##### 









UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




---

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



|  |                                                                                         
|- | ----------------------------------------------------------------------------------------
|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2004

OR



|  |                                                                                             
|- | --------------------------------------------------------------------------------------------
|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-22832

ALLIED CAPITAL CORPORATION

(Exact Name of Registrant as specified in its
Charter)


|                                                                                             |  |                                                        
|-------------------------------------------------------------------------------------------- |  | -------------------------------------------------------
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Maryland
    (State or Other Jurisdiction
    of Incorporation)                              |  | 52-1081052
    (I.R.S. Employer
    Identification No.)
|                                                                                            
|1919 Pennsylvania Avenue NW
    Washington, D.C.
    (Address of Principal Executive Office) |  | 20006
    (Zip Code)                                   

Registrants Telephone Number, Including Area Code:
(202) 331-1112

Securities Registered Pursuant to Section 12(b) of the
Act:

|                                |  |                        
|------------------------------- |  | -----------------------
|                                |  | Name of Each Exchange  
|Title of Each Class             |  | On Which Registered    
|                                |  |                        
|Common Stock, $0.0001 par value |  | New York Stock Exchange

Securities Registered Pursuant to Section 12(g) of the
Act:

NONE

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

YES  x  NO o


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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act Rule 12b-2) 
 YES  x  NO
o

The aggregate market value of the
registrants common stock held by non-affiliates of the
registrant as of June 30, 2004, was approximately
$2.9 billion based upon the last sale price for the
registrants common stock on that date. As of
March 14, 2005, there were 133,474,125 shares of the
registrants common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants Annual Report
to Shareholders for the year ended December 31, 2004, are
incorporated by reference into Parts II and IV of this
Report. Portions of the registrants definitive Proxy
Statement for the Annual Meeting of Stockholders to be held on
May 17, 2005, are incorporated by reference into
Part III of this Report.









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##### 



PART I

Item 1.     Business.

General

As a business development company, or BDC, we are in the private
equity business. Specifically, we provide long-term debt and
equity capital. We believe the private equity capital markets
are important to the growth of small and middle market companies
because such companies often have difficulty accessing the
public debt and equity capital markets because their capital
needs are too small to be attractive to the public markets, or
because they are in need of long-term growth capital, which
banks do not generally provide. We believe that we are well
positioned to be a source of capital for such companies.

We have participated in the private equity business since we
were founded in 1958. We have financed thousands of companies
nationwide. We generally invest in established, middle market
companies with adequate cash flow for debt service. We are not
venture capitalists, and we generally do not provide seed, or
early stage, capital.

We invest in the American entrepreneurial economy. Our private
finance portfolio includes investments in over 100 companies
with aggregate annual revenue of approximately $11 billion
that employ more than 100,000 jobs.

Our investment objective is to achieve current income and
capital gains. In order to achieve this objective, we invest in
companies in a variety of industries, non-investment grade
commercial mortgage-backed securities (CMBS) and collateralized
debt obligation bonds and preferred shares (CDOs).

Private Equity Investing

As a private equity investor, we spend significant time and
effort identifying, structuring, performing due diligence,
monitoring, valuing, and ultimately exiting our investments. We
generally target companies in less cyclical industries with,
among other things, high return on invested capital, management
teams with meaningful equity ownership, well-constructed balance
sheets, and that have the ability to generate free cash flow.
Each investment is subject to an extensive due diligence
process. It is not uncommon for a single investment to take from
two months to a full year to complete, depending on the
complexity of the transaction.

Our investment activity is primarily focused in three areas:



|  |                                                                                                                                                 
|- | ------------------------------------------------------------------------------------------------------------------------------------------------
| | Lending second lien or subordinated debt with or without equity
    features to middle market companies (also known as mezzanine
    investing),
| 
| | Buying controlling equity stakes in middle market companies
    (also known as buyout investing), and                                           
| 
| | Investing in non-investment grade classes of commercial
    mortgage-backed securities and collateralized debt obligations.                     

We have chosen these investment classes because the investments
can be structured to provide recurring cash flow to us as the
investor. In addition to earning interest income, we may earn
income from management, diligence, structuring or other fees. We
may also enhance our total return through capital gains through
equity features, such as a nominal cost warrants, or by
investing in equity instruments. Net realized gains received
over the past ten years as a percentage of total assets are
shown in the chart below.

2



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Our investments in mezzanine loans, equity investments in middle
market companies, and non-investment grade tranches of CMBS and
CDO pools are generally long-term in nature and privately
negotiated, and no readily available market exists for them.
This makes our investments highly illiquid and, as a result, we
cannot readily trade them. When we make an investment, we enter
into a long-term arrangement where our ultimate exit from that
investment may be five to ten years in the future.

We believe illiquid investments generally provide better
investment returns on average over time than do more liquid
investments, such as public equities, public debt instruments,
or large syndicated senior loans, because of the increased risk
in holding such investments. Investors in illiquid investments
cannot manage risk through investment trading techniques. In
order to manage our risk, we focus on careful investment
selection, thorough due diligence, portfolio monitoring and
portfolio diversification. Our investment management processes
have been designed to incorporate these tools.

We believe our business model is well suited for long-term
illiquid investing. Our balance sheet is capitalized with
significant equity capital and we use only a modest level of
debt capital, which allows us the ability to manage through
difficult market conditions with less risk of liquidity issues.
Under the Investment Company Act of 1940 we are restricted to a
debt to equity ratio of approximately one-to-one. Thus, our
capital structure, which includes a modest level of long-term
leverage, is well suited for long-term illiquid investments.
However, since we are limited as to the amount of debt capital
we can use to finance our commercial real estate investments, we
are evaluating various strategic alternatives for our commercial
real estate platform. These alternatives may include the sale,
spin-out or recapitalization of all or part of our commercial
real estate investments.

In general, we compete for investments with a large number of
private equity funds and mezzanine funds, other business
development companies, investment banks, other equity and
non-equity based investment funds, and other sources of
financing, including specialty finance companies and traditional
financial services companies such as commercial banks. However,
we primarily compete with private equity funds because they are
also focused on providing long-term debt and equity capital to
middle market companies. We believe that we have key structural
and operational advantages when compared to private equity funds.

Many private equity funds operate with different cost structures
than ours, which often include management and carried interest
fees (which are sometimes referred to as incentive fees) paid to
the management of an external investment adviser. We are
internally managed and have no external adviser. In addition,
our access to the public equity markets generally allows us the
opportunity to raise equity capital at a lower cost than that of
private equity funds. Our lower cost of capital may give us a
pricing advantage when competing for new investments. In
addition, we believe the perpetual nature of our

3



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##### 





Private Finance Portfolio

Our private finance portfolio is primarily composed of mezzanine
loans (junior capital generally in the form of subordinated
debt, with or without equity features) and equity securities
(including preferred and common interests). Our capital is used
to fund:

|                    |  |                            
|------------------- |  | ---------------------------
| growth            |  |  note purchases           
| acquisitions      |  |  bridge financings        
| buyouts           |  |  other types of financings
| recapitalizations |  |                            

We focus on mezzanine and buyout investments where we can select
investments that are structured to generate current returns as
well as potential future capital gains. It is our preference to
structure our investments with a focus on current recurring
interest and other portfolio income. Our loans generally have
interest-only payments in the early years and payments of both
principal and interest in the later years with maturities of
five to ten years, although maturities and principal
amortization schedules may vary. Our loans are also generally
unsecured and generally carry a fixed rate of interest, which is
generally paid to us quarterly. We generally target a minimum
10% weighted average current portfolio yield on the debt
component of our private finance portfolio. The weighted average
yield on our private finance loans and debt securities was 13.9%
at December 31, 2004.

To the extent that we buy a controlling equity stake in a
company, we generally structure our investments such that we
earn a current return through a combination of interest income
on our senior loans and subordinated debt, dividends on our
preferred and common equity, and management or transaction
services fees to compensate us for the managerial assistance
that we may provide to a controlled portfolio company. We
believe that the transaction fees charged for the services we
provide to portfolio companies are generally comparable with
transaction fees charged by others in the private equity
industry for performing similar services. In our buyout
investments, we own a substantial percentage of the equity of
the portfolio company as compared to a non-control mezzanine
investment. Thus there is potential to realize larger capital
gains as well as current return through buyout investing as
compared to mezzanine investing.

We may fund most or all of the debt and equity capital upon the
closing of buyout transactions, which may include investments in
lower-yielding senior debt. Subsequent to closing, the portfolio
company may refinance all or a portion of this senior debt,
resulting in a repayment to us. The amount of lower-yielding
senior debt outstanding to portfolio companies at any point in
time may cause the weighted average yield on the private finance
debt portfolio to fluctuate.

We intend to continue a balanced approach to private finance
investing that emphasizes a complementary mix of mezzanine
investments and buyout investments, subject to regulatory
diversity requirements. The combination of these two types of
investments provides current interest and related portfolio
income and the potential for future capital gains.

At December 31, 2004, 70% of the private finance portfolio
at value consisted of loans and debt securities and 30%
consisted of equity securities. At December 31, 2004, 59.1%
of the private finance investments at value were in companies
more than 25% owned, 8.2% were in companies 5% to 25% owned, and
32.7% were in companies less than 5% owned.

Our largest buyout investments at December 31, 2004, were
in Business Loan Express, LLC and Advantage Sales &
Marketing, Inc.

Business Loan Express, LLC. At December 31, 2004,
our investment in Business Loan Express, LLC (BLX) totaled
$335.2 million at value, or 10.3% of our total assets,
which includes unrealized appreciation of $54.8 million.
BLX is a national, non-bank lender utilizing the SBAs 7(a)
Guaranteed Loan Program

4



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##### 





Advantage Sales and Marketing, Inc. At December 31,
2004, our investment in Advantage Sales & Marketing, Inc.
(Advantage) totaled $283.0 million at value, or 8.7% of our
total assets, which includes unrealized appreciation of
$24.3 million. Advantage is a leading sales and marketing
agency providing outsourced sales, merchandising, and marketing
services to the consumer packaged goods industry. We completed
the purchase of a majority ownership in Advantage in June 2004.
Advantage has offices across the United States and is
headquartered in Irvine, CA.

We generally invest in private companies though, from time to
time, we may invest in public companies that lack access to
public capital or whose securities may not be marginable. These
investments are also generally illiquid.

When assessing a prospective private finance investment, we
generally look for companies in less cyclical industries in the
middle market (i.e., $50 million to $500 million in
revenues) with certain target characteristics, which may or may
not be present in the companies in which we invest. Our target
investments generally are in companies with the following
characteristics:



|  |                                                 
|- | ------------------------------------------------
| | Management team with meaningful equity ownership
| 
| | Dominant or defensible market position          
| 
| | High return on invested capital                 
| 
| | Stable operating margins                        
| 
| | Ability to generate free cash flow              
| 
| | Well-constructed balance sheet                  

The industry and geographic compositions of the private finance
portfolio at value at December 31, 2004 and 2003, were as
follows:

|                       |       |      |    |      |   |  |    |     |  
|---------------------- | ----- | ---- | -- | ---- | - |  | -- | --- | -
|                       |       | 2004 |    | 2003
|                       |       |      |    |     
|Industry               |       |      |    |      |   |  |    |    
|                      
|                      
|                      
|                      
|Business services      |       |      | 32 | %    |   |  | 22 | %  
|                      
|                      
|                      
|                      
|Financial services     |       |      | 21 |      |   |  | 19 |    
|                      
|                      
|                      
|                      
|Consumer products      |       |      | 20 |      |   |  | 30 |    
|                      
|                      
|                      
|                      
|Healthcare services    |       |      | 8  |      |   |  | 8  |    
|                      
|                      
|                      
|                      
|Industrial products    |       |      | 8  |      |   |  | 6  |    
|                      
|                      
|                      
|                      
|Retail                 |       |      | 2  |      |   |  | 4  |    
|                      
|                      
|                      
|                      
|Energy Services        |       |      | 2  |      |   |  | 4  |    
|                      
|                      
|                      
|                      
|Broadcasting and cable |       |      | 2  |      |   |  | 2  |    
|                      
|                      
|                      
|                      
|Other                  |       |      | 5  |      |   |  | 5  |    
|                       |       |      |    |      |   |  |    |    
|                       | Total |      |    | 100  | % |  |    | 100 | %
|                       |       |      |    |      |   |  |    |    
|Geographic Region      |       |      |    |      |   |  |    |    
|                      
|                      
|                      
|                      
|Mid-Atlantic           |       |      | 40 | %    |   |  | 40 | %  
|                      
|                      
|                      
|                      
|West                   |       |      | 30 |      |   |  | 16 |    
|                      
|                      
|                      
|                      
|Midwest                |       |      | 16 |      |   |  | 26 |    
|                      
|                      
|                      
|                      
|Southeast              |       |      | 10 |      |   |  | 13 |    
|                      
|                      
|                      
|                      
|Northeast              |       |      | 4  |      |   |  | 4  |    
|                      
|                      
|                      
|                      
|International          |       |      |   |      |   |  | 1  |    
|                       |       |      |    |      |   |  |    |    
|                       | Total |      |    | 100  | % |  |    | 100 | %
|                       |       |      |    |      |   |  |    |    

5



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##### 



We monitor the portfolio to maintain diversity within the
industries in which we invest. We currently do not have a policy
with respect to concentrating (i.e., investing 25%
or more of our total assets) in any particular industry and
currently our portfolio is not concentrated. We may or may not
concentrate in any industry or group of industries in the
future. The geographic region for the private finance portfolio
depicts the location of the headquarters for our portfolio
companies. The portfolio companies may have a number of other
locations.

Commercial Real Estate Finance Portfolio

Our commercial real estate investments are generally in the
non-investment grade tranches of commercial mortgage-backed
securities, also known as CMBS, and in the bonds and preferred
shares of collateralized debt obligations, also known as CDOs.

With regard to CMBS, non-investment grade means that
nationally recognized statistical rating organizations rate
these securities below the top four investment-grade rating
categories (i.e., AAA through BBB), and
are sometimes referred to as junk bonds. Unlike most
junk bonds, which are typically unsecured debt
instruments, the non-investment grade CMBS bonds in which we
invest are secured by an underlying collateral pool of
commercial mortgage loans, which are, in turn, secured by
commercial real estate. The underlying collateral for our CMBS
bonds consist of senior mortgage loans on commercial real estate
properties where the loans, on average, were underwritten to
achieve a loan to value ratio of approximately 70%. We generally
invest at the initial issuance of the CMBS, and are able to
review the underlying collateral of mortgage loans as if we were
making an initial decision to fund such loans and to determine
if we want to exclude loans that do not meet our credit,
collateral, structural or other standards. We also negotiate to
acquire the securities at significant discounts from their face
amount. When we acquire CMBS bonds at initial issuance, we have
generally acquired bonds rated BB+ through unrated. From
time-to-time, we may sell the BB+ through B+ rated bonds
individually or in pools to provide liquidity and/or to reduce
the level of lower yielding bonds in the portfolio. The yield on
the CMBS bond portfolio will vary depending on the concentration
of lower yielding bonds held at any point in time. At
December 31, 2004, our CMBS portfolio had a weighted
average yield to maturity of 14.6%.

