Filed Pursuant to Rule 497
Securities Act File No. 333-216138

The information in this preliminary prospectus supplement is not complete and may be changed. A registration statement relating to these securities has been filed with and declared effective by the Securities and Exchange Commission. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell and are not soliciting offers to buy these securities in any state where such offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED MARCH 14, 2019

PRELIMINARY PROSPECTUS SUPPLEMENT
(to Prospectus dated June 29, 2018)

2,750,000 Shares

Stellus Capital Investment Corporation

Common Stock



 

We are offering for sale 2,750,000 shares of our common stock. The underwriters have agreed to purchase shares of our common stock from us at a price of $     per share which will result in approximately $     million of net proceeds, after deducting estimated offering expenses, to us, or $     million assuming full exercise of the underwriters’ option to purchase additional shares described below. We expect that our expenses for this offering will be approximately $135,000.

The underwriters may also exercise their option to purchase up to an additional 412,500 shares of common stock from us, at the price per share set forth above, for 30 days after the date of this prospectus supplement.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating below investment grade (i.e., below BBB or Baa), which are often referred to as “junk.”

Our common stock is listed on the New York Stock Exchange, or NYSE, under the trading symbol “SCM.” The last sale price, as reported on NYSE on March 13, 2019, was $14.68 per share. The net asset value per share of our common stock at December 31, 2018 (the last date prior to the date of this prospectus supplement on which we determined net asset value) was $14.09.

Shares of closed-end investment companies, including BDCs, frequently trade at a discount to their net asset value. If our shares trade at a discount to our net asset value, it will likely increase the risk of loss for purchasers in this offering.

This prospectus supplement and the accompanying prospectus, contain important information about us that a prospective investor should know before investing in our common stock. Please read this prospectus supplement and the accompanying prospectus before you invest and keep it for future reference. We file annual, quarterly and current reports, proxy statements and other information about us with the Securities and Exchange Commission, or the SEC. The SEC also maintains a website at http://www.sec.gov that contains such information. This information is also available free of charge by contacting us at 4400 Post Oak Parkway, Suite 2200, Houston, Texas 77027, Attention: Investor Relations, or by calling us collect at (713) 292-5400 or on our website at www.stelluscapital.com. Information contained on our website is not incorporated by reference into this prospectus, and you should not consider that information to be part of this prospectus supplement and the accompanying prospectus.

Investing in our common stock involves a high degree of risk. Before buying any shares, you should read the discussion of the material risks of investing in our common stock in “Risk Factors” beginning on page 17 of the accompanying prospectus.

Neither the SEC nor any state securities commission has approved or disapproved of these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.



 

 
Per Share   Total
Public offering price
Sales load to be paid by us (1)
Proceeds to us before expenses (2)     

(1) Stellus Capital Management, LLC has agreed to bear $    , or $     per share, of the sales load in connection with the shares of our common stock sold in this offering, which is not reflected in the above table. If the underwriters exercise their option to purchase additional shares in full, Stellus Capital Management, LLC will bear $    , or $     per share.
(2) Before deducting estimated offering expenses payable by us of approximately $135,000.

The underwriters have the option to purchase up to an additional 412,500 shares of common stock at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus supplement. If the option is exercised in full, the total public offering price will be $   , and the total underwriting discount (    %) will be $    . The proceeds to us would be $    , before deducting estimated expenses payable by us of $135,000.

Joint Bookrunning Managers

   
RAYMOND JAMES   Keefe, Bruyette & Woods
                            A Stifel Company
  Goldman Sachs & Co. LLC

The date of this prospectus supplement is March   , 2019


 
 

TABLE OF CONTENTS

TABLE OF CONTENTS

Prospectus Supplement

 
  Page
PROSPECTUS SUPPLEMENT SUMMARY     S-1  
THE OFFERING     S-10  
FEES AND EXPENSES     S-12  
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS     S-15  
USE OF PROCEEDS     S-16  
CAPITALIZATION     S-17  
SELECTED FINANCIAL AND OTHER DATA     S-18  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     S-19  
SENIOR SECURITIES     S-38  
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS     S-40  
UNDERWRITING     S-42  
LEGAL MATTERS     S-47  
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     S-47  
AVAILABLE INFORMATION     S-47  

Prospectus

 
PROSPECTUS SUMMARY     1  
THE OFFERING     9  
FEES AND EXPENSES     13  
SELECTED FINANCIAL DATA     16  
RISK FACTORS     17  
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS     47  
USE OF PROCEEDS     48  
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS     49  
RATIOS OF EARNINGS TO FIXED CHARGES     52  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     53  
SENIOR SECURITIES     71  
THE COMPANY     73  
PORTFOLIO COMPANIES     86  
MANAGEMENT     96  
MANAGEMENT AGREEMENTS     105  
RELATED PARTY TRANSACTIONS AND CERTAIN RELATIONSHIPS     115  
CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS     117  
DETERMINATION OF NET ASSET VALUE     119  
SALES OF COMMON STOCK BELOW NET ASSET VALUE     122  
DIVIDEND REINVESTMENT PLAN     127  

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MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS     129  
DESCRIPTION OF OUR COMMON STOCK     136  
DESCRIPTION OF OUR PREFERRED STOCK     142  
DESCRIPTION OF OUR SUBSCRIPTION RIGHTS     143  
DESCRIPTION OF OUR DEBT SECURITIES     145  
DESCRIPTION OF OUR WARRANTS     158  
REGULATION     160  
PLAN OF DISTRIBUTION     165  
CUSTODIAN, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR     166  
BROKERAGE ALLOCATION AND OTHER PRACTICES     166  
LEGAL MATTERS     166  
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     167  
AVAILABLE INFORMATION     167  
INDEX TO FINANCIAL STATEMENTS     F-1  

YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS. WE HAVE NOT, AND THE UNDERWRITERS HAVE NOT, AUTHORIZED ANY OTHER PERSON TO PROVIDE YOU WITH DIFFERENT OR ADDITIONAL INFORMATION. IF ANYONE PROVIDES YOU WITH DIFFERENT OR ADDITIONAL INFORMATION, YOU SHOULD NOT RELY ON IT. WE ARE NOT, AND THE UNDERWRITERS ARE NOT, MAKING AN OFFER TO SELL THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THAT THE INFORMATION APPEARING IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS IS ACCURATE ONLY AS OF THEIR RESPECTIVE DATES, REGARDLESS OF THE TIME OF DELIVERY OF THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS OR ANY SALES OF THE SECURITIES. OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS AND PROSPECTS MAY HAVE CHANGED SINCE THOSE DATES.

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ABOUT THIS PROSPECTUS SUPPLEMENT

This document is in two parts. The first part is this prospectus supplement, which describes the specific terms of this offering and certain matters relating to us. The second part, the accompanying prospectus, gives more general information about the securities that we may offer from time to time, some of which may not apply to the common stock offered by this prospectus supplement. For information about our common stock, see “Description of Our Common Stock” in the accompanying prospectus.

If information varies between this prospectus supplement and the accompanying prospectus, you should rely only on such information in this prospectus supplement. The information contained in this prospectus supplement supersedes any inconsistent information included in the accompanying prospectus. In various places in this prospectus supplement and the accompanying prospectus, we refer you to other sections of such documents for additional information by indicating the caption heading of such other sections. The page on which each principal caption included in this prospectus supplement and the accompanying prospectus can be found is listed in the table of contents above. All such cross references in this prospectus supplement are to captions contained in this prospectus supplement and not in the accompanying prospectus, unless otherwise stated.

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PROSPECTUS SUPPLEMENT SUMMARY

This summary highlights some of the information in this prospectus supplement and the accompanying prospectus. It is not complete and may not contain all of the information that you may want to consider. You should read the more detailed information set forth under “Risk Factors” and the other information included in this prospectus supplement and the accompanying prospectus carefully. Except as otherwise indicated, the terms “we,” “us,” “our,” and the “Company” refer to Stellus Capital Investment Corporation; and “Stellus Capital Management” refers to our investment adviser and administrator, Stellus Capital Management, LLC.

Stellus Capital Investment Corporation

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a BDC under the 1940 Act. We originate and invest primarily in private middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien (including unitranche), second lien and unsecured debt financing, with corresponding equity co-investments. Unitranche debt is typically structured as first lien loans with certain risk characteristics of unsecured debt. Unsecured debt includes senior unsecured and subordinated loans.

Our investment activities are managed by our investment adviser, Stellus Capital Management, an investment advisory firm led by Robert T. Ladd and its other senior investment professionals. We source investments primarily through the extensive network of relationships that the senior investment professionals of Stellus Capital Management have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating that is often referred to as “junk.”

Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation. We seek to achieve our investment objective by:

accessing the extensive origination channels that have been developed and established by the Stellus Capital Management senior investment professionals that include long-standing relationships with private equity firms, commercial banks, investment banks and other financial services firms;
investing in what we believe to be companies with strong business fundamentals, generally within our core middle-market company focus;
focusing on a variety of industry sectors, including business services, energy, general industrial, government services, healthcare, software and specialty finance;
focusing primarily on directly originated transactions;
applying the disciplined underwriting standards that the Stellus Capital Management senior investment professionals have developed over their extensive investing careers; and
capitalizing upon the experience and resources of the Stellus Capital Management investment team to monitor our investments.

In addition, on October 23, 2013, we received an exemptive order (the “Prior Order”) from the SEC to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). On December 18, 2018, we received a new exemptive order (the “Order”) that supersedes the Prior Order and permits us greater flexibility to enter into co-investment transactions. The Order expands on the Prior Order and allows us to co-invest with additional types of private funds, other BDCs, and registered investment companies

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managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the conditions included therein. Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We co-invest, subject to the conditions included in the Order, with private credit funds managed by Stellus Capital Management that have an investment strategy that is similar to or identical to our investment strategy, and we may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

As a BDC, we are required to comply with certain regulatory requirements. Prior to June 28, 2018, we were only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, was equal to at least 200% after giving effect to such leverage. On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances. On April 4, 2018, our board of directors, or “the Board”, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, which was approved by stockholders at our 2018 annual meeting of stockholders. As a result, the asset coverage ratio applicable to the Company was decreased from 200% to 150%, effective as of June 28, 2018. In other words, prior to the enactment of the SBCAA, a BDC could borrow $1.00 for investment purposes for every $1.00 of investor equity. Now, for those BDCs, like the Company, that satisfy the SBCAA’s approval and disclosure requirements, the BDC can borrow $2.00 for investment purposes for every $1.00 of investor equity. As of December 31, 2018, our asset coverage ratio was 251%. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

We have elected and intend to qualify annually to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders as dividends if we meet certain source-of-income, distribution and asset diversification requirements.

SBIC License

Our wholly owned subsidiary holds a license from the Small Business Administration, or SBA, to operate as a small business investment company, or SBIC. Current SBA regulations allow an SBIC to obtain leverage by issuing SBA-guaranteed debentures up to a maximum of $175 million under current SBIC regulations, subject to required capitalization of the SBIC subsidiary, SBA approval, and other requirements. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with ten-year maturities. We believe that the SBA-guaranteed debentures are an attractive source of debt capital.

We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act. The exemptive relief provides us

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with increased flexibility under the asset coverage test by permitting us to borrow up to $175.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.

Portfolio Composition

Our investments generally range in size from $5.0 million to $30.0 million, and we may also selectively invest in larger positions. We generally expect that the size of our positions will increase in proportion to the size of our capital base. Pending such investments, we may reduce our outstanding indebtedness or invest in cash, cash equivalents, U.S. government securities and other high-quality debt investments with a maturity of one year or less. In the future, we may adjust opportunistically the percentage of our assets held in various types of loans, our principal loan sources and the industries to which we have greatest exposure, based on market conditions, the credit cycle, available financing and our desired risk/return profile.

The following table provides a summary of our portfolio investments as of December 31, 2018:

 
  As of
December 31,
2018
($ in millions)
Number of investments     57  
Fair value (a)   $ 504.5  
Cost   $ 502.7  
% of portfolio at fair value – first lien debt (b)     57.9 % 
% of portfolio at fair value – second lien debt     29.7 % 
% of portfolio at fair value – unsecured debt     5.0 % 
% of portfolio at fair value – equity     7.4 % 
Weighted-average annual yield (c)     10.9 % 

(a) As of December 31, 2018, $422.3 million of our debt investments at fair value were at floating interest rates, which represented approximately 91% of our total portfolio of debt investments at fair value. As of December 31, 2018, $43.0 million of our debt investments at fair value were at fixed interest rates, which represented approximately 9% of our total portfolio of debt investments at fair value.
(b) Includes unitranche investments, which account for 20.6% of our investment portfolio at fair value.
(c) The weighted average yield on all of our debt investments as of December 31, 2018, was approximately 10.9%, of which approximately 10.2% was current cash interest. The weighted average yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investments, which represents the interest rate on our debt investment restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion of original issue discount. There can be no assurance that the weighted average yield will remain at its current level.

Leverage

Credit Facility.  We have entered into a senior secured revolving credit agreement, dated as of October 10, 2017, with ZB, N.A., dba Amegy Bank and various other leaders (the “Credit Facility”). The Credit Facility provides for borrowings up to a maximum of $180.0 million on a committed basis with an accordion feature that allows us to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. We pay unused commitment fees of 0.50% per annum on the unused lender commitments. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 1, 2021. Our obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. As of December 31, 2018, we had approximately $99.6 million outstanding under the Credit Facility.

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2022 Notes.  On August 21, 2017, we issued $42.5 million in aggregate principal amount of 5.75% notes due 2022, or the 2022 Notes, and received net proceeds of approximately $41.0 million. We issued an additional $6.375 million in aggregate principal amount of the 2022 Notes on September 8, 2017 pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at our option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. The 2022 Notes bear interest at a rate of 5.75% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year. The Notes are listed on the NYSE under the trading symbol “SCA” with a par value of $25.00 per share.

SBA guaranteed debentures.  Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. As of December 31, 2018, the SBIC subsidiary had $150.0 million of SBA guaranteed debentures outstanding.

Stellus Capital Management

Stellus Capital Management manages our investment activities and is responsible for analyzing investment opportunities, conducting research and performing due diligence on potential investments, negotiating and structuring our investments, originating prospective investments and monitoring our investments and portfolio companies on an ongoing basis.

The senior investment professionals of Stellus Capital Management have an average of over 29 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management senior investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing loans and debt securities through market cycles. The Stellus Capital Management senior investment professionals continue to provide investment sub-advisory services to the D. E. Shaw & Co., L.P. and its associated investment funds, or the D. E. Shaw group, with respect to an approximately $17.0 million investment portfolio at fair value (as of December 31, 2018) in middle-market companies pursuant to sub-advisory arrangements.

In addition to serving as our investment adviser and the sub-advisor to the D. E. Shaw group as noted above, Stellus Capital Management currently manages a private credit funds, some of which have an investment strategy that is similar or identical to our investment strategy and energy private equity funds. We received the Order from the SEC, which permits us to to co-invest with investment funds managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification. We will not co-invest with the energy private equity funds, as the energy private equity funds focus on predominantly equity-related investments and we focus on predominantly credit-related investments. In addition, we will not co-invest with the D. E. Shaw group funds,

Stellus Capital Management is headquartered in Houston, Texas, and also maintains offices in the Washington, D.C. area and Charlotte, North Carolina.

Market Opportunity

We originate and invest primarily in private middle-market companies through first lien (including unitranche), second lien and unsecured debt financing, often with a corresponding equity co-investment. We believe the environment for investing in middle-market companies is attractive for several reasons, including:

Robust Demand for Debt Capital.  We believe that private equity firms have significant committed but uncalled capital, a large portion of which is still available for investment in the United States. We expect the large amount of uninvested capital commitments will drive buyout

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activity over the next several years, which should, in turn, create lending opportunities for us. In addition to increased buyout activity, a high volume of senior secured and high yield debt was originated in the calendar years 2011 through 2013 and will come due in the near term and, accordingly, we believe that new financing opportunities will increase as many companies seek to refinance this indebtedness.

Attractive Environment to Lend To Middle-Market Companies.  We believe the current strength of the U.S. economy provides an attractive environment to lend to middle-market companies. The U.S. services and manufacturing sector continues to show strong growth and profitability, allowing middle market companies to continue to service their debt and prudently borrow to support growth initiatives and mergers and acquisitions activity. This dynamism, coupled with ample capital from private equity firms to support middle market companies, is creating a large population of credit worthy companies looking for debt capital.

Attractive Deal Pricing and Structures.  We believe that the pricing of middle-market debt investments is higher, and the terms of such investments are more conservative, compared to larger liquid, public debt financings, due to the more limited universe of lenders as well as the highly negotiated nature of these financings. These transactions tend to offer stronger covenant packages, higher interest rates, lower leverage levels and better call protection compared to larger financings. In addition, middle-market loans typically offer other investor protections such as default penalties, lien protection, change of control provisions and information rights for lenders.

Specialized Lending Requirements.  Lending to middle-market companies requires in-depth diligence, credit expertise, restructuring experience and active portfolio management. We believe that several factors render many U.S. financial institutions ill-suited to lend to middle-market companies. For example, based on the experience of Stellus Capital Management’s senior investment professionals, lending to middle-market companies in the United States (a) is generally more labor intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of the information available with respect to such companies, (b) requires specialized due diligence and underwriting capabilities, and (c) may also require more extensive ongoing monitoring by the lender. We believe that, through Stellus Capital Management, we have the experience and expertise to meet these specialized lending requirements.

