**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

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**FORM 10-K**

**(MarkOne)**
| **ý**                               | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                 |
|------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                               | ** ** | **for the fiscal year ended March  31, 2006**                                                                                                                                                                   |
| **OR**                                   |
| **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 number****814-00704** |

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| **GLADSTONE INVESTMENT CORPORATION**                            |
|-----------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)          |
| **Delaware**                                                    | ** ** | **83-0423116** |
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |   |
| **1521 Westbranch Drive, Suite 200  McLean, Virginia**          | ** ** | **22102** |
| (Address of principal executive offices)                        |   | (Zip Code) |
|                                                            |   |   |
| **(703) 287-5800**                                         |
| (Registrant’s telephone number, including area code)       |

 

Securitiesregistered pursuant to Section 12(b) of the Act: **None**

 

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

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act YES  o  NO  ý

 

Indicateby check if the registrant is not required to file reports pursuant to Section13 or Section 15 (d) of the Act. YES o  NO  ý

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past90 days.   YES  ý  NO  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this 10-K or any amendment tothis Form 10-K. o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

| Large Accelerated Filer o |   | Accelerated Filer o |   | Non-Accelerated Filer ý. |
|---------------------------|--------|---------------------|--------|-------------------------------|

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12 b-2 of the Exchange Act).YES  o  NO  ý.

 

Theaggregate market value of the voting stock held by non-affiliates of theRegistrant on September 30, 2005, based on the closing price on that date of$14.68 on the NASDAQ National Market, was $241,236,513. For the purposes ofcalculating this amount only, all directors and executive officers of theRegistrant have been treated as affiliates.

 

Therewere 16,560,100 shares of the Registrant’s Common Stock, $0.001 par value,outstanding as of June 12, 2006.

 

**Documents Incorporated by Reference.**  Portions of the Registrant’s Proxy Statementrelating to the Registrant’s 2006 Annual Meeting of Stockholders areincorporated by reference into Part III of this Report.

 

 

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**GLADSTONE INVESTMENT CORPORATION**

**FORM 10-K FOR THE FISCAL YEARENDED**

**MARCH 31, 2006**

 

**TABLE OF CONTENTS**

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

 

 

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**FORWARD-LOOKING STATEMENTS**

 

*All statements contained herein, other thanhistorical facts, may constitute**“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended. These statements may relate to, among otherthings, future events or ourfuture performance or financial condition. In some cases, you can identify forward-looking statementsby terminology such as “may,” “might,”“believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,”“would,” “if,” “seek,” “possible,”“potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statementsinvolve known and unknown risks, uncertaintiesand other factors that may cause our actual results, levels of activity, performance or achievements to bematerially different from any futureresults, levels of activity, performance or achievements expressed or implied by such forward-looking statements.Such factors include, among others: (1) our future operating results as we are a company with a limitedoperating history; (2) the lossof one or more of our executive officers, in particular, David Gladstone, Terry Lee Brubaker, orGeorge Stelljes, III; (3) the impact of the investments that we make and the ability of these investments toachieve their objectives; (4)our contractual relationships with third parties; (5) the adequacy of our cash resources and workingcapital; (6) our ability to obtain future financing, if at all; and (7) those factors listed under thecaption “Risk Factors” of theCompany’s prospectus dated June 22, 2005, as filed with the Securities and Exchange Commission onJune 23, 2005. We caution readers not to place undue reliance on any such forward-looking statements, which aremade pursuant to the PrivateSecurities Litigation Reform Act of 1995 and, as such, speak only as of the date made. We undertakeno obligation to publicly update orrevise any forward-looking statements, whether as a result of new information, future events or otherwise,after the date of this Form 10-K.*

 

**PART I**

 

**Item 1. Business**

 

**Gladstone Investment Corporation**

 

We were incorporated under the GeneralCorporation Laws of the State of Delaware on February 18, 2005. On June 22,2005 we completed an initial public offering and commenced operations.  We were primarily established for the purposeof investing in subordinated loans, mezzanine debt, preferred stock andwarrants to purchase common stock of small and medium-sized companies inconnection with buyouts and other recapitalizations. We may also invest insenior secured loans and common stock and, from time to time, we may alsoinvest in senior and subordinated syndicated loans. Our investment objective isto generate both current income and capital gains through these debt and equityinstruments. We operate as a closed-end, non-diversified management investmentcompany and have elected to be treated as a business development company underthe Investment Company Act of 1940 as amended, which we refer to in this annualreport as the 1940 Act.

 

Our primary investment focuses are situationsinvolving buyouts and recapitalizations of small and mid-sized companies withestablished management teams. We expect that our investments will generallyrange between $10 million and $30 million each, although this investmentsize may vary proportionately as the size of our capital base changes. Weintend to invest either by ourselves or jointly with other buyout funds,depending on the opportunity. If we are participating in an investment with oneor more co-investors, then our investment is likely to be smaller than if wewere to be investing alone.

 

**OurAdviser**

 

Our affiliate GladstoneManagement Corporation (the “Adviser” or “GMC”) is our investment adviser andis led by a management team which has extensive experience in our lines ofbusiness.  GMC is controlled by DavidGladstone, our chairman and chief executive officer.  Mr. Gladstone is also the chairman and chiefexecutive officer of our Adviser.  TerryLee Brubaker, our vice chairman, chief operating officer and director, is amember of the Board of Directors of GMC and its vice chairman and chiefoperating officer.  George Stelljes III,our president, chief investment officer and director, is a member of the Boardof Directors of GMC and its president and chief investment officer.  Harry Brill, our chief financial officer, isthe chief financial officer of GMC.

 

GMC also providesinvestment advisory and administrative services to our affiliates GladstoneCommercial Corporation, a publicly traded real estate investment trust;Gladstone Capital Corporation, a publicly traded registered investment company;and Gladstone Land Corporation, an agricultural real estate company owned byMr. Gladstone.  We refer to GMC and ourother affiliates managed by GMC in this annual report as the GladstoneCompanies.  All of our directors andexecutive officers serve as either directors or executive officers, or both, ofGladstone Commercial Corporation and Gladstone Capital Corporation.  In the future, GMC may provide investmentadvisory and administrative services to other funds, both public and private,of which it is the sponsor.

 

 

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We have been externallymanaged by GMC pursuant to an investment advisory and management agreementsince our inception.  GMC was organizedas a corporation under the laws of the State of Delaware on July 2, 2002, andis a registered investment adviser under the 1940 Act.  GMC is headquartered in McLean, Virginia, asuburb of Washington, DC, and has offices in New York, New York, Chicago,Illinois, Pittsburgh, Pennsylvania, Morristown, New Jersey, Lexington, Kentuckyand Dallas, Texas.

 

**OurInvestment Strategy**

 

We seek to achieve returns from current income and capital gains fromjunior subordinated and mezzanine debt, as well as preferred stock and warrantsto purchase common stock, representing controlling investments that we make inconnection with buyouts and recapitalizations of small and mid-sizedcompanies.  We expect that our targetportfolio over time will include mostly subordinated loans, mezzanine debt,preferred stock, and warrants to buy common stock. Structurally, subordinatedloans and mezzanine loans usually rank lower in priority of payment to seniordebt, such as senior bank debt, and may be unsecured. However, subordinateddebt and mezzanine loans rank senior to common and preferred equity in aborrower’s capital structure. Typically, subordinated debt and mezzanine loanshave elements of both debt and equity instruments, offering the returns in theform of interest payments associated with senior debt, while providing lendersan opportunity to participate in the capital appreciation of a borrower, ifany, through an equity interest. This equity interest typically takes the formof warrants. Due to its higher risk profile and often less restrictivecovenants as compared to senior debt, mezzanine debt generally earns a higherreturn than senior secured debt. The warrants associated with mezzanine loansare typically detachable, which allows lenders to receive repayment of theirprincipal on an agreed amortization schedule while retaining their equityinterest 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 aprice determined through an agreed upon formula. We believe that mezzanineloans offer an attractive investment opportunity based upon their historicreturns and resilience during economic downturns.

 

**InvestmentProcess**

 

***Overviewof Investment and Approval Process***

 

To originate investments,our Adviser’s investment professionals use an extensive referral networkcomprised of venture capitalists, leveraged buyout funds, investment bankers,attorneys, accountants, commercial bankers and business brokers.  Our Adviser’s investment professionals reviewinformation received from these and other sources in search of potentialfinancing opportunities.  If a potentialopportunity matches our investment objectives, the investment professionalswill seek an initial screening of the opportunity from our Adviser’s investmentcommittee, which is composed of Messrs. Gladstone, Brubaker and Stelljes.  If the prospective portfolio company passesthis initial screening, the investment professionals will conduct a duediligence investigation of the prospective portfolio company. Upon completionof the due diligence investigation, the investment professionals create adetailed profile summarizing the prospective portfolio company’s historicalfinancial statements, industry and management team and analyzing its conformityto our general investment criteria. The investment professionals then presentthis profile to the investment committee, which must unanimously approve eachinvestment.  Further, each financing isreviewed by the members of our Board of Directors, a majority of whom are not “interestedpersons” as defined in Section 2(a)(19) of the 1940 Act.

 

***Prospectiveportfolio company characteristics***

 

We have identifiedcertain characteristics that we believe are important in identifying andinvesting in prospective portfolio companies. The criteria listed below providegeneral guidelines for our investment decisions, although not all of thesecriteria may be met by each portfolio company.

 

•                  *Value-and-IncomeOrientation and Positive Cash Flow.*  Our investmentphilosophy places a premium on fundamental analysis from an investor’sperspective and has a distinct value-and-income orientation. In seeking value,we focus on companies in which we can invest at relatively low multiples ofearnings before interest, taxes, depreciation and amortization, or EBITDA(which is a measure of operating cash flow), and that have positive operatingcash flow at the time of investment. In seeking income, we seek to invest incompanies that generate relatively high and stable cash flow to provide someassurance that they will be able to service their debt and pay any requireddividends on preferred stock. Typically, we do not expect to invest in start-upcompanies or companies having speculative business plans.

 

•                  *ExperiencedManagement*.  We generally require that our portfoliocompanies have experienced management teams. We also require the portfoliocompanies to have in place proper incentives to induce management to succeedand to act in concert with our interests as investors, including havingsignificant equity or other interests in the financial performance of theircompanies.

 

 

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•                  *StrongCompetitive Position in an Industry.* We seek toinvest in target companies that have developed strong market positions withintheir respective markets and that we believe are well-positioned to capitalizeon growth opportunities. We seek companies that demonstrate significantcompetitive advantages versus their competitors, which we believe will help toprotect their market positions and profitability.

 

•                  *ExitStrategy.* We seek to invest in companies that we believe will provide a stable stream ofcash flow that is sufficient to repay the loans we make to them and to reinvestin their respective businesses. We expect that such internally generated cashflow, which will allow our portfolio companies to pay interest on, and repaythe principal of, our investments, will be a key means by which we exit fromour investments over time. In addition, we will also seek to invest incompanies whose business models and expected future cash flows offer attractivepossibilities for capital appreciation on any equity interests we retain. Thesecapital appreciation possibilities include strategic acquisitions by otherindustry participants or financial buyers, initial public offerings of commonstock, or other capital market transactions.

 

•                  *LiquidationValue of Assets*. The prospective liquidation value of the assets, if any, collateralizing loansin which we invest will be an important factor in our investment analysis. Wewill emphasize both tangible assets, such as accounts receivable, inventory,equipment, and real estate and intangible assets, such as intellectualproperty, customer lists, networks, and databases, although the relative weightwe place on these asset classes will vary by company and industry.

 

 

***ExtensiveDue Diligence***

 

Our Adviser conducts whatwe believe are extensive due diligence investigations of our prospectiveportfolio companies and investment opportunities.  Our due diligence investigation of aprospective portfolio company may begin with a review of publicly availableinformation, and generally includes some or all of the following:

 

•                  a review of the prospective portfolio company’s historical andprojected financial information;

•                  visits to the prospective portfolio company’s business site(s);

•                  interviews with the prospective portfolio company’s management,employees, customers and vendors;

•                  review of all loan documents;

•                  background checks on the prospective portfolio company’s managementteam; and

•                  research on the prospective portfolio company’s products, services orparticular industry.

 

Upon completion of a due diligence investigation and adecision to proceed with an investment in a buyout or other recapitalization,GMC’s investment professionals who have primary responsibility for theinvestment present the investment opportunity to GMC’s investment committee,which consists of Messrs. Gladstone, Brubaker and Stelljes. The investmentcommittee determines whether to pursue the potential investment. Additional duediligence of a potential investment may be conducted on our behalf by attorneysand independent accountants prior to the closing of the investment, as well asother outside advisers, as appropriate.

 

We also rely on thelong-term relationships that our Adviser’s professionals have with venturecapitalists, leveraged buyout funds, investment bankers, commercial bankers andbusiness brokers, and on the extensive direct experiences of our executiveofficers and managing directors in providing debt and equity capital to smalland medium-sized private businesses.

 

***InvestmentStructure***

 

Once we have determined that a prospectiveacquisition, buyout or recapitalization meets our standards and investmentcriteria, we work with the management of that company and other capitalproviders to structure the transaction in a way that provides us the greatestopportunity to maximize our return on the investment, while providingappropriate incentives to management of the company.

 

*Subordinated Debt and Mezzanine Debt. *We anticipate that over time, themajority of the capital that we invest will be in the form of subordinated ormezzanine debt. Most of our mezzanine loans will be unsecured loans while mostof the subordinated loans will be collateralized by a subordinated lien on someor all of the assets of the borrower. We will seek to structure most of ourmezzanine and subordinated loans with variable interest rates; however it ispossible that some will have fixed rates. In either event, we will attempt tostructure the loans at relatively high rates of interest that will provide uswith significant current interest income. We expect our subordinated andmezzanine loans to typically have maturities of five to ten years and toprovide for interest-only payments in the early years, with amortization ofprincipal deferred to the later years of the mezzanine loans. In some cases, wemay enter into loans that, by their terms, convert into equity or additionaldebt securities or defer payments of interest for the first few years after ourinvestment. 

 

 

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We will generally target a current return of 10% to14% for our subordinated and mezzanine loan investments before giving effect toany warrants that we receive in connection with these loans. We cannot give anyassurance that our returns will approximate these estimates.

 

Our subordinated and mezzanine debt investments mayinclude equity features, such as warrants or options to buy a significantcommon stock ownership interest in the portfolio company or success fees if thebusiness is sold. If a portfolio company appreciates in value, we may achieveadditional investment returns from any equity interests we hold. If we are aminority interest holder, we may structure the warrants to provide provisionsprotecting our rights as a minority-interest holder such as the right to sellthe warrants back to the company upon the occurrence of specified events. Inmany cases, we will also obtain registration rights in connection with theseequity interests, which may include demand and co- registration rights.

 

*Senior Secured Debt.*We also anticipate providing senior securedacquisition financing for some portfolio companies. We expect these seniorsecured loans to have terms of three to ten years, and they may provide fordeferred interest payments in the first few years of the term of the loan. Wegenerally will obtain security interests in the assets of our portfoliocompanies that will serve as collateral in support of the repayment of thesesenior loans. This collateral will usually take the form of first priorityliens on the assets of the portfolio company. We expect that the interest rateon our senior secured loans will be variable rates ranging between 2% and 5%over the London Interbank Offer Rate, or LIBOR. We will generally provide thistype of financing when there is a time constraint in closing an investment andwould expect to be repaid as soon as practical by either selling our interestin such debt or by having a bank or other senior lender provide financing topay off our senior loan.

 

*Common and Preferred Stock.*We may also acquire common or preferred stock inconnection with a buyout or recapitalization. With respect to preferred orcommon stock investments, we expect to target an investment returnsubstantially higher than our investments in senior or subordinated loans.However, we can offer no assurance that we can achieve such a return withrespect to any investment or our portfolio as a whole. The features of thepreferred stock we receive will vary by transaction, but may include prioritydividend rights, superior voting rights, redemption rights, liquidationpreferences and other provisions intended to protect our interests. Generallyspeaking, common stock does not have any current income and its value isrealized if at all, upon the sale of the business or following the company’sinitial public offering.

 

*Risk Management.*****We will seek to limit the downside riskof our investments by:

 

•                  making investments with an expected totalreturn on our investments (including both interest and potential equityappreciation) that we believe compensates us for the credit risk of theinvestment;

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

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

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

 

We expect to hold most of our investments insubordinated debt and mezzanine debt until maturity or repayment, but will sellour investments earlier if a liquidity event takes place, such as the sale orrecapitalization of a portfolio company or, in the case of an equity investmentin a company, its initial public offering. Occasionally, we may sell some orall of our subordinated debt, mezzanine debt or equity interests in a portfoliocompany to a third party, such as an existing investor in the company, througha privately negotiated transaction.

 

As described above, we may also provide senior debt inaddition to junior debt and equity in connection with an acquisition. In suchcircumstances, we would not expect to hold our senior debt for more than oneyear. Finally, we may attempt to securitize some of the debt securities in ourportfolio and if we do so, these loans would be transferred to a securitizationvehicle and generallywould be held by the securitization vehicle untilmaturity.

 

***TemporaryInvestments***

 

Pending investment in thedebt of private companies, we invest our otherwise uninvested cash primarily incash, cash items, government securities or high-quality debt securitiesmaturing in one year or less from the time of investment, to which we refercollectively as temporary investments, so that at least 70% of our assets are “qualifyingassets”, for purposes of the business development company provisions of the1940 Act. For information regarding regulations to which we are subject and thedefinition of “qualifying assets,” see “Regulation.”

 

 

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**CompetitiveAdvantages**

 

We believe that we have the following competitiveadvantages over other companies that provide capital to small and mid-sizedcompanies in connection with buyout and recapitalization transactions:

 

***ManagementExpertise***

 

David Gladstone, our chairman and chief executiveofficer, is also the chairman and chief executive officer of GMC, GladstoneCapital and Gladstone Commercial and has been involved in all aspects of theGladstone Companies’ investment activities, including serving as a member ofGMC’s investment committee. Terry Lee Brubaker is our vice chairman and hassubstantial experience in acquisitions and operations of companies. GeorgeStelljes III is our president and has extensive experience in leveragedfinance. Messrs. Gladstone, Brubaker and Stelljes have principalmanagement responsibility for GMC as its senior executive officers. Theseindividuals dedicate a significant portion of their time to managing ourinvestment portfolio. Our senior management has extensive experience providingcapital to small and mid-sized companies and has worked together for more than10 years. In addition, we have access to the resources and expertise ofGMC’s investment professionals and supporting staff who possess a broad rangeof transactional, financial, managerial, and investment skills. We expect thatGMC will continue to hire additional investment professionals in the future.

 

As a result of the extensive investment experience ofGMC, its executive officers and other investment professionals, GMC and itsexecutive officers have developed a positive reputation in the capital markets.We believe that this reputation and experience, together with the experience ofthe executive officers of GMC in investing in debt and equity securities, andmanaging investments in companies, affords us a competitive advantage inidentifying opportunities to invest in small and mid-sized companies.

 

***Increased access to investment opportunities developedthrough proprietary research capability and extensive network of contacts***

 

GMC seeks to identify potential investments boththrough active origination and due diligence and through its dialogue withnumerous management teams, members of the financial community, and potentialcorporate partners with whom GMC’s investment professionals have had long-termrelationships. We believe that GMC’s investment professionals have developed abroad network of contacts within the investment, commercial banking, privateequity, and investment management communities, and that their reputation ininvestment management enables us to identify well-positioned prospectiveportfolio companies which provide attractive investment opportunities.Additionally, GMC expects to generate information from its professionals’network of accountants, consultants, lawyers, and management teams of portfoliocompanies and other companies.

 

***Disciplined, value-and-income-oriented investment philosophywith a focus on preservation of capital***

 

In making its investment decisions, GMC focuses on therisk and reward profile of each prospective portfolio company, seeking tominimize the risk of capital loss without foregoing the potential for capitalappreciation. We expect GMC to use the same value-and-income-orientedinvestment philosophy that its professionals use in the management of the otherGladstone Companies and to commit resources to management of downside exposure.GMC’s approach seeks to reduce risk in investments by using some or all of thefollowing:

 

•                  focusing on companies with good marketpositions, established management teams and good cash flow;

•                  investing in businesses with experiencedmanagement teams;

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

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

•                  adopting flexible transaction structuresby drawing on the experience of the investment professionals of GMC and itsaffiliates.

 

***Versatile transaction structuring***

 

We believe our management team’s broad expertise andits ability to draw upon many years of combined experience will enable GMC toidentify, assess, and structure investments successfully across all levels of acompany’s capital structure and manage potential risk and return at all stagesof the economic cycle. We will not be subject to many of the regulatorylimitations that govern traditional lending institutions such as banks. As aresult, we expect to be flexible in selecting and structuring investments,adjusting investment criteria and transaction structures, and, in some cases,the types of securities in which we invest. We believe that this approachshould enable GMC to identify attractive investment opportunities that willcontinue to generate current income and capital gain potential throughout theeconomic cycle, including during turbulent periods in the capital markets. Oneexample of our flexibility is our ability to exchange our publicly-traded stockfor the stock of an acquisition target in a tax-free reorganization under theInternal Revenue 

 

 

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Code. After completing an acquisition in such anexchange, we can restructure the capital of the small company to include seniorand subordinated debt.

 

***Longer investment horizon with attractive publicly tradedmodel***

 

Unlike private equity and venture capital funds thatare typically organized as finite-life partnerships, we will not be subject tostandard periodic capital return requirements. The partnership agreements ofmost private equity and venture capital funds typically provide that thesefunds may only invest investors’ capital once and must return all capital andrealized gains to investors within a finite time period, often seven to tenyears. These provisions often force private equity and venture capital funds toseek returns on their investments by causing their portfolio companies topursue mergers, public equity offerings, or other liquidity events more quicklythan might otherwise be optimal or desirable, potentially resulting in both alower overall return to investors and an adverse impact on their portfoliocompanies. We believe that our flexibility to make investments with a long-termview and without the capital return requirements of traditional privateinvestment vehicles provides us with the opportunity to achieve greaterlong-term returns on invested capital.

 

**OngoingRelationships with and Monitoring of Portfolio Companies**

 

***Monitoring***

 

Our Adviser’s investmentprofessionals monitor the financial trends of each portfolio company on anongoing basis to determine if each is meeting its respective business plans andto assess the appropriate course of action for each company.  We monitor this information regarding thestatus and performance of each portfolio company, and use it to evaluate theoverall performance of our portfolio.

 

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

 

•                  Assessment of success in the portfolio company’s overall adherence toits business plan and compliance with covenants;

•                  Attendance at and participation in meetings of the portfolio company’sBoard of Directors;

•                  Periodic contact, including formal update interviews with portfoliocompany management, and, if appropriate, the financial or strategic sponsor;

•                  Comparison with other companies in the portfolio company’s industry;and

•                  Review of monthly and quarterly financial statements and financialprojections for portfolio companies.

 

***ManagerialAssistance******and Services***

 

As a business developmentcompany, we make available significant managerial assistance to our portfoliocompanies and provide other services to such portfolio companies. Neither wenor our Adviser receives fees in connection with managerial assistance,however, our Adviser may provide other services to our portfolio companies andmay receive fees for other services it provides to a portfolio company andthose fees would then be partially credited against the investment advisoryfees that we pay to our Adviser.

 

***ValuationProcess***

 

We carry our assets atfair value.  A portion of our investmentportfolio consists of securities for which a limited market does not exist andare not publicly traded.  As of March 31,2006, four of our investments were valued by Standard & Poor’s LoanEvaluations Service (“S&P). In fiscal 2007, to value these securities, weintend to provide loan portfolio data S&P for its independent review.  S&P will provide an independentassessment of the loan portfolio data provided by us and will assess its owndata to develop recommendations as to market values for these securities.  Supported by our internal valuations andS&P estimates, our Board of Directors will vote to accept or not accept theanalyses and values recommended by our management and S&P.  If an event comes to the attention of ourBoard of Directors subsequent to the S&P valuation date, our Board ofDirectors may alter the S&P valuation in order to present a more accuratereflection of the fair value of an investment.****Dueto the uncertainty inherent in the valuation process for these securities, suchestimates of fair value may differ significantly from the values that wouldhave been obtained had a ready market for the securities existed, and thedifferences could be material. Additionally, changes in the market environmentand other events that may occur over the life of the investments may cause thegains or losses ultimately realized on these investments to be different thanthe valuations currently assigned.  Securitiesin our portfolio that are publicly traded, if any, are valued at the closingprice of the exchange or securities market on which they are listed on thevaluation date (to date there are no publicly traded securities in ourportfolio). Securities in our portfolio which are not publicly traded on anexchange or securities market, but for which a limited 

 

 

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market exists, such asparticipations in syndicated loans, are valued at the indicative bid priceoffered by the syndication agent on the valuation date.

 

A substantial portion ofour assets will consist of securities carried at fair market value, asdetermined by our Board of Directors. Determination of fair market values forthose securities and investments not valued by S&P involves subjectivejudgment not susceptible to substantiation by auditing procedures. Accordingly,under generally accepted accounting principles, the notes to our consolidatedfinancial statements will refer to the uncertainty with respect to the possibleeffect of such valuations on our financial statements.

 

The net asset value pershare of our outstanding shares is determined quarterly, as soon as practicableafter and as of the end of each calendar quarter, by dividing the value oftotal assets minus liabilities by the actual number of shares outstanding atthe date as of which the determination is made.