Our CMBS bonds by rating classification at December 31,
2004, were as follows:

|                |       |       |       |               |  |  |      |       |  
|--------------- | ----- | ----- | ----- | ------------- |  |  | ---- | ----- | -
|                |       |      
|                |       | 2004 
|                |       |      
|                |       |       |       | Percentage of
|                |       | Value |       | Total Value  
|($ in millions) |       |       |       |              
|AA              |       | $     | 4.6   |               |  |  | 1.2  | %    
|               
|               
|               
|               
|A               |       |       | 4.5   |               |  |  | 1.2  |      
|               
|               
|               
|               
|BBB-            |       |       | 9.0   |               |  |  | 2.4  |      
|               
|               
|               
|               
|BB+             |       |       | 7.7   |               |  |  | 2.1  |      
|               
|               
|               
|               
|BB              |       |       | 6.0   |               |  |  | 1.6  |      
|               
|               
|               
|               
|BB-             |       |       | 7.7   |               |  |  | 2.1  |      
|               
|               
|               
|               
|B+              |       |       | 15.3  |               |  |  | 4.1  |      
|               
|               
|               
|               
|B               |       |       | 62.6  |               |  |  | 16.7 |      
|               
|               
|               
|               
|B-              |       |       | 88.1  |               |  |  | 23.6 |      
|               
|               
|               
|               
|CCC+            |       |       | 18.6  |               |  |  | 5.0  |      
|               
|               
|               
|               
|CCC             |       |       | 20.3  |               |  |  | 5.4  |      
|               
|               
|               
|               
|CC              |       |       | 0.6   |               |  |  | 0.2  |      
|               
|               
|               
|               
|Unrated         |       |       | 128.8 |               |  |  | 34.4 |      
|                |       |       |       |               |  |  |      |      
|                | Total |       | $     | 373.8         |  |  |      | 100.0 | %
|                |       |       |       |               |  |  |      |      

6



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##### 



At December 31, 2004, the age of our bonds with a rating
class of B+ and lower was as follows:

|                         |       |  |  |       |  |               |       |       |  |  |      |       |  
|------------------------ | ----- |  |  | ----- |  | ------------- | ----- | ----- |  |  | ---- | ----- | -
|                         |       |  |  |       |  | Percentage of
|                         |       |  |  | Value |  | Total Value  
|($ in millions)          |       |  |  |       |  |              
|Less than one year old   |       |  |  |       |  | $             | 82.9  |       |  |  | 24.8 | %    
|                        
|                        
|                        
|                        
|One to two years old     |       |  |  |       |  |               | 55.4  |       |  |  | 16.6 |      
|                        
|                        
|                        
|                        
|Two to three years old   |       |  |  |       |  |               | 29.9  |       |  |  | 8.9  |      
|                        
|                        
|                        
|                        
|Three years old or older |       |  |  |       |  |               | 166.1 |       |  |  | 49.7 |      
|                         |       |  |  |       |  |               |       |       |  |  |      |      
|                         | Total |  |  |       |  |               | $     | 334.3 |  |  |      | 100.0 | %
|                         |       |  |  |       |  |               |       |       |  |  |      |      

At December 31, 2004, the underlying pools of mortgage
loans that are collateral for our CMBS consisted of
approximately 6,200 commercial mortgage loans and real estate
properties owned. The underlying mortgage loans securing the
CMBS, calculated using the outstanding principal balance at
December 31, 2004 and 2003, were diversified over the
following property types and geographic locations:

|                  |       |      |    |      |   |  |    |     |  
|----------------- | ----- | ---- | -- | ---- | - |  | -- | --- | -
|                  |       | 2004 |    | 2003
|                  |       |      |    |     
|Property Type     |       |      |    |      |   |  |    |    
|                 
|                 
|                 
|                 
|Retail            |       |      | 34 | %    |   |  | 35 | %  
|                 
|                 
|                 
|                 
|Office            |       |      | 26 |      |   |  | 24 |    
|                 
|                 
|                 
|                 
|Housing           |       |      | 24 |      |   |  | 25 |    
|                 
|                 
|                 
|                 
|Industrial        |       |      | 6  |      |   |  | 5  |    
|                 
|                 
|                 
|                 
|Hospitality       |       |      | 4  |      |   |  | 5  |    
|                 
|                 
|                 
|                 
|Other             |       |      | 6  |      |   |  | 6  |    
|                  |       |      |    |      |   |  |    |    
|                  | Total |      |    | 100  | % |  |    | 100 | %
|                  |       |      |    |      |   |  |    |    
|Geographic Region |       |      |    |      |   |  |    |    
|                 
|                 
|                 
|                 
|West              |       |      | 29 | %    |   |  | 31 | %  
|                 
|                 
|                 
|                 
|Mid-Atlantic      |       |      | 27 |      |   |  | 27 |    
|                 
|                 
|                 
|                 
|Midwest           |       |      | 22 |      |   |  | 21 |    
|                 
|                 
|                 
|                 
|Southeast         |       |      | 17 |      |   |  | 17 |    
|                 
|                 
|                 
|                 
|Northeast         |       |      | 5  |      |   |  | 4  |    
|                  |       |      |    |      |   |  |    |    
|                  | Total |      |    | 100  | % |  |    | 100 | %
|                  |       |      |    |      |   |  |    |    

In addition to our CMBS investments, we have invested in the
bonds and preferred shares of CDOs which are secured by
investment grade unsecured debt issued by various real estate
investment trusts, or REITs, investment grade and non-investment
grade CMBS, and other real estate related collateral. The bonds
and the preferred shares of the CDOs in which we have invested
are junior in priority for payment of interest and principal to
the more senior tranches of debt issued by the CDOs. The yield
on our CDO bonds and preferred shares at December 31, 2004,
was 16.8%.

Business Processes

Private Finance

Business Development and New Deal Origination.Over the
years, we have developed and maintained relationships with
numerous private equity investors, investment banks, business
brokers, merger and acquisition advisors, financial services
companies, banks, law firms and accountants through whom we
source investment opportunities. Through these relationships,
especially those with private equity sponsors, we believe we
have been able to strengthen our position as a long-term
investor. We are well known in the private equity industry, and
we believe that our experience and reputation provide a
competitive advantage in originating new investments.

New Deal Underwriting and Investment Execution. In a
typical private finance transaction, we review, analyze, and
substantiate through due diligence the business plan and
operations of the potential portfolio

7



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##### 





Once we have determined that a prospective portfolio company is
suitable for investment, we work with the management and the
other capital providers, including senior, junior, and equity
capital providers, to structure a deal. We negotiate
among these parties to agree on how our investment is expected
to perform relative to the other capital in the portfolio
companys capital structure. The typical mezzanine
transaction requires approximately two to six months of
diligence and structuring before funding occurs. The typical
buyout transaction may take up to one year to complete because
the due diligence and structuring process is significantly
longer when investing in a substantial equity stake in the
company.

Our investments are tailored to the facts and circumstances of
the deal. The specific structure is designed to protect our
rights and manage our risk in the transaction. We may structure
the debt instrument to require restrictive affirmative and
negative covenants, default penalties, lien protection, or other
protective provisions. In addition, each debt investment is
individually priced to achieve a return that reflects our rights
and priorities in the portfolio companys capital
structure, the structure of the debt instrument, and our
perceived risk of the investment. Our loans and debt securities
have an annual stated interest rate; however, that interest rate
is only one factor in pricing the investment. The annual stated
interest rate may include some component of contractual
payment-in-kind interest, which represents contractual interest
accrued and added to the loan balance that generally becomes due
at maturity or upon prepayment. In addition to the interest
earned on loans and debt securities, our mezzanine investments
may include equity features, such as warrants or options to buy
a minority interest in the portfolio company. The warrants we
receive with our debt securities generally require only a
nominal cost to exercise, and thus, if the portfolio company
appreciates in value, we achieve additional investment return
from this equity interest. We may structure the warrants to
provide minority rights provisions and event-driven puts. In
many cases, we will also obtain registration rights in
connection with these equity interests, which may include demand
and piggyback registration rights.

The key steps in our private finance investment process are:



| |   |                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Initial investment screening;                                                                                                                                                                               
|
| |  | Initial investment committee approval;                                                                                                                                                                      
|
| |  | Due diligence, structuring and negotiation;                                                                                                                                                                 
|
| |  | Internal review of diligence results;                                                                                                                                                                       
|
| |  | Final investment committee approval;                                                                                                                                                                        
|
| |  | Approval by the Executive Committee of the Board of Directors
    (for all mezzanine investments that represent a commitment equal
    to or greater than $20 million and every buyout
    transaction); and
|
| |  | Funding of the investment (due diligence must be completed with
    final investment committee approval before funds are disbursed).                                                                        

The investment process benefits from the significant
professional experience of the members of our investment
committee, which is chaired by our Chief Executive Officer and
includes our Chief Operating Officer, our Chief Financial
Officer and other senior investment officers.

Portfolio Monitoring and Development.We monitor the
progress of the companies in our portfolio. Middle market
companies often lack the management expertise and experience
found in larger companies. As a BDC, we are required by the 1940
Act to make available significant managerial assistance to our
portfolio companies. Our senior level professionals work with
portfolio company management teams to assist them to acquire
other companies, to optimize their cost structures, to recruit
management talent, to

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With respect to our private finance portfolio, our team of
investment professionals regularly monitors the status and
performance of each investment. This portfolio company
monitoring process generally includes review of the
companys financial performance against its business plan,
review of current financial statements and compliance with
financial covenants, evaluation of significant current
developments and assessment of future exit strategies. We may
have board observation rights for mezzanine investments, which
allows us to attend portfolio company board meetings. For buyout
investments, we generally hold a majority of the seats on the
board of directors.

From time to time we will identify investments that require
closer monitoring or become workout assets. We develop a workout
strategy for workout assets and gauge our progress against the
strategy at periodic portfolio management committee meetings.
Our portfolio management committee is chaired by our Chief
Executive Officer and includes our Chief Operating Officer, our
Chief Financial Officer, and other senior professionals.

Private finance investments are priced to provide an investment
return considering the fact that certain investments in the
portfolio may underperform or result in loss of investment
return or investment principal. As a private equity investor, we
will incur losses from our investing activities, however we have
a history of working with troubled portfolio companies in order
to recover as much of our investments as is practicable.

Commercial Real Estate Finance

CMBS and CDOs. The typical CMBS or CDO investment takes
between two to three months to complete. We receive extensive
underwriting information regarding the mortgage loans and other
securities comprising a CMBS or CDO pool from the issuer. We
then work with the issuer, the investment bank, and the rating
agencies to underwrite the collateral securing our investment.
For instance when we review the underlying commercial mortgage
loans securing a CMBS transaction, we analyze the estimate of
cash flow and debt service coverage, and assess the collateral
value and loan-to-value ratios. We study the local real estate
market trends and form an opinion as to whether the loan as
originally underwritten by the issuer is sound. Based on the
findings of our diligence procedures, we may reject certain
mortgage loans from inclusion in the collateral pool.

The key steps in our CMBS and CDO investment process are:



| |   |                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------
| |  | Initial assessment of collateral pool data;                                                                                                   
|
| |  | Preparation of preliminary bid letter;                                                                                                        
|
| |  | Due diligence, structuring and negotiation;                                                                                                   
|
| |  | Investment committee approval;                                                                                                                
|
| |  | Approval by the Executive Committee of the Board of Directors
    (for all investments that are equal to or greater than
    $20 million); and
|
| |  | Funding of the investment (due diligence must be completed with
    final investment committee approval before funds are disbursed).          

The investment process benefits from the significant
professional experience of our real estate investment committee
members. CMBS and CDO transactions are approved by the
commercial real estate investment committee, which is chaired by
our Chief Executive Officer and includes our Chief Operating
Officer, our Chief Financial Officer and other senior investment
officers.

With respect to our CMBS and CDO portfolio, we monitor the
performance of the underlying collateral pool through data
provided by master and special servicers. These third-party
master servicers are responsible for the day-to-day loan
servicing functions, including billing, payment processing,
collections on

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When a loan moves to the designated special servicer, a workout
plan is formulated by the special servicer and reviewed by us
when we hold the controlling interest in the lowest rated
tranche outstanding, which is generally the non-rated tranche at
issuance. Once reviewed by us, the special servicer carries out
the workout plan, updating us on the status. With respect to
certain CMBS issuances where we own the controlling class of
securities, we generally have the ability to replace the
existing named special servicer at any time. In addition, we are
the named special servicer on certain CMBS issuances. We act as
the disposition consultant with respect to certain of our CDO
investments, which allows us to approve disposition plans for
individual collateral securities.

Portfolio Grading

We employ a standard grading system to monitor the quality of
our portfolio. Grade 1 is for those investments from which
a capital gain is expected. Grade 2 is for investments
performing in accordance with plan. Grade 3 is for
investments that require closer monitoring; however, no loss of
investment return or principal is expected. Grade 4 is for
investments that are in workout and for which some loss of
current investment return is expected, but no loss of principal
is expected. Grade 5 is for investments that are in workout
and for which some loss of principal is expected.

Portfolio Valuation

We determine the value of each investment in our portfolio on a
quarterly basis, and changes in value result in unrealized
appreciation or depreciation being recognized in our statement
of operations. Value, as defined in Section 2(a)(41) of the
Investment Company Act of 1940, is (i) the market price for
those securities for which a market quotation is readily
available and (ii) for all other securities and assets,
fair value is as determined in good faith by the Board of
Directors. Since there is typically no readily available market
value for the investments in our portfolio, we value
substantially all of our portfolio investments at fair value as
determined in good faith by the Board of Directors pursuant to a
valuation policy and a consistently applied valuation process.
At December 31, 2004, portfolio investments recorded at
fair value were approximately 92% of our total assets. Because
of the inherent uncertainty of determining the fair value of
investments that do not have a readily available market value,
the fair value of our investments determined in good faith by
the Board of Directors may differ significantly from the values
that would have been used had a ready market existed for the
investments, and the differences could be material.

There is no single standard for determining fair value in good
faith. As a result, determining fair value requires that
judgment be applied to the specific facts and circumstances of
each portfolio investment while employing a consistently applied
valuation process for the types of investments we make. Unlike
banks, we are not permitted to provide a general reserve for
anticipated loan losses. Instead, we are required to
specifically value each individual investment on a quarterly
basis. We will record unrealized depreciation on investments
when we believe that an investment has become impaired,
including where collection of a loan or realization of an equity
security is doubtful, or when the enterprise value of the
portfolio company does not currently support the cost of our
debt or equity investment. Enterprise value means the entire
value of the company to a potential buyer, including the sum of
the values of debt and equity securities used to capitalize the
enterprise at a point in time. We will record unrealized
appreciation if we believe that the underlying portfolio company
has appreciated in value and, therefore, our equity security has
also appreciated in value. Changes in fair value are recorded in
the statement of operations as net change in unrealized
appreciation or depreciation.

As a business development company, we invest in illiquid
securities including debt and equity securities of companies,
non-investment grade CMBS bonds, and CDO bonds and preferred
shares. The structure of each private finance debt and equity
security is specifically negotiated to enable us to protect our

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Valuation Methodology  Private Finance.Our process for determining the fair value of a private
finance investment begins with determining the enterprise value
of the portfolio company. The fair value of our investment is
based on the enterprise value at which the portfolio company
could be sold in an orderly disposition over a reasonable period
of time between willing parties other than in a forced or
liquidation sale. The liquidity event whereby we exit a private
finance investment is generally the sale, the recapitalization
or, in some cases, the initial public offering of the portfolio
company.

There is no one methodology to determine enterprise value and,
in fact, for any given portfolio company, enterprise value is
best expressed as a range of fair values, from which we derive a
single estimate of enterprise value. To determine the enterprise
value of a portfolio company, we analyze its historical and
projected financial results. We generally require portfolio
companies to provide annual audited and quarterly unaudited
financial statements, as well as annual projections for the
upcoming fiscal year. Typically in the private equity business,
companies are bought and sold based on multiples of EBITDA, cash
flow, net income, revenues or, in limited instances, book value.
The private equity industry uses financial measures such as
EBITDA or EBITDAM (Earnings Before Interest, Taxes,
Depreciation, Amortization and, in some instances, Management
fees) in order to assess a portfolio companys financial
performance and to value a portfolio company. EBITDA and EBITDAM
are not intended to represent cash flow from operations as
defined by U.S. generally accepted accounting principles and
such information should not be considered as an alternative to
net income, cash flow from operations, or any other measure of
performance prescribed by U.S. generally accepted accounting
principles. When using EBITDA to determine enterprise value, we
may adjust EBITDA for non-recurring items. Such adjustments are
intended to normalize EBITDA to reflect the portfolio
companys earnings power. Adjustments to EBITDA may include
compensation to previous owners, acquisition, recapitalization,
or restructuring related items or one-time non-recurring income
or expense items.

In determining a multiple to use for valuation purposes, we
generally look to private merger and acquisition statistics,
discounted public trading multiples or industry practices. In
estimating a reasonable multiple, we consider not only the fact
that our portfolio company may be a private company relative to
a peer group of public comparables, but we also consider the
size and scope of our portfolio company and its specific
strengths and weaknesses. In some cases, the best valuation
methodology may be a discounted cash flow analysis based on
future projections. If a portfolio company is distressed, a
liquidation analysis may provide the best indication of
enterprise value.

If there is adequate enterprise value to support the repayment
of our debt, the fair value of our loan or debt security
normally corresponds to cost unless the borrowers
condition or other factors lead to a determination of fair value
at a different amount. The fair value of equity interests in
portfolio companies is determined based on various factors,
including the enterprise value remaining for equity holders
after the repayment of the portfolio companys debt and
other preference capital, and other pertinent factors such as
recent offers to purchase a portfolio company, recent
transactions involving the purchase or sale of the portfolio
companys equity securities, or other liquidation events.
The determined equity values are generally discounted when we
have a minority position, restrictions on resale, specific
concerns about the receptivity of the capital markets to a
specific company at a certain time, or other factors.