Competitive Strengths

We believe that the following competitive strengths will allow us to achieve positive returns for our investors:

Experienced Investment Team.  Through our investment adviser, Stellus Capital Management, we have access to the experience and expertise of the Stellus Capital Management senior investment professionals, including its senior investment professionals who have an average of over 29 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing debt and equity securities through market cycles. We believe the members of Stellus Capital Management’s senior investment professionals are proven and experienced, with extensive capabilities in credit investing, having participated in these markets for the predominant portion of their careers. We believe that these characteristics enhance the quantity and quality of investment opportunities available to us.

Established, Rigorous Investment and Monitoring Process.  The Stellus Capital Management senior investment professionals have developed an extensive review and credit analysis process. Each investment that is reviewed by Stellus Capital Management is brought through a structured, multi-stage approval process. In addition, Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management. Stellus Capital Management’s

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investment and monitoring process and the depth and experience of its investment professionals should allow it to conduct the type of due diligence and monitoring that enables it to identify and evaluate risks and opportunities.

Demonstrated Ability to Structure Investments Creatively.  Stellus Capital Management has the expertise and ability to structure investments across all levels of a company’s capital structure. Furthermore, we believe that current market conditions will allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, PIK, interest and various forms of equity securities.

Resources of Stellus Capital Management Platform.  We have access to the resources and capabilities of Stellus Capital Management, which has 17 investment professionals, including Robert T. Ladd, Dean D’Angelo, Joshua T. Davis and Todd A. Overbergen, who are supported by eight managing directors, two vice presidents and three analysts. These individuals have developed long-term relationships with middle-market companies, management teams, financial sponsors, lending institutions and deal intermediaries by providing flexible financing throughout the capital structure. We believe that these relationships provide us with a competitive advantage in identifying investment opportunities in our target market. We also expect to benefit from Stellus Capital Management’s due diligence, credit analysis, origination and transaction execution experience and capabilities, including the support provided with respect to those functions by Mr. Huskinson, who serves as our chief financial officer and chief compliance officer, and his staff of ten finance and operations professionals.

Risk Factors

An investment in our securities is subject to risks. The following is a summary of the principal risks that you should carefully consider before investing in our securities. In addition, see “Risk Factors” beginning on page 17 of the accompanying prospectus to read about factors you should consider before deciding to invest in our securities.

We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.
Our business model depends to a significant extent upon strong referral relationships. Any inability of Stellus Capital Management to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
Our financial condition, results of operations and cash flows will depend on our ability to manage our business effectively.
There are significant potential conflicts of interest that could negatively affect our investment returns.
The incentive fee structure we have with Stellus Capital Management may create incentives that are not fully aligned with the interests of our stockholders.
We will be subject to corporate-level income tax and may default under the Credit Facility if we are unable to maintain our qualification as a RIC under Subchapter M of the Code.
Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital and, as a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.
Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.
Because we use debt to finance our investments, changes in interest rates will affect our cost of capital and net investment income.

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Adverse developments in the credit markets may impair our ability to borrow money.
Most of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.
Our ability to enter into transactions with our affiliates will be restricted, which may limit the scope of investments available to us.
The involvement of our interested directors in the valuation process may create conflicts of interest.
There are conflicts related to other arrangements with Stellus Capital Management.
If we fail to maintain our status as a BDC, our business and operating flexibility could be significantly reduced.
Because we have received Board and stockholder approval, we are subject to 150% Asset Coverage. This approval allows us to incur twice as much debt as we could have without such approval, potentially heightening the risks associated with leverage described above.
The effect of global climate change may impact the operations of our portfolio companies.
Existing stockholders may incur dilution if, in the future, we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock.

Conflicts of Interests

We may have conflicts of interest arising out of the investment advisory activities of Stellus Capital Management, including those described below.

Our investment strategy includes investments in secured debt (including first lien, second lien and unitranche) and mezzanine debt (including senior unsecured and subordinated debt), as well as related equity securities of private middle-market companies. Stellus Capital Management also manages, and in the future may manage, other investment funds, accounts or investment vehicles that invest or may invest in assets eligible for purchase by us. For example, Stellus Capital Management currently manages private credit funds that have an investment strategy that is identical to our investment strategy. Stellus Capital Management also provides non-discretionary advisory services to the D. E. Shaw group, pursuant to sub-advisory arrangements, with respect to a private investment fund and a strategy of a private multi-strategy investment fund (collectively with the D. E. Shaw group fund, the “D. E. Shaw group funds”) to which the D. E. Shaw group serves as investment adviser that have an investment strategy similar to our investment strategy. Our investment policies, fee arrangements and other circumstances may vary from those of other investment funds, accounts or investment vehicles managed by Stellus Capital Management.

In addition, on October 23, 2013, we received the Prior Order from the SEC to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). On December 18, 2018, we received the Order that supersedes the Prior Order and permits us greater flexibility to enter into co-investment transactions. The Order expands on the Prior Order and allows us to co-invest with additional types of private funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the conditions included therein. Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is

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consistent with our investment objectives and strategies. We co-invest, subject to the conditions included in the Order, with private credit funds managed by Stellus Capital Management that have an investment strategy that is similar to or identical to our investment strategy, and we may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

In the course of our investing activities, we pay management and incentive fees to Stellus Capital Management. We have entered into an investment advisory agreement with Stellus Capital Management that provides that these fees are based on the value of our gross assets. Because these fees are based on the value of our gross assets, Stellus Capital Management will benefit when we incur debt or use leverage. This fee structure may encourage Stellus Capital Management to cause us to borrow money to finance additional investments. Our board of directors is charged with protecting our interests by monitoring how Stellus Capital Management addresses these and other conflicts of interests associated with its management services and compensation. While our board of directors is not expected to review or approve each investment decision, borrowing or incurrence of leverage, our independent directors will periodically review Stellus Capital Management’s services and fees as well as its portfolio management decisions and portfolio performance. See “Risk Factors — The incentive fee structure we have with Stellus Capital Management may create incentives that are not fully aligned with the interests of our stockholders” in the accompanying prospectus.

Stellus Capital Management may from time to time incur expenses in connection with investments to be made on our behalf and on behalf of other investment funds, accounts and investment vehicles managed by Stellus Capital Management. Stellus Capital Management will allocate such expenses on a pro rata basis according to the participation in a transaction, subject to oversight by our board of directors.

Corporate Information

Our principal executive offices are located at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, and our telephone number is (713) 292-5400. We maintain a website located at www.stelluscapital.com (under the Public Investors section). Information on our website is not incorporated into or a part of this prospectus or any accompanying prospectus supplement and you should not consider information on our website to be part of this prospectus or any accompanying prospectus.

Recent Developments

Investment Portfolio

On January 4, 2019, we received full repayment on our first lien term loan to EOS Fitness OPCO Holdings, LLC for total proceeds of $3.1 million. We also received a distribution related to our equity position of $0.1 million.

On January 7, 2019, we received $0.3 million in full realization on the equity of OGS Holdings, Inc., resulting in a realized gain of $0.2 million.

On February 4, 2019, we invested $8.5 million in a first lien term loan to ASC Communications, LLC, an existing portfolio company.

On February 8, 2019, we invested $12.3 million in a first lien term loan to Exacta Land Surveyors LLC, a provider of land surveys and field management services used to facilitate the purchasing, selling, and development of residential real estate in the United States. Additionally, we committed $1.5 million in the unfunded revolver, $4.0 million in the unfunded delayed draw term loan, and we invested $1.0 million in the equity of the company.

On February 15, 2019, we received $0.05 million in full realization on the equity of Glori Energy Production, LLC.

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On February 28, 2019, we invested $1.4 million in a first lien term loan to Convergence Technologies, Inc., an existing portfolio company. Additionally, we funded $5.4 million under the existing delayed draw term loan and an additional $0.1 million in the equity of the company.

Credit Facility

The outstanding balance under the Credit Facility as of March 13, 2019 was $115.1 million.

SBA-guaranteed Debentures

The total balance of SBA-guaranteed debentures outstanding as of March 13, 2019 was $150.0 million.

Dividend Declared

On January 11, 2019, the Board declared a regular monthly dividend for each of January, February and March 2019.

       
Declared   Ex-Dividend
Date
  Record
Date
  Payment
Date
  Amount
per Share
1/11/2019     1/30/2019       1/31/2019       2/15/2019     $ 0.1133  
1/11/2019     2/27/2019       2/28/2019       3/15/2019     $ 0.1133  
1/11/2019     3/28/2019       3/29/2019       4/15/2019     $ 0.1133  

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THE OFFERING

Common stock offered by us    
    2,750,000 shares
Common stock outstanding prior to this offering    
    15,953,810 shares
Common stock to be outstanding after this offering    
    18,703,810 shares (assuming no exercise of the underwriters’ option to purchase additional shares)
Use of proceeds    
    The net proceeds from this offering (without exercise of the option to purchase additional shares and after deducting estimated expenses payable by us of approximately $135,000) will be $    million. See “Use of Proceeds” in this prospectus supplement for more information.
Distributions    
    We pay monthly distributions to our stockholders out of assets legally available for distribution. Our monthly distributions, if any, will be determined by our board of directors.
    Our board of directors has declared a regular monthly dividend of $0.1133 per share payable on April 15, 2019, May 15, 2019 and June 14, 2019 to common stockholders of record on March 29, 2019, April 30, 2019 and May 31, 2019, respectively.
Taxation    
    We have elected to be treated for U.S. federal income tax purposes as a RIC. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders. To maintain our qualification as a RIC and the associated tax benefits, we must meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our net ordinary income and net short-term capital gains, if any, in excess of our net long-term capital losses. See “Distributions” and “Material U.S. Federal Income Tax Considerations” in the accompanying prospectus.
New York Stock Exchange symbol    
    “SCM”
Trading at a discount    
    Shares of closed-end investment companies, including BDCs, frequently trade in the secondary market at a discount to their net asset values. The risk that our shares may trade at a discount to our net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our shares will trade above, at or below net asset value. See “Risk Factors” beginning on page 17 of the accompanying prospectus for a discussion of risks you should carefully consider before deciding to invest in shares of our common stock.
Leverage    
    We expect to continue to use borrowed funds in order to make additional investments. We expect to use this practice, which is known as “leverage,” when the terms and conditions are favorable to long-term investing and well aligned with our investment strategy and portfolio composition in an effort to

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    increase returns to our stockholders, but this strategy involves significant risks. See “Risk Factors” beginning on page 17 of the accompanying prospectus. At our 2018 annual meeting on June 28, 2018, our stockholders approved a proposal to permit the Company to be subject to 150% Asset Coverage with immediate effect. This approval allows us to incur twice as much debt as we could have without such approval. The amount of leverage that we employ will depend on Stellus Capital Management’s and our Board’s assessment of market and other factors at the time of any proposed borrowing.
    Our current borrowings include:
   

•  

Our $195.0 million Credit Facility, of which $115.1 million was outstanding as of March 13, 2019;

   

•  

Our SBA Debentures, of which $150.0 million were outstanding as of March 13, 2019; and

   

•  

Our 2022 Notes, of which $48.9 million were outstanding as of March 13, 2019.

Risk Factors    
    See “Risk Factors” beginning on page 17 of the accompanying prospectus for a discussion of risks you should carefully consider before deciding to invest in shares of our common stock.

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FEES AND EXPENSES

The following table is intended to assist you in understanding the costs and expenses that an investor in our common stock will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Moreover, the information set forth below does not include any transaction costs and expenses that investors will incur in connection with each offering of our securities pursuant to this prospectus supplement. Except where the context suggests otherwise, whenever this prospectus supplement contains a reference to fees or expenses paid by “us” or that “we” will pay fees or expenses, common stockholders will indirectly bear such fees or expenses.

 
Stockholder Transaction Expenses:
        
Sales load (as a percentage of offering price)        % (1 ) 
Offering expenses (as a percentage of offering price)        % (2 ) 
Dividend reinvestment plan expenses     —    (3 ) 
Total Stockholder Transaction Expenses (as a percentage of offering price)    
Annual Expenses (as percentage of net assets attributable to common stock):
        
Base management fees     3.89% (4 ) 
Incentive fees payable under the investment advisory agreement     2.99% (5 ) 
Interest payments on borrowed funds     5.44% (6 ) 
Other expenses     2.83% (7 ) 
Total annual expenses     15.15 % 

(1) Represents the commission with respect to the shares of common stock being sold in this offering not including the portion of the commission borne by Stellus Capital Management. There is no guarantee that there will be any sales of our common stock pursuant to this prospectus supplement and the accompanying prospectus.
(2) The percentage reflects estimated offering expenses of approximately $135,000.
(3) The expenses of the dividend reinvestment plan are included in “Other expenses.”
(4) Our base management fee, payable quarterly in arrears, is 1.75% of our gross assets, including assets purchased with borrowed amounts or other forms of leverage (including traditional and effective leverage such as preferred stock, public and private debt issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and excluding cash and cash equivalents and is based on the base management fee incurred for the year ended December 31, 2018.
(5) This item represents the incentive fee payable to Stellus Capital Management based on the actual amounts earned on our “pre-incentive fee net investment income” for the year ended December 31, 2018.

For purposes of this table, we have assumed that these fees will be payable (in the case of the capital gains incentive fee) and that they will remain constant, although they are based on our performance and will not be paid unless we achieve certain goals.

The incentive fee consists of two components, ordinary income and capital gains:

  The ordinary income component, which is payable quarterly in arrears, equals 20.0% of the excess, if any, of our “pre-incentive fee net investment income” over a 2.0% quarterly (8.0% annualized) hurdle rate, expressed as a rate of return on the value of our net assets attributable to our common stock, and a “catch-up” provision, measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, our investment adviser receives no incentive fee until our net investment income equals the hurdle rate of 2.0% but then receives, as a “catch-up,” 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5% subject to a total return requirement and deferral of non-cash amounts. The effect of the “catch-up” provision is that, subject to the total return and deferral provisions discussed below, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, Stellus Capital Management will receive 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. The ordinary income component of the incentive fee is computed on income that may include interest that is accrued but not yet received in cash. The foregoing ordinary income component of the incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations (as defined below) over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees

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accrued and/or paid for the 11 preceding calendar quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter will be limited to the lesser of (i) 20.0% of the amount by which our pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20.0% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding calendar quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the portion of such incentive fee that is attributable to deferred interest (sometimes referred to as PIK or original issue discount, or OID) will be paid to Stellus Capital Management, together with interest thereon from the date of deferral to the date of payment, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such accounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possibly elimination of the incentive fees for such quarter. There is no accumulation of amounts on the hurdle rate from quarter to quarter, and accordingly, there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle, and there is no delay of payment if prior quarters are below the quarterly hurdle.

The capital gains component of the incentive fee equals 20.0% of our “Incentive Fee Capital Gains,” if any, which equals our aggregate cumulative realized capital gains from inception through the end of each calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation, less the aggregate amount of any previously paid capital gain incentive fees. The second component of the incentive fee is payable, in arrears, at the end of each calendar year (or upon termination of the investment advisory agreement, as of the termination date). We will record an expense accrual relating to the capital gains component of the incentive fee payable by us to Stellus Capital Management when the net unrealized gains on our investments exceed all realized capital losses on our investments given the fact that a capital gains incentive fee would be owed to Stellus Capital Management if we were to liquidate our investment portfolio at such time. The actual incentive fee payable to our investment adviser related to capital gains is determined and payable in arrears at the end of each fiscal year and includes only realized capital gains for the period. See “Management Agreements — Management Fee and Incentive Fee” in the accompanying prospectus.

Stellus Capital Management has agreed to permanently waive any interest accrued on the portion of the incentive fee attributable to deferred interest (such as PIK interest or OID).

(6) In addition to our existing SBA guaranteed debentures, the 2022 Notes and the Credit Facility, we may borrow funds from time to time to make investments to the extent we determine that additional capital would allow us to take advantage of additional investment opportunities or if the economic situation is otherwise conducive to doing so. The costs associated with any borrowings are indirectly borne by our stockholders. As of December 31, 2018, we had $150.0 million of SBA guaranteed debentures outstanding, $48.9 million in aggregate principal amount of 5.75% Notes outstanding, plus accrued interest and approximately $99.6 million outstanding under the Credit Facility. For purposes of this calculation, we have assumed that the December 31, 2018 amounts of SBA Debentures remain outstanding and have computed interest expense using the weighted average interest rate as of December 31, 2018 of 3.20%. For the 2022 Notes, we have used the fixed interest rate of 5.75%. We have also assumed borrowings under the Credit Facility incur interest at a rate equal to 4.70% per annum the weighted average interest rate as of December 31, 2018. We expect our borrowings over the 12 months following the offering will be consistent with the amounts outstanding as of December 31, 2018. See “Senior Securities” in this prospectus supplement.
(7) Includes our overhead expenses, including payments under the administration agreement based on our allocable portion of overhead and other expenses incurred by Stellus Capital Management. See “Management Agreements —  Administration Agreement” in the accompanying prospectus.

Example

The following example demonstrates the projected dollar amount of total cumulative expenses over various periods with respect to a hypothetical investment in us. In calculating the following expense amounts, we have assumed that our annual operating expenses would remain at the levels set forth in the table above.

