities (3% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          16,559,610

          

          

          $

          6,040,895
 CLO Fund Securities CLO Equity Investments  Portfolio Company

          

          Investment

          

          Percentage Interest

          

          Cost

          

          Value(2)Grant Grove CLO, Ltd.(3),(10)

          

          

          Subordinated Securities

          

          

          

          22.2

          %

          

          $

          4,724,303

          

          

          $

          2,730,000Katonah III, Ltd.(3),(10)

          

          

          Preferred Shares

          

          

          

          23.1

          %

          

          

          4,500,000

          

          

          

          1,000Katonah V, Ltd.(3),(10),(11)

          

          

          Preferred Shares

          

          

          

          26.7

          %

          

          

          3,320,000

          

          

          

          1,000Katonah VII CLO Ltd.(3),(7),(10)

          

          

          Subordinated Securities

          

          

          

          16.4

          %

          

          

          4,500,000

          

          

          

          2,210,000Katonah VIII CLO Ltd(3),(7),(10)

          

          

          Subordinated Securities

          

          

          

          10.3

          %

          

          

          3,400,000

          

          

          

          1,800,000Katonah IX CLO Ltd(3),(7),(10)

          

          

          Preferred Shares

          

          

          

          6.9

          %

          

          

          2,000,000

          

          

          

          1,240,000Katonah X CLO Ltd(3),(7),(10)

          

          

          Subordinated Securities

          

          

          

          33.3

          %

          

          

          11,631,226

          

          

          

          8,320,000Katonah 2007-I CLO Ltd.(3),(7),(10)

          

          

          Preferred Shares

          

          

          

          100.0

          %

          

          

          30,027,384

          

          

          

          23,540,000Total Investment in CLO Equity Securities

          

          

          

          

          

          

          

          

          

          $

          64,102,913

          

          

          $

          39,842,000
 CLO Rated-Note Investment  Portfolio Company

          

          Investment

          

          Percentage Interest

          

          Cost

          

          Value(2)Katonah 2007-I CLO Ltd.(3),(7),(10)

          

          

          Class B-2L Notes Par Value of $10,500,000 100.0%, Due 4/22

          

          

          

          100.0

          %

          

          $

          1,106,896

          

          

          $

          6,570,000Total Investment in CLO Rated-Note

          

          

          

          

          

          

          

          

          

          $

          1,106,896

          

          

          $

          6,570,000Total Investment in CLO Fund Securities (26% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          65,209,809

          

          

          $

          46,412,000
 Asset Manager Affiliate  Portfolio Company/Principal Business

          

          Investment

          

          Percentage Interest

          

          Cost

          

          Value(2)Katonah Debt Advisors

          

          

          Asset Management Company

          

          

          

          100.0

          %

          

          $

          44,338,301

          

          

          $

          40,814,000Total Investment in Asset Manager Affiliate (23% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          44,338,301

          

          

          $

          40,814,000
 F-11    TABLE OF CONTENTS Time Deposits and Money Market Account  Time Deposits and Money Market Account

          

          Investment

          

          Yield

          

          Par/Cost

          

          Value(2)JP Morgan Asset Account

          

          

          Time Deposit

          

          

          

          0.0

          %

          

          $

          229,152

          

          

          $

          229,152JP Morgan Business Money Market Account(9)

          

          

          Money Market Account

          

          

          

          0.2

          %

          

          

          164,573

          

          

          

          164,573US Bank Money Market Account

          

          

          Money Market Account

          

          

          

          0.4

          %

          

          

          31,457,561

          

          

          

          31,457,561Total Investment in Time Deposit and Money Market Accounts(18% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          31,851,286

          

          

          $

          31,851,286Total Investments(5)(133% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          292,270,244

          

          

          $

          239,791,687
  (1)

          A majority of the variable rate loans to the Companys portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at December 31, 2011. (2)

          Reflects the fair market value of all existing investments as of December 31, 2011, as determined by the Companys Board of Directors. (3)

          Non-U.S. company or principal place of business outside the U.S. (4)

          Buildings and real estate relate to real estate ownership, builders, managers and developers and excludes mortgage debt investments and mortgage lenders or originators. As of December 31, 2011, the Company had no exposure to mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities), companies providing mortgage lending or emerging markets investments either directly or through the Companys investments in CLO funds. (5)

          The aggregate cost of investments for federal income tax purposes is approximately $292 million. The aggregate gross unrealized appreciation is approximately $8 million, the aggregate gross unrealized depreciation is approximately $60 million, and the net unrealized depreciation is approximately $52 million. (6)

          Non-income producing. (7)

          An affiliate CLO Fund managed by Katonah Debt Advisors, L.L.C. or its affiliate. (8)

          Loan or debt security is on non-accrual status and therefore is considered non-income producing. (9)

          Money market account holding restricted cash for employee flexible spending accounts. (10)

          These securities were acquired in a transaction that was exempt from the registration requirements of the Securities Act of 1933, as amended (the Securities Act), pursuant to Rule 144A thereunder. These securities may be resold only in transactions that are exempt from the registration requirements of the Securities Act, normally to qualified institutional buyers. (11)

          As of December 31, 2011, this CLO Fund Security was not providing a dividend distribution.
 F-12    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   SCHEDULE OF INVESTMENTS As of December 31, 2010 Debt Securities Portfolio  Portfolio Company/Principal Business

          

          Investment Interest Rate(1)/Maturity

          

          Principal

          

          Cost

          

          Value(2)Advanced Lighting Technologies, Inc.Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Senior Secured Loan  Revolving Loan3.7% Cash, Due 6/13

          

          

          $

          1,080,000

          

          

          $

          1,075,943

          

          

          $

          979,452Advanced Lighting Technologies, Inc.(6)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Junior Secured Loan  Second Lien Term Loan Note 6.3% Cash, Due 6/14

          

          

          

          5,000,000

          

          

          

          5,000,000

          

          

          

          5,000,000Awesome Acquisition Company (CiCi's Pizza)(6)Personal, Food and Miscellaneous Services

          

          

          Junior Secured Loan  Term Loan (Second Lien) 5.3% Cash, Due 6/14

          

          

          

          4,000,000

          

          

          

          3,985,854

          

          

          

          3,840,000Bankruptcy Management Solutions, Inc.(6)Diversified/Conglomerate Service

          

          

          Junior Secured Loan  Second Lien Facility1.3% Cash, 7.0% PIK, Due 8/15

          

          

          

          1,217,438

          

          

          

          1,217,438

          

          

          

          95,368Bankruptcy Management Solutions, Inc.(6)Diversified/Conglomerate Service

          

          

          Senior Secured Loan  Term Loan B7.5% Cash, Due 8/14

          

          

          

          1,438,720

          

          

          

          1,448,006

          

          

          

          719,360Bicent Power LLC(6)Utilities

          

          

          Junior Secured Loan  Advance (Second Lien) 4.3% Cash, Due 12/14

          

          

          

          4,000,000

          

          

          

          4,000,000

          

          

          

          2,367,600BP Metals, LLC (fka Constellation Enterprises)(6)Mining, Steel, Iron and Non-Precious Metals

          

          

          Senior Secured Loan  Term Loan 12.0% Cash, Due 6/13

          

          

          

          3,982,143

          

          

          

          3,982,143

          

          

          

          4,002,054Caribe Information Investments Incorporated(6)Printing and Publishing

          

          

          Senior Secured Loan  Term Loan2.5% Cash, Due 3/13

          

          

          

          1,611,045

          

          

          

          1,608,021

          

          

          

          1,273,692Charlie Acquisition Corp.(9)Personal, Food and Miscellaneous Services

          

          

          Mezzanine Investment  Senior Subordinated Notes 17.5% Cash, Due 6/13

          

          

          

          14,261,996

          

          

          

          10,744,496

          

          

          

          250,000CoActive Technologies LLC (fka CoActive Technologies, Inc.)(6)Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

          

          

          Junior Secured Loan  Term Loan (Second Lien)7.1% Cash, Due 1/15

          

          

          

          2,000,000

          

          

          

          1,977,696

          

          

          

          1,464,600eInstruction Corporation(6)Healthcare, Education and Childcare

          

          

          Junior Secured Loan  Term Loan (Second Lien)7.8% Cash, Due 7/14

          

          

          

          10,000,000

          

          

          

          10,000,000

          

          

          

          10,000,000Freescale Semiconductor, Inc.Electronics

          

          

          Senior Subordinated Bond  10.125%  12/2016   35687MAP210.1% Cash, Due 12/16

          

          

          

          3,000,000

          

          

          

          3,006,137

          

          

          

          3,176,250Ginn LA Conduit Lender, Inc.(9)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  First Lien Tranche A Credit-Linked Deposit 7.8% Cash, Due 6/11

          

          

          

          1,257,143

          

          

          

          1,224,101

          

          

          

          72,286Ginn LA Conduit Lender, Inc.(9)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  First Lien Tranche B Term Loan 7.8% Cash, Due 6/11

          

          

          

          2,694,857

          

          

          

          2,624,028

          

          

          

          154,954Ginn LA Conduit Lender, Inc.(9)Buildings and Real Estate(4)

          

          

          Junior Secured Loan  Loan (Second Lien)11.8% Cash, Due 6/12

          

          

          

          3,000,000

          

          

          

          2,715,997

          

          

          

          15,000HMSC Corporation (aka Swett and Crawford)(6)Insurance

          

          

          Junior Secured Loan  Loan (Second Lien)5.8% Cash, Due 10/14

          

          

          

          5,000,000

          

          

          

          4,890,322

          

          

          

          4,049,000
 F-13    TABLE OF CONTENTS Portfolio Company/Principal Business

          

          Investment Interest Rate(1)/Maturity

          

          Principal

          

          Cost

          

          Value(2)Hunter Fan Company(6)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Junior Secured Loan  Loan (Second Lien)7.0% Cash, Due 10/14

          

          

          $

          3,000,000

          

          

          $

          3,000,000

          

          

          $

          2,682,900International Architectural Products, Inc.(6),(9)Mining, Steel, Iron and Non-Precious Metals

          

          

          Senior Secured Loan  Term Loan8.8% Cash, 3.3% PIK, Due 5/15

          

          

          

          967,622

          

          

          

          948,809

          

          

          

          929,498Intrapac Corporation/Corona Holdco(6)Containers, Packaging and Glass

          

          

          Junior Secured Loan  Term Loans (Second Lien)7.8% Cash, Due 5/13

          

          

          

          3,000,000

          

          

          

          3,009,682

          

          

          

          3,000,000Jones Stephens Corp.(6),(9)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  Term Loan (2006)7.8% Cash, Due 9/12

          

          

          

          9,541,180

          

          

          

          9,527,522

          

          

          

          6,364,921KIK Custom Products Inc.(6)Personal and Non Durable Consumer Products (Mfg. Only)

          

          

          Junior Secured Loan  Loan (Second Lien)5.3% Cash, Due 12/14

          

          

          

          5,000,000

          

          

          

          5,000,000

          

          

          

          3,435,000LBREP/L-Suncal Master I LLC(9)Buildings and Real Estate(4)

          

          

          Junior Secured Loan  Term Loan (Third Lien) 15.0% Cash, Due 2/12

          

          

          

          2,332,868

          

          

          

          2,332,868

          

          

          

          933LBREP/L-Suncal Master I LLC(6),(9)Buildings and Real Estate(4)

          

          

          Senior Secured Loan  Term Loan (First Lien) 7.5% Cash, Due 1/10

          

          

          

          3,875,156

          

          

          

          3,875,156

          

          

          

          58,127LBREP/L-Suncal Master I LLC(6),(9)Buildings and Real Estate(4)

          

          

          Junior Secured Loan  Term Loan (Second Lien)9.5% Cash, Due 1/11

          

          

          

          2,000,000

          

          

          

          1,920,211

          

          

          

          7,600Legacy Cabinets, Inc.(6)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Senior Secured Loan  Term Loan7.3% Cash, Due 5/14

          

          

          

          463,380

          

          

          

          463,380

          

          

          

          92,676MCCI Group Holdings, LLC(6)Healthcare, Education and Childcare

          

          

          Junior Secured Loan  Term Loan (Second Lien)7.5% Cash, Due 6/13

          

          

          

          1,000,000

          

          

          

          1,000,000

          

          

          

          1,000,000Pegasus Solutions, Inc.(12)Leisure, Amusement, Motion Pictures, Entertainment

          

          

          Senior Subordinated Bond  Senior Subordinated Second Lien PIK Notes13.0% Cash, Due 4/14

          

          

          

          1,314,459

          

          

          

          1,314,459

          

          

          

          1,314,459Perseus Holding Corp.(7)Leisure, Amusement, Motion Pictures, Entertainment

          

          

          Preferred Stock  Preferred Stock14.0% Cash

          

          

          

          400,000

          

          

          

          400,000

          

          

          

          356,960QA Direct Holdings, LLC(6)Printing and Publishing

          

          

          Senior Secured Loan  Term Loan8.3% Cash, Due 8/14

          

          

          

          4,396,024

          

          

          

          4,372,508

          

          

          

          4,396,024Resco Products, Inc.Mining, Steel, Iron and Non-Precious Metals

          

          

          Junior Secured Loan  Term Loan (Second Lien)12.0% Cash, 8.0% PIK, Due 6/14

          

          

          

          2,078,079

          

          

          

          2,078,079

          

          

          

          2,078,079Resco Products, Inc.(6)Mining, Steel, Iron and Non-Precious Metals

          

          

          Junior Secured Loan  Term Loan (Second Lien)12.0% Cash, 8.0% PIK, Due 6/14

          

          

          

          7,193,458

          

          

          

          7,079,981

          

          

          

          7,193,458Specialized Technology Resources, Inc.(6)Diversified/Conglomerate Service

          

          

          Junior Secured Loan  Loan (Second Lien)7.3% Cash, Due 12/14

          

          

          

          7,500,000

          

          

          

          7,500,000

          

          

          

          7,500,000TUI University, LLC(6)Healthcare, Education and Childcare

          

          

          Senior Secured Loan  Term Loan (First Lien)3.3% Cash, Due 10/14

          

          

          

          3,119,818

          

          

          

          3,033,934

          

          

          

          2,958,212Walker Group Holdings LLCCargo Transport

          

          

          Junior Secured Loan  Term Loan B13.3% Cash, Due 12/13

          

          

          

          470,643

          

          

          

          470,643

          

          

          

          470,643Walker Group Holdings LLC(6)Cargo Transport

          

          

          Junior Secured Loan  Term Loan B13.3% Cash, Due 12/13

          

          

          

          4,469,539

          

          

          

          4,469,539

          

          

          

          4,469,539
 F-14    TABLE OF CONTENTS Portfolio Company/Principal Business

          

          Investment Interest Rate(1)/Maturity

          

          Principal

          

          Cost

          

          Value(2)Wesco Aircraft Hardware Corp.Aerospace and Defense

          

          

          Junior Secured Loan  Loan (Second Lien)6.0% Cash, Due 3/14

          

          

          $

          1,720,000

          

          

          $

          1,679,298

          

          

          $

          1,720,000Wesco Aircraft Hardware Corp.(6)Aerospace and Defense

          

          

          Junior Secured Loan  Loan (Second Lien)6.0% Cash, Due 3/14

          

          

          

          3,554,283

          

          

          

          3,569,258

          

          

          

          3,554,283Total Investment in Debt Securities (49% of net asset value at fair value)

          

          

          

          

          

          $

          130,939,851

          

          

          $

          126,545,510

          

          

          $

          91,042,928
 Equity Portfolio  Portfolio Company/Principal Business

          

          Investment

          

          Percentage Interest/Shares

          

          Cost

          

          Value(2)Aerostructures Holdings L.P.(7)Aerospace and Defense

          

          

          Partnership Interests

          

          

          

          1.2

          %

          

          $

          1,000,000

          

          

          $

          88,600Aerostructures Holdings L.P.(7)Aerospace and Defense

          

          

          Series A Preferred Interests

          

          

          

          1.2

          %

          

          

          250,961

          

          

          

          250,961Bankruptcy Management Solutions, Inc.(6),(7)Diversified/Conglomerate Service

          

          

          Warrants

          

          

          

          0.1

          %

          

          

          

          

          

          

          Coastal Concrete Holding II, LLC(7)Buildings and Real Estate(4)

          

          

          Class A Units

          

          

          

          10.8

          %

          

          

          8,625,626

          

          

          

          250,143eInstruction Acquisition, LLC(7)Healthcare, Education and Childcare

          

          

          Membership Units

          

          

          

          1.1

          %

          

          

          1,079,617

          

          

          

          1,079,724FP WRCA Coinvestment Fund VII, Ltd.(3),(7)Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

          

          

          Class A Shares

          

          

          

          1,500

          

          

          

          1,500,000

          

          

          

          2,400,000International Architectural Products, Inc.(6),(7)Mining, Steel, Iron and Non-Precious Metals

          

          

          Common

          

          

          

          2.5

          %

          

          

          292,851

          

          

          

          227,223Legacy Cabinets, Inc.(6),(7)Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          Equity

          

          

          

          4.0

          %

          

          

          115,580

          

          

          

          49,422Perseus Holding Corp.(7)Leisure, Amusement, Motion Pictures, Entertainment

          

          

          Common

          

          

          

          0.2

          %

          

          

          400,000

          

          

          

          312,200Bankruptcy Management Solutions, Inc.(6),(7)Diversified/Conglomerate Service

          

          

          Common Stock

          

          

          

          1.2

          %

          

          

          218,592

          

          

          

          30,559Total Investment in Equity Securities (3% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          13,483,227

          

          

          $

          4,688,832
 CLO Fund Securities CLO Equity Investments  Portfolio Company

          

          Investment

          

          Percentage Interest

          

          Cost

          

          Value(2)Grant Grove CLO, Ltd.(3),(12)

          

          

          Subordinated Securities

          

          

          

          22.2

          %

          

          $

          4,720,982

          

          

          $

          3,150,000Katonah III, Ltd.(3),(12)

          

          

          Preferred Shares

          

          

          

          23.1

          %

          

          

          4,500,000

          

          

          

          470,000Katonah IV, Ltd.(3),(12)

          

          

          Preferred Shares

          

          

          

          17.1

          %

          

          

          3,150,000

          

          

          

          1,300,000Katonah V, Ltd.(3),(12),(13)

          

          

          Preferred Shares

          

          

          

          26.7

          %

          

          

          3,320,000

          

          

          

          1,000Katonah VII CLO Ltd.(3),(8),(12)

          

          

          Subordinated Securities

          

          

          

          16.4

          %

          

          

          4,500,000

          

          

          

          2,090,000Katonah VIII CLO Ltd(3),(8),(12)

          

          

          Subordinated Securities

          

          

          

          10.3

          %

          

          

          3,400,000

          

          

          

          1,690,000Katonah IX CLO Ltd(3),(8),(12)

          

          

          Preferred Shares

          

          

          

          6.9

          %

          

          

          2,000,000

          

          

          

          1,300,000Katonah X CLO Ltd (3),(8),(12)

          

          

          Subordinated Securities

          

          

          

          33.3

          %

          

          

          11,612,677

          

          

          

          8,820,000Katonah 2007-I CLO Ltd.(3),(8),(12)

          

          

          Preferred Shares

          

          

          

          100.0

          %

          

          

          29,987,959

          

          

          

          26,200,000Total Investment in CLO Equity Securities

          

          

          

          

          

          

          

          

          

          $

          67,191,618

          

          

          $

          45,021,000
 F-15    TABLE OF CONTENTS CLO Rated-Note Investment  Portfolio Company

          

          Investment

          

          Percentage Interest

          

          Cost

          

          Value(2)Katonah 2007-I CLO Ltd.(3),(8),(12)

          

          

          Class B-2L NotesPar Value of $44,674 5.2%, Due 1/00

          

          

          

          100.0

          %

          

          $

          1,088,582

          

          

          $

          8,010,000Total Investment in CLO Rated-Note

          

          

          

          

          

          

          

          

          

          $

          1,088,582

          

          

          $

          8,010,000Total Investment in CLO Fund Securities (28% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          68,280,200

          

          

          $

          53,031,000
 Asset Manager Affiliate  Portfolio Company / Principal Business

          

          Investment

          

          Percentage Interest

          

          Cost

          

          Value(2)Katonah Debt Advisors

          

          

          Asset Management Company

          

          

          

          100.0

          %

          

          $

          44,532,329

          

          

          $

          41,493,000Total Investment in Asset Manager Affiliate (22% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          44,532,329

          

          

          $

          41,493,000
 Time Deposits and Money Market Account  Time Deposits and Money Market Account