Valuation Methodology  CMBS Bonds and CDO Bonds
and Preferred Shares.CMBS bonds and CDO bonds and
preferred shares are carried at fair value, which is based on a
discounted cash flow model that utilizes prepayment and loss
assumptions based on historical experience and projected
performance, economic factors, the characteristics of the
underlying cash flow and comparable yields for similar CMBS

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Valuation Process.The portfolio valuation process
is managed by our Chief Valuation Officer (CVO). The
CVO works with the investment professionals responsible for each
investment. The following is a description of the steps we take
each quarter to determine the value of our portfolio.



| |   |                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our valuation process begins with each portfolio company or
    investment being initially valued by our deal team, led by the
    Managing Director or senior officer who is responsible for the
    portfolio company relationship.                                                                                                                                             
|
| |  | The CVO reviews the valuation data. The CVO, members of the
    valuation team, and an independent third-party consultant, as
    applicable for private finance investments, meet with each
    Managing Director or responsible senior officer to discuss the
    preliminary valuation determined and documented by the deal team
    for each of their respective investments.
|
| |  | Each investment committee (private finance and commercial real
    estate finance) meets with the CVO where members of the
    investment committees have the opportunity to discuss the
    preliminary valuation results.                                                                                                                                                       
|
| |  | Valuation documentation is distributed to the members of the
    Board of Directors.                                                                                                                                                                                                                                                                                              
|
| |  | The Board of Directors meets to discuss valuations and review
    the input of the CVO and management.                                                                                                                                                                                                                                                                            
|
| |  | To the extent there are changes or if additional information is
    deemed necessary, a follow-up Board meeting may take place.                                                                                                                                                                                                                                                   
|
| |  | The Board of Directors determines the fair value of the
    portfolio in good faith.                                                                                                                                                                                                                                                                                              

In connection with our valuation process to determine the fair
value of a private finance investment, we work with independent
third-party consultants to obtain assistance and advice as
additional support in the preparation of our internal valuation
analysis for a portion of the portfolio each quarter (for all
investments with a cost or value greater than $250,000). In
addition, we may receive independent assessments of a particular
private finance portfolio companys value in the ordinary
course of business, most often in the context of a prospective
sale transaction or in the context of a bankruptcy process. The
valuation analysis prepared by management using these
independent valuation resources is submitted to our Board of
Directors for its determination of fair value of the portfolio
in good faith.

Disposition of Investments

We manage our portfolio of investments in an effort to maximize
our expected returns. Our portfolio is large and diverse and we
frequently are repaid by our borrowers and exit our debt and
equity investments as portfolio companies are sold,
recapitalized or complete an initial public offering. In our
mezzanine investments, we frequently are in a minority ownership
position in a portfolio company, and as a result, generally exit
the investment when the majority equity stakeholder decides to
sell or recapitalize the company. Where we have a control
position in our investment, as we frequently have in buyout
investments and in CMBS and CDO investments, we have more
flexibility and can determine whether or not we should exit our
investment. Our most common exit strategy for a buyout
investment is the sale of a

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We are in the investment business, which includes acquiring and
exiting investments. It is our policy not to comment on
potential transactions in the portfolio prior to reaching a
definitive agreement or, in many cases, prior to consummating a
transaction. To the extent we enter into any material
transactions, we would provide disclosure as required.

Dividends

We have elected to be taxed as a regulated investment company
under subchapter M of the Internal Revenue Code. As such,
we are not subject to corporate level income taxation on income
we timely distribute to our stockholders as dividends. We pay
regular quarterly dividends based upon an estimate of annual
taxable income, which includes our taxable interest, dividend,
and fee income, as well as taxable net capital gains. Taxable
income generally differs from net income for financial reporting
purposes due to temporary and permanent differences in the
recognition of income and expenses and generally excludes net
unrealized appreciation or depreciation, as gains or losses are
not included in taxable income until they are realized. Taxable
income includes non-cash income, such as changes in accrued and
reinvested interest and dividends, which includes contractual
payment-in-kind interest, and the amortization of discounts and
fees. Cash collections of income resulting from contractual
payment-in-kind interest or the amortization of discounts and
fees generally occur upon the repayment of the loans or debt
securities that include such items. Non-cash taxable income is
reduced by non-cash expenses, such as realized losses and
depreciation and amortization expense.

We began paying quarterly dividends in 1963, and our portfolio
has provided sufficient ordinary taxable income and realized net
capital gains to sustain or grow our dividends over time. The
percentage of our dividend generated by ordinary taxable income
versus capital gain income will vary from year to year.
Depending on many factors impacting portfolio activities,
including the amount of debt and equity capital available to
middle market companies, the level of merger and acquisition
activity for such companies, the general economic environment,
and the competitive environment for the types of investments we
make, we will be in a build or harvest
mode for our portfolio investments. As illustrated in the chart
below, when we are building the portfolio, ordinary
taxable income typically grows as a percentage of the total
dividend. When we are exiting investments, or in a
harvest mode, net capital gains typically grow as a
percentage of the total dividend. We believe that the ability to
generate both ordinary and capital gain income has built
predictability in the dividends we pay. The percentage of
ordinary taxable income versus net capital gain income
supporting the dividend since 1985 is shown below.

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(Bar Graph)

Corporate Structure and Offices

We are a Maryland corporation and a closed-end, non-diversified
management investment company that has elected to be regulated
as a business development company under the 1940 Act. We have a
subsidiary, Allied Investment Corporation, which has also
elected to be regulated as a BDC and is licensed under the Small
Business Investment Act of 1958 as a Small Business Investment
Company. See Certain Government Regulations below
for further information about small business investment company
regulation.

In addition, we have a real estate investment trust subsidiary,
Allied Capital REIT, Inc., and several subsidiaries that are
single-member limited liability companies established primarily
to hold real estate properties. We also have a subsidiary, A.C.
Corporation, that provides diligence and structuring services on
private finance and commercial real estate transactions, as well
as structuring, transaction, management, and advisory services
to Allied Capital, our portfolio companies and other third
parties.

Our executive offices are located at 1919 Pennsylvania Avenue,
NW, Washington, DC 20006-3434 and our telephone number is
(202) 331-1112. In addition, we have regional offices in
New York, Chicago, and Los Angeles.

Available Information

Our Internet address is www.alliedcapital.com. We make available
free of charge on our website our annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports as soon
as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC. Information contained
on our website is not incorporated by reference into this annual
report on Form 10-K and you should not consider information
contained on our website to be part of this annual report on
Form 10-K.

Employees

At December 31, 2004, we employed 162 individuals including
investment and portfolio management professionals, operations
professionals and administrative staff. The majority of these
individuals are located in our Washington, DC office. We believe
that our relations with our employees are excellent.

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Certain Government Regulations

We operate in a highly regulated environment. The following
discussion generally summarizes certain government regulations.

Business Development Company.A business
development company is defined and regulated by the 1940 Act. A
business development company must be organized in the United
States for the purpose of investing in or lending to primarily
private companies and making managerial assistance available to
them. A business development company may use capital provided by
public shareholders and from other sources to invest in
long-term, private investments in businesses. A business
development company provides shareholders the ability to retain
the liquidity of a publicly traded stock, while sharing in the
possible benefits, if any, of investing in primarily privately
owned companies.

As a business development company, we may not acquire any asset
other than qualifying assets unless, at the time we
make the acquisition, the value of our qualifying assets
represent at least 70% of the value of our total assets. The
principal categories of qualifying assets relevant to our
business are:



| |   |                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Securities purchased in transactions not involving any public
    offering, the issuer of which is an eligible portfolio company;                                                                                  
|
| |  | Securities received in exchange for or distributed with respect
    to securities described in the bullet above or pursuant to the
    exercise of options, warrants or rights relating to such
    securities; and
|
| |  | Cash, cash items, government securities or high quality debt
    securities (within the meaning of the 1940 Act), maturing in one
    year or less from the time of investment.                                    

An eligible portfolio company is generally a domestic company
that is not an investment company (other than a small business
investment company wholly owned by a business development
company, such as our investment in Allied Investment
Corporation) and that:



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | does not have a class of securities with respect to which a
    broker may extend margin credit at the time the acquisition is
    made;               
|
| |  | is actively controlled by the business development company and
    has an affiliate of a business development company on its board
    of directors; or
|
| |  | meets such other criteria as may be established by the SEC.                                                                                            

Control as defined by the 1940 Act is presumed to exist
where a business development company beneficially owns more than
25% of the outstanding voting securities of the portfolio
company.

To include certain securities described above as qualifying
assets for the purpose of the 70% test, a business development
company must make available to the issuer of those securities
significant managerial assistance such as providing significant
guidance and counsel concerning the management, operations, or
business objectives and policies of a portfolio company. We
offer to provide significant managerial assistance to our
portfolio companies. See Risk Factors 
Our ability to invest in private companies may be limited
in certain circumstances.

As a business development company, we are entitled to issue
senior securities in the form of stock or senior securities
representing indebtedness, including debt securities and
preferred stock, as long as each class of senior security has an
asset coverage of at least 200% immediately after each such
issuance. In addition, while any senior securities remain
outstanding, we must make provisions to prohibit any
distribution to our shareholders unless we meet the applicable
asset coverage ratio at the time of the distribution. This
limitation is not applicable to borrowings by our small business
investment company subsidiary, and therefore any borrowings by
this subsidiary are not included in this asset coverage test
pursuant to exemptive relief. See Risk Factors.

We may also be prohibited under the 1940 Act from knowingly
participating in certain transactions with our affiliates
without the prior approval of our Board of Directors who are not
interested persons and, in some cases, prior approval by the
SEC. We have been granted an exemptive order by the SEC
permitting

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We have designated a chief compliance officer and established a
compliance program pursuant to the requirements of the
1940 Act. We are periodically examined by the SEC for
compliance with the 1940 Act.

As with other companies regulated by the 1940 Act, a business
development company must adhere to certain substantive
regulatory requirements. A majority of our directors must be
persons who are not interested persons, as that term is defined
in the 1940 Act. Additionally, we are required to provide and
maintain a bond issued by a reputable fidelity insurance company
to protect us against larceny and embezzlement. Furthermore, as
a business development company, we are prohibited from
protecting any director or officer against any liability to us
or our shareholders arising from willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in
the conduct of such persons office.

We maintain a code of ethics that establishes procedures for
personal investment and restricts certain transactions by our
personnel. Our code of ethics generally does not permit
investment by our employees in securities that may be purchased
or held by us. The code of ethics is filed as an exhibit to our
registration statement which is on file with the SEC. You may
read and copy the code of ethics at the SECs Public
Reference Room in Washington, D.C. You may obtain
information on operations of the Public Reference Room by
calling the SEC at (202) 942-8090. In addition, the code of
ethics is available on the EDGAR Database on the SEC Internet
site at http://www.sec.gov. You may obtain copies of the code of
ethics, after paying a duplicating fee, by electronic request at
the following email address: publicinfo@sec.gov, or by writing
to the SECs Public Reference Section, 450 5th Street,
NW, Washington, D.C. 20549. Our code of ethics is also
posted on our website at www.alliedcapital.com.

As a business development company under the 1940 Act, we are
entitled to provide and have provided loans to our officers in
connection with the exercise of options. However, as a result of
provisions of the Sarbanes-Oxley Act of 2002, we have been
prohibited from making new loans to our executive officers since
July 2002.

We may not change the nature of our business so as to cease to
be, or withdraw our election as, a business development company
unless authorized by vote of a majority of the outstanding
voting securities, as defined in the 1940 Act. A majority
of the outstanding voting securities of a company is defined
under the 1940 Act as the lesser of: (i) 67% or more of
such companys shares present at a meeting if more than 50%
of the outstanding shares of such company are present and
represented by proxy or (ii) more than 50% of the
outstanding shares of such company.

Small Business Administration Regulations.Allied
Investment Corporation, a wholly owned subsidiary of Allied
Capital, is licensed by the Small Business Administration as a
small business investment company under Section 301(c) of
the Small Business Investment Act of 1958, and has elected to be
regulated as a business development company.

Small business investment companies are designed to stimulate
the flow of private equity capital to eligible small businesses.
Under present Small Business Administration regulations,
eligible small businesses include businesses that have a
tangible net worth not exceeding $18 million and have
average annual fully taxed net income not exceeding
$6 million for the two most recent fiscal years. In
addition, a small business investment company must devote 20% of
its investment activity to smaller concerns as
defined by the Small Business Administration. A smaller concern
is one that has a tangible net worth not exceeding
$6 million and has average annual fully taxed net income
not exceeding $2 million for the two most recent fiscal
years. Small Business Administration regulations also provide
alternative size standard criteria to determine eligibility,
which depend on the industry in which the business is engaged
and are based on such factors as the number of employees and
gross sales. According to Small Business Administration
regulations, small business investment companies may make loans
to small businesses, invest in the equity securities of such
businesses, and provide them with consulting and advisory
services.

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Allied Investment is periodically examined and audited by the
Small Business Administrations staff to determine its
compliance with small business investment company regulations.

We, through Allied Investment, have debentures payable to the
Small Business Administration with contractual maturities of ten
years. The notes require payment of interest only semi-annually,
and all principal is due upon maturity. Under the small business
investment company program, we may borrow up to
$119.0 million from the Small Business Administration. At
December 31, 2004, we had $77.5 million outstanding
and the Small Business Administration had a commitment to lend
up to an additional $7.3 million above the amount
outstanding. The commitment expires on September 30, 2005.

Regulated Investment Company Status.We have
elected to be taxed as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986,
otherwise referred to as the Code. As long as we qualify as a
regulated investment company, we are not taxed on our investment
company taxable income or realized net capital gains, to the
extent that such taxable income or gains are distributed, or
deemed to be distributed, to shareholders on a timely basis.

Taxable income generally differs from net income for financial
reporting purposes due to temporary and permanent differences in
the recognition of income and expenses, and generally excludes
net unrealized appreciation or depreciation, as gains or losses
are not included in taxable income until they are realized. In
addition, gains realized for financial reporting purposes may
differ from gains included in taxable income as a result of our
election to recognize gains using installment sale treatment,
which results in the deferment of gains for tax purposes until
notes received as consideration from the sale of investments are
collected in cash.

Dividends declared and paid by the Company in a year generally
differ from taxable income for that year as such dividends may
include the distribution of current year taxable income, the
distribution of prior year taxable income carried forward into
and distributed in the current year, or returns of capital. We
are generally required to distribute 98% of our taxable income
during the year the income is earned to avoid paying an excise
tax. If this requirement is not met, the Code imposes a
nondeductible excise tax equal to 4% of the amount by which 98%
of the current years taxable income exceeds the
distribution for the year. The taxable income on which an excise
tax is paid is generally carried forward and distributed to
shareholders in the next tax year. Depending on the level of
taxable income earned in a tax year, we may choose to carry
forward taxable income in excess of current year distributions
into the next tax year and pay a 4% excise tax on such income,
as required.

In order to maintain our status as a regulated investment
company, we must, in general, (1) continue to qualify as a
business development company; (2) derive at least
90% of our gross income from dividends, interest, gains
from the sale of securities and other specified types of income;
(3) meet asset diversification requirements as defined in
the Code; and (4) timely distribute to shareholders at
least 90% of our annual investment company taxable income
as defined in the Code. We intend to take all steps necessary to
continue to qualify as a regulated investment company. However,
there can be no assurance that we will continue to qualify for
such treatment in future years.

Compliance with the Sarbanes-Oxley Act of 2002 and NYSE
Corporate Governance Regulations.The Sarbanes-Oxley Act
of 2002 (the Sarbanes-Oxley Act) imposes a wide
variety of regulatory requirements on publicly held companies
and their insiders. Many of these requirements apply to us,
including:



| |   |                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our Chief Executive Officer and Chief Financial Officer certify
    the accuracy of the financial statements contained in our
    periodic reports, and so certified through the filing of
    Section 302 certifications as exhibits to the
    Form 10-K filed in 2004;
|
| |  | Our periodic reports disclose our conclusions about the
    effectiveness of our disclosure controls and procedures;                                                                                                                                                     

17



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our annual report on Form 10-K contains a report from our
    management on internal control over financial reporting,
    including a statement that our management is responsible for
    establishing and maintaining adequate internal control over
    financial reporting as well as our managements assessment
    of the effectiveness of our internal control over financial
    reporting, which must be audited by our independent registered
    public accounting firm.
|
| |  | Our periodic reports disclose whether there were significant
    changes in our internal control over financial reporting or in
    other factors that could significantly affect our internal
    control over financial reporting subsequent to the date of their
    evaluation, including any corrective actions with regard to
    significant deficiencies and material weaknesses; and                                                                                        
|
| |  | We may not make any loan to any director or executive officer
    and we may not materially modify any existing loans.                                                                                                                                                                                                                                                                                                                                                               

We have adopted procedures to comply with the Sarbanes-Oxley Act
and the regulations promulgated thereunder. We will continue to
monitor our compliance with all future regulations that are
adopted under the Sarbanes-Oxley Act and will take actions
necessary to ensure that we are in compliance therewith.