 

**InvestmentAdvisory and Management Agreement**

 

We have entered into an investment advisoryand management agreement with GMC, which is controlled by our chairman andchief executive officer. In accordance with the investment advisory andmanagement agreement, we will pay GMC a fee, as compensation for its services,consisting of a base management fee and an incentive fee.

 

The base management fee is assessed at an annualrate of 2% computed on the basis of our gross invested assets, which are totalassets less the cash proceeds and cash and cash equivalent investments from theproceeds of our initial public offering that are not invested in debt andequity securities of portfolio companies. Through March 31, 2006, the base management fee was computed and payablemonthly.  Subsequent to March 31, 2006,the base management fee will be computed and payable quarterly to GMC.   Beginning in periods subsequent to June 30, 2006,the base management fee will be assessed at an annual rate of 2% computed onthe basis of our gross assets, which are total assets, including investmentsmade with proceeds of borrowings, less any uninvested cash or cash equivalentsresulting from borrowings.  Thiscalculation was set to begin in periods after March 31, 2006, however, on April11, 2006 our Board of Directors accepted a voluntary waiver from GMC that willallow the current calculation of the base management fee to be effectivethrough June 30, 2006.  GMC receives feesfrom our portfolio companies, such as investment banking fees, structuring feesor executive recruiting services fees, one half of these fees will be creditedagainst the base management fee that we would otherwise be required to pay toGMC.

 

The incentive fee consists of two parts: anincome-based incentive fee and a capital gains incentive fee. The income-basedincentive fee is calculated and payable quarterly in arrears based on ourpre-incentive fee net investment income for the immediately preceding calendarquarter. For this purpose, “pre-incentive fee net investment income” meansinterest income, dividend income, and any other income, including any otherfees (other than fees for providing managerial assistance) such as commitment,origination, structuring, diligence and consulting fees, and other fees that wereceive from portfolio companies accrued during the calendar quarter, minusoperating expenses for the quarter (including the base management fee, expensespayable under the administration agreement, operating expenses that we paydirectly, and any interest expense and dividends paid on any issued andoutstanding preferred stock, but excluding the incentive fee). Pre-incentivefee net investment income includes, in the case of investments with a deferredinterest feature (such as securities issued with original issue discount, debtinstruments with payment-in-kind interest, and zero coupon securities), accruedincome that we have not yet received in cash. Thus, if we do not havesufficient liquid assets to pay this incentive fee or distributions tostockholders on such accrued income, we may be required to liquidate assets orborrow money in order to do so.

 

Pre-incentive fee net investment income doesnot include any realized capital gains, realized capital losses, or unrealizedcapital appreciation or depreciation. Pre-incentive fee net investment income,expressed as a rate of return on the value of our net assets at the end of theimmediately preceding calendar quarter, will be compared to a “hurdle rate” of1.75% of our net assets per quarter (7% annualized). For this purpose, “netassets” means total assets less total liabilities and less preferred stock ifany. Because the hurdle rate is fixed and has been based on current interestrates, if interest rates increase, it would become easier for investment incometo exceed the hurdle rate and, as a result, more likely that GMC will receivean income-based incentive fee than if interest rates on our investments remainedconstant. On the other hand, if interest rates rise, there will be greater riskthat small and medium-sized businesses cannot make payments, which risk mayresult in fewer opportunities to make safe investments. Our net investmentincome used to calculate this income-based portion of the incentive fee is alsoincluded in the amount of gross assets used to calculate the 2% base managementfee. We will pay GMC an income-based incentive fee with respect to itspre-incentive fee net investment income in each calendar quarter as follows:

 

•                       no incentivefee in any calendar quarter in which pre-incentive fee net investment incomedoes not exceed the hurdle rate of 1.75% (7% annualized);

 

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•                       100% ofpre-incentive fee net investment income with respect to that portion of suchpre-incentive fee net investment income, if any, that exceeds the hurdle ratebut is less than 125% of the hurdle rate (2.1875%) in any calendar quarter(8.75% annualized). This portion of the income-based incentive fee is referredto as the “catch-up.” The “catch-up” provision is intended to provide GMC withan incentive fee of 20% on all of pre-incentive fee net investment income up to125% of the quarterly hurdle rate once the hurdle rate has been surpassed; and

 

•                       20% of theamount of pre-incentive fee net investment income, if any, that exceeds 125% ofthe quarterly hurdle rate of 2.1875% in any calendar quarter (8.75%annualized).

 

The foregoing calculations will beappropriately pro rated for any period of less than three months and adjustedfor any share issuances or repurchases made during the current quarter.

 

The capital gains incentive fee will bedetermined and payable annually in arrears as of the end of each fiscal year(or upon termination of the investment advisory agreement, as of thetermination date), commencing on March 31, 2006, and will equal 20.0% of therealized capital gains since inception through the end of the current fiscalyear, if any, computed net of all realized capital losses, and unrealizedcapital depreciation  since inception atthe end of each fiscal year. In determining the capital gains incentive feepayable to GMC, we will calculate the cumulative aggregate realized capitalgains and cumulative aggregate realized capital losses and depreciation sinceinception to the end of the current fiscal year with respect to each of theinvestments in the portfolio. For this purpose, cumulative aggregate realizedcapital gains, if any, will equal the sum of the differences between the netsales price of each investment, when sold, and the original cost of suchinvestment since inception. Cumulative aggregate realized capital losses willequal the sum of the amounts by which the net sales price of each investment,when sold, is less than the original cost of such investment since inception.Aggregate unrealized capital depreciation will equal the sum of the difference,if negative, between the valuation of each investment as of the applicablecalculation date and the original cost of such investment adjusted for anyrepayments of principal thereon. At the end of the applicable fiscal year, theamount of net capital gains (after losses and depreciation) that will serve asthe basis for the calculation of the capital gains incentive fee will equal thecumulative aggregate realized capital gains less cumulative aggregate realizedcapital losses, less aggregate unrealized capital depreciation, with respect tothe portfolio of investments. If this number is positive at the end of suchfiscal year, then the capital gains incentive fee for such year will be equalto 20% of such amount, less the aggregate amount of any capital gains incentivefees paid in respect of the portfolio since inception.

 

Because of the structure of the incentivefee, it is possible that we may have to pay an incentive fee in a quarter wherewe incurr a loss. For example, we receive pre-incentive fee net investmentincome in excess of the hurdle rate for a quarter, we will pay the applicableincome incentive fee even if we have incurred a loss in that quarter due torealized or unrealized capital depreciation on investments.

 

**AdministrationAgreement**

 

We have entered into an administrationagreement with Gladstone Administration, LLC (“Gladstone Administration”), awholly owned subsidiary of GMC, which is controlled by our chairman and chiefexecutive officer. Pursuant to the administration agreement, GladstoneAdministration furnishes us with office facilities, equipment and clerical,bookkeeping and record keeping services at such facilities and performs, oroversees the performance of our required administrative services. Such requiredadministrative services include, among other things, being responsible for thefinancial records which we are required to maintain and preparing reports toour stockholders and reports filed with the Securities and Exchange Commission.

 

The administration agreement requires us toreimburse Gladstone Administration for the performance of its obligations underthe administration agreement based upon our allocable portion of GladstoneAdministration’s overhead, including, but not limited to, rent and ourallocable portion of the salaries and benefits of our chief financial officer,chief compliance officer, controller and their respective staffs. Our allocableportion of expenses is derived by multiplying Gladstone Administration’s totalexpenses by the percentage of our average assets (the assets at the beginningand ending of each quarter) in comparison to the average assets of allcompanies managed by GMC.  Currently, GMCmanages us and our affiliates Gladstone Capital Corporation, GladstoneCommercial Corporation and Gladstone Land Corporation.

 

**LicenseAgreement**

 

We have entered into a license agreement withGMC, pursuant to which GMC has granted us a non-exclusive license to use thename “Gladstone” and the “Diamond G” trademark. This license agreement requiresus to pay GMC a royalty fee of $1 per quarter. The amount of the fee isnegotiable on an annual basis by our compensation committee and approved by amajority of our independent directors. The license arrangement will terminate in the event that GMC is nolonger our Adviser.

 

 

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

 

***RegulatedInvestment Company Status***

 

In order to maintain thequalification for treatment as a regulated investment company, or RIC, underSubchapter M of the Internal Revenue Code of 1986 (the “Code”), we mustdistribute to our stockholders, for each taxable year, at least 90% of ourinvestment company taxable income, which is generally our ordinary income plusshort-term capital gains. We refer to this as the annual distributionrequirement. We must also meet several additional requirements, including:

 

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

 

•                                            *Asset diversificationrequirements.* Asof the close of each quarter of our taxable year: (1) at least 50% of thevalue of our assets must consist of cash, cash items, US government securities,the securities of other regulated investment companies and other securities tothe extent that (a) we do not hold more than 10% of the outstanding votingsecurities of an issuer of such other securities and (b) such othersecurities of any one issuer do not represent more than 5% of our total assets,and (2) no more than 25% of the value of our total assets may be investedin the securities of one issuer (other than US government securities or thesecurities of other regulated investment companies), or of two or more issuersthat are controlled by us and are engaged in the same or similar or relatedtrades or businesses.

 

If we are unable toqualify for treatment as a RIC, we will be subject to tax on all of our taxableincome at regular corporate rates. We would not be able to deduct distributionsto stockholders, nor would we be required to make such distributions.Distributions would be taxable to our stockholders as ordinary dividend incometo the extent of our current and accumulated earnings and profits. Subject tocertain limitations under the Code, corporate distributees would be eligiblefor the dividends received deduction.

 

Distributions in excessof our current and accumulated earnings and profits would be treated first as areturn of capital to the extent of the stockholder’s tax basis, and then as again realized from the sale or exchange of property. If we fail to meet the RICrequirements for more than two consecutive years and then seek to requalify asa RIC, we would be required to recognize a gain to the extent of any unrealizedappreciation on our assets unless we make a special election to paycorporate-level tax on any such unrealized appreciation recognized during thesucceeding 10-year period. Absent such special election, any gain we recognizedwould be deemed distributed to our stockholders as a taxable distribution. Ifwe qualify as a RIC and distribute to stockholders each year in a timely mannerat least 90% of our investment company taxable income, we will not be subjectto federal income tax on the portion of our taxable income and gains wedistribute to stockholders. We would, however, be subject to a 4% nondeductiblefederal excise tax if we do not distribute, actually or on a deemed basis, 98%of our income, including both ordinary income and capital gains. The excise taxwould apply only to the amount by which 98% of our income exceeds the amount ofincome we distribute, actually or on a deemed basis, to stockholders.

 

We will be subject toregular corporate income tax, currently at rates up to 35%, on anyundistributed income, including both ordinary income and capital gains. Weintend to retain some or all of our capital gains, but to designate theretained amount as a deemed distribution. In that case, among otherconsequences, we will pay tax on the retained amount, each stockholder will berequired to include its share of the deemed distribution in income as if it hadbeen actually distributed to the stockholder and the stockholder will beentitled to claim a credit or refund equal to its allocable share of the tax wepay on the retained capital gain. The amount of the deemed distribution net ofsuch tax will be added to the stockholder’s cost basis for its common stock.Since we expect to pay tax on any retained capital gains at our regularcorporate capital gain tax rate, and since that rate is in excess of themaximum rate currently payable by individuals on long-term capital gains, theamount of tax that individual stockholders will be treated as having paid willexceed the tax they owe on the capital gain dividend and such excess may beclaimed as a credit or refund against the stockholder’s other tax obligations.A stockholder that is not subject to US federal income tax or tax on long-termcapital gains would be required to file a US federal income tax return onthe appropriate form in order to claim a refund for the taxes we paid. In orderto utilize the deemed distribution approach, we must provide written notice tothe stockholders prior to the expiration of 60 days after the close of therelevant tax year. We will also be subject to alternative minimum tax, but anytax preference items would be apportioned between us and our stockholders inthe same proportion that dividends, other than capital gain dividends, paid toeach stockholder bear to our taxable income determined without regard to thedividends paid deduction.

 

If we acquire debtobligations that were originally issued at a discount, which would generallyinclude loans we make that are 

 

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accompanied by warrants,that bear interest at rates that are not either fixed rates or certainqualified variable rates or that are not unconditionally payable at leastannually over the life of the obligation, we will be required to include intaxable income each year a portion of the “original issue discount” thataccrues over the life of the obligation. Such original issue discount will beincluded in our investment company taxable income even though we receive nocash corresponding to such discount amount. As a result, we may be required tomake additional distributions corresponding to such original issue discountamounts in order to satisfy the annual distribution requirement and to continueto qualify as a RIC or to avoid the 4% excise tax. In this event, we may berequired to sell temporary investments or other assets to meet the RICdistribution requirements.  Through March31, 2006, we incurred no original issue discount income.

 

For any period duringwhich we qualify for treatment as a RIC for federal income tax purposes,distributions to our stockholders attributable to our investment companytaxable income generally will be taxable as ordinary income to stockholders tothe extent of our current or accumulated earnings and profits. Anydistributions in excess of our earnings and profits will first be treated as areturn of capital to the extent of the stockholder’s adjusted basis in his orher shares of common stock and thereafter as gain from the sale of shares ofour common stock. Distributions of our long-term capital gains, designated byus as such, will be taxable to stockholders as long-term capital gainsregardless of the stockholder’s holding period for its common stock and whetherthe distributions are paid in cash or invested in additional common stock.Corporate stockholders are generally eligible for the 70% dividends receiveddeduction with respect to ordinary income, but not to capital gains dividendsto the extent such amount designated by us does not exceed the dividends receivedby us from domestic corporations. Any dividend declared by us in October,November or December of any calendar year, payable to stockholders ofrecord on a specified date in such a month and actually paid duringJanuary of the following year, will be treated as if it were paid by usand received by the stockholders on December 31 of the previous year. Inaddition, we may elect to relate a dividend back to the prior taxable year ifwe (1) declare such dividend prior to the due date for filing our returnfor that taxable year, (2) make the election in that return, and(3) distribute the amount in the 12-month period following the close ofthe taxable year but not later than the first regular dividend paymentfollowing the declaration. Any such election will not alter the general rulethat a stockholder will be treated as receiving a dividend in the taxable yearin which the distribution is made, subject to the October, November,December rule described above.

 

The “Jobs and Growth TaxRelief Reconciliation Act of 2003” did not alter the nature of our dividendsthat we pay to stockholders as taxable ordinary income.  Accordingly, our dividends paid are noteligible for the lower tax rate.

 

**Regulationas a Business Development Company**

 

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

 

We intend to conduct ourbusiness so as to retain our status as a business development company. Abusiness development  company may usecapital provided by public shareholders and from other sources to invest inlong-term private investments in businesses. A business development company provides shareholders the ability toretain the liquidity of a publicly traded stock while sharing in the possiblebenefits, if any, of investing in primarily privately owned companies.  In general, a business development companymust have been organized and have its principal place of business in the UnitedStates and must be operated for the purpose of making investments in the typesof securities described in (1) or (2) below.

 

***QualifyingAssets***

 

Under the 1940 Act, abusiness development company may not acquire any asset other than assets of thetype listed in Section 55(a) of the 1940 Act, which are referred to asqualifying assets, unless, at the time the acquisition is made, qualifyingassets represent at least 70% of the company’s total assets. The types ofqualifying assets in which we may invest under the 1940 Act include, but arenot limited to the following:

 

(1)                                  Securities purchased in transactions notinvolving any public offering from the issuer of such securities, which issueris an eligible portfolio company. An eligible portfolio company is generallydefined in the 1940 Act as any issuer which, first, is organized under the lawsof, and has its principal place of business in, the United States. Second, theissuer must not be an investment company, other than a small businessinvestment company wholly owned by the 

 

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businessdevelopment company. Finally, the issuer may not have any class of publicly tradedsecurities with respect to which a broker or dealer may extend margin credit.

 

 

(2)                                  Securities of any eligible portfoliocompany over which we exercise a controlling influence and for which anaffiliate of ours serves as a director.

 

(3)                                  Securities received in exchange for ordistributed on or with respect to securities described in (1) or(2) above, or pursuant to the exercise of options, warrants or rightsrelating to such securities.

 

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

 

Securities ofpublic companies are generally not qualifying assets unless they were acquiredin a distribution or in exchange for, or upon the exercise of, a right relatingto securities that were qualifying assets.

 

***AssetCoverage***

 

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

 

***SignificantManagerial Assistance***

 

For portfolio securitiesto be qualifying assets for the 70% test described above, the businessdevelopment company must either exercise a controlling influence over theissuer of the securities or must make available to the issuer of the securitiessignificant managerial assistance. However, with respect to certain but not allsuch securities, where the business development company purchases suchsecurities in conjunction with one or more other persons acting together, oneof the other persons in the group may make available such managerialassistance, or the business development company may exercise such controljointly. Making available significant managerial assistance means, among otherthings, any arrangement whereby the business development company, through itsdirectors, officers or employees, offers to provide, and, if accepted, does soprovide, significant guidance and counsel concerning the management, operationsor business objectives and policies of a portfolio company.

 

***FundamentalInvestment Policies***

 

We seek to achieve a highlevel of current income and capital gains through investments in debtsecurities and preferred and common stock that we acquired in connection withbuyout and other recapitalizations.  Thefollowing restrictions, along with these investment objectives, are our onlyfundamental policies, which are policies that may not be changed without theapproval of the holders of the majority of our outstanding voting securities,as defined in the 1940 Act. For a fuller explanation of the regulatoryframework in which we operate, see “Business-Regulation as a BusinessDevelopment Company.” The percentage restrictions set forth below, other thanthe restriction pertaining to the issuance of senior securities, as well asthose contained elsewhere in this Form 10-K, apply at the time we effect atransaction, and a subsequent change in a percentage resulting from marketfluctuations or any cause other than an action by us will not require us todispose of portfolio securities or to take other action to satisfy thepercentage restriction. We will at all times conduct our business so as toretain our status as a business development company. In order to retain thatstatus, we may not acquire any assets (other than non-investment assetsnecessary and appropriate to our operations as a business development company)if, after giving effect to such acquisition, the value of our “qualifyingassets” is less than 70% of the value of our total assets. We anticipate thatthe securities we seek to acquire (provided that we control or, through ourofficers or other participants in the financing transaction, make significantmanagerial assistance available to the issuers of these securities), as well astemporary investments, will generally be qualifying assets.

 

We may invest up to 100%of our assets in securities acquired directly from issuers in privatelynegotiated transactions. With respect to 

 

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such securities, we may,for the purpose of public resale, be deemed an “underwriter” as that term isdefined in the Securities Act. We may invest up to 20% of our assets insecurities of a particular issuer. We may exceed this limitation in connectionwith bridge financings, although these bridge investments will never exceed 25%of our total assets at any time. We do not intend to concentrate ourinvestments in any particular industry or group of industries. However, it ispossible that, as the values of our portfolio companies change, one industry ora group of industries may comprise in excess of 25% of the value of our totalassets.

 

We will at all timesendeavor to conduct our business so as to retain our status as a regulatedinvestment company under the 1940 Act. In order to do so, we must meet incomesource, asset diversification and annual distribution requirements. We mayissue senior securities, such as debt or preferred stock, to the extentpermitted by the 1940 Act for the purpose of making investments, to fund sharerepurchases, or for temporary emergency or other purposes. For a discussion ofthe risks associated with the resulting leverage, see “Business—Leverage” and “RiskFactors—Our business is dependent upon external financing which may expose usto the risks associated with leverage.”

 

We will not (1) actas an underwriter of securities of other issuers (except to the extent that wemay be deemed an “underwriter” of securities we purchase that must beregistered under the Securities Act before they may be offered or sold to thepublic); (2) purchase or sell real estate or interests in real estate orreal estate investment trusts (except that we may (a) purchase and sellreal estate or interests in real estate in connection with the orderlyliquidation of investments, (b) own the securities of companies orparticipate in a partnership or partnerships that are in the business ofbuying, selling or developing real estate, or (c) finance the purchase ofreal estate by our portfolio companies); (3) sell securities short (exceptwith regard to managing the risks associated with publicly-traded securitiesissued by our portfolio companies); (4) purchase securities on margin(except to the extent that we may purchase securities with borrowed money);(5) write or buy put or call options (except (i) to the extent ofwarrants or conversion privileges in connection with our acquisition financingor other investments and rights to require the issuers of such investments ortheir affiliates to repurchase them under certain circumstances, (ii) withregard to managing risks associated with publicly-traded securities issued byour portfolio companies, or (iii) with regard to managing the risksassociated with interest rate fluctuations); (6) engage in the purchase orsale of commodities or commodity contracts, including futures contracts (exceptwhere necessary in working out distressed loan or investment situations or inmanaging the risks associated with interest rate fluctuations); or(7) acquire more than 3% of the voting stock of, or invest more than 5% ofour total assets in, any securities issued by any other investment company(except as they may be acquired as part of a merger, consolidation oracquisition of assets). That portion of our investments that is in securitiesissued by other investment companies may subject our stockholders to additionalexpenses.

 

***Codeof Ethics***

 

We and our Adviser haveeach adopted a code of ethics and business conduct applicable to our officers, directorsand all employees that comply with the guidelines set forth in Item 406 ofRegulation S-K of the Securities Act.  Asrequired by the 1940 Act, this code establishes procedures for personalinvestments, restricts certain transactions by our personnel and requires thereporting of certain transactions and holdings by our personnel.  A copy of this code is available for review,free of charge, at our website at www.gladstoneinvestment.com.  We intend to provide disclosure of anyamendments to or waivers of the provisions of this code by posting informationregarding any such amendment or waiver to our website within four days of itseffectiveness.

 

***CompliancePolicies and Procedures***

 

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

 

**Staffing**

 

We do not currently haveany employees and do not expect to have any employees in the foreseeablefuture.  Currently, services necessaryfor our business are provided by individuals who are employees of GMC andGladstone Administration pursuant to the terms of the investment advisory andmanagement agreement and administration agreement.  Each of our executive officers is an employeeand executive officer of GMC or Gladstone Administration.  No employee of GMC or GladstoneAdministration will dedicate all of his or her time to us.  However, we expect that 20-25 full timeemployees of GMC will spend substantial time on our matters during the calendaryear 2007.  We anticipated that thenumber of employees of GMC and Gladstone Administration who devote time to ourmatters will increase as we acquire more investments.

 

 

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As of March 31, 2006, GMCand Gladstone Administration had 38 full-time employees.  As of March 31, 2006 a break-down of GMC’sand Gladstone Administration’s 38 full-time employees by functional area issummarized in the table below:

 
| **Number of Individuals** | ** ** | **Functional Area**                                                                                                            |
|---------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|
| ** **                | ** ** | ** **                                                                                                                     |
| 4                         |       | Executive Management (Chief Executive Officer, Chief Operating  Officer, Chief Investment Officer and Chief Financial Officer) |
| 24                        |       | Investment Management, Portfolio Management, and Due Diligence                                                                 |
| 10                        |       | Administration, Accounting, Compliance, Human Resources, Investor  Relations and Treasury.                                     |

 

**AvailableInformation:**

 

Copies of our annualreport on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K, and amendments, if any, to those reports filed pursuant toSection 13(a) or 15(d) of the Exchange Act are available free of chargethrough our website at www.gladstoneinvestment.com.  A request for any of these reports may alsobe submitted to us by sending a written request addressed to Investor RelationsManager, Gladstone Investment Corporation, 1521 Westbranch Drive, Suite 200,McLean, VA 22102, or by calling our toll-free investor relations line at1-866-366-5745.  The public may read andcopy materials that we file with the SEC at the SEC’s Public Reference Room at100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may beobtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website that contains reports, proxy andinformation statements, and other information regarding issuers that fileelectronically with the SEC at http://www.sec.gov.

 

**Item 1A. Risk Factors**

 

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

 

**We are a new company with limited operatinghistory.**

 

We were incorporated in Delawareon February 18, 2005. We are subject to all of the business risks anduncertainties associated with any new business, including the risk that we willnot achieve our investment objectives and that the value of your investmentcould decline substantially. We anticipate that it will take us up to two yearsto invest substantially all of the net proceeds of our initial public offering.During this period, we will invest in temporary investments, such as cash andcash equivalents, and then senior secured loans, all of which we expect willearn yields substantially lower than the interest income that we anticipatereceiving with respect to investments in subordinated debt, mezzanine debt,preferred stock and other types of investments we may make. As a result, ourdividends may be substantially lower than the dividends that we expect to paywhen our portfolio is fully invested.

 

**We aredependent upon our key management personnel and the key management personnel ofour Adviser for our future success, particularly David Gladstone, GeorgeStelljes III and Terry Lee Brubaker.**

 

We are dependent on thediligence, skill and network of business contacts of our senior management andother management members for the final selection, structuring, closing andmonitoring of our investments. Our future success depends to a significantextent on the continued service and coordination of our senior management team,particularly David Gladstone, our chairman and chief executive officer, GeorgeStelljes III, our president and chief investment officer, and Terry LeeBrubaker, our vice-chairman and chief operating officer. The departure of anyof our executive officers or key employees from us or from our adviser, GMC,could have a material adverse effect on our ability to implement our businessstrategy and to achieve our investment objectives.

 

**We aredependent on our Adviser’s continued operations and may not find a suitablereplacement if our Adviser discontinues operations or terminates the investmentadvisory agreement.**

 

We have noemployees.  We expect that our chiefexecutive officer, chief operating officer, chief investment officer and chieffinancial officer, and the employees of our Adviser, will not spend all oftheir time managing our activities and our investment portfolio.  Our executive officers and the employees ofour Adviser may allocate some, or a material portion, of their time tobusinesses and activities that are not related to our business.  We have no separate facilities and arecompletely reliant on our Adviser, which has significant 

 

 

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discretion as to theimplementation and execution of our business strategies and risk managementpractices.  We are subject to the risk ofdiscontinuation of our Adviser’s operations or termination of the investmentadvisory agreement and the risk that, upon such event, no suitable replacementwill be found.  We believe that oursuccess depends to a significant extent upon our Adviser and thatdiscontinuation of its operations could have a material adverse effect on ourability to achieve our investment objectives.