       
  1 Year   3 Years   5 Years   10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return (excluding incentive fees)   $     $     $     $  

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While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%. The incentive fee under the investment management agreement, which, assuming a 5% annual return, would either not be payable or would have a de minimis effect, is not included in the example. If we achieve sufficient returns on our investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, our expenses, and returns to our investors, would be higher. For example, if we assumed that we received our 5.0% annual return completely in the form of net realized capital gains on our investments, which results in a capital gains incentive fee earned, the projected dollar amount of total cumulative expenses set forth in the above illustration and the capital gains incentive fee would be as follows:

       
  1 Year   3 Years   5 Years   10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return   $     $     $     $  

While the examples assume reinvestment of all distributions at net asset value, participants in our dividend reinvestment plan will receive a number of shares of our common stock, determined by dividing the total dollar amount of the distribution payable to a participant by (a) 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our board of directors or (b) the average purchase price of all shares of common stock purchased by the administrator of the dividend reinvestment plan in the event shares are purchased in the open market to satisfy the share requirements of the dividend reinvestment plan, which may be at, above or below net asset value.

This example and the expenses in the table above should not be considered a representation of our future expenses, and actual expenses (including the cost of debt, if any, and other expenses) may be greater or less than those shown.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements in this prospectus supplement and the accompanying prospectus constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this prospectus supplement and the accompanying prospectus may include, but are not limited to, statements as to:

our future operating results;
our business prospects and the prospects of our portfolio companies;
the effect of investments that we expect to make;
our contractual arrangements and relationships with third parties;
actual and potential conflicts of interest with Stellus Capital Management;
the dependence of our future success on the general economy and its effect on the industries in which we invest;
the ability of our portfolio companies to achieve their objectives;
the use of borrowed money to finance a portion of our investments;
the adequacy of our financing sources and working capital;
the timing of cash flows, if any, from the operations of our portfolio companies;
the ability of Stellus Capital Management to locate suitable investments for us and to monitor and administer our investments;
the ability of Stellus Capital Management to attract and retain highly talented professionals;
our ability to qualify and maintain our qualification as a RIC and as a BDC; and
the effect of future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to BDCs or RICs.

Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words.

We have based the forward-looking statements included in this prospectus supplement and the accompanying prospectus on information available to us on the date of this prospectus supplement and the accompanying prospectus and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or SEC rule or regulation. You are advised to consult any additional disclosures that we may make directly to you, including in the form of a prospectus supplement or post-effective amendment to the registration statement to which this prospectus relates, or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

You should understand that, under Sections 27A(b)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E(b)(2)B of the Securities Exchange Act of 1934, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 do not apply to statements made in connection with any offering of securities pursuant to this prospectus supplement and the accompanying prospectus, if any.

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USE OF PROCEEDS

The net proceeds from the sale of the 2,750,000 shares of common stock in this offering are $    million, and $    million if the underwriter’s option to purchase additional shares is exercised in full, after deducting the underwriting discount and estimated offering expenses payable by us.

We intend to use the net proceeds from this offering to repay a portion of the amount outstanding under the Credit Facility, for general corporate purposes, which may include investing in debt or equity securities, and other general corporate purposes, including working capital requirements.

As of March 13, 2019, we had $115.1 million outstanding under the Credit Facility. The Credit Facility has a maturity date of October 10, 2021. Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) LIBOR plus 2.50% (or 2.75% during certain periods in which our asset coverage ratio is equal to or below 1.90 to 1.00) with no LIBOR floor or (ii) 1.50% (or 1.75% during certain periods in which our asset coverage ratio is equal to or below 1.90 to 1.00) plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%.

We intend to seek to invest the net proceeds received in this offering as promptly as practicable after receipt thereof consistent with our investment objective. We anticipate that substantially all of the net proceeds from this offering of our securities will be used as described above within three to six months, depending on market conditions. We anticipate that the remainder will be used for working capital and general corporate purposes, including potential payments or distributions to stockholders. Pending such use, we will invest a portion of the net proceeds of this offering in short-term investments, such as cash and cash equivalents, which we expect will earn yields substantially lower than the interest income that we anticipate receiving in respect of investments in accordance with our investment objective.

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2018:

on an actual basis; and
on an as further adjusted basis giving effect to the assumed sale of 2,750,000 shares of our common stock at a price of $      per share, less commissions and expenses, and the application of the proceeds thereof.

This table should be read in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto included in this prospectus supplement and the accompanying prospectus.

   
  As of December 31, 2018
     Actual   As Adjusted (1)
(Unaudited)
Assets
                 
Cash and cash equivalents   $ 17,467,146     $ 17,467,146  
Investments, at fair value   $ 504,483,668     $ 504,483,668  
Other assets   $ 4,336,437     $ 4,336,437  
Total assets   $ 526,287,251     $ 526,287,251  
Liabilities:
                 
5.75% Notes due 2022   $ 47,641,797     $ 47,641,797  
Credit Facility (1)   $ 98,237,227     $  
SBA-Guaranteed debentures   $ 146,387,802     $ 146,387,802  
Other liabilities   $ 9,175,418     $ 9,175,418  
Total liabilities   $ 301,442,244     $  
Stockholder’s equity:
                 
Common stock, par value $0.001 per share (100,000,000 shares authorized; 15,953,810 shares issued and outstanding, actual; 18,703,810(2) shares issued and outstanding, as adjusted)   $ 15,954     $  
Paid-in capital in excess of par value   $ 228,160,491     $  
Accumulated net realized loss   $ (10,786,240 )    $ (10,786,240 ) 
Accumulated undistributed net investment income   $ 5,782,736     $ 5,782,736  
Net unrealized appreciation (depreciation) on investments and cash equivalents   $ 1,672,066     $ 1,672,066  
Total stockholders’ equity   $ 224,845,007     $  
Total liabilities and stockholders’ equity   $ 526,287,251     $  
Net asset value per share   $ 14.09     $  

(1) As of March 13, 2019, we had approximately $115.1 million outstanding under our Credit Facility outstanding. This table has not been adjusted to reflect the changes in our outstanding borrowings under the Credit Facility subsequent to December 31, 2018.
(2) Excludes up to 412,500 shares of our common stock issuable upon exercise of the underwriters’ option to purchase additional shares.

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SELECTED FINANCIAL AND OTHER DATA

The following selected financial data for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 was derived from our financial statements which have been audited by Grant Thornton, LLP, our independent registered public accounting firm. The data should be read in conjunction with our financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus supplement and the accompanying prospectus.

         
Statement of Operations Data   For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
  For the year
ended
December 31,
2014
Total investment income   $ 53,266,338     $ 39,648,193     $ 39,490,197     $ 35,158,559     $ 32,324,847  
Total expenses, net of fee waiver   $ 30,629,801     $ 21,677,433     $ 22,177,996     $ 18,611,431     $ 15,812,750  
Net investment income   $ 22,636,537     $ 17,970,760     $ 17,312,201     $ 16,547,128     $ 16,512,097  
Net increase in net assets resulting from operations   $ 26,194,578     $ 22,613,257     $ 23,199,062     $ 7,670,536     $ 10,179,142  
Per Share Data:
                                            
Net asset value   $ 14.09     $ 13.81     $ 13.69     $ 13.19     $ 13.94  
Net investment income   $ 1.42     $ 1.21     $ 1.39     $ 1.33     $ 1.34  
Net increase in net assets resulting from operations   $ 1.64     $ 1.52     $ 1.86     $ 0.61     $ 0.83  
Distributions declared   $ 1.36     $ 1.36     $ 1.36     $ 1.36     $ 1.36  

         
Balance Sheet Data   As of
December 31,
2018
  As of
December 31,
2017
  As of
December 31,
2016
  As of
December 31,
2015
  As of
December 31,
2014
Investments at fair value   $ 504,483,668     $ 371,839,772     $ 365,625,891     $ 349,017,697     $ 315,965,434  
Cash and cash equivalents   $ 17,467,146     $ 25,110,718     $ 9,194,129     $ 10,875,790     $ 2,046,563  
Total assets(2)   $ 526,287,251     $ 400,260,855     $ 379,878,729     $ 365,368,412     $ 323,776,402  
Total liabilities(2)   $ 301,442,244     $ 180,013,613     $ 208,996,944     $ 200,717,308     $ 149,826,950  
Total net assets   $ 224,845,007     $ 220,247,242     $ 170,881,785     $ 164,651,104     $ 173,949,452  
Other Data:
                                            
Number of portfolio companies at period end     57       48       45       39       32  
Weighted average yield on debt investments at period end(1)(3)     10.9%       10.8%       11.0%       10.6%       10.9%  

(1) Computed using the effective interest rates for all of our debt investments, including accretion of original issue discount.
(2) ASU No. 2015-03 — Simplifying the Presentation of Debt Issuance Costs was effective for the quarter ended March 31, 2016. Total assets and total liabilities for the periods prior to the effective date have been modified from their respective filings to conform to this presentation.
(3) The weighted average yield of our debt investments is not the same as a return on investment for our stockholders, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investment restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion of original issue discount.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements and notes thereto contained elsewhere in this prospectus supplement.

Statements we make in the following discussion which express a belief, expectation or intention, as well as those that are not historical fact, are forward-looking statements that are subject to risks, uncertainties and assumptions. Our actual results, performance or achievements, or industry results, could differ materially from those we express in the following discussion as a result of a variety of factors, including the risks and uncertainties we have referred to under the headings “Special Note Regarding Forward-Looking Statements” in this prospectus supplement and “Risk Factors” in the accompanying prospectus.

Overview

We were organized as a Maryland corporation on May 18, 2012 and formally commenced operations on November 7, 2012. Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies.

We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. Our investment activities are managed by our investment adviser, Stellus Capital Management.

As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets. Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all private operating companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized and with their principal of business in the United States.

We have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As of December 31, 2018, we were in compliance with the RIC requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income we distribute to our stockholders.

As a BDC, we are required to comply with certain regulatory requirements. Prior to June 28, 2018, we were only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, was equal to at least 200% after giving effect to such leverage. On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

On April 4, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, which was approved by shareholders at the Company’s 2018 annual meeting of stockholders. As a result, the asset coverage ratio applicable to the Company was decreased from 200% to 150%, effective June 28, 2018. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

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Portfolio Composition and Investment Activity

Portfolio Composition

We originate and invest primarily in privately-held middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA) through first lien (including unitranche), second lien, and unsecured debt financing, often times with a corresponding equity investment.

As of December 31, 2018, we had $504.5 million (at fair value) invested in 57 companies. As of December 31, 2018, our portfolio included approximately 58% of first lien debt, 30% of second lien debt, 5% of unsecured debt and 7% of equity investments at fair value. The composition of our investments at cost and fair value as of December 31, 2018 was as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 297,965,589     $ 292,004,982  
Senior Secured – Second Lien     155,382,612       149,661,220  
Unsecured Debt     25,436,237       23,697,466  
Equity     23,959,211       39,120,000  
Total Investments   $ 502,743,649     $ 504,483,668  

(1) Includes unitranche investments, which account for 20.6% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.

As of December 31, 2017, we had $371.8 million (at fair value) invested in 48 companies. As of December 31, 2017, our portfolio included approximately 38% of first lien debt, 48% of second lien debt, 7% of unsecured debt and 7% of equity investments at fair value. The composition of our investments at cost and fair value as of December 31, 2017 was as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 140,915,106     $ 141,006,923  
Senior Secured – Second Lien     181,164,730       178,432,850  
Unsecured Debt     27,903,141       27,430,000  
Equity     18,470,229       24,969,999  
Total Investments   $ 368,453,206     $ 371,839,772  

(1) Includes unitranche investments, which account for 13.2% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.

Our investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require us to provide funding when requested by portfolio companies in accordance with the terms and conditions of the underlying loan agreements. As of December 31, 2018 and December 31, 2017, we had unfunded commitments of $21.2 million and $8.7 million, respectively, to provide debt financing for eleven and four portfolio companies, respectively. As of December 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments should the need arise.

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The following is a summary of geographical concentration of our investment portfolio as of December 31, 2018:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Texas   $ 100,229,354     $ 97,474,226       19.32 % 
California     86,550,134       85,880,918       17.03 % 
New Jersey     43,513,698       41,473,072       8.22 % 
Ohio     36,209,514       36,273,224       7.19 % 
Illinois     19,941,053       29,880,018       5.92 % 
Canada     27,902,537       27,935,931       5.54 % 
Arizona     21,682,522       21,603,741       4.28 % 
South Carolina     20,871,587       20,385,325       4.04 % 
New York     20,446,690       20,287,086       4.02 % 
Tennessee     20,117,218       19,381,134       3.84 % 
Arkansas     17,696,537       18,013,941       3.57 % 
Pennsylvania     17,732,831       17,824,372       3.53 % 
Maryland     17,237,500       17,237,500       3.42 % 
Wisconsin     11,437,711       10,869,000       2.15 % 
Colorado     10,777,822       10,777,822       2.14 % 
Georgia     5,988,728       9,820,000       1.95 % 
Indiana     7,363,628       7,087,500       1.40 % 
Puerto Rico     8,797,954       5,029,913       1.00 % 
North Carolina     4,946,554       4,425,000       0.88 % 
Massachusetts     1,317,406       1,670,000       0.33 % 
Missouri     139,656       670,000       0.13 % 
Virginia     50,001       280,000       0.06 % 
Florida     242,304       110,000       0.02 % 
Utah     1,550,710       93,945       0.02 % 
     $ 502,743,649     $ 504,483,668       100.00 % 

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
Texas   $ 109,043,496     $ 108,445,000       29.16 % 
New Jersey     34,531,876       34,595,527       9.30 % 
New York     28,939,268       29,365,000       7.90 % 
Canada     26,315,677       26,440,000       7.11 % 
California     25,519,753       25,930,000       6.97 % 
Illinois     24,250,169       25,700,000       6.91 % 
Massachusetts     22,534,191       22,247,850       5.98 % 
Arizona     13,565,958       13,840,000       3.72 % 
North Carolina     12,248,770       12,499,167       3.36 % 
Ohio     10,112,627       9,990,000       2.69 % 
Tennessee     9,848,614       9,950,000       2.68 % 
Missouri     9,152,087       9,530,000       2.56 % 
Georgia     5,929,223       8,329,998       2.24 % 
Pennsylvania     7,848,470       8,058,746       2.17 % 
Arkansas     7,397,881       7,618,484       2.05 % 
Minnesota     5,421,770       5,420,000       1.46 % 
Puerto Rico     8,827,864       5,080,000       1.37 % 
Washington     4,172,743       4,520,000       1.22 % 
Alabama     1,206,682       2,880,000       0.77 % 
Utah     1,293,782       880,000       0.24 % 
Florida     242,304       420,000       0.11 % 
Virginia     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

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The following is a summary of industry concentration of our investment portfolio as of December 31, 2018:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Services: Business   $ 60,784,467     $ 63,810,643       12.65 % 
Healthcare & Pharmaceuticals     58,682,811       54,785,327       10.86 % 
Consumer Goods: Durable     44,218,515       44,049,052       8.73 % 
Finance     34,208,412       41,910,000       8.30 % 
Software     37,427,547       38,026,250       7.54 % 
Media: Broadcasting & Subscription     38,137,844       37,733,004       7.48 % 
Retail     28,764,221       27,525,897       5.45 % 
Education     26,562,249       25,325,000       5.02 % 
High Tech Industries     21,094,192       21,094,192       4.18 % 
Beverage, Food, & Tobacco     20,709,134       18,213,945       3.61 % 
Services: Consumer     17,952,663       17,640,255       3.50 % 
Automotive     17,457,259       17,282,187       3.43 % 
Energy: Oil & Gas     14,312,328       15,542,102       3.08 % 
Consumer goods: non-durable     14,994,980       14,579,375       2.89 % 
Chemicals, Plastics, & Rubber     11,835,100       11,707,835       2.32 % 
Containers, Packaging, & Glass     11,437,711       10,869,000       2.15 % 
Construction & Building     10,374,827       10,280,000       2.04 % 
Utilities: Oil & Gas     9,853,435       9,853,435       1.95 % 
Capital Equipment     7,535,876       7,929,775       1.57 % 
Transportation: Cargo     6,808,345       6,841,739       1.36 % 
Insurance     5,425,301       5,460,000       1.08 % 
Hotel, Gaming, & Leisure     3,170,307       3,414,655       0.68 % 
Environmental Industries     946,124       330,000       0.07 % 
Services: Government     50,001       280,000       0.06 % 
     $ 502,743,649     $ 504,483,668       100.00 % 

The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
Software   $ 48,560,675     $ 48,997,850       13.18 % 
Healthcare & Pharmaceuticals     41,192,879       37,829,167       10.17 % 
High Tech Industries     36,058,477       35,460,000       9.54 % 
Finance     26,500,097       28,330,000       7.62 % 
Services: Business     23,386,714       25,749,999       6.93 % 
Capital Equipment     24,300,027       24,170,000       6.50 % 
Media: Broadcasting & Subscription     21,680,239       23,665,000       6.36 % 
Chemicals, Plastics, & Rubber     20,825,458       21,145,000       5.69 % 
Services: Consumer     17,862,616       18,070,000       4.86 % 
Construction & Building     17,913,413       17,980,000       4.84 % 
Education     17,197,396       17,335,526       4.66 % 
Consumer Goods: Durable     16,559,947       16,798,484       4.52 % 
Consumer goods: non-durable     13,250,000       13,250,000       3.56 % 
Retail     8,288,083       8,280,000       2.23 % 
Automotive     7,848,470       8,058,746       2.17 % 
Transportation: Cargo     6,785,894       6,840,000       1.84 % 
Energy: Oil & Gas     6,766,968       6,700,000       1.80 % 
Insurance     5,410,226       5,500,000       1.48 % 
Beverage, Food, & Tobacco     3,964,242       3,580,000       0.96 % 
Hotel, Gaming, & Leisure     3,284,942       3,420,000       0.92 % 
Environmental Industries     766,442       580,000       0.16 % 
Services: Government     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

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At December 31, 2018, our average portfolio company investment at amortized cost and fair value was approximately $8.9 million and $8.9 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $21.6 million and $22.3 million, respectively. At December 31, 2017, our average portfolio company investment at amortized cost and fair value was approximately $7.7 million and $7.4 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $22.5 million and $22.2 million, respectively.