          

          Investment

          

          Yield

          

          Par / Cost

          

          Value(2)JP Morgan Asset Account

          

          

          Time Deposit

          

          

          

          0.03

          %

          

          $

          720,225

          

          

          $

          720,225JP Morgan Business Money Market Account(11)

          

          

          Money Market Account

          

          

          

          0.2

          %

          

          

          210,311

          

          

          

          210,311Total Investment in Time Deposit and Money Market Accounts (0% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          930,536

          

          

          $

          930,536Total Investments(5)(102% of net asset value at fair value)

          

          

          

          

          

          

          

          

          

          $

          253,771,802

          

          

          $

          191,186,296
  (1)

          A majority of the variable rate loans to the Companys portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at December 31, 2010. (2)

          Reflects the fair market value of all existing investments as of December 31, 2010, as determined by the Companys Board of Directors. (3)

          Non-U.S. company or principal place of business outside the U.S. (4)

          Buildings and real estate relate to real estate ownership, builders, managers and developers and excludes mortgage debt investments and mortgage lenders or originators. As of December 31, 2010, the Company had no exposure to mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities), companies providing mortgage lending or emerging markets investments either directly or through the Companys investments in CLO funds. (5)

          The aggregate cost of investments for federal income tax purposes is approximately $254 million. The aggregate gross unrealized appreciation is approximately $8 million, the aggregate gross unrealized depreciation is approximately $71 million, and the net unrealized depreciation is approximately $63 million. (6)

          Pledged as collateral for the secured revolving credit facility (see Note 6 to the financial statements). (7)

          Non-income producing. (8)

          An affiliate CLO Fund managed by Katonah Debt Advisors L.L.C. or its affiliate. (9)

          Loan or debt security is on non-accrual status and therefore is considered non-income producing. (10)

          Time deposit investment partially restricted under terms of the secured credit facility (see Note 6 to financial statements).
 F-16    TABLE OF CONTENTS (11)

          Money market account holding restricted cash for employee flexible spending accounts. (12)

          These securities were acquired in a transaction that was exempt from the registration requirements of the Securities Act of 1933, as amended (the Securities Act), pursuant to Rule 144A thereunder. These securities may be resold only in transactions that are exempt from the registration requirements of the Securities Act, normally to qualified institutional buyers. (13)

          As of December 31, 2010, this CLO Fund securities were not providing a dividend distribution.
 F-17    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   FINANCIAL HIGHLIGHTS ($ per share)  For the Year Ended December 31,2011

          

          2010

          

          2009

          

          2008

          

          2007Per Share Data:Net asset value, at beginning of year

          

          $

          8.21

          

          

          $

          9.56

          

          

          $

          9.03

          

          

          $

          14.38

          

          

          $

          14.29Net investment income(1)

          

          

          0.70

          

          

          

          0.53

          

          

          

          0.83

          

          

          

          1.50

          

          

          

          1.27Net realized losses(1)

          

          

          (0.81

          )

          

          

          (0.79

          )

          

          

          (0.71

          )

          

          

          (0.03

          )

          

          

          0.01Net change in unrealized appreciation/depreciation on investments(1)

          

          

          0.37

          

          

          

          (0.54

          )

          

          

          1.19

          

          

          

          (6.80

          )

          

          

          0.12Net income

          

          

          0.26

          

          

          

          (0.80

          )

          

          

          1.31

          

          

          

          (5.33

          )

          

          

          1.40Net decrease in net assets resulting from distributionsFrom net investment income

          

          

          (0.69

          )

          

          

          (0.52

          )

          

          

          (0.84

          )

          

          

          (1.43

          )

          

          

          (1.36

          )In excess of net investment income

          

          

          

          

          

          

          (0.14

          )

          

          

          (0.08

          )

          

          

          (0.01

          )

          

          

          (0.04

          )Net decrease in net assets resulting from distributions

          

          

          (0.69

          )

          

          

          (0.66

          )

          

          

          (0.92

          )

          

          

          (1.44

          )

          

          

          (1.40

          )Net increase in net assets relating to stock-based transactionsIssuance of common stock (not including DRIP)

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          1.26

          

          

          

          Issuance of common stock under dividend reinvestment plan

          

          

          0.04

          

          

          

          0.07

          

          

          

          0.10

          

          

          

          0.12

          

          

          

          0.06Stock based compensation expense

          

          

          0.03

          

          

          

          0.04

          

          

          

          0.04

          

          

          

          0.04

          

          

          

          0.03Net increase in net assets relating to stock-based transactions

          

          

          0.07

          

          

          

          0.11

          

          

          

          0.14

          

          

          

          1.42

          

          

          

          0.09Net asset value, end of year

          

          $

          7.85

          

          

          $

          8.21

          

          

          $

          9.56

          

          

          $

          9.03

          

          

          $

          14.38Total net asset value return(2)

          

          

          4.0

          %

          

          

          (7.1

          )%

          

          

          16.0

          %

          

          

          (27.2

          )%

          

          

          10.4

          %Ratio/Supplemental Data:Per share market value at beginning of year

          

          $

          6.97

          

          

          $

          4.56

          

          

          $

          3.64

          

          

          $

          12.00

          

          

          $

          17.30Per share market value at end of year

          

          $

          6.31

          

          

          $

          6.97

          

          

          $

          4.56

          

          

          $

          3.64

          

          

          $

          12.00Total market return(3)

          

          

          0.4

          %

          

          

          67.6

          %

          

          

          50.5

          %

          

          

          (57.7

          )%

          

          

          (22.5

          )%Shares outstanding at end of year

          

          

          22,992,211

          

          

          

          22,767,130

          

          

          

          22,363,281

          

          

          

          21,771,186

          

          

          

          18,017,699Net assets at end of year

          

          $

          180,525,942

          

          

          $

          186,925,667

          

          

          $

          213,895,724

          

          

          $

          196,566,018

          

          

          $

          259,068,164Portfolio turnover rate

          

          

          24.5

          %

          

          

          3.4

          %

          

          

          3.2

          %

          

          

          14.4

          %

          

          

          24.7

          %Average debt outstanding

          

          $

          53,974,098

          

          

          $

          154,952,070

          

          

          $

          236,184,703

          

          

          $

          248,300,441

          

          

          $

          105,616,438Average debt outstanding per share

          

          $

          2.35

          

          

          $

          6.81

          

          

          $

          10.56

          

          

          $

          11.41

          

          

          $

          5.86Asset coverage ratio

          

          

          401

          %

          

          

          315

          %

          

          

          198

          %

          

          

          175

          %

          

          

          202

          %Ratio of net investment income to average net assets

          

          

          8.1

          %

          

          

          5.8

          %

          

          

          8.7

          %

          

          

          12.0

          %

          

          

          8.6

          %Ratio of total expenses to average net assets

          

          

          6.0

          %

          

          

          8.5

          %

          

          

          7.4

          %

          

          

          7.2

          %

          

          

          5.9

          %Ratio of interest expense to average net assets

          

          

          2.3

          %

          

          

          3.4

          %

          

          

          4.4

          %

          

          

          4.3

          %

          

          

          2.7

          %Ratio of non-interest expenses to average net assets

          

          

          3.7

          %

          

          

          5.0

          %

          

          

          3.0

          %

          

          

          3.0

          %

          

          

          3.2

          %
  (1)

          Based on weighted average number of common shares outstanding for the period. (2)

          Total net asset value return (not annualized) equals the change in the net asset value per share over the beginning of period net asset value per share plus dividends, divided by the beginning net asset value per share. (3)

          Total market return equals the change in the ending market price over the beginning of period price per share plus dividends, divided by the beginning price.
 F-18    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION Kohlberg Capital Corporation (Kohlberg Capital or the Company) is an internally managed, non-diversified closed-end investment company that is regulated as a business development company (BDC) under the Investment Company Act of 1940. The Company originates, structures, and invests in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies. The Company defines the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization (EBITDA), of $10 million to $50 million and/or
total debt of $25 million to $150 million. The Company was formed as a Delaware limited liability company on August 8, 2006 and, prior to the issuance of shares of the Companys common stock in its initial public offering (IPO), converted to a corporation incorporated in Delaware on December 11, 2006. Prior to its IPO, the Company did not have material operations. The Companys IPO of 14,462,000 shares of common stock raised net proceeds of approximately $200 million. Prior to the IPO, the Company issued 3,484,333 shares to affiliates of Kohlberg & Co., L.L.C. (Kohlberg & Co.), a leading middle market private equity firm, in exchange for the contribution to the Company of their ownership interests in Katonah Debt Advisors, L.L.C., and related affiliates controlled by the Company (collectively, Katonah Debt Advisors) and in securities issued by collateralized loan obligation funds (CLO Funds) managed by Katonah Debt
Advisors and two other asset managers. As of December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of assets under management. The Companys investment objective is to generate current income and capital appreciation from investments made in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. The Company also expects to continue to receive distributions of recurring fee income and to generate capital appreciation from its investment in the asset management business of Katonah Debt Advisors. Katonah Debt Advisors manages CLO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments. The Companys investment portfolio as well as the investment portfolios of the CLO
Funds in which it has invested and the investment portfolios of the CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments and other securities issued by corporations and do not include any asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. The Company has elected to be treated as a regulated investment company (RIC) under Subchapter M of the Internal Revenue Code of 1986, as amended (the Code). To qualify as a RIC, the Company must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, the Company generally will not have to pay corporate-level taxes on any income that it distributes in a timely manner to its stockholders. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (GAAP). The financial statements reflect all adjustments, both normal and recurring which, in the opinion of management, are necessary for the fair presentation of the Companys results of operations and financial condition for the periods presented. Furthermore, the preparation of the financial statements requires management to make significant estimates and assumptions including the fair value of investments that do not have a readily available market value. Actual results could differ from those estimates, and the differences could be material. The results of operations for the interim periods presented are not necessarily indicative of the operating
results to be expected for the full year.
 F-19    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) In accordance with Article 6 of Regulation S-X under the Securities Act of 1933, as amended (the Securities Act), and the Securities Exchange Act of 1934, as amended (the Exchange Act), the Company does not consolidate portfolio company investments, including those in which it has a controlling interest (Katonah Debt Advisors, including related affiliates, is currently the only company in which the Company has a controlling interest). Effective January 1, 2010, Katonah Debt Advisors adopted guidance encompassed in Accounting Standards Codification Topic 810, Consolidation. Although the Company cannot consolidate
portfolio company investments, the adoption of this new guidance had an impact on the required disclosures relating to Katonah Debt Advisors, as it requires Katonah Debt Advisors to consolidate its managed CLO Funds that were not previously consolidated. As a result of the consolidation of these CLO Funds into Katonah Debt Advisors, Katonah Debt Advisors qualifies as a significant subsidiary and, as a result, the Company is required to include additional disclosure regarding Katonah Debt Advisors in its filings. The additional disclosures regarding Katonah Debt Advisors do not directly impact the financial operations or results of the Company. Accounting Standards Codification.  In June 2009, the Financial Accounting Standards Board (FASB) issued a pronouncement establishing the FASB Accounting Standards Codification (ASC) as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with GAAP. The ASC reorganized existing U.S. accounting and reporting standards issued by the FASB and other related private sector standard setters into a single source of authoritative accounting principles arranged by topic. The standard explicitly recognizes rules and interpretive
releases of the Commission under federal securities laws as authoritative GAAP for SEC registrants. The ASC supersedes all existing U.S. accounting standards; all other accounting literature not included in the ASC (other than SEC guidance for publicly-traded companies) is considered non-authoritative. The ASC was effective on a prospective basis for interim and annual reporting periods ending after September 15, 2009. The adoption of the ASC changed the Companys references to U.S. GAAP accounting standards but did not impact its results of operations, financial position or liquidity. Investments Investment transactions are recorded on the applicable trade date. Realized gains or losses are determined using the specific identification method. Valuation of Portfolio Investments.  The Companys Board of Directors is ultimately and solely responsible for making a good faith determination of the fair value of portfolio investments on a quarterly basis. Debt and equity securities for which market quotations are readily available are generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued by the Board of Directors based on detailed analyses prepared by management, the Valuation Committee of the Board of Directors, and, in certain circumstances, third parties with valuation
expertise. Valuations are conducted by management on 100% of the investment portfolio at the end of each quarter. The Company follows the provisions of ASC Fair Value Measurements and Disclosures (Fair Value Measurements and Disclosures). This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. Fair Value Measurements and Disclosures defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Subsequent to the adoption of Fair Value Measurements and Disclosures, the FASB has issued various staff positions clarifying the initial standard as noted below. In January 2010, the FASB issued guidance that clarifies and requires new disclosures about fair value measurements. The clarifications and requirement to disclose the amounts and reasons for significant transfers between Level 1 and Level 2, as well as significant transfers in and out of Level 3 of the fair value hierarchy, were adopted by the Company in the first quarter of 2010. Note 4 below reflects the amended disclosure requirements. The new guidance also requires that purchases, sales, issuances and settlements be presented
 F-20    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) gross in the Level III reconciliation and that requirement is effective for fiscal years beginning after December 15, 2010 and for interim periods within those years. The Company is evaluating the increased disclosure requirements for implementation by the effective date. Since this new guidance only amends the disclosures requirements, it did not impact our statements of financial position, statements of operations, or cash flow statements. Fair Value Measurements and Disclosures requires the disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period. In 2011 and 2010, the Company engaged an independent valuation firm, to provide a third-party review of our CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine CLO fair values, in the absence of Level 1 or Level 2 trading activity or observable market inputs. The independent valuation firm concluded that the Companys CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow for fair value purposes and that the inputs were being employed correctly. Beginning with the period ending June 30, 2011, the Company has engaged an independent valuation firm to provide third party valuation consulting services to the Companys Board of Directors. Each quarter, the independent valuation firm will perform third party valuations on the Companys investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. Third party valuations were performed on approximately 8% of investments at fair value as of December 31, 2011. These third party valuation estimates were considered as one of the relevant data inputs in the Companys determination of fair
value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process. The Board of Directors may consider other methods of valuation than those set forth above to determine the fair value of Level III investments as appropriate in conformity with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Companys investments may differ materially from the values that would have been used had a ready market existed for such investments. Further, such investments may be generally subject to legal and other restrictions on resale or otherwise be less liquid than publicly traded securities. In addition, changes in the
market environment and other events may occur over the life of the investments that may cause the value realized on such investments to be different from the currently assigned valuations. The Companys valuation methodology and procedures are as follows: 1)

          Each portfolio company or investment is cross-referenced to an independent pricing service to determine if a current market quote is available. The nature and quality of such quote is reviewed to determine reliability and relevance of the quote. Factors considered in this determination include whether the quote is from a transaction or is a broker quote, the date and aging of such quote, whether the transaction is arms-length, whether it is of a liquidation or distressed nature and certain other factors judged to be relevant by management within the framework of Fair Value Measurements and Disclosures. 2)

          If an investment does not have a market quotation on either a broad market exchange or from an independent pricing service, the investment is initially valued by the Companys investment professionals responsible for the portfolio investment in conjunction with the portfolio management team. 3)

          Preliminary valuation conclusions are discussed and documented by management.
 F-21    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) 4)

          Illiquid loans, junior and mezzanine securities, equity investments, CLO Fund securities and Katonah Debt Advisors may be selected for review by an independent valuation firm, which is engaged by the Companys Board of Directors. Such independent valuation firm reviews managements preliminary valuations and makes their own independent valuation assessment. 5)

          The Valuation Committee of the Board of Directors reviews the portfolio valuations, as well as the input and report of such independent valuation firm, as applicable. 6)

          Upon approval of the investment valuations by the Valuation Committee of the Board of Directors, the Audit Committee of the Board of Directors reviews the results for inclusion in the Companys quarterly and annual financial statements, as applicable. 7)

          The Board of Directors discusses the valuations and determines in good faith that the fair values of each investment in the portfolio is reasonable based upon any applicable independent pricing service, input of management, estimates from independent valuation firms (if any) and the recommendations of the Valuation Committee of the Board of Directors. The majority of the Companys investment portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a valuation of each individual investment that considers multiple levels of market and asset specific inputs, including historical and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest rates, and independent valuations and reviews. Loans and Debt Securities.  To the extent that the Companys investments are exchange traded and are priced or have sufficient price indications from normal course trading at or around the valuation date (financial reporting date), such pricing will determine fair value. Pricing service marks from third party pricing services may be used as an indication of fair value, depending on the volume and reliability of the marks, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading activity. However, most of the Companys investments are illiquid investments with little or
no trading activity. Further, the Company has been unable to identify directly comparable market indices or other market guidance that correlate directly to the types of investments the Company owns. As a result, for most of its assets, the Company determines fair value using alternative methodologies using available market data, as adjusted, to reflect the types of assets the Company owns, their structure, qualitative and credit attributes and other asset specific characteristics. The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using a present value technique that discounts the estimated contractual cash flows for the underlying assets with discount rates imputed by broad market indices, bond spreads and yields for comparable issuers relative to the subject assets (the Market Yield Approach) and also considers recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the
debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad market information related to its loan and debt investments. Because the Company has not identified any market index that directly correlates to the loan and debt investments held by the Company and therefore uses the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Market Yield Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is
subject to adjustment for many factors, including priority, collateral used as security,
 F-22    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other
fair value indications and given relatively less weight based on their relevancy. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments. Equity and Equity-Related Securities.  The Companys equity and equity-related securities in portfolio companies for which there is no liquid public market are carried at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including EBITDA and cash flows from operations less capital expenditures and other pertinent factors, such as recent offers to purchase a portfolio companys securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority ownership positions. The values of the
Companys equity and equity-related securities in public companies for which market quotations are readily available are based upon the closing public market prices on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security. The significant inputs used to determine the fair value of equity and equity-related securities include prices, earnings, EBITDA and cash flows after capital expenditures for similar peer comparables and the investment entity itself. Equity and equity related securities are classified as Level III, as described in Note 4 below, when there is limited activity or less transparency around inputs to the valuation given the lack of information related to such equity investments held in nonpublic companies. Significant assumptions observed for comparable companies are applied to relevant financial data for the specific investment. Such assumptions, such as
model discount rates or price/earnings multiples, vary by the specific investment, equity position and industry and incorporate adjustments for risk premiums, liquidity and company specific attributes. Such adjustments require judgment and may be material to the calculation of fair value. Affiliate Asset Manager.  The Companys investment in its wholly-owned asset management company, Katonah Debt Advisors, is carried at fair value, which is determined after taking into consideration a percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation includes an analysis of comparable asset management companies. Katonah Debt Advisors is classified as a Level III investment (as described
below). Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation. CLO Fund Securities.  The Company typically makes a minority investment in the most junior class of securities of CLO Funds raised and managed by Katonah Debt Advisors and may selectively invest in securities issued by funds managed by other asset management companies (collectively CLO Fund securities). The Companys CLO Fund securities relate exclusively to credit instruments issued by corporations and do not include any asset-backed securities secured by commercial mortgages, residential mortgages, or consumer borrowings. The Companys investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds that are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay down CLO Fund debt (or will begin to do so shortly), and for which there continue to be net cash distributions to the class of securities owned by the Company, or (ii) a discounted cash flow model
for more recent CLO Funds that utilizes prepayment and loss assumptions based on historical
 F-23    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested. The Company recognizes unrealized appreciation or depreciation on the Companys investments in CLO Fund securities as comparable yields in the market change and/or based on changes in NAVs or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in
the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund investment. The Company determines the fair value of its investments in CLO Fund securities on an individual security-by-security basis. Due to the individual attributes of each CLO Fund security, they are classified as a Level III investment unless specific trading activity can be identified at or near the valuation date. When available, observable market information will be identified, evaluated and weighted accordingly in the application of such data to the present value models and fair value determination. Significant assumptions to the present value calculations include default rates, recovery rates, prepayment rates, investment/reinvestment rates and spreads and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly,
depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund securitys underlying assets, historic, current and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented. For bond rated tranches of CLO Fund securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes. Such adjustments
require judgment and may be material to the calculation of fair value. Cash.  The Company defines cash as demand deposits. The Company places its cash with financial institutions and, at times, cash held in checking accounts may exceed the Federal Deposit Insurance Corporation insured limit. Restricted Cash.  Restricted cash at December 31, 2010 consisted mostly of cash held in an operating account pursuant to the Companys secured credit facility agreement with its lender. As the Company paid off its secured credit facility as of January 31, 2011, no such restricted cash balances were needed. Time Deposits and Money Market Accounts.  Time deposits primarily represent investments of cash held in non-demand deposit accounts. Money market accounts primarily represent short term interest-bearing deposit accounts including an account that contains restricted cash held for employee flexible spending accounts. Interest Income.  Interest income, including the amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan or security on non-accrual status and ceases recognizing cash interest income on such loan or security when a loan or security becomes 90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until
 F-24    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of December 31, 2011, three issuers representing less than 1% of total investments at fair value were considered in default. Dividends from Affiliate Asset Manager.  The Company records dividend income from its affiliate asset manager on the declaration date, which represents the ex-dividend date. Dividend Income from CLO Fund Securities.  The Company generates dividend income from its investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by Katonah Debt Advisors and selective investments in securities issued by funds managed by other asset management companies. The Companys CLO Fund junior class securities are subordinated to senior bond holders who typically receive a fixed rate of return on their investment. The CLO Funds are leveraged funds and any excess cash flow or excess spread (interest earned by the underlying
securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is paid to the holders of the CLO Funds subordinated securities or preferred shares. The Company makes estimated interim accruals of such dividend income based on recent historical distributions and CLO Fund performance and adjusts such accruals on a quarterly basis to reflect actual distributions. For non-junior class CLO Fund securities, such as the Companys investment in the Class B-2L Notes of the Katonah 2007-1 CLO, interest is earned at a fixed spread relative to the LIBOR index. Capital Structuring Service Fees.  The Company may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities. Generally, the Company will capitalize loan origination fees, then amortize these fees into interest income over the term of the loan using the effective interest rate method, recognizes prepayment and liquidation fees upon receipt and equity structuring fees as earned, which generally occurs when an investment transaction closes. Debt Issuance Costs.  Debt issuance costs represent fees and other direct costs incurred in connection with the Companys borrowings. These amounts are capitalized and amortized ratably over the contractual term of the borrowing. In January 31, 2011, the Company fully repaid its outstanding secured credit borrowing facility which had a balance of $86.7 million as of December 31, 2010 and, at repayment, all related debt issuance costs were fully amortized. During March 2011, the Company issued $60 million of convertible senior notes (the Convertible Senior Notes) and incurred debt issuance costs of
approximately $2.4 million which will be amortized over a five-year period. At December 31, 2011, there was an unamortized debt issuance cost of approximately $2.0 million included in other assets in the accompanying balance sheet. Amortization expense for the year ended December 31, 2011 and 2010 was approximately $353,000 and $596,000, respectively. Expenses.  The Company is internally managed and expenses costs, as incurred, with regard to the running of its operations. Primary operating expenses include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing the Companys investments and related overhead charges and expenses, including rental expense, and any interest expense incurred in connection with borrowings. The Company and its asset manager affiliates share office space and certain other operating expenses. The Company has entered into an Overhead Allocation Agreement with its asset manager
affiliates which provides for the sharing of such expenses based on an equal sharing of office lease costs and the ratable usage of other shared resources. The aggregate net payments of such expenses under the Overhead Allocation Agreement are not material. Dividends.  Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is generally based upon the earnings estimated by management for the period and year.
 F-25    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) The Company has adopted a dividend reinvestment plan that provides for reinvestment of its distributions on behalf of its stockholders, unless a stockholder opts out of the plan to receive cash in lieu of having their cash dividends automatically reinvested in additional shares of the Companys common stock. Recent Accounting Pronouncements Improved Disclosures Regarding Fair Value Measurements.  In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Improving Disclosures About Fair Value Measurements (Topic 820), which provides for improving disclosures about fair value measurements, primarily significant transfers in and out of Levels I and II, and activity in Level III fair value measurements. The new disclosures and clarifications of existing disclosures are effective for the interim and annual reporting periods beginning after December 15, 2009, while the disclosures about the purchases, sales, issuances, and
settlements in the roll forward activity in Level 3 fair value measurements are effective for fiscal years beginning after December 15, 2010 and for the interim periods within those fiscal years. Except for certain detailed Level III disclosures, which are effective for fiscal years beginning after December 15, 2010 and interim periods within those years, the new guidance became effective for the Companys fiscal 2010 second quarter. The adoption of this disclosure-only guidance is included in Note 4  Portfolio Investments and did not have a material impact on the Companys financial results. In May 2011, the FASB issued FASB Accounting Standards Update (ASU) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRS. The
amendments in this ASU are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011. Management currently believes that the adoption of this ASU will not have a material impact on the Companys operating results, financial position or cash flows. 3. EARNINGS (LOSSES) PER SHARE The following information sets forth the computation of basic and diluted net increase (decrease) in stockholders equity per share for the years ended December 31, 2011, 2010, and 2009:  For the Years ended December 31,2011