In addition, the New York Stock Exchange has adopted corporate
governance changes to its listing standards. We have adopted
certain policies and procedures to comply with the New York
Stock Exchanges corporate governance rules, and in 2004 we
submitted the required CEO certification to the New York Stock
Exchange pursuant to Section 303A 12(a) of the listed
company standards.

Forward-Looking Statements

You should read the information contained in this Form 10-K in
conjunction with the Companys 2004 Consolidated Financial
Statements and Notes thereto contained in the Companys
2004 Annual Report to Stockholders. The 2004 Annual Report to
Stockholders and this Form 10-K contain certain
forward-looking statements. These statements include
managements plans and objectives for future operations and
financial objectives, loan portfolio growth and availability of
funds. There are inherent uncertainties in predicting future
results and conditions, and certain factors could cause actual
results and conditions to differ materially from those projected
in these forward-looking statements. These factors are described
in the Risk Factors section below. Other factors
that could cause actual results to differ materially include
changes in the economy, risks associated with possible
disruption in our operations due to terrorism, future changes in
laws or regulations and conditions in our operating areas and
other risks and uncertainties as may be detailed from time to
time in our public announcements and SEC filings. Although we
believe that the assumptions underlying the forward-looking
statements included or incorporated by reference in this
document are reasonable, any of the assumptions could be
inaccurate and therefore, we cannot assure you that the
forward-looking statements included or incorporated by reference
in this document will prove to be accurate. Therefore, you
should not regard the inclusion of this information as an
assurance that our plans and objectives will be achieved.

Risk Factors

Investing in Allied Capital involves a number of significant
risks relating to our business and investment objective. As a
result, there can be no assurance that we will achieve our
investment objective.

Our portfolio of investments is illiquid. We generally
acquire our investments directly from the issuer in privately
negotiated transactions. The majority of the investments in our
portfolio are typically subject to restrictions on resale or
otherwise have no established trading market. We typically exit
our investments when the portfolio company has a liquidity event
such as a sale, recapitalization, or initial public offering of
the company. The illiquidity of our investments may adversely
affect our ability to dispose of debt and equity securities at
times when it may be otherwise advantageous for us to liquidate
such investments. In addition, if we were forced to immediately
liquidate some or all of the investments in the portfolio, the
proceeds of such liquidation would be significantly less than
the current value of such investments.

18



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Investing in private companies involves a high degree of
risk. Our portfolio consists of primarily long-term loans to
and investments in private companies. Investments in private
businesses involve a high degree of business and financial risk,
which can result in substantial losses and accordingly should be
considered speculative. There is generally no publicly available
information about the companies in which we invest, and we rely
significantly on the diligence of our employees and agents to
obtain information in connection with our investment decisions.
In addition, these businesses generally have narrower product
lines and market shares than their competition and may be more
vulnerable to customer preferences, market conditions, loss of
key personnel, or economic downturns, which may adversely affect
the return on, or the recovery of, our investment in such
businesses.

Substantially all of our portfolio investments are recorded
at fair value as determined in good faith by our Board of
Directors and, as a result, there is uncertainty regarding the
value of our portfolio investments. At December 31,
2004, portfolio investments recorded at fair value were
approximately 92% of our total assets. Pursuant to the
requirements of the 1940 Act, we value substantially all of our
investments at fair value as determined in good faith by our
Board of Directors on a quarterly basis. Since there is
typically no readily available market value for the investments
in our portfolio, our Board of Directors determines in good
faith the fair value of these investments pursuant to a
valuation policy and a consistently applied valuation process.

There is no single standard for determining fair value in good
faith. As a result, determining fair value requires that
judgment be applied to the specific facts and circumstances of
each portfolio investment while employing a consistently applied
valuation process for the types of investments we make. Unlike
banks, we are not permitted to provide a general reserve for
anticipated loan losses; we are instead required by the 1940 Act
to specifically value each individual investment on a quarterly
basis and record unrealized depreciation for an investment that
we believe has become impaired, including where collection of a
loan or realization of an equity security is doubtful, or when
the enterprise value of the portfolio company does not currently
support the cost of our debt or equity investment. Enterprise
value means the entire value of the company to a potential
buyer, including the sum of the values of debt and equity
securities used to capitalize the enterprise at a point in time.
We will record unrealized appreciation if we believe that the
underlying portfolio company has appreciated in value and,
therefore, our equity security has also appreciated in value.
Without a readily available market value and because of the
inherent uncertainty of valuation, the fair value of our
investments determined in good faith by the Board of Directors
may differ significantly from the values that would have been
used had a ready market existed for the investments, and the
differences could be material.

We adjust quarterly the valuation of our portfolio to reflect
the Board of Directors determination of the fair value of
each investment in our portfolio. Any changes in fair value are
recorded in our statement of operations as net change in
unrealized appreciation or depreciation.

Economic recessions or downturns could impair our portfolio
companies and harm our operating results. Many of the
companies in which we have made or will make investments may be
susceptible to economic slowdowns or recessions. An economic
slowdown may affect the ability of a company to engage in a
liquidity event such as a sale, recapitalization, or initial
public offering. Our nonperforming assets are likely to increase
and the value of our portfolio is likely to decrease during
these periods. These conditions could lead to financial losses
in our portfolio and a decrease in our revenues, net income, and
assets.

Our business of making private equity investments and
positioning them for liquidity events also may be affected by
current and future market conditions. The absence of an active
senior lending environment or a slow down in middle market
merger and acquisition activity may slow the amount of private
equity investment activity generally. As a result, the pace of
our investment activity may slow. In addition, significant
changes in the capital markets could have an effect on the
valuations of private companies and on the potential for
liquidity events involving such companies. This could affect the
timing of exit events in our portfolio and could negatively
affect the amount of gains or losses upon exit.

Our borrowers may default on their payments, which may have a
negative effect on our financial performance. We make
long-term unsecured, subordinated loans and invest in equity
securities, which

19



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Our private finance investments may not produce current
returns or capital gains. Our private finance investments
are typically structured as unsecured debt securities with a
relatively high fixed rate of interest and with equity features
such as conversion rights, warrants, or options. As a result,
our private finance investments are generally structured to
generate interest income from the time they are made and may
also produce a realized gain from an accompanying equity
feature. We cannot be sure that our portfolio will generate a
current return or capital gains.

Our financial results could be negatively affected if
Business Loan Express fails to perform as expected. Business
Loan Express, LLC (BLX) is our largest portfolio investment. Our
financial results could be negatively affected if BLX, as a
portfolio company, fails to perform as expected or if government
funding for, or regulations related to the Small Business
Administration 7(a) Guaranteed Loan Program change. At
December 31, 2004, our investment in BLX totaled
$335.2 million at value, or 10.3% of total assets and for
the year ended December 31, 2004, interest and related
portfolio income earned from our investment in BLX was
$50.0 million, or 13.6% of total interest and related
portfolio income.

In addition, as controlling equity owner of BLX, we have
provided an unconditional guaranty to BLXs senior credit
facility lenders in an amount equal to 50% of BLXs total
obligations on its $275.0 million revolving credit
facility. The amount we have guaranteed at December 31,
2004, was $94.6 million. This guaranty can only be called
in the event of a default by BLX. At December 31, 2004, we
had also provided four standby letters of credit totaling
$35.6 million in connection with four term securitization
transactions completed by BLX.

Our financial results could be negatively affected if a
significant portfolio investment fails to perform as
expected. We purchase controlling equity positions in
companies and our total debt and equity investment in controlled
companies may be significant individually or in the aggregate.
Investments in controlled portfolio companies are generally
larger and in fewer companies than our investments in companies
that we do not control. As a result, if a significant investment
in one or more controlled companies fails to perform as
expected, our financial results could be more negatively
affected and the magnitude of the loss could be more significant
than if we had made smaller investments in more companies.

Investments in non-investment grade commercial
mortgage-backed securities and collateralized debt obligations
may be illiquid, may have a higher risk of default, and may not
produce current returns. The commercial mortgage-backed
securities and collateralized debt obligation bonds and
preferred shares in which we invest are not investment grade,
which means that nationally recognized statistical rating
organizations rate them below the top four investment-grade
rating categories (i.e., AAA through
BBB), and are sometimes referred to as junk
bonds. Non-investment grade commercial mortgage-backed
securities and collateralized debt obligation bonds and
preferred shares tend to be less liquid, may have a higher risk
of default and may be more difficult to value. Non-investment
grade securities usually provide a higher yield than do
investment grade securities, but with the higher return comes
greater risk of default. In addition, the fair value of these
securities may change as interest rates change over time.
Economic recessions or downturns may cause defaults or losses on
collateral securing these securities to increase. Non-investment
grade securities are considered speculative, and their capacity
to pay principal and interest in accordance with the terms of
their issue is not ensured.

We borrow money, which magnifies the potential for gain or
loss on amounts invested and may increase the risk of investing
in us. Borrowings, also known as leverage, magnify the
potential for gain or loss on amounts invested and, therefore,
increase the risks associated with investing in our securities.
We borrow from and issue senior debt securities to banks,
insurance companies, and other lenders. Lenders of these senior
securities have fixed dollar claims on our consolidated assets
that are superior to the claims of our

20



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At December 31, 2004, we had $1,176.6 million of
outstanding indebtedness bearing a weighted average annual
interest cost of 6.6%. In order for us to cover these annual
interest payments on indebtedness, we must achieve annual
returns on our assets of at least 2.4%.

We may not borrow money unless we maintain asset coverage for
indebtedness of at least 200%, which may affect returns to
shareholders. We must maintain asset coverage for total
borrowings of at least 200%. Our ability to achieve our
investment objective may depend in part on our continued ability
to maintain a leveraged capital structure by borrowing from
banks, insurance companies or other lenders on favorable terms.
There can be no assurance that we will be able to maintain such
leverage. If asset coverage declines to less than 200%, we may
be required to sell a portion of our investments when it is
disadvantageous to do so. As of December 31, 2004, our
asset coverage for senior indebtedness was 280%.

Changes in interest rates may affect our cost of capital and
net investment income. Because we borrow money to make
investments, our net investment income is dependent upon the
difference between the rate at which we borrow funds and the
rate at which we invest these funds. As a result, there can be
no assurance that a significant change in market interest rates
will not have a material adverse effect on our net investment
income. In periods of rising interest rates, our cost of funds
would increase, which would reduce our net investment income. We
use a combination of long-term and short-term borrowings and
equity capital to finance our investing activities. We utilize
our revolving line of credit as a means to bridge to long-term
financing. Our long-term fixed-rate investments are financed
primarily with long-term fixed-rate debt and equity. We may use
interest rate risk management techniques in an effort to limit
our exposure to interest rate fluctuations. Such techniques may
include various interest rate hedging activities to the extent
permitted by the 1940 Act. We have analyzed the potential impact
of changes in interest rates on interest income net of interest
expense.

Assuming that the balance sheet were to remain constant and no
actions were taken to alter the existing interest rate
sensitivity, a hypothetical immediate 1% change in interest
rates would have affected the net income by less than 1% over a
one year horizon. Although management believes that this measure
is indicative of our sensitivity to interest rate changes, it
does not adjust for potential changes in credit quality, size
and composition of the assets on the balance sheet and other
business developments that could affect net increase in net
assets resulting from operations, or net income. Accordingly, no
assurances can be given that actual results would not differ
materially from the potential outcome simulated by this estimate.

We will continue to need additional capital to grow because
we must distribute our income. We will continue to need
capital to fund growth in our investments. Historically, we have
borrowed from financial institutions and have issued equity
securities to grow our portfolio. A reduction in the
availability of new debt or equity capital could limit our
ability to grow. We must distribute at least 90% of our taxable
ordinary income, which excludes realized net long-term capital
gains, to our shareholders to maintain our regulated investment
company status. As a result, such earnings will not be available
to fund investment originations. In addition, as a business
development company, we are generally required to maintain a
ratio of at least 200% of total assets to total borrowings,
which may restrict our ability to borrow in certain
circumstances. We expect to continue to borrow from financial
institutions and issue additional debt and equity securities. If
we fail to obtain funds from such sources or from other sources
to fund our

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Loss of regulated investment company tax treatment would
substantially reduce net assets and income available for
dividends. We have operated so as to qualify as a regulated
investment company under Subchapter M of the Code. If we
meet source of income, asset diversification, and distribution
requirements, we will not be subject to corporate level income
taxation on income we timely distribute to our stockholders as
dividends. We would cease to qualify for such tax treatment if
we were unable to comply with these requirements. In addition,
we may have difficulty meeting the requirement to make
distributions to our shareholders because in certain cases we
may recognize income before or without receiving cash
representing such income. If we fail to qualify as a regulated
investment company, we will have to pay corporate-level taxes on
all of our income whether or not we distribute it, which would
substantially reduce the amount of income available for
distribution to our stockholders. Even if we qualify as a
regulated investment company, we generally will be subject to a
corporate-level income tax on the income we do not distribute.
Moreover, if we do not distribute at least 98% of our annual
taxable income in the year earned, we generally will be subject
to a 4% excise tax on such income carried forward and
distributed in the next tax year.

There is a risk that you may not receive dividends or
distributions. We intend to make distributions on a
quarterly basis to our stockholders. We may not be able to
achieve operating results that will allow us to make
distributions at a specific level or to increase the amount of
these distributions from time to time. In addition, due to the
asset coverage test applicable to us as a business development
company, we may be limited in our ability to make distributions.
Also, our credit facilities limit our ability to declare
dividends if we default under certain provisions. If we do not
distribute a certain percentage of our income annually, we will
suffer adverse tax consequences, including possible loss of our
status as a regulated investment company. In addition, in
accordance with U.S. generally accepted accounting principles
and tax regulations, we include in income certain amounts that
we have not yet received in cash, such as contractual
payment-in-kind interest which represents contractual interest
added to the loan balance that becomes due at the end of the
loan term. The increases in loan balances as a result of
contractual payment-in-kind arrangements are included in income
in advance of receiving cash payment and are separately included
in the change in accrued or reinvested interest and dividends in
our consolidated statement of cash flows. Since we may recognize
income before or without receiving cash representing such
income, we may have difficulty meeting the requirement to
distribute at least 90% of our investment company taxable income
to maintain our status as a regulated investment company.

We operate in a competitive market for investment
opportunities. We compete for investments with a large
number of private equity funds and mezzanine funds, other
business development companies, investment banks, other equity
and non-equity based investment funds, and other sources of
financing, including specialty finance companies and traditional
financial services companies such as commercial banks. Some of
our competitors may have greater resources than we do. Increased
competition would make it more difficult for us to purchase or
originate investments at attractive prices. As a result of this
competition, sometimes we may be precluded from making otherwise
attractive investments.

Our business depends on our key personnel. We depend on
the continued services of our executive officers and other key
management personnel. If we were to lose any of these officers
or other management personnel, such a loss could result in
inefficiencies in our operations and lost business
opportunities, which could have a negative effect on our
business.

Changes in the law or regulations that govern us could have a
material impact on us or our operations. We are regulated by
the SEC and the Small Business Administration. In addition,
changes in the laws or regulations that govern business
development companies, regulated investment companies, real
estate investment trusts, and small business investment
companies may significantly affect our business. Any change in
the law or regulations that govern our business could have a
material impact on us or our operations. Laws and regulations
may be changed from time to time, and the interpretations of the

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Our ability to invest in private companies may be limited in
certain circumstances. If we are to maintain our status as a
business development company, we must not acquire any assets
other than qualifying assets unless, at the time of
and after giving effect to such acquisition, at least 70% of our
total assets are qualifying assets. If we acquire debt or equity
securities from an issuer that has outstanding marginable
securities at the time we make an investment, these acquired
assets cannot be treated as qualifying assets. This result is
dictated by the definition of eligible portfolio
company under the 1940 Act, which in part looks to whether
a company has outstanding marginable securities.

Amendments promulgated in 1998 by the Federal Reserve expanded
the definition of a marginable security under the Federal
Reserves margin rules to include any non-equity security.
Thus, any debt securities issued by any entity are marginable
securities under the Federal Reserves current margin
rules. As a result, the staff of the SEC has raised the question
as to whether a private company that has outstanding debt
securities would qualify as an eligible portfolio
company under the 1940 Act.