At December 31, 2018, 91% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 9% bore interest at fixed rates. At December 31, 2017, 87% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 13% bore interest at fixed rates.

The weighted average yield on all of our debt investments as of December 31, 2018 and December 31, 2017 was approximately 10.9% and 10.8%, respectively. The weighted average yield was computed using the effective interest rates for all of our debt investments, including accretion of original issue discount. The weighted average yield of our debt investments is not the same as a return on investment for our stockholders, but, rather relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses.

As of December 31, 2018 and December 31, 2017, we had cash and cash equivalents of $17.5 million and $25.1 million, respectively.

Investment Activity

During the year ended December 31, 2018, we made $272.9 million of investments in seventeen new portfolio companies and twelve existing portfolio companies. During the year ended December 31, 2018, we received $147.6 million in proceeds principally from prepayments of our investments, including $22.9 million from amortization of certain other investments.

During the year ended December 31, 2017, we made $172.2 million of investments in fourteen new portfolio companies and two existing portfolio companies. During the year ended December 31, 2017, we received $172.3 million in proceeds principally from prepayments of our investments, including $7.2 million from amortization of certain other investments.

Our level of investment activity can vary substantially from period to period depending on many factors, including the amount of debt and equity capital to middle market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.

Asset Quality

In addition to various risk management and monitoring tools, Stellus Capital Management uses an investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment rating system uses a five-level numeric scale. The following is a description of the conditions associated with each investment category:

Investment Category 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.
Investment Category 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.
Investment Category 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.

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Investment Category 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of return but no loss of principal is expected.
Investment Category 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.

           
  As of December 31, 2018   As of December 31, 2017
     (dollars in millions)
Investment Category   Fair
Value
  % of Total
Portfolio
  Number of
Portfolio
Companies(1)
  Fair
Value
  % of Total
Portfolio
  Number of
Portfolio
Companies(1)
1   $   92.5           18 %          13     $   25.9            7 %          5  
2     372.3       74 %      37       306.7       82 %      36  
3     26.8       5 %      3       37.0       10 %      5  
4     12.8       3 %      4       1.9       1 %      2  
5     0.1       %      1       0.4       %      1  
Total   $ 504.5       100 %      58     $ 371.9       100 %      49  

(1) One portfolio company appears in two categories as of December 31, 2018 and December 31, 2017.

Loans and Debt Securities on Non-Accrual Status

We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. As of December 31, 2018, we had four loans on non-accrual status, which represented approximately 3.9% of our loan portfolio at cost and 2.8% at fair value. As of December 31, 2017, we had two loans on non-accrual status, which represented approximately 1.2% of our loan portfolio at cost and 0.3% at fair value.

Results of Operations

An important measure of our financial performance is net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, dividends, fees and other investment income and our operating expenses including interest on borrowed funds. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

Comparison of the Years ended December 31, 2018, 2017, and 2016

Revenues

We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, on investment securities that we may acquire in portfolio companies. Our debt investments typically have a term of five to seven years and bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments may pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the total dollar amount of interest and any dividend income that

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we earn to increase as the size of our investment portfolio increases. In addition, we may generate revenue in the form of prepayment fees, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.

The following shows the breakdown of investment income for the years ended December 31, 2018, 2017, and 2016 (in millions).

     
  Year ended
December 31,
2018
  Year ended
December 31,
2017
  Year ended
December 31,
2016
Interest Income(1)   $       49.6     $       37.6     $       38.0  
PIK Income     1.9       0.5       0.2  
Miscellaneous fees(1)     1.8       1.6       1.3  
Total   $ 53.3     $ 39.7     $ 39.5  

(1) For the years ended December 31, 2018, 2017 and 2016, we recognized $3.4 million, $2.5 million and $1.6 million of non-recurring income, respectively. Non-recurring income was mostly related to early repayments and amendments to specific loan positions with the exception of the year ended December 31, 2018 which includes recognition of prior period interest reserve.

The increase in interest income from the respective periods were due primarily to growth in the overall investment portfolio and increased interest rates.

Expenses

Our primary operating expenses include the payment of fees to Stellus Capital Management under the investment advisory agreement, our allocable portion of overhead expenses under the administration agreement and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which may include:

organization and offering;
calculating our net asset value (including the cost and expenses of any independent valuation firm);
fees and expenses payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments;
interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts;
offerings of our common stock and other securities;
base management and incentive fees;
administration fees and expenses, if any, payable under the administration agreement (including our allocable portion of Stellus Capital Management’s overhead in performing its obligations under the administration agreement, including rent and the allocable portion of the cost of our chief compliance officer and chief financial officer and his staff);
transfer agent, dividend agent and custodial fees and expenses;
U.S. federal and state registration fees;
all costs of registration and listing our shares on any securities exchange;
U.S. federal, state and local taxes;
independent directors’ fees and expenses;

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costs of preparing and filing reports or other documents required by the SEC or other regulators;
costs of any reports, proxy statements or other notices to stockholders, including printing costs;
costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs;
proxy voting expenses; and
all other expenses incurred by us or Stellus Capital Management in connection with administering our business.

The following shows the breakdown of operating expenses for the years ended December 31, 2018, 2017 and 2016 (in millions).

     
  Year ended
December 31,
2018
  Year ended
December 31,
2017
  Year ended
December 31,
2016
Operating Expenses
                          
Management Fees   $       8.2     $       6.3     $       6.3  
Valuation Fees     0.3       0.3       0.4  
Administrative services expenses     1.4       1.3       1.0  
Income incentive fees     5.5       2.9       4.3  
Capital gain incentive fees     0.1              
Professional fees     1.2       1.3       0.7  
Directors’ fees     0.3       0.3       0.3  
Insurance expense     0.3       0.4       0.5  
Interest expense and other fees     12.3       7.9       8.0  
Income tax expense     0.3              
Deferred offering costs                 0.3  
Other general and administrative     0.7       0.6       0.4  
Total Operating Expenses   $ 30.6     $ 21.3     $ 22.2  
Loss on extinguishment of debt           0.4        
Total Expenses   $ 30.6     $ 21.7     $ 22.2  

The increase in operating expenses for the respective periods was primarily due to 1) an increase in management fees directly related to the growth of our portfolio, 2) increased interest expense due to the greater principal amount of the additional 2022 Notes, despite their lower annual interest rate as compared to the 2019 Notes, the higher balance and increased rates on the Credit Facility and SBA-guaranteed debentures outstanding during the period, and 3) higher income incentive fees and capital gains incentive fees due to performance of the portfolio.

Net Investment Income

Net investment income was $22.6 million, or $1.42 per common share based on 15,953,571 weighted-average common shares outstanding at December 31, 2018. Net investment income was $18.0 million, or $1.21 per common share based on 14,870,981 weighted-average common shares outstanding at December 31, 2017. Net investment income was $17.3 million, or $1.39 per common share based on 12,479,959 weighted-average common shares outstanding at December 31, 2016.

Net investment income for the year ended December 31, 2018 increased compared to the year ended December 31, 2017 as a result of an increase in interest income due to growth in the overall

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investment portfolio and increased interest rates, offset by an increase in management and incentive fees and interest expense incurred related to the portfolio growth.

Net Realized Gains and Losses

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or other disposition and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.

Proceeds from repayments of investments and amortization of certain other investments for the year ended December 31, 2018 totaled $147.5 million and net realized gains totaled $5.5 million from the realization of our equity investments in certain portfolio companies. Proceeds from repayments of investments and amortization of certain other investments for the year ended December 31, 2017 totaled $172.3 million and net realized gain totaled $4.7 million from the realization of our equity investments in certain portfolio companies. Proceeds from the sales and repayments of investments and amortization of certain other investments for the year ended December 31, 2016 totaled $55.9 million and net realized loss totaled $13.1 million, $12.2 million of which is related to the realized loss of our term loan to Binder and Binder.

Provision for Taxes on Realized Gains

In connection with the gain realized from the exit of its equity investment in Eating Recovery Center, LLC, the Company recorded an income tax provision on realized gains of $0.3 million for the year ended December 31, 2018. No income tax provision was recorded on realized gains for the years ended December 31, 2017 and 2016. As of December 31, 2018 and 2017, no tax liability related to the taxes on realized gains were included on the Consolidated Statement of Assets and Liabilities.

Net Change in Unrealized Appreciation (Depreciation) of Investments

Net change in unrealized appreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.

Net change in unrealized appreciation (depreciation) on investments and cash equivalents for the year ended December 31, 2018, 2017 and 2016 totaled ($1.6) million, $22.0 thousand, and $18.6 million, respectively.

The change in unrealized depreciation in 2018 was due to a significant widening of spreads right at year end, offset by the write up of a specific equity investment. There was relatively no change in unrealized appreciation in 2017. The change in unrealized appreciation in 2016 was due primarily to two factors: a) the reversal of $8.3 million of unrealized depreciation accrued in prior years resulting from realized losses and b) $10.3 million from tightening interest rate spreads in 2016.

Provision for Taxes on Unrealized Appreciation on Investments

We have direct wholly owned subsidiaries that have elected to be taxable entities (the “Taxable Subsidiaries”). The Taxable Subsidiaries permit us to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with us for income tax filing purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in our consolidated financial statements.

For the year ended December 31, 2018, 2017 and 2016, we recognized a deferred tax benefit (provision) related to unrealized appreciation on certain equity investments for income tax at our Taxable Subsidiaries of $(67.0) thousand, $9.0 thousand and $0.4 million, respectively. As of

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December 31, 2018 and 2017, a deferred tax liability of $67.0 thousand and $0, respectively, were included on the Consolidated Statement of Assets and Liabilities.

Net Increase in Net Assets Resulting from Operations

Net increase in net assets resulting from operations totaled $26.2 million, or $1.64 per common share based on weighted-average shares of 15,953,571 for the year ended December 31, 2018, as compared to $22.6 million, or $1.52 per common share based on weighted-average shares of 14,870,981 common shares outstanding for the year ended December 31, 2017, as compared to $23.2 million, or $1.86 per common share based on weighted-average shares of 12,479,959 common shares outstanding for the year ended December 31, 2016.

The increase in net assets resulting from operations for the year ended December 31, 2018 as compared to the year ended December 31, 2017 was higher due primarily to a higher net investment income due to the growth of the portfolio, as well as a larger amount of realized gains. The increase in net assets resulting from operations for the year ended December 31, 2017 as compared to the year ended December 31, 2016 was lower due to higher net unrealized gains on the portfolio in 2016, offset by net realized gains and a higher net investment income in 2017.

Financial Condition, Liquidity and Capital Resources

Cash Flows from Operating and Financing Activities

Our operating activities used net cash of $102.4 million for the year ended December 31, 2018, primarily in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments. Our financing activities for the year ended December 31, 2018 provided cash of $94.8 million primarily from proceeds from SBA-guaranteed debentures and net borrowings on our credit facility.

Our operating activities provided net cash of $18.9 million for the year ended December 31, 2017, primarily in connection with the income earned on portfolio investments, offset by the purchase and origination of portfolio investments. Our financing activities for the year ended December 31, 2017 used cash of $2.9 million primarily from net repayments on our credit facility.

Our operating activities provided net cash of $8.8 million for the year ended December 31, 2016, primarily in connection with the sale and repayment of portfolio investments, offset by the purchase and origination of portfolio investments. Our financing activities for the year ended December 31, 2016 used cash of $10.5 million, primarily from repayments on our credit facility.

Liquidity and Capital Resources

Our liquidity and capital resources are derived from the Credit Facility, the 2022 Notes, SBA-guaranteed debentures and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and other operating expenses we incur, as well as the payment of dividends to the holders of our common stock. We used, and expect to continue to use, these capital resources as well as proceeds from turnover within our portfolio and from public and private offerings of securities to finance our investment activities.

Although we expect to fund the growth of our investment portfolio through the net proceeds from future public and private equity offerings and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, if our common stock trades at a price below our then-current net asset value per share, we may be limited in our ability to raise equity capital given that we cannot sell our common stock at a price below net asset value per share unless our stockholders approve such a sale and our board of directors makes certain determinations in connection therewith. A proposal, approved by our stockholders at our 2018 annual stockholders meeting, authorizes us to sell shares equal to up to 25% of our outstanding common stock of our common stock below the then current net asset value per share of our common stock in one or more offerings. This

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authorization will expire on June 28, 2019, the one year anniversary of our 2018 annual stockholders meeting. We would need similar future approval from our stockholders to issue shares below the then current net asset value per share any time after the expiration of the current approval. In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

Also, as a BDC, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 150% effective June 28, 2018 (at least 200% prior to June 28, 2018). This requirement limits the amount that we may borrow. We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the asset coverage test under the 1940 Act. We were in compliance with the asset coverage ratios at all times. As of December 31, 2018 and December 31, 2017, our asset coverage ratio was 251% and 346%, respectively. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. As of December 31, 2018 and December 31, 2017, we had cash and cash equivalents of $17.5 million and $25.1 million, respectively.

Credit Facility

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120.0 million on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. The Company terminated the Original Facility on October 11, 2017, in conjunction with securing and entering into a new senior secured revolving credit agreement, dated as of October 10, 2017, as amended on March 28, 2018 and August 2, 2018, with ZB, N.A., dba Amegy Bank and various other lenders (the “Credit Facility”).

The Credit Facility, as amended, provides for borrowings up to a maximum of $180.0 million on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% (or 2.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) with no LIBOR floor, or (ii) 1.50% (or 1.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021.

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The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10.0 million, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 1.75 to 1.0, and (iii) maintaining a minimum stockholder’s equity. As of December 31, 2018, the Company was in compliance with these covenants.

As of December 31, 2018 and December 31, 2017, the outstanding balance under the Credit Facility was $99.6 million and $40.8 million, respectively. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The fair values of the Credit Facility is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Credit Facility is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. The Company had previously incurred total costs of $3.1 million in connection with obtaining, amending, and maintaining the Original Facility. The Company incurred additional costs of $1.5 million in connection with the current Credit Facility, which are being amortized over the life of the facility. Additionally, $0.3 million of costs from the Original Facility will continue to be amortized over the remaining life of the Credit Facility. As of December 31, 2018 and 2017, $1.3 million and $1.4 million of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our consolidated statement of assets and liabilities as a deduction from the debt liability attributable to the Credit Facility as required by ASU No. 2015-3.

Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the years ended December 31, 2018, 2017, and 2016 (dollars in millions):

     
  For the years ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Interest expense   $       3.7     $       2.2     $       3.4  
Loan fee amortization     0.4       0.4       0.5  
Commitment fees on unused portion     0.4       0.3       0.1  
Administration fees     0.1       0.1        
Total interest and financing expenses   $ 4.6     $ 3.0     $ 4.0  
Loss on extinguishment of debt   $     $ 0.1     $  
Weighted average interest rate     4.7 %      3.7 %      3.2 % 
Effective interest rate (including fee amortization)     5.7 %      5.0 %      3.7 % 
Average debt outstanding   $ 79.8     $ 60.1     $ 106.6  
Cash paid for interest and unused fees   $ 4.2     $ 2.5     $ 3.4  

SBA-guaranteed debentures

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, a single licensee can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. As of December 31, 2018 and 2017, the SBIC subsidiary had $75.0 million and $67.5 million, respectively, in regulatory capital, as such term is defined by the SBA.

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our asset coverage test under the 1940

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Act. The exemptive relief provides us with increased flexibility under the asset coverage test by permitting us to borrow up to $150.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.

On a stand-alone basis, the SBIC subsidiary held $225.5 million and $162.0 million in assets at December 31, 2018 and 2017, respectively, which accounted for approximately 42.9% and 40.4% of our total consolidated assets at December 31, 2018 and 2017, respectively.

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of December 31, 2018 and 2017, the SBIC subsidiary had $150.0 million and $90.0 million of the SBA-guaranteed debentures outstanding, respectively. SBA-guaranteed debentures incur upfront fees of 3.425%, which consists of a 1.00% commitment fee and a 2.425% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. Once pooled, which occurs in March and September each year, the SBA-guaranteed debentures bear interest at a fixed rate that is set to the current 10-year treasury rate plus a spread at each pooling date.