 

**Our financial condition and results of operationwill depend on our ability to manage future growth effectively.**

 

Our ability to achieve our investment objectives willdepend on our ability to grow, which in turn will depend on GMC’s ability toidentify, invest in, and monitor companies that meet our investment criteria.

 

Accomplishing this result ona cost-effective basis will largely be a function of GMC’s structuring of theinvestment process, its ability to provide competent, attentive and efficientservices to us, and our access to financing on acceptable terms. The executiveofficers of GMC will have substantial responsibilities under the investmentadvisory and management agreement, as well as in connection with their roles asofficers of Gladstone Commercial Corporation, Gladstone Capital Corporation,GMC and other entities managed by our Adviser (“the Gladstone Companies”). Theymay also be called upon to provide managerial assistance to our portfoliocompanies. These demands on their time may distract them or slow the rate atwhich they are able to invest our assets. In order for us to grow, GMC willneed to hire, train, supervise, and manage new investment professionals andsupporting employees. However, we can offer no assurance that GMC will be able to find and/or hire newinvestment professionals or supporting employees or that any such employeeswill contribute to the work of GMC. Any failure to manage our future growtheffectively could have a material adverse effect on our business, financialcondition and results of operations.

 

**If we do not invest the proceeds of our initialoffering in a timely manner, our returns to stockholders will be significantlylower.**

 

We have estimated that itmay take us up to two years to invest all the cash proceeds from our initialoffering in the types of investments we intend to make. We can give noassurance that we will be successful in meeting that estimate. To the extentthat it takes us longer to invest the cash proceeds from our initial publicoffering, the returns to stockholders are likely to be less than if we investedthe proceeds over the time period we have allotted.

 

**If our primary investments are deemed not to bequalifying assets, we could lose our status as a business development companyor be precluded from investing according to our current business plan.**

 

If we are to maintain our status as a businessdevelopment company, we must not acquire any assets other than “qualifyingassets” unless, at the time of and after giving effect to each suchacquisition, at least 70% of our total assets are qualifying assets. If weacquire mezzanine loans or dividend-paying equity securities from an issuerthat has outstanding marginable securities at the time we make an investment,these acquired assets cannot be treated as qualifying assets. See “Regulationas a Business Development Company — Qualifying Assets.” This results fromthe definition of “eligible portfolio company” under the 1940 Act, which inpart looks to whether a company has outstanding marginable securities.

 

Amendments promulgated in 1998 by the Board ofGovernors of the Federal Reserve System to Regulation T under theSecurities Exchange Act of 1934, as amended, or the Exchange Act, expanded thedefinition of marginable security to include any non-equity security. Theseamendments have raised questions as to whether a private company that hasoutstanding debt securities would qualify as an eligible portfolio company.

 

We believe that the junior debt and equity instrumentsthat we expect to make should constitute qualifying assets because theprivately held companies in which we invest will generally not, at the time ofour investment, have outstanding marginable securities. Until the questionsraised by the amendments to Regulation T have been clarified through SECrulemaking or addressed by legislative, administrative, or judicial action, weintend to treat as qualifying assets only those loans that are not investmentgrade, do not have a public secondary market, and are issued by a privateissuer that does not have outstanding a class of margin-eligible securities atthe time of our investment. Likewise, we will treat equity securities issued bya portfolio company as qualifying assets only if such securities are issued bya private company that has no marginable securities outstanding at the time wepurchase such securities.

 

To date, we do not believe that either the SEC or itsstaff has taken any position with respect to our analysis of the issuesdiscussed above, and neither the SEC nor its staff has indicated that itconcurs with our analysis. We intend to adjust our investment focus as neededto comply with and/or take advantage of any future administrative position,judicial decision or legislative action. The SEC has recently proposedamendments to the rules concerning business development companies that wouldclarify that, among other things, companies that do not have a class ofsecurities listed on an exchange or NASDAQ would be considered eligibleportfolio companies.

 

 

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Further, separate and similar legislation, entitledthe “Increased Capital Access for Growing Businesses Act,” has been introducedin both the U.S. House of Representatives and the U.S. Senate.  If passedin current form, the legislation would strike the 1940 Act language that tiesthe definition of eligible portfolio company to whether a company hasoutstanding marginable securities. In lieu of this language, the legislationwould provide that, among other things, companies that do not have a class ofsecurities listed on a national securities exchange would be consideredeligible portfolio companies.  The legislation introduced in the U.S.House of Representatives, H.R. 436, was passed unanimously and referred to theU.S. Senate Committee on Banking, Housing and Urban Affairs in April2005.  The U.S. Senate bill, S. 1396, was introduced and referred to theU.S. Senate Committee on Banking, Housing and Urban Affairs in July 2005. There can be no guarantee that this legislation will be passed and becomeeffective without substantial amendment, if it becomes effective at all.

 

Unless and until theproposed rules or legislation described above are adopted or passed , if therewere a court ruling or regulatory decision that conflicted with ourinterpretations, we could lose our status as a business development company orbe precluded from investing in the manner described in this prospectus. This inturn could cause us to lose our status as a RIC. Any of these results wouldhave a material adverse effect on our ability to invest in the manner describedin this prospectus, on our operating results, financial condition and abilityto pay dividends, and on the value of our common stock. See “—Regulations governing our operation as a businessdevelopment company will affect our ability to and the way in which we raiseadditional capital.”

 

Such a ruling or decision also may require us to disposeof investments that we made based on our interpretation of Regulation T.Such dispositions could have a material adverse effect on our stockholders. Wemay need to dispose of such investments quickly, which would make it difficultto dispose of such investments on favorable terms. In addition, because thesetypes of investments will generally be illiquid, we may have difficulty findinga buyer and, even if we do find a buyer, we may have to sell the investments ata substantial loss. See “Risk Factors—The lack of liquidity in our investmentsmay adversely affect our business.”

 

**OurAdviser’s failure to identify and invest in securities that meet our investmentcriteria or perform its responsibilities under the investment advisoryagreement may adversely affect our ability for future growth.**

 

Our ability to achieveour investment objectives will depend on our ability to grow, which in turnwill depend on our Adviser’s ability to identify and invest in securities thatmeet our investment criteria.  Accomplishingthis result on a cost-effective basis will be largely a function of our Adviser’sstructuring of the investment process, its ability to provide competent andefficient services to us, and our access to financing on acceptable terms.  The senior management team of our Adviser hassubstantial responsibilities under the investment advisory agreement.  In order to grow, our Adviser will need tohire, train supervise and manage new employees successfully.  Any failure to manage our future growtheffectively could have a material adverse effect on our business, financialcondition and results of operations.

 

**Weoperate in a highly competitive market for investment opportunities.**

 

A number of entities will compete with us forinvestments in small and mid-sized companies. We will compete with public andprivate buyout funds, commercial and investment banks, commercial financingcompanies, and, to the extent they provide an alternative form of financing,hedge funds. Many of our competitors are substantially larger and haveconsiderably greater financial, technical, and marketing resources than we do.For example, some competitors may have a lower cost of funds and access tofunding sources that are not available to us. In addition, some of ourcompetitors may have higher risk tolerances or different risk assessments,which would allow them to consider a wider variety of investments and establishmore relationships than us. Furthermore, many of our competitors are notsubject to the regulatory restrictions that the 1940 Act imposes on us as abusiness development company. The competitive pressures we face could have amaterial adverse effect on our business, financial condition, and results ofoperations. Also, as a result of this competition, we may not be able to takeadvantage of attractive investment opportunities from time to time, and we canoffer no assurance that we will be able to identify and make investments thatare consistent with our investment objective.

 

We will not seek to compete primarily based on theinterest rates we will offer, and we believe that some of our competitors maymake loans with interest rates that will be comparable to or lower than therates we offer.

 

We may lose investment opportunities if we do notmatch our competitors’ pricing, terms, and structure. If we match ourcompetitors’ pricing, terms, and structure, we may experience decreased netinterest income and increased risk of credit loss.

 

 

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**Regulations governing our operation as a businessdevelopment company will affect our ability to and the way in which we raiseadditional capital.**

 

We may issue debt securities or preferred stock and/orborrow money from banks or other financial institutions, which we refer tocollectively as “senior securities,” up to the maximum amount permitted by the1940 Act. Senior securities are defined by the 1940 Act to include bonds,debentures, notes or similar obligations or instruments that are securities andevidence indebtedness and stock of a class having priority over any other classas to distribution of assets or payment of dividends. Under the provisions ofthe 1940 Act, we will be permitted, as a business development company, to issuesenior securities only in amounts such that our asset coverage, as defined inthe 1940 Act, equals at least 200% after each issuance of senior securities. Ifthe value of our assets declines, we may be unable to satisfy this test. Ifthat happens, we may be required to sell a portion of our investments and, dependingon the nature of our leverage, repay a portion of our indebtedness at a timewhen such sales may be disadvantageous.

     We are not generally able to issue and sell our common stock at a price belownet asset value per share. We may, however, sell our common stock or warrants,options, or rights to acquire our common stock at a price below the current netasset value of the common stock if our Board of Directors determines that suchsale is in our best interests and the best interests of our stockholders, andour stockholders approve such sale. In any such case, the price at which oursecurities are to be issued and sold may not be less than a price which, in thedetermination of our Board of Directors, closely approximates the market valueof such securities (less any distributing commission or discount).

 

In addition to issuing securities to raise capital asdescribed above, we may in the future seek to securitize certain of our assetsto generate cash for funding new investments. Securitization involves ourcreating a wholly-owned subsidiary and contributing a pool of loans to thesubsidiary, which then would deposit the loans to a single purpose trust. Thetrust would then typically sell a class of investment grade interests to thepublic, and we would retain a residual portion of the equity in the securitizedpool of loans. The declaration of trust for the securitization entity wouldtypically provide for preferential distributions of interest, principal andliquidation proceeds to the holders other than the holder of the residualequity. Accordingly, in a securitization transaction, the residual equity thatwe would retain would typically bear greater risk than if we held all the loanscomprising the securitized pool in their entirety. An inability to successfullysecuritize our loan portfolio could limit our ability to grow our business,fully execute our business strategy, and decrease our earnings, if any.Moreover, the successful securitization of our loan portfolio might expose usto losses as the residual loans in which we do not sell interests will tend tobe those that are riskier and more apt to generate losses.

 

 

**If we issue senior securities, including debt, wewill be exposed to additional risks, including the typical risks associated withleverage.**

 

We will be exposed to increased risk of loss if weincur debt to make investments. If we do incur debt, a decrease in the value ofour investments would have a greater negative impact on the value of our commonstock than if we did not use debt.

 

Our ability to pay dividends would be restricted ifour asset coverage ratio was not at least 200%, and any amounts that we woulduse to service our indebtedness would not be available for dividends to ourcommon stockholders.

 

It is likely that any senior debt securities we issuewill be governed by an indenture or other instrument containing covenantsrestricting our operating flexibility.

 

We, and indirectly our stockholders, will bear thecost of issuing and servicing such securities.

 

Any convertible or exchangeable securities that weissue in the future may have rights, preferences and privileges more favorablethan those of our common stock.

 

**We will be exposed to risks associated with changesin interest rates.**

 

General interest rate fluctuations may have asubstantial negative impact on our investments and investment opportunitiesand, accordingly, may have a material adverse effect on investment objectivesand our rate of return on invested capital. In addition, an increase ininterest rates would make it more expensive to use debt to finance ourinvestments.

 

**Many of our portfolio investments will be recordedat fair value as determined in good faith by our Board of Directors based onrecommendations by Standard & Poor’s Evaluation Service, who recommendsvalues using its own methodology; this may result in uncertainty as to thevalue of our portfolio investments.**

 

A large percentage of our portfolio investments willbe in the form of securities that are not publicly traded. The fair value of securitiesand other investments that are not publicly traded may not be readilydeterminable. Our Board of Directors will determine the fair 

 

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value of these securities quarterly, and will use therecommendations of Standard & Poor’s’ Evaluation Service (“S&P”) todetermine the value of many of our debt securities. The types of factors thatmay be considered in determining the fair value of our investments include thenature and realizable value of any collateral, the portfolio company’s earningsand cash flows and its ability to make payments on its obligations, the marketsin which the portfolio company does business, comparison to publicly tradedcompanies, discounted cash flow, and other relevant factors. Because suchvaluations, particularly valuations of private securities and privatecompanies, are inherently uncertain, may fluctuate over short periods of time,and may be based on estimates, our determinations of fair value may differmaterially from the values that might have resulted from a readily availablemarket for these securities. Our net asset value could be adversely affected ifour determinations regarding the fair value of our investments were materiallyhigher than the values that we ultimately realize upon the disposal of suchsecurities. At this time S&P will only evaluate the debt portion of ourinvestments, and our Board of Directors will establish the fair value of theequity securities we may hold without the evaluation of S&P.

 

**Becausethe loans we make and equity securities we receive when we make loans are notpublicly traded, there will be uncertainty regarding the value of our privatelyheld securities that could adversely affect our determination of our net assetvalue.**

 

We expect that very few,if any, of our portfolio loans or equity securities, at least initially, willbe publicly traded or have a readily determinable market value. We value thesesecurities based on a determination of their fair value, based on recommendationsprovided by S&P and management and approved by our Board of Directors. Dueto the uncertainty inherent in valuing these securities, our determinations offair value may differ materially from the values that would exist if a readymarket for these securities existed. Our net asset value could be materiallyaffected if our determinations regarding the fair value of our investments arematerially different from the values that we ultimately realize on our disposalof such securities.

 

**The lackof liquidity of our privately held investments may adversely affect ourbusiness.**

 

We will generally make investments in privatecompanies whose securities are not traded in any public market. Substantiallyall of these securities will be subject to legal and other restrictions onresale and will otherwise be less liquid than publicly traded securities. Theilliquidity of our investments may make it difficult for us to sell suchinvestments if the need arises. In addition, if we are required to liquidateall or a portion of our portfolio quickly, we may realize substantial booklosses upon liquidation. In addition, we may face other restrictions on ourability to liquidate an investment in a portfolio company to the extent thatwe, GMC, or our respective officers, employees or affiliates have materialnon-public information regarding such portfolio company.

 

**We may experience fluctuations in our quarterlyresults.**

 

We could experiencefluctuations in our quarterly operating results due to a number of factors,including the interest rates payable on the debt securities we acquire, thedefault rates on such securities, the level of our expenses, variations in andthe timing of the recognition of realized and unrealized gains or losses, thedegree to which we encounter competition in our markets, and general economicconditions. As a result of these factors, results for any period should not berelied upon as being indicative of performance in future periods.

 

**There are significant potential conflicts ofinterest which could impact our investment returns.**

 

Our executive officers anddirectors, and the officers and directors of our investment adviser, GMC, serveor may serve as officers, directors or principals of entities that operate inthe same or a related line of business as we do or of investment funds managedby our affiliates. Accordingly, they may have obligations to investors in thoseentities, the fulfillment of which might not be in the best interests of us or our stockholders. Forexample, Mr. Gladstone, our chairman and chief executive officer, is thechairman of the board and chief executive officer of GMC, Gladstone Capital andGladstone Commercial. In addition, Mr. Brubaker, our vice chairman andsecretary is either the vice-chairman or president, chief operating officer  and secretary of GMC, Gladstone Capital andGladstone Commercial. Moreover, GMC may establish or sponsor other investmentvehicles which from time to time may have potentially overlapping investmentobjectives with those of the Company and accordingly may invest in, whetherprincipally or secondarily, asset classes similar to those targeted by theCompany. While GMC generally has broad authority to make investments on behalfof the investment vehicles that it advises, GMC has adopted investment allocationprocedures to address these potential conflicts and intends to directinvestment opportunities to the our Gladstone affiliate with the investmentstrategy that most closely fits the investment opportunity. Nevertheless, themanagement of GMC may face conflicts in the allocation of investmentopportunities to other entities managed by GMC. As a result, it ispossible that we may not be given the opportunity to participate in certaininvestments made by other members of the Gladstone Group or investment fundsmanaged by investment managers affiliated with GMC.

 

 

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While we will not invest in any portfolio company inwhich any of our affiliates currently has an investment, our affiliate,Gladstone Commercial, may purchase property from or lease property to portfoliocompanies that we do not control under certain circumstances. We may pursuesuch transactions only if (i) the portfolio company is not controlled byus or any of our affiliates, (ii) the portfolio company satisfies thetenant underwriting criteria or owns real estate that meets the leaseunderwriting criteria of Gladstone Commercial, and (iii) the transactionis approved by a majority of our independent directors and a majority of theindependent directors of Gladstone Commercial. We expect that any suchnegotiations between Gladstone Commercial and our portfolio companies wouldresult in lease terms consistent with the terms that the portfolio companieswould be likely to receive were they not portfolio companies of ours. However,if Gladstone Commercial provides a lease to a current or prospective portfoliocompany of ours, it is likely that there will be a conflict of interest inconnection with such a transaction. There is a risk that, for GladstoneCommercial to provide a lease to a portfolio company, there could be situationswhere we enter into a transaction that is riskier than we would customarilymake in order to enable Gladstone Commercial, or another affiliate, to providethe lease portion of the financing; this carries a greater risk of default. Ifany of these risks were to materialize, it could have a material adverse effecton our ability to generate cash flow to make distributions to stockholders.

 

Certain of our officers, who are also officers of GMC,may from time to time serve as directors of certain of our portfolio companies.If an officer serves in such capacity with one of our portfolio companies, suchofficer will owe fiduciary duties to all shareholders of the portfolio company,which duties may from time to time conflict with the interests of ourstockholders.

 

 In the courseof our investing activities, we will pay management and incentive fees to GMCand will reimburse Gladstone Administration for certain expenses it incurs. Asa result, investors in our common stock will invest on a “gross” basis andreceive distributions on a “net” basis after expenses, resulting in, amongother things, a lower rate of return than one might achieve through ourinvestors themselves making direct investments. As a result of thisarrangement, there may be times when the management team of GMC has intereststhat differ from those of our stockholders, giving rise to a conflict.

 

GMC will receive a quarterlyincentive fee based, in part, on our pre-incentive fee net investment income,if any, for the immediately preceding calendar quarter. This income-basedportion of the incentive fee is subject to a quarterly hurdle rate beforeproviding an income incentive fee return to GMC. Because the hurdle rate isfixed and is based in relation to current interest rates, which are currentlyrelatively low on a historical basis, if interest rates rise, it would becomeeasier for our investment income to exceed the hurdle rate and, as a result,more likely that GMC will receive an income-based incentive fee than if interest rates on ourinvestments remained constant or decreased. Subject to the receipt of anyrequisite stockholder approval under the 1940 Act, our Board of Directors mayreadjust the hurdle rate by amending the investment advisory and managementagreement.

 

We have entered into a license agreement with GMC,pursuant to which GMC has agreed to grant us a non-exclusive license to use thename “Gladstone” and the Diamond G logo. Under the license agreement, we willhave the right to use the “Gladstone” name and the Diamond G logo as long asGMC remains our investment adviser.

 

**We will typically invest in transactions involvingacquisitions, buyouts and recapitalizations of companies, which will subject usto the risks associated with change in control transactions.**

 

Our strategy includesmaking debt and equity investments in companies in connection withacquisitions, buyouts and recapitalizations, which will subject us to the risksassociated with change in control transactions. Change in control transactionsoften present a number of uncertainties. Companies undergoing change in controltransactions often face challenges retaining key employees, maintainingrelationships with customers and suppliers. While we hope to avoid many ofthese difficulties by participating in transactions where the management teamis retained and by conducting thorough due diligence in advance of our decisionto invest, if our portfolio companies experience one or more of these problems,we may not realize the value that we expect in connection with our investmentswhich would likely harm our operating results and financial condition

 

**We maynot realize gains from our equity investments.**

 

When we invest inmezzanine or senior secured loans, we may acquire warrants or other equitysecurities as well. In addition we may invest in preferred and common stock.Our goal is ultimately to dispose of such equity interests and realize gainsupon our disposition of such interests. However, the equity interests wereceive 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, andany gains that we do realize on the disposition of any equity interests may notbe sufficient to offset any other losses we experience.

 

 

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**Our investments in prospective portfolio companiesmay be risky, and you could lose all or part of your investment.**

 

Investing in small andmid-sized companies involves a number of significant risks, including:

•                  these companies may have limited financial resources and may be unableto meet their obligations under their debt securities that we hold, which maybe accompanied by a deterioration in the value of any collateral and areduction in the likelihood of us collecting on any guarantees we may haveobtained in connection with our investment;

•                  these companies typically have shorter operating histories, narrowerproduct lines and smaller market shares than larger businesses, which tend torender them more vulnerable to competitors’ actions and market conditions, aswell as general economic downturns;

•                  these companies are more likely to depend on the management talents andefforts of a small group of persons; therefore, the death, disability,resignation or termination of one or more of these persons could have amaterial adverse impact on our portfolio company and, in turn, on us; and

•                  these companies generally have less predictable operating results, mayfrom time to time be parties to litigation, may be engaged in rapidly changingbusinesses with products subject to a substantial risk of obsolescence, and mayrequire substantial additional capital to support their operations, financeexpansion, or maintain their competitive positions. In addition, our executiveofficers, directors, and GMC may, in the ordinary course of business, be namedas defendants in litigation arising from our investments in these portfoliocompanies.

 

**Economic recessions or downturns could impair ourportfolio companies and harm our operating results.**

 

Many of our portfolio companies may be susceptible toeconomic slowdowns or recessions and may be unable to make interest orprincipal payments on our loans during these periods. Therefore, ourunder-performing assets are likely to increase and the value of our portfoliois likely to decrease during these periods. Adverse economic conditions alsomay decrease the value of collateral securing some of our loans and the value ofour equity investments. Economic slowdowns or recessions could lead tofinancial losses in our portfolio and a decrease in revenues, net income andassets. Unfavorable economic conditions also could increase our funding costs,limit our access to the capital markets or result in a decision by lenders notto extend credit to us. These events could prevent us from increasinginvestments and could harm our operating results.

 

A portfolio company’s failure to satisfy financial oroperating covenants imposed by us or other lenders could lead to defaults and,potentially, acceleration of the maturity of its senior and other loans andforeclosure on its assets pledged as collateral for such loans, which couldtrigger cross-defaults under other agreements and jeopardize our portfoliocompany’s ability to meet its obligations under the debt securities that wehold. We may incur expenses to the extent necessary to seek recovery upondefault or to negotiate new terms with a defaulting portfolio company. Inaddition, if one of our portfolio companies were to be forced to seekbankruptcy protection, even though we may have structured our interest assenior debt, depending on the facts and circumstances, including the extent towhich we actually provided managerial assistance to that portfolio company, abankruptcy court might re-characterize our debt holdings and subordinate all ora portion of our claim to those of other creditors.

 

**An investment strategy focused primarily onprivately-held companies presents certain challenges, including the lack ofavailable information about these companies.**

 

We invest primarily in privately-held companies.Generally, little public information exists about these companies, and we willbe required to rely on the ability of GMC’s investment professionals to obtainadequate information to evaluate the potential returns from investing in thesecompanies. If we are unable to uncover all material information about thesecompanies, we may not make a fully informed investment decision, and we maylose money on our investments. Also, privately-held companies frequently haveless diverse product lines and smaller market presence than larger competitors.These factors could affect our investment returns.

 

**Our portfolio companies are likely to have debtthat ranks equally with, or senior to, our investments in such companies.**

 

We invest primarily in subordinated debt, mezzaninedebt and preferred equity securities issued by our portfolio companies inconnection with buyouts or recapitalizations of these companies. Portfoliocompanies undergoing these types of transactions usually will have other debtthat ranks equally with, or senior to, the debt securities in which we invest.By their terms, such debt instruments may provide that the holders are entitledto receive payment of interest or principal on or before the dates on which weare entitled to receive payments in respect of the debt securities in which weinvest. Also, in the event of insolvency, liquidation, dissolution,reorganization, or bankruptcy of a portfolio company, holders of debtinstruments ranking senior to our investment in that portfolio company wouldtypically be entitled to receive payment in full before we receive anydistribution with respect to our investment. After repaying its seniorcreditors, our portfolio company may not have any remaining assets to use forrepaying its obligation to us. In the case of debt ranking equally with debtsecurities in which we invest, we would have to share on an equal basis anydistributions with other creditors holding such debt in the event of aninsolvency, liquidation, dissolution, reorganization, or bankruptcy of therelevant portfolio company. In addition, we may not be in a position to controlany portfolio company by investing in its debt securities. 

 

 

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Therefore, we are subject to the risk that a portfoliocompany in which we invest may make business decisions with which we disagree,and the management of such company, as representatives of the holders of theirequity securities, may take risks or otherwise act in ways that do not serveour interests as debt investors.