Until the question raised by the staff of the SEC pertaining to
the Federal Reserves 1998 change to its margin rules has
been addressed by legislative, administrative or judicial
action, we intend to treat as qualifying assets only those debt
and equity securities that are issued by a private company that
has no marginable securities outstanding at the time we purchase
such securities or those that otherwise qualify as an
eligible portfolio company under the 1940 Act.

The SEC has recently issued proposed rules to correct the
unintended consequence of the Federal Reserves 1998 margin
rule amendments of apparently limiting the investment
opportunities of business development companies. In general, the
SECs proposed rules would define an eligible portfolio
company as any company that does not have securities listed on a
national securities exchange or association. We are currently in
the process of reviewing the SECs proposed rules and
assessing its impact, to the extent such proposed rules are
subsequently approved by the SEC, on our investment activities.
We do not believe that these proposed rules will have a material
adverse effect on our operations.

Results may fluctuate and may not be indicative of future
performance. Our operating results may fluctuate and,
therefore, you should not rely on current or historical period
results to be indicative of our performance in future reporting
periods. Factors that could cause operating results to fluctuate
include, but are not limited to, variations in the investment
origination volume and fee income earned, variation in timing of
prepayments, variations in and the timing of the recognition of
net realized gains or losses and changes in unrealized
appreciation or depreciation, the degree to which we encounter
competition in our markets, and general economic conditions.

Our common stock price may be volatile. The trading price
of our common stock may fluctuate substantially. The price of
the common stock may be higher or lower than the price you pay
for your shares, depending on many factors, some of which are
beyond our control and may not be directly related to our
operating performance. These factors include, but are not
limited to, the following:



|  |                                                                                                                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | price and volume fluctuations in the overall stock market from
    time to time;                                                                                                                         
| 
| | significant volatility in the market price and trading volume of
    securities of business development companies or other financial
    services companies;                                             
| 
| | volatility resulting from trading in derivative securities
    related to our common stock including puts, calls, long-term
    equity anticipation securities, or LEAPs, or short trading
    positions;
| 
| | changes in regulatory policies or tax guidelines with respect to
    business development companies or regulated investment companies;                                                                   
| 
| | actual or anticipated changes in our earnings or fluctuations in
    our operating results or changes in the expectations of
    securities analysts;                                                    
| 
| | general economic conditions and trends;                                                                                                                                                                  

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|  |                                   
|- | ----------------------------------
| | loss of a major funding source; or
| 
| | departures of key personnel.      

Item 2. Properties.

Our principal offices are located at 1919 Pennsylvania
Avenue, N.W., Washington, DC 20006-3434. Our lease for
approximately 52,000 square feet of office space at that
location expires in December 2010. The office is equipped with
an integrated network of computers for word processing,
financial analysis, accounting and loan servicing. We believe
our office space is suitable for our needs for the foreseeable
future. We also maintain offices in Chicago, New York, and
Los Angeles.

Item 3. Legal Proceedings.

On June 23, 2004, we were notified by the SEC that they are
conducting an informal investigation of us. On December 22,
2004, we received letters from the U.S. Attorney for the
District of Columbia requesting the preservation and production
of information regarding us and Business Loan Express, LLC in
connection with a criminal investigation. Based on the
information available to us at this time, the inquiries appear
to pertain to matters related to portfolio valuation and our
portfolio company, Business Loan Express, LLC. We are
cooperating with the SECs and the
U.S. Attorneys investigations.

On May 28, 2004, Ferolie Corporation, a food broker with
business and contractual relationships with an entity that is
now affiliated with one of our portfolio companies, Advantage
Sales & Marketing Inc., filed suit against us,
Advantage Sales & Marketing and the affiliated entity
in the United States District Court for the District of Columbia
alleging that, among other things, we and Advantage
Sales & Marketing had tortiously interfered with
Ferolies contract with the affiliated entity by causing
the affiliated entity (i) to breach its obligations to
Ferolie regarding Ferolies participation in a
reorganization transaction involving the affiliated entity and
(ii) to induce clients of Ferolie to transfer their
business to the affiliated entity. Ferolie seeks actual and
punitive damages against us and Advantage Sales &
Marketing and declaratory and injunctive relief. On
July 15, 2004, the United States District Court for the
District of Columbia dismissed the lawsuit for lack of
jurisdiction. On August 17, 2004, Ferolie filed a
Petition to Compel Arbitration in the United States
District Court for the Northern District of Illinois naming us,
Advantage Sales & Marketing and the affiliated entity
as respondents. Ferolie attached to its petition an
Amended Demand for Arbitration and Statement of
Claims that asserts essentially the same claims as were
asserted in the lawsuit that was dismissed by the United States
District Court for the District of Columbia. On October 29,
2004, the United States District Court for the Northern District
of Illinois dismissed Ferolies petition after finding that
Ferolie had failed to adequately allege the existence of subject
matter jurisdiction.

On November 4, 2004, Ferolie refiled its Petition to
Compel Arbitration in the Circuit Court of Cook County,
Illinois. The allegations and relief requested in this
proceeding are identical to the assertions made by Ferolie in
the two previously dismissed proceedings. On February 15,
2005, the Circuit Court of Cook County, Illinois entered an
order denying Ferolies motion for an order compelling the
Company to arbitrate the claims asserted by Ferolie against it.
In the same order, the Circuit Court of Cook County, Illinois
granted Ferolies motion to compel arbitration of the
claims asserted against Advantage Sales & Marketing and the
affiliated entity.

In addition to the above matters, we are party to certain
lawsuits in the normal course of business.

While the outcome of these legal proceedings and other matters
cannot at this time be predicted with certainty, we do not
expect that these matters will have a material effect upon our
financial condition or results of operations.

Item 4. Submission of Matters to a Vote of Security
Holders.

No matters were submitted to a vote of stockholders during
the fourth quarter of 2004.

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PART II

Item 5. Market For Registrants Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity
Securities.

Information in response to this Item is incorporated herein by
reference to the Stockholder Information and to the
Selected Consolidated Financial Data section of our
Annual Report to Stockholders for the year ended
December 31, 2004, (the 2004 Annual Report) as
well as Note 11, Dividends and Distributions
from our Notes to the Consolidated Financial Statements included
in the 2004 Annual Report. The quarterly stock prices quoted
therein represent interdealer quotations and do not include
markups, markdowns, or commissions and may not necessarily
represent actual transactions.

During 2004, we issued 221,531 shares of common stock
pursuant to a dividend reinvestment plan. This plan is not
registered and relies on an exemption from registration under
the Securities Act of 1933. See Note 7,
Shareholders Equity of our Notes to the
Consolidated Financial Statements included in the 2004 Annual
Report for additional information.

On May 26, 2004, we issued 123,814 shares of our common
stock to stockholders of Legacy Partners Group, LLC in
connection with our buyout of Legacy Partners Group, LLC. Such
shares were issued pursuant to an exemption from the
registration requirements of the Securities Act of 1933 under
Section 4(2) of the Securities Act or Regulation D
promulgated thereunder as transactions by an issuer not
involving any public offering.

The following table provides information for the quarter ended
December 31, 2004, regarding shares of our common stock that
were purchased under our Non-Qualified Deferred Compensation
Plan I (DCP I) and Non-Qualified Deferred Compensation Plan
II (DCP II), which are administered by independent third-party
trustees.

|          |                        |              |         |                |  |   |       |       | 
|--------- | ---------------------- | ------------ | ------- | -------------- |  | - | ----- | ----- | 
|          |                        | Total Number |         |               
|          |                        | of Shares    |         | Average Price 
|          |                        | Purchased    |         | Paid Per Share
|          |                        |              |         |               
|DCP I(1)  |                        |              |         |                |  |   |       |      
|         
|         
|         
|         
|          | 10/1/2004  10/31/2004 |              |         | 30             |  |   | $     | 24.99 | 
|         
|         
|         
|         
|          | 11/1/2004  11/30/2004 |              |         |               |  |   |       |      | 
|         
|         
|         
|         
|          | 12/1/2004  12/31/2004 |              |         | 29             |  |   |       | 26.54 | 
|DCP II(2) |                        |              |         |                |  |   |       |      
|         
|         
|         
|         
|          | 10/1/2004  10/31/2004 |              |         | 5,760          |  |   |       | 24.99 | 
|         
|         
|         
|         
|          | 11/1/2004  11/30/2004 |              |         | 77             |  |   |       | 24.99 | 
|         
|         
|         
|         
|          | 12/1/2004  12/31/2004 |              |         | 122,678        |  |   |       | 27.61 | 
|          |                        |              |         |                |  |   |       |      
|Total     |                        |              | 128,574 |                |  | $ | 27.49 |      
|          |                        |              |         |                |  |   |       |      



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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The DCP I is an unfunded plan, as defined by
    the Internal Revenue Code of 1986, that provides for the
    deferral of compensation by our directors, employees, and
    consultants. Our directors, employees, or consultants are
    eligible to participate in the plan at such time and for such
    period as designated by the Board of Directors. The DCP I
    is administered through a trust by an independent third-party
    trustee, and we fund this plan through cash contributions.
    Directors may choose to defer directors fees through the
    DCP I, and may choose to invest such deferred income in
    shares of our common stock. To the extent a director elects to
    invest in our common stock, the trustee of the DCP I will be
    required to use such deferred directors fees to purchase
    shares of our common stock in the market.
|   
|(2) | We have established a long-term incentive
    compensation program whereby we will generally determine an
    individual performance award for certain officers annually at
    the beginning of each year. In conjunction with the program, we
    instituted the DCP II, which is an unfunded plan (as
    defined by the Internal Revenue Code of 1986) that is
    administered through a trust by an independent third-party
    trustee. The individual performance awards are deposited in the
    trust in four equal installments, generally on a quarterly basis
    in the form of cash and the DCP II requires the trustee to
    use the cash to purchase shares of our common stock in the
    market.                                                                                                                                                            

25



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##### 



Item 6. Selected Financial Data.

Information in response to this Item is incorporated herein by
reference to the table in the Selected Consolidated
Financial Data section of the 2004 Annual Report.

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

Information in response to this Item is incorporated herein by
reference to the Managements Discussion and Analysis
of Financial Condition and Results of Operations section
of the 2004 Annual Report.

Item 7A. Quantitative and Qualitative Disclosure about
Market Risk.

Our business activities contain elements of risk. We consider
the principal types of market risk to be fluctuations in
interest rates and treasury rates. We consider the management of
risk essential to conducting our businesses. Accordingly, our
risk management systems and procedures are designed to identify
and analyze our risks, to set appropriate policies and limits
and to continually monitor these risks and limits by means of
reliable administrative and information systems and other
policies and programs.

Because we borrow money to make investments, our net investment
income is dependent upon the difference between the rate at
which we borrow funds and the rate at which we invest these
funds. As a result, there can be no assurance that a significant
change in market interest rates will not have a material adverse
effect on our net investment income. In periods of rising
interest rates, our cost of funds would increase, which would
reduce our net investment income. We use a combination of
long-term and short-term borrowings and equity capital to
finance our investing activities. We utilize our revolving line
of credit as a means to bridge to long-term financing. Our
long-term fixed-rate investments are financed primarily with
long-term fixed-rate debt and equity. We may use interest rate
risk management techniques in an effort to limit our exposure to
interest rate fluctuations. Such techniques may include various
interest rate hedging activities to the extent permitted by the
1940 Act. We have analyzed the potential impact of changes in
interest rates on interest income net of interest expense.
Assuming that the balance sheet were to remain constant and no
actions were taken to alter the existing interest rate
sensitivity, a hypothetical immediate 1% change in interest
rates would have affected the net income by less than 1% over a
one year horizon. Although management believes that this measure
is indicative of our sensitivity to interest rate changes, it
does not adjust for potential changes in credit quality, size
and composition of the assets on the balance sheet and other
business developments that could affect net increase in assets
resulting from operations, or net income. Accordingly, no
assurances can be given that actual results would not differ
materially from the potential outcome simulated by this estimate.

We invest in CMBS and CDO bonds, which were purchased at prices
that are based in part on comparable Treasury rates. The fair
value of these bonds may change as interest rates change over
time. We have entered into transactions with financial
institutions to hedge against movement in Treasury rates on
certain of the higher rated CMBS and CDO bonds. These
transactions, referred to as short sales, involve receiving the
proceeds from the short sales of borrowed Treasury securities,
with the obligations to replenish the borrowed Treasury
securities at a later date based on the then current market
price, whatever that price may be. Risks in these contracts
arise from movements in the value of the borrowed Treasury
securities due to changes in interest rates and from the
possible inability of counterparties to meet the terms of their
contracts.

If the value of the borrowed Treasury securities increases, we
will incur losses on these transactions, which are limited only
by the increase in value of the borrowed Treasury securities;
conversely, the value of the hedged CMBS and CDO bonds would
likely increase. If the value of the borrowed Treasury
Securities decreases, we will incur gains on these transactions
which are limited only by the decline in value of the borrowed
Treasury securities; conversely, the value of the hedged CMBS
and CDO bonds would likely decrease. We do not anticipate
nonperformance by any counterparty in connection with these
transactions.

The total obligations to replenish borrowed Treasury securities,
including accrued interest payable on the obligations, were
$38.2 million and $98.5 million at December 31,
2004 and 2003, respectively. The net

26



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##### 





In addition, we may have risk regarding portfolio valuation. See
Business  Portfolio Valuation above.

Item 8. Financial Statements and Supplementary
Data.

Information in response to this Item is incorporated by
reference to the Consolidated Financial Statements, Notes
thereto, Managements Report on Internal Control Over
Financial Reporting, and Reports of Independent Public
Accountants thereon contained in the 2004 Annual Report.

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

None.

Item 9A. Controls and Procedures.

(a) Evaluation of Controls and Procedures.As
of the end of the year covered by this annual report on
Form 10-K, our Chief Executive Officer and Chief Financial
Officer conducted an evaluation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) of the Securities
Exchange Act of 1934). Based upon this evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely
alerting them of any material information relating to us that is
required to be disclosed by us in the reports we file or submit
under the Securities Exchange Act of 1934.

(b) Managements Report on Internal Controls
over Financial Reporting. Our Management is responsible
for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in
Rule 13a-15(f) under the Securities Act of 1934 and for the
assessment of the effectiveness of internal control over
financial reporting. Managements report on internal
control over financial reporting is set forth under the heading
Managements Report on Internal Control over
Financial Reporting in the Annual Report and is
incorporated herein by reference. Managements assessment
of the effectiveness of our internal control over financial
reporting as of December 31, 2004, has been audited by KPMG
LLP, our independent registered public accounting firm, as
stated in the report that is set forth under the heading
Report of Independent Registered Public Accounting
Firm on page 45 in our 2004 Annual Report and is
incorporated herein by reference.

(c) Attestation Report of the Registered Public
Accounting Firm. Our independent registered public
accounting firm, KPMG LLP, has issued an attestation report on
managements assessment of the Companys internal
control over financial reporting, which is set forth under the
heading Report of Independent Registered Public Accounting
Firm on page 45 in our 2004 Annual Report and is
incorporated herein by reference.

(d) Changes in Internal Controls.There have
been no changes in our internal control over financial reporting
(as defined in Rule 13a-f of the Securities Exchange Act of
1934) that occurred during our most recently completed fiscal
quarter, that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.

Item 9B. Other Information.

Additional Compensation Information

The Compensation Committee has established a long-term incentive
compensation program whereby the Compensation Committee of the
Board of Directors determines an individual performance award
(IPA)for certain officers annually at the beginning
of each year. In determining the award for any one

27



---



##### 





|                                                                         |  |                      |           | 
|------------------------------------------------------------------------ |  | -------------------- | --------- | 
|                                                                         |  | 2005                
|                                                                         |  | Individual          
|Name and Position                                                        |  | Performance Award(1)
|                                                                         |  |                     
|William L. Walton, Chief Executive Officer                               |  | $                    | 1,475,000 | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Joan M. Sweeney, Chief Operating Officer                                 |  |                      | 750,000   | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|John M. Scheurer, Managing Director                                      |  |                      | 550,000   | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|All Executive Officers as a Group (excluding the
    three listed above) |  |                      | 3,385,500 | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Non-Executive Officers as a Group                                        |  |                      | 1,345,000 | 



---

|    |                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents individual performance awards expected
    to be expensed for financial reporting purposes for 2005,
    assuming each participant remains employed by the Company
    throughout the year.