As of December 31, 2018 and 2017, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At December 31, 2018 and 2017, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

As of December 31, 2018, the Company has incurred $5.1 million in financing costs related to the SBA-guaranteed debentures since receiving our SBIC license, which were recorded as prepaid loan fees. As of December 31, 2018 and 2017, $3.6 million and $2.2 million of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the years ended December 31, 2018, 2017 and 2016 (dollars in millions):

     
  For the years ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Interest expense   $       4.0     $       2.1     $       1.9  
Debenture fee amortization     0.6       0.3       0.3  
Total interest and financing expenses   $ 4.6     $ 2.4     $ 2.2  
Weighted average interest rate     3.2 %      3.1 %      2.9 % 
Effective interest rate (including fee amortization)     3.7 %      3.6 %      3.4 % 
Average debt outstanding   $ 125.4     $ 67.3     $ 65.0  
Cash paid for interest   $ 3.1     $ 2.0     $ 1.5  

Notes

On May 5, 2014, the Company closed a public offering of $25.0 million aggregate principal amount of 6.50% notes (the “2019 Notes”) due April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The

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Company redeemed all $25.0 million in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date. As a result of the redemption, the Company recognized a loss on the extinguishment of debt of $0.3 million for the year ended December 31, 2017, due to the write off of the remaining deferred financing costs on the 2019 Notes.

The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for the years ended December 31, 2018, 2017, and 2016 (dollars in millions):

     
  For the years ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Interest expense   $   —     $ 1.2     $ 1.6  
Deferred financing costs           0.1       0.2  
Total interest and financing expenses   $     $ 1.3     $ 1.8  
Loss on extinguishment of debt           0.3        
Cash paid for interest   $     $ 1.4     $ 1.6  

On August 21, 2017, the Company issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6.4 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

The Company used all of the net proceeds from the 2022 Notes offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of both December 31, 2018 and 2017, the aggregate carrying amount of all Notes was $48.9 million and the fair value of the Notes was approximately $47.6 million and $49.5 million, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1.7 million of fees that are being amortized over the term of the 2022 Notes, of which $1.2 million and $1.6 million remained to be amortized as of December 31, 2018 and 2017, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the years ended December 31, 2018, 2017, 2016 (in millions):

     
  For the years ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Interest expense   $       2.8     $       1.0     $       —  
Deferred financing costs     0.3       0.1        
Total interest and financing expenses   $ 3.1     $ 1.1     $  
Cash paid for interest   $ 2.8     $ 0.9     $  

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Contractual Obligations

As of December 31, 2018, our future fixed commitments for cash payments on contractual obligations for each of the next five years and thereafter are as follows:

             
  Total   2019   2020   2021   2022   2023   2024 and thereafter
     (dollars in thousands)
Credit facility payable   $ 99,550                 $ 99,550                    
Notes payable   $ 48,875                       $ 48,875              
SBA-guaranteed debentures   $ 150,000                                   $ 150,000  
Total   $ 298,425     $     —     $     —     $ 99,550     $ 48,875     $     —     $ 150,000  

Off-Balance Sheet Arrangements

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of December 31, 2018, our only off-balance sheet arrangements consisted of $21.2 million of unfunded commitments to provide debt financing to eleven of our portfolio companies. As of December 31, 2017, our only off-balance sheet arrangements consisted of a $8.7 million unfunded commitments to provide debt financing to four of our portfolio companies.

Regulated Investment Company Status and Dividends

We have elected to be treated as a RIC under Subchapter M of the Code. So long as we maintain our qualification as a RIC, we will not be 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 stockholders as dividends 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 until realized. Distributions declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.

To qualify for RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). If we maintain our qualification as a RIC, we must also satisfy certain distribution requirements each calendar year in order to avoid a federal excise tax on our undistributed earnings of a RIC.

We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, the covenants contained in the Credit Facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders.

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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, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in Credit Facility. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.

In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.

Recent Accounting Pronouncements

See Note 1 to the financial statements for a description of recent accounting pronouncements, if any, including the expected dates of adoption and the anticipated impact on the financial statements.

Critical Accounting Policies

The preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. In addition to the discussion below, our significant accounting policies are further described in the notes to the financial statements.

Valuation of portfolio investments

As a business development company, we generally invest in illiquid loans and securities including debt and equity securities of middle-market companies. Under procedures established by our Board, we value investments for which market quotations are readily available at such market quotations. We obtain these market values from an independent pricing service or at the mean between the bid and ask prices obtained from at least two brokers or dealers (if available, otherwise by a principal market maker or a primary market dealer). Debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by our Board. Such determination of fair values may involve subjective judgments and estimates, although we engage independent valuation providers to review the valuation of each portfolio investment that does not have a readily available market quotation at least once each quarter. Investments purchased within 90 days of maturity are valued at cost plus accreted discount, or minus amortized premium, which approximates value. With respect to unquoted securities, our Board, together with our independent valuation advisors, values each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors.

When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, our Board uses the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because there is not a readily available market for substantially all of the investments in our portfolio, we value most of our portfolio investments at fair value as determined in good faith by our Board using a documented valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of

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investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

With respect to investments for which market quotations are not readily available, our Board undertakes a multi-step valuation process each quarter, as described below:

Our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals of Stellus Capital Management responsible for the portfolio investment;
Preliminary valuation conclusions are then documented and discussed with our senior investment professionals and Stellus Capital Management;
At least twice annually, the valuation for each portfolio investment is reviewed by an independent valuation firm;
The audit committee of our Board then reviews these preliminary valuations and makes a recommendation to our Board; and
The Board then discusses valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of Stellus Capital Management, the independent valuation firm and the audit committee.

Revenue recognition

We record interest income on an accrual basis to the extent that we expect to collect such amounts. For loans and debt securities with contractual PIK interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, we do not accrue PIK interest if the portfolio company valuation indicates that such PIK interest is not collectible. We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. Loan origination fees, original issue discount and market discount or premium are capitalized, and we then accrete or amortize such amounts using the effective interest method as interest income. Upon the prepayment of a loan or debt security, any unamortized loan origination is recorded as interest income. We record prepayment premiums on loans and debt securities as interest income. Dividend income, if any, will be recognized on the ex-dividend date.

We have investments in our portfolio that contain a PIK interest provision. Any PIK interest is added to the principal balance of such investments and is recorded as income, if the portfolio company valuation indicates that such PIK interest is collectible. In order to maintain our status as a RIC, substantially all of this income must be paid out to stockholders in the form of dividends, even if we have not collected any cash.

Net realized gains or losses and net change in unrealized appreciation or depreciation

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale, or other disposition and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

Capital Gains Incentive Fee

Under GAAP, we calculate the capital gains incentive fee payable to Stellus Capital Management as if we had realized all investments at their fair values as of the reporting date. Accordingly, we accrue a provisional capital gains incentive fee taking into account any unrealized gains or losses. As the provisional incentive fee is subject to the performance of investments until

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there is a realization event, the amount of provisional capital gains incentive fee accrued at a reporting date may vary from the incentive fee that is ultimately realized and the differences could be material.

Recent Developments

Investment Portfolio

On January 4, 2019, we received full repayment on the first lien term loan of EOS Fitness OPCO Holdings, LLC for total proceeds of $3.1 million. We also received a distribution related to our equity of $0.1 million.

On January 7, 2019, we received 0.3 million in full realization on the equity of OGS Holdings, Inc., resulting in a realized gain $0.2 million.

On February 4, 2019, we invested $8.5 million in the first lien term loan of ASC Communications, LLC, an existing portfolio company.

On February 8, 2019, we invested $12.3 million in the first lien term loan of Exacta Land Surveyors LLC, a provider of land surveys and field management services used to facilitate the purchasing, selling, and development of residential real estate in the U.S. Additionally, we committed $1.5 million in the unfunded revolver, $4.0 million in the unfunded delayed draw term loan, and we invested $1.0 million in the equity of the company.

On February 15, 2019, we received $0.05 million in full realization on the equity of Glori Energy Production, LLC.

On February 28, 2019, we invested $1.4 million in the first lien term loan of Convergence Technologies, Inc., an existing portfolio company. Additionally, we funded $5.4 million under the existing delayed draw term loan and an additional $0.1 million in the equity of the company.

Credit Facility

The outstanding balance under the Credit Facility as of March 4, 2019 was $112.8 million.

SBA-guaranteed Debentures

The total balance of SBA-guaranteed debentures outstanding as of March 4, 2019 was $150.0 million.

Dividend Declared

On January 11, 2019, the Company’s Board declared a regular monthly dividend for each of January, February and March 2019.

       
Declared   Ex-Dividend Date   Record
Date
  Payment Date   Amount per Share
1/11/2019     1/30/2019       1/31/2019       2/15/2019     $ 0.1133  
1/11/2019     2/27/2019       2/28/2019       3/15/2019     $ 0.1133  
1/11/2019     3/28/2019       3/29/2019       4/15/2019     $ 0.1133  

Quantitative and Qualitative Disclosures About Market Risk

We are subject to financial market risks, including changes in interest rates. For the year ended December 31, 2018 and 2017, 91% and 87% of the loans in our portfolio bore interest at floating rates, respectively. These floating rate loans typically bear interest in reference to LIBOR, which are indexed to 30-day or 90-day LIBOR rates, subject to an interest rate floor. December 31, 2018 and 2017, the weighted average interest rate floor on our floating rate loans was 0.94% and 0.92%, respectively.

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Assuming that the Statement of Assets and Liabilities as of December 31, 2018 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, the following table shows the annual impact on net income of changes in interest rates:

     
                                                                                                     ($ in millions)
Change in Basis Points   Interest Income   Interest Expense   Net Interest Income(1)
Up 300 basis points   $ 13.2     $ (2.5 )    $ 10.7  
Up 200 basis points     9.0       (1.7 )      7.3  
Up 100 basis points     4.8       (0.8 )      4.0  
Down 100 basis points     (3.5 )      0.8       (2.7 ) 
Down 200 basis points     (6.6 )      1.7       (4.9 ) 
Down 300 basis points     (7.8 )      2.5       (5.3 ) 

(1) Excludes the impact of incentive fees based on pre-incentive fee net investment income. See Note 2 for more information on the incentive fee.

Although we believe 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. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate. We may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contacts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our portfolio of investments. For the years ended December 31, 2018 and 2017, we did not engage in hedging activities.

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SENIOR SECURITIES

Information about our senior securities is shown in the following table for the fiscal years ended December 31, 2018, 2017, 2016, 2015, 2014, 2013 and 2012. The report of Grant Thornton LLP, our independent registered public accounting firm, on the senior securities table as of December 31, 2018, is attached as an exhibit to the registration statement of which this supplement prospectus is a part.

       
Class and Year   Total Amount
Outstanding
Exclusive of
Treasury
Securities(1)
  Asset
Coverage
per Unit(2)
  Involuntary
Liquidating
Preference
per Unit(3)
  Average
Market
Value
per Unit(4)
     (Dollars in thousands)
SBA Debentures
                                   
Fiscal 2014   $ 16,250       N/A (6)            N/A  
Fiscal 2015   $ 65,000       N/A (6)            N/A  
Fiscal 2016   $ 65,000       N/A (6)            N/A  
Fiscal 2017   $ 90,000       N/A (6)            N/A  
Fiscal 2018   $ 150,000       N/A (6)            N/A  
Original Credit Facility(7)
                                   
Fiscal 2012   $ 38,000     $ 3,090             N/A  
Fiscal 2013   $ 110,000     $ 2,470             N/A  
Fiscal 2014   $ 106,500     $ 2,320 (6)            N/A  
Fiscal 2015   $ 109,500     $ 2,220 (6)            N/A  
Fiscal 2016   $ 116,000     $ 2,210 (6)            N/A  
Credit Facility
                                   
Fiscal 2017   $ 40,750     $ 3,460 (6)            N/A  
Fiscal 2018   $ 99,550     $ 2,520 (6)            N/A  
5.75% Notes due 2022
                                   
Fiscal 2017   $ 48,875     $ 3,460 (6)          $ 25.34  
Fiscal 2018   $ 48,875     $ 2,520 (6)          $ 25.18  
6.50% Notes due 2019(7)
                                   
Fiscal 2014   $ 25,000     $ 2,320 (6)          $ 25.41  
Fiscal 2015   $ 25,000     $ 2,220 (6)          $ 25.27  
Fiscal 2016   $ 25,000     $ 2,210 (6)          $ 25.11  
Short-Term Loan(5)
                                   
Fiscal 2012   $ 45,000     $ 3,090             N/A  
Fiscal 2013   $ 9,000     $ 2,470             N/A  

(1) Total amount of senior securities outstanding at the end of the period presented.
(2) Asset coverage per unit is the ratio of the carrying value of our total assets, less all liabilities and indebtedness not represented by senior securities, in relation to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtedness.
(3) The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it. The “—” indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities.
(4) Average market value per unit for the Notes represents the average of the daily closing prices as reported on the NYSE during the period presented. Average market value per unit for our SBA Debentures and Credit Facility are not applicable because these are not registered for public trading.
(5) Refers to short-term loans that the Company obtained from Raymond James and repaid in full on January 2, 2013 and January 2, 2014, respectively.

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(6) We have excluded our SBA-guaranteed debentures from the asset coverage calculation as of December 31, 2018, 2017, 2016, 2015 and 2014 pursuant to the exemptive relief granted by the SEC in August 2014 that permits us to exclude such debentures from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act.
(7) Such senior securities were retired during the 2017 fiscal year.

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PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

Our common stock is traded on the NYSE under the symbol “SCM.” In connection with our initial public offering, our shares of common stock began trading on November 8, 2012, and before that date, there was no established trading market for our common stock.

The following table sets forth, for each fiscal quarter during the last two most recently completed fiscal years and the current fiscal year to date, the range of high and low closing prices of our common stock as reported on the NYSE, the sales price as a percentage of our net asset value.

         
Fiscal Year Ended   NAV Per Share(1)   Closing Sales Price(2)   Premium or
Discount of
High Sales
to NAV(3)
  Premium or
Discount of
Low Sales to
NAV(3)
  High   Low
December 31, 2019
 
First Quarter (through March 13, 2019)       $ 15.20     $ 13.27          
December 31, 2018
 
Fourth Quarter   $ 14.09     $ 13.65     $ 11.91       -3.12 %      -15.47 % 
Third Quarter   $ 14.29     $ 13.98     $ 12.79       -2.17 %      -10.50 % 
Second Quarter   $ 14.07     $ 13.60     $ 11.56       -3.34 %      -17.84 % 
First Quarter   $ 13.93     $ 13.00     $ 11.34       -6.67 %      -18.59 % 
December 31, 2017
                                            
Fourth Quarter   $ 13.81     $ 14.29     $ 12.19       3.48 %       -11.73 %  
Third Quarter   $ 13.85     $ 13.85     $ 13.30             -3.97 % 
Second Quarter   $ 13.84     $ 14.55     $ 13.25       5.13 %      -4.26 % 
First Quarter   $ 13.84     $ 14.57     $ 12.09       5.27 %      -12.64 % 

(1) Net asset value is determined as of the last date in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low sales prices. The net asset values shown are based on outstanding shares at the end of each period.
(2) Closing sales price is determined as the high or low closing sales price noted within the respective quarter, not adjusted for dividends.
(3) Calculated as of the respective high or low sales price divided by the quarter end net asset value.
* Not determinable at the time of filing.

On March 13, 2019, the last reported sales price of our common stock was $14.68 per share. As of March 13, 2019, we had 8 stockholders of record, which did not include stockholders for whom shares are held in nominee or street name.

Shares of BDCs may trade at a market price that is less than the value of the net assets attributable to those shares. The possibility that our shares of common stock will trade at a discount from net asset value or at premiums that are unsustainable over the long term are separate and distinct from the risk that our net asset value will decrease. Since they began trading on November 8, 2012, in connection with our initial public offering, our shares of common stock have traded at times at a discount to the net assets attributable to those shares.

To the extent that we have income available, we intend to make monthly distributions to our stockholders. Our monthly stockholder distributions, if any, will be determined by our board of directors. Any stockholder distribution to our stockholders will be declared out of assets legally available for distribution.

We have elected to be treated as a RIC under the Code. To maintain RIC tax treatment, we must distribute at least 90% of our net ordinary income and net short-term capital gains in excess of our net long-term capital losses, if any, to our stockholders. In order to avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least

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equal to the sum of: (a) 98% of our net ordinary income for such calendar year; (b) 98.2% of our capital gain net income for the one-year period ending on October 31 of the calendar year; and (c) any net ordinary income and capital gain net income for preceding years that were not distributed during such years and on which we previously paid no U.S. federal income tax.

We currently intend to distribute net capital gains (i.e., net long-term capital gains in excess of net short-term capital losses), if any, at least annually out of the assets legally available for such distributions. However, we may decide in the future to retain such capital gains for investment and elect to treat such gains as deemed distributions to you. If this happens, you will be treated for U.S. federal income tax purposes as if you had received an actual distribution of the capital gains that we retain and reinvested the net after tax proceeds in us. In this situation, you would be eligible to claim a tax credit (or in certain circumstances a tax refund) equal to your allocable share of the tax we paid on the capital gains deemed distributed to you. See “Material U.S. Federal Income Tax Considerations” in this prospectus supplement. We cannot assure you that we will achieve results that will permit us to pay any cash distributions, and if we issue senior securities, we may be prohibited from making distributions if doing so would cause us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if such distributions are limited by the terms of any of our borrowings.