 

**Our incentive fee may induce GMC to make certaininvestments, including speculative investments.**

 

The incentive fee payable byus to GMC may create an incentive for GMC to make investments on our behalfthat are more speculative than GMC would make in the absence of suchcompensation arrangement. The way in which the incentive fee payable to GMC isdetermined, which is calculated as a percentage of the return on investedcapital, may encourage GMC to use leverage to increase the return on ourinvestments. Under certain circumstances, the use of leverage carries with itthe risk of our default on our debt obligations, which could result inpremature sale or liquidation of our assets and otherwise adversely affect theholders of our common stock. In addition, GMC receives the incentive fee based,in part, upon net capital gains realized on our investments. Unlike the portionof the incentive fee based on income, there is no hurdle rate applicable to theportion of the incentive fee based on net capital gains. As a result, GMC mayhave a tendency to invest more in investments that are likely to result incapital gains as compared to income producing securities. Such a practice couldresult in our investing in more speculative securities than would otherwise bethe case, which could result in higher investment losses, particularly duringeconomic downturns. Moreover, once an incentive fee on capital gains has beenpaid to GMC, it is not subject to being returned in the event we realizecapital losses in the future.

 

The incentive fee payable byus to GMC also may create an incentive for GMC to invest on our behalf ininstruments, such as zero coupon bonds, that may be higher yielding but mayhave a deferred interest feature. Under these investments, we would accrue theinterest over the life of the investment but would not receive the cash incomefrom the investment until the end of the term. The income-based portion of ournet investment that is used to calculate the income portion of our investmentfee, however, includes accrued interest. For example, accrued interest, if any,on our investments in any zero coupon bonds will be included in the calculationof our incentive fee, even though we will not receive any cash interestpayments in respect of payment on any such bonds until their maturity dates.Thus, a portion of this incentive fee would be based on income that we have notyet received in cash.

 

**Our investments in securities of companies withforeign operations may involve significant risks in addition to the risksinherent in investments in companies primarily based in the U.S.**

 

Our investment strategy does not contemplate potentialinvestments in debt or equity securities of foreign companies, however, some ofour portfolio companies may have operations outside the United States.Investing in companies with a significant presence outside the U.S. may exposeus to additional risks not typically associated with investing in companieswhose operations are primarily conducted in the U.S. These risks includechanges in exchange control regulations, political and social instability,expropriation, imposition of foreign taxes, fluctuations in foreign currencyexchange rates, less liquid markets and less available information than isgenerally the case in the United States, higher transaction costs, lessgovernment supervision of exchanges, brokers, and issuers, less developedbankruptcy laws, difficulty in enforcing contractual obligations, lack ofuniform accounting and auditing standards, and greater price volatility.

 

Although most of our investments will be U.S.dollar-denominated, we may make investments denominated in foreign currencies,most likely Canadian dollars, that would subject us to the risk that the valueof the foreign currency will change in relation to the U.S. dollar. Among thefactors that may affect currency values are trade balances, the level ofshort-term interest rates, differences in relative values of similar assets indifferent currencies, long-term opportunities for investment and capitalappreciation, and political developments. We may employ hedging techniques tominimize these risks, but we can offer no assurance that such strategies willbe effective.

 

**Our hedging activities may not fully protect usfrom adverse changes in exchange rates or interest rates.**

 

If we engage in hedging transactions, we may exposeourselves to risks associated with such transactions. We may utilizeinstruments such as forward contracts, currency options and interest rateswaps, caps, collars and floors to seek to hedge against fluctuations in therelative values of our portfolio positions from changes in currency exchangerates and market interest rates. Hedging against a decline in the values of ourportfolio positions does not eliminate the possibility of fluctuations in thevalues of such positions or prevent losses if the values of such positionsdecline. However, such hedging can establish other positions designed to gainfrom those same developments, thereby offsetting the decline in the value ofsuch portfolio positions. Such hedging transactions may also limit theopportunity for gain if the values of the portfolio positions should increase.Moreover, it may not be possible to hedge against a situation of an exchangerate or interest rate fluctuation that is so generally anticipated that we arenot able to enter into a hedging transaction at an acceptable price.

 

 

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Thesuccess of our hedging transactions will depend on our ability to correctlypredict movements in currency exchange and interest rates. Therefore, while wemay enter into such transactions to seek to reduce currency exchange rate andinterest rate risks, unanticipated changes in currency exchange rates orinterest rates may result in poorer overall investment performance than if wehad not engaged in any such hedging transactions. In addition, the degree ofcorrelation between price movements of the instruments used in a hedgingstrategy and price movements in the portfolio positions being hedged may vary.Moreover, for a variety of reasons, we may not seek to establish a perfectcorrelation between such hedging instruments and the portfolio holdings beinghedged. Any such imperfect correlation may prevent us from achieving theintended hedge and expose us to risk of loss. In addition, it may not bepossible to hedge fully or perfectly against currency fluctuations affectingthe value of securities denominated in non- U.S. currencies because the valueof those securities is likely to fluctuate as a result of factors not relatedto currency fluctuations.   At March 31,2006, we were not engaged in any hedging activities.

 

 

**We willbe subject to corporate level tax if we are unable to satisfy Internal RevenueCode requirements for RIC qualification.**

 

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

 

 

**There isa risk that you may not receive dividends or that our dividends may not growover time.**

 

Our current intention isto distribute at least 90% of our ordinary income and short-term capital gainsto our stockholders on a quarterly basis. We expect to retain net realizedlong-term capital gains to supplement our equity capital and support the growthof our portfolio, although our Board of Directors may determine in certaincases to distribute these gains. We cannot assure you that we will achieveinvestment results or maintain a tax status that will allow or require anyspecified level of cash distributions or year-to-year increases in cashdistributions.

 

**Themarket price of our shares may fluctuate significantly.**

 

The market price andmarketability of our shares may from time to time be significantly affected bynumerous factors, including many over which we have no control and that may notbe directly related to us. These factors include the following:

 

•                                            price and volume fluctuations in thestock market from time to time, which are often unrelated to the operatingperformance of particular companies;

•                                            significant volatility in the marketprice and trading volume of shares of RICs, business development companies orother companies in our sector, which is not necessarily related to theoperating performance of these companies;

•                                            changes in regulatory policies or taxguidelines, particularly with respect to RICs or business developmentcompanies;

•                                            loss of BDC status;

•                                            loss of RIC status;

•                                            changes in our earnings or variations inour operating results;

•                                            changes in the value of our portfolio ofinvestments;

•                                            any shortfall in our revenue or netincome or any increase in losses from levels expected by securities analysts;

•                                            departure of key personnel;

 

 

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•                                            operating performance of companiescomparable to us;

•                                            short-selling pressure with respect toour shares or business development companies generally;

•                                            general economic trends and otherexternal factors; and

•                                            loss of a major funding source.

 

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

 

**Shares ofclosed-end investment companies frequently trade at a discount from net assetvalue.**

 

Shares of closed-endinvestment companies frequently trade at a discount from net asset value. Thischaracteristic of shares of closed-end investment companies is separate anddistinct from the risk that our net asset value per share will decline.Although shares of our common stock have historically traded at a premium tonet asset value, there can be no guarantee that they will continue to do so.

 

 

**Item 1B. Unresolved StaffComments**

 

None

 

**Item 2. Properties**

 

Wedo not own any real estate or other physical properties materially important toour operation.  GMC is the currentleaseholder of all properties in which we operate.  We occupy these premises pursuant to ourinvestment advisory and administrative agreement with GMC Corporation.  Our headquarters are located in McLean,Virginia and we also have operations in New York, New York, Morristown, NewJersey, Chicago, Illinois, Pittsburgh, Pennsylvania, Lexington, Kentucky, andDallas, Texas.

 

**Item 3. Legal Proceedings**

 

Weare not currently subject to any material legal proceedings, nor, to ourknowledge, is any material legal proceeding threatened against us.

 

**Item 4. Submission of Matters toa Vote of Security Holders**

 

Nomatters were submitted to a vote of security holders during the fourth quarterof the fiscal year ended March 31, 2006.

 

 

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**PART II**

 

**Item 5. Market for Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities**

 

Ourcommon stock is traded on the NASDAQ National Market under the symbol “GAIN.”The following table reflects, by quarter, the high and low closing prices pershare of our common stock on the NASDAQ National Market for each fiscal quarterduring the current fiscal year.

 

| ** ** | ** ** | **Quarter  Ended** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------|------------|--------------------|------------|----------|------------|---------|------------|
|       |       |               |       |     |       |    |       |
| FY 2006    |       | 3/31/06            |       | $        | 15.25      |    | $          | 13.84 |   |
|       |       | 12/31/05           |       | 14.96    |       | 13.43   |       |
|       |       | 9/30/05            |       | 16.10    |       | 14.68   |       |
|       |       | 6/30/05            |       | 15.09    |       | 15.00   |       |
|            |            |                    |            |          |            |         |            |  |  |

 

 

Asof May 10, 2006 there were 28 shareholders of record of our Common Stock.

 

**Dividends**

 

Wecurrently intend to distribute in the form of cash dividends a minimum of 90%of our ordinary income and short-term capital gains, if any, on a quarterlybasis to our stockholders. Since our inception, dividends were declaredquarterly and paid monthly.  Amountspresented for each fiscal quarter of 2006 represent the cumulative amount ofthe dividends declared for the months composing such quarter. The followingtable reflects, by quarter, the dividends per share that we have declared onour common stock for each quarter:

 

| ** ** | ** ** | **Quarter  Ended** | ** ** | **Cash Dividend  Per Share** | ** ** |
|------------|------------|--------------------|------------|------------------------------|------------|
|       |       |               |       |                         |       |
| FY 2006    |       | 3/31/06            |       | $                            | 0.21       |   |
|       |       | 12/31/05           |       | 0.12                         |       |
|       |       | 9/30/05            |       | 0.06                         |       |
|       |       | 6/30/05            |       | 0.00                         |       |
|            |            |                    |            |                              |            |  |

 

 

**Recent Sales of Unregistered Securities**

 

There were no unregistered sales of our securitiesduring the fiscal year ended March 31, 2006.

 

**Securities Authorized for Issuance Under Equity CompensationPlans**

 

There are no securities authorized for issuanceunder equity compensation plans as of March 31, 2006.

 

 

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**Item 6. Selected Financial Data**

 

Thefollowing selected financial data for the period June 22, 2005 (Commencement ofoperations) through March 31, 2006 are derived from our audited consolidatedfinancial statements. The data should be read in conjunction with ourconsolidated financial statements and notes thereto and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included elsewhere in this report.

 

**GLADSTONE INVESTMENT CORPORATION**

**SELECTED FINANCIAL DATA**

 

| ** **                                            | ** ** | **Period June 22, 2005 (Commencement of Operations) Through March 31,  2006** | ** **  |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------|-------------|
|                                                  |       |                                                                          |        |
| Total Investment Income                               |       | $                                                                             | 7,370,856   |   |
| Total Expenses                                        |       | 1,486,958                                                                     |        |
| Net Investment Income (Loss)                          |       | 5,883,898                                                                     |        |
| Net Gain on Investments                               |       | 170,399                                                                       |        |
| Net Increase in Net Assets Resulting from Operations  |       | 6,054,297                                                                     |        |
|                                                  |       |                                                                          |        |
| Per Share Data:                                       |       |                                                                          |        |
|                                                  |       |                                                                          |        |
| Net Increase in Net Assets Resulting from Operations: |       |                                                                          |        |
| Basic & Diluted                                   |       | $                                                                             | 0.37        |   |
| Cash Distributions Declared per Share                 |       | 0.39                                                                          |        |
|                                                  |       |                                                                          |        |
| Statement of Assets and Liabilities Data:             |       |                                                                          |        |
| Total Assets                                          |       | $                                                                             | 230,323,807 |   |
| Total Net Assets                                      |       | 229,841,697                                                                   |        |
|                                                  |       |                                                                          |        |
| Other Data:                                           |       |                                                                          |        |
| Number of Portfolio Companies at Period End           |       | 22                                                                            |        |
| New Investments                                       |       | $                                                                             | 160,646,470 |   |
|                                                  |       |                                                                          |        |
| Proceeds from Loan Repayments and Investments Sold    |       | $                                                                             | 7,381,468   |   |
| Total Return (1)                                      |       | 3.39                                                                          | %           |
|                                                  |       |                                                                          |        |
| Weighted Average Yield on Investments (2)             |       | 7.02                                                                          | %           |

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(1)                                  Total returnequals the increase of the ending market value over the beginning market valueplus monthly dividends divided by the monthly beginning market value.

 

(2)                                  Weighted averageyield on investments equals interest income on investments divided by theannualized weighted average investment balance throughout the year.

 

 

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**Item 7. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

*The following analysis of our financial condition and results ofoperations should be read in conjunction with our financial statements and thenotes thereto contained elsewhere in this Form 10-K.*

 

**OVERVIEW**

 

We were incorporated under the GeneralCorporation Laws of the State of Delaware on February 18, 2005. We wereprimarily established for the purpose of investing in subordinated loans,mezzanine debt, preferred stock and warrants to purchase common stock of smalland medium-sized companies in connection with buyouts and recapitalizations. Wealso may invest in common stock and from time to time, we also may invest insenior and subordinated syndicated loans. Our investment objective is togenerate both current income and capital gains through these debt and equityinstruments. We operate as a closed-end, non-diversified management investmentcompany, and have elected to be treated as a business development company underthe 1940 Act.

 

Our primary investment focuses are situationsinvolving buyouts and recapitalizations of small and mid-sized companies withestablished management teams. We expect that our investments will generallyrange between $10 million and $30 million each, although this investmentsize may vary proportionately as the size of our capital base changes. Weintend to invest either by ourselves or jointly with other buyout funds,depending on the opportunity. If we are participating in an investment with oneor more co-investors, then our investment is likely to be smaller than if wewere to be investing alone.

 

We initially have invested some of theproceeds of our initial public offering in senior secured syndicated loans,since these investments typically may be made more quickly than investments incompanies undergoing a buyout or recapitalization. We have employed thisstrategy in order to more quickly invest our initial capital to generatecurrent income. Senior secured syndicated loans typically involve a number ofbanks or other financial institutions and are generally more marketable thanloans that are not syndicated. We believe we will be able to sell our interestsin senior secured syndicated loans and reinvest the proceeds in subordinated debt,mezzanine debt, preferred stock and other higher yielding investments when suchinvestment opportunities are available. In order to invest in certain seniorsecured syndicated loans, we may have to purchase these investments at apremium, or in some instances, at a discount. We will amortize these premiumsor discounts over the contractual life of the investment. In the event that aninvestment is sold prior to its contractual maturity date, we would recognize aloss on any unamortized premium or a gain on any unamortized discount. Whileour portfolio consists primarily of senior secured loans, over time we expectthat it will consist primarily of subordinated debt, mezzanine debt andpreferred stock. To date, we have acquired interests in 19 such syndicatedloans in the aggregate principal amount, net of any repayments, ofapproximately $96.6 million.

 

Through March 31, 2006, we have investedapproximately $43.1 million in senior and subordinated debt of three portfoliocompanies.  In addition, through March31, 2006 we have invested approximately $12.8 million in preferred and commonequity of those companies. These investments represent our primary investmentfocuses and we intend to continue to invest in such investments using theremaining proceeds from our initial public offering and by the potential futuresale of our existing senior syndicated loans.  A summary of these investments for the period June 22, 2005(commencement of operations) to March 31, 2006 is as follows:

 

•                  $15.3 million in QuenchHoldings Corporation including senior debt of $4.0 million, subordinated debtof $8.0 million, a revolving credit facility of $2.0 million that remainsundrawn as of March 31, 2006, $3.3 million of common equity;

 

•                  $34.1 millionin Chase II Holdings Corporation. including senior debt of $20.9 million,subordinated debt of $6.1 million, a revolving credit facility of $0.5 millionthat remains undrawn as of March 31, 2006, redeemable preferred stock of $7.0million and common stock of $0.1 million;

 

•                  $6.5 million in HaileyTransport Corporation including $4.0 million of senior subordinated debt and$2.5 million of common equity.

 

Certain loan investments may have a form ofinterest that is not paid currently but is accrued and added to the loanbalance and paid at the end of the term. This interest is called “paid in kind”interest or “PIK.” We will generally seek investments that do not generate PIKinterest as we have to pay out this accrued interest as dividends to ourstockholders and we may have to borrow money or raise additional capital inorder to meet the tax test for regulated investment companies (“RIC”) by havingto pay out at least 90% of our income. As of March 31, 2006, none of our investments bear PIK interest.

 

We may also encounter “original issuediscount” income, or “OID” income, which arises when an investor simultaneouslypurchases a 

 

 

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warrant and a note from a company. Thistransaction requires an allocation of a portion of the purchase price to thewarrant and reduces the note by the same amount. This would cause us to have torecord the note as if we paid less than the face amount of the note and,therefore, we would have to amortize the OID over the life of the loan. Thiswould create income that would be required to be paid out as dividends to ourstockholders in accordance with the tax test for RICs to pay out at least 90%of our income. We will seek to purchase warrants from the issuer at fair marketvalue in order to avoid OID income.

 

Inaddition, as a business development company under the 1940 Act, we are requiredto make available significant managerial assistance to our portfolio companies.We provide these services through Gladstone Management Corporation (the “Adviser” or “GMC”),who provides these services on our behalf through its officers who arealso our officers.  In addition, GMCprovides other services to our portfolio companies, for which it receives fees,in connection with our investments. These fees are generally non-recurring, however in some instances theymay have a recurring component which is also paid to GMC.  One half of any such fees received, with theexception of the recurring fees, by GMC are credited against the managementadvisory fee payable to GMC pursuant to the terms of our advisory agreement,which has the effect of reducing our expenses to the extent of any such feesreceived by GMC.  The specific servicesGMC provides vary by portfolio company, but generally include a wide variety ofservices to the portfolio companies such as investment banking services,arranging bank financing, arranging equity financing, structuring financingfrom multiple lenders and investors, reviewing existing credit facilities,restructuring existing loans, raising equity and debt capital, turnaroundmanagement, merger and acquisition services and recruiting new managementpersonnel.

 

Inthe event that we expend significant effort in considering and negotiating apotential investment that ultimately is not consummated, we generally will seekreimbursement from the proposed borrower for our reasonable expenses incurredin connection with the proposed transaction. Any amounts collected for expenses incurred by GMC in connection with unconsummatedinvestments will be reimbursed to GMC. Amounts collected for these expensesincurred by us will be reimbursed to us and will be recognized as “other income”in the period in which such reimbursement is received.  Also, in the event that we have incurredsignificant legal fees in connection with the transaction, we will typicallyseek reimbursement for these expenses from the proposed borrower.  However, there can be no guarantee that wewill be successful in collecting any such reimbursements.

 

 

**OurAdviser**

 

Our affiliate GMC is our investmentadviser and is led by a management team which has extensive experience in ourlines of business.  GMC is controlled byDavid Gladstone, our chairman and chief executive officer.  Mr. Gladstone is also the chairman and chiefexecutive officer of our Adviser.  TerryLee Brubaker, our vice chairman, chief operating officer and director, is amember of the Board of Directors of GMC and is its vice chairman and chiefoperating officer.  George Stelljes III,our president, chief investment officer and director, is a member of the Boardof Directors of GMC and is its president and chief investment officer.  Harry Brill, our chief financial officer, isthe chief financial officer of GMC.

 

GMC also providesinvestment advisory and administrative services to our affiliates GladstoneCommercial Corporation, a publicly traded real estate investment trust;Gladstone Capital Corporation, a publicly traded registered investment company;and Gladstone Land Corporation, an agricultural real estate company owned by Mr.Gladstone.  All of our directors andexecutive officers serve as either directors or executive officers, or both, ofGladstone Commercial Corporation and Gladstone Capital Corporation.  In the future, GMC may provide investmentadvisory and administrative services to other funds, both public and private,of which it is the sponsor.

 

We have been externallymanaged by GMC pursuant to an investment advisory and administrative agreementsince our inception.  GMC was organizedas a corporation under the laws of the State of Delaware on July 2, 2002, andis a registered investment adviser under the 1940 Act.  GMC is headquartered in McLean, Virginia, asuburb of Washington, DC, and has offices in New York, New York, Chicago,Illinois, Pittsburgh, Pennsylvania, Morristown, New Jersey, Lexington, Kentuckyand Dallas, Texas.

 

**InvestmentAdvisory and Management Agreement**

 

Pursuant to our investment advisory andmanagement agreement with GMC we will pay GMC a fee, as compensation for itsservices, consisting of a base management fee and an incentive fee.

 

The base management fee is assessed at anannual rate of 2% computed on the basis of our gross invested assets, which aretotal assets less the cash proceeds and cash and cash equivalent investmentsfrom the proceeds of our initial public offering that are not invested in debtand equity securities of portfolio companies. Through March 31, 2006, the base management fee was computed and payablemonthly.  Subsequent to March 31, 2006,the base management fee will be computed and payable quarterly to GMC.   Beginning in periods subsequent to June 30,2006, the base management fee will be assessed at an annual rate of 2% computedon the basis of our 

 

 

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gross assets, which are total assets,including investments made with proceeds of borrowings, less any uninvestedcash or cash equivalents resulting from borrowings.  This calculation was set to begin in periodsafter March 31, 2006, however, on April 11, 2006 our Board of Directorsaccepted a voluntary waiver from GMC that will allow the current calculation ofthe base management fee to be effective through June 30, 2006.  When GMC also receives fees from ourportfolio companies, such as investment banking fees, structuring fees orexecutive recruiting services fees, one half of these fees will be creditedagainst the base management fee that we would otherwise be required to pay toGMC.

 

The incentive fee consists of two parts: anincome-based incentive fee and a capital gains incentive fee. The income-basedincentive fee will reward the Adviser if our quarterly net investment income(before giving effect to the incentive fee) exceeds 1.75% of our netassets.  The Adviser will receive acapital gains incentive fee of 20% of our realized capital gains (net ofrealized capital losses and unrealized capital depreciation).

 

**AdministrationAgreement**

 

We have entered into an administrationagreement with Gladstone Administration, LLC (“Gladstone Administration”), awholly owned subsidiary of GMC, which is controlled by our chairman and chiefexecutive officer. Pursuant to the administration agreement, GladstoneAdministration furnishes us with office facilities, equipment and clerical,bookkeeping and record keeping services at such facilities and performs, oroversees the performance of our required administrative services. Such requiredadministrative services include, among other things, being responsible for thefinancial records which we are required to maintain and preparing reports toour stockholders and reports filed with the Securities and Exchange Commission.

 

The administration agreement requires us toreimburse Gladstone Administration for the performance of its obligations underthe administration agreement based upon our allocable portion of GladstoneAdministration’s overhead, including, but not limited to, rent and ourallocable portion of the salaries and benefits of our chief financial officer,chief compliance officer, controller and their respective staffs. Our allocableportion of expenses is derived by multiplying Gladstone Administration’s totalexpenses by the percentage of our average total assets (the total assets at thebeginning and ending of each quarter) in comparison to the average total assetsof all companies managed by GMC.

 

**OurInvestment Strategy**

 

We seek to achieve returns from current income and capital gains fromjunior subordinated and mezzanine debt, as well as preferred stock and warrantsto purchase common stock, representing controlling investments that we make inconnection with buyouts and recapitalizations of small and mid-sizedcompanies.  We expect that our targetportfolio over time will include mostly subordinated loans, mezzanine debt,preferred stock, and warrants to buy common stock. Structurally, subordinatedloans and mezzanine loans usually rank lower in priority of payment to seniordebt, such as senior bank debt, and may be unsecured. However, subordinateddebt and mezzanine loans rank senior to common and preferred equity in a borrower’scapital structure. Typically, subordinated debt and mezzanine loans haveelements of both debt and equity instruments, offering the returns in the formof interest payments associated with senior debt, while providing lenders anopportunity to participate in the capital appreciation of a borrower, if any,through an equity interest. This equity interest typically takes the form ofwarrants. Due to its higher risk profile and often less restrictive covenantsas compared to senior debt, mezzanine debt generally earns a higher return thansenior secured debt. The warrants associated with mezzanine loans are typicallydetachable, which allows lenders to receive repayment of their principal on anagreed amortization schedule while retaining their equity interest in theborrower. Mezzanine debt also may include a “put” feature, which permits theholder to sell its equity interest back to the borrower at a price determinedthrough an agreed formula. We believe that mezzanine loans offer an alternativeinvestment opportunity based upon their historic returns and resilience duringeconomic downturns.

 

 

**Off-Balance Sheet Arrangements**

 

Wedo not have any significant off-balance sheet arrangements as defined inItem 303(a) (4) (ii) of SEC Regulation S-K as of March 31, 2006.

 

**Critical Accounting Policies**

 

Thepreparation of financial statements and related disclosures in conformity withgenerally accepted accounting principles in the United States requiresmanagement to make estimates and assumptions that affect the reportedconsolidated amounts of assets and liabilities, disclosure of contingent assetsand liabilities at the date of the financial statements, and revenues andexpenses during the 

 

 

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periodsreported. Actual results could materially differ from those estimates. Ouraccounting policies are more fully described in the “Notes to ConsolidatedFinancial Statements” contained elsewhere in this report. We have identifiedour investment valuation process, tax status and revenue recognition as ourmost critical accounting policies.

 

**Investment Valuation**

 

Themost significant estimate inherent in the preparation of our consolidatedfinancial statements is the valuation of investments and the related amounts ofunrealized appreciation and depreciation of investments recorded.

 

*General Valuation Policy:* We value ourinvestment portfolio each quarter. We carry our investments at fair value, asdetermined in good faith by our Board of Directors.  Securities that are publicly traded, if any,are valued at the closing price of the exchange or securities market on whichthey are listed on the valuation date. Securities which are not traded on apublic exchange or securities market, but for which a limited market exists andthat have been rated by a NRSRO (as defined below), such as certainparticipations in syndicated loans, are valued at the indicative bid priceoffered by the syndication agent on the valuation date.