As a result of recent changes in regulation imposed by the Jobs
Creation Act of 2004 associated with deferred compensation
arrangements, as well as an increase in the competitive market
for recruiting and retaining top performers in private equity
firms, the Compensation Committee recommended to the Board and
the Board has approved that for 2005 a portion of the IPA should
be replaced with an individual performance bonus
(IPB). The IPB for 2005 has been determined to be
approximately $7.5 million. The IPB will be distributed in
cash to award recipients in equal bi-weekly installments as long
as each recipient remains employed by the Company. If a
recipient terminates employment during the year, any remaining
cash payments under the IPB would be forfeited. The following
table presents the individual performance bonuses that have been
awarded for 2005 for the three highest paid executive officers,
as well as for other recipients as a group:

|                                                                         |  |                      |           | 
|------------------------------------------------------------------------ |  | -------------------- | --------- | 
|                                                                         |  | 2005                
|                                                                         |  | Individual          
|Name and Position                                                        |  | Performance Bonus(1)
|                                                                         |  |                     
|William L. Walton, Chief Executive Officer                               |  | $                    | 1,475,000 | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Joan M. Sweeney, Chief Operating Officer                                 |  |                      | 750,000   | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|John M. Scheurer, Managing Director                                      |  |                      | 550,000   | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|All Executive Officers as a Group (excluding the
    three listed above) |  |                      | 3,385,500 | 
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Non-Executive Officers as a Group                                        |  |                      | 1,345,000 | 



---

|    |                                                                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents individual performance bonuses
    expected to be expensed for financial reporting purposes for
    2005, assuming each recipient remains employed by the Company
    throughout the year.

PART III

Item 10. Directors and Executive Officers of the
Registrant.

Information in response to this Item is incorporated by
reference to the identification of directors and nominees
contained in the Proposal 1. Election of
Directors section, and the subsections
Proposal 1. Election of Directors 
Section 16(a) Beneficial Ownership Reporting
Compliance, Proposal 1. Election of
Directors  Committees of the Board of Directors
and Proposal 1. Election of Directors 
Information about Executive Officers of our definitive
proxy statement in connection with its 2005 Annual Meeting of
Stockholders, scheduled to be held on May 17, 2005, (the
2005 Proxy Statement).

We have adopted a Code of Business Conduct for all of our
directors and employees, including our Chief Executive Officer
and Chief Financial Officer. We have posted a copy of our Code
of Business Conduct on our website at www.alliedcapital.com. We
will provide you a copy of our Code of Business Conduct

28



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##### 





Any waivers of the Code of Business Conduct must be approved, in
advance, by our Board of Directors. Any amendments to, or
waivers from the Code of Business Conduct that apply to our
executive officers and directors will be posted on our website
located at www.alliedcapital.com.

Our common stock is listed on the New York Stock Exchange
(NYSE). Effective in 2004, the NYSE revised its listing
standards to include comprehensive corporate governance
standards. As part of these revised listing standards, the NYSE
requires the Chief Executive Officer of each listed company to
certify to the NYSE annually, after the companys annual
meeting of stockholders, that the company is in compliance with
the NYSEs corporate governance listing standards. In
accordance with the NYSEs procedures, shortly after our
2004 annual meeting of stockholders, William L. Walton, our
Chairman and Chief Executive Officer, certified to the NYSE that
he was unaware of any violation of the NYSEs corporate
governance listing standards.

Item 11. Executive Compensation.

Information in response to this Item is incorporated by
reference to the subsection Proposal 1. Election of
Directors  Compensation of Directors and Certain
Executive Officers of the 2005 Proxy Statement.

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

Information in response to this Item is incorporated by
reference to the subsections Proxy Statement 
Security Ownership of Management and Certain Beneficial
Owners of the 2005 Proxy Statement.

Item 13. Certain Relationships and Related
Transactions.

Information in response to this Item is incorporated by
reference to the section Proposal 1. Election of
Directors  Certain Relationships and Related
Transactions of the 2005 Proxy Statement.

Item 14. Principal Accountant Fees and Services.

Information in response to this Item is incorporated by
reference to the subsections
Proposal 2. Ratification of Selection of
Independent Registered Public Accounting Firm  Fees
Paid to KPMG LLP for 2004 and 2003 and
Proposal 2. Ratification of Selection of
Independent Registered Public Accounting Firm  Report
of the Audit Committee of the 2005 Proxy Statement.

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a) Documents filed as part of this Report:



| |                                                                                                                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. The following financial statements are incorporated by
    reference from the Consolidated Financial Statements, Notes
    thereto and Reports of Independent Registered Public Accounting
    Firm thereon contained in the Companys 2004 Annual Report,
    filed herewith.

Managements Report on Internal Control over Financial
Reporting.

Reports of Independent Registered Public Accounting Firm.

Consolidated Balance Sheet as of December 31, 2004 and
2003.

Consolidated Statement of Operations for the years ended
December 31, 2004, 2003, and 2002.

29



---



##### 



Consolidated Statement of Changes in Net Assets for the years
ended December 31, 2004, 2003, and 2002.

Consolidated Statement of Cash Flows for the years ended
December 31, 2004, 2003, and 2002.

Consolidated Statement of Investments as of December 31,
2004.

Notes to Consolidated Financial Statements.



| |                                                                       
| | ----------------------------------------------------------------------
| | 2. The following financial statement schedules are filed
    herewith:

Schedule 12-14 of Investments in and Advances to Affiliates.

In addition, there may be additional information not provided
in a schedule because (i) such information is not required
or (ii) the information required has been presented in the
aforementioned financial statements.

30



---



##### 





| |                                                                                                  
| | -------------------------------------------------------------------------------------------------
| | 3. The following exhibits are filed herewith or incorporated by
    reference as set forth below:

|        |         |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------- | ------- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |         |            
|Number  |         | Description
|        |         |            
|        | 3.1     |             |  | Restated Articles of Incorporation.
    (Incorporated by reference to Exhibit a.1 filed with
    Allied Capitals Post-Effective Amendment No. 2 to
    registration statement on Form N-2 (File
    No. 333-67336) filed on March 22, 2002).                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 3.2     |             |  | Amended and Restated Bylaws. (Incorporated by
    reference to Exhibit 3.1. filed with Allied Capitals
    Form 8-K on December 15, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | 4.1     |             |  | Specimen Certificate of Allied Capitals
    Common Stock, par value $0.0001 per share. (Incorporated by
    reference to Exhibit d. filed with Allied Capitals
    registration statement on Form N-2 (File
    No. 333-51899) filed on May 6, 1998).                                                                                                                                                                                                                                                                                                                                                                                               
|        | 4.2     |             |  | Form of debenture between certain subsidiaries of
    Allied Capital and the U.S. Small Business Administration.
    (Incorporated by reference to Exhibit 4.2 filed by a
    predecessor entity to Allied Capital on Form 10-K for the
    year ended December 31, 1996).                                                                                                                                                                                                                                                                                                                                                                            
|        | 10.1    |             |  | Dividend Reinvestment Plan, as amended.
    (Incorporated by reference to Exhibit e. filed with
    Allied Capitals registration statement on Form N-2
    (File No. 333-87862) filed on May 8, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                               
|        | 10.2    |             |  | Third Amended and Restated Credit Agreement,
    dated April 18, 2003. (Incorporated by reference to
    Exhibit 10.2 filed with Allied Capitals
    Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 10.2(a) |             |  | First Amendment to Restated Credit Agreement,
    dated as of October 6, 2003. (Incorporated by reference
    to Exhibit 10.2(a) filed with Allied Capitals
    Form 10-Q for the period ended September 30, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 10.2(b) |             |  | Second Amendment to Credit Agreement, dated as of
    December 17, 2003. (Incorporated by reference to
    Exhibit 10.2(b) filed with Allied Capitals
    Form 10-K for the year ended December 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | 10.2(c) |             |  | Third Amendment to Credit Agreement, dated
    May 28, 2004. (Incorporated by reference to
    Exhibit 10.2(c) filed with Allied Capitals
    Form 10-Q for the period ended June 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 10.3    |             |  | Note Agreement, dated as of April 30, 1998.
    (Incorporated by reference to Exhibit 10.2 filed with
    Allied Capitals Form 10-Q for the period ended
    June 30, 1998).                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        | 10.4    |             |  | Loan Agreement between a predecessor entity to
    Allied Capital and Overseas Private Investment Corporation,
    dated April 10, 1995. (Incorporated by reference to
    Exhibit f.7 filed by a predecessor entity to Allied Capital
    to Pre-Effective Amendment No. 2 to the registration
    statement on Form N-2 (File No. 33-64629) filed on
    January 24, 1996).Letter, dated December 11, 1997,
    evidencing assignment of Loan Agreement from the predecessor
    entity of Allied Capital to Allied Capital. (Incorporated by
    reference to Exhibit 10.3 of Allied Capitals
    Form 10-K for the year ended December 31, 1997).
|        | 10.5    |             |  | Note Agreement, dated as of May 1, 1999.
    (Incorporated by reference to Exhibit 10.5 filed with
    Allied Capitals Form 10-Q for the period ended
    June 30, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 10.11   |             |  | Note Agreement, dated as of November 15,
    1999. (Incorporated by reference to Exhibit 10.4a of
    Allied Capitals Form 10-K for the year ended
    December 31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | 10.12   |             |  | Note Agreement, dated as of October 15,
    2000. (Incorporated by reference to Exhibit 10.4b filed
    with Allied Capitals Form 10-Q for the period ended
    September 30, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

31



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##### 



|        |          |             |  |                                                                                                                                                                                                                                                                                                                                                                 
|------- | -------- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |          |            
|Number  |          | Description
|        |          |            
|        | 10.13    |             |  | Note Agreement, dated as of October 15,
    2001. (Incorporated by reference to Exhibit f.10 filed
    with Allied Capitals Post-Effective Amendment No. 1
    to registration statement on Form N-2 (File
    No. 333-67336) filed on November 14, 2001).                                                                                                     
|        | 10.15    |             |  | Control Investor Guaranty Agreement, dated as of
    March 28, 2001, between Allied Capital and Fleet National
    Bank and Business Loan Express, Inc. (Incorporated by
    reference to Exhibit f.14 filed with Allied Capitals
    Post-Effective Amendment No. 3 to registration statement on
    Form N-2 (File No. 333-43534) filed on May 15,
    2001).
|        | 10.17    |             |  | Non-Qualified Deferred Compensation Plan II.
    (Incorporated by reference to Exhibit A filed with
    Allied Capitals Proxy Statement filed on March 30,
    2004).                                                                                                                                                                                          
|        | 10.18    |             |  | Amended and Restated Deferred Compensation Plan,
    dated January 30, 2004. (Incorporated by reference to
    Exhibit 10.16 filed with Allied Capitals
    Form 10-K for the year ended December 31, 2003).                                                                                                                                                   
|        | 10.19    |             |  | Amended Stock Option Plan. (Incorporated by
    reference to Exhibit B of Allied Capitals definitive
    proxy statement for Allied Capitals 2004 Annual Meeting of
    Stockholders filed on March 30, 2004).                                                                                                                                                
|        | 10.20(a) |             |  | Allied Capital Corporation 401(k) Plan, dated
    September 1, 1999. (Incorporated by reference to
    Exhibit 4.4 filed with Allied Capitals registration
    statement on Form S-8 (File No. 333-88681) filed on
    October 8, 1999).                                                                                                                       
|        | 10.20(b) |             |  | Amendment to Allied Capital Corporation 401(k)
    Plan, dated April 15, 2004. (Incorporated by reference
    to Exhibit 10.20(b) filed with Allied Capitals
    Form 10-Q for the period ended June 30, 2004).                                                                                                                                                
|        | 10.21    |             |  | Employment Agreement, dated January 1, 2004,
    between Allied Capital and William L. Walton.
    (Incorporated by reference to Exhibit 10.21 filed with
    Allied Capitals Form 10-K for the year ended
    December 31, 2003).                                                                                                                             
|        | 10.22    |             |  | Employment Agreement, dated January 1, 2004,
    between Allied Capital and Joan M. Sweeney.
    (Incorporated by reference to Exhibit 10.22 filed with
    Allied Capitals Form 10-K for the year ended
    December 31, 2003).                                                                                                                               
|        | 10.25    |             |  | Form of Custody Agreement with Riggs Bank N.A.
    (Incorporated by reference to Exhibit j.1 filed with
    Allied Capitals registration statement on Form N-2
    (File No. 333-51899) filed on May 6, 1998).                                                                                                                                                 
|        | 10.26    |             |  | Form of Custody Agreement with LaSalle National
    Bank. (Incorporated by reference to Exhibit j.2 filed
    with Allied Capitals registration statement on
    Form N-2 (File No. 333-51899) filed on May 6,
    1998).                                                                                                                                      
|        | 10.27    |             |  | Custodian Agreement with LaSalle National Bank
    Association dated July 9, 2001. (Incorporated by
    reference to Exhibit j.3 filed with Allied Capitals
    registration statement on Form N-2 (File
    No. 333-67336) filed on August 10, 2001).                                                                                                         
|        | 10.28    |             |  | Code of Ethics. (Incorporated by reference to
    Exhibit 10.28 filed with Allied Capitals
    Form 10-K for the year ended December 31, 2003.)                                                                                                                                                                                                                
|        | 10.30    |             |  | Agreement and Plan of Merger by and among Allied
    Capital, Allied Capital Lock Acquisition Corporation, and
    Sunsource, Inc dated June 18, 2001. (Incorporated by
    reference to Exhibit k.1 filed with Allied Capitals
    registration statement on Form N-2 (File
    No. 333-67336) filed on August 10, 2001).                                     
|        | 10.31    |             |  | Note Agreement, dated as of May 14, 2003.
    (Incorporated by reference to Exhibit 10.31 filed with
    Allied Capitals Form 10-Q for the quarter ended
    March 31, 2003.)                                                                                                                                                                                  
|        | 10.32    |             |  | Amendment, dated as of April 30, 2003, to
    Note Agreement, dated as of April 30, 1998.
    (Incorporated by reference to Exhibit 10.32 filed with
    Allied Capitals Form 10-Q for the period ended
    March 31, 2003.                                                                                                                                    

32



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##### 



|        |       |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|------- | ----- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 10.33 |             |  | Amendment, dated as of April 30, 2003, to Note Agreement, dated
    as of May 1, 1999. (Incorporated by reference to
    Exhibit 10.33 filed with Allied Capitals
    Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                             
|        | 10.34 |             |  | Amendment, dated as of April 30, 2003, to Note Agreement, dated
    as of November 15, 1999. (Incorporated by reference to
    Exhibit 10.34 filed with Allied Capitals
    Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                       
|        | 10.35 |             |  | Amendment, dated as of April 30, 2003, to Note Agreement,
    dated as of October 15, 2000. (Incorporated by reference
    to Exhibit 10.35 filed with Allied Capitals
    Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                        
|        | 10.36 |             |  | Amendment, dated as of April 30, 2003, to Note Agreement,
    dated as of October 15, 2001. (Incorporated by reference
    to Exhibit 10.36 filed with Allied Capitals
    Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                        
|        | 10.37 |             |  | Form of Indemnification Agreement between Allied Capital and its
    directors and certain officers. (Incorporated by reference to
    Exhibit 10.37 filed with Allied Capitals
    Form 10-K for the year ended December 31, 2003).                                                                                                                                                                                                                                                                                                                              
|        | 10.38 |             |  | Note Agreement, dated as of March 25, 2004.
    (Incorporated by reference to Exhibit 10.38 filed with
    Allied Capitals Form 10-Q for the period ended
    March 31, 2004.)                                                                                                                                                                                                                                                                                                                                                                                    
|        | 10.39 |             |  | Note Agreement, dated as of November 15, 2004.
    (Incorporated by reference to Exhibit 99.1 filed with
    Allied Capitals current report on Form 8-K filed on
    November 18, 2004.)                                                                                                                                                                                                                                                                                                                                                                          
|        | 11    |             |  | Statement regarding computation of per share earnings is
    incorporated by reference to Note 8 to the Allied
    Capitals Notes to the Consolidated Financial Statements
    contained in Allied Capitals 2004 Annual Report filed as
    Exhibit 13 herewith.                                                                                                                                                                                                                                                                                                 
|        | 13*   |             |  | Excerpts from Allied Capitals 2004 Annual Report to
    Shareholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|        | 21    |             |  | Subsidiaries of Allied Capital and jurisdiction of
    incorporation/organization:     A.C.
    Corporation                                                                 Delaware     Allied
    Investment
    Corporation                                            Maryland     Allied
    Capital REIT,
    Inc.                                                     Maryland     Allied
    Capital Holdings
    LLC                                               Delaware     Allied
    Capital Beteiligungsberatung GmbH
    (inactive)        Germany
|        | 23*   |             |  | Report and Consent of KPMG LLP, independent registered public
    accounting firm.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 31.1* |             |  | Certification of the Chief Executive Officer pursuant to Rule
    13a-14 of the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        | 31.2* |             |  | Certification of the Chief Financial Officer pursuant to Rule
    13a-14 of the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        | 32.1* |             |  | Certification of the Chief Executive Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
    Section 1350.                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 32.2* |             |  | Certification of the Chief Financial Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
    Section 1350.                                                                                                                                                                                                                                                                                                                                                                                                                            



---



|  |                
|- | ---------------
|* | Filed herewith.