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. Unless you elect to receive your distributions in cash, we intend to make such distributions in additional shares of our common stock under our dividend reinvestment plan. Although distributions paid in the form of additional shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in our dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes. If you hold shares of our common stock in the name of a broker or financial intermediary, you should contact such broker or financial intermediary regarding your election to receive distributions in cash in lieu of shares of our common stock. Any distributions reinvested through the issuance of shares through our dividend reinvestment plan will increase our gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital Management. See “Dividend Reinvestment Plan” beginning on page 127 of the accompanying prospectus.

The following table summarizes our distributions per share that our board of directors has declared on our common stock since January 1, 2018:

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2018
                          
January 11, 2018     January 31, 2018       February 15, 2018     $ 0.1133  
January 11, 2018     February 28, 2018       March 15, 2018     $ 0.1133  
January 11, 2018     March 29, 2018       April 13, 2018     $ 0.1133  
April 16, 2018     April 30, 2018       May 15, 2018     $ 0.1133  
April 16, 2018     May 31, 2018       June 15, 2018     $ 0.1133  
April 16, 2018     June 29, 2018       July 13, 2018     $ 0.1133  
July 12, 2018     July 31, 2018       August 15, 2018     $ 0.1133  
July 12, 2018     August 31, 2018       September 14, 2018     $ 0.1133  
July 12, 2018     September 28, 2018       October 15, 2018     $ 0.1133  
October 16, 2018     October 31, 2018       November 15, 2018     $ 0.1133  
October 16, 2018     November 29, 2018       December 14, 2018     $ 0.1133  
October 16, 2018     December 31, 2018       January 15, 2019     $ 0.1133  
Total               $ 1.3596  

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UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting agreement dated March   , 2019, the underwriters named below, for whom Raymond James and Keefe, Bruyette & Woods, Inc. are acting as representatives, have severally agreed to purchase, and we have agreed to sell to them, the number of shares of common stock indicated below:

 
Underwriter   Number of Shares
Raymond James & Associates, Inc.           
Keefe, Bruyette & Woods, Inc.           
Goldman Sachs & Co. LLC         
Total     2,750,000  

The underwriting agreement provides that the obligations of the underwriters to pay for and accept delivery of the shares of common stock offered hereby are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriters are severally obligated to take and pay for all shares of common stock offered hereby (other than those covered by the underwriters’ option to purchase additional shares described below) if any such shares are taken. The offering of the common stock by the underwriters is subject to receipt and acceptance and subject to the underwriters’ right to reject any order in whole or in part. We have agreed to indemnify the several underwriters against certain liabilities, including liabilities under the Securities Act.

Our common stock is listed on the NYSE under the symbol “SCM.”

The underwriters are purchasing the shares of common stock from us at $    per share (representing approximately $    million aggregate proceeds to us, before we deduct our aggregate out-of-pocket expenses of approximately $    million, or approximately $    million if the underwriters’ option to purchase additional shares described below is exercised in full). Stellus Capital Management had agreed to bear $    , or $     per share, of the commissions (sales load) to be paid to the underwriters in connection with this offering, or $     if the underwriters’ option to purchase additional shares is exercised in full.

Option to Purchase Additional Shares

We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus supplement, to purchase up to an aggregate of     additional shares of common stock at the price set forth on the cover page of this prospectus supplement. To the extent such option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares of common stock as the number set forth next to such underwriter’s name in the preceding table bears to the total number of shares set forth next to the names of all underwriters in the preceding table.

Lock-Up Agreements

We, and our executive officers and directors, have agreed, subject to certain exceptions, not to issue, sell, offer to sell, contract or agree to sell, hypothecate, pledge, transfer, grant any option to purchase, establish an open put equivalent position or otherwise dispose of or agree to dispose of directly or indirectly, any shares of our common stock, or any securities convertible into or exercisable or exchangeable for any shares of our common stock or any right to acquire shares of our common stock, for 90 days from the date of this prospectus supplement, subject to extension upon material announcements or earnings releases. The representatives, at any time and without notice, may release all or any portion of the common stock subject to the foregoing lock-up agreements.

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Price Stabilization, Short Positions and Penalty Bids

In connection with this offering, the underwriters may purchase and sell shares of our common stock in the open market. These transactions may include over-allotment, syndicate covering transactions and stabilizing transactions. An over-allotment involves syndicate sales of shares in excess of the number of shares to be purchased by the underwriters in the offering, which creates a syndicate short position. Syndicate covering transactions involve purchases of shares in the open market after the distribution has been completed in order to cover syndicate short positions.

Stabilizing transactions consist of some bids or purchases of shares of our common stock made for the purpose of preventing or slowing a decline in the market price of the shares while the offering is in progress.

In addition, the underwriters may impose penalty bids, under which they may reclaim the selling concession from a syndicate member when the shares of our common stock originally sold by that syndicate member are purchased in a stabilizing transaction or syndicate covering transaction to cover syndicate short positions.

Similar to other purchase transactions, these activities may have the effect of raising or maintaining the market price of the common stock or preventing or slowing a decline in the market price of the common stock. As a result, the price of the common stock may be higher than the price that might otherwise exist in the open market. Except for the sale of shares of our common stock in this offering, the underwriters may carry out these transactions on the NYSE, in the over-the-counter market or otherwise.

Neither the underwriters nor we make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the shares. In addition, neither the underwriters nor we make any representation that the underwriters will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice.

Conflicts of Interest

An affiliate of Keefe, Bruyette & Woods, Inc., an underwriter in this offering, acts as a lender and/or agent under the Credit Facility. Certain of the net proceeds from the sale of our common stock, not including underwriting compensation, may be paid to such affiliate of Keefe, Bruyette & Woods, Inc. in connection with the repayment of debt owed under the Credit Facility. As a result, Keefe, Bruyette & Woods, Inc. and/or its affiliate may receive more than 5% of the net proceeds of this offering, not including underwriting compensation.

The underwriters and their respective affiliates are full service financial institutions engaged in various activities, which may include sales and trading, commercial and investment banking, advisory, investment management, investment research, principal investment, hedging, market making, brokerage and other financial and non-financial activities and services. The underwriters and/or their affiliates from time to time provide and may in the future provide investment banking, commercial banking and financial advisory services to us, for which they have received and may receive customary compensation.

In the ordinary course of their various business activities, the underwriters and their respective affiliates, officers, directors and employees may purchase, sell or hold a broad array of investments and actively trade securities, derivatives, loans, commodities, currencies, credit default swaps and other financial instruments for their own account and for the accounts of their customers, and such investment and trading activities may involve or relate to our assets, securities and/or instruments (directly, as collateral securing other obligations or otherwise) and/or persons and entities with relationships with us. The underwriters and their respective affiliates may also communicate independent investment recommendations, market color or trading ideas and/or publish or express independent research views in respect of such assets, securities or instruments and may at any time hold, or recommend to clients that they should acquire, long

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and/or short positions in such assets, securities and instruments. In addition, the underwriters and/or their affiliates may from time to time refer investment banking clients to us as potential portfolio investments. If we invest in those clients, we may utilize net proceeds from this offering to fund such investments, and the referring underwriter or its affiliate may receive placement fees from its client in connection with such financing, which placement fees may be paid out of the amount funded by us.

The addresses of the underwriters are: Raymond James & Associates, Inc., 880 Carillon Parkway, St. Petersburg, Florida 33716 and Keefe, Bruyette & Woods, Inc. 787 7th Avenue, 4th Floor, New York, NY 10019.

Selling Restrictions

European Economic Area

In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive (each, a “Relevant Member State”) with effect from and including the date on which the Prospectus Directive is implemented in that Relevant Member State (the “Relevant Implementation Date”) an offer of shares may not be made to the public in that Relevant Member State other than:

(a) to any legal entity which is a qualified investor as defined in the Prospectus Directive;
(b) to fewer than 100 or, if the Relevant Member State has implemented the relevant provision of the 2010 PD Amending Directive, 150, natural or legal persons (other than qualified investors as defined in the Prospectus Directive), as permitted under the Prospectus Directive, subject to obtaining the prior consent of the representative of the several underwriters; or
(c) in any other circumstances falling within Article 3(2) of the Prospectus Directive,

provided that no such offer of shares of our common stock shall require us or any underwriter to publish a prospectus pursuant to Article 3 of the Prospectus Directive or supplement a prospectus pursuant to Article 16 of the Prospectus Directive.

For the purposes of this provision, the expression an “offer of shares to the public” in relation to any shares of our common stock in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms of the offer and the shares of our common stock to be offered so as to enable an investor to decide to purchase or subscribe for any shares of our common stock, as the same may be varied in that Relevant Member State by any measure implementing the Prospectus Directive in that Relevant Member State. The expression “Prospectus Directive” means Directive 2003/71/EC (and amendments thereto, including the 2010 PD Amending Directive to the extent implemented in the Relevant Member State) and includes any relevant implementing measure in each Relevant Member State and the expression “2010 PD Amending Directive” means Directive 2010/73/EU.

The sellers of shares of our common stock have not authorized and do not authorize the making of any offer of shares of our common stock through any financial intermediary, other than offers made by the underwriters with a view to underwriting the shares of our common stock as contemplated in this prospectus supplement and the accompanying prospectus. Accordingly, no purchaser of shares of our common stock, other than the underwriters, is authorized to make any further offer of shares of our common stock on behalf of the sellers or the underwriters.

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United Kingdom

Each underwriter has represented and agreed that:

(a) it has complied and will comply with all applicable provisions of the Financial Services and Markets Act 2000 (“FSMA”) with respect to anything done by it in relation to the shares of common stock in, from or otherwise involving the United Kingdom; and
(b) it will only communicate or cause to be communicated an invitation or inducement to engage in investment activity (within the meaning of Section 21 of the FSMA) received by it in connection with the issue and sale of such shares of common stock in circumstances in which Section 21(1) of the FSMA does not apply to us.

Japan

The securities have not been and will not be registered under the Financial Instruments and Exchange Law of Japan (the Financial Instruments and Exchange Law) and each underwriter has agreed that it will not offer or sell any securities, directly or indirectly, in Japan or to, or for the benefit of, any resident of Japan (which term as used herein means any person resident in Japan, including any corporation or other entity organized under the laws of Japan), or to others for re-offering or resale, directly or indirectly, in Japan or to a resident of Japan, except pursuant to an exemption from the registration requirements of, and otherwise in compliance with, the Financial Instruments and Exchange Law and any other applicable laws, regulations and ministerial guidelines of Japan.

Hong Kong

The shares may not be offered or sold by means of any document other than (i) in circumstances which do not constitute an offer to the public within the meaning of the Companies Ordinance (Cap.32, Laws of Hong Kong), or (ii) to “professional investors” within the meaning of the Securities and Futures Ordinance (Cap.571, Laws of Hong Kong) and any rules made thereunder, or (iii) in other circumstances which do not result in the document being a “prospectus” within the meaning of the Companies Ordinance (Cap.32, Laws of Hong Kong), and no advertisement, invitation or document relating to the shares may be issued or may be in the possession of any person for the purpose of issue (in each case whether in Hong Kong or elsewhere), which is directed at, or the contents of which are likely to be accessed or read by, the public in Hong Kong (except if permitted to do so under the laws of Hong Kong) other than with respect to shares which are or are intended to be disposed of only to persons outside Hong Kong or only to “professional investors” within the meaning of the Securities and Futures Ordinance (Cap. 571, Laws of Hong Kong) and any rules made thereunder.

Singapore

This prospectus supplement and the accompanying prospectus have not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, this prospectus and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of the shares may not be circulated or distributed, nor may the shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 274 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”), (ii) to a relevant person, or any person pursuant to Section 275(1A), and in accordance with the conditions specified in Section 275 of the SFA or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. Where the shares are subscribed or purchased under Section 275 of the SFA by a relevant person which is: (a) a corporation (which is not an accredited investor) the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; or (b) a trust (where the trustee is not an accredited investor) whose sole purpose is to hold investments and each beneficiary is an accredited investor, shares, debentures and units of shares and debentures of that corporation or the beneficiaries’ rights and interest in that trust will not be transferable for

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six months after that corporation or that trust has acquired the shares under Section 275 of the SFA except: (1) to an institutional investor under Section 274 of the SFA or to a relevant person, or any person pursuant to Section 275(1A) of the SFA and in accordance with the conditions specified in Section 275 of the SFA; (2) where no consideration is given for the transfer; or (3) by operation of law.

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LEGAL MATTERS

Certain legal matters regarding the shares of common stock offered by this prospectus will be passed upon for us by Eversheds Sutherland (US) LLP, Washington, DC 20001. Certain legal matters in connection with the offering will be passed upon for the underwriters by Mayer Brown LLP, New York, NY.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The financial statements, financial highlights and senior securities table of Stellus Capital Investment Corporation included in this prospectus and elsewhere in the registration statement have been so included in reliance upon the reports of Grant Thornton LLP. Grant Thornton LLP, located at 171 N. Clark Street, Chicago, Illinois, 60601, serves as the Company’s independent registered public accounting firm, providing audit services and review of certain documents to be filed with the SEC.

AVAILABLE INFORMATION

We have filed with the SEC a registration statement on Form N-2, together with all amendments and related exhibits, under the Securities Act with respect to the shares of common stock offered by this prospectus supplement. The registration statement contains additional information about us and the shares of common stock being offered by this prospectus supplement.

We also file with or submit to the SEC annual, quarterly and current reports, proxy statements and other information meeting the informational requirements of the Exchange Act. You may inspect and copy these reports, proxy statements and other information, as well as the registration statement and related exhibits and schedules, at the SEC’s website www.sec.gov.

We maintain a website at www.stelluscapital.com and make all of our annual, quarterly and current reports, proxy statements and other publicly filed information available, free of charge, on or through our website. Information contained on our website is not incorporated into this prospectus supplement or the accompanying prospectus, and you should not consider information on our website to be part of this prospectus supplement or the accompanying prospectus. You may also obtain such information by contacting us in writing at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, Attention: Investor Relations. The SEC maintains a website that contains reports, proxy and information statements and other information we file with the SEC at www.sec.gov. Copies of these reports, proxy and information statements and other information may also be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov.

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INDEX TO AUDITED FINANCIAL STATEMENTS

 
Reports of Independent Registered Public Accounting Firm     SF-2  
Consolidated Statements of Assets and Liabilities as of December 31, 2018 and December 31, 2017     SF-5  
Consolidated Statements of Operations for the years ended December 31, 2018, 2017 and 2016     SF-6  
Consolidated Statements of Changes in Net Assets for the years ended December 31, 2018, 2017 and 2016     SF-7  
Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017 and 2016     SF-8  
Consolidated Schedule of Investments as of December 31, 2018 and December 31, 2017     SF-10  
Notes to Consolidated Financial Statements     SF-26  

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders’
Stellus Capital Investment Corporation

Opinion on the financial statements

We have audited the accompanying consolidated statements of assets and liabilities of Stellus Capital Investment Corporation (a Maryland corporation) and subsidiaries (the “Company”), including the consolidated schedules of investments, as of December 31, 2018 and 2017, the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes, schedules and financial highlights (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, and the financial highlights for each of the five years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 5, 2019 expressed an unqualified opinion.

Basis for opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our procedures included verification by confirmation of securities as of December 31, 2018 and 2017, by correspondence with the portfolio companies and custodians, or by other appropriate auditing procedures where replies were not received. We believe that our audits provide a reasonable basis for our opinion.

/s/ GRANT THORNTON LLP

We have served as the Company’s auditor since 2012.
Dallas, Texas
March 5, 2019

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders’
Stellus Capital Investment Corporation

Opinion on internal control over financial reporting

We have audited the internal control over financial reporting of Stellus Capital Investment Corporation (a Maryland corporation) and subsidiaries (the “Company”) as of December 31, 2018, based on criteria established in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in the 2013 Internal Control — Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company, as of and for the year ended December 31, 2018 and our report dated March 5, 2019, expressed an unqualified opinion on those financial statements.