 

Debt and equity securities that are notpublicly traded, for which a limited market does not exist, or for which alimited market exists but that have not been rated by a NRSRO (or for which wehave various degrees of trading restrictions) are valued at fair value asdetermined in good faith by our Board of Directors.  In making the good faith determination of thevalue of these securities, we start with the cost basis of the security, whichincludes the amortized original issue discount, and PIK interest, if any.  We then apply the methods set out below in “ValuationMethods.”  Members of our portfoliomanagement team prepare the valuations of our investments in portfoliocompanies using the most recent portfolio company financial statements andforecasts.  These individuals alsoconsult with portfolio company senior management and ownership to obtainfurther updates on the portfolio company’s performance, including informationsuch as industry trends, new product development, and other operationalissues.  Due to the uncertainty inherentin the valuation process, such estimates of fair value may differ significantlyfrom the values that would have been obtained had a ready market for thesecurities existed, and the differences could be material.  Additionally, changes in the marketenvironment and other events that may occur over the life of the investmentsmay cause the gains or losses ultimately realized on these investments to bedifferent than the valuations currently assigned.  There is no single standard for determiningfair value in good faith, as fair value depends upon circumstances of eachindividual case.  In general, fair valueis the amount that we might reasonably expect to receive upon the current saleof the security.

 

We currently engage Standard & Poor’sLoan Evaluation Service (S&P) to help evaluate the value of four of ourloan securities (other than those which are publicly traded or for which alimited market exists, as described above), as well as for evaluations onsuccess fees (conditional interest included in some loan securities).  We and S&P only evaluate the value of asuccess fee if the probability of receiving the success fee on a given loan isabove 6-8%, a threshold of significance, in which case a value isassigned.  Upon completing our collectionof data with respect to the investments (including the information describedunder “Credit Information,” the risk ratings of the loans described under “LoanGrading and Risk Rating” and the factors described under “Valuation Methods”),this valuation data is presented to S&P. S&P makes its independent assessment of the data that we haveassembled and assesses its own data to determine market values for thesecurities.  With regard to its work,S&P has issued the following paragraph:

 

S&P provides evaluatedprice opinions which are reflective of what S&P believes the bid side ofthe market would be for each loan after careful review and analysis ofdescriptive, market and credit information. Each price reflects S&P’s best judgment based upon carefulexamination of a variety of market factors. Because of fluctuation in the market and in other factors beyond itscontrol, S&P cannot guarantee these evaluations.  The evaluations reflect the market prices, orestimates thereof, on the date specified. The prices are based on comparable market prices for similarsecurities.  Market information has beenobtained from reputable secondary market sources.  Although these sources are consideredreliable, S&P cannot guarantee their accuracy.

 

With our assessment and S&P valueestimates as a backdrop, our Board of Directors votes to accept or not acceptthe analyses and values recommended by management and S&P.  At March 31, 2006 the Board of Directorselected to accept the valuations recommended by S&P on the loans in ourportfolio as denoted on the Schedule of Investments as of March 31, 2006 in ourconsolidated financial statements.

 

Because there is a delay between when weclose an investment and when the investment can be evaluated by S&P, newloans are not valued immediately by S&P; rather, the Board of Directorsmakes its own determination about the value of these investments in accordancewith our valuation policy.  BecauseS&P does not provide values for equity securities our Board of Directorsalso determines the fair value of these investments using our valuation policywithout the input of S&P.

 

 

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*Credit Information:*****We monitor a wide variety of key credit statistics that provideinformation regarding our portfolio companies to help us assess credit qualityand portfolio performance.  We requireour portfolio companies to provide annual audited and either monthly orquarterly unaudited financial statements. Using these statements, we calculate and evaluate the creditstatistics.  For purposes of analyzingthe financial performance of our portfolio companies, we may make certainadjustments to their cash flow statements to reflect the pro forma results of acompany consistent with a change of control transaction, to reflect anticipatedcost savings resulting from a merger or restructuring, costs related to newproduct development, compensation to previous owners, and other acquisition orrestructuring related items.  For thoseinvestments for which S&P prepares valuation recommendations, we providethis credit information to S&P for its use in preparing itsrecommendations.  For those investmentsfor which S&P does not prepare valuation recommendations, management usesthis credit information in connection with its preparation of valuation recommendations.

 

*Loan Grading and Risk Rating:*****As part of our valuation procedures we riskrate all of our investments in debt securities. Our risk rating system uses a scale of 0 to 10, with 10 being thelowest probability of default.  Thissystem is used to estimate the probability of default on our debt securitiesand the probability of loss if there is a default.  These types of systems are referred to asrisk rating systems and are used by banks and rating agencies.  The risk rating system covers both qualitativeand quantitative aspects of the business and the securities we hold.  Forthose investments for which S&P prepares valuation recommendations, wecompile this information and provide it to S&P for its consideration indetermining its valuation recommendations. For those investments for which S&P does not prepare valuationrecommendations, management uses this information to develop valuationrecommendations.

 

We seek to have our risk rating system mirrorthe risk rating systems of major risk rating organizations such as thoseprovided by nationally recognized statistical rating organizations (“NRSRO”) asdefined in Rule 2a-7 under the 1940 Act. While we seek to mirror the NRSROsystems, we cannot provide any assurance that our risk rating system providesthe same risk rating as a NRSRO. The following chart is an estimate of therelationship of our risk rating system to the designations used by two NRSROsas they risk rate debt securities of major companies.  Because we have established our system to ratedebt securities of companies that are unrated by any NRSRO, there can be noassurance that the correlation to the NRSRO set out below is accurate.  We believe our risk rating would besignificantly higher than a typical NRSRO risk rating because the risk ratingof the typical NRSRO is designed for larger businesses that can afford to payan NRSRO to rate their securities. However, our risk rating has been designed to risk rate the securitiesof smaller businesses that are not rated by a typical NRSRO. Therefore, when weuse our risk rating on larger business securities, the risk rating is higherthan a typical NRSRO rating.  The primarydifference between our risk rating and the rating of a typical NRSRO is that ourrisk rating uses more quantitative determinants and includes qualitativedeterminants that we believe are not used in the NRSRO rating.  It is our understanding that most debtsecurities of middle market companies do not exceed the grade of BBB on a NRSROscale, so there would be no debt securities in the middle market that wouldmeet the definition of AAA, AA or A. Therefore, our scale begins with the designation 10 as the best riskrating which may be equivalent to a BBB from a NRSRO, however, no assurance canbe given that a 10 on our scale is equal to a BBB on a NRSRO scale.

 

 

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| **Company’s  System** | ** ** | **First  NRSRO** | ** ** | **Second  NRSRO** | ** ** | **Gladstone Investment’s Description(a)**                                                       |
|----------------------------|------------|------------------|------------|-------------------|------------|------------------------------------------------------------------------------------------------------|
| **>10**                 |       | Baa2             |       | BBB               |       | Probability of Default (PD  during the next ten years is 4% and the Expected Loss (EL is 1% or less) |
| **10**                     |       | Baa3             |       | BBB-              |       | PD is 5 and the EL is 1 to  2%                                                                       |
| **9**                      |       | Ba1              |       | BB+               |       | PD is 10 and the EL is 2  to 3%                                                                      |
| **8**                      |       | Ba2              |       | BB                |       | PD is 16 and the EL is 3  to 4%                                                                      |
| **7**                      |       | Ba3              |       | BB-               |       | PD is 17.8 and the EL is 4  to 5%                                                                    |
| **6**                      |       | B1               |       | B+                |       | PD is 22.0 and the EL is 5  to 6.5%                                                                  |
| **5**                      |       | B2               |       | B                 |       | PD is 25 and the EL is 6.5  to 8%                                                                    |
| **4**                      |       | B3               |       | B-                |       | PD is 27 and the EL is 8  to 10%                                                                     |
| **3**                      |       | Caa1             |       | CCC+              |       | PD is 30 and the EL is  10.0 to 13.3%                                                                |
| **2**                      |       | Caa2             |       | CCC               |       | PD is 35 and the EL is  13.3 to 16.7%                                                                |
| **1**                      |       | Caa3             |       | CC                |       | PD is 65 and the EL is  16.7 to 20%                                                                  |
| **0**                      |       | N/a              |       | D                 |       | PD is 85 or there is a  Payment Default and the EL is greater than 20%                               |

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*(a) thedefault rates set here are for a ten year term debt, if the company’s debtsecurity is less than ten years then the probability of default is adjusted toa lower percentage for the shorter period which may move the security higher onthe company’s risk rating scale.*

 

The above scale gives anindication of the probability of default and the magnitude of the loss if thereis a default.  The following table liststhe risk ratings for all of the debt securities by quarter during the fiscalyear ended March 31, 2006:

 

| **Rating**       | ** ** | **June 30, 2005** | ** ** | **September 30, 2005** | ** ** | **December, 2005** | ** ** | **March 31, 2006** | ** ** |
|------------------|------------|------------------------|------------|-----------------------------|------------|--------------------|------------|--------------------|------------|
| Average          |       | n/a                    |       | 7.9                         |       | 7.3                |       | 7.1                |       |
| Weighted Average |       | n/a                    |       | 7.5                         |       | 7.3                |       | 6.6                |       |
| Highest          |       | n/a                    |       | 9.0                         |       | 9.0                |       | 9.0                |       |
| Lowest           |       | n/a                    |       | 7.0                         |       | 6.0                |       | 5.0                |       |

 

Theabove scale gives an indication of the probability of default and the magnitudeof the loss if there is a default.  Ourpolicy is to stopaccruing interest on an investment if we determine that interest is no longercollectible.  At March 31, 2006, nopayments were past due on any of our debt securities.  The decrease in quarterly ratings for fiscal2006 in the above scale is due to a movement of our investments from seniorsyndicate loans to subordinated debt and mezzanine loans.  Additionally, we do not risk rate our equitysecurities.

 

*Valuation Methods:*  For debt securities, we first determine ifthe debt security is publicly traded (i.e., if it is listed on an exchange orsecurities market).  If it is publiclytraded, then we determine the value based on the closing price for the securityon the exchange or securities market on which it is listed on the valuationdate.  If the security is not publiclytraded, but a limited market for the security exists, such as for aparticipation in a syndicated loan, then we value it at the indicative bidprice offered by the syndication agent on the valuation date.  At March 31, 2006, none of the debtsecurities in our portfolio were publicly traded and there was a limited marketfor 19 debt securities in our portfolio.

 

For debt securities that are not publiclytraded, for which there is no market, or for which there is a market but havenot been rated by a NRSRO, we begin with the risk rating designation of thesecurity described above.  Using the riskrating designation above, we seek to determine the value of the security as ifwe intended to sell the security in a current sale.  To determine the current sale price of thesecurity, we consider some or all of the following factors:

 

•                  financial standing of theissuer of the security;

•                  comparison of the businessand financial plan of the issuer with actual results;

•                  the cost of the security;

•                  the size of the securityheld as it relates to the liquidity of the market for such securities;

•                  contractual restrictions onthe disposition of the security;

•                  pending public offering ofthe issuer of the security;

 

 

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•                  pending reorganizationactivity affecting the issuer such as mergers or debt restructuring;

•                  reported prices of similarsecurities of the issuer or comparable issuers;

•                  ability of the issuer toobtain needed financing;

•                  changes in the economyaffecting the issuer;

•                  recent purchases or sale ofa security of the issuer;

•                  pricing by other buyers orsellers of similar securities;

•                  financial statements of theborrower;

•                  reports from portfoliocompany senior management and ownership;

•                  the type of security;

•                  cost at date of purchase;

•                  size of holding;

•                  discount from market valueof unrestricted securities of the same class at the time of purchase;

•                  special reports prepared byanalysts;

•                  information as to anytransactions or offers with respect to the security;

•                  existence of mergerproposals or tender offers affecting the securities;

•                  the collateral;

•                  the issuer’s ability to makepayments;

•                  the current and forecastedearnings of the issuer;

•                  sales to third parties ofsimilar securities;

•                  statistical ratios comparedto lending standards;

•                  statistical ratios comparedto other similar securities; and

•                  other pertinent factors.

 

For those debt securities for which S&Pprepares valuation recommendations, we provide the foregoing information toS&P for its use in preparing its recommendations.

 

For convertible debt, equity, success fees orother equity-like securities, we first determine if there is any market for thesecurity.  If there is a market, then wedetermine the value based on the market prices for the security, even if thatmarket is not robust.  At March 31, 2006there was no market for any of the equity securities we owned.  If there is no market for the equitysecurities, then we use the same information we would use for a debt securityvaluation described above, except risk-rating, as well as standard valuationtechniques used by major valuation firms to value the equity securities ofprivate companies.  These valuationtechniques consist of discounted cash flow of the expected sale price in the future,valuation of the securities based on recent sales in comparable transactions,and a review of similar companies that are publicly traded and the marketmultiple of their equity securities.  AtMarch 31, 2006 we had $12.8 million invested, at cost, in equity securitiescompared to our debt portfolio with a cost basis of $140.5 million.

 

At March 31, 2006 we had total unrealizedappreciation of approximately $113,000, which was mainly composed of netunrealized appreciation of our syndicated loan investments.

 

**Tax Status**

 

*Federal Income Taxes*

 

Weintend to continue to qualify for treatment as a RIC under Subtitle A, Chapter1 of Subchapter M of the Code. As a RIC, we are not subject to federal incometax on the portion of our taxable income and gains distributed to stockholders.To qualify as a RIC, we are required to distribute to stockholders at least 90%of investment company taxable income, as defined by the Code.  We have a policy to pay out as a dividend upto 100% of that amount.

 

**Revenue Recognition**

 

*Interest Income Recognition*

 

Interestincome is recorded on the accrual basis to the extent that such amounts areexpected to be collected. We will stop accruing interest on investments when itis determined that interest is no longer collectible. Conditional interest or asuccess fee is recorded upon full repayment of a loan investment.

 

 

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*Fee Income*

 

The1940 Act requires that a business development company make available managerialassistance to its portfolio companies by providing significant guidance andcounsel concerning the management, operations, or business objectives andpolicies of the respective portfolio company. We provide these and otherservices through our adviser, GMC.  Currently, neither we nor GMC receive fees in connection with managerialassistance. However, GMC, receives the fees for the other services it provides,and 50% of those fees for other services are credited to the investmentadvisory fees due to GMC.  These otherfees are generally paid to GMC upon the closing of the investment.  These fees are generally non-recurring, arerecognized as revenue when earned and are paid directly to GMC by the borroweror potential borrower.  The services GMCprovides vary by investment, but generally include a wide variety of servicesto the portfolio companies such as investment banking services, arranging bankfinancing, arranging equity financing, structuring financing from multiplelenders and investors, reviewing existing credit facilities, restructuringexisting loans, raising equity and debt capital, turnaround management, mergerand acquisition services and recruiting new management personnel.  Any services of this nature subsequent to theclosing would generally generate a separate fee at the time of completion whichis payable either to us or GMC. From time to time, we are invited toparticipate as a co-lender in a transaction. In the event that we do notprovide significant services in connection with our investment, loan fees paiddirectly to GMC in such situations are deferred and amortized over the life ofthe loan.

 

**RESULTS OF OPERATIONS**

 

*For theperiod June 22, 2005 (commencement of operations) to March 31, 2006*

 

**InvestmentIncome**

 

Investment income for the period June 22,2005 (commencement of operations) to March 31, 2006 was $7,370,856 andconsisted of interest income on our portfolio investments of $2,705,965,interest income of $4,434,706 from cash and cash equivalents, representingincome earned on the investment of the net proceeds of our initial public offeringand $230,185 of fee and other income.

 

The annualized weighted average yield on ourportfolio of investments, excluding cash and cash equivalents, was 7.02% forthe period June 22, 2005 (commencement of operations) to March 31, 2006.

 

**OperatingExpenses**

 

Operating expenses for the period June 22,2005 (commencement of operations) to March 31, 2006 were $1,486,958.

 

The administration fee payable to GladstoneAdministration was $288,471 for the period June 22, 2005 (commencement ofoperations) to March 31, 2006. This fee consists of our allocable portion ofGladstone Administration’s rent and other overhead expenses and the allocableportion of the salaries and benefits of our chief financial officer, chiefcompliance officer, controller and their respective staffs. The allocableportion of our expenses is derived by multiplying Gladstone Administration’stotal expenses by the percentage of our average assets (the assets at thebeginning and ending of each quarter) in comparison to the average assets of allcompanies managed by GMC.

 

The base management fee to GMC was $360,771for the period June 22, 2005 (commencement of operations) to March 31, 2006.The base management fee is computed monthly as described under “InvestmentManagement and Advisory Agreement.”

 

The following table setsforth the quarterly computations of the management fee for the three monthsended March 31, 2006, December 31, 2005, September 30, 2005 and June 30, 2005:

 
| ** **                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------|------------|---------------|------------|------------------|------------|-------------------|------------|--------------|------------|
| ** **                                     | ** ** | **2006**      | ** ** | **2005**         | ** ** | **2005**          | ** ** | **2005**     | ** ** |
| **Fee:**                                       | ** ** | ** **    | ** ** | ** **       | ** ** | ** **        | ** ** | ** **   | ** ** |
| Fee assessed based on invested assets          |       | $             | 557,730    |             | $          | 265,522           |       | $            | 92,108     |   | $ | — |   |
| Gross management fee before fee revenue credit |       | 557,730       |       | 265,522          |       | 92,108            |       | —       |       |
|                                           |       |          |       |             |       |              |       |         |       |
| **Direct Credit to Management Fee:**           | ** ** | ** **    | ** ** | ** **       | ** ** | ** **        | ** ** | ** **   | ** ** |
| Fee revenue recorded by Gladstone Management:  |       | 554,589       |       | —           |       | —            |       | —       |       |
| Net management fee for the three months ended: |       | $             | 3,141      |             | $          | 265,522           |       | $            | 92,108     |   | $ | — |   |

 

 

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Directors’ fees for the period June 22, 2005(commencement of operations) to March 31, 2006 were $160,000 and consisted ofthe amortization of the directors’ annual stipend and individual meeting fees.

 

Insurance expense for the period June 22,2005 (commencement of operations) to March 31, 2006 was $184,642 and consistedof the amortization of the directors and officers insurance policy andprofessional liability policy.

 

Organizational costs for the period June 22,2005 (commencement of operations) to March 31, 2006 were $7,002 and consistedof expenses incurred in connection with the preparation of certainadministrative agreements.

 

Professional fees for the period June 22,2005 (commencement of operations) to March 31, 2006 were $163,369 and primarilyconsisted of legal fees and audit and accounting fees.

 

Stockholder related costs for the period June22, 2005 (commencement of operations) to March 31, 2006 were $89,563 andconsisted of the amortization of annual NASDAQ listing fees, transfer agentfees, Securities and Exchange Commission filing and press release costs.

 

Interest expense for the period June 22, 2005(commencement of operations) to March 31, 2006 was $378 and consisted ofinterest due on a loan payable to affiliate, which was repaid in June 2005.

 

Taxes and licenses expense for the periodJune 22, 2005 (commencement of operations) to March 31, 2006 was $195,270 andwas comprised of fees surrounding state and regulatory licensing, registrationand other corporate filing fees.  Of thisamount, approximately $185,000 related to franchise taxes to the state ofDelaware for calendar year 2005 and the first quarter of calendar year2006.  The maximum franchise tax thatwill be paid to the state of Delaware for a calendar year is $165,000; howeverthe current fiscal year expense includes franchise tax from our date ofincorporation in February 2005 through December 31, 2005, in addition to anaccrual of $41,250 for the current 2006 calendar year.  We expect that in future periods this amountwill remain at $165,000 annually subject to future increases by the state ofDelaware.

 

General and administrative expenses for theperiod June 22, 2005 (commencement of operations) to March 31, 2006 were$37,492 and consisted of conferences, travel, bank fees and miscellaneousexpenses.

 

**Realizedand Unrealized Gain (Loss) on Investments**

 

For the period June 22, 2005 (commencement ofoperations) to March 31, 2006, we recognized an aggregate of $57,431 ofrealized gains on related to the sale of five loan participations and werecorded net unrealized appreciation of investments in the aggregate amount of$112,968.

 

**NetIncrease in Net Assets from Operations**

 

Overall, we realized a net increase in netassets resulting from operations of $6,054,297 for the period June 22, 2005(commencement of operations) to March 31, 2006. Based on basic and dilutedweighted average common shares of 16,391,589 outstanding, our net increase innet assets from operations per basic and diluted weighted average common sharefor the period June 22, 2005 (commencement of operations) to March 31, 2006 was$0.37.

 

We do not expect this level of investmentincome and operating expenses to be indicative of our future operatingperformance. In particular, we expect investment income to increase in futureperiods, as compared to the period June 22, 2005 (commencement of operations)to March 31, 2006 as a result of the investment of the net proceeds from theinitial public offering and as we make investments in portfolio companysecurities that we expect will yield a greater return than the cash and cashequivalents in which the vast majority of the net proceeds of our initialpublic offering are currently invested.

 

We will continue to incur base managementfees which are likely to increase as our investment portfolio grows, and maypotentially begin to incur incentive fees. Our administrative expenses payableto Gladstone Administration are also likely to increase during future periodsas our average assets increase in comparison to average assets at March 31,2006 and as the expenses incurred by Gladstone Administration to support ouroperations increase.

 

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

Net cash used in operating activities for theperiod June 22, 2005 (commencement of operations) to March 31, 2006 wasapproximately $148.1 million and consisted of the funding of our portfolioinvestments and their respective principal repayments, net investment incomegenerated from our portfolio and short-term investments, an increase inaccounts payable, base management fee and administrative fees payable andaccrued expenses offset by an increase in interest receivable and prepaidassets.

 

A summary of our investment activity for theperiod ended March 31, 2006 is as follows:

 
| **Quarter Ended**  | ** ** | **New Investments** | ** **  | **Principal Repayments** | ** ** | **Investments Sold** | ** ** | **Gain on Disposal** | ** ** |
|--------------------|------------|---------------------|-------------|--------------------------|------------|----------------------|------------|----------------------|------------|
|               |       |                |        |                     |       |                 |       |                 |       |
| June 30, 2005      |       | $                   | —      |                     | $          | —               |       | $                    | —     |   | $ | — |   |
| September 30, 2005 |       | 40,844,381          |        | 333,363                  |       | —               |       | —               |       |
| December 31, 2005  |       | 23,376,958          |        | 1,043,120                |       | 2,000,000            |       | 38,056               |       |
| March 31, 2006     |       | 96,425,131          |        | 425,054                  |       | 3,522,500            |       | 19,375               |       |
| **Total**          |       | $                   | 160,646,470 |                     | $          | 1,801,537            |       | $                    | 5,522,500  |   | $ | 57,431 |   |

 

The following table summarizes thecontractual principal amortization and maturity of our investment portfolio byfiscal year:

 

| **Fiscal Year Ended March 31,**          | ** ** | **Amount**  | ** **  |
|------------------------------------------|------------|-------------|-------------|
| 2007                                     |       | $           | 1,117,733   |   |
| 2008                                     |       | 3,794,224   |        |
| 2009                                     |       | 3,947,053   |        |
| 2010                                     |       | 11,516,595  |        |
| 2011                                     |       | 36,820,199  |        |
| Thereafter                               |       | 82,472,120  |        |
|                                     |       |        |        |
| **Total contractual repayments**         |       | 139,667,924 |        |
|                                     |       |        |        |
| Investments in equity securities         |       | 12,778,508  |        |
| Unamortized premiums on debt securities: |       | 822,890     |        |
| **Total**                                |       | $           | 153,269,322 |   |

 

Cash provided by financing activitiesconsisted of the net proceeds from the initial public offering of $230,292,203(which includes $30.1 million of proceeds received in July 2005 in connectionwith the closing of the underwriters’ over-allotment option and other relatedoffering costs anddoes not include approximately $48,000 of offering costs incurred prior tofiscal 2006), partially offset by the payment of dividends of $6,458,439 and therepayment of the loan payable to affiliate of $50,000. Our dividends paid of $6,458,439 for the2006 fiscal year exceeded net investment income (including realized gains) by$517,110. We declared these dividends based on estimates of net investment incomefor the 2006 fiscal year. Our investment pace was slower than expected in ourfirst year of operations, and consequently, net investment income was lowerthan originally anticipated.

 

As a result of the initial public offeringand other factors listed above, during the period June 22, 2005 (commencementof operations) to March 31, 2006, cash and cash equivalents increased from$3,636 at the beginning of the period to $75,672,605 at the end of the period.We will continue to use the proceeds from our initial public offering to makeinvestments in syndicated loans, subordinated debt, mezzanine debt, preferredstock and other higher yielding investments. Further, we expect to establish a line of creditfacility to enable us to continue our investment activities.