33



---



##### 



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused
this Report to be signed on its behalf by the undersigned,
thereunto duly authorized on March 15, 2005.



| |                          
| | -------------------------
| | /s/ WILLIAM L. WALTON    
| |                          
| | William L. Walton        
| | Chairman of the Board and
| | Chief Executive Officer  

Pursuant to the requirements of the Securities Exchange Act of
1934, this Report has been signed below by the following persons
on behalf of the Registrant in the capacities and on the dates
indicated.

|                                           |  |                                                                          |  |               
|------------------------------------------ |  | ------------------------------------------------------------------------ |  | --------------
|                                           |  | Title                                                                    |  |               
|Signature                                  |  | (Capacity)                                                               |  | Date          
|                                           |  |                                                                          |  |               
|/s/ WILLIAM L. WALTONWilliam L. Walton     |  | Chairman and Chief Executive Officer (Principal
    Executive Officer)   |  | March 15, 2005
|                                          
|/s/ BROOKS H. BROWNEBrooks H. Browne       |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ JOHN D. FIRESTONEJohn D. Firestone     |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ ANTHONY T. GARCIAAnthony T. Garcia     |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ ANN TORRE GRANTAnn Torre Grant         |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ LAWRENCE I. HEBERTLawrence I. Hebert   |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ JOHN I. LEAHYJohn I. Leahy             |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ ROBERT E. LONGRobert E. Long           |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ ALEX J. POLLOCKAlex J. Pollock         |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ GUY T. STEUART IIGuy T. Steuart II     |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ JOAN M. SWEENEYJoan M. Sweeney         |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ LAURA W. VAN ROIJENLaura W. van Roijen |  | Director                                                                 |  | March 15, 2005
|                                          
|/s/ PENNI F. ROLLPenni F. Roll             |  | Chief Financial Officer (Principal Financial and
    Accounting Officer) |  | March 15, 2005

34



---



##### 



EXHIBIT INDEX

|        |      |             |  |                                                                                                                                        
|------- | ---- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 13   |             |  | Excerpts from Allied Capitals 2004 Annual
    Report to Shareholders.                                                                 
|        | 23   |             |  | Report and Consent of KPMG LLP, independent
    registered public accounting firm.                                                     
|        | 31.1 |             |  | Certification of the Chief Executive Officer
    pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.                       
|        | 31.2 |             |  | Certification of the Chief Financial Officer
    pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.                       
|        | 32.1 |             |  | Certification of the Chief Executive Officer
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
    18 U.S.C. Section 1350.
|        | 32.2 |             |  | Certification of the Chief Financial Officer
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
    18 U.S.C. Section 1350.

35



---



##### 



Schedule 12-14 ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES PRIVATE FINANCE
        
        
        
        
        **Amount
            of Interest
            or Dividends**Portfolio Company
        
        
        
        
        **Credited**
        
        
        
        December 31, 2003
        
        Gross
        
        Gross
        
        December 31, 2004(in
          thousands)
        
        Investment
          (1)
        
        
        **to
            Income(7)**
        
        **Other(2)**
        
        Value
        
        Additions (3)
        
        Reductions (4)
        
        ValueCompanies
            More Than 25% OwnedACE Products, Inc.
        
        Loan
        
        $
        245
        
        
        
        $
        50
        
        
        $
        
        
        
        $
        (50
        )
        
        $
        (Industrial Products)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Acme Paging, L.P.
        
        Loan(5)
        
        
        
        
        
        
        
        4,496
        
        
        
        135
        
        
        
        (4,631
        )
        
        
        (Telecommunications)
        
        Equity Interests
        
        
        
        
        
        
        
        2,586
        
        
        
        
        
        
        
        (1,356
        )
        
        
        1,230Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Advantage Sales Marketing,
            Inc.
        
        Loan
        
        
        3,724
        
        
        
        
        
        
        
        
        59,729
        
        
        
        
        
        
        
        59,729(Business Services)
        
        Debt Securities
        
        
        11,844
        
        
        
        
        
        
        
        
        125,498
        
        
        
        
        
        
        
        125,498Common Stock
        
        
        
        
        
        
        
        
        
        
        
        97,724
        
        
        
        
        
        
        
        97,724Alaris Consulting,
            LLC
        
        Loan(5)
        
        
        (64)
        
        
        
        
        8,160
        
        
        
        4,310
        
        
        
        (7,807
        )
        
        
        4,663(Business Services)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        American Healthcare
            Services, Inc. and Affiliates
        
        Loan(5)
        
        
        
        
        
        
        
        23,501
        
        
        
        5,744
        
        
        
        (25,020
        )
        
        
        4,225(Healthcare Services)
        
        Debt Securities
        
        
        
        
        
        
        
        8,684
        
        
        
        
        
        
        
        (8,684
        )
        
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Avborne, Inc.
        
        Loan
        
        
        272
        
        177
        
        
        2,863
        
        
        
        
        
        
        
        (1,771
        )
        
        
        1,092(Business Services)
        
        Preferred Stock
        
        
        
        
        
        
        
        2,300
        
        
        
        5,020
        
        
        
        
        
        
        
        7,320Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Avborne Heavy Maintenance,
            Inc.
        
        Preferred Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        (Business Services)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Business Loan Express,
            LLC
        
        Loan
        
        
        2
        
        
        
        
        
        
        
        
        10,000
        
        
        
        (10,000
        )
        
        
        (Financial Services)
        
        Debt Securities
        
        
        10,577
        
        
        
        
        40,044
        
        
        
        4,571
        
        
        
        
        
        
        
        44,615Class A Equity Interests
        
        
        12,676
        
        
        
        
        47,800
        
        
        
        6,062
        
        
        
        
        
        
        
        53,862Class B Equity Interests *
        
        
        14,750
        
        
        
        
        99,386
        
        
        
        14,750
        
        
        
        (15,395
        )
        
        
        98,741Class C Equity Interests
        
        
        
        
        39
        
        
        154,960
        
        
        
        
        
        
        
        (16,972
        )
        
        
        137,988Callidus Capital
            Corporation
        
        Loan
        
        
        273
        
        
        
        
        
        
        
        
        42,213
        
        
        
        
        
        
        
        42,213(Financial Services)
        
        Loan
        
        
        63
        
        
        
        
        
        
        
        
        1,391
        
        
        
        (1,325
        )
        
        
        66Debt Securities
        
        
        734
        
        
        
        
        3,500
        
        
        
        551
        
        
        
        
        
        
        
        4,051Common Stock
        
        
        
        
        
        
        
        1,768
        
        
        
        1,832
        
        
        
        
        
        
        
        3,600Chickasaw Sales &
            Marketing, Inc.
        
        Preferred Stock
        
        
        
        
        
        
        
        
        
        
        
        1,000
        
        
        
        (1,000
        )
        
        
        (Consumer Services)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        2,812
        
        
        
        (2,812
        )
        
        
        The Color Factory,
            Inc.
        
        Loan
        
        
         
        
        
        
        
        6,952
        
        
        
        1,812
        
        
        
        (8,764
        )
        
        
        (Consumer
            Products)
        
        Preferred Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Fairchild Industrial
            Products Company
        
        Loan
        
        
        261
        
        
        
        
        7,166
        
        
        
        264
        
        
        
        (392
        )
        
        
        7,038(Industrial Products)
        
        Debt Securities
        
        
        198
        
        
        
        
        3,534
        
        
        
        2,420
        
        
        
        (2,121
        )
        
        
        3,833Common Stock
        
        
        
        
        
        
        
        
        
        
        
        2,841
        
        
        
        (718
        )
        
        
        2,123Financial Pacific
            Company
        
        Loan
        
        
        4,987
        
        
        
        
        
        
        
        
        68,473
        
        
        
        
        
        
        
        68,473(Financial Services)
        
        Preferred Stock *
        
        
        327
        
        
        
        
        
        
        
        
        10,448
        
        
        
        
        
        
        
        10,448Common Stock
        
        
        
        
        
        
        
        
        
        
        
        14,819
        
        
        
        
        
        
        
        14,819ForeSite Towers,
            LLC
        
        Equity Interests *
        
        
        366
        
        
        
        
        17,638
        
        
        
        3,873
        
        
        
        
        
        
        
        21,511(Tower Leasing)GAC Investments,
            Inc.
        
        Loan(5)
        
        
        
        
        
        
        
        
        
        
        
        11,000
        
        
        
        (3,483
        )
        
        
        7,517(Broadcasting &
            Cable)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        43,353
        
        
        
        (43,353
        )
        
        
        Global Communications,
            LLC
        
        Loan
        
        
        507
        
        
        
        
        2,350
        
        
        
        3,919
        
        
        
        
        
        
        
        6,269(Business Services)
        
        Debt Securities
        
        
        2,842
        
        
        
        
        17,247
        
        
        
        946
        
        
        
        
        
        
        
        18,193Preferred Equity Interest
        
        
        
        
        
        
        
        18,351
        
        
        
        
        
        
        
        (3,742
        )
        
        
        14,609Options
        
        
        
        
        
        
        
        1,639
        
        
        
        522
        
        
        
        
        
        
        
        2,161Gordian Group, Inc.
        
        Loan(5)
        
        
        (19)
        
        664
        
        
        9,382
        
        
        
        3,080
        
        
        
        (5,081
        )
        
        
        7,381(Business Services)
        
        Common Stock
        
        
        
        
        
        
        
        4,000
        
        
        
        3,435
        
        
        
        (7,435
        )
        
        
        HealthASPex, Inc.
        
        Preferred Stock
        
        
        
        
        
        
        
        700
        
        
        
        
        
        
        
        
        
        
        
        700(Business Services)
        
        Preferred Stock
        
        
        
        
        
        
        
        2,650
        
        
        
        
        
        
        
        (897
        )
        
        
        1,753Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        The Hillman Companies,
            Inc.
        
        Debt Securities
        
        
        2,091
        
        
        
        
        43,965
        
        
        
        604
        
        
        
        (44,569
        )
        
        
        (Consumer Products)
        
        Common Stock
        
        
        
        
        
        
        
        190,577
        
        
        
        
        
        
        
        (190,577
        )
        
        
        HMT, Inc.
        
        Debt Securities
        
        
        1,478
        
        
        
        
        9,186
        
        
        
        128
        
        
        
        
        
        
        
        9,314(Energy Services)
        
        Preferred Stock *
        
        
        150
        
        
        
        
        2,303
        
        
        
        234
        
        
        
        
        
        
        
        2,537Common Stock
        
        
        
        
        
        
        
        4,264
        
        
        
        
        
        
        
        (654
        )
        
        
        3,610Warrants
        
        
        
        
        
        
        
        1,641
        
        
        
        
        
        
        
        (251
        )
        
        
        1,390Housecall Medical
            Resources, Inc.
        
        Loan
        
        
        2,668
        
        
        
        
        15,242
        
        
        
        368
        
        
        
        
        
        
        
        15,610(Healthcare Services)
        
        Preferred Stock
        
        
        
        
        3,889
        
        
        3,889
        
        
        
        
        
        
        
        (3,889
        )
        
        
        Common Stock
        
        
        
        
        
        
        
        23,000
        
        
        
        8,898
        
        
        
        
        
        
        
        31,898Impact
            Innovations Group, LLC
        
        Equity Interests in Affiliate
        
        
        
        
        
        
        
        
        
        
        
        15,528
        
        
        
        (14,756
        )
        
        
        772(Business
            Services)
        
        Warrants
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Insight Pharmaceuticals Corporation
        
        Senior Loan
        
        
        21
        
        
        
        
        
        
        
        
        66,115
        
        
        
        
        
        
        
        66,115(Consumer
            Products)
        
        Loan
        
        
        18
        
        
        
        
        
        
        
        
        57,213
        
        
        
        
        
        
        
        57,213Preferred Stock
        
        
        
        
        
        
        
        
        
        
        
        25,000
        
        
        
        
        
        
        
        25,000Common Stock
        
        
        
        
        
        
        
        
        
        
        
        6,325
        
        
        
        
        
        
        
        6,325
 This schedule should be read in conjunction with the Companys consolidated financial statements as of and for the year ended December 31, 2004, including the consolidated statement of investments and Note 3 to the consolidated financial statements. Note 3 includes additional information regarding activities in the private finance portfolio for the year ended December 31, 2004. (1) Common stock, preferred stock,
    warrants, options, and equity interests are generally non-income producing
    and restricted. The principal amount for loans and debt securities and the
    number of shares of common stock and preferred stock is shown in the consolidated
    statement of investments as of December 31, 2004. (2) Other includes interest,
dividend, or other income which was applied to the principal of the
investment and therefore reduced the total investment. These
reductions are also included in the Gross Reductions for the
investment, as applicable. (3) Gross additions include increases
     in the cost basis of investments resulting from new portfolio investments,
    paid-in-kind interest or dividends, the amortization of discounts and closing
     fees, and the exchange of one or more existing securities for one or more
    new securities. Gross additions also include net increases in unrealized
    appreciation  or net decreases in unrealized depreciation. (4) Gross reductions include decreases
     in the cost basis of investments resulting from principal collections related
    to investment repayments or sales and the exchange of one or more existing
     securities for one or more new securities. Gross reductions also include
    net increases in unrealized depreciation or net decreases in unrealized appreciation. (5) Loan or debt security is on
    non-accrual status at December 31, 2004, and is therefore considered non-income
    producing. Loans or debt securities on non-accrual status at the end of the
    year may or may not have been on non-accrual status for the full year ended
    December 31, 2004. (6) Data is included for these
    companies less than 5% owned at December 31, 2004, as these companies were
    included in the companies 5% to 25% owned category during the past year, however,
    due to changes in affiliation status were classified in the less than 5% owned
    category at December 31, 2004. (7) Represents the total amount of
interest or dividends credited to income
  for the portion of the year an investment was included in the companies more than
25% owned or
companies 5% to 25% owned categories, respectively. * All or a portion of the dividend income on this investment
was or will be paid in the form of additional securities. Dividends paid-in-kind are also included in the
Gross Additions for the investment, as applicable.




---



##### 



PRIVATE FINANCE
        
        
        
        
        **Amount
            of Interest
            or Dividends**Portfolio Company
        
        
        
        
        **Credited**
        
        
        
        December 31, 2003
        
        Gross
        
        Gross
        
        December 31, 2004(in
          thousands)
        
        Investment
          (1)
        
        
        **to
            Income(7)**
        
        **Other(2)**
        
        Value
        
        Additions (3)
        
        Reductions (4)
        
        ValueJakel, Inc.
        
        Loan (5)
        
        $
        461
        
        
        
        $
        2,062
        
        
        $
        3,350
        
        
        $
        
        
        
        $
        5,412(Industrial Products)
        
        Debt Securities (5)
        
        
        1,007
        
        
        
        
        7,770
        
        
        
        560
        
        
        
        
        
        
        
        8,330Preferred Stock
        
        
        
        
        
        
        
        4,069
        
        
        
        
        
        
        
        (3,233
        )
        
        
        836Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Legacy Partners Group,
            LLC
        
        Loan (5)
        
        
        147
        
        
        
        
        
        
        
        
        6,647
        
        
        
        
        
        
        
        6,647(Financial Service)
        
        Debt Securities (5)
        
        
        152
        
        
        
        
        
        
        
        
        2,952
        
        
        
        (1,056
        )
        
        
        1,896Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        2,729
        
        
        
        (2,729
        )
        
        
        Litterer Beteiligungs-GmbH
        
        Debt Securities
        
        
        31
        
        
        
        
        1,379
        
        
        
        52
        
        
        
        (716
        )
        
        
        715(Business Service)
        
        Equity Interest
        
        
        
        
        
        
        
        
        
        
        
        2,656
        
        
        
        (60
        )
        
        
        2,596Maui Body Works,
            Inc.
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        2,500
        
        
        
        (1,420
        )
        
        
        1,080(Healthcare Services)Mercury Air Centers,
            Inc.
        
        Senior Loan
        
        
        1,470
        
        
        
        
        
        
        
        
        20,000
        
        
        
        
        
        
        
        20,000(Business
        Services)
        
        Loan
        
        
        4,020
        
        
        
        
        
        
        
        
        34,613
        
        
        
        
        
        
        
        34,613Common Stock
        
        
        
        
        
        
        
        
        
        
        
        31,214
        
        
        
        
        
        
        
        31,214MVL Group, Inc.
        