          

          2010

          

          2009Net increase (decrease) in net assets from operations

          

          $

          7,649,544

          

          

          $

          (14,288,677

          )

          

          $

          34,403,270Net increase (decrease) in net assets available to common stockholders

          

          

          7,649,544

          

          

          

          (14,288,677

          )

          

          

          34,403,270Weighted average number of common shares outstanding for basic shares computation

          

          

          22,868,647

          

          

          

          22,598,185

          

          

          

          22,105,800Effect of dilutive securities  stock options

          

          

          

          

          

          

          

          

          

          

          Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation

          

          

          22,868,647

          

          

          

          22,598,185

          

          

          

          22,105,800Net increase (decrease) in net assets per basic common shares:Net increase (decrease) in Net assets from operations(1)

          

          

          0.33

          

          

          

          (0.63

          )

          

          

          1.56
 F-26    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 3. EARNINGS (LOSSES) PER SHARE   (continued) Share-based awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and included in the computation of both basic and diluted earnings per share. Grants of restricted stock awards to our employees and directors are considered participating securities when there are earnings in the period and the earnings per share calculations include outstanding unvested restricted stock awards in the basic weighted average shares outstanding calculation. Included in the weighted average shares outstanding for the year ended December 31, 2011 are 305,221 shares of unvested restricted stock,
which were deemed to be participating securities. Options to purchase 20,000 shares were included in the computation of diluted earnings per share for the year ended December 31, 2011. For the year ended December 31, 2010, options to purchase 40,000 shares were not included in the computation of diluted earnings per share because the effect would be antidilutive as the exercise prices exceeded the average market price of the common shares. The Companys Convertible Senior Notes are included in the computation of the diluted net increase or decrease in net assets resulting from operations per share in accordance with ASC 261-10-45-40-b by application of the if-converted method. Under the if-converted method, interest charges applicable to the convertible debt for the period are added to the reported net increase or decrease in net assets resulting from operations and the full amount of shares (pro-rata if not outstanding for the full period) that would be issued are added to weighted average basic shares. Convertible debt is considered anti-dilutive only when its
interest per share upon conversion exceeds the basic net increase or decrease in net assets resulting from operations per share. For the year ended December 31, 2011, the convertible debt is anti-dilutive. The if-converted method of computing the dilutive effects on convertible debt assumes a conversion even if the contracted conversion price exceeds the market value of the shares. The Companys Convertible Senior Notes have a conversion price of $8.44 per share which was above the Companys net asset value per share at the time of issuance. Upon conversion, the Company would issue the full amount of common stock upon conversion and retire the full amount of debt outstanding. On February 29, 2012, the Company completed the acquisition of Trimaran Advisors, L.L.C. (Trimaran) through a newly-formed, wholly-owned subsidiary of the Company. The aggregate consideration paid for all of the outstanding equity interests in Trimaran consisted of $13.0 million in cash and 3,600,000 shares of common stock, par value $0.01 per share, of the Company. The change in the number of common shares outstanding at December 31, 2011 as if this acquisition had closed prior to year end would be an increase of 3,600,000 common shares to a total outstanding share amount of 26,367,130.
 F-27    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS The Company invests in senior secured loans and mezzanine debt and, to a lesser extent, equity capital of middle market companies in a variety of industries. The Company generally targets companies that generate positive cash flows because the Company looks to cash flows as the primary source for servicing debt. However, the Company may invest in other industries if it is presented with attractive opportunities. The following table shows the Companys portfolio by security type at December 31, 2011 and December 31, 2010:  December 31, 2011

          

          December 31, 2010Security Type

          

          Cost

          

          Fair Value

          

          %

          

          Cost

          

          Fair Value

          

          %Time Deposits

          

          $

          229,152

          

          

          $

          229,152

          

          

          

          

          %

          

          $

          720,225

          

          

          $

          720,225

          

          

          

          

          %Money Market Account

          

          

          31,622,134

          

          

          

          31,622,134

          

          

          

          18

          

          

          

          210,311

          

          

          

          210,311

          

          

          

          Senior Secured Loan

          

          

          54,045,184

          

          

          

          45,259,328

          

          

          

          25

          

          

          

          34,183,551

          

          

          

          22,001,256

          

          

          

          12Junior Secured Loan

          

          

          58,936,728

          

          

          

          47,300,172

          

          

          

          26

          

          

          

          76,896,867

          

          

          

          63,944,003

          

          

          

          34Mezzanine Investment

          

          

          10,931,428

          

          

          

          11,588,115

          

          

          

          6

          

          

          

          10,744,496

          

          

          

          250,000

          

          

          

          Senior Subordinated Bond

          

          

          9,997,898

          

          

          

          10,125,891

          

          

          

          6

          

          

          

          4,320,596

          

          

          

          4,490,709

          

          

          

          3CLO Fund Securities

          

          

          65,209,809

          

          

          

          46,412,000

          

          

          

          26

          

          

          

          68,280,200

          

          

          

          53,031,000

          

          

          

          28Equity Securities

          

          

          16,559,610

          

          

          

          6,040,895

          

          

          

          3

          

          

          

          13,232,266

          

          

          

          4,437,871

          

          

          

          3Preferred

          

          

          400,000

          

          

          

          400,000

          

          

          

          

          

          

          

          650,961

          

          

          

          607,921

          

          

          

          Affiliate Asset Managers

          

          

          44,338,301

          

          

          

          40,814,000

          

          

          

          23

          

          

          

          44,532,329

          

          

          

          41,493,000

          

          

          

          22Total

          

          $

          292,270,244

          

          

          $

          239,791,687

          

          

          

          133

          %

          

          $

          253,771,802

          

          

          $

          191,186,296

          

          

          

          102

          %
  (1)

          Calculated as a percentage of net asset value
 F-28    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) The industry concentrations, based on the fair value of the Companys investment portfolio as of December 31, 2011 and December 31, 2010, were as follows:  December 31, 2011

          

          December 31, 2010Industry Classification

          

          Cost

          

          Fair Value

          

          %(1)

          

          Cost

          

          Fair Value

          

          %(1)Aerospace and Defense

          

          $

          19,683,821

          

          

          $

          19,439,230

          

          

          

          10

          %

          

          $

          6,499,518

          

          

          $

          5,613,844

          

          

          

          3

          %Asset Management Company(2)

          

          

          44,338,301

          

          

          

          40,814,000

          

          

          

          23

          

          

          

          44,532,329

          

          

          

          41,493,000

          

          

          

          22Beverage, Food and Tobacco

          

          

          9,892,274

          

          

          

          9,796,565

          

          

          

          5

          

          

          

          

          

          

          

          

          

          

          

          Broadcasting and Entertainment(3)

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          Buildings and Real Estate

          

          

          18,591,674

          

          

          

          662,443

          

          

          

          

          

          

          

          32,845,509

          

          

          

          6,923,964

          

          

          

          4Cargo Transport

          

          

          4,374,350

          

          

          

          4,374,351

          

          

          

          2

          

          

          

          4,940,182

          

          

          

          4,940,182

          

          

          

          3Chemicals, Plastics and Rubber

          

          

          4,809,459

          

          

          

          4,614,828

          

          

          

          3

          

          

          

          

          

          

          

          

          

          

          

          CLO Fund Securities

          

          

          65,209,809

          

          

          

          46,412,000

          

          

          

          26

          

          

          

          68,280,200

          

          

          

          53,031,000

          

          

          

          28Containers, Packaging and Glass

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          3,009,682

          

          

          

          3,000,000

          

          

          

          2Diversified/Conglomerate Manufacturing

          

          

          6,905,447

          

          

          

          7,000,000

          

          

          

          4

          

          

          

          

          

          

          

          

          

          

          

          Diversified/Conglomerate Service

          

          

          2,870,642

          

          

          

          372,599

          

          

          

          

          

          

          

          10,384,036

          

          

          

          8,345,287

          

          

          

          4Electronics

          

          

          8,831,440

          

          

          

          9,026,186

          

          

          

          5

          

          

          

          3,006,137

          

          

          

          3,176,250

          

          

          

          2Healthcare, Education and Childcare

          

          

          20,956,582

          

          

          

          19,523,824

          

          

          

          11

          

          

          

          15,113,551

          

          

          

          15,037,936

          

          

          

          8Home and Office Furnishings, Housewares, and Durable Consumer Products

          

          

          21,683,112

          

          

          

          20,604,850

          

          

          

          11

          

          

          

          9,654,903

          

          

          

          8,804,450

          

          

          

          5Insurance

          

          

          4,919,522

          

          

          

          3,753,000

          

          

          

          2

          

          

          

          4,890,322

          

          

          

          4,049,000

          

          

          

          2Leisure, Amusement, Motion Pictures, Entertainment

          

          

          2,290,892

          

          

          

          2,084,012

          

          

          

          1

          

          

          

          2,114,458

          

          

          

          1,983,619

          

          

          

          1Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

          

          

          3,483,174

          

          

          

          3,891,900

          

          

          

          2

          

          

          

          3,477,696

          

          

          

          3,864,600

          

          

          

          2Mining, Steel, Iron and Non-Precious Metals

          

          

          797,091

          

          

          

          438,913

          

          

          

          

          

          

          

          14,381,863

          

          

          

          14,430,312

          

          

          

          8Personal and Non Durable Consumer Products (Mfg. Only)

          

          

          5,000,000

          

          

          

          3,250,000

          

          

          

          2

          

          

          

          5,000,000

          

          

          

          3,435,000

          

          

          

          2Personal, Food and Miscellaneous Services

          

          

          2,872,500

          

          

          

          2,827,359

          

          

          

          2

          

          

          

          14,730,350

          

          

          

          4,090,000

          

          

          

          2Personal Transportation

          

          

          2,993,092

          

          

          

          2,983,648

          

          

          

          2

          

          

          

          

          

          

          

          

          

          

          

          Printing and Publishing

          

          

          1,044,539

          

          

          

          1,223,743

          

          

          

          1

          

          

          

          5,980,529

          

          

          

          5,669,716

          

          

          

          3Retail Stores

          

          

          1,885,086

          

          

          

          1,932,500

          

          

          

          1

          

          

          

          

          

          

          

          

          

          

          

          Telecommunications

          

          

          2,986,151

          

          

          

          2,776,950

          

          

          

          2

          

          

          

          

          

          

          

          

          

          

          

          Time Deposit and Money Market Accounts

          

          

          31,851,286

          

          

          

          31,851,286

          

          

          

          18

          

          

          

          930,537

          

          

          

          930,536

          

          

          

          Utilities

          

          

          4,000,000

          

          

          

          137,500

          

          

          

          

          

          

          

          4,000,000

          

          

          

          2,367,600

          

          

          

          1Total

          

          $

          292,270,244

          

          

          $

          239,791,687

          

          

          

          133

          %

          

          $

          253,771,802

          

          

          $

          191,186,296

          

          

          

          102

          %
  (1)

          Calculated as a percentage of net asset value. (2)

          Represents Katonah Debt Advisors and related asset manager affiliates. (3)

          Buildings and real estate relate to real estate ownership, builders, managers and developers and excludes mortgage debt investments and mortgage lenders or originators. As of December 31, 2011 and December 31, 2010, the Company had no exposure to mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities) or companies providing mortgage lending.
 F-29    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) The Company may invest up to 30% of the investment portfolio in opportunistic investments in high-yield bonds, debt and equity securities of CLO Funds, distressed debt or equity securities of public companies. However, the Companys investment strategy is to limit the value of its investments in debt or equity securities issued by CLO Funds to not more than 15% of the value of its total investment portfolio at the time of investment. The Company expects that these public companies generally will have debt that is non-investment grade. The Company also may invest in debt of middle market companies located outside of the United States, which
investments (excluding the Companys investments in CLO Funds) are generally not anticipated to be in excess of 10% of the investment portfolio at the time such investments are made. The Company is generally prohibited from buying or selling any security from or to any portfolio company of a private equity fund managed by Kohlberg & Co. without the prior approval of the SEC. In addition, the Company may co-invest on a concurrent basis with Kohlberg & Co. or any of its affiliates, subject to compliance with existing regulatory guidance, applicable regulations and its allocation procedures. Certain types of negotiated co-investments may be made only if the Company receives an order from the SEC permitting it to do so. There can be no assurance that any such order will be applied for or, if applied for, obtained. At December 31, 2011 and December 31, 2010, approximately 21% and 29% of the Companys investments were foreign assets (including the Companys investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 19% and 28% of its portfolio on such dates), respectively. At December 31, 2011, no foreign assets were in U.S. dollar denominated over-night time Eurodollar deposits which revert to cash each business morning. At December 31, 2011 and December 31, 2010, the Companys ten largest portfolio companies represented approximately 62% and 65%, respectively, of the total fair value of its investments. The Companys largest investment, Katonah Debt Advisors which is its wholly-owned asset manager affiliate, represented 17% and 22% of the total fair value of the Companys investments at December 31, 2011 and December 31, 2010, respectively. Excluding Katonah Debt Advisors and CLO Fund securities, the Companys ten largest portfolio companies represented approximately 26% and 30% of the total fair value of the Companys investments at
December 31, 2011 and December 31, 2010, respectively. Investment in CLO Fund Securities The Company typically makes a minority investment in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by Katonah Debt Advisors and may selectively invest in securities issued by funds managed by other asset management companies. However, as noted above, the Companys investment strategy is to limit the value of its investments in the debt or equity securities issued by CLO Funds to not more than 15% of the value of its total investment portfolio at the time of investment. Preferred shares or subordinated securities issued by CLO Funds are entitled to recurring dividend distributions
which generally equal the net remaining cash flow of the payments made by the underlying CLO Funds securities less contractual payments to senior bond holders and CLO Fund expenses. CLO Funds managed by Katonah Debt Advisors (CLO fund securities managed by affiliate) invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which the Company has an investment are generally diversified secured or unsecured corporate debt and exclude mortgage pools or mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset-backed securities), debt to companies providing mortgage lending and emerging markets investments. The CLO Funds are leveraged funds and any excess cash flow or excess spread (interest earned by the underlying securities in the fund less payments made to senior bond holders, fund
expenses and management fees) is paid to the holders of the CLO Funds subordinated securities or preferred shares.
 F-30    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) The subordinated securities and preferred share securities are considered equity positions in the CLO Funds and, as of December 31, 2011 and December 31, 2010, the Company had approximately $40 million and $45 million, respectively, of such CLO equity investments at fair value. The cost basis of the Companys investment in CLO Fund equity securities as of December 31, 2011 was approximately $64 million and aggregate unrealized depreciation on the CLO Fund securities totaled approximately $24 million. The cost basis of the Companys investment in CLO Fund equity securities as of December 31, 2010, was approximately $67 million and aggregate
unrealized depreciation on the CLO Fund securities totaled approximately $22 million. In May, 2009 the Company purchased the class B-2L notes of the Katonah 2007-1 CLO investment managed by Katonah Debt Advisors (Katonah 2007-1 B-2L). The Company purchased the Katonah 2007-1 B-2L for 10% of the par value. The fair value, cost basis, and aggregate unrealized appreciation of the Katonah 2007-1 B-2L investment as of December 31, 2011 were approximately $7 million, $1 million, and $6 million, respectively, and at December 31, 2010, the fair value, cost basis, and aggregate unrealized appreciation of the Katonah 2007-1 B-2L investment were $8 million, $1 million, and $7 million, respectively. Both the B-2L notes and preferred
shares of Katonah 2007-1 are owned 100% by the Company and are making their required quarterly distributions. All CLO Funds managed by Katonah Debt Advisors are currently making quarterly dividend distributions to the Company and are paying all senior and subordinate management fees to Katonah Debt Advisors. With the exception of the Katonah V, Ltd. CLO Fund, all third-party managed CLO Funds held as investments are making quarterly dividend distributions to the Company. Fair Value Measurements The Company follows the provisions of Fair Value Measurements and Disclosures, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. Fair Value Measurements and Disclosures defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of Fair Value Measurements and Disclosures, the FASB has issued various staff positions clarifying the initial standard (see Note 2. Significant Accounting
Policies  Investments). Fair Value Measurements and Disclosures establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date: Level I  Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by Fair Value Measurements and Disclosures, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.
 F-31    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) Level II  Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid corporate loans and bonds and less liquid, privately held or
restricted equity securities for which some level of recent trading activity has been observed. Level III  Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Companys own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other
financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investments level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Companys assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment. Substantially all of the Companys investments are classified as Level III. The Company evaluates the source of inputs, including any markets in which its investments are
trading, in determining fair value. Inputs that are backed by actual transactions, those that are highly correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a higher weighting in determining fair value. Ongoing reviews by the Companys investment analysts, Chief Investment Officer, Valuation Committee and independent valuation firms (if engaged) are based on an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors. The following table summarizes the fair value of investments by the above Fair Value Measurements and Disclosures fair value hierarchy levels as of December 31, 2011 and December 31, 2010, respectively:  As of December, 31 2011Level I