Basis for opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and limitations of internal control over financial reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ GRANT THORNTON LLP

Dallas, Texas
March 5, 2019

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PART I — FINANCIAL INFORMATION
STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

   
  December 31,
2018
  December 31,
2017
ASSETS
                 
Non-controlled, affiliated investments, at fair value (amortized cost of $52,185 and $1,052,185, respectively)   $ 50,000     $ 990,000  
Non-controlled, non-affiliated investments, at fair value (amortized cost of $502,691,464 and $367,401,021, respectively)     504,433,668       370,849,772  
Cash and cash equivalents     17,467,146       25,110,718  
Receivable for sales and repayments of investments     99,213       26,891  
Interest receivable     3,788,684       2,922,204  
Other receivables     85,246        
Deferred offering costs     18,673        
Prepaid expenses     344,621       361,270  
Total Assets   $ 526,287,251     $ 400,260,855  
LIABILITIES
                 
Notes payable   $ 47,641,797     $ 47,306,488  
Credit facility payable     98,237,227       39,332,479  
SBA-guaranteed debentures     146,387,802       87,818,813  
Dividends payable     1,807,570       1,806,671  
Management fees payable     2,183,975       1,621,592  
Income incentive fees payable     1,936,538       371,647  
Capital gains incentive fees payable     81,038        
Interest payable     1,863,566       1,021,173  
Unearned revenue     410,593       139,304  
Administrative services payable     392,191       327,033  
Deferred tax liability     67,953        
Income tax payable     316,092        
Other accrued expenses and liabilities     115,902       268,413  
Total Liabilities   $ 301,442,244     $ 180,013,613  
Commitments and contingencies (Note 7)
                 
Net Assets   $ 224,845,007     $ 220,247,242  
NET ASSETS
                 
Common Stock, par value $0.001 per share (200,000,000 shares and 100,000,000 shares authorized; 15,953,810 and 15,945,879 issued and outstanding, respectively)   $ 15,954     $ 15,946  
Paid-in capital     228,160,491       228,066,762  
Accumulated net realized loss from investments, net of cumulative dividends of $9,519,362 and $4,246,819, respectively, and tax provision on realized gain of $267,975 and $0, respectively     (10,786,240 )      (10,786,240 ) 
Accumulated undistributed net investment income     5,782,736       (435,794 ) 
Net unrealized appreciation on non-controlled, non-affiliated investments and cash equivalents, net of provision for taxes of $67,953 and $0, respectively (Note 13)     1,674,251       3,448,753  
Net unrealized depreciation on non-controlled, affiliated investments     (2,185 )      (62,185 ) 
Net Assets   $ 224,845,007     $ 220,247,242  
Total Liabilities and Net Assets   $ 526,287,251     $ 400,260,855  
Net Asset Value Per Share   $ 14.09     $ 13.81  

 
 
See accompanying notes to these consolidated financial statements.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF OPERATIONS

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
INVESTMENT INCOME
                          
Interest income   $ 51,463,033     $ 38,071,449     $ 38,176,617  
Other income     1,803,305       1,576,744       1,313,580  
Total Investment Income   $ 53,266,338     $ 39,648,193     $ 39,490,197  
OPERATING EXPENSES
                          
Management fees   $ 8,154,842     $ 6,255,911     $ 6,281,863  
Valuation fees     307,838       336,300       397,330  
Administrative services expenses     1,390,375       1,245,727       1,045,648  
Income incentive fees     5,529,376       2,911,392       4,275,436  
Capital gains incentive fees     81,038              
Professional fees     1,189,071       1,274,066       712,524  
Directors’ fees     317,000       331,000       324,000  
Insurance expense     348,500       429,897       471,427  
Interest expense and other fees     12,338,755       7,855,211       7,992,185  
Income tax expense     275,106              
Deferred offering costs                 261,761  
Other general and administrative expenses     697,900       621,204       415,822  
Total Operating Expenses   $ 30,629,801     $ 21,260,708     $ 22,177,996  
Loss on extinguishment of debt           416,725        
Net Investment Income   $ 22,636,537     $ 17,970,760     $ 17,312,201  
Net realized gain (loss) on non-controlled,
non-affiliated investments and cash equivalents
  $ 5,540,518     $ 4,655,976     $ (13,089,671 ) 
Tax provision on realized gain on investments     (267,975 )             
Net change in unrealized appreciation (depreciation) on non-controlled, non-affiliated investments and cash equivalents   $ (1,706,549 )    $ 40,113     $ 18,603,401  
Net change in unrealized appreciation (depreciation) on non-controlled, affiliated investments and cash equivalents     60,000       (62,185 )       
Benefit (provision) for taxes on net unrealized gain (loss) on investments   $ (67,953 )    $ 8,593     $ 373,131  
Net Increase in Net Assets Resulting from Operations   $ 26,194,578     $ 22,613,257     $ 23,199,062  
Net Investment Income Per Share   $ 1.42     $ 1.21     $ 1.39  
Net Increase in Net Assets Resulting from Operations Per Share   $ 1.64     $ 1.52     $ 1.86  
Weighted Average Shares of Common Stock Outstanding     15,953,571       14,870,981       12,479,959  
Distributions Per Share   $ 1.36     $ 1.36     $ 1.36  

 
 
See accompanying notes to these consolidated financial statements.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
Increase in Net Assets Resulting from Operations
                          
Net investment income   $ 22,636,537     $ 17,970,760     $ 17,312,201  
Net realized gain (loss) on investments and cash equivalents     5,540,518       4,655,976       (13,089,671 ) 
Tax provision on realized gain on
investments
    (267,975 )             
Net change in unrealized appreciation (depreciation) on non-controlled, non-affiliated investments and cash equivalents     (1,706,549 )      40,113       18,603,401  
Net change in unrealized appreciation (depreciation) on non-controlled, affiliated investments and cash equivalents     60,000       (62,185 )       
Benefit (provision) for taxes on unrealized appreciation on investments     (67,953 )      8,593       373,131  
Net Increase in Net Assets Resulting from
Operations
  $ 26,194,578     $ 22,613,257     $ 23,199,062  
Stockholder distributions from:
                          
Net investment income     (16,418,007 )      (17,970,760 )      (16,968,350 ) 
Net realized capital gains     (5,272,543 )      (2,352,545 )       
Total Distributions   $ (21,690,550 )    $ (20,323,305 )    $ (16,968,350 ) 
Capital Share Transactions
                          
Issuance of common stock   $ 94,788     $ 48,741,549     $  
Sales load           (1,358,880 )       
Offering costs           (307,022 )       
Partial share redemption     (1,051 )      (142 )      (31 ) 
Net Increase (Decrease) in Net Assets Resulting From Capital Share
Transactions
  $ 93,737     $ 47,075,505     $ (31 ) 
Total Increase in Net Assets   $ 4,597,765     $ 49,365,457     $ 6,230,681  
Net Assets at Beginning of Period   $ 220,247,242     $ 170,881,785     $ 164,651,104  
Net Assets at End of Period (Includes $5,782,736, $(435,794) and $(435,794) of Accumulated Undistributed Net Investment Income (Loss), Respectively)   $ 224,845,007     $ 220,247,242     $ 170,881,785  

 
 
See accompanying notes to these consolidated financial statements.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
Cash flows from operating activities
                          
Net Increase in net assets resulting from operations   $ 26,194,578     $ 22,613,257     $ 23,199,062  
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operating activities:
                          
Purchases of investments     (272,927,459 )      (172,171,246 )      (65,661,034 ) 
Proceeds from sales and repayments of
investments
    147,528,448       172,260,541       55,949,177  
Net change in unrealized depreciation (appreciation) on investments     1,646,549       22,072       (18,603,401 ) 
Increase in investments due to PIK     (1,869,905 )      (499,595 )      (243,766 ) 
Amortization of premium and accretion of discount, net     (1,553,333 )      (1,196,566 )      (1,128,511 ) 
Deferred tax provision (benefit)     67,953       (8,593 )      (373,130 ) 
Amortization of loan structure fees     456,151       455,893       523,835  
Amortization of deferred financing costs     335,309       251,826       326,190  
Amortization of loan fees on SBA-guaranteed debentures     623,989       333,027       184,783  
Net realized (gain) loss on investments     (5,540,518 )      (4,655,976 )      13,089,341  
Loss on extinguishment of debt           416,725        
Deferred offering costs                 261,761  
Changes in other assets and liabilities
                          
Decrease (increase) in interest receivable     (866,480 )      1,679,538       118,289  
Decrease (increase) in other receivable     (85,246 )      748       6,936  
Decrease in prepaid expenses     16,649       94,949       19,230  
Increase in management fees payable     562,383       13,297       89,516  
Increase (decrease) in incentive fees payable     1,564,891       (981,624 )      745,315  
Increase in capital gains incentive fees payable     81,038              
Increase (decrease) in administrative services
payable
    65,158       54,522       (125,288 ) 
Increase in interest payable     842,393       47,361       403,623  
Increase (decrease) in unearned revenue     271,289       119,349       (16,922 ) 
Increase in income tax payable     316,092              
Increase (decrease) in other accrued expenses and liabilities     (152,511 )      1,022       71,714  
Net Cash Provided by (Used in) Operating
Activities
  $ (102,422,582 )    $ 18,850,527     $ 8,836,720  

 
 
See accompanying notes to these consolidated financial statements.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS – (continued)

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
Cash flows from financing activities
                          
Proceeds from the issuance of common stock   $     $ 48,741,549     $  
Sales load for common stock issued           (1,358,880 )       
Offering costs paid for common stock     (18,673 )      (307,022 )       
Proceeds from notes issued           48,875,000        
Financing costs paid for Notes issued           (1,688,961 )       
Repayments on Notes issued           (25,000,000 )       
Stockholder distributions paid     (21,594,863 )      (19,930,616 )      (16,968,350 ) 
Proceeds from SBA Debentures     60,000,000       25,000,000        
Financing costs paid on SBA Debentures     (2,055,000 )      (856,250 )       
Borrowings under Credit Facility     246,300,000       194,250,000       56,500,000  
Repayments of Credit Facility     (187,500,000 )      (269,500,000 )      (50,000,000 ) 
Financing costs paid on Credit facility     (351,403 )      (1,158,616 )      (50,000 ) 
Partial Share Redemption     (1,051 )      (142 )      (31 ) 
Net Cash Provided by (Used in) Financing
Activities
  $ 94,779,010     $ (2,933,938 )    $ (10,518,381 ) 
Net Increase (Decrease) in Cash and Cash
Equivalents
  $ (7,643,572 )    $ 15,916,589     $ (1,681,661 ) 
Cash and cash equivalents balance at beginning of period     25,110,718       9,194,129       10,875,790  
Cash and Cash Equivalents Balance at End of
Period
  $ 17,467,146     $ 25,110,718     $ 9,194,129  
Supplemental and Non-Cash Activities
                          
Cash paid for interest expense   $ 10,075,913     $ 6,762,104     $ 6,548,754  
Excise tax paid     27,717       37,648        
Shares issued pursuant to Dividend Reinvestment
Plan
    94,788              
Conversion from debt to equity           864,101        
Increase in Distribution Payable     899       392,689        

 
 
See accompanying notes to these consolidated financial statements.

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Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Non-controlled, affiliated
investments
    (2)
                                                                                                             
Glori Energy Production Inc.                                                                             Houston, TX                                      
Glori Energy Production, LLC Class A Common Units     (4)
      Equity                               2/1/2017             Energy: Oil &
Gas
      1,000
shares
    $ 52,185     $ 50,000       0.02%  
Subtotal Non-controlled, affiliated
investments
                                                                52,185       50,000       0.02%  
Non-controlled,
non-affiliated
investments
    (2)
                                                                                                             
Abrasive Products & Equipment, LLC,
et al
                                                                            Deer Park, TX                                      
Term Loan (SBIC)     (2)(12)(20)
      Second
Lien
      3M
L+10.50%
      1.00%       0.00%                9/5/2014       3/5/2020       Chemicals,
Plastics, &
Rubber
    $ 5,325,237       5,294,907       4,712,835       2.10%  
APE Holdings, LLC Class A Common Units     (4)
      Equity                               9/5/2014                   375,000
units
      375,000       0       0.00%  
Total                                                                 5,669,907       4,712,835       2.10%  
Adams Publishing Group, LLC     (3)
                                                                     Greenville, TN
                                     
Term Loan     (12)
      First Lien       3M
L+7.50%
      1.00%       9.93%                8/3/2018       6/30/2023       Media:
Broadcasting &
Subscription
    $ 7,125,000       7,058,675       6,875,625       3.06%  
Advanced Barrier Extrusions, LLC     (8)
                                                                     Rhinelander,
WI
                                     
Term Loan (SBIC)     (2)(12)
      First Lien       3M
L+5.75%
      1.00%       8.56%                8/8/2018       8/8/2023       Containers,
Packaging &
Glass
    $ 11,400,000       11,187,711       10,659,000       4.74%  
GP ABX Holdings Partnership, L.P. Common Stock     (4)
      Equity                               8/8/2018                   250,000
units
      250,000       210,000       0.09%  
Total                                                                 11,437,711       10,869,000       4.83%  
Apex Environmental Resources Holdings, LLC                                                                             Amsterdam, OH                                      
Common Units     (4)
      Equity                                           10/30/2015                Environmental Industries       945
shares
      945       0       0.00%  
Preferred Units     (4)
      Equity                                                 945
shares
      945,179       330,000       0.15%  
Total                                         10/30/2015                         946,124       330,000       0.15%  
APG Intermediate Sub 2 Corp.                                                                             Castle Rock,
CO
                                     
Term Loan     (13)(22)
      First Lien       3M
L+6.00%
      1.00%       10.05%                11/30/2018       11/30/2023       Services:
Business
      10,000,000       9,777,822       9,777,822       4.35%  
APG Holdings, LLC Class A Preferred Units     (4)
      Equity                               11/30/2018                   1,000,000
units
      1,000,000       1,000,000       0.44%  
Total                                                                 10,777,822       10,777,822       4.79%  
Atmosphere Aggregator Holdings II, LP                                                                             Atlanta, GA                                      
Common Units     (4)
      Equity                                           6/30/2015                Services:
Business
      254,250
units
      254,250       1,190,000       0.53%  
Atmosphere Aggregator Holdings, LP Common Units     (4)
      Equity                               6/30/2015                   750,000
units
      750,000       3,510,000       1.56%  
Total                                                                 1,004,250       4,700,000       2.09%  

 
 
See accompanying notes to these consolidated financial statements.

SF-10


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
ASC Communications, LLC     (7)
                                                                     Chicago, IL                                      
Term Loan (SBIC)     (2)(12)
      First Lien       1M
L+5.75%
      1.00%       8.27%                6/29/2017       6/29/2022       Healthcare &
Pharmaceuticals
    $ 5,083,335     $ 5,045,552     $ 5,057,916       2.25%  
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)     (2)(4)
      Equity                               6/29/2017                   73,529
shares
      483,540       800,000       0.36%  
Total                                                                 5,529,092       5,857,916       2.61%  
Beneplace, LLC                                                                             Austin TX                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+10.00%
      1.00%       12.81%                3/27/2017       9/27/2022       FIRE:
Insurance
    $ 5,000,000       4,925,301       4,950,000       2.20%  
Beneplace Holdings, LLC Preferred
Units
    (4)
      Equity                               3/27/2017                   500,000
units
      500,000       510,000       0.23%  
Total                                                                 5,425,301       5,460,000       2.43%  
BFC Solmetex, LLC     (23)
                                                                     Nashville, TN                                      
Revolver     (12)(19)
      First Lien       3M
L+6.25%
      1.00%       9.06%                4/2/2018       9/26/2023       Services:
Business
    $ 305,623       305,623       288,814       0.13%  
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+6.25%
      1.00%       9.06%                4/2/2018       9/26/2023              $ 11,711,033       11,552,684       11,066,926       4.92%  
Bonded Filter Co. LLC, Term Loan (SBIC)     (2)(12)
      First Lien       3M
L+6.25%
      1.00%       9.06%             4/2/2018       9/26/2023           $ 1,216,687       1,200,236       1,149,769       0.51%  
Total                                                                 13,058,543       12,505,509       5.56%  
BW DME Acquisition, LLC                                                                             Tempe, AZ                                      
Term Loan
(SBIC)
    (2)(13)(22)
      First Lien       3M
L+6.00%
      1.00%       10.50%                8/24/2017       8/24/2022       Healthcare &
Pharmaceuticals
    $ 16,695,804       16,297,319       16,111,451       7.17%  
BW DME Holdings, LLC, Term Loan (SBIC)     (6)
      Unsecured       17.50%                         17.50%       6/1/2018       12/31/2019              $ 277,635       277,635       277,635       0.12%  
BW DME Holdings, LLC Class A-1 Preferred Units     (4)
      Equity                                           8/24/2017                         1,000,000
shares
      1,000,000       930,000       0.41%  
BW DME Holdings, LLC Class A-2 Preferred Units     (4)
      Equity                               1/26/2018                   937,261 shares       937,261       870,000       0.39%  
Total                                                                 18,512,215       18,189,086       8.09%  
C.A.R.S. Protection Plus, Inc.                                                                             Murrysville, PA                                      
Term Loan     (12)
      First Lien       3M
L+8.50%
      0.50%       11.21%                12/31/2015       12/31/2020       Automotive     $ 98,746       97,843       98,746       0.04%  
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+8.50%
      0.50%       11.21%                12/31/2015       12/31/2020              $ 7,702,191       7,631,725       7,702,191       3.43%  
CPP Holdings LLC Class A Common Units     (4)
      Equity                               12/31/2015                   149,828
shares
      149,828       170,000       0.08%  
Total                                                                 7,879,396       7,970,937       3.55%  
Catapult Learning,
Inc.
                                                                            Camden, NJ                                      
Term Loan     (13)(22)
      First Lien       3M
L+6.35%
      1.00%       11.08%                6/27/2018       4/24/2023       Education     $ 20,856,549       20,472,244       19,813,722       8.81%  
Delayed Draw Term Loan     (13)(22)
      First Lien       3M
L+6.35%
      1.00%       11.22%             6/27/2018       4/24/2023           $ 1,143,451       1,143,451       1,086,278       0.48  
Total                                                                 21,615,695       20,900,000       9.29%  
Colford Capital Holdings, LLC                                                                             New York, NY                                      
Preferred Units     (4)(5)
      Equity                                           8/20/2015                Finance       38,893
units
      247,815       60,000       0.03%  
Condor Borrower,
LLC
                                                                            Clifton, NJ                                      
Term Loan     (12)
      Second
Lien
      3M
L+8.75%
      1.00%       11.28%                10/27/2017       4/27/2025       Services:
Business
      13,750,000       13,505,368       13,062,500       5.81%  

 
 
See accompanying notes to these consolidated financial statements.