 

In order to qualify as a RIC and to avoidcorporate level tax on the income we distribute to our stockholders, we arerequired, under Subchapter M of the Code, to distribute at least 90% of ourordinary income and realized net short-term capital gains to our stockholderson an annual basis. In accordance with these requirements, we declared thefollowing dividends:

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|----------------------|------------|-----------------|------------|------------------|------------|------------------------|------------|
| January 10, 2006     |       | Mar. 17, 2006   |       | Mar. 31, 2006    |       | $                      | 0.07       |   |
| January 10, 2006     |       | Feb. 16, 2006   |       | Feb. 28, 2006    |       | $                      | 0.07       |   |
| January 10, 2006     |       | Jan. 23, 2006   |       | Jan. 31, 2006    |       | $                      | 0.07       |   |
| October 7, 2005      |       | Dec. 21, 2005   |       | Dec. 31, 2005    |       | $                      | 0.04       |   |
| October 7, 2005      |       | Nov. 21, 2005   |       | Nov. 30, 2005    |       | $                      | 0.04       |   |
| October 7, 2005      |       | Oct. 21, 2005   |       | Oct. 30, 2005    |       | $                      | 0.04       |   |
| July 7, 2005         |       | Sept. 22, 2005  |       | Sept. 30, 2005   |       | $                      | 0.02       |   |
| July 7, 2005         |       | Aug. 23, 2005   |       | Aug. 31, 2005    |       | $                      | 0.02       |   |
| July 7, 2005         |       | July 21, 2005   |       | July 29, 2005    |       | $                      | 0.02       |   |

 

 

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**ContractualObligations and Off-Balance Sheet Arrangements**

 

Asof March 31, 2006, we were a party to signed and non-binding term sheets forthree allocations of syndicate loan participations.  The future scheduled contractual payments atMarch 31, 2006 are as follows:

 
| ** **                  | ** ** | ** ** | ** ** | **Payment Due by Period** | ** ** |
|-----------------------------|------------|------------|------------|---------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less than 1 Year**      | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than   5 Years** | ** ** |
|                        |       |       |       |                      |       |   |   |   |   |   |   |
| Investments                 |       | 20,000,000 |       | 20,000,000                |       |   |   |   |   |   |   |
| Total                       |       | $          | 20,000,000 |                      | $          | 20,000,000 |   | $ | — |   | $ | — |   | $ | — |   |
|                             |            |            |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |

 

As of the date of this report, the investmentpurchase obligations above have been funded. See Note 13 “Subsequent Events” inour Consolidated Financial Statements for further information.

 

 

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

 

We are subject to financial market risks,including changes in interest rates. General interest rate fluctuations mayhave a substantial negative impact on our investments and investmentopportunities and, accordingly have a material adverse effect on our investmentobjectives and our rate of return on invested capital. Currently our entireinvestment portfolio is comprised of investments earning variable rates ofinterest. In addition, an increase in interest rates would make it moreexpensive to use debt for our financing needs, if any.

 

We expect to borrow funds to finance futurelending activities after we have substantially fully invested the proceeds ofour initial public offering. These future borrowings may be at fixed orvariable rates. To date, we have not borrowed any funds nor do we currentlyforesee the short-term necessity to borrow funds.

 

To illustrate the potential impact of changesin interest rates on our net increase in net assets resulting from operations,we have performed the following analysis, which assumes that our balance sheetremains constant. Under this analysis, a hypothetical increase in the one monthLIBOR by 1% would increase our net increase in net assets resulting fromoperations by approximately $1.1 million or 19%, over the next twelve months,compared to the net increase in net assets resulting from operations for theperiod June 22, 2005 (commencement of operations) to March 31, 2006. Ahypothetical decrease in the one month LIBOR by 1% would decrease our netincrease in net assets resulting from operations by approximately $1.1 millionor 19%, over the next twelve months, compared to the net increase in net assetsfrom operations for the period June 22, 2005 (commencement of operations) toMarch 31, 2006. Although management believes that this analysis is indicativeof our existing interest rate sensitivity, it does not adjust for potentialchanges in credit quality, size of our investment portfolio and other businessdevelopments that could affect net increase in net assets resulting fromoperations. Further, at March 31, 2006 approximately 75% of our investmentportfolio consisted of senior syndicated loans and cash equivalents which arenot indicative of the future composition of our portfolio.  Accordingly, no assurances can be given thatactual results would not differ materially from the results under thishypothetical analysis.

 

We expect to hedge against interest ratefluctuations in the future by using standard hedging instruments such asforward contracts, futures, currency options, interest rate swaps, caps,collars and floors. While hedging activities may insulate us against adversefluctuations in interest rates, they may also limit our ability to participatein the benefits of lower interest rates with respect to our portfolio ofinvestments.

 

We may also experience risk associated withinvesting in securities of companies with foreign operations. We currently donot anticipate investing in debt or equity of foreign companies, however, somepotential portfolio companies may have operations located outside the UnitedStates. These risks include, but are not limited to, fluctuations in foreigncurrency exchange rates, imposition of foreign taxes, changes in exportationregulations and political and social instability.

 

 

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

 

**Index to Consolidated Financial Statements**

 
| Report  of Independent Registered Public Accounting Firm                                                                     |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated Statement of Assets and Liabilities as of  March 31, 2006                                                       |   |
| Consolidated Schedule of Investments as of March 31,  2006                                                                   |   |
| Consolidated Statement of Operations for the period  June 22, 2005 (Commencement of Operations) to March 31, 2006            |   |
| Consolidated Statement of Changes in Net Assets for  the period June 22, 2005 (Commencement of Operations) to March 31, 2006 |   |
| Consolidated Statement of Cash Flows for the period  June 22, 2005 (Commencement of Operations) to March 31, 2006            |   |
| Financial Highlights for the period June 22, 2005  (Commencement of Operations) to March 31, 2006                            |   |
| Notes to Consolidated Financial Statements                                                                                   |   |

 

 

 

**Management’sReport on the Financial Statements**

 

Ourmanagement is responsible for the preparation, integrity and objectivity of theaccompanying consolidated financial statements and the related financialinformation.  The financial statementshave been prepared in conformity with accounting principles generally acceptedin the United States of America and necessarily include certain amounts thatare based on estimates and informed judgments. Our management also prepares therelated financial information included in this Annual Report on Form 10-K andis responsible for its accuracy and consistency with the financial statements.

 

Theconsolidated financial statements have been audited by PricewaterhouseCoopersLLP, an independent registered public accounting firm, who conducted theiraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). The independent registered public accountingfirm’s responsibility is to express an opinion as to the fairness with whichsuch financial statements present our financial position, results of operationsand cash flows in accordance with accounting principles generally accepted inthe United States.

 

**Management’sAnnual Report on Internal Control over Financial Reporting**

 

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined inRule 13a-15(f) under the Securities Exchange Act of 1934. Our internal controlover financial reporting is designed to provide reasonable assurance regardingthe reliability of financial reporting and the preparation of financialstatements for external purposes in accordance with generally acceptedaccounting principles and include those policies and procedures that:(1) pertain to the maintenance of records that in reasonable detailaccurately and fairly reflect our transactions and the dispositions of ourassets; (2) provide reasonable assurance that our transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that our receiptsand expenditures are being made only in accordance with appropriateauthorizations; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use or disposition of ourassets that could have a material effect on our financial statements.

 

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Therefore,even those systems determined to be effective can provide only reasonableassurance with respect to financial statement preparation and presentation.

 

Under the supervision and with the participation ofour management, we assessed the effectiveness of our internal control overfinancial reporting as of March 31, 2006, using the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control—Integrated Framework. Based on its assessment, management hasconcluded that our internal control over financial reporting was effective asof March 31, 2006.

 

 

37

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**Report of Independent Registered Public Accounting Firm**

 

 

To the Stockholders and Board of Directors

of Gladstone Investment Corporation:

 

 

In our opinion, the consolidated financialstatements listed in the accompanying index present fairly, in all materialrespects, the financial position of Gladstone Investment Corporation (the “Company”)at March 31, 2006 and March 31, 2005, and the results of its operations,changes in its net assets, and its cash flows for the period from June 22, 2005(commencement of operations) to March 31, 2006, in conformity with accountingprinciples generally accepted in the United States of America.  In addition, in our opinion, the financialstatement schedules listed in the index appearing under Item 15 (a) (2) presentfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.  These financial statements and financialstatement schedules are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements and financial statement schedules based on ouraudits.  We conducted our audits of thesestatements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

 

 

**PricewaterhouseCoopers LLP**

 

McLean, Virginia

June 13, 2006

 

38

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**GLADSTONE INVESTMENT CORPORATION**

**CONSOLIDATEDSTATEMENTS OF ASSETS AND LIABILITIES**

 
| ** **                                                                                                                        | ** ** | **March 31,** | ** **  | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------|-------------|---------------|------------|
| ** **                                                                                                                        | ** ** | **2006**      | ** **  | **2005**      | ** ** |
|                                                                                                                              |       |          |        |          |       |
| ASSETS                                                                                                                            |       |          |        |          |       |
| Non-Control/Non-Affiliate investments (Cost 3/31/06: $97,423,004)                                                                 |       | $             | 97,585,972  |          | $          | — |   |
| Control investments (Cost 3/31/06: $55,846,318)                                                                                   |       | 55,796,318    |        | —        |       |
| Total investments at fair value (Cost 3/31/06: $153,269,322)                                                                      |       | 153,382,290   |        | —        |       |
| Cash and cash equivalents                                                                                                         |       | 75,672,605    |        | 3,636         |       |
| Interest receivable                                                                                                               |       | 761,388       |        | —        |       |
| Prepaid insurance                                                                                                                 |       | 99,874        |        | —        |       |
| Deferred offering costs                                                                                                           |       | —        |        | 47,864        |       |
| Due from Adviser                                                                                                                  |       | 234,551       |        | —        |       |
| Other assets                                                                                                                      |       | 173,099       |        | —        |       |
| TOTAL ASSETS                                                                                                                      |       | $             | 230,323,807 |          | $          | 51,500 |   |
|                                                                                                                              |       |          |        |          |       |
| LIABILITIES                                                                                                                       |       |          |        |          |       |
| Administration fee payable to Gladstone Administration                                                                            |       | 110,002       |        | —        |       |
| Loan payable to affiliate                                                                                                         |       | —        |        | 50,000        |       |
| Accrued expenses                                                                                                                  |       | 367,031       |        | —        |       |
| Other liabilities                                                                                                                 |       | 5,077         |        | —        |       |
| Total Liabilities                                                                                                                 |       | 482,110       |        | 50,000        |       |
| NET ASSETS                                                                                                                        |       | $             | 229,841,697 |          | $          | 1,500 |   |
|                                                                                                                              |       |          |        |          |       |
| ANALYSIS OF NET ASSETS:                                                                                                           |       |          |        |          |       |
| Common stock, $0.001 par value, 100,000,000 shares authorized and  16,560,100 and 100 shares issued and outstanding, respectively |       | $             | 16,560      |          | $          | — |   |
| Capital in excess of par value                                                                                                    |       | 230,229,279   |        | 1,500         |       |
| Net unrealized appreciation of investment portfolio                                                                               |       | 112,968       |        | —        |       |
| Distributions in excess of net investment income                                                                                  |       | (517,110      | )           | —        |       |
| Total Net Assets                                                                                                                  |       | $             | 229,841,697 |          | $          | 1,500 |   |
| Net assets per share                                                                                                              |       | $             | 13.88       |          | $          | 15.00 |   |

 

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.*

 

 

39

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**GLADSTONEINVESTMENT CORPORATION**

**SCHEDULE OFINVESTMENTS**

**MARCH 31, 2006**

** **
| **Company  (1)**                                | ** ** | **Industry**                                       | ** ** | **Investment  (2)**                      | ** ** | **Cost**       | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------|------------|----------------|------------|-----------------|------------|
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| **NON-CONTROL/NON-AFFILIATE INVESTMENTS**       | ** ** | ** **                                         | ** ** | ** **                               | ** ** | ** **     | ** ** | ** **      | ** ** |
| ** **                                      | ** ** | ** **                                         | ** ** | ** **                               | ** ** | ** **     | ** ** | ** **      | ** ** |
| CRC Health Group, Inc.                          |       | Service - substance abuse treatment                |       | Senior Term Debt (6.9%, Due 2/2016) (3)  |       | $              | 5,056,761  |            | $          | 5,056,250 |   |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Graham Packaging Holdings Co.                   |       | Manufacturing-custom blow molded                   |       | Senior Term Debt (7.0%, Due 10/2011) (3) |       | 10,071,296     |       | 10,061,087      |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Hertz Equipment Rental Corporation              |       | Service - car rentals                              |       | Senior Term Debt (6.7%, Due 12/2010) (3) |       | 871,388        |       | 876,560         |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Latham Manufacturing Corp.                      |       | Manufacturing-swimming pool components accessories |       | Senior Term Debt (7.8%, Due 12/2010) (3) |       | 4,454,333      |       | 4,461,188       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Le-Natures, Inc.                                |       | Marketing and Development - natural beverages      |       | Senior Term Debt (7.7%, Due 6/2010) (3)  |       | 5,042,467      |       | 5,074,713       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| LVI Services, Inc.                              |       | Service-asbestos and   mold remediation            |       | Senior Term Debt (7.3%, Due 11/2010) (3) |       | 6,511,390      |       | 6,540,483       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Madison River Capital LLC                       |       | Service-communications and   information           |       | Senior Term Debt (6.8%, Due 7/2012) (3)  |       | 5,788,660      |       | 5,829,062       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Maidenform, Inc.                                |       | Intimate apparel                                   |       | Senior Term Debt (6.5%, Due 5/2010) (3)  |       | 3,118,448      |       | 3,122,787       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| MedAssets, Inc.                                 |       | Pharmaceuticals and healthcare GPO                 |       | Senior Term Debt (7.7%, Due 7/2010) (3)  |       | 2,340,111      |       | 2,348,526       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Ozburn-Hessey Holding Co. LLC                   |       | Third party logistics provider                     |       | Senior Term Debt (7.3%, Due 8/2012) (3)  |       | 6,382,673      |       | 6,376,646       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Patriot Media & Communications CNJ, LLC     |       | Service - telecommunications                       |       | Senior Term Debt (7.0%, Due 3/2013) (3)  |       | 4,360,777      |       | 4,359,125       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Revere Industries, LLC                          |       | Manufacturing-plastic and   metal components       |       | Senior Term Debt (7.6%, Due 9/2010) (3)  |       | 3,508,831      |       | 3,504,546       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| RPG Holdings, Inc.                              |       | Manufacturing and Design - greeting cards          |       | Senior Term Debt (8.2%, Due 12/2011) (3) |       | 5,001,332      |       | 5,000,000       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| SGS International, Inc.                         |       | Service - digital imaging and graphics             |       | Senior Term Debt (7.2%, Due 12/2011) (3) |       | 1,404,081      |       | 1,415,702       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| SunGard Data Systems, Inc.                      |       | Integrated software and processing solutions       |       | Senior Term Debt (7.2%, Due 2/2013) (3)  |       | 10,033,531     |       | 10,049,063      |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Triad Laboratory Alliance, LLC                  |       | Service - regional medical laboratories            |       | Senior Term Debt (7.8%, Due 12/2011) (3) |       | 5,006,982      |       | 5,012,438       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| TexStar Operating, L.P.                         |       | Manufacturing - midstream natural gas processing   |       | Senior Term Debt (8.3%, Due 12/2011) (3) |       | 3,000,161      |       | 2,999,981       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| US Investigative Services, Inc.                 |       | Service-background investigations                  |       | Senior Term Debt (7.4%, Due 10/2012) (3) |       | 9,948,345      |       | 9,984,478       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| Wastequip, Inc.                                 |       | Manufacturing-waste removal equipment              |       | Senior Term Debt (7.0%, Due 7/2011) (3)  |       | 5,521,437      |       | 5,513,337       |       |
|                                            |       |                                               |       |                                     |       |           |       |            |       |
| **Total Non-Control/Non-Affiliate Investments** |       |                                               | ** ** | **97,423,004**                           | ** ** | **97,585,972** | ** ** |
|                                                 |            |                                                    |            |                                          |            |                |            |                 |            |  |  |

 

40

----

 
| **Company  (1)**                            | ** ** | **Industry**                                | ** ** | **Investment  (2)**                               | ** **            | **Cost**        | ** ** | **Fair  Value** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------|-----------------------|-----------------|------------|-----------------|------------|
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| **CONTROL INVESTMENTS**                     |       |                                        |       |                                              |                  |            |       |            |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| Chase II Holdings Corporation               |       | Manufacturing - Traffic doors               |       | Revolving Credit Facility (5)                     |                  | —          |       | —          |       |
|                                        |       |                                        |       | Senior Term Debt (9.1%, Due 3/2011)               |                  | 12,900,000      |       | 12,900,000      |       |
|                                        |       |                                        |       | Senior Term Debt (12.0% Due 3/2011)               |                  | 8,000,000       |       | 8,000,000       |       |
|                                        |       |                                        |       | Subordinated Term Debt (13% Due 3/2013)           |                  | 6,167,810       |       | 6,167,810       |       |
|                                        |       |                                        |       | Redeemable Preferred Stock (4)                    |                  | 6,960,806       |       | 6,960,806       |       |
|                                        |       |                                        |       | Common Stock (4)                                  |                  | 61,384          |       | 61,384          |       |
|                                        |       |                                        |       |                                              |                  | 34,090,000      |       | 34,090,000      |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| Hailey Transport Corporation                |       | Retail and Service - school buses and parts |       | Senior Subordinated Term Debt (12.0%, Due 1/2012) |                  | 4,000,000       |       | 3,950,000       |       |
|                                        |       |                                        |       | Common Stock (4)                                  |                  | 2,500,000       |       | 2,500,000       |       |
|                                        |       |                                        |       |                                              |                  | 6,500,000       |       | 6,450,000       |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| Quench Holdings Corporation                 |       | Service - sales, installation and service   |       | Revolving Credit Facility (6)                     |                  | —          |       | —          |       |
|                                        |       | of water coolers                            |       | Senior Term Debt (9.1%, Due 3/2011)               |                  | 4,000,000       |       | 4,000,000       |       |
|                                        |       |                                        |       | Subordinated Term Debt (11.5%, Due 3/2011)        |                  | 8,000,000       |       | 8,000,000       |       |
|                                        |       |                                        |       | Common Stock (4)                                  |                  | 3,256,318       |       | 3,256,318       |       |
|                                        |       |                                        |       |                                              |                  | 15,256,318      |       | 15,256,318      |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| **Total Control Investments**               |       |                                        |       |                                              | ** **            | **55,846,318**  | ** ** | **55,796,318**  | ** ** |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| **Total Investments**                       |       |                                        |       |                                              | ** **            | **153,269,322** | ** ** | **153,382,290** | ** ** |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| **Cash equivalents**                        |       |                                        |       |                                              |                  |            |       |            |       |
|                                        |       | Government                                  |       | US Treasury Bill                                  |                  | 3,989,800       |       | 3,989,800       |       |
|                                        |       |                                        |       | (4.2%, 4/20/2006)                                 |                  |            |       |            |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
|                                        |       | Government                                  |       | US Treasury Bill                                  |                  | 15,241,694      |       | 15,241,694      |       |
|                                        |       |                                        |       | (4.4%, 4/27/2006)                                 |                  |            |       |            |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
|                                        |       | Government                                  |       | US Treasury Bill                                  |                  | 35,132,347      |       | 35,132,347      |       |
|                                        |       |                                        |       | (4.4%, 5/4/2006)                                  |                  |            |       |            |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
|                                        |       | Government                                  |       | US Treasury Bill                                  |                  | 15,243,245      |       | 15,243,245      |       |
|                                        |       |                                        |       | (4.4%, 5/25/2006)                                 |                  |            |       |            |       |
|                                        |       |                                        |       |                                              |                  |            |       |            |       |
| **Total cash equivalents:**                 |       |                                        |       |                                              | ** **            | **69,607,086**  | ** ** | **69,607,086**  | ** ** |
| **Total investments and cash equivalents:** |       |                                        | ** ** | **$**                                             | ** 222,876,408** | ** **      | **$**      | **222,989,376** | ** ** |
|                                             |            |                                             |            |                                                   |                       |                 |            |                 |            |  |  |

----

(1)  Certain of the listed securities are issuedby affiliate(s) of the indicated portfolio company.

(2)  Percentage represents the weighted averageinterest rates in effect at March 31, 2006 and due date represents thecontractual maturity date.

(3)  Marketable securities arevalued based on the indicative bid price, as of March 31, 2006, from therespective originating syndication agent’s trading desk.

(4)  Security is non-incomeproducing

(5)  Total available under therevolving credit facility is $500,000 which was undrawn as of March 31, 2006.

(6)  Total available under therevolving credit facility is $2,000,000 which was undrawn as of March 31, 2006.

 

 

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.*

 

 

41

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**GLADSTONE INVESTMENT CORPORATION**

**CONSOLIDATEDSTATEMENT OF OPERATIONS**

 
| ** **                                                              | ** ** | **For the period June 22, 2005   (Commencement of Operations)   to March 31, 2006** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
|                                                                    |       |                                                                                |       |
| INVESTMENT INCOME                                                       |       |                                                                                |       |
| Interest income                                                         |       |                                                                                |       |
| Non-Control/Non-Affiliate investments                                   |       | $                                                                                   | 2,450,906  |   |
| Control investments                                                     |       | 255,059                                                                             |       |
| Cash and cash equivalents                                               |       | 4,434,706                                                                           |       |
| Total interest income                                                   |       | 7,140,671                                                                           |       |
| Fee income — Control investments                                   |       | 230,000                                                                             |       |
| Other income                                                            |       | 185                                                                                 |       |
| Total investment income                                                 |       | 7,370,856                                                                           |       |
|                                                                    |       |                                                                                |       |
| EXPENSES                                                                |       |                                                                                |       |
| Administration fee                                                      |       | 288,471                                                                             |       |
| Base management fee                                                     |       | 360,771                                                                             |       |
| Directors fees                                                          |       | 160,000                                                                             |       |
| Insurance expense                                                       |       | 184,642                                                                             |       |
| Professional fees                                                       |       | 163,369                                                                             |       |
| Stockholder related costs                                               |       | 89,563                                                                              |       |
| Organizational costs                                                    |       | 7,002                                                                               |       |
| Interest expense                                                        |       | 378                                                                                 |       |
| Taxes and licenses                                                      |       | 195,270                                                                             |       |
| General and administrative expenses                                     |       | 37,492                                                                              |       |
| Total expenses                                                          |       | 1,486,958                                                                           |       |
| NET INVESTMENT INCOME                                                   |       | 5,883,898                                                                           |       |
|                                                                    |       |                                                                                |       |
| REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS                      |       |                                                                                |       |
| Realized gain on sale of Non-Control/Non-Affiliate investments          |       | 57,431                                                                              |       |
| Net unrealized appreciation of investment portfolio                     |       | 112,968                                                                             |       |
| Net gain on investments                                                 |       | 170,399                                                                             |       |
|                                                                    |       |                                                                                |       |
| NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS (Refer to Note  5) |       | $                                                                                   | 6,054,297  |   |
|                                                                    |       |                                                                                |       |
| NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS PER COMMON  SHARE: |       |                                                                                |       |
| Basic and Diluted                                                       |       | $                                                                                   | 0.37       |   |
|                                                                    |       |                                                                                |       |
| SHARES OF COMMON STOCK OUTSTANDING:                                     |       |                                                                                |       |
| Basic and diluted weighted average shares                               |       | 16,391,589                                                                          |       |

 

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.*

 

 

42

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**GLADSTONE INVESTMENT CORPORATION**

**CONSOLIDATED STATEMENT OF CHANGESIN NET ASSETS**

 
| ** **                                             | ** ** | **For the period June 22, 2005   (Commencement of Operations)   to March 31, 2006** | ** **  |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------------|-------------|
| *Operations:*                                          | * *   | * *                                                                            | * *    |
| Net investment income                                  |       | $                                                                                   | 5,883,898   |   |
| Realized gain on sale of investments                   |       | 57,431                                                                              |        |
| Unrealized appreciation of portfolio                   |       | 112,968                                                                             |        |
| Increase in net assets from operations                 |       | 6,054,297                                                                           |        |
|                                                   |       |                                                                                |        |
| *Capital transactions:*                                | * *   | * *                                                                            | * *    |
| Issuance of common stock                               |       | 230,244,339                                                                         |        |
| Dividends from net investment income                   |       | (6,458,439                                                                          | )           |
| Total increase in net assets from capital transactions |       | 223,785,900                                                                         |        |
|                                                   |       |                                                                                |        |
| Total increase in net assets                           |       | 229,840,197                                                                         |        |
|                                                   |       |                                                                                |        |
| Net Assets                                             |       |                                                                                |        |
| Commencement of operations                             |       | 1,500                                                                               |        |
| End of period                                          |       | $                                                                                   | 229,841,697 |   |

 

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.*

 

 

43

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**GLADSTONE INVESTMENT CORPORATION**

**CONSOLIDATEDSTATEMENT OF CASH FLOWS**

** **
| ** **                                                                                                                | ** ** | **For the period June 22, 2005   (Commencement of Operations)   to March 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
|                                                                                                                      |       |                                                                                |       |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                  | ** ** | ** **                                                                          | ** ** |
| ** **                                                                                                                | ** ** | ** **                                                                          | ** ** |
| Net increase in net assets resulting from operations                                                                      |       | $                                                                                   | 6,054,297  |   |
| Adjustments to reconcile net increase in net assets   resulting from operations to net cash used in operating activities: |       |                                                                                |       |
| Purchase of investments                                                                                                   |       | (160,646,470                                                                        | )          |
| Principal repayments of investments                                                                                       |       | 1,801,537                                                                           |       |
| Proceeds from the sale of debt investments                                                                                |       | 5,579,931                                                                           |       |
| Net unrealized appreciation of investment portfolio                                                                       |       | (112,968                                                                            | )          |
| Net realized gains on sales of investments                                                                                |       | (57,431                                                                             | )          |
| Net amortization of premiums and discounts                                                                                |       | 53,111                                                                              |       |
| Increase in interest receivable                                                                                           |       | (761,388                                                                            | )          |
| Increase in prepaid insurance                                                                                             |       | (99,874                                                                             | )          |
| Increase in other assets                                                                                                  |       | (173,099                                                                            | )          |
| Increase in other liabilities                                                                                             |       | 5,077                                                                               |       |
| Increase in administration fee payable to Gladstone Administration                                                        |       | 110,002                                                                             |       |
| Decrease in base management fee payable to Gladstone Management                                                           |       | (234,551                                                                            | )          |
| Increase in accrued expenses                                                                                              |       | 367,031                                                                             |       |
| Net cash used in operating activities                                                                                     |       | (148,114,795                                                                        | )          |
|                                                                                                                      |       |                                                                                |       |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                 | ** ** | ** **                                                                          | ** ** |
| ** **                                                                                                                | ** ** | ** **                                                                          | ** ** |
| Net proceeds from the issuance of common stock   (including deferred offering costs of $47,864)                           |       | 230,292,203                                                                         |       |
| Distributions paid                                                                                                        |       | (6,458,439                                                                          | )          |
| Decrease in loan payable to affiliate                                                                                     |       | (50,000                                                                             | )          |
| Net cash provided by financing activities                                                                                 |       | 223,783,764                                                                         |       |
|                                                                                                                      |       |                                                                                |       |
| **NET INCREASE IN CASH AND CASH EQUIVALENTS (1)**                                                                         |       | 75,668,969                                                                          |       |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                                        |       | 3,636                                                                               |       |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                                                              |       | $                                                                                   | 75,672,605 |   |
|                                                                                                                      |       |                                                                                |       |
| **CASH PAID DURING PERIOD FOR INTEREST TO  AFFILIATE**                                                                    |       | $                                                                                   | 378        |   |

----

(1)          Cash and cash equivalentsconsist of demand deposits and highly liquid investments with originalmaturities of three months or less when purchased.