          

          Level II

          

          Level III

          

          TotalTime deposit and money market account

          

          $

          

          

          

          $

          31,851,286

          

          

          $

          

          

          

          $

          31,851,286Debt securities

          

          

          

          

          

          

          31,578,832

          

          

          

          83,094,674

          

          

          

          114,673,506CLO fund securities

          

          

          

          

          

          

          

          

          

          

          46,412,000

          

          

          

          46,412,000Equity securities

          

          

          

          

          

          

          

          

          

          

          6,040,895

          

          

          

          6,040,895Asset manager affiliate

          

          

          

          

          

          

          

          

          

          

          40,814,000

          

          

          

          40,814,000
  As of December, 31 2010Level I

          

          Level II

          

          Level III

          

          TotalTime deposit and money market account

          

          $

          

          

          

          $

          930,536

          

          

          $

          

          

          

          $

          930,536Debt securities

          

          

          

          

          

          

          

          

          

          

          91,042,928

          

          

          

          91,042,928CLO fund securities

          

          

          

          

          

          

          

          

          

          

          53,031,000

          

          

          

          53,031,000Equity securities

          

          

          

          

          

          

          

          

          

          

          4,688,832

          

          

          

          4,688,832Asset manager affiliate

          

          

          

          

          

          

          

          

          

          

          41,493,000

          

          

          

          41,493,000
 F-32    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) As a BDC, it is required that the Company invest primarily in the debt and equity of non-public companies for which there is little, if any, market-observable information. As a result, most, if not all, of the Companys investments at any given time will most likely be deemed Level III investments. The Company believes that investments classified as Level III for Fair Value Measurements and Disclosures have a further hierarchal framework which prioritizes and ranks such valuations based on the degree of independent and observable inputs, objectivity of data and models and the level of judgment required to adjust comparable data. The
hierarchy of such methodologies are presented in the above table and discussed below in descending rank. Investment values derived by a third party pricing service are deemed Level III values since such values are not traded on an active public exchange and may represent a traded or broker quote on an asset that is infrequently traded. The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using the Market Yield Approach and also considers recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as
benchmarks for broad market information related to its loan and debt investments. Because the Company has not identified any market index that directly correlates to the loan and debt investments held by the Company and therefore uses the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Market Yield Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted
along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. The appropriateness of specific valuation methods and techniques may change as market conditions and available data change. In 2011 and 2010, the Company engaged an independent valuation firm, to provide a third-party review of our CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine CLO fair values, in the absence of Level 1 or Level 2 trading activity or observable market inputs. The independent valuation firm concluded that the Companys CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow for fair value purposes and that the inputs were being employed correctly.
 F-33    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) Beginning with the period ending June 30, 2011, the Company has engaged an independent valuation firm to provide third party valuation consulting services to the Companys Board of Directors. Each quarter, the independent valuation firm will perform third party valuations on the Companys investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. Third party valuations were performed on approximately 8% of investments at fair value as of December 31, 2011. These third party valuation estimates were considered as one of the relevant data inputs in the Companys determination of fair
value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process. Values derived for debt securities using public/private company comparables generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as earnings or cash flows) for the private, underlying company/issuer. Such non-observable company/issuer data is typically provided on a monthly basis, is certified as correct by the management of the company/issuer and/or audited by an independent accounting firm on an annual basis. Since such private company/issuer data is not publicly available it is not deemed market-observable data and, as a result, such investment values are grouped as
Level III assets. Values derived for asset manager affiliates using public/private company comparables generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as assets under management, historical and prospective earnings) for the asset manager affiliate. The Company recognizes that comparable asset managers may not be fully comparable to its asset manager affiliates and typically identifies a range of performance measures and/or adjustments within the comparable population with which to determine value. Since any such ranges and adjustments are entity specific they are not considered
market-observable data and thus require a Level III grouping. Illiquid investments that have values derived through the use of discounted cash flow models and residual enterprise value models are grouped as Level III assets.
 F-34    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 4. INVESTMENTS   (continued) The changes in investments measured at fair value for which the Company has used unobservable inputs to determine fair value are as follows:  Year Ended December 31, 2011Debt Securities

          

          CLO Fund Securities

          

          Equity Securities

          

          Asset Manager Affiliates

          

          TotalBalance, December 31, 2010

          

          $

          91,042,928

          

          

          $

          53,031,000

          

          

          $

          4,688,832

          

          

          $

          41,493,000

          

          

          $

          190,255,760Transfers out of Level III(1)

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          Net accretion of discount

          

          

          156,180

          

          

          

          79,609

          

          

          

          

          

          

          

          

          

          

          

          235,789Purchases

          

          

          81,815,921

          

          

          

          

          

          

          

          3,218,151

          

          

          

          (194,027

          )

          

          

          84,840,045Sales

          

          

          (56,944,765

          )

          

          

          (1,935,000

          )

          

          

          (141,769

          )

          

          

          

          

          

          

          (59,021,534

          )Total loss realized and unrealized included in earnings

          

          

          (1,396,758

          )

          

          

          (4,763,609

          )

          

          

          (1,724,319

          )

          

          

          (484,973

          )

          

          

          (8,369,659

          )Balance, December 31, 2011

          

          $

          114,673,506

          

          

          $

          46,412,000

          

          

          $

          6,040,895

          

          

          $

          40,814,000

          

          

          $

          207,940,401Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date

          

          $

          (2,344,027

          )

          

          

          (4,198,609

          )

          

          

          (1,724,321

          )

          

          

          (1,703,973

          )

          

          

          (9,970,930

          )
  Year Ended December 31, 2010Debt Securities

          

          CLO Fund Securities

          

          Equity Securities

          

          Asset Manager Affiliates

          

          TotalBalance, December 31, 2009

          

          $

          297,356,529

          

          

          $

          48,971,000

          

          

          $

          4,713,246

          

          

          $

          58,064,720

          

          

          $

          409,105,495Transfers out of Level III(1)

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          Net accretion of discount

          

          

          381,677

          

          

          

          85,149

          

          

          

          

          

          

          

          

          

          

          

          466,826Purchases

          

          

          9,981,426

          

          

          

          

          

          

          

          1,927,366

          

          

          

          3,780,817

          

          

          

          15,689,609Sales

          

          

          (208,820,374

          )

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (208,820,374

          )Total gain (loss) realized and unrealized included in earnings

          

          

          (7,856,330

          )

          

          

          3,974,851

          

          

          

          (1,951,780

          )

          

          

          (20,352,537

          )

          

          

          (26,185,796

          )Balance, December 31, 2010

          

          $

          91,042,928

          

          

          $

          53,031,000

          

          

          $

          4,688,832

          

          

          $

          41,493,000

          

          

          $

          190,255,760Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date

          

          $

          (5,623,079

          )

          

          $

          3,974,851

          

          

          $

          (1,142,038

          )

          

          $

          (20,352,537

          )

          

          $

          (23,142,803

          )
  (1)

          Transfers out of Level III represent a transfer of $0 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of Dec 31, 2011 5. AFFILIATE ASSET MANAGERS Wholly-Owned Asset Manager Katonah Debt Advisors is a wholly-owned portfolio company. Katonah Debt Advisors manages CLO Funds primarily for third party investors that invest in broadly syndicated loans, high yield bonds and other credit instruments issued by corporations. These CLO Funds do not invest in asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. At December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of par value of assets under management, and the Companys 100% equity interest in Katonah Debt Advisors was valued at approximately $41 million.
 F-35    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 5. AFFILIATE ASSET MANAGERS   (continued) As a manager of the CLO Funds, Katonah Debt Advisors receives contractual and recurring management fees and may receive a one-time structuring fee from the CLO Funds for its management and advisory services. The annual fees which Katonah Debt Advisors receives are generally based on a fixed percentage of assets under management (at par value and not subject to changes in market value), and Katonah Debt Advisors generates annual operating income equal to the amount by which its fee income exceeds it operating expenses. The annual management fees Katonah Debt Advisors receives have two components  a senior management fee and a
subordinated management fee. Currently, all CLO Funds managed by Katonah Debt Advisors are paying both their senior and subordinated management fees on a current basis. During 2009, certain CLO funds managed by Katonah Debt Advisors were restricted from currently paying their subordinated management fees as a result of the failure by those CLO Funds to satisfy certain restrictive covenants contained in their indenture agreements. At such time, those subordinated management fees continued to be accrued by the applicable CLO Fund to become payable to Katonah Debt Advisors when such CLO Fund becomes compliant with the applicable covenants. During the year ended December 31, 2010, all those CLO Funds which deferred payment of their subordinated management fees regained compliance with all applicable covenants in order
to pay current subordinated management fees as well as a portion of previously accrued subordinated management fees. During the year ended December 31, 2010, approximately $5 million of deferred subordinated management fees had been paid. In future years, Katonah Debt Advisors may receive accrued incentive fees upon the liquidation of CLO Funds it manages, provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares. On January 2, 2008, the Katonah Debt Advisors platform acquired substantially all of the assets of Scotts Cove Capital Management LLC (Scotts Cove), an asset manager focused on an event-driven credit long short investment strategy. On February 4, 2011, Katonah Debt Advisors entered to an Asset Purchase Agreement with a third-party buyer controlled by a former Katonah Debt Advisors employee to sell substantially all of the Scotts Cove assets for a purchase price of $25,000. The transaction closed on February 28, 2011. At closing, Katonah Debt Advisors and the buyer entered into a Services Agreement, pursuant to which the
buyer paid to Katonah Debt Advisors $225,000 for certain transitional services to be provided by Katonah Debt Advisors (including access to office space, secretarial services and information technology support) and agreed to pay an additional amount of $75,000 on each of the first and second anniversaries of the closing date (subject to, in the case of the first payment, deferment for up to one year under certain circumstances). Katonah Debt Advisors obligation to provide transitional services under the Services Agreement continued through June 30, 2011. At closing, Katonah Debt Advisors and the employees that formerly managed the Scotts Cove assets also entered into employee termination agreements, whereby they agreed to terminate their employment with Katonah Debt Advisors and to relinquish all claims against Katonah Debt Advisors or its affiliates. The revenue that Katonah Debt Advisors generates through the fees it receives for managing CLO Funds and after paying the expenses associated with its operations, including compensation of its employees, may be distributed to the Company. Any distributions of Katonah Debt Advisors net income are recorded as dividends from affiliate asset manager are recorded as declared (where declaration date represents ex-dividend date) by Katonah Debt Advisors as income on our statement of operations. For the year ended December 31, 2011, Katonah Debt Advisors made distributions of $1.9 million to the Company. Dividends are recorded as declared (where
declaration date represents ex-dividend date) by Katonah Debt Advisors as income on our statement of operations. The declared fourth quarter dividend of $750,000 by Katonah Debt Advisors was recorded as a dividend receivable as of December 31, 2011.
 F-36    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 5. AFFILIATE ASSET MANAGERS   (continued) As with all other investments, Katonah Debt Advisors fair value is periodically determined. The valuation is primarily based on an analysis of both a percentage of its assets under management and Katonah Debt Advisors estimated operating income. Any change in value from period to period is recognized as unrealized gain or loss. See Note 2, Significant Accounting Policies and Note 4, Investments for further information relating to the Companys valuation methodology. For the year ended December 31, 2011 Katonah Debt Advisors had a decrease in fair value of approximately $679,000. As a separately regarded entity for tax purposes, Katonah Debt Advisors is taxed at normal corporate rates. For tax purposes, any distributions of taxable net income earned by Katonah Debt Advisors to the Company would generally need to be distributed to the Companys shareholders. Generally, such distributions of Katonah Debt Advisors income to the Companys shareholders will be considered as qualified dividends for tax purposes. Katonah Debt Advisors taxable net income will differ from GAAP net income because of deferred tax timing adjustments and permanent tax adjustments. Deferred tax timing adjustments may include
differences for the recognition and timing of depreciation, bonuses to employees and stock option expense. Permanent differences may include adjustments, limitations or disallowances for meals and entertainment expenses, penalties, tax goodwill amortization and net operating loss carryforward. Goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to the Companys IPO in exchange for shares of the Companys stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for GAAP purposes, such exchange was considered an asset purchase under Section 351(a) of the Code. At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which will be amortized for tax purposes on a straight-line basis
over 15 years, which accounts for an annual difference between GAAP income and taxable income by approximately $2 million per year over such period. At December 31, 2011 and December 31, 2010 there were no intercompany balances with our affiliates. 6. BORROWINGS The Companys debt obligations consist of the following:  As of December 31, 2011

          

          As of December 31, 2010Convertible Senior Notes, due March 15, 2016

          

          $

          60,000,000

          

          

          $

          Secured credit facility, due February 28, 2011(1)

          

          $

          

          

          

          $

          86,746,582
  (1)

          February 28, 2011 was the maturity date as established by a Forbearance and Settlement Agreement dated September 20, 2010 Secured Credit Facility At December 31, 2010, the Company had a secured credit facility with an outstanding balance of $86,746,582. On January 31, 2011, the Company repaid in full the outstanding balance under this facility, resulting in the lenders release to the Company of approximately $73 million of collateral previously securing the facility and their payment of a $2 million cash settlement to the Company.
 F-37    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 6. BORROWINGS   (continued) Convertible Senior Notes On March 16, 2011, the Company issued $55 million in aggregate principal amount of unsecured 8.75% convertible senior notes due 2016 (Convertible Senior Notes). On March 23, 2011, pursuant to an over-allotment option, the Company issued an additional $5 million of such Convertible Senior Notes for a total of $60 million in aggregate principal amount. The net proceeds for the Convertible Senior Notes, following underwriting expenses, were approximately $57.7 million. Interest on the Convertible Senior Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Notes mature on
March 15, 2016 unless converted earlier. The Convertible Senior Notes are senior unsecured obligations of the Company. The Convertible Senior Notes are convertible into shares of Companys common stock based on an initial conversion rate of 118.5255 shares of common stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price of approximately $8.44 per share of common stock. The conversion rate will be subject to adjustment upon certain events. Upon conversion, unless a holder converts after a record date for an interest payment but prior to the corresponding interest payment date, the holder will receive a separate cash payment with respect to the Convertible Senior Notes surrendered for conversion representing accrued and unpaid interest to, but not including the conversion date. Any such payment will be made on the settlement date applicable to the relevant conversion on the Convertible Senior Notes. No holder of Convertible Senior Notes will be entitled to receive shares of the Companys common stock upon conversion to the extent (but only to the extent) that such receipt would cause such converting holder to become, directly or indirectly, a beneficial owner (within the meaning of Section 13(d) of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder) of more than 5.0% of the shares of the Companys common stock outstanding at such time. The 5.0% limitation shall no longer apply following the effective date of any fundamental change. The Company will not issue any shares in connection with the
conversion or redemption of the Convertible Senior Notes which would equal or exceed 20% of the shares outstanding at the time of the transaction in accordance with NASDAQ rules. Subject to certain exceptions, holders may require us to repurchase, for cash, all or part of their Convertible Senior Notes upon a fundamental change at a price equal to 100% of the principal amount of the Convertible Senior Notes being repurchased plus any accrued and unpaid interest up to, but excluding, the fundamental change repurchase date.. In addition, in the case of certain fundamental changes and without duplication of the foregoing amount, the Company will also pay holders an amount in cash (or, in certain circumstances, shares of the Companys common stock) equal to the present value of the remaining interest payments on such notes
through, and including, the maturity date. In connection with the issuance of the Convertible Senior Notes, the Company incurred approximately $2.4 million of debt offering costs which are being amortized over the term of the facility on a straight-line basis, which approximates the effective yield method, of which approximately $2.0 million remains to be amortized. The Convertible Senior Notes have been analyzed for any features that would require its accounting to be bifurcated. There are no features that require accounting to be bifurcated, and as a result, they are recorded as a liability at their contractual amounts. For the period from March 11, 2011 (the date of issuance of the notes) to December 31, 2011, the Company recorded approximately $4.5 million of interest costs and amortization of financing costs as interest expense.
 F-38    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 6. BORROWINGS   (continued) Fair Value of Convertible Senior Notes.  The Company carries the Convertible Senior Notes at cost. The Convertible Senior Notes were issued in a private placement and there is no active trading of these notes. The fair value of the Companys outstanding Convertible Senior Notes was approximately $55.2 million at December 31, 2011. The fair value was determined based on the average of indicative bid and offer pricing for the Convertible Senior Notes. 7. DISTRIBUTABLE TAX INCOME Effective December 11, 2006, the Company elected to be treated as a RIC under the Code and adopted a December 31 calendar year end. As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Companys quarterly dividends, if any, are determined by the Board of Directors. The Company anticipates distributing at least 90% of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a federal
excise tax based on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2011). Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required. The Company anticipates timely distribution of its taxable income within the tax rules, and the Company anticipates that it will not incur a US federal excise tax for the calendar year 2011. The following reconciles net decrease in shareholders equity resulting from operations to taxable income for the year ended December 31, 2011:  Year Ended December 31,2011

          

          2010Net increase (decrease) in stockholders' equity resulting from operations

          

          $

          7,649,544

          

          

          $

          (14,288,677

          )Net change in unrealized (appreciation) depreciation from investments

          

          

          (10,106,949

          )

          

          

          8,322,812Excess capital losses over capital gains

          

          

          18,476,608

          

          

          

          17,862,984Income not on GAAP books currently taxable

          

          

          85,608

          

          

          

          241,110Income not currently taxable

          

          

          (89,793

          )

          

          

          (76,990

          )Expenses not currently deductible

          

          

          (120,240

          )

          

          

          347,883Expenses not on GAAP books currently deductible

          

          

          (3,978

          )

          

          

          (3,978

          )Taxable income before deductions for distributions

          

          $

          15,890,800

          

          

          $

          12,405,144Taxable income before deductions for distributions per weighted average shares for the period

          

          $

          0.69

          

          

          $

          0.55
 Taxable income differs from net increase (decrease) in stockholders equity resulting from operations primarily due to: (1) unrealized appreciation (depreciation) on investments, as investment gains and losses are not included in taxable income until they are realized; (2) amortization of discount on CLO Fund Securities; (3) amortization of organizational costs; (4) non-deductible expenses; (5) stock compensation expense that is not currently deductible for tax purposes; (6) excess of capital losses over capital gains; and (7) recognition of interest income on certain loans.
 F-39    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 7. DISTRIBUTABLE TAX INCOME   (continued) Distributions which exceed tax distributable income (tax net investment income and realized gains, if any) are reported as distributions of paid-in capital (i.e., return of capital). The tax character of distributions paid during the years ended December 31, 2011, 2010, and 2009 was as follows:  Year Ended December 31,2011

          

          2010

          

          2009Distributions paid from:Ordinary income

          

          $

          15,890,800

          

          

          $

          12,405,144

          

          

          $

          19,869,70815,890,800

          

          

          

          12,405,144

          

          

          

          19,869,708(Under distribution) Return of Capital

          

          

          (114,461

          )

          

          

          2,817,067

          

          

          

          333,017$

          15,776,339

          

          

          $

          15,222,211

          

          

          $

          20,202,725
 As of December 31, 2011 and 2010, the components of accumulated earnings on a tax basis were as follows:  Year Ended December 31,2011

          

          2010Distributable ordinary income

          

          $

          947,068

          

          

          $

          818,664Capital loss carryforward

          

          

          (50,501,419

          )

          

          

          (32,024,811

          )Net unrealized depreciation

          

          

          (52,478,555

          )

          

          