        Loan
        
        
        2,517
        
        
        
        
        19,075
        
        
        
        54
        
        
        
        (3,473
        )
        
        
        15,656(Business Services)
        
        Debt Securities
        
        
        2,681
        
        
        
        
        16,787
        
        
        
        739
        
        
        
        
        
        
        
        17,526Common Stock
        
        
        
        
        
        
        
        643
        
        
        
        9,157
        
        
        
        
        
        
        
        9,800Pennsylvania Avenue
            Investors, L.P.
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        1,027
        
        
        
        (235
        )
        
        
        792(Private Equity Fund)Powell Plant Farms,
            Inc.
        
        Loan
        
        
        4,290
        
        
        
        
        21,542
        
        
        
        11,500
        
        
        
        (9,850
        )
        
        
        23,192(Consumer Products)
        
        Debt Securities (5)
        
        
        
        
        
        
        
        11,692
        
        
        
        
        
        
        
        (1,104
        )
        
        
        10,588Preferred Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Warrants
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Redox Brands, Inc.
        
        Loan
        
        
        627
        
        
        
        
        3,127
        
        
        
        198
        
        
        
        
        
        
        
        3,325(Consumer Products)
        
        Debt Securities
        
        
        1,887
        
        
        
        
        10,243
        
        
        
        429
        
        
        
        
        
        
        
        10,672Preferred Stock
        
        
        458
        
        
        
        
        6,965
        
        
        
        4,699
        
        
        
        
        
        
        
        11,664Warrants
        
        
        
        
        
        
        
        584
        
        
        
        
        
        
        
        
        
        
        
        584Staffing Partners
            Holding Company, Inc.
        
        Loan (5)
        
        
        
        
        
        
        
        
        
        
        
        1,000
        
        
        
        
        
        
        
        1,000(Business Services)
        
        Debt Securities (5)
        
        
        216
        
        
        
        
        5,794
        
        
        
        290
        
        
        
        
        
        
        
        6,084Preferred Stock
        
        
        
        
        
        
        
        2,018
        
        
        
        
        
        
        
        (57
        )
        
        
        1,961Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Warrants
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Startec
            Global Communications Corporation
        
        Loan
        
        
        992
        
        
        
        
        22,170
        
        
        
        4,022
        
        
        
        (9,671
        )
        
        
        16,521(Telecommunications)
        
        Debt Securities
        
        
        (649)
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        37,255
        
        
        
        (29,455
        )
        
        
        7,800STS Operating, Inc.
        
        Preferred Stock
        
        
        412
        
        
        
        
        6,473
        
        
        
        576
        
        
        
        (773
        )
        
        
        6,276(Industrial
            Products)
        
        Common Stock
        
        
        
        
        
        
        
        3,700
        
        
        
        5,932
        
        
        
        
        
        
        
        9,632Options
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Sure-Tel, Inc.
        
        Preferred Stock
        
        
        
        
        
        
        
        1,000
        
        
        
        
        
        
        
        (1,000
        )
        
        
        (Consumer Services)
        
        Common Stock
        
        
        
        
        
        
        
        320
        
        
        
        
        
        
        
        (320
        )
        
        
        Total companies more than 25% owned
        
        
        
        

$91,710
        
        
        
        
        
        
        
        
        
        
        
        ****
        
        ****
        
        **$**
        **1,359,641**Companies 5% to 25% OwnedAir Evac Lifeteam
        
        Debt Securities
        
        $
        2,455
        
        
        
        $
        
        
        
        $
        39,964
        
        
        $
        
        
        
        $
        39,964(Healthcare Services)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        3,000
        
        
        
        (1,908
        )
        
        
        1,092Aspen Pet Products,
            Inc.
        
        Loans
        
        
        3,558
        
        
        
        
        17,675
        
        
        
        1,109
        
        
        
        
        
        
        
        18,784(Consumer Products)
        
        Preferred Stock
        
        
        
        
        
        
        
        845
        
        
        
        79
        
        
        
        (27
        )
        
        
        897Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Warrants
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Becker Underwood,
            Inc.
        
        Loan
        
        
        1,144
        
        
        
        
        
        
        
        
        22,939
        
        
        
        
        
        
        
        22,939(Industrial Products)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        5,000
        
        
        
        
        
        
        
        5,000Border Foods, Inc.
        
        Loan
        
        
        396
        
        
        
        
        3,000
        
        
        
        
        
        
        
        
        
        
        
        3,000(Consumer Products)
        
        Debt Securities
        
        
        1,375
        
        
        
        
        9,454
        
        
        
        56
        
        
        
        
        
        
        
        9,510Preferred Stock
        
        
        
        
        
        
        
        2,000
        
        
        
        
        
        
        
        
        
        
        
        2,000Common Stock
        
        
        
        
        
        
        
        71
        
        
        
        
        
        
        
        (71
        )
        
        
        Warrants
        
        
        
        
        
        
        
        1,059
        
        
        
        
        
        
        
        (1,059
        )
        
        
        CBA-Mezzanine Capital
            Finance, LLC
        
        Loan
        
        
        467
        
        
        
        
        16,185
        
        
        
        1,028
        
        
        
        (17,213
        )
        
        
        (Financial Services)CorrFlex Graphics,
            LLC
        
        Debt Securities
        
        
        952
        
        
        
        
        12,699
        
        
        
        419
        
        
        
        (13,118
        )
        
        
        (Business Services)
        
        Warrants
        
        
        
        
        
        
        
        18,411
        
        
        
        
        
        
        
        (18,411
        )
        
        
        Options
        
        
        
        
        
        
        
        1,589
        
        
        
        
        
        
        
        (1,589
        )
        
        
        The Debt Exchange
            Inc.
        
        Preferred Stock
        
        
        75
        
        
        
        
        1,250
        
        
        
        207
        
        
        
        
        
        
        
        1,457(Business Services)GFC Holdings, LLC
        
        Warrants
        
        
        
        
        
        
        
        
        
        
        
        800
        
        
        
        (800
        )
        
        
        (Business Services)Liberty-Pittsburgh
            Systems, Inc.
        
        Debt Securities
        
        
        
        
        
        
        
        2,454
        
        
        
        658
        
        
        
        (3,112
        )
        
        
        (Business Services)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        MasterPlan, Inc.
        
        Loan
        
        
        147
        
        
        
        
        959
        
        
        
        245
        
        
        
        
        
        
        
        1,204(Business Services)
        
        Common Stock
        
        
        
        
        
        
        
        200
        
        
        
        3,100
        
        
        
        
        
        
        
        3,300MedBridge Healthcare,
            LLC
        
        Loan
        
        
        208
        
        
        
        
        
        
        
        
        11,311
        
        
        
        
        
        
        
        11,311(Healthcare Services)
        
        ConvertibleDebenture (5)
        
        
        
        
        
        
        
        
        
        
        
        1,015
        
        
        
        (337
        )
        
        
        678MortgageRamp,
            Inc.
        
        Common Stock
        
        
        
        
        
        
        
        2,084
        
        
        
        
        
        
        
        (1,181
        )
        
        
        903(Business Services)
 This schedule should be read in conjunction with the Companys consolidated financial statements as of and for the year ended December 31, 2004, including the consolidated statement of investments and Note 3 to the consolidated financial statements. Note 3 includes additional information regarding activities in the private finance portfolio for the year ended December 31, 2004. (1) Common stock, preferred stock,
    warrants, options, and equity interests are generally non-income producing
    and restricted. The principal amount for loans and debt securities and the
    number of shares of common stock and preferred stock is shown in the consolidated
    statement of investments as of December 31, 2004. (2) Other includes interest,
dividend, or other income which was applied to the principal of the
investment and therefore reduced the total investment. These
reductions are also included in the Gross Reductions for the
investment, as applicable. (3) Gross additions include increases
     in the cost basis of investments resulting from new portfolio investments,
    paid-in-kind interest or dividends, the amortization of discounts and closing
     fees, and the exchange of one or more existing securities for one or more
    new securities. Gross additions also include net increases in unrealized
    appreciation  or net decreases in unrealized depreciation. (4) Gross reductions include decreases
     in the cost basis of investments resulting from principal collections related
    to investment repayments or sales and the exchange of one or more existing
     securities for one or more new securities. Gross reductions also include
    net increases in unrealized depreciation or net decreases in unrealized appreciation. (5) Loan or debt security is on
     non-accrual status at December 31, 2004, and is therefore considered non-income
    producing. Loans or debt securities on non-accrual status at the
end of the year may or may not have been on non-accrual status for
the full year ended December 31, 2004. (6) Data
    is included for these companies
    less than 5% owned at December 31, 2004, as these companies were included
    in the companies 5% to 25% owned category during the
    past year, however, due to changes in affiliation status were classified
    in the less than 5% owned category at December 31, 2004. (7) Represents the total amount of
interest or dividends credited to income
  for the portion of the year an investment was included in the companies more than
25% owned or
companies 5% to 25% owned categories, respectively. * All or a portion of the dividend income on this investment
was or will be paid in the form of additional securities. Dividends paid-in-kind are also included in the
Gross Additions for the investment, as applicable.




---



##### 





PRIVATE FINANCE
        
        
        
        
        **Amount
            of Interest
            or Dividends**Portfolio Company
        
        
        
        
        **Credited**
        
        
        
        December 31, 2003
        
        
        Gross
        
        
        Gross
        
        
        December 31, 2004(in
          thousands)
        
        Investment
          (1)
        
        
        **to
            Income (7)**
        
        **Other
            (2)**
        
        Value
        
        
        Additions
          (3)
        
        
        Reductions
          (4)
        
        
        ValueNexcel Synthetics,
            LLC
        
        Loan
        
        $
        2,158
        
        
        
        $
        
        
        
        $
        10,211
        
        
        $
        
        
        
        $
        10,211(Consumer Products)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        1,690
        
        
        
        (1,003
        )
        
        
        687Packaging Advantage
            Corporation
        
        Debt Securities
        
        
        1,800
        
        75
        
        
        14,350
        
        
        
        456
        
        
        
        (75
        )
        
        
        14,731(Business Services)
        
        Common Stock
        
        
        
        
        
        
        
        1,069
        
        
        
        410
        
        
        
        
        
        
        
        1,479Warrants
        
        
        
        
        
        
        
        431
        
        
        
        166
        
        
        
        
        
        
        
        597Pres Air Trol LLC
        
        Debt Securities
        
        
        582
        
        
        
        
        
        
        
        
        6,521
        
        
        
        (500
        )
        
        
        6,021(Industrial Products)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        1,323
        
        
        
        (423
        )
        
        
        900Professional Paint,
            Inc.
        
        Loan
        
        
        736
        
        
        
        
        4,976
        
        
        
        346
        
        
        
        (5,322
        )
        
        
        (Consumer Products)
        
        Debt Securities
        
        
        3,428
        
        
        
        
        24,258
        
        
        
        1,566
        
        
        
        (25,824
        )
        
        
        Preferred Stock
        
        
        2,257
        
        
        
        
        22,156
        
        
        
        2,955
        
        
        
        (25,111
        )
        
        
        Common Stock
        
        
        
        
        
        
        
        5,500
        
        
        
        
        
        
        
        (5,500
        )
        
        
        Progressive International
            Corporation
        
        Debt Securities
        
        
        678
        
        
        
        
        3,977
        
        
        
        23
        
        
        
        (4,000
        )
        
        
        (Consumer Products)
        
        Loan
        
        
        658
        
        
        
        
        
        
        
        
        7,221
        
        
        
        
        
        
        
        7,221Preferred Stock
        
        
        
        
        
        
        
        707
        
        
        
        
        
        
        
        (121
        )
        
        
        586Common Stock
        
        
        
        
        
        
        
        668
        
        
        
        
        
        
        
        (655
        )
        
        
        13Warrants
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Soteria Imaging Services,
            LLC
        
        Loan
        
        
        168
        
        
        
        
        
        
        
        
        8,340
        
        
        
        
        
        
        
        8,340(Healthcare Services)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        2,114
        
        
        
        
        
        
        
        2,114Total Foam, Inc.
        
        Debt Securities
        
        
        
        
        52
        
        
        105
        
        
        
        
        
        
        
        (105
        )
        
        
        (Industrial Products)
        
        Common Stock
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Universal Environmental
            Services, LLC
        
        Loan
        
        
        670
        
        
        
        
        
        
        
        
        12,099
        
        
        
        
        
        
        
        12,099(Business Services)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        1,864
        
        
        
        
        
        
        
        1,864Total companies 5% to 25% owned
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        $
        188,902**Companies less than 5% owned (6)**Apogen Technologies
            Inc. (f/k/a Sidarus Holdings, Inc.)
        
        Debt Securities
        
        
        90
        
        
        
        
        4,978
        
        
        
        4
        
        
        
        
        
        
        
        4,982(Business Services)
        
        Preferred Stock
        
        
        
        
        
        
        
        980
        
        
        
        2,175
        
        
        
        
        
        
        
        3,155Common Stock
        
        
        
        
        
        
        
        896
        
        
        
        1,399
        
        
        
        
        
        
        
        2,295Warrants
        
        
        
        
        
        
        
        5
        
        
        
        443
        
        
        
        
        
        
        
        448EDM Consulting, LLC
        
        Debt Securities
        
        
        
        
        1
        
        
        218
        
        
        
        
        
        
        
        (218
        )
        
        
        (Business Services)
        
        Equity Interests
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        Loan
        
        
        
        
        
        
        
        
        
        
        
        100
        
        
        
        
        
        
        
        100International Fiber Corporation
        
        Debt Securities
        
        
        1,502
        
        
        
        
        22,828
        
        
        
        510
        
        
        
        (23,338
        )
        
        
        (Industrial Products)
        
        Common Stock
        
        
        
        
        
        
        
        6,816
        
        
        
        
        
        
        
        (6,816
        )
        
        
        Warrants
        
        
        
        
        
        
        
        684
        
        
        
        
        
        
        
        (684
        )
        
        
        Debt Securities
        
        
        
        
        
        
        
        
        
        
        
        21,016
        
        
        
        
        
        
        
        21,016Preferred Stock
        
        
        
        
        
        
        
        
        
        
        
        2,500
        
        
        
        
        
        
        
        2,500Nobel Learning
            Communities, Inc.
        
        Debt Securities
        
        
        172
        
        
        
        
        9,838
        
        
        
        162
        
        
        
        (10,000
        )
        
        
        (Education)
        
        Preferred Stock *
        
        
        26
        
        
        
        
        2,764
        
        
        
        
        
        
        
        
        
        
        
        2,764Warrants
        
        
        
        
        
        
        
        166
        
        
        
        142
        
        
        
        
        
        
        
        308Total
        
        
        
        $
        25,702


This schedule should be read in conjunction with the Companys consolidated financial statements as of and for the year ended December 31, 2004, including the consolidated statement of investments and Note 3 to the consolidated financial statements. Note 3 includes additional information regarding activities in the private finance portfolio for the year ended December 31, 2004.

(1) Common stock, preferred stock,
    warrants, options, and equity interests are generally non-income producing
    and restricted. The principal amount for loans and debt securities and the
    number of shares of common stock and preferred stock is shown in the consolidated
    statement of investments as of December 31, 2004.

(2) Other includes interest,
dividend, or other income which was applied to the principal of the
investment and therefore reduced the total investment. These
reductions are also included in the Gross Reductions for the
investment, as applicable.

(3) Gross additions include increases
     in the cost basis of investments resulting from new portfolio investments,
    paid-in-kind interest or dividends, the amortization of discounts and closing
     fees, and the exchange of one or more existing securities for one or more
    new securities. Gross additions also include net increases in unrealized
    appreciation  or net decreases in unrealized depreciation.

(4) Gross reductions include decreases
     in the cost basis of investments resulting from principal collections related
    to investment repayments or sales and the exchange of one or more existing
     securities for one or more new securities. Gross reductions also include
    net increases in unrealized depreciation or net decreases in unrealized appreciation.

(5) Loan or debt security is on
     non-accrual status at December 31, 2004, and is therefore considered non-income
    producing. Loans or debt securities on non-accrual status at the
end of the year may or may not have been on non-accrual status for
the full year ended December 31, 2004.

(6) Data
    is included for these companies
    less than 5% owned at December 31, 2004, as these companies were included
    in the companies 5% to 25% owned category during the
    past year, however, due to changes in affiliation status were classified
    in the less than 5% owned category at December 31, 2004.

(7) Represents the total amount
    of interest or dividends credited to income for the portion of the year an
    investment was included in the companies more than 25% owned or companies
    5% to 25% owned categories, respectively.

* All or a portion of the dividend income on this investment
was or will be paid in the form of additional securities. Dividends paid-in-kind are also included in the
Gross Additions for the investment, as applicable.