 

 

*THEACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.*

 

 

44

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**GLADSTONE INVESTMENT CORPORATION**

**FINANCIALHIGHLIGHTS**

 

 
| ** **                                                | ** ** | **For the period June 22, 2005   (Commencement of Operations)   to March 31, 2006** | ** **  |
|-----------------------------------------------------------|------------|-------------------------------------------------------------------------------------|-------------|
| Per Share Data  (1)                                       |       |                                                                                |        |
| Balance at  beginning of period                           |       | $                                                                                   | —      |   |
| Net proceeds  from initial public offering (2)            |       | 13.95                                                                               |        |
| Offering costs                                            |       | (0.05                                                                               | )           |
|                                                      |       |                                                                                |        |
| *Income  from investment operations:*                     | * *   | * *                                                                            | * *    |
| Net investment  income (3)                                |       | 0.36                                                                                |        |
| Realized gain on  sale of investments (3)                 |       | 0.00                                                                                |        |
| Net unrealized  appreciation of investments (3)           |       | 0.01                                                                                |        |
| Total from investment  operations                         |       | 0.37                                                                                |        |
| Distributions                                             |       | (0.39                                                                               | )           |
| Net asset value  at end of period                         |       | $                                                                                   | 13.88       |   |
|                                                      |       |                                                                                |        |
| Per share market  value at beginning of period            |       | $                                                                                   | 15.00       |   |
| Per share market  value at end of period                  |       | 15.10                                                                               |        |
| Total Return (4)                                          |       | 3.39                                                                                | %           |
| Shares  outstanding at end of period                      |       | 16,560,100                                                                          |        |
|                                                      |       |                                                                                |        |
| Ratios/Supplemental  Data                                 |       |                                                                                |        |
| Net assets at  end of period                              |       | $                                                                                   | 229,841,697 |   |
| Average net  assets (5)                                   |       | $                                                                                   | 226,875,738 |   |
| Ratio of  expenses to average net assets (6)              |       | 0.66                                                                                | %           |
| Ratio of net  investment income to average net assets (6) |       | 2.59                                                                                | %           |

----

(1)       Based on actual sharesoutstanding.

(2)       Net of initial underwritingdiscount of $1.05 per share.

(3)       Based on weighted averagebasic per share data.

(4)       Total return equals thechange in the market value of the Company’s common stock from the beginning ofthe period taking into account dividends reinvested in accordance with theterms of our dividend reinvestment plan.

(5)       Average net assetscalculated from June 22, 2005 (commencement of operations) to March 31, 2006.

(6)       Amounts are not annualized

 

 

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

 

 

45

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**GLADSTONE INVESTMENT CORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**March 31, 2006**

 

**Note 1. Organization**

 

GladstoneInvestment Corporation (the “Company”) was incorporated under the GeneralCorporation Laws of the State of Delaware on February 18, 2005 and completed aninitial public offering on June 22, 2005.  The Company has elected to be treated as a business development companyunder the Investment Company Act of 1940, as amended (the “1940 Act”), asamended. In addition, the Company has elected to be treated for tax purposes asa regulated investment company, or RIC, under the Internal Revenue Code of1986, as amended (the “Code”). The Company’s investment objectives are toachieve a high level of current income and capital gains by investing in debtand equity securities of established private businesses.

 

TheCompany is externally managed by Gladstone Management Corporation (“GMC”), anunconsolidated affiliate of the Company.

 

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

 

*Basis of Presentation*

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries. All significant intercompanybalances and transactions have been eliminated.

 

*Consolidation*

 

Under Article 6 of Regulation S-X under theSecurities Act of 1933, as amended, and the authoritative accounting guidanceprovided by the AICPA Audit and Accounting Guide for Investment Companies, theCompany is not permitted to consolidate any subsidiary or other entity that isnot an investment company.

 

*Use of Estimates*

 

Theconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America thatrequire management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Actual results maydiffer from those estimates.

 

*Cash and Cash Equivalents*

 

Cashand cash equivalents consist of demand deposits and highly liquid investmentswith original maturities of three months or less when purchased. Cash and cashequivalents are carried at cost which approximates fair value as of March 31,2006.

 

*Concentration of Credit Risk*

 

TheCompany places its cash and cash equivalents with financial institutions and,at times, cash held in checking accounts may exceed the Federal DepositInsurance Corporation insured limit.

 

*Investment Valuation*

 

The Company carries itsinvestments at fair value, as determined by its Board of Directors.  Securities that are publicly traded arevalued at the closing price on the valuation date.  Securities for which a limited market exists,such as participations in syndicated loans, are valued at the indicative bidprice on the valuation date from the respective originating syndication agent’strading desk.  Debt and equity securitiesthat are not publicly traded are valued at fair value as determined in goodfaith by the Board of Directors. The Company currently engages Standard &Poor’s Loan Evaluation Service (S&P) to perform independent valuations ofits investments.  The Board of Directorsuses the recommended valuations as prepared by S&P as a component of thefoundation for the final fair value determination.  In making such determination, the Board ofDirectors values non-convertible debt securities at cost plus amortizedoriginal issue discount plus payment in kind (“PIK”) interest, if any, unlessadverse factors lead to a determination of a lesser valuation.  In valuing convertible debt, equity, successor exit fees or other equity like securities, the Board of Directors determinesthe fair value based on the collateral, the issuer’s ability to make payments,the earnings of the issuer, sales to third parties 

 

 

46

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of similar securities,the comparison to publicly traded securities, discounted cash flow and otherpertinent factors.  Due to theuncertainty inherent in the valuation process, such estimates of fair value maydiffer significantly from the values that would have resulted had a readymarket for the securities existed, and the differences could be material.Additionally, changes in the market environment and other events that may occurover the life of the investments may cause the gains ultimately realized onthese investments to be different than the valuation currently assigned.  Because there is a lag between when theCompany closes a loan and when the loan can be evaluated by S&P, new loansare not valued immediately by S&P; rather, the Board of Directors makes itsown determination about the value of the loan in accordance with the Company’svaluation policy without the input of S&P. Because S&P does not perform independent valuations of mortgageloans or equity securities, the Board of Directors also determines the fairvalue of these investments without the input of S&P.  The Board of Directors considers a number ofqualitative and quantitative factors in current market conditions whenperforming valuations.

 

*Classification of Investments*

 

The 1940 Act requires classification of the Company’sinvestments by its respective level of control. As defined in the 1940 Act, “Control Investments” are investments inthose portfolio companies that the Company is deemed to “Control”.  “Affiliate Investments” are investments in thoseportfolio companies that are “Affiliated Companies” of the Company, as definedin the 1940 Act, other than Control Investments.  “Non-Control/Non-Affiliate Investments” arethose that are neither Control Investments nor Affiliate Investments.  In general, the 1940 Act prescribes that theCompany has control over a portfolio company if it owns greater than 25% of thevoting securities of the portfolio company. The Company is deemed to be an affiliate of a portfolio company if itowns between 5% and 25% of the voting securities of such portfolio company orhas one or more seats on the affiliated company’s Board of Directors.  However, if the Company holds 50% or more representationon a portfolio company’s Board of Directors, the Company will be deemed to havecontrol over the portfolio company.

 

*Interest Income Recognition*

 

Interestincome, adjusted for amortization of premiums and acquisition costs and for theaccretion of discounts, is recorded on the accrual basis to the extent thatsuch amounts are expected to be collected. The Company stops accruing intereston its investments when it is determined that interest is no longercollectible.  Conditional interest or asuccess fee is recorded upon full repayment of a loan investment.

 

*Dividend Income*

Dividendincome is recognized on the accrual basis for preferred equity securities tothe extent that such amounts are expected to be collected. The Company stopsaccruing dividends on our investments when it is determined that the dividendis no longer collectible.

 

*Fee Income*

 

The1940 Act requires that a business development company make available managerialassistance to its portfolio companies by providing significant guidance andcounsel concerning the management, operations, or business objective and policiesof the respective portfolio company. The Company provides these and otherservices through its Adviser, GMC.  Currently, neither the Company, nor GMC receives fees in connection withmanagerial assistance. However, GMC receives fees for the other services itprovides, and one half of those fees for other services are credited to theinvestment advisory fees due to GMC. These other fees are generally paid to GMC upon the closing of theinvestment.  These fees are typicallynon-recurring, are recognized as revenue when earned and are paid directly toGMC by the borrower or potential borrower. The services GMC provides vary by investment, but generally include awide variety of services to the portfolio companies such as investment bankingservices, arranging bank financing, arranging equity financing structuringfinancing from multiple lenders and investors, reviewing existing creditfacilities, restructuring existing loans, raising equity and debt capital,turnaround management, merger and acquisition services and recruiting newmanagement personnel.  Any services ofthis nature subsequent to the closing would generally generate a separate feeat the time of completion. From time to time, the Company is invited toparticipate as a co-lender in a transaction. In the event that the Company doesnot provide significant services in connection with the investment, loan feespaid directly to GMC in such situations are deferred and amortized over thelife of the loan in accordance with Statement of Financial Accounting StandardsNo. 91 “*Accountingfor Nonrefundable Fees and Costs Associated with Originating or Acquiring Loansand Initial Direct Costs of Leases”.*

 

 

*RealizedGain or Loss and Unrealized Appreciation or Depreciation of PortfolioInvestments*

 

Realized gain or loss is recognized when aninvestment is disposed of and is computed as the difference between the Company’scost basis in the investment at the disposition date and the net proceedsreceived from such disposition. Unrealized appreciation or 

 

 

47

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depreciation displays the difference between thefair market value of the investment and the cost basis of such investment.

 

*Investment Advisory and Management Agreement with GladstoneManagement Corporation*

 

Pursuant to the Company’s investment advisoryand management agreement with GMC, the Company will pay GMC a fee, ascompensation for its services, consisting of a base management fee and anincentive fee.

 

The base management fee is assessed at an annualrate of 2% computed on the basis of the Company’s gross invested assets, whichare total assets less the cash proceeds and cash and cash equivalentinvestments from the proceeds of the Company’s initial public offering that arenot invested in debt and equity securities of portfolio companies.  Through March 31, 2006, the base managementfee was computed and payable monthly. Subsequent to March 31, 2006, the base management fee will be computedmonthly and payable quarterly to GMC.  Beginning in periods subsequent to June 30, 2006, the base managementfee will be assessed at an annual rate of 2% computed on the basis of theCompany’s gross assets, which are total assets, including investments made withproceeds of borrowings, less any uninvested cash or cash equivalents resultingfrom borrowings.  This calculation wasset to begin in periods after March 31, 2006, however, on April 11, 2006 theCompany’s Board of Directors accepted a voluntary waiver from GMC that willallow the current calculation of the base management fee to be effectivethrough June 30, 2006.  When GMC receivesfees from the Company’s portfolio companies, such as investment banking fees,structuring fees or executive recruiting services fees, one half of these feeswill be credited against the base management fee that the Company wouldotherwise be required to pay to GMC.

 

The incentive fee consists of two parts: anincome-based incentive fee and a capital gains incentive fee. The income-basedincentive fee will reward the Adviser if the Company’s quarterly net investmentincome (before giving effect to the incentive fee) exceeds 1.75% of our netassets.  The Adviser will receive acapital gains incentive fee of 20% of the Company’s realized capital gains (netof realized capital losses and unrealized capital depreciation).

 

*Administration Agreement with Gladstone Administration, LLC*

 

The Company has entered into anadministration agreement with Gladstone Administration, LLC (“GladstoneAdministration”), a wholly owned subsidiary of GMC, which is controlled by theCompany’s chairman and chief executive officer. Pursuant to the administrationagreement, Gladstone Administration furnishes the Company with officefacilities, equipment and clerical, bookkeeping and record keeping services atsuch facilities and performs, or oversees the performance of the Company’srequired administrative services. Such required administrative servicesinclude, among other things, being responsible for the financial records whichwe are required to maintain and preparing reports to our stockholders andreports filed with the Securities and Exchange Commission.

 

Theadministration agreement requires the Company to reimburse GladstoneAdministration for the performance of its obligations under the administrationagreement. The reimbursement is based upon the allocable portion of GladstoneAdministration’s overhead, including, but not limited to, rent and theallocable portion of salaries and benefits of the Company’s chief financialofficer, controller, chief compliance officer and their respective staff.

 

*Federal Income Taxes*

 

TheCompany intends to continue to qualify for treatment as a RIC under SubchapterM of the Code. As a RIC, the Company is not subject to federal income tax onthe portion of its taxable income and gains distributed to stockholders. Toqualify as a RIC, the Company is required to distribute to its stockholders atleast 90% of investment company taxable income, as defined by the Code.

 

*Dividends*

 

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

 

 

48

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*New Accounting Pronouncements*

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections”, a replacement of APB Opinion No. 20, “Accounting Changes”,and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”and changes the requirements for the accounting for and reporting of a changein accounting principle.  SFAS 154applies to all voluntary changes in accounting principle and also applies tochanges required by an accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions.  SFAS 154 requires retrospective applicationto prior periods’ financial statements of changes in accounting principle.  SFAS 154 is effective for accounting changesand corrections of errors made in fiscal years beginning after December 15,2005.  Early adoption is permitted foraccounting changes and corrections of errors made in fiscal years beginningafter the date of issuance.  The Companyis required to adopt the provisions of SFAS 154, as applicable, beginning infiscal year 2007.  The Company does notexpect this pronouncement to have a material impact on the Company’s financialposition or net increase to net assets resulting from operations.

 

 

**Note 3. Investments**

At March 31, 2006 the Company held investments inNon-Control/Non-Affiliates of approximately $97.6 million.  These investments all represent syndicatedloan participations of senior notes of both public and private companiesrepresenting approximately 42% of the Company’s net assets at March 31, 2006.

 

On March 27, 2006, the Company invested $3.3million in Quench Holdings Corporation (“Quench Holdings”) to purchase  $3.0 million of preferred units in QuenchUSA, LLC (“Quench USA”) and $0.3 million of warrants to purchase 6,041,538common units of Quench USA.  QuenchHoldings is wholly-owned by the Company.  Quench USA installs and services water coolersin commercial settings using machines that filter and purify water dispensedfrom a facility’s existing water supply. In addition, the Company made a $4.0 million senior term loan and an$8.0 million subordinated loan to Quench USA, both maturing on March 27,2011.  The Company further entered into a$2.0 million revolving promissory note agreement with Quench USA that remainsundrawn as of March 31, 2006.

 

On March 17, 2006, the Company investedapproximately $7.1 million in Chase II Holding Corporation (“Chase Holding”) topurchase $7.0 million of preferred stock and $0.1 million of common stock ofChase Industries, Inc. (“Chase Industries”). As a result of these equity holdings, the Company currently has 2 out of4 seats on Chase Industries’ Board of Directors.  Chase Industries is a leading designer,manufacturer and marketer of impact traffic doors and sliding door systems inNorth America, serving over 4,000 retail, commercial and industrial customersin the United States, Canada Mexico and selected international markets.  The Company also made two senior term loansto Chase Industries in the amounts of $12.9 million and $8.0 million, bothmaturing on March 17, 2011.  In addition,the Company made a $7.0 million subordinated loan to Chase Industries maturingMarch 17, 2013, of which $6.2 million was actually disbursed.  Finally, the Company extended a revolving promissorynote of $0.5 million to Chase Industries that remains undrawn as of March 31,2006.

 

On January 4, 2006, the Company invested $2.5million in Hailey Transport Corporation (“Hailey”) to purchase preferredmembership interests in Rocky Mountain Bus Company, LLC (“RMBC”). The acquiredmembership interests represent a $4.2 million interest in RMBC to which Haileyenabled RMBC to borrow the additional $1.7 million in therecapitalization.  Hailey is wholly-ownedby the Company. RMBC is the sole owner of Auto Safety House LLC (“ASH”), aretailer and service-provider for school buses, commercial buses, trucks andtrailers in Arizona and Nevada. Also on January 4, 2006, the Company made aloan of $4.0 million comprised of subordinated notes to RMBC and ASH maturingon January 4, 2012.

 

The following table summarizes thecontractual principal amortization and maturity of the Company’s investmentportfolio by fiscal year:

 

| **Fiscal Year Ended March 31,**          | ** ** | **Amount**  | ** **  |
|------------------------------------------|------------|-------------|-------------|
| 2007                                     |       | $           | 1,117,733   |   |
| 2008                                     |       | 3,794,224   |        |
| 2009                                     |       | 3,947,053   |        |
| 2010                                     |       | 11,516,595  |        |
| 2011                                     |       | 36,820,199  |        |
| Thereafter                               |       | 82,472,120  |        |
| **Total contractual repayments**         |       | 139,667,924 |        |
|                                     |       |        |        |
| Investments in equity securities         |       | 12,778,508  |        |
| Unamortized premiums on debt securities: |       | 822,890     |        |
| **Total**                                |       | $           | 153,269,322 |   |

 

 

49

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**Note 4. Commitments and Contingencies**

 

AtMarch 31, 2006 the Company was party to signed and non-binding term sheets forthree allocations of syndicate loan participations for an aggregate amount of$20.0 million.

 

Allprospective investments are subject to, among other things, the satisfactorycompletion of the Company’s due diligence investigation of each borrower,acceptance of terms and structure and receipt of necessary consents. Withrespect to each prospective loan, the Company will only agree to provide theloan if, among other things, the results of its due diligence investigationsare satisfactory, the terms and conditions of the loan are acceptable and allnecessary consents are received.   Allthree allocations were funded subsequent to March 31, 2006.

 

**Note 5. Common Stock Transactions**

** **

| ** **                                                                        | ** ** | **Common Stock** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                        | ** ** | **Shares**       | ** ** | **Amount** | ** ** |
|                                                                              |       |             |       |   |   |
| Beginning balance, March 31, 2005                                                 |       | 100              |       | $ | 1,500 |   |
|                                                                              |       |             |       |   |   |
| Issuance of common shares in public offering (net of offering costs  of $767,661) |       | 16,560,000       |       | 230,244,339 |   |
|                                                                              |       |             |       |   |   |
| Ending balance, March 31, 2006                                                    |       | 16,560,100       |       | $ | 230,245,839 |   |

 

 

 

**Note 6. Net Increase in Net Assets Resulting fromOperations per Share**

 

Thefollowing table sets forth the computation of basic and diluted net increase innet assets resulting from operations per share for the period June 22, 2005(Commencement of Operations) to March 31, 2006:

 

| ** **                                                                                      | ** ** | **For the period June 22, 2005  (Commencement of Operations)  to March 31, 2006** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
|                                                                                            |       |                                                                              |       |
| Numerator for basic and diluted net increase in net assets resulting  from operations per share |       | $                                                                                 | 6,054,297  |   |
|                                                                                            |       |                                                                              |       |
| Denominator for basic and diluted shares                                                        |       | 16,391,589                                                                        |       |
|                                                                                            |       |                                                                              |       |
| Basic and diluted net increase in net assets per share resulting from  operations               |       | $                                                                                 | 0.37       |   |

 

 

**Note 7. Related Party Transactions**

 

*LicenseAgreement*

The Company has entered into a licenseagreement with GMC, pursuant to which GMC has granted the Company anon-exclusive license to use the name “Gladstone” and the “Diamond G”trademark. This license agreement requires the Company to pay GMC a royalty feeof $1 per quarter and is recorded in general and administrative expenses on thestatement of operations. The amount of the fee is negotiable on an annual basisby the Company’s compensation committee and approved by a majority of theCompany’s independent directors.

 

 

50

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*LoanPayable to Affiliate*

On June 30, 2005, the Company repaid a$50,000 loan payable to its chairman and chief executive officer. The demandrecourse promissory note accrued interest at the rate of 3% per annum and wasrepaid with accrued interest of $378 using a portion of the net proceeds fromthe Offering.

 

 

**Note 8. Dividends**

 

The following tableillustrates the monthly dividends per share for the period June 22, 2005(Commencement of Operations) to March 31, 2006:

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date**   | ** ** | **Dividend per Share** | ** ** |
|----------------------|------------|-----------------|------------|--------------------|------------|------------------------|------------|
| January 10, 2006     |       | Mar. 17, 2006   |       | Mar. 31, 2006      |       | $                      | 0.07       |   |
| January 10, 2006     |       | Feb. 16, 2006   |       | Feb. 28, 2006      |       | $                      | 0.07       |   |
| January 10, 2006     |       | Jan. 23, 2006   |       | Jan. 31, 2006      |       | $                      | 0.07       |   |
| October 7, 2005      |       | Dec. 21, 2005   |       | Dec. 31, 2005      |       | $                      | 0.04       |   |
| October 7, 2005      |       | Nov. 21, 2005   |       | Nov. 30, 2005      |       | $                      | 0.04       |   |
| October 7, 2005      |       | Oct. 21, 2005   |       | Oct. 30, 2005      |       | $                      | 0.04       |   |
| July 7, 2005         |       | Sept. 22, 2005  |       | Sept. 30, 2005     |       | $                      | 0.02       |   |
| July 7, 2005         |       | Aug. 23, 2005   |       | Aug. 31, 2005      |       | $                      | 0.02       |   |
| July 7, 2005         |       | July 21, 2005   |       | July 29, 2005      |       | $                      | 0.02       |   |
|                 |       |            |       | Total  Fiscal 2006 |       | $                      | 0.39       |   |

 

Aggregatedividends declared and paid for the 2006 fiscal year were approximately $6.5million which were declared based on an estimate of net investment income forthe year.  Net investment income exceededdividends declared by approximately $0.5 million.

 

**Note 9. Fee Income**

 

Asa result of fees received by GMC for its services to portfolio companies on theCompany’s behalf as discussed in Note 2, the Company recognized a reduction of$0.5 million in its base management fee payable to GMC under the investmentadvisory agreement between the Company and GMC for the period June 22, 2005(Commencement of Operations) to March 31, 2006. In addition, the Company recognized $0.2 million in financing fees forthe period June 22, 2005 (Commencement of Operations), to March 31, 2006 forfees associated with the closing of financings for one of its portfolioinvestments.

 

**Note 10. Advisory Agreement withGladstone Management Corporation**

 

We have entered into an investment advisoryand management agreement with GMC, which is controlled by our chairman andchief executive officer. In accordance with the investment advisory andmanagement agreement, we will pay GMC a fee, as compensation for its services,consisting of a base management fee and an incentive fee.

 

The base management fee is assessed at anannual rate of 2% computed on the basis of the Company’s gross invested assets,which are total assets less the cash proceeds and cash and cash equivalentinvestments from the proceeds of the Company’s initial public offering that arenot invested in debt and equity securities of portfolio companies.  Through March 31, 2006, the base managementfee was computed and payable monthly. Subsequent to March 31, 2006, the base management fee will be computedmonthly and payable quarterly to GMC.  Beginning in periods subsequent to June 30, 2006, the base managementfee will be assessed at an annual rate of 2% computed on the basis of theCompany’s gross assets, which are total assets, including investments made withproceeds of borrowings, less any uninvested cash or cash equivalents resultingfrom borrowings.  This calculation wasset to begin in periods after March 31, 2006, however, on April 11, 2006 theCompany’s Board of Directors accepted a voluntary waiver from GMC that willallow the current calculation of the base management fee to be effectivethrough June 30, 2006.  When GMC receivesfees from the Company’s portfolio companies, such as investment banking fees,structuring fees or executive recruiting services fees, one half of these feeswill be credited against the base management fee that the Company wouldotherwise be required to pay to GMC.