          (62,585,504

          )
 At December 31, 2011, the Company had a net capital loss carryforward of $51 million to offset net capital gains, to the extent provided by federal tax law. The capital loss carryforward will begin to expire in the tax year ending December 31, 2015. The Company adopted Financial Accounting Standards Board ASC Topic 740 Accounting for Uncertainty in Income Taxes (ASC 740) as of January 1, 2007. ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Companys tax returns to determine whether the tax positions are more-likely-than-not of being sustained by the applicable tax authority. The Company recognizes the tax benefits of uncertain tax positions only where the position
is more likely than not to be sustained assuming examination by tax authorities. Management has analyzed the Companys tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years (the last three fiscal years) or expected to be taken in the Companys current year tax return. The Company identifies its major tax jurisdictions as U.S. Federal and New York State, and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months. The adoption of ASC 740 did not have an effect on the financial position or results of operations of the Company as there was no liability for unrecognized tax benefits and no change to the beginning capital of the Company. Managements determinations regarding ASC 740 may be subject to review and adjustment
at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. 8. COMMITMENTS AND CONTINGENCIES The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Companys investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on the Companys balance sheet. Prior to extending such credit, the Company attempts to limit its credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of both December 31, 2011 and December 31, 2010, the Company had committed
to make a total of approximately $2 million of investments in various revolving
 F-40    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 8. COMMITMENTS AND CONTINGENCIES   (continued) senior secured loans, of which approximately $0 had been funded as of December 31, 2011 and $1 million had been funded as of December 31, 2010. As of December 31, 2011 and December 31, 2010, the Company had committed to make no investments in delayed draw senior secured loans. The Company and certain directors and officers were named as defendants in three putative class actions pending in the Southern District of New York brought by stockholders of the Company and filed in December 2009 and January 2010. The complaints in these three actions alleged violations of Sections 10 and 20 of the Exchange Act based on the Companys disclosures of its year-end 2008 and first- and second-quarter 2009 financial statements. The federal court consolidated the three lawsuits and appointed a lead plaintiff under the Private Securities Litigation Reform Act on March 21, 2011, and lead plaintiff filed a consolidated amended complaint
on May 11, 2011. The Company moved to dismiss the consolidated amended complaint. On July 28, 2011, the Court granted that motion and dismissed the consolidated amended complaint, giving the plaintiff until August 22, 2011 to file any further amended complaint. Lead plaintiff filed a second amended consolidated class action complaint on August 22, 2011, which defendants moved to dismiss. The Court dismissed that complaint with prejudice on October 7, 2011. The time for that Lead plaintiff to appeal the dismissal has now passed. In addition, the Company and certain directors and officers were also named as defendants in a derivative action filed on March 2, 2010 in the Supreme Court of New York, County of New York. The complaint in this action purported to state causes of action for breaches of fiduciary duties, unjust enrichment, abuse of control, gross mismanagement, and corporate waste. On October 20, 2010, the court dismissed the complaint, and found, among other things, that the plaintiff had not alleged that any of the Companys directors knowingly misrepresented or permitted others to misrepresent KCAPs financial condition, or that
the directors were confronted with red flags sufficient to put them on notice of potential problems with KCAPs investment valuations so as to excuse plaintiffs requirement under Delaware law to make a demand on KCAPs board before filing suit. On January 12, 2011, the court entered the final judgment dismissing the complaint. While plaintiff filed a timely notice of appeal, the time to perfect that appeal expired in November. On January 11, 2010, the staff of the SECs Division of Enforcement informed the Company that it was conducting an informal inquiry. The focus of the inquiry concerns the valuation methodology and procedures used by the Company to value its investments. On April 30, 2010, the SEC Staff advised the Company that a formal order of private investigation had been issued and that the informal inquiry was now a formal investigation. A subpoena has been issued to the Company in connection with the formal investigation. The subpoena requests that the Company produce documents that primarily relate to the valuation methodology and procedures used by the
Company to value its investments. Since January 2010, the Company has been providing documents in response to the informal inquiry and the subpoena, and the SEC Staff has taken testimony from Company representatives. The Company is cooperating fully with the SEC Staffs investigation. The Company cannot predict the outcome of, or the time frame for, the conclusion of this investigation. 9. STOCKHOLDERS EQUITY On April 28, 2008 the Company completed a rights offering which resulted in the issuance of 3.1 million common shares and net proceeds of approximately $27 million. During the year ended December 31, 2011 and December 31, 2010, the Company issued 141,278 and 301,663 shares, respectively, of common stock under its dividend reinvestment plan. For the year ended December 31, 2011, the Company issued 90,805 shares of restricted stock for which 3,668 shares were forfeited and 96,122 shares were converted to common stock during the year due to vesting. The total number of shares issued and outstanding as of December 31, 2011 was and 22,992,211,
respectively and shares issued and outstanding as of December 31, 2010 was 22,767,130.
 F-41    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 10. EQUITY INCENTIVE PLAN During 2006 and as amended in 2008, the Company established an equity incentive plan (the Plan) and reserved 2,000,000 shares of common stock for issuance under the Plan. The purpose of the Plan is to provide officers and prospective employees of the Company with additional incentives and align the interests of its employees with those of its shareholders. Options granted under the Plan are exercisable at a price equal to the fair market value (market closing price) of the shares on the day the option is granted. Restricted stock granted under the Plan is granted at a price equal to the fair market value (market closing price) of the
shares on the day such restricted stock is granted. Stock Options During the years ended December 31, 2009, and December 31, 2010, 20,000 options per year were granted to non-employee directors as partial annual compensation for their services as director. Each of these annual options grants have a vesting period by which 50% of such options vest on the grant date and 50% vest on the first grant date anniversary. The exercise price of these grants and other characteristics of these grants are as follows:  Options granted for the year ended:

          

          Exercise Price

          

          Exercise Period (years)

          

          Risk Free Rate

          

          Volatility Rate

          

          Weighted Average Grant Date Fair Value per ShareDecember 31, 2009

          

          $

          4.93

          

          

          

          10

          

          

          

          4.3

          %

          

          

          41

          %

          

          $

          0.90December 31, 2010

          

          $

          4.83

          

          

          

          10

          

          

          

          3.1

          %

          

          

          59

          %

          

          $

          1.46
 On June 10, 2011, the Companys shareholders approved the Amended and Restated Non-Employee Director Plan. Accordingly, the previous annual grant of 20,000 options to non-employee directors was discontinued and replaced with an annual grant of 4,000 shares of restricted stock as partial annual compensation for the services of the non-employee directors. Information with respect to options granted, exercised and forfeited under the Plan for the period January 1, 2010 through December 31, 2011 is as follows:  Shares

          

          Weighted Average Exercise Price per Share

          

          Weighted Average Contractual Remaining Term (years)

          

          Aggregate Intrinsic Value(1)Options outstanding at January 1, 2010

          

          

          40,000

          

          

          $

          8.45Granted

          

          

          20,000

          

          

          $

          4.83Exercised

          

          

          

          

          

          $

          Forfeited

          

          

          

          

          

          $

          Options outstanding at December 31, 2010

          

          

          60,000

          

          

          $

          7.24Granted

          

          

          

          

          

          $

          Exercised

          

          

          

          

          

          $

          Forfeited

          

          

          

          

          

          $

          Outstanding at December 31, 2011

          

          

          60,000

          

          

          $

          7.24

          

          

          

          7.5

          

          

          $

          57,200Total vested at December 31, 2011

          

          

          60,000

          

          

          $

          7.24

          

          

          

          7.5
  (1)

          Represents the difference between the market value of shares of the Company upon exercise of the options at December 31, 2011 and the cost for the option holders to exercise the options.
 F-42    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 10. EQUITY INCENTIVE PLAN   (continued) For the year ended December 31, 2011, 20,000 options with a weighted average grant date fair value of $4.88 vested during the period and 50,000 options issued at a weighted average grant date fair value of $7.73 remained unvested. For the year ended December 31, 2010, 10,000 options with a weighted average grant date fair value of $4.83 vested during the period and 60,000 options issued at a grant date fair value of $7.24 weighted average remained unvested. The Company uses a Binary Option Pricing Model (American, call option) to establish the expected value of all stock option grants. For the year ended December 31, 2011, the Company recognized non-cash compensation expense related to stock options of approximately $8,000. For the year ended December 31, 2010, the Company recognized non-cash compensation expense related to stock options of approximately $25,000. For the year ended December 31, 2009, the Company recognized non-cash compensation expense related to stock options of approximately $21,000. At December 31, 2011, the Company had no remaining compensation cost related to unvested stock-based
awards. Restricted Stock On June 13, 2008, the Companys shareholders approved the Plan, as amended and the Board of Directors approved the grant of awards of 100,250 shares of restricted stock to certain executive officers of the Company. On October 7, 2011 and July 22, 2010, the Board of Directors approved the grant of an additional 86,805 and 103,519 shares of restricted stock, respectively, to a certain executive officer of the Company. Such awards of restricted stock will vest as to 50% of the shares on the third anniversary of the grant date and the remaining 50% of the shares on the fourth anniversary of the grant date. On June 13, 2008, the Companys Board of Directors authorized the Company to allow employees who agree to cancel options that they hold to receive shares of the Company's common stock to receive 1 share of restricted stock for every 5 options so cancelled. The shares of restricted stock received by employees through any such transaction will vest annually generally over the remaining vesting schedule as was applicable to the cancelled options. Subsequently, employees holding options to purchase 1,295,000 shares individually entered into agreements to cancel such options and to receive 259,000 shares of restricted stock. As of December 31, 2011,
233,998 of such shares were vested and converted to common shares. The remaining 25,002 shares have been forfeited. On June 10, 2011, the Companys shareholders approved the Amended and Restated Non-Employee Director Plan, and the Board of Directors approved the grant of awards of 4,000 shares of restricted stock to the non-employee directors of the Company as partial annual compensation for their services as director. Such awards of restricted stock will vest as to 50% of the shares on the grant date and the remaining 50% of the shares on the first anniversary of the grant date.
 F-43    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 10. EQUITY INCENTIVE PLAN   (continued) During the year ended December 31, 2011, 96,122 shares of restricted stock were vested and converted to common shares. As of December 31, 2011, after giving effect to these option cancellations and restricted stock awards, there were options to purchase 60,000 shares of common stock outstanding and there were 327,339 shares of restricted stock outstanding. Information with respect to restricted stock granted, exercised and forfeited under the Plan for the period January 1, 2009 through December 31, 2011 is as follows:  Non-Vested Restricted Shares

          

          Weighted Average Exercise Price per ShareNon-vested shares outstanding at December 31, 2009

          

          

          302,139

          

          

          $

          9.63Granted

          

          

          103,519

          

          

          $

          4.83Vested

          

          

          (64,667

          )

          

          $

          10.39Forfeited

          

          

          (4,667

          )

          

          $

          9.82Non-vested shares outstanding at December 31, 2010

          

          

          336,324

          

          

          $

          8.01Granted

          

          

          90,805

          

          

          $

          8.11Vested

          

          

          (96,122

          )

          

          $

          11.16Forfeited

          

          

          (3,668

          )

          

          $

          9.67Outstanding at December 31, 2011

          

          

          327,339

          

          

          $

          6.46Total non-vested shares at December 31, 2011

          

          

          327,339

          

          

          $

          6.46
 For the year ended December 31, 2011, non-cash compensation expense related to restricted stock was approximately $766,000; of this amount approximately $677,000 was expensed at the Company and approximately $89,000 was a reimbursable expense allocated to Katonah Debt Advisors. For the year ended December 31, 2010, non-cash compensation expense related to restricted stock was approximately $894,000; of this amount approximately $654,000 was expensed at the Company and approximately $240,000 was a reimbursable expense allocated to Katonah Debt Advisors. For the year ended December 31, 2009 non-cash compensation expense related to restricted stock was
approximately $890,000; of this amount approximately $609,000 was expensed at the Company and approximately $281,000 was a reimbursable expense allocated to Katonah Debt Advisors. Dividends are paid on all outstanding shares of restricted stock, whether or not vested. In general, shares of unvested restricted stock are forfeited upon the recipients termination of employment. At December 31, 2011, the Company had approximately $1 million of total unrecognized compensation cost related to nonvested share-based awards. That cost is expected to be recognized over a weighted average period of 2.3 years. 11. OTHER EMPLOYEE COMPENSATION The Company adopted a 401(k) plan (401K Plan) effective January 1, 2007. The 401K Plan is open to all full time employees. The Plan permits an employee to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility. The Company makes contributions to the 401K Plan of up to 2.67% of the employees first 74.9% of maximum eligible compensation, which fully vest at the time of contribution. For the years ended December 31, 2011 and 2010, the Company made contributions to the 401K Plan of approximately $23,000 and $29,000, respectively. The Company has also adopted a deferred compensation plan (Profit-Sharing Plan) effective January 1, 2007. Employees are eligible for the Profit-Sharing Plan provided that they are employed and working with the Company for at least 100 days during the year and remain employed as of the last day of the year. Employees do not make contributions to the Profit-Sharing Plan. On behalf of the employee, the Company may contribute to the Profit-Sharing Plan 1) up to 8.0% of all compensation up to the Internal Revenue Service annual maximum and 2) up to 5.7% excess contributions on any incremental amounts above the social security wage base
limitation and up to the Internal Revenue Service annual maximum. Employees vest 100%
 F-44    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 11. OTHER EMPLOYEE COMPENSATION   (continued) in the Profit-Sharing Plan after five years of service. For the year ended December 31, 2011, the Company made contributions of approximately $139,000 to the Profit-Sharing Plan. 12. IMPACT OF NEW ACCOUNTING STANDARDS In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurements: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements (ASU 2011-04). ASU 2011-04 amends Topic 820 to clarify existing fair value measurement disclosures to (1) specifically provide quantitative information about the significant unobservable inputs used for all level 3 measurements and (2) disclose any transfers between levels 1 and 2 of the fair value hierarchy, not just significant transfers. ASU 2011-04 also requires a number of additional disclosures regarding fair value measurements. Specifically, ASU 2011-04 requires
entities to disclose: (1) a qualitative discussion about the sensitivity of recurring level 3 measurements to changes in the unobservable inputs disclosed, including the interrelationship between inputs; (2) a description of the Companys valuation processes surrounding level 3 measurements; (3) information about when the current use of a non-financial asset measured at fair value differs from its highest and best use; and (4) the hierarchy classification for items whose fair value is not recorded on the balance sheet but is disclosed in the notes. ASU 2011-04 amends Topic 820 to change the fair value measurement of financial instruments and the application of premiums and discounts in a fair value measurement. ASU 2011-04 also clarifies existing fair value measurement regarding the concepts of valuation premise, the application of the highest and best use, and the fair value measurement of an instrument classified in an entitys shareholders equity. The adoption of ASU
2011-04 is not expected to have an effect on the Companys current fair value measurements but is expected to have a significant impact on the Companys disclosures related to the assets and liabilities of its consolidated investment products that are classified as level 3 assets within the fair value hierarchy. The amendments to Topic 820 made by ASU 2011-04 are effective for interim and annual periods beginning on or after December 15, 2011. As such, these disclosure changes will be required in the Companys Form 10-Q for the three months ended March 31, 2012. 13. SELECTED QUARTERLY DATA (Unaudited)  Q1 2011

          

          Q2 2011

          

          Q3 2011

          

          Q4 2011Total interest and related portfolio income

          

          $

          7,346,660

          

          

          $

          6,293,311

          

          

          $

          7,260,030

          

          

          $

          7,106,522Net investment income

          

          $

          5,007,602

          

          

          $

          2,900,004

          

          

          $

          4,047,546

          

          

          $

          4,064,052Net increase (decrease) in net assets resulting from operations

          

          $

          9,604,633

          

          

          $

          873,829

          

          

          $

          (1,485,255

          )

          

          $

          (1,343,663

          )Net increase (decrease) in net assets resulting from operations per share  basic

          

          $

          0.43

          

          

          $

          0.04

          

          

          $

          (0.07

          )

          

          $

          (0.06

          )Net increase (decrease) in net assets resulting from operations per share  diluted

          

          $

          0.43

          

          

          $

          0.04

          

          

          $

          (0.07

          )

          

          $

          (0.06

          )Net investment income per share  basic

          

          $

          0.22

          

          

          $

          0.13

          

          

          $

          0.18

          

          

          $

          0.18Net investment income per share  diluted

          

          $

          0.22

          

          

          $

          0.13

          

          

          $

          0.18

          

          

          $

          0.18
 F-45    TABLE OF CONTENTS KOHLBERG CAPITAL CORPORATION   NOTES TO FINANCIAL STATEMENTS 13. SELECTED QUARTERLY DATA (Unaudited)   (continued)  Q1 2010

          

          Q2 2010

          

          Q3 2010

          

          Q4 2010Total interest and related portfolio income

          

          $

          6,963,826

          

          

          $

          7,382,805

          

          

          $

          8,091,217

          

          

          $

          6,916,015Net investment income

          

          $

          2,578,494

          

          

          $

          297,198

          

          

          $

          3,831,270

          

          

          $

          5,190,156Net increase (decrease) in net assets resulting from operations

          

          $

          1,594,909

          

          

          $

          (5,690,916

          )

          

          $

          (3,319,312

          )

          

          $

          (6,873,359

          )Net increase (decrease) in net assets resulting from operations per share  basic and diluted

          

          $

          0.07

          

          

          $

          (0.26

          )

          

          $

          (0.15

          )

          

          $

          (0.31

          )Net increase (decrease) in net assets resulting from operations per share  diluted

          

          $

          0.07

          

          

          $

          (0.26

          )

          

          $

          (0.15

          )

          

          $

          (0.31

          )Net investment income per share  basic

          

          $

          0.12

          

          

          $

          0.01

          

          

          $

          0.17

          

          

          $

          0.23Net investment income per share  diluted

          

          $

          0.12

          

          

          $

          0.01

          

          

          $

          0.17

          

          

          $

          0.23
 14. SUBSEQUENT EVENTS On February 24, 2012, the Company entered into a Note Purchase Agreement (the Note Purchase Agreement) with Credit Suisse AG, Cayman Islands Branch (CS), Credit Suisse Securities (USA) LLC, as arranger, The Bank of New York Mellon Trust Company, National Association, as collateral administrator and collateral agent (BNYM), and KCAP Funding, a special-purpose bankruptcy remote wholly-owned subsidiary of the Company (KCAP Funding), whereby KCAP Funding purchased a portfolio of senior secured term loans (the Collateral Debt Obligations), the purchase of which was financed by the issuance of (a)
a senior note in an aggregate principal amount of $30.0 million, issued to CS in exchange for $30.0 million in cash and (b) a junior note in an aggregate principal amount of $12.5 million, issued to the Company in exchange for the sale by the Company to KCAP Funding of the Collateral Debt Obligations. Pursuant to the Note Purchase Agreement, the Company has agreed to act as Portfolio Manager on behalf of KCAP Funding and CS of the Collateral Debt Obligations, and has granted a security interest to KCAP Funding in all of the Companys right to receive certain management fees, and KCAP Funding granted to CS a security interest in, among other things, the Collateral Debt Obligations and its rights to receive the management fees pledged to it by the Company. In its capacity as Portfolio Manager, the Company also entered into a Collateral Administration Agreement, dated as of February 24, 2012, with KCAP Funding, CS and BNYM, as collateral administrator and collateral agent, whereby
BNYM will, among other things, hold the collateral on behalf of CS, as secured party, administer the Collateral Debt Obligations and perform certain other administrative obligations. On February 29, 2012, the Company completed the acquisition of Trimaran Advisors, L.L.C. (Trimaran) through a newly-formed, wholly-owned subsidiary of the Company. The aggregate consideration paid for all of the outstanding equity interests in Trimaran consisted of $13.0 million in cash and 3,600,000 shares of common stock, par value $0.01 per share, of the Company. Trimaran manages four CLO Funds with aggregate assets under management of approximately $1.5 billion. Contemporaneously with the acquisition, the Company also acquired the subordinated or preferred share interests in certain CLO Funds managed by Trimaran for an aggregate cash
purchase price of $12.0 million.
 F-46    TABLE OF CONTENTS OTHER FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
 S-1    TABLE OF CONTENTS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Member ofKatonah Debt Advisors Katonah Debt Advisors, L.L.C. We have audited the accompanying combined balance sheets of Katonah Debt Advisors, L.L.C., and affiliates, Katonah Management Holding, LLC, Katonah X Management LLC, Katonah 2007-I Management LLC, Katonah Scotts Cove Capital Management LLC, Katonah VII CLO Ltd., Katonah VIII CLO Ltd., Katonah IX CLO Ltd., Katonah X CLO Ltd., and Katonah 2007-I CLO, Ltd., (a Delaware corporation) (collectively, the Company) as of December 31, 2011 and 2010, and the related combined statements of operations, changes in members equity, and cash flows for the years then ended. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America established by the American Institute of Certified Public Accountants. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly,
we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of Katonah Debt Advisory, L.L.C. and affiliates as of December 31, 2011 and 2010, and the results of their operations, changes in members equity and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ GRANT THORNTON LLP New York, New York March 15, 2012
 S-2    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   COMBINED BALANCE SHEETS  As of December 31, 2011

          

          As of December 31, 2010ASSETSInvestments of CLO Funds at fair value

          

          $

          1,768,088,977

          

          

          $

          1,741,497,876Cash

          

          

          6,364,939

          

          

          

          4,497,282Restricted cash of CLO Funds

          

          

          71,888,141

          

          

          

          137,546,770Accrued management fees receivable

          

          

          

          

          

          

          198,521Accrued interest receivable

          

          

          8,065,586

          

          

          

          7,968,701Deferred tax asset

          

          

          383,348

          

          

          

          Other assets

          

          

          722,440

          

          

          

          2,874,698Total assets

          

          $

          1,855,513,431

          

          

          $

          1,894,583,848LIABILITIESCLO Fund liabilities at fair value

          

          $

          1,727,560,760

          

          

          $

          1,717,378,071Accrued interest expense

          

          

          7,676,896

          

          

          

          6,231,024Payable for open trades

          

          

          15,454,626

          

          

          

          32,235,824Accounts payable and accrued expenses

          

          

          2,749,899

          

          

          

          2,481,610Deferred tax liability

          

          

          

          

          

          

          182,585Total liabilities

          

          $

          1,753,442,181

          

          

          $

          1,758,509,114MEMBER'S EQUITYMember's contributions

          

          $

          12,933,258

          

          

          $

          12,112,655Accumulated earnings (deficit)

          

          

          (6,707,276

          )

          

          

          (5,548,487

          )Total Katonah Debt Advisors L.L.C. equity

          

          

          6,225,982

          

          

          

          6,564,168Appropriated retained earnings of Consolidated Variable Interest Entities

          

          

          95,845,268

          

          

          

          129,510,566Total member's equity

          

          

          102,071,250

          

          

          

          136,074,734Total liabilities and member's equity

          

          $

          1,855,513,431

          

          

          $

          1,894,583,848
 See accompanying notes to combined financial statements.
 S-3    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   COMBINED STATEMENTS OF OPERATIONS  For the Year Ended December 31,2011

          

          2010

          

          2009(unaudited)IncomeInterest income  investments of CLO Funds

          

          $

          68,772,354

          

          

          $

          63,504,932

          

          

          $

          Interest income  cash and time deposits

          

          

          72,372

          

          

          

          81,297

          

          

          

          17,617Management and incentive fees

          

          

          448,790

          

          

          

          1,376,108

          

          

          

          10,158,056Fee income  investments of CLO Funds

          

          

          3,769,889

          

          

          

          2,318,083

          

          

          

          Other income

          

          

          7,231

          

          

          

          24,244

          

          

          

          6,897Total income

          

          

          73,070,636

          

          

          

          67,304,664

          

          

          

          10,182,570ExpensesInterest expense of CLO Fund liabilities

          

          

          55,650,280

          

          

          

          36,043,196

          

          

          

          Compensation

          

          

          5,399,450

          

          

          

          6,557,730

          

          

          

          6,497,776Insurance

          

          

          469,089

          

          

          

          403,171

          

          

          

          372,531Professional fees

          

          

          990,307

          

          

          

          2,262,786

          

          

          

          382,506Administrative and other

          

          

          1,429,837

          

          

          

          1,609,358

          

          

          

          1,110,023Trustee fees

          

          

          540,683

          

          

          

          545,326

          

          

          

          Total expenses

          

          

          64,479,646

          

          

          

          47,421,567

          

          

          

          8,362,836Net realized and unrealized gain (loss)

          

          

          (41,726,392

          )

          

          

          (29,488,314

          )

          

          

          Net income (loss) before tax

          

          

          (33,135,402

          )

          

          

          (9,605,217

          )

          

          

          1,819,734Income tax expense (benefit)

          

          

          (221,315

          )

          

          

          873,901

          

          

          

          1,228,518Net income (loss)

          

          

          (32,914,087

          )

          

          

          (10,479,118

          )

          

          

          591,216Net income (loss) attributable to noncontrolling interests in consolidated Variable Interest Entities

          

          

          (33,665,298

          )

          

          

          (11,002,220

          )

          

          

          Net income (loss) attributable to Katonah Debt Advisors, L.L.C.

          

          $

          751,211

          

          

          $

          523,102

          

          

          $

          591,216
 See accompanying notes to combined financial statements.
 S-4    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   COMBINED STATEMENTS OF CHANGES IN MEMBER'S EQUITY  Member's Contributions

          

          Accumulated Earnings (Deficit)

          

          Appropriated Retained Earnings of Variable Interest Entities

          

          Total Member's EquityTotal at January 1, 2009 (unaudited)

          

          $

          4,748,421

          

          

          $

          (2,162,805)

          

          

          $

          

          

          

          $

          2,585,616Net income (loss) (unaudited)

          

          

          

          

          

          

          591,216

          

          

          

          

          

          

          

          591,216Contributions (unaudited)

          

          

          3,600,016

          

          

          

          

          

          

          

          

          

          

          

          3,600,016Total at December 31, 2009 (unaudited)

          

          

          8,348,437

          

          

          

          (1,571,589)

          

          

          

          

          

          

          

          6,776,848Adoption of guidance now encompassed in ASC Topic 810

          

          

          

          

          

          

          

          

          

          

          140,512,786

          

          

          

          140,512,786January 1, 2010, as adjusted

          

          

          8,348,437

          

          

          

          (1,571,589

          )

          

          

          140,512,786

          

          

          

          147,289,634Net income (loss)

          

          

          

          

          

          

          523,102

          

          

          

          

          

          

          

          523,102Contributions

          

          

          3,764,218

          

          

          

          

          

          

          

          

          

          

          

          3,764,218Distributions

          

          

          

          

          

          

          (4,500,000

          )

          

          

          

          

          

          

          (4,500,000

          )Net income (loss) classified as appropriated retained earnings

          

          

          

          

          

          

          

          

          

          

          (11,002,220

          )

          

          

          (11,002,220

          )Total at December 31, 2010

          

          

          12,112,655

          

          

          

          (5,548,487)

          

          

          

          129,510,566

          

          

          

          136,074,734Net income (loss)

          

          

          

          

          

          

          751,211

          

          

          

          

          

          

          

          751,211Distributions

          

          

          (34,640

          )

          

          

          (1,910,000

          )

          

          

          

          

          

          

          (1,944,640

          )Contributions

          

          

          855,243

          

          

          

          

          

          

          

          

          

          

          

          855,243Net income (loss) classified as appropriated retained earnings

          

          

          

          

          

          

          

          

          

          

          (33,665,298

          )

          

          

          (33,665,298

          )Total at December 31, 2011

          

          $

          12,933,258

          

          

          $

          (6,707,276)

          

          

          $

          95,845,268

          

          

          $

          102,071,250
 See accompanying notes to combined financial statements.
 S-5    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   COMBINED STATEMENTS OF CASH FLOWS  Year Ended December 31,2011

          

          2010

          

          2009 (unaudited)Katonah Debt Advisors, L.L.C. cash

          

          Katonah Debt Advisors CLO Restricted Cash

          

          Katonah Debt Advisors, L.L.C. cash

          

          Katonah Debt Advisors CLO Restricted Cash

          

          Katonah Debt Advisors, L.L.C. cash

          

          Katonah Debt Advisors CLO Restricted CashOPERATING ACTIVITIES:Net income (loss) attributable to Katonah Debt Advisors

          

          $

          751,211

          

          

          

          

          

          

          $

          523,102

          

          

          

          

          

          

          $

          591,216

          

          

          

          Net income (loss) attributable to Variable Interest Entities

          

          

          

          

          

          $

          (33,665,298

          )

          

          

          

          

          

          $

          (11,002,220

          )

          

          

          

          

          

          

          Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:Net change in deferred tax assets

          

          

          (565,933

          )

          

          

          

          

          

          

          620,648

          

          

          

          

          

          

          

          (63,285

          )

          

          

          Net realized and unrealized loss

          

          

          1,808,520

          

          

          

          39,917,872

          

          

          

          

          

          

          

          29,488,314

          

          

          

          

          

          

          

          Changes in operating assets and liabilities:Decrease (increase) in accrued management fees receivable

          

          

          190,826

          

          

          

          7,694

          

          

          

          3,849,962

          

          

          

          (3,878,142

          )

          

          

          (2,265,122

          )

          

          

          Decrease (increase) in accrued interest receivable

          

          

          (13

          )

          

          

          (96,872

          )

          

          

          3

          

          

          

          (2,348,135

          )

          

          

          243

          

          

          

          Decrease receivable for open trades

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          1,855,000

          

          

          

          

          

          

          

          Decrease (increase) in other assets

          

          

          78,190

          

          

          

          (131,130

          )

          

          

          283,247

          

          

          

          9,039

          

          

          

          510,312

          

          

          

          Increase (decrease) in accounts payable and accrued expenses

          

          

          444,253

          

          

          

          (29,284

          )

          

          

          (369,846

          )

          

          

          (31,487

          )

          

          

          (4,639,838

          )

          

          

          Increase (decrease) in payable for open trades

          

          

          

          

          

          

          (16,781,198

          )

          

          

          

          

          

          

          13,508,283

          

          

          

          

          

          

          

          Increase (decrease) in accrued interest expense

          

          

          

          

          

          

          1,445,871

          

          

          

          

          

          

          

          2,503,203

          

          

          

          

          

          

          

          Net cash provided by (used in) operating activities

          

          

          2,707,054

          

          

          

          (9,332,345

          )

          

          

          4,907,116

          

          

          

          30,103,855

          

          

          

          (5,866,474

          )

          

          

          Investing activities:Change in Investments:Purchase of investments

          

          

          

          

          

          

          (836,925,087

          )

          

          

          

          

          

          

          (646,646,273

          )

          

          

          

          

          

          

          Sale of investments

          

          

          

          

          

          

          77,790,466

          

          

          

          

          

          

          

          117,530,020

          

          

          

          

          

          

          

          Proceeds from sale and redemption of investments

          

          

          250,000

          

          

          

          704,008,337

          

          

          

          

          

          

          

          532,448,082

          

          

          

          

          

          

          

          Net cash provided by (used in) investing activities

          

          

          250,000

          

          

          

          (55,126,284

          )

          

          

          

          

          

          

          3,331,829

          

          

          

          

          

          

          

          Financing Activities:Members contributions

          

          

          855,243

          

          

          

          

          

          

          

          3,764,218

          

          

          

          

          

          

          

          3,600,016

          

          

          

          Members distributions

          

          

          (34,640

          )

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          Dividends paid in cash

          

          

          (1,910,000

          )

          

          

          

          

          

          

          (4,500,000

          )

          

          

          

          

          

          

          

          

          

          

          Repayments of Debt

          

          

          

          

          

          

          (1,200,000

          )

          

          

          

          

          

          

          (9,821,734

          )

          

          

          

          

          

          

          Net cash provided by (used in) financing activities

          

          

          (1,089,397

          )

          

          

          (1,200,000

          )

          

          

          (735,782

          )

          

          

          (9,821,734

          )

          

          

          3,600,016

          

          

          

          CHANGE IN CASH

          

          

          1,867,657

          

          

          

          (65,658,629

          )

          

          

          4,171,334

          

          

          

          23,613,950

          

          

          

          (2,266,458

          )

          

          

          CASH, BEGINNING OF YEAR

          

          

          4,497,282

          

          

          

          137,546,770

          

          

          

          325,948

          

          

          

          113,932,820

          

          

          

          2,592,406

          

          

          

          CASH, END OF YEAR

          

          $

          6,364,939

          

          

          $

          71,888,141

          

          

          $

          4,497,282

          

          

          $

          137,546,770

          

          

          $

          325,948

          

          

          

          Supplemental Information:Cash paid for interest

          

          

          

          

          

          $

          54,204,409

          

          

          

          

          

          

          $

          33,539,993

          

          

          

          Cash paid for taxes

          

          $

          40,500

          

          

          

          

          

          

          $

          477,904

          

          

          

          

          

          

          $

          579,944
 See accompanying notes to combined financial statements.
 S-6    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 1. ORGANIZATION Katonah Debt Advisors, L.L.C., and affiliates, Katonah Management Holding, LLC, Katonah X Management LLC, Katonah 2007-I Management LLC, Katonah Scotts Cove Capital Management LLC, Katonah VII CLO Ltd., Katonah VIII CLO Ltd., Katonah IX CLO Ltd., Katonah X CLO Ltd., and Katonah 2007-I CLO, Ltd. (collectively with its affiliates, Katonah Debt Advisors) manages collateralized loan obligation funds (CLO Funds) which invest in broadly syndicated loans, high-yield bonds and other credit instruments. Katonah Debt Advisors is wholly owned by Kohlberg Capital Corporation (Kohlberg Capital) which is an internally
managed, non-diversified closed-end publically traded investment company that is regulated as a business development company (BDC) under the Investment Company Act of 1940. Katonah Debt Advisors does not have any investment interests in the CLO Funds it manages; however, Kohlberg Capital holds investments in a portion of the bonds issued by the CLO Funds managed by Katonah Debt Advisors. Katonah Debt Advisors provides investment management services to CLO Funds, making day-to-day investment decisions concerning the assets of the CLO Funds. The CLO Funds managed by Katonah Debt Advisors consist exclusively of credit instruments and other securities issued by corporations and do not include any asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. As of December 31, 2011, Katonah Debt Advisors had approximately $1.9 billion of assets under management in five CLO Funds.  The five CLO funds managed by Katonah Debt Advisors are considered to be variable interest entities (VIEs) for which Katonah Debt Advisors is the primary beneficiary are consolidated into the financial statements of Katonah Debt Advisors as discussed in Note 3  CLO Funds. On January 2, 2008, the Katonah Debt Advisors platform acquired substantially all of the assets of Scotts Cove Capital Management LLC (Scotts Cove), an asset manager focused on an event-driven credit long short investment strategy. On February 28, 2011, Katonah Debt Advisors sold its interest in Scotts Cove to a third-party buyer controlled by a former Katonah Debt Advisors employee for a purchase price of $25,000 and the buyer entered into a Services Agreement, pursuant to which the buyer paid to Katonah Debt Advisors $225,000 for certain transitional services to be provided by Katonah Debt Advisors and agreed to pay an
additional amount of $75,000 on each of the first and second anniversaries of the closing date (subject to, in the case of the first payment, deferment for up to one year under certain circumstances). During the year ended December 31, 2011, Katonah Debt Advisors recognized a loss of $1.8 million on the sale of Scotts Cove which is included in net realized and unrealized gain (loss) on the combined statements of operations. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Accounting and Combination In the opinion of management, the combined financial statements reflect all adjustments, consisting of normal recurring accruals, which are necessary for the fair presentation of the financial condition and results of operations for the periods presented. All significant intercompany transactions, balances, revenues and expenses are eliminated upon combination. Use of Estimates The preparation of the financial statements requires management to make significant estimates and assumptions that affect reported revenues, expenses, assets and liabilities and disclosure of contingent liabilities, including the fair value of CLO fund investments and CLO fund liabilities that do not have a readily available market value. Actual results could differ from those estimates, and the differences could be material. The combined financial statements have been prepared in accordance with U.S. GAAP and include the financial statements of Katonah Debt Advisors and any VIEs required to be consolidated. A VIE is an entity that does not have sufficient equity to finance its operations without additional subordinated financial support,
 S-7    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) or an entity for which the risks and rewards of ownership are not directly linked to voting interests. Control is deemed to be present when the Parent holds a majority voting interest or otherwise has the power to govern the financial and operating policies of the subsidiary or VIE so as to obtain the benefits from its activities. Katonah Debt Advisors provides investment management services to CLO Funds, making day-to-day investment decisions concerning the assets of the CLO Funds. All of the CLO Funds are considered to be VIEs as discussed in Note 3  CLO Funds. Although Katonah Debt Advisors has no ownership interests in the CLO Funds it manages, Katonah Debt Advisors follows the provisions of Accounting Standards Codification (ASC) Topic 810, Consolidation, when accounting for VIEs further detailed below. For CLO Funds, if Katonah Debt Advisors is deemed to have the power to direct the activities of the CLO that most significantly impact the CLOs economic performance, and the obligation to absorb losses/right to receive benefits (management fees and potential incentive fees) from the CLO that could potentially be significant to the CLO, then Katonah Debt Advisors is deemed to be the CLOs primary beneficiary and is required to consolidate the CLO. All of the investments held and notes issued by CLO Funds considered to be VIEs are presented at fair value in Katonah Debt Advisors Combined Balance Sheet and interest income and expense of consolidated CLO Funds are presented in Katonah Debt Advisors Combined Statement of Operations. The surplus of consolidated CLO assets over CLO liabilities is reflected in Katonah Debt Advisors Combined Balance Sheets as retained earnings appropriated for investors in consolidated variable interest entities. Current period gains (losses) attributable to investors in consolidated CLOs are included in gains (losses) attributable to non-controlling
interests in consolidated variable interest entities in the Combined Statement of Operations and in appropriated retained earnings of consolidated variable interest entities in the Consolidated Balance Sheets, as they are considered non-controlling interests of Katonah Debt Advisors. Accounting Standards Codification.  In June 2009, the Financial Accounting Standards Board (FASB) issued a pronouncement establishing the FASB Accounting Standards Codification (ASC) as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with GAAP. The ASC reorganized existing U.S. accounting and reporting standards issued by the FASB and other related private sector standard setters into a single source of authoritative accounting principles arranged by topic. The standard explicitly recognizes rules and interpretive
releases of the Commission under federal securities laws as authoritative GAAP for SEC registrants. The ASC supersedes all existing U.S. accounting standards; all other accounting literature not included in the ASC (other than SEC guidance for publicly-traded companies) is considered non-authoritative. The ASC was effective on a prospective basis for interim and annual reporting periods ending after September 15, 2009. The adoption of the ASC changed the references to U.S. GAAP accounting standards but did not impact its results of operations, financial position or liquidity. Investments of CLO Funds at Fair Value.Investment transactions are recorded on the applicable trade date. Realized gains or losses are determined using the specific identification method. Investments held by the CLO Funds are stated at fair value. ASC 820-10, Fair Value Measurements and Disclosures (ASC 820-10), requires among other things, disclosures about assets and liabilities that are measured and reported at fair value. Hierarchy of Fair Value Inputs.  The provisions of ASC 820-10 establish a hierarchy that prioritizes inputs to valuation techniques used to measure fair value and require companies to disclose the fair value of their financial instruments according to the fair value hierarchy (i.e., Level 1, 2 and 3 inputs, as defined). The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. Additionally, companies are required to provide additional disclosure regarding instruments in the Level 3 category (which have inputs
to the
 S-8    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) valuation techniques that are unobservable and require significant management judgment), including a reconciliation of the beginning and ending balances separately for each major category of assets and liabilities. Assets and liabilities measured and reported at fair value are classified and disclosed in one of the following categories: Level 1 Inputs: Quoted prices (unadjusted) in active markets for identical assets or liabilities at the reporting date. 

          Level 1 assets may include listed mutual funds (including those accounted for under the equity method of accounting as these mutual funds are investment companies, that have publicly available NAVs which in accordance with GAAP are calculated under fair value measures and are equal to the earnings of such funds), ETFs, equities and certain derivatives. Level 2 Inputs: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities that are not active; quotes from pricing services or brokers, for which Katonah Debt Advisors can determine that orderly transactions took place at the quoted price or that the inputs used to arrive at the price were observable; and inputs other than quoted prices that are observable, such as models or other valuation methodologies. 

          Level 2 assets in this category may include debt securities, bank loans, short-term floating rate notes and asset-backed securities, restricted public securities valued at a discount, as well as over the counter derivatives, including interest and inflation rate swaps and foreign currency exchange contracts that have inputs to the valuations that generally can be corroborated by observable market data. Level 3 Inputs: Unobservable inputs for the valuation of the asset or liability, which may include non-binding broker quotes. Level 3 assets include investments for which there is little, if any, market activity. These inputs require significant management judgment or estimation. 

          Level 3 assets in this category may include general and limited partnership interests in private equity funds, funds of private equity funds, real estate funds, hedge funds, and funds of hedge funds, direct private equity investments held within consolidated funds, bank loans, bonds issued by CLO Funds and certain held for sale real estate disposal assets.  