 

 

51

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The following table setsforth the quarterly computation of the management fee for the three monthsended March 31, 2006, December 31, 2005, September 30, 2005 and June 30, 2005:

 
| ** **                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------|------------|---------------|------------|------------------|------------|-------------------|------------|--------------|------------|
| ** **                                     | ** ** | **2006**      | ** ** | **2005**         | ** ** | **2005**          | ** ** | **2005**     | ** ** |
| **Fee:**                                       | ** ** | ** **    | ** ** | ** **       | ** ** | ** **        | ** ** | ** **   | ** ** |
| Fee assessed based on invested assets          |       | $             | 557,730    |             | $          | 265,522           |       | $            | 92,108     |   | $ | — |   |
| Gross management fee before fee revenue credit |       | 557,730       |       | 265,522          |       | 92,108            |       | —       |       |
|                                           |       |          |       |             |       |              |       |         |       |
| **Direct Credit to Management Fee:**           | ** ** | ** **    | ** ** | ** **       | ** ** | ** **        | ** ** | ** **   | ** ** |
| Fee revenue recorded by Gladstone Management:  |       | 554,589       |       | —           |       | —            |       | —       |       |
| Net management fee for the three months ended: |       | $             | 3,141      |             | $          | 265,522           |       | $            | 92,108     |   | $ | — |   |

 

The incentive fee consists of two parts: anincome-based incentive fee and a capital gains incentive fee. The income-basedincentive fee is calculated and payable quarterly in arrears based on ourpre-incentive fee net investment income for the immediately preceding calendarquarter. For this purpose, “pre-incentive fee net investment income” meansinterest income, dividend income, and any other income, including any otherfees (other than fees for providing managerial assistance) such as commitment,origination, structuring, diligence and consulting fees, and other fees that wereceive from portfolio companies accrued during the calendar quarter, minusoperating expenses for the quarter (including the base management fee, expensespayable under the administration agreement, operating expenses that we paydirectly, and any interest expense and dividends paid on any issued andoutstanding preferred stock, but excluding the incentive fee). Pre-incentivefee net investment income includes, in the case of investments with a deferredinterest feature (such as securities issued with original issue discount, debtinstruments with payment-in-kind interest, and zero coupon securities), accruedincome that we have not yet received in cash. Thus, if we do not havesufficient liquid assets to pay this incentive fee or distributions tostockholders on such accrued income, we may be required to liquidate assets orborrow money in order to do so.

 

Pre-incentive fee net investment income doesnot include any realized capital gains, realized capital losses, or unrealizedcapital appreciation or depreciation. Pre-incentive fee net investment income,expressed as a rate of return on the value of our net assets at the end of theimmediately preceding calendar quarter, will be compared to a “hurdle rate” of1.75% of our net assets per quarter (7% annualized). For this purpose, “netassets” means total assets less total liabilities and less preferred stock ifany. Because the hurdle rate is fixed and has been based on current interestrates, if interest rates increase, it would become easier for investment incometo exceed the hurdle rate and, as a result, more likely that GMC will receivean income-based incentive fee than if interest rates on our investments remainedconstant. On the other hand, if interest rates rise, there will be greater riskthat small and medium-sized businesses cannot make payments, which risk mayresult in fewer opportunities to make safe investments. Our net investmentincome used to calculate this income-based portion of the incentive fee is alsoincluded in the amount of gross assets used to calculate the 2% base managementfee. We will pay GMC an income-based incentive fee with respect to itspre-incentive fee net investment income in each calendar quarter as follows:

 

•                       no incentivefee in any calendar quarter in which pre-incentive fee net investment incomedoes not exceed the hurdle rate of 1.75% (7% annualized);

 

•                       100% ofpre-incentive fee net investment income with respect to that portion of suchpre-incentive fee net investment income, if any, that exceeds the hurdle ratebut is less than 125% of the hurdle rate (2.1875%) in any calendar quarter(8.75% annualized). This portion of the income-based incentive fee is referredto as the “catch-up.” The “catch-up” provision is intended to provide GMC withan incentive fee of 20% on all of pre-incentive fee net investment income up to125% of the quarterly hurdle rate once the hurdle rate has been surpassed; and

 

•                       20% of theamount of pre-incentive fee net investment income, if any, that exceeds 125% ofthe quarterly hurdle rate of 2.1875% in any calendar quarter (8.75%annualized).

 

The foregoing calculations will beappropriately pro rated for any period of less than three months and adjustedfor any share issuances or repurchases made during the current quarter.

 

The capital gains incentive fee will bedetermined and payable annually in arrears as of the end of each fiscal year(or upon termination of the investment advisory agreement, as of thetermination date), commencing on March 31, 2006, and will equal 20.0% of therealized capital gains since inception through the end of the current fiscalyear, if any, computed net of all realized capital losses, and unrealizedcapital depreciation  since inception atthe end of each fiscal year. In determining the capital gains incentive feepayable to GMC, we will calculate the cumulative aggregate realized capitalgains and cumulative aggregate realized capital losses and depreciation sinceinception to the end of the current fiscal year with respect to each of theinvestments in the portfolio. For this purpose, cumulative aggregate realizedcapital gains, if any, will equal the sum of the differences between the netsales price of each investment, when sold, and the original cost of suchinvestment since inception. Cumulative aggregate realized capital losses willequal 

 

 

52

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the sum of the amounts by which the net salesprice of each investment, when sold, is less than the original cost of suchinvestment since inception. Aggregate unrealized capital depreciation willequal the sum of the difference, if negative, between the valuation of eachinvestment as of the applicable calculation date and the original cost of suchinvestment. At the end of the applicable fiscal year, the amount of net capitalgains (after losses and depreciation) that will serve as the basis for thecalculation of the capital gains incentive fee will equal the cumulative aggregaterealized capital gains less cumulative aggregate realized capital losses, lessaggregate unrealized capital depreciation, with respect to the portfolio ofinvestments. If this number is positive at the end of such fiscal year, thenthe capital gains incentive fee for such year will be equal to 20% of suchamount, less the aggregate amount of any capital gains incentive fees paid inrespect of the portfolio since inception.

 

Because of the structure of the incentivefee, it is possible that we may have to pay an incentive fee in a quarter wherewe incur a loss. For example, we receive pre-incentive fee net investmentincome in excess of the hurdle rate for a quarter, we will pay the applicableincome incentive fee even if we have incurred a loss in that quarter due torealized or unrealized capital depreciation on investments.

 

Because pre-incentive fee net investmentincome was below the hurdle rate no income-based incentive fee was recorded forthe period June 22, 2005 (Commencement of operations) to March 31, 2006.  In addition, there was no capital gainsincentive fee as unrealized capital depreciation exceeded net realized capitalappreciation for the period June 22, 2005 (Commencement of operations) to March31, 2006.

 

**Note 11. Administration Agreement with GladstoneAdministration, LLC**

 

The Company has entered into anadministration agreement with Gladstone Administration, LLC (“GladstoneAdministration”), a wholly owned subsidiary of GMC. Pursuant to theadministration agreement, Gladstone Administration furnishes the Company withoffice facilities, equipment and clerical, bookkeeping and record keepingservices at such facilities and performs, or oversees the performance of theCompany’s required administrative services. Such required administrative servicesinclude, among other things, being responsible for the financial records whichwe are required to maintain and preparing reports to our stockholders andreports filed with the Securities and Exchange Commission.

 

The administration agreement requires theCompany to reimburse Gladstone Administration for the performance of itsobligations under the administration agreement. The reimbursement is based uponthe allocable portion of Gladstone Administration’s overhead, including, butnot limited to, rent and the allocable portion of salaries and benefits of theCompany’s chief financial officer, controller, chief compliance officer andtheir respective staff. The Company recorded fees to Gladstone Administrationon the statement of operations of $288,471 for the period June 22, 2005(commencement of operations) to March 31, 2006. As of March 31, 2006 $110,002was unpaid and included in administration fee payable to GladstoneAdministration in the accompanying balance sheet.

 

**Note 12. Federal and State Income Taxes**

 

The Company operates andintends to continue to operate, in a manner to qualify for treatment as a RICunder Subchapter M of the Code.  As aRIC, the Company is not subject to federal or state income tax on the portionof its taxable income and gains distributed to stockholders.  To qualify as a RIC, the Company is requiredto distribute to its stockholders at least 90% of investment company taxableincome, as defined by the Code and as such no income tax provisions have beenrecorded for the Company.

 

 

53

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**Note13. Subsequent Events**

 

*Investments*

 

Through June 8, 2006, the Company purchasedadditional loan participations of 3 portfolio companies of approximately $3.6million and loan participations of 7 companies not currently in our investmentportfolio of approximately $24.0 million. In addition, the Company sold 3 ofits loan participations totaling $15.5 million realizing an aggregate net lossof approximately $3,000 on the transactions.

 

Through June 8, 2006,Quench USA, LLC borrowed $400,000 against their $2.0 million credit facilityissued by the Company.

 

*Dividends*

 

On April 11, 2006, theCompany’s Board of Directors declared the following monthly dividends which itbelieves will be paid from ordinary income:

 
| **Declaration Date** | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend per Share** | ** ** |
|----------------------|------------|-----------------|------------|------------------|------------|------------------------|------------|
| April 11, 2006       |       | June 22, 2006   |       | June 30, 2006    |       | $                      | 0.07       |   |
| April 11, 2006       |       | May 22, 2006    |       | May 31, 2006     |       | $                      | 0.07       |   |
| April 11, 2006       |       | April 20, 2006  |       | April 28, 2006   |       | $                      | 0.07       |   |

 

 

 

**Note 14. Selected QuarterlyData (Unaudited)**

 
| ** **                                                                                                    | ** ** | **Period June 22, 2005 (Commencement of operations) to March 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **Quarter Ended**                                                       | ** ** | **Quarter Ended** | ** ** | **Quarter Ended** | ** ** | **Quarter Ended** | ** ** |
| ** **                                                                                                    | ** ** | **June 30, 2005**                                                       | ** ** | **September 30, 2005** | ** ** | **December 31, 2005** | ** ** | **March 31, 2006** | ** ** |
|                                                                                                          |       |                                                                    |       |   |   |   |   |   |   |
| Total Investment Income                                                                                       |       | $                                                                       | 48,198     |   | $ | 1,806,590 |   | $ | 2,321,688 |   | $ | 3,194,380 |   |
| Net Investment Income                                                                                         |       | 19,800                                                                  |       | 1,412,906 |   | 1,752,570 |   | 2,698,622 |   |
| Net Increase in Net Assets Resulting From Operations                                                          |       | 19,800                                                                  |       | 1,476,732 |   | 1,614,747 |   | 2,943,018 |   |
|                                                                                                          |       |                                                                    |       |   |   |   |   |   |   |
| Net Increase in Net Assets Resulting From Operations per Weighted  Average Common Share (Basic & Diluted) |       | $                                                                       | —     |   | $ | 0.09 |   | $ | 0.10 |   | $ | 0.18 |   |

 

 

54

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**Item 9. Changes in and Disagreements with Accountantson Accounting and Financial Disclosure**

 

Notapplicable.

 

**Item 9A. Controls and Procedures.**

 

a)  Disclosure Controls and Procedures

 

Asof March 31, 2006 (the end of the period covered by this report), we, includingour Chief Executive Officer and Chief Financial Officer, evaluated theeffectiveness and design and operation of our disclosure controls andprocedures.  Based on that evaluation, ourmanagement, including the Chief Executive Officer and Chief Financial Officer,concluded that our disclosure controls and procedures were effective in timelyalerting management, including the Chief Executive Officer and Chief FinancialOfficer, of material information about us required to be included in periodicSEC filings.  However, in evaluation of thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

b) Management’s Annual Report on Internal ControlOver Financial Reporting

 

Our management is responsible forestablishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rule 13a-15(f). Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of our internal control over financialreporting based on the framework in *Internal Control -Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on our evaluation under theframework in *Internal Control - Integrated Framework*,our management concluded that our internal control over financial reporting waseffective as of March 31, 2006.

 

c) Not applicable

 

d) Change in Internal Control over FinancialReporting

 

There were no changes in internal controls for theperiod ended March 31, 2006 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

**Item 9B. Other Information.**

 

Not applicable.

 

 

55

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**PART III**

 

Wewill file a definitive Proxy Statement for our 2006 Annual Meeting ofStockholders (the “2006 Proxy Statement”) with the SEC, pursuant toRegulation 14A, not later than 120 days after the end of our fiscalyear. Accordingly, certain information required by Part III has beenomitted under General Instruction G(3) to Form 10-K. Only those sectionsof the 2006 Proxy Statement that specifically address the items set forthherein are incorporated by reference.

 

**Item 10. Directors and Executive Officers of theRegistrant**

 

Theinformation required by Item 10 is hereby incorporated by reference from our2006 Proxy Statement under the captions “Election of Directors” and “Section 16(a)Beneficial Ownership Reporting Compliance.”

 

**Item 11. Executive Compensation**

 

Theinformation required by Item 11 is hereby incorporated by reference from our2006 Proxy Statement under the caption “Compensation of Directors.”

 

**Item 12. Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**

 

Theinformation required by Item 12 is hereby incorporated by reference from our2006 Proxy Statement under the caption “Security Ownership of CertainBeneficial Owners and Management.”

 

**Item 13. Certain Relationships and RelatedTransactions**

 

Theinformation required by Item 13 is hereby incorporated by reference from our2006 Proxy Statement under the caption “Certain Transactions.”

 

**Item 14. Principal Accountant Fees and Services.**

 

Theinformation required by Item 14 is hereby incorporated by reference from our2006 Proxy Statement under the caption “Independent Registered PublicAccounting Firm Fees.”

 

 

56

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**PART IV**

 

**Item 15. Exhibits and Financial Statement Schedules**

 

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

 

1.                                       The followingfinancial statements are filed herewith:

 

| Report of Independent Registered Public Accounting  Firm                                                                      |
|-------------------------------------------------------------------------------------------------------------------------------|
| Consolidated Statements of Assets and Liabilities as  of March 31, 2006 and March 31, 2005                                    |
| Consolidated Schedule of Investments as of March 31,  2006                                                                    |
| Consolidated Statements of Operations for the period  June 22, 2005 (Commencement of operations) to March 31, 2006            |
| Consolidated Statements of Changes in Net Assets for  the period June 22, 2005 (Commencement of operations) to March 31, 2006 |
| Consolidated Statements of Cash Flows for the period  June 22, 2005 (Commencement of operations) to March 31, 2 006           |
| Notes to Consolidated Financial Statements                                                                                    |

 

2.                                       Financialstatement schedules

 

Thefollowing financial statement schedule is filed herewith:

 

•                  Schedule 12-14 Investment inand Advances to Affiliates

 

Noother financial statement schedules are filed herewith because (1) suchschedules are not required or (2) the information has been presented inthe aforementioned financial statements.

 

3.             Exhibits

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

 
| 3.1   |   | Articles of Amendment  and Restatement of the Articles of Incorporation, incorporated by reference  to Exhibit a.2 to Pre-Effective Amendment No. 1 to the Registration  Statement on Form N-2 (File No. 333-123699), filed March 31,  2005. |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2   |   | By-laws, incorporated  by reference to Exhibit b to the Registration Statement on Form N-2  (File No. 333-123699), filed March 31, 2005.                                                                                                          |
| 4.1   |   | Specimen  Stock Certificate, incorporated by reference to Exhibit 99.E on Form N-2/A  (File No. 333-123699), filed June 21, 2005.                                                                                                                                |
| 10.1* |   | Investment Advisory and  Management Agreement between the Company and Gladstone Management  Corporation, dated June 22, 2005                                                                                                                                |
| 10.2* |   | Administration  Agreement between the Company and Gladstone Administration, LLC, dated June  22, 2005.                                                                                                                                                           |
| 10.3* |   | Trademark License  Agreement between the Company and Gladstone Management Corporation,  incorporated by reference to Exhibit k.3 to the Registration Statement on  Form N-2 (File No. 333-123699), filed on March 31, 2005.                                      |
| 11    |   | Computation  of Per Share Earnings (included in the notes to the audited financial  statements contained in this report).                                                                                                                                        |
| 14    |   | Code  of Business Conduct and Ethics, dated October 11, 2005, incorporated by  reference to Exhibity 14.1 to Current Report on Form 8-K (File No.  814-00704), filed October 12, 2005.                                                                           |
| 21    |   | Subsidiaries  of the Registrant.                                                                                                                                                                                                                                 |
| 31.1  |   | Certification  of Chief Executive Officer pursuant to section 302 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                       |
| 31.2  |   | Certification  of Chief Financial Officer pursuant to section 302 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                       |
| 32.1  |   | Certification  of Chief Executive Officer pursuant to section 906 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                       |
| 32.2  |   | Certification  of Chief Financial Officer pursuant to section 906 of The Sarbanes-Oxley  Act of 2002.                                                                                                                                                       |

----

*                                         Denotesmanagement contract or compensatory plan or arrangement.

 

 

57

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Actof 1934, the registrant has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.

 
| ** **                | **GLADSTONE INVESTMENT CORPORATION** |
|---------------------------|--------------------------------------|
| ** **                | ** **                           | ** ** |
| Date:  June 13, 2006 | By:                                  | /s/  HARRY BRILL |
|                      |                                 | Harry  Brill |
|                      |                                 | Chief  Financial Officer and Treasurer |

 

 

58

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Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacity and on the dates indicated.

 
| Date:  June 13, 2006 | By:    | /s/  DAVID GLADSTONE                                                                           |
|---------------------------|--------|------------------------------------------------------------------------------------------------|
|                      |   | David  Gladstone                                                                               |
|                      |   | Chief  Executive Officer and Chairman of the Board of Directors  (principal executive officer) |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  TERRY LEE BRUBAKER                                                                        |
|                      |   | Terry  Lee Brubaker                                                                            |
|                      |   | Vice  Chairman, Chief Operating Officer and Director                                      |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  HARRY BRILL                                                                               |
|                      |   | Harry  Brill                                                                                   |
|                      |   | Chief  Financial Officer  (principal financial and accounting officer)                         |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  GEORGE STELLJES, III                                                                      |
|                      |   | George  Stelljes, III                                                                          |
|                      |   | President,  Chief Investment Officer and Director                                              |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    |                                                                                           |
|                      |   | David  A.R. Dullum                                                                             |
|                      |   | Director                                                                                       |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  ANTHONY W. PARKER                                                                         |
|                      |   | Anthony  W. Parker                                                                             |
|                      |   | Director                                                                                       |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  MICHELA A. ENGLISH                                                                        |
|                      |   | Michela  A. English                                                                            |
|                      |   | Director                                                                                       |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  PAUL ADELGREN                                                                             |
|                      |   | Paul  Adelgren                                                                                 |
|                      |   | Director                                                                                       |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    |                                                                                           |
|                      |   | Maurice  Coulon                                                                                |
|                      |   | Director                                                                                       |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    | /s/  JOHN OUTLAND                                                                              |
|                      |   | John  Outland                                                                                  |
|                      |   | Director                                                                                       |
|                      |   |                                                                                           |
| Date:  June 13, 2006 | By:    |                                                                                           |
|                      |   | Gerard  Mead                                                                                   |
|                      |   | Director                                                                                       |

 

 

59

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**SCHEDULE 12-14**

 

**GLADSTONE INVESTMENT CORPORATION**

**INVESTMENTSIN AND ADVANCES TO AFFILIATES**

** **

 
| **Name of  Issuer (1)**       | ** ** | **Title of  Issue or Nature of Indebtedness** | ** ** | **Number  of Shares or Principal Amount of Indebtedness Held at March 31, 2006** | ** ** | **Interest  Earned from June 22, 2005 (Commencement of Operations) to March 31, 2006** | ** **  | **Equity  in Net Profit (Loss) from June 22, 2005 (Commencement of Operations) to March  31, 2006 (3)** | ** ** | **Value at  March 31, 2006**                 | ** ** |
|-------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|-------------|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| * *                      |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| **CONTROL INVESTMENTS**       |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| Chase II Holdings Corporation |       | Revolving Credit Facility                     |       | —                                                                           |       |                                                                                   |        |                                                                                                    |       | $                                            | —     |   |
|                          |       | Senior Term Debt                              |       | 12,900,000                                                                       |       |                                                                                   |        |                                                                                                    |       | 12,900,000                                   |       |
|                          |       | Senior Term Debt                              |       | 8,000,000                                                                        |       |                                                                                   |        |                                                                                                    |       | 8,000,000                                    |       |
|                          |       | Subordinated Term Debt                        |       | 6,167,810                                                                        |       |                                                                                   |        |                                                                                                    |       | 6,167,810                                    |       |
|                          |       | Redeemable Preferred Stock (2)                |       | 69,608                                                                           |       |                                                                                   |        |                                                                                                    |       | 6,960,806                                    |       |
|                          |       | Common Stock (2)                              |       | 61,384                                                                           |       |                                                                                   |        |                                                                                                    |       | 61,384                                       |       |
|                          |       |                                          |       |                                                                             |       | $                                                                                      | 122,536     |                                                                                                    | $          | —                                       |       | 34,090,000 |   |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| Hailey Transport Corporation  |       | Senior Subordinated Term Debt                 |       | 4,000,000                                                                        |       |                                                                                   |        |                                                                                                    |       | 3,950,000                                    |       |
|                          |       | Common Stock (2)                              |       | 1,000                                                                            |       |                                                                                   |        |                                                                                                    |       | 2,500,000                                    |       |
|                          |       |                                          |       |                                                                             |       | 114,667                                                                                |        | —                                                                                                  |       | 6,450,000                                    |       |
| Quench Holdings Corporation   |       | Revolving Credit Facility                     |       | —                                                                           |       |                                                                                   |        |                                                                                                    |       | —                                       |       |
|                          |       | Senior Term Debt                              |       | 4,000,000                                                                        |       |                                                                                   |        |                                                                                                    |       | 4,000,000                                    |       |
|                          |       | Subordinated Term Debt                        |       | 8,000,000                                                                        |       |                                                                                   |        |                                                                                                    |       | 8,000,000                                    |       |
|                          |       | Common Stock (2)                              |       | 1,000                                                                            |       |                                                                                   |        |                                                                                                    |       | 3,256,318                                    |       |
|                          |       |                                          |       |                                                                             |       | 17,856                                                                                 |        | —                                                                                                  |       | 15,256,318                                   |       |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| **Total Control Investments** |       |                                          |       |                                                                             | ** ** | **$**                                                                                  | **255,059** | ** **                                                                                              | **$**      | **—**                                   | ** ** | **$** | **55,796,318** | ** ** |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| **Name of Issuer (1)**        | ** ** | **Title of  Issue or Nature of Indebtedness** | ** ** | **Value of  Each Item as of March 31, 2005**                                     | ** ** | **Gross  Additions**                                                                   | ** **  | **Gross  Reductions**                                                                                   | ** ** | **Value of  Each Item as of March 31, 2006** | ** ** |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| **CONTROL INVESTMENTS**       |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| Chase II Holdings Corporation |       | Revolving Credit Facility                     |       | $                                                                                | —     |                                                                                   | $           | —                                                                                                  |       | $                                            | —     |   | $ | — |   |
|                          |       | Senior Term Debt                              |       | —                                                                           |       | 12,900,000                                                                             |        | —                                                                                                  |       | 12,900,000                                   |       |
|                          |       | Senior Term Debt                              |       | —                                                                           |       | 8,000,000                                                                              |        | —                                                                                                  |       | 8,000,000                                    |       |
|                          |       | Subordinated Term Debt                        |       | —                                                                           |       | 6,167,810                                                                              |        | —                                                                                                  |       | 6,167,810                                    |       |
|                          |       | Redeemable Preferred Stock (2)                |       | —                                                                           |       | 6,960,806                                                                              |        | —                                                                                                  |       | 6,960,806                                    |       |
|                          |       | Common Stock (2)                              |       | —                                                                           |       | 61,384                                                                                 |        | —                                                                                                  |       | 61,384                                       |       |
|                          |       |                                          |       | —                                                                           |       | 34,090,000                                                                             |        | —                                                                                                  |       | 34,090,000                                   |       |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| Hailey Transport Corporation  |       | Senior Subordinated Term Debt                 |       | —                                                                           |       | 4,000,000                                                                              |        | 50,000                                                                                                  |       | 3,950,000                                    |       |
|                          |       | Common Stock (2)                              |       | —                                                                           |       | 2,500,000                                                                              |        | —                                                                                                  |       | 2,500,000                                    |       |
|                          |       |                                          |       | —                                                                           |       | 6,500,000                                                                              |        | 50,000                                                                                                  |       | 6,450,000                                    |       |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| Quench Holdings Corporation   |       | Revolving Credit Facility                     |       | —                                                                           |       | —                                                                                 |        | —                                                                                                  |       | —                                       |       |
|                          |       | Senior Term Debt                              |       | —                                                                           |       | 4,000,000                                                                              |        | —                                                                                                  |       | 4,000,000                                    |       |
|                          |       | Subordinated Term Debt                        |       | —                                                                           |       | 8,000,000                                                                              |        | —                                                                                                  |       | 8,000,000                                    |       |
|                          |       | Common Stock (2)                              |       | —                                                                           |       | 3,253,318                                                                              |        | —                                                                                                  |       | 3,256,318                                    |       |
|                          |       |                                          |       | —                                                                           |       | 15,256,318                                                                             |        | —                                                                                                  |       | 15,256,318                                   |       |
|                          |       |                                          |       |                                                                             |       |                                                                                   |        |                                                                                                    |       |                                         |       |
| **Total Control Investments** |       |                                          | ** ** | **$**                                                                            | **—** | ** **                                                                             | **$**       | **55,846,318**                                                                                          | ** ** | **$**                                        | **50,000** | ** ** | **$** | **55,796,318** | ** ** |

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(1)  Certain of the listedsecurities are issued by affiliate(s) of the indicated portfolio company.

(2)  Security is non-incomeproducing.

(3)  In accordance with Regulation S-X, rule6-03(c)(i), the Company does not consolidate its portfolio investments.  Therefore, no equity in the net profit (loss)was recorded as of March 31, 2006.

 

 

60

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