          Level 3 liabilities included in this category include borrowings of consolidated collateralized loan obligations valued based upon non-binding broker quotes or discounted cash flow model based on a discount margin calculation. Significance of Inputs: Katonah Debt Advisors assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. Valuation of Portfolio Investments.  Debt and equity securities for which market quotations are readily available are generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued based on detailed analyses prepared by management, and, in certain circumstances, may utilize third parties with valuation expertise. Katonah Debt Advisors follows the provisions of ASC 820-10. This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. Fair Value
Measurements and Disclosures defines fair value as the price that would be received to sell an asset or paid
 S-9    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) to transfer a liability in an orderly transaction between market participants at the measurement date. Subsequent to the adoption of ASC 820-10, the FASB has issued various staff positions clarifying the initial standard as noted below. In January 2010, the FASB issued guidance that clarifies and requires new disclosures about fair value measurements. The clarifications and requirement to disclose the amounts and reasons for significant transfers between Level 1 and Level 2, as well as significant transfers in and out of Level 3 of the fair value hierarchy, were adopted by Katonah Debt Advisors in 2010. Fair Value Measurements and Disclosures requires the disclosure of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period. Katonah Debt Advisors valuation methodology and procedures for investments held by the CLO Funds are generally as follows: 1.

          For any asset which is also held by Kohlberg Capital on the applicable date, the Kohlberg Capital fair value mark as of such applicable date is used. 2.

          Each portfolio company or investment is cross-referenced to an independent pricing service to determine if a current market quote is available. The nature and quality of such quote is reviewed to determine reliability and relevance of the quote. Factors considered in this determination include whether the quote is from a transaction or is a broker quote, the date and aging of such quote, whether the transaction is arms-length, whether it is of a liquidation or distressed nature and certain other factors judged to be relevant by management within the framework of ASC 820-10. 3.

          If an investment does not have a market quotation on either a broad market exchange or from an independent pricing service, the investment is initially valued by Katonah Debt Advisors investment professionals responsible for the portfolio investment in conjunction with the portfolio management team. Generally, such fair values are determined by reference to public market or private transactions or valuations for comparable companies or assets in the relevant asset class and or industry when such amounts are available. Generally these valuations are derived by multiplying a key performance metric of the investee company or asset (e.g., EBITDA) by the relevant valuation multiple observed for comparable companies or transactions, adjusted by management for differences between the investment and the referenced comparable. If the fair value of such investments cannot be valued by reference to observable valuation measures for comparable
companies, then the primary analytical method used to estimate the fair value is a discounted cash flow method and/or cap rate analysis. A sensitivity analysis is applied to the estimated future cash flows using various factors depending on the investment, including assumed growth rates (in cash flows), capitalization rates (for determining terminal values) and appropriate discount rates to determine a range of reasonable values or to compute projected return on investment. 4.

          Preliminary valuation conclusions are discussed and documented by management. 5.

          Illiquid loans, junior and mezzanine securities and investments in other CLO bonds are fair valued using models developed by management with applicable market assumptions. 6.

          Management discusses the valuations and determines in good faith that the fair values of each investment in the portfolio is reasonable based upon any applicable independent pricing service, input of management, and estimates from independent valuation firms (if any). Debt Securities.  Most of the CLO Funds investment portfolio is composed of broadly syndicated debt securities for which an independent pricing service quote is available. To the extent that the investments are exchange traded and are priced or have sufficient price indications from normal course trading at or around
 S-10    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) the valuation date (financial reporting date), such pricing will determine fair value. Pricing service marks from third party pricing services may be used as an indication of fair value, depending on the volume and reliability of the marks, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading activity. CLO Fund Securities.The CLO Funds managed by Katonah Debt Advisors may selectively invest in securities issued by funds managed by other asset management companies. For bond rated tranches of CLO Funds (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as the default and recovery rates of underlying assets
in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes. Such adjustments require judgment and may be material to the calculation of fair value. Cash.  Katonah Debt Advisors defines cash as demand deposits. Katonah Debt Advisors places its cash with financial institutions and, at times, cash held in checking accounts may exceed the Federal Deposit Insurance Corporation insured limit. Restricted Cash of CLO Funds.  Restricted cash consist of cash held for reinvestment, quarterly interest and principal distributions (if any) to holders of CLO Fund liabilities, and payment of CLO Fund expenses. CLO Fund Liabilities at Fair Value.  Katonah Debt Advisors has no debt; however the CLO Funds it manages and that are consolidated herein, have issued rated and unrated bonds to finance their operations. Debt is presented at fair value. Interest Income.  Interest income is recorded on the accrual basis on interest-bearing assets. The CLO Funds generally places a loan or security on non-accrual status and ceases recognizing cash interest income on such loan or security when a loan or security becomes 90 days or more past due or if Katonah Debt Advisors otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans represented 0.23% and 0.63% of Investments of CLO Funds at fair value as of December 31, 2011 and December 31, 2010, respectively. The aggregate unpaid principal value of loans past due as of December 31, 2011 was
approximately $28.0 million and the difference between fair value and the unpaid principal balance was approximately $24.1 million. The aggregate unpaid principal value of loans past due as of December 31, 2010 was approximately $47.9 million and the difference between fair value and the unpaid principal balance was approximately $36.9 million.  Management and Incentive Fees.  As a manager of CLO Funds and the Scotts Cove Funds, Katonah Debt Advisors receives management fees and incentive fees, which are contractual interests that Katonah Debt Advisors earns based on assets under management, and a percentage of net profits (Scotts Cove Funds) and residual cash flows, subject to a specified relative and/or absolute investment (CLO Funds), respectively. Incentive fees may be earned by Katonah Debt Advisors upon exceeding specified relative and/or absolute investment return thresholds. Such fees are recorded upon completion of the measurement period which varies by CLO
Fund. If incentive fees are paid upon reaching such investment return thresholds, they are not subject to claw-back provisions. At December 31, 2011, and December 31, 2010, Katonah Debt Advisors has not earned any incentive fees from the CLO Funds. For the year ended December 31, 2009, Kohlberg Debt Advisors earned management fees of $10.2 million. For the years ended December 31, 2011 and 2010, Katonah Debt Advisors earned management fees and incentive fees from the Scotts Cove Funds of $500 thousand and $1.4 million respectively. The management fees Katonah Debt Advisors receives from the CLO Funds, which have two components  a senior management fee and a subordinated management fee  have been eliminated in consolidation for the years ended December 31, 2011 and 2010.
 S-11    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) Fee Income.  Fee income is earned upon the completion of transactions involving collateral assets in our CLO Funds and include, but are not limited to, restructuring fees, delayed closing fees, commitment fees and consent fees, which are recorded in the combined Financial Statements on the date the transactions are legally closed. Dividends to Member.  Dividends payable to Katonah Debt Advisors sole member are recognized on the declaration date. Generally, dividends are declared and paid on a quarterly basis. Expenses.  Katonah Debt Advisors is internally managed and expenses costs, as incurred, with regard to the running of its operations. Primary operating expenses include employee salaries and benefits, the costs of identifying, evaluating, monitoring and servicing the CLO Fund investments managed Katonah Debt Advisors and related overhead charges and expenses, including rental expense. Katonah Debt Advisors and its asset manager affiliates share office space and certain other operating expenses. Katonah Debt Advisors has entered into an Overhead Allocation Agreement with its sole member, Kohlberg Capital, which provides
for the sharing of such expenses based on an equal sharing of office lease costs and the ratable usage of other shared resources. The aggregate net payments of such expenses under the Overhead Allocation Agreement are settled quarterly. Katonah Debt Advisors accounts for its operating leases, which may include escalations, in accordance with ASC 840-10, Leases, and expenses the lease payments associated with operating leases evenly during the lease term (including rent-free periods), beginning on the commencement of the lease term. Interest Expenses.  Katonah Debt Advisors has no debt; however the CLO Funds it manages and that are consolidated herein, have issued rated and unrated bonds to finance their operations. Interest on CLO Fund liabilities is calculated by the third party trustee of the CLO Funds. Interest is accrued and generally paid quarterly. Trustee Fees.  Each CLO Fund has a third party trustee that is the custodian for all investments of the CLO Funds and receives and disburses all cash in accordance to the trustee and custodial agreements. Trustee fees are accrued and paid quarterly by the CLO Funds. Income Taxes.  Katonah Debt Advisors accounts for income taxes under the asset and liability method prescribed by ASC 740-10, Income Taxes (ASC 740-10). Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases using currently enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred income tax assets and liabilities is recognized in income in the period
that includes the enactment date. Management periodically assesses the recoverability of its deferred income tax assets based upon expected future earnings, taxable income in prior carryback years, future deductibility of the asset, changes in applicable tax laws and other factors. If management determines that it is not more likely than not that the deferred tax asset will be fully recoverable in the future, a valuation allowance will be established for the difference between the asset balance and the amount expected to be recoverable in the future. This allowance will result in a charge to income tax expense on the combined statements of income. Katonah Debt Advisors records its
income taxes receivable and payable based upon its estimated income tax liability. ASC 740-10 clarifies the accounting for uncertainty in income taxes recognized in a companys financial statements by prescribing a threshold for measurement and recognition in the financial statements of an asset or liability resulting from a tax position taken or expected to be taken in an income tax return. ASC 740-10 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
 S-12    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) Accounting Policies Adopted in the Year Ended December 31, 2010 New Consolidation Guidance for Variable Interest Entities In June 2009, the Financial Accounting Standards Board (FASB) issued ASU 2009-17, which amended the consolidation guidance for VIEs. The amendments include: (1) the elimination of the exemption from consolidation for qualifying special purpose entities, (2) a new approach for determining the primary beneficiary of a VIE, which requires that the primary beneficiary have both (i) the power to control the most significant activities of the VIE and (ii) either the obligation to absorb losses or the right to receive benefits that potentially could be significant to the VIE, and (3) the requirement to continually reassess the primary
beneficiary of a VIE. On January 1, 2010, upon the adoption of the forgoing guidance now encompassed in ASC 810, Katonah Debt Advisors determined it was the primary beneficiary of all five of the CLO Funds it manages as it has the power to direct the activities of the CLO Funds that most significantly impact the CLO Funds economic performance, and the obligation to absorb losses/right to receive benefits (in the form of senior and subordinate management fees as well as the potential to earn an incentive fee) from the CLO Funds that could potentially be significant to the CLO Funds. As a result, these CLO Funds are consolidated into the combined financial statements
of Katonah Debt Advisors. Fair Value Option Upon consolidation of the CLO Funds, the assets and liabilities of the consolidated CLOs were measured at fair value, as the determination of carrying amounts was not practicable. Katonah Debt Advisors has elected the fair value option under ASC Topic 825-10-25 to measure the assets and liabilities of all consolidated CLOs at fair value subsequent to the date of initial adoption of this additional guidance to mitigate accounting mismatches between the carrying value of the assets and liabilities and to achieve operational simplifications. The cumulative effect adjustment upon adoption at January 1, 2010 resulted in an appropriation of retained earnings of $140.5 million. Improved Disclosures Regarding Fair Value Measurements. In January 2010, the FASB issued Accounting Standards Update 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06). ASU 2010-06 amends Topic 820 to require a number of additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose: (1) the amount of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers; (2) the reasons for any transfers in or out of Level 3; and (3) information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. ASU
2010-06 also clarifies existing fair value disclosures about the appropriate level of disaggregation and about inputs and valuation techniques for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The additional disclosure requirements with respect to rollforward activity did not have a significant impact on the Companys disclosures. In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurements: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements (ASU 2011-04). ASU 2011-04 amends Topic 820 to clarify existing fair value measurement disclosures to (1) specifically provide quantitative information about the significant unobservable inputs used for all level 3 measurements and (2) disclose any transfers between levels 1 and 2 of the fair value hierarchy, not just significant transfers. ASU 2011-04 also requires a number of additional disclosures regarding fair value measurements. Specifically,
 S-13    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 2. SIGNIFICANT ACCOUNTING POLICIES   (continued) ASU 2011-04 requires entities to disclose: (1) a qualitative discussion about the sensitivity of recurring level 3 measurements to changes in the unobservable inputs disclosed, including the interrelationship between inputs; (2) a description of the Companys valuation processes surrounding level 3 measurements; (3) information about when the current use of a non-financial asset measured at fair value differs from its highest and best use; and (4) the hierarchy classification for items whose fair value is not recorded on the balance sheet but is disclosed in the notes. ASU 2011-04 amends Topic 820 to change the fair value measurement of financial
instruments and the application of premiums and discounts in a fair value measurement. ASU 2011-04 also clarifies existing fair value measurement regarding the concepts of valuation premise, the application of the highest and best use, and the fair value measurement of an instrument classified in an entitys shareholders equity. The adoption of ASU 2011-04 is not expected to have an effect on the Companys current fair value measurements but is expected to have a significant impact on the Companys disclosures related to the assets and liabilities of its consolidated investment products that are classified as level 3 assets within the fair value hierarchy. The amendments to Topic 820 made by ASU 2011-04 are effective for interim and annual periods beginning on or after December 15, 2011. 3. CLO FUNDS A CLO Fund generally refers to a special purpose vehicle that owns a portfolio of investments and issues various tranches of debt and subordinated note securities to finance the purchase of those investments. Investments purchased by the CLO Funds are governed by extensive investment guidelines, including limits on exposure to any single industry or issuer and limits on the ratings of the CLO Funds assets. The CLO Funds managed by Katonah Debt Advisors have a defined investment period during which they are allowed to make investments or reinvest capital as it becomes available. Katonah Debt Advisors manages five CLO Funds primarily for third party investors that invest in broadly syndicated loans, high yield bonds and other credit instruments issued by corporations. These CLO Funds do not invest in asset-backed securities secured by commercial mortgages, residential mortgages or other consumer borrowings. At December 31, 2011 and 2010, Katonah Debt Advisors had approximately $1.9 billion of par value of assets under management in these CLO Funds.  CLO Funds typically issue multiple tranches of debt and subordinated note securities with varying ratings and levels of subordination to finance the purchase their underlying investments. Interest and principal payments (net of designated CLO Fund expenses) from the CLO Fund are paid to each issued security in accordance with an agreed upon priority of payments, commonly referred to as the waterfall. The most senior notes, generally rated AAA/Aaa, commonly represent the majority of the total liabilities of the CLO Fund. AAA/Aaa notes are issued at a specified spread over LIBOR and normally have the first claim on the earnings on the CLO
Funds investments after payment of certain fees and expenses. Lower subordinated mezzanine tranches of rated notes generally have ratings ranging from AA/Aa to BB/Ba and are usually issued at a specified spread over LIBOR with higher spreads paid on the tranches with lower ratings. Each tranche is typically only entitled to a share of the earnings on the CLO Funds investments if the required interest and principal payments have been made on the more senior tranches in the waterfall. The most junior tranche can take the form of either subordinated notes or preferred shares. The subordinated notes or preferred shares generally do not have a stated coupon but are entitled to residual cash flows from the CLO Funds investments after all of the other tranches of notes and certain other fees and expenses are paid. The CLO Funds are primarily financed via capital contributed by equity and debt holders. Katonah Debt Advisors risk with respect to each investment in the CLO Funds it manages is limited to any uncollected management fees (as Katonah Debt Advisors has no investment in the CLO Funds and it has no exposure or benefits in the ownership of the CLO Funds bonds). Therefore, the gains or losses of the CLO Funds have not had a significant impact on Katonah Debt Advisors financial position, results of operations or cash flows. Katonah Debt Advisors has no right to the benefits from, nor does it bear the risks associated with, these investments,
beyond the management fees generated from the CLO Funds. If Katonah Debt Advisors were to
 S-14    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 3. CLO FUNDS   (continued) liquidate, these investments would not be available to any general creditors of Katonah Debt Advisors. Additionally, the collateral assets of consolidated CLO Funds are held solely to satisfy the obligations of the CLO Funds, and the investors in the consolidated CLO Funds have no recourse to the general credit of Katonah Debt Advisors for the notes issued by the CLO Funds. CLO Funds are investment vehicles created for the sole purpose of issuing collateralized loan instruments that offer investors the opportunity for returns that vary with the risk level of their investment. The notes issued by the CLO Funds are backed by diversified collateral asset portfolios consisting primarily of loans or structured debt. For managing the collateral for the CLO Fund entities, Katonah Debt Advisors earns investment management fees, including subordinated management fees, as well as contingent incentive fees. Katonah Debt Advisors has no investment in the CLO Funds it manages. However, its sole shareholder, Kohlberg Capital, has
invested in certain of the CLO Funds, generally taking a portion of the unrated, junior subordinated position (generally subordinated to other interests in the entities and entitle Kohlberg Capital and other subordinated tranche investors to receive the residual cash flows, if any, from the entities). Upon adoption of guidance encompassed in ASC Topic 810, Katonah Debt Advisors determined that it was the primary beneficiary of these CLO Funds, as it has the power to direct the activities of the CLO Funds that most significantly impact the CLO Funds economic performance, and the obligation to absorb losses/right to receive benefits (in the form of senior and subordinate management fees as well as the potential to earn an incentive fee) from the CLO Funds that could potentially be significant to the CLO Funds. The primary beneficiary assessment includes an analysis of the rights of Katonah Debt Advisors in its capacity as investment manager.
In certain CLOs, Katonah Debt Advisors role as investment manager provides that Katonah Debt Advisors contractually has the power, as defined in ASC Topic 810, to direct the activities of the CLO Funds that most significantly impact the CLO Funds economic performance, such as managing the collateral portfolio and its credit risk. Additionally, the primary beneficiary assessment includes an analysis of Katonah Debt Advisors rights to receive benefits and obligations to absorb losses associated with its management/incentive fees. As a manager of the CLO Funds, Katonah Debt Advisors receives contractual and recurring management fees and may receive a one-time structuring fee from the CLO Funds for its management and advisory services. The annual fees which Katonah Debt Advisors receives are generally based on a fixed percentage of assets under management (at par value and not subject to changes in market value), and Katonah Debt Advisors generates annual operating income equal to the amount by which its fee income exceeds it operating expenses. The annual management fees Katonah Debt Advisors receives have two components  a senior management fee and a
subordinated management fee. At December 31, 2011, Katonah Debt Advisors continued to receive all senior and subordinated management fees payable by the CLO Funds managed by it. During 2009, certain CLO funds managed by Katonah Debt Advisors were restricted from currently paying their subordinated management fees as a result of the failure by those CLO Funds to satisfy certain restrictive covenants contained in their indenture agreements. At such time, those subordinated management fees continued to be accrued by the applicable CLO Fund to become payable to Katonah Debt Advisors if and when such CLO Fund becomes compliant with the applicable covenants. During the year ended December 31, 2010, all those CLO Funds which deferred payment of their subordinated management fees regained compliance with all applicable covenants in
order to pay current subordinated management fees as well as a portion of previously accrued subordinated management fees. Currently, all CLO Funds managed by Katonah Debt Advisors are paying both their senior and subordinated management fees on a current basis. In future years, Katonah Debt Advisors may receive accrued incentive fees upon the liquidation of CLO Funds it manages, provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares.
 S-15    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 3. CLO FUNDS   (continued) Fair value of consolidated CLO Funds The investments held by consolidated CLO Funds are primarily invested in senior secured bank loans (typically syndicated by banks), bonds, equity securities, and other CLOs and structured finance securities. Bank loan investments, which comprise the majority of consolidated CLO Fund portfolio collateral, are senior secured corporate loans from a variety of industries, including but not limited to the aerospace and defense, broadcasting, technology, utilities, household products, healthcare, oil and gas, and finance industries. Bank loan investments mature at various dates between 2012 and 2019, pay interest at Libor plus a spread of up to 8.5%, and
typically range in credit rating categories from BBB down to unrated. At December 31, 2011, the unpaid par principal balance exceeded the fair value of the senior secured bank loans and bonds by approximately $211 million. At December 31, 2010, the unpaid par principal balance exceeded the fair value of the senior secured bank loans and bonds by approximately $239 million. Less than 0.23% and 0.63% of the collateral assets at fair value are in default as of December 31, 2011 and December 31, 2010, respectively. Substantially all the CLO Fund investments are valued based on price quotations provided by an independent third-party pricing source which are indicative of traded prices and/or dealer price quotations. In the event that a third-party pricing source is unable to price an investment, other relevant factors, data and information are considered, including: i) information relating to the market for the investment, including price quotations for and trading in the investment and
interest in similar investments and the market environment and investor attitudes towards the investment and interests in similar investments; ii) the characteristics of and fundamental analytical data relating to the investment, including the cost, size, current interest rate, period until next interest rate reset, maturity and base lending rate, the terms and conditions of the loan and any related agreements, and the position of the loan in the issuers debt structure; iii) the nature, adequacy and value of the senior secured corporate loans collateral, including the CLOs rights, remedies and interests with respect to the collateral; iv) the creditworthiness of the borrower, based on an evaluation of its financial condition, financial statements and information about the business, cash flows, capital structure and future prospects; v) the reputation and financial condition of the agent and any intermediate participants in the senior secured corporate loan; and vi)
general economic and market conditions affecting the fair value of the senior secured corporate loan. CLO Fund liabilities issued by consolidated CLO Funds have a legal maturity at various dates between 2013 and 2022 and have a weighted average maturity of 7.6 years. The CLO Fund liabilities are issued in various tranches with different risk profiles and ratings. The interest rates are generally variable rates based on Libor plus a pre-defined spread, which varies from 0.225% for the more senior tranches to 5.00% for the more subordinated tranches. At December 31, 2011 and 2010, the outstanding balance on the CLO Fund liabilities issued by consolidated CLO Funds exceeds their fair value by approximately $252 million and $263 million, respectively.
The investors in the CLO Fund liabilities have no recourse to the general credit of Katonah Debt Advisors. CLO Fund liabilities are recorded at fair value using an income approach, driven by cash flows expected to be received from the portfolio collateral assets. Fair value is determined using current information, notably market yields and projected cash flows of collateral assets based on forecasted default and recovery rates that a market participant would use in determining the current fair value of the liabilities, taking into account the overall credit quality of the issuers and Katonah Debt Advisors past experience in managing similar securities. Market yields, default rates and recovery rates used in Katonah Debt Advisors estimate of fair value vary based on the nature of the investments in the underlying collateral pools. In periods of rising market yields, default rates and lower debt recovery rates, the fair value, and therefore the carrying value, of the
liabilities may be adversely affected. Once the undiscounted cash flows of the collateral assets have been determined, Katonah Debt Advisors applies appropriate discount rates that a market participant would use, to determine the discounted cash flow valuation of the liabilities.
 S-16    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 3. CLO FUNDS   (continued) The following table presents the fair value hierarchy levels of the CLO investments held and CLO Fund liabilities issued by the CLO Funds, which are measured at fair value as of December 31, 2011 and December 31, 2010:  December 31, 2011($ in millions)

          

          Fair Value

          

          Quoted Prices in Active Markets for Identical Assets (Level 1)

          

          Significant Other Observable Inputs (Level 2)

          

          Significant Unobservable Inputs(Level 3)Assets:Investments of CLO Funds

          

          

          1,768.1

          

          

          

          

          

          

          

          1,562.7

          

          

          

          205.4Liabilities:CLO Fund Liabilities

          

          

          1,727.6

          

          

          

          

          

          

          

          

          

          

          

          1,727.6
  December 31, 2010($ in millions)

          

          Fair Value

          

          Quoted Prices in Active Markets for Identical Assets (Level 1)

          

          Significant Other Observable Inputs (Level 2)

          

          Significant Unobservable Inputs(Level 3)Assets:Investments of CLO Funds

          

          

          1,741.5

          

          

          

          

          

          

          

          1,625.0

          

          

          

          116.5Liabilities:CLO Fund Liabilities

          

          

          1,717.4

          

          

          

          

          

          

          

          

          

          

          

          1,717.4
 The following table shows a reconciliation of the beginning and ending fair value measurements for Level 3 assets using significant unobservable inputs:  For the year ended December 31,($ in millions)

          

          2011

          

          2010Beginning balance

          

          

          116.5

          

          

          

          235.1Transfers to Level 3

          

          

          13.0

          

          

          

          5.0Transfers from Level 3

          

          

          (7.0

          )

          

          

          (115.6

          )Purchase of investments

          

          

          104.9

          

          

          

          30.4Sale of investments

          

          

          (5.0

          )

          

          

          (6.3

          )Proceeds from paydown and redemption of investments

          

          

          (7.8

          )

          

          

          (40.0

          )Realized and unrealized gains / (losses), net

          

          

          (9.2

          )

          

          

          8.0Ending balance

          

          

          205.4

          

          

          

          116.6Changes in unrealized appreciation (depreciation) included in net realized and unrealized loss related to investments still held at the reporting date

          

          

          4.0

          

          

          

          (10.8

          )
 S-17    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 3. CLO FUNDS   (continued) The following table shows a reconciliation of the beginning and ending fair value measurements for Level 3 liabilities using significant unobservable inputs:  For the year ended December 31,($ in millions)

          

          2011

          

          2010Beginning balance

          

          

          1,717.4

          

          

          

          1,618.0Repayment of debt

          

          

          (1.2

          )

          

          

          (9.8

          )Unrealized appreciation/(depreciation)

          

          

          11.4

          

          

          

          109.2Ending balance

          

          

          1,727.6

          

          

          

          1,717.4Changes in unrealized appreciation (depreciation) included in net realized and unrealized loss related to liabilities still held at the reporting date

          

          

          11.4

          

          

          

          109.2
 All transfers into and out of Level 3 represent transfers between Level 3 and Level 2. There were no transfers in or out of Level 1 for the periods presented. All Level 1, 2, and 3 transfers are recognized at the beginning of each accounting period, the actual date of the event, or change in circumstance that caused the transfer, or at the end of the accounting period. 4. UNCONSOLIDATED VIEs Katonah Debt Advisors deems the funds managed by Scotts Cove (Scotts Cove Funds) to be VIEs for which Katonah Debt Advisors is not the primary beneficiary and thus the Scotts Cove Funds are not consolidated into the financial statements of Katonah Debt Advisors. A primary beneficiary is one that absorbs a majority of the entitys expected losses, receives a majority of the entitys residual returns or both. Katonah Debt Advisors has no obligation to absorb any of the entitys expected losses. In addition, Katonah Debt Advisors does not receive the majority of the entitys expected residual returns. As a result,
Katonah Debt Advisors does not consolidate the Scotts Cove Funds. Katonah Debt Advisors maximum exposure to loss as a result of it involvement in the Scotts Cove Funds is limited to any uncollected management fees due from the funds it manages. At December 31, 2010 Katonah Debt Advisors had a $67,000 investment interest in the Scotts Cove Funds and no investment interest in the Scotts Cove Funds at December 31, 2011 due to the sale of Scotts Cove on February 28, 2011, as discussed in Note 1. 5. INCOME TAXES As a separately regarded entity for tax purposes, Katonah Debt Advisors is taxed at normal corporate rates. The CLO Funds are not taxed. For tax purposes, Katonah Debt Advisors taxable net income will differ from GAAP net income because of deferred tax timing adjustments and permanent tax adjustments. Deferred tax timing adjustments may include differences for the recognition and timing of depreciation, bonuses to employees and stock option expense. Permanent differences may include adjustments, limitations or disallowances for meals and entertainment expenses, penalties and tax goodwill amortization. Goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors by its sole member, Kohlberg Capital, in exchange for shares of the Kohlberg Capitals stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for GAAP purposes, such exchange was considered an asset purchase under Section 351(a) of the Code. At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which will be amortized for tax purposes on a
straight-line basis over 15 years, which accounts for an annual difference between GAAP income and taxable income by approximately $2 million per year over such period.
 S-18    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 5. INCOME TAXES   (continued) Any distributions of taxable net income earned by Katonah Debt Advisors to Kohlberg Capital would generally need to be distributed to the Kohlberg Capitals shareholders. Generally, such distributions of Katonah Debt Advisors income to the Kohlberg Capitals shareholders will be considered as qualified dividends for tax purposes. The components of income tax expense (benefit) for the years ended December 31, 2011, 2010 and 2009 are as follows:  For the year ended December 31,($ in millions)

          

          2011

          

          2010

          

          2009Current income tax expense:Federal

          

          

          84,821

          

          

          

          290,622

          

          

          

          191,846State & local

          

          

          259,797

          

          

          

          (39,719

          )

          

          

          (24,115

          )Total current income tax expense

          

          

          344,618

          

          

          

          250,903

          

          

          

          167,731Deferred income tax expense (benefit):Federal

          

          

          (350,459

          )

          

          

          (39,639

          )

          

          

          1,205,433State & local

          

          

          (215,474

          )

          

          

          662,637

          

          

          

          (144,646

          )Total deferred income tax expense (benefit)

          

          

          (565,933

          )

          

          

          622,998

          

          

          

          1,060,787Total income tax expense

          

          

          (221,315

          )

          

          

          873,901

          

          

          

          1,228,518
 The Companys effective income tax rate and pre-tax book income was 0.7%, -9.1% and 67.5% for tax years 2011, 2010 and 2009, respectively. The difference between the Companys reported provision for income taxes and the U.S. federal statutory rate of 35% is primarily due to tax goodwill amortization and the CLO funds having no tax consequences. Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements. These temporary differences result in taxable or deductible amounts in future years. The components of deferred income tax assets and liabilities are shown below:  For the year ended December 31,($ in millions)

          

          2011

          

          2010Deferred income tax assets:Net operating loss and tax credit carryforward

          

          

          3,912,080

          

          

          

          3,671,698Restricted stock

          

          

          327,886

          

          

          

          242,533Other

          

          

          21,490

          

          

          

          231,359Less: Valuation allowance

          

          

          (3,878,108

          )

          

          

          (3,623,183

          )Total deferred tax assets

          

          

          383,348

          

          

          

          (522,407

          )Deferred income tax liabilities:Fixed asset and intangible depreciation/amortization

          

          

          

          

          

          

          (704,992

          )Total deferred tax liabilities

          

          

          383,348

          

          

          

          (182,585

          )Net deferred tax assets

          

          

          383,348

          

          

          

          (887,577

          )
 The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. If it is not more likely than not that some portion or all of the gross deferred income tax assets will be realized in future years, a valuation allowance is recorded.
 S-19    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 5. INCOME TAXES   (continued) At December 31, 2011 the Company had federal and state net loss carryovers of $8.7 million and $8.3 million available to offset future taxable income. At December 31, 2010, federal and state net loss carryovers were $7.7 million and $8.1 million, respectively. The net loss carryovers expire in the years 2022 to 2029. At December 31, 2011, the federal and state net operating loss carryovers made up $3.0 million and $0.9 million of the deferred tax asset, respectively. At the present time, the Company believes it is more likely than not that the deferred tax assets related to net operating loss carryovers will not be recognized. Accordingly, the
Company has provided a full valuation allowance against such carryovers. Katonah Debt Advisors adopted Financial Accounting Standards Board ASC Topic 740 Accounting for Uncertainty in Income Taxes (ASC 740) as of January 1, 2009. ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the tax returns to determine whether the tax positions are more-likely-than-not of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold are recorded as a tax
benefit or expense in the current year. Adoption of ASC 740 was applied to all open taxable years (the last three fiscal years) as of the effective date. The adoption of ASC 740 did not have an effect on the financial position or results of operations of the Company as there was no liability for unrecognized tax benefits and no change to the beginning capital of the Company. Managements determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. With a few exceptions, the Company is no longer subject to U.S. federal, state and local tax examinations by tax authorities for years prior to 2008. 6. COMMITMENTS AND CONTINGENCIES Katonah Debt Advisors has no direct commitments and contingencies; however, the CLO Funds have purchase commitments to fund approximately $326,000 and $6 million of investments as of December 31, 2011 and December 2010, respectively. Rent expense was approximately $295,459, $341,441 and $322,256 for the years ended December 31, 2011, 2010 and 2009, respectively. The following table summarizes our future minimum lease payments as of December 31, 2011:  Contractual Obligations

          

          2012

          

          2013

          

          2014

          

          2015

          

          2016

          

          More than 5 yearsOperating lease obligations

          

          $

          335,445

          

          

          $

          342,611

          

          

          $

          361,177

          

          

          $

          369,432

          

          

          $

          369,432

          

          

          $

          2,893,884
 7. MEMBERS EQUITY The member interest of Katonah Debt Advisors is held solely by Kohlberg Capital. Kohlberg Capital owns 100 common units (no par or stated value) of Katonah Debt Advisors. 8. OTHER EMPLOYEE COMPENSATION Katonah Debt Advisors adopted a 401(k) plan (401K Plan) effective January 1, 2007 that it shares with its sole shareholder, Kohlberg Capital. The 401K Plan is open to all full time employees. The Plan permits an employee to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility. Katonah Debt Advisors makes contributions to the 401K Plan of up to 2.67% of the employees first 74.9% of maximum eligible compensation, which fully vest at the time of contribution. For the years ended December 31, 2011 and 2010, Katonah Debt Advisors made contributions to the 401K
Plan of approximately $41,000 and $66,000, respectively.
 S-20    TABLE OF CONTENTS KATONAH DEBT ADVISORS, L.L.C.   NOTES TO COMBINED FINANCIAL STATEMENTS 8. OTHER EMPLOYEE COMPENSATION   (continued) Certain employees of Katonah Debt Advisors may receive restricted stock grants in the stock of Katonah Debt Advisors sole member, Kohlberg Capital. On October 7, 2011 and July 22, 2010, the Board of Directors approved the grant of an additional 86,805 and 103,519 shares of restricted stock, respectively, to a certain executive officer of the Katonah Debt Advisors. Such awards of restricted stock will vest as to 50% of the shares on the third anniversary of the grant date and the remaining 50% of the shares on the fourth anniversary of the grant date. For the years ended December 31, 2011, December 31, 2010, and December 31, 2009, non-cash compensation expense of $89,000, $240,000, $281,000 respectively, was expensed at Katonah Debt Advisors related to an allocated reimbursable expense for a grant of restricted stock of Kohlberg Capital. 9. SUBSEQUENT EVENTS Katonah Debt Advisors has evaluated events or transactions that have occurred since December 31, 2011 through March 15, 2012 the date the financial statements were available for issuance. KDA has determined that there are no material events that would require the disclosure in the financial statements other than the following. On February 29, 2012, Katonah Debt Advisors acquired 100% of the equity interest of Trimaran Advisors, L.L.C. (Trimaran). The aggregate consideration paid for all of the outstanding equity interests in Trimaran consisted of $13.0 million in cash and 3,600,000 shares of common stock, par value $0.01 per share, of Kohlberg Capital. Trimaran manages four CLO Funds with aggregate assets under management of approximately $1.5 billion. Contemporaneously with the acquisition, Kohlberg Capital also acquired the subordinated or preferred share interests in certain CLO Funds managed by Trimaran for an aggregate cash purchase price of $12.0 million.
An estimate of the financial effects of this acquisition has not been fully quantified pending the final determination of financial information up to the closing date of Trimaran.
 S-21    TABLE OF CONTENTS EXHIBIT INDEX  Exhibit Number

          

          Description2.1

          

          Purchase and Sale Agreement, dated February 29, 2012, by and among Kohlberg Capital Corporation (the Company), Commodore Holdings, L.L.C., Trimaran Advisors, L.L.C., HBK Caravelle, L.L.C., Trimaran Fund Management, L.L.C., Jay R. Bloom, and Dean C. Kehler.(1)2.2

          

          Escrow Agreement, dated February 29. 2012, by and among Commodore Holdings, L.L.C., Trimaran Fund Management, L.L.C., HBK Caravelle, L.L.C. and The Bank of New York Mellon, as escrow agent.(2)3.1

          

          Form of Certificate of Incorporation of the Company.(3)3.2

          

          Form of Bylaws of the Company, as amended and restated effective February 29, 2012.(4)4.1

          

          Specimen certificate of the Companys common stock, par value $0.01 per share.(3)4.2

          

          Form of Registration Rights Agreement.(5)4.3

          

          Form of Dividend Reinvestment Plan.(5)4.4

          

          Indenture dated as of March 16, 2011, by and between the Company and U.S. Bank National Association, as trustee.(6)4.5

          

          Form of 8.75% Convertible Senior Note Due 2016 (included as part of Exhibit 4.5).10.1

          

          Form of the Amended and Restated 2006 Equity Incentive Plan.(7)*10.2

          

          Form of Company Non-Qualified Stock Option Certificate.(5)*10.3

          

          Form of Custodian Agreement by and among Kohlberg Capital Corporation and U.S. Bank National Association.(5)10.4

          

          Form of License and Referral Agreement between the Company and Kohlberg & Company, L.L.C.(3)10.5

          

          Form of Overhead Allocation Agreement between the Company and Katonah Debt Advisors, L.L.C.(5)10.6

          

          Form of Employment Agreement between the Company and Dayl W. Pearson.(5)*10.7

          

          Form of Employment Agreement between the Company and Michael I. Wirth.(5)*10.8

          

          Form of Employment Agreement between the Company and R. Jon Corless.(5)*10.9

          

          Form of Employment Agreement between the Company and E.A. Kratzman.(5)*10.10

          

          Form of Employment Agreement between Katonah Debt Advisors and E.A. Kratzman.(5)*10.11

          

          Letter Agreement, dated December 10, 2010, between the Company and John M. Stack.(8)*10.12

          

          Consulting Agreement, dated December 10, 2010, between Katonah Debt Advisors, L.L.C. and John M. Stack.(9)*10.13

          

          Form of Employment Agreement between Katonah Debt Advisors and Daniel P. Gilligan.(10)*10.14

          

          Form of Indemnification Agreement for Officers and Directors of the Company.(11)10.19

          

          Forebearance and Settlement Agreement, dated as of September 20, 2010, by and among the Company, BMO Capital Markets Corp. and the other lender parties thereto.(12)10.20

          

          Amended and Restated Non-Employee Director Plan.(13)*10.21

          

          Note Purchase Agreement, dated as of February 24, 2012, by and among the Company, Credit Suisse AG, Cayman Islands Branch, Credit Suisse Securities (USA) LLC, as arranger, The Bank of New York Mellon Trust Company, National Association, as collateral administrator and collateral agent, and KCAP Funding.(14)10.22

          

          Collateral Administration Agreement, dated as of February 24, 2012, by and among the Company, KCAP Funding, Credit Suisse AG, Cayman Islands Branch, The Bank of New York Mellon Trust Company, National Association, as collateral administrator and collateral agent.(15)
 E-1    TABLE OF CONTENTS Exhibit Number

          

          Description10.23

          

          Employment Agreement, dated February 29, 2012, by and among, Jay R. Bloom and Trimaran Advisors, L.L.C., and, solely as to the last three sentences of Section 1(a) and Section 2(d), the Company.(16)*10.24

          

          Employment Agreement, dated February 29, 2012,by and among, Dean C. Kehler and Trimaran Advisors, L.L.C., and, solely as to the last three sentences of Section 1(a) and Section 2(d), the Company.(17)*21.1

          

          List of Subsidiaries.23.1

          

          Consent of Grant Thornton LLP, Independent Registered Public Accounting Firm.31.1

          

          Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

          

          Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1

          

          Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2

          

          Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  (1)

          Incorporated by reference to Exhibit 2.1 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735). (2)

          Incorporated by reference to Exhibit 2.2 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735). (3)

          Incorporated by reference to the exhibit included in Pre-Effective Amendment No. 1 on Form N-2, as filed on October 6, 2006 (File No. 333-136714). (4)

          Incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735). (5)

          Incorporated by reference to the exhibit included in Pre-Effective Amendment No. 2 on Form N-2, as filed on November 20, 2006 (File No. 333-136714). (6)

          Incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K, as filed on March 16, 2011 (File No. 814-00735). (7)

          Incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, as filed on June 19, 2008 (File No. 814-00735). (8)

          Incorporated by reference to Exhibit 10.11 of the Annual Report on Form 10-K, as filed on March 15, 2011 (File No. 814-00735). (9)

          Incorporated by reference to Exhibit 10.12 of the Annual Report on Form 10-K, as filed on March 15, 2011 (File No. 814-00735). (10)

          Incorporated by reference to Exhibit 10.13 of the Annual Report on Form 10-K, as filed on March 15, 2011 (File No. 814-00735). (11)

          Incorporated by reference to the exhibit included in Pre-Effective Amendment No. 3 on Form N-2, as filed on November 24, 2006 (File No. 333-136714). (12)

          Incorporated by reference to Exhibit 10.1 of the Quarterly Report on Form 10-Q, as filed on November 8, 2010 (File No. 333-814-00735). (13)

          Incorporated by reference to Exhibit 4.1 included in the Registration Statement on form S-8, as filed on July 28, 2011 (File No. 333-175838).. (14)

          Incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735).
 E-2    TABLE OF CONTENTS (15)

          Incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735). (16)

          Incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735). (17)

          Incorporated by reference to Exhibit 10.4 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735). *

          Indicates a management contract or compensatory plan, contract or agreement.
 E-3