SF-11


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Condor Top Holdco Limited Convertible Preferred
Shares
    (4)
      Equity                                           10/27/2017                         500,000
shares
    $ 442,197     $ 330,000       0.15%  
Condor Holdings Limited Preferred Shares, Class B     (4)
      Equity                               10/27/2017                   500,000
shares
      57,804       40,000       0.02%  
Total                                                                 14,005,369       13,432,500       5.98%  
Convergence Technologies,
Inc.
    (14)
                                                                     Indianpolis, IN                                      
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+6.75%
      1.50%       9.56%                8/31/2018       8/30/2024       Services:
Business
    $ 7,125,000       6,988,628       6,697,500       2.98%  
Tailwind Core Investor, LLC Class A Preferred Units     (4)
      Equity                               8/31/2018                   3,750
units
      375,000       390,000       0.17%  
Total                                                                 7,363,628       7,087,500       3.15%  
Douglas Products Group, LP                                                                             Liberty, MO                                      
Class A Common
Units
    (4)
      Equity                                           12/27/2018                Chemicals,
Plastics, &
Rubber
      322
shares
      139,656       670,000       0.30%  
Dream II Holdings,
LLC
                                                                            Boca Raton, FL                                      
Class A Common
Units
    (4)
      Equity                                           10/20/2014                Services:
Consumer
      250,000
units
      242,304       110,000       0.05%  
DTE Enterprises,
LLC
    (18)
                                                                     Roselle, IL                                      
Term Loan     (12)
      First Lien       3M
L+7.50%
      1.50%       10.12%                4/13/2018       4/13/2023       Energy: Oil &
Gas
    $ 12,491,941       12,271,851       12,242,102       5.44%  
DTE Holding Company, LLC Common Shares, Class A-2     (4)
      Equity                                           4/13/2018                         776,316
shares
      776,316       1,410,000       0.63%  
DTE Holding Company, LLC Preferred Shares, Class AA     (4)
      Equity                               4/13/2018                   723,684
shares
      613,794       1,320,000       0.59%  
Total                                                                 13,661,961       14,972,102       6.66%  
Empirix Inc.                                                                             Billerica, MA                                      
Empirix Holdings I, Inc. Common Shares,
Class A
    (4)
      Equity                                           11/1/2013                Software       1,304
shares
      1,304,232       1,650,000       0.73%  
Empirix Holdings I, Inc. Common Shares, Class B     (4)
      Equity                               11/1/2013                   1,317,406
shares
      13,174       20,000       0.01%  
Total                                                                 1,317,406       1,670,000       0.74%  
Energy Labs Inc.                                                                             Houston, TX                                      
Energy Labs Holding Corp. Common
Stock
    (4)
      Equity                                           9/29/2016                Energy: Oil &
Gas
      598
shares
      598,182       520,000       0.23%  
EOS Fitness OPCO Holdings, LLC                                                                             Phoenix, AZ                                      
Term Loan
(SBIC)
    (2)(12)
      First Lien       1M
L+8.25%
      0.75%       10.60%                12/30/2014       12/30/2019       Hotel, Gaming,
& Leisure
    $ 3,064,655       3,049,620       3,064,655       1.36%  
EOS Fitness Holdings, LLC Class A Preferred Units     (4)
      Equity                                           12/30/2014                         118
shares
      117,670       340,000       0.15%  
EOS Fitness Holdings, LLC Class B Common Units     (4)
      Equity                               12/30/2014                   3,017
shares
      3,017       10,000       0.00%  
Total                                                                 3,170,307       3,414,655       1.51  

 
 
See accompanying notes to these consolidated financial statements.

SF-12


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Fast Growing Tree,
LLC
    (16)
                                                                     Fort Mill, SC                                      
Term Loan (SBIC)     (2)(12)
      First Lien       3M
L+7.75%
      1.00%       10.56%                2/5/2018       02/05/23       Retail     $ 20,215,000     $ 19,871,587     $ 19,305,325       8.59%  
SP FGT Holdings, LLC, Class A Common     (4)
      Equity                               2/5/2018                   1,000,000
shares
      1,000,000       1,080,000       0.48%  
Total                                                                 20,871,587       20,385,325       9.07%  
Furniture Factory Outlet, LLC                                                                             Fort Smith, AR                                      
Term Loan     (12)
      First Lien       3M
L+8.00%
      0.50%       10.81%                6/10/2016       6/10/2021       Consumer
Goods: Durable
    $ 15,163,885       14,961,912       15,163,885       6.74%  
Revolver     (12)
      First Lien       3M
L+8.00%
      0.50%       10.81%                12/17/2018       6/10/2021              $ 2,500,000       2,500,000       2,500,000       1.11%  
Furniture Factory Holdings, LLC Term Loan     (6)
      Unsecured       11.00%                         11.00%       6/10/2016       2/3/2021              $ 140,056       140,056       140,056       0.06%  
Furniture Factory Ultimate Holdings, LP Common
Units
    (4)
      Equity                               6/10/2016                   13,445
shares
      94,569       210,000       0.09%  
Total                                                                 17,696,537       18,013,941       8.00%  
GK Holdings, Inc.                                                                             Cary, NC                                      
Term Loan     (12)
      Second
Lien
      3M
L+10.25%
      1.00%       13.05%                2/6/2015       1/30/2022       Education     $ 5,000,000       4,946,554       4,425,000       1.97%  
General LED OPCO, LLC                                                                             San Antonio,
TX
                                     
Term Loan     (12)
      Second
Lien
      3M
L+9.00%
      1.50%       11.81%                5/1/2018       11/1/2023       Services:
Business
    $ 4,500,000       4,418,420       4,252,500       1.89%  
Good Source Solutions, Inc.                                                                             Carlsbad, CA                                      
Term Loan     (13)(22)
      First Lien       3M
L+6.00%
      1.00%       11.13%                6/29/2018       6/29/2023       Beverage,
Food, &
Tobacco
    $ 18,500,000       18,158,424       17,390,000       7.73%  
HV GS Acquisition, LLC Class A Preferred Units     (4)
      Equity                                           6/29/2018                         1,000
shares
      1,000,000       730,000       0.32%  
HV GS Acquisition, LLC Class B Common Units     (4)
      Equity                               6/29/2018                   28,125
shares
      0       0       0.00%  
Total                                                                 19,158,424       18,120,000       8.05%  
Grupo HIMA San Pablo, Inc., et al                                                                             San Juan, PR                                      
Term Loan     (12)
      First Lien       3M
L+7.00%
      1.50%       9.54%                2/1/2013       1/31/2018       Healthcare &
Pharmaceuticals
    $ 4,688,430       4,688,430       4,125,818       1.83%  
Term Loan     (15)
      Second
Lien
      13.75%             0.00%             2/1/2013       7/31/2018           $ 4,109,524       4,109,524       904,095       0.40%  
Total                                                                 8,797,954       5,029,913       2.23%  
ICD Intermediate Holdco 2, LLC                                                                             San Francisco,
CA
                                     
Term Loan
(SBIC)
    (2)(5)(12)
      Second
Lien
      3M
L+9.00%
      1.00%       11.81%                1/2/2018       7/1/2024       Finance     $ 10,000,000       9,822,706       9,900,000       4.40%  
ICD Holdings, LLC, Class A
Preferred
    (4)(5)
      Equity                               1/2/2018                   9,962
shares
      496,409       820,000       0.36%  
Total                                                                 10,319,115       10,720,000       4.76%  
J.R. Watkins, LLC                                                                             San Francisco,
CA
                                     
Revolver     (12)
      First Lien       3M
L+6.50%
      1.25%       9.31%                12/22/2017       12/22/2022       Consumer
Goods:
non-durable
    $ 1,750,000       1,750,000       1,671,250       0.74%  
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+6.50%
      1.25%       9.31%                12/22/2017       12/22/2022              $ 12,375,000       12,169,222       11,818,125       5.26%  
J.R. Watkins Holdings, Inc. Class A
Preferred
    (4)
      Equity                               12/22/2017                   1,076
shares
      1,075,758       1,090,000       0.48%  
Total                                                                 14,994,980       14,579,375       6.48%  

 
 
See accompanying notes to these consolidated financial statements.

SF-13


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Jurassic Intermediate Holdings Corp.                                                                             Sparks, MD                                      
Term Loan     (12)
      First Lien       3M
L+5.50%
      0.00%       8.14%                12/28/2018       11/15/2024       Consumer
Goods: Durable
    $ 17,500,000     $ 17,237,500     $ 17,237,500       7.67%  
Kelleyamerit Holdings, Inc.                                                                             Walnut Creek,
CA
                                     
Term Loan
(SBIC)
    (2)(13)(22)
      First Lien       3M
L+7.50%
      1.50%       10.98%                3/30/2018       3/30/2023       Automotive     $ 9,750,000       9,577,863       9,311,250       4.14%  
Keais Records Service, LLC                                                                             Houston, TX                                      
Keais Holdings, LLC Class A Units     (4)
      Equity                                           6/30/2016                         148,335 units       736,595       820,000       0.36%  
KidKraft, Inc.                                                                             Dallas, TX                                      
Term Loan     (6)
      Second
Lien
      12.00%                11.00%       1.00%       9/30/2016       3/30/2022       Consumer
Goods: Durable
    $ 9,409,210       9,284,478       8,797,611       3.91%  
Livingston International,
Inc.
                                                                            Toronto,
Ontario
                                     
Term Loan     (5)(12)
      Second
Lien
      3M
L+8.25%
      1.25%       11.05%                4/23/2013       4/18/2020       Transportation:
Cargo
    $ 6,841,739       6,808,345       6,841,739       3.04%  
Madison Logic,
Inc.
                                                                            New York, NY                                      
Term Loan
(SBIC)
    (2)(12)
      First Lien       1M
L+8.00%
      0.50%       10.51%                11/30/2016       11/30/2021       Media:
Broadcasting &
Subscription
    $ 4,730,117       4,700,059       4,706,466       2.09%  
Madison Logic Holdings, Inc. Common Stock (SBIC)     (2)(4)
      Equity                                           11/30/2016                         5,000 shares       50,000       50,000       0.02%  
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)     (2)(4)
      Equity                               11/30/2016                   4,500 shares       450,000       470,000       0.21%  
Total                                                                 5,200,059       5,226,466       2.32%  
Magdata Intermediate Holdings, LLC                                                                             Austin TX                                      
Term Loan     (12)
      Second
Lien
      3M
L+9.50%
      1.00%       12.31%                10/16/2017       4/16/2024       Software     $ 14,750,000       14,490,683       14,086,250       6.26%  
Mobileum, Inc.                                                                             Santa Clara,
CA
                                     
Term Loan     (12)
      Second
Lien
      3M
L+10.25%
      0.75%       13.06%                11/1/2016       5/1/2022       Software     $ 21,500,000       21,164,073       21,500,000       9.56%  
Mobile Acquisition Holdings, LP Class A-2 Common Units     (4)
      Equity                               11/1/2016                   750 units       455,385       770,000       0.34%  
Total                                                                 21,619,458       22,270,000       9.90%  
MTC Parent, L.P.                                                                             Oak Brook, IL                                      
Class A-2 Common Units     (4)
      Equity                                           12/1/2015                Finance       750,000 shares       0       7,750,000       3.45%  
National Trench Safety, LLC, et al                                                                             Houston, TX                                      
Term Loan
(SBIC)
    (2)
      Second
Lien
      11.50%                11.50%                3/31/2017       3/31/2022       Construction &
Building
    $ 10,000,000       9,874,827       9,650,000       4.29%  
NTS Investors, LP Class A Common Units     (4)
      Equity                               3/31/2017                   2,335 units       500,000       380,000       0.17%  
Total                                                                 10,374,827       10,030,000       4.46%  
NGS US Finco,
LLC
                                                                            Bradford, PA                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      1M
L+8.50%
      1.00%       10.88%                10/4/2018       4/1/2026       Utilities: Oil &
Gas
    $ 10,000,000       9,853,435       9,853,435       4.38%  

 
 
See accompanying notes to these consolidated financial statements.

SF-14


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Nutritional Medicinals, LLC     (24)
                                                                     Centerville, OH                                      
Term Loan     (12)
      First Lien       3M
L+6.00%
      1.00%       8.81%                11/15/2018       11/15/2023       Healthcare &
Pharmaceuticals
    $ 15,500,000     $ 15,198,412     $ 15,198,412       6.76%  
Functional Aggregator, LLC Common Units     (4)
      Equity                               11/15/2018                   12,500
shares
      1,250,000       1,250,000       0.56%  
Total                                                                 16,448,412       16,448,412       7.32%  
OGS Holdings, Inc.                                                                             Chantilly,
Virginia
                                     
Series A Convertible Preferred
Stock
    (4)
      Equity                                           4/22/2014                Services:
Government
      11,521
shares
      50,001       280,000       0.12%  
Premiere Digital Services, Inc.     (10)
                                                                     Los Angeles,
CA
                                     
Term Loan
(SBIC)
    (2)(13)(22)
      First Lien       3M
L+5.50%
      1.50%       9.60%                10/18/2018       10/18/2023       Media:
Broadcasting &
Subscription
    $ 8,250,000       8,019,407       8,019,407       3.57%  
Term Loan     (13)(22)
      First Lien       3M
L+5.50%
      1.50%       9.60%                10/18/2018       10/18/2023              $ 2,428,772       2,360,887       2,360,887       1.05%  
Premiere Digital Holdings, Inc., Common Stock     (4)
      Equity                                           10/18/2018                         5,000
shares
      50,000       50,000       0.02%  
Premiere Digital Holdings, Inc., Preferred
Stock
    (4)
      Equity                               10/18/2018                   4,500
shares
      450,000       450,000       0.20%  
Total                                                                 10,880,294       10,880,294       4.84%  
Price for Profit,
LLC
    (17)
                                                                     Cleveland, OH                                      
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+6.50%
      1.00%       9.31%                1/31/2018       1/31/2023       Services:
Business
    $ 8,818,907       8,669,840       8,774,812       3.90%  
I2P Holdings, LLC, Series A
Preferred
    (4)
      Equity                               1/31/2018                   750,000
shares
      750,000       1,460,000       0.65%  
Total                                                                 9,419,840       10,234,812       4.55%  
Protect America,
Inc.
                                                                            Austin TX                                      
Term Loan
(SBIC)
    (2)(6)(12)
      Second
Lien
      3M
L+9.75%
      1.00%       10.56%       2.00%       8/30/2017       10/30/2020       Services:
Consumer
    $ 17,979,749       17,710,359       17,530,255       7.80%  
Refac Optical Group,
et al
    (11 )                                                                     Blackwood, NJ                                      
Revolver     (9)(10)(12)
      First Lien       1M
L+8.00%
               0.00%                11/7/2012       9/30/2018       Retail     $ 880,000       880,000       880,000       0.39%  
Term A Loan     (9)(12)
      First Lien       1M
L+8.00%
               0.00%                11/7/2012       9/30/2018              $ 472,968       472,968       472,968       0.21%  
Term B Loan     (6)(9)(12)
      First Lien       1M
L+10.75%
            0.00%       0.00%       11/7/2012       9/30/2018           $ 6,539,666       6,539,666       5,787,604       2.57%  
Total                                                                 7,892,634       7,140,572       3.17  
Resolute Industrial,
LLC
                                                                            Wheeling, IL                                      
Resolute Industrial Holdings, LLC Class A Preferred Units     (4)
      Equity                                           7/26/2017                Capital
Equipment
      601 units       750,000       1,300,000       0.58%  
Total                                                                                                                 %  
Roberts-Gordon,
LLC
                                                                            Buffalo, NY                                      
Specified Air Solutions, LLC Class A Common Units     (4)
      Equity                                           6/30/2017                Construction &
Building
      3,846 shares       0       250,000       0.11%  
Skopos Financial,
LLC
                                                                            Irving, TX                                      
Term Loan     (5)
      Unsecured       12.00%
               12.00%                1/31/2014       1/31/2020       Finance     $ 17,500,000       17,494,460       17,150,000       7.63%  
Skopos Financial Group, LLC Class A Units     (4)(5)
      Equity                               1/31/2014                   1,120,684
units
      1,162,544       1,110,000       0.49%  
Total                                                                 18,657,004       18,260,000       8.12%  

 
 
See accompanying notes to these consolidated financial statements.

SF-15


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
SQAD, LLC                                                                             Tarrytown, NY                                      
Term Loan
(SBIC)
    (2)
      First Lien       3M
L+6.50
      1.00%       9.30%                12/22/2017       12/22/2022       Media:
Broadcasting &
Subscription
    $ 14,846,000     $ 14,780,330     $ 14,400,620       6.40%  
SQAD Holdco, Inc. Preferred Shares, Series A
(SBIC)
    (2)(4)
      Equity                                           10/31/2013                         5,624 shares       156,001       310,000       0.14%  
SQAD Holdco, Inc. Common Shares (SBIC)     (2)(4)
      Equity                               10/31/2013                   5,800 shares       62,485       40,000       0.02%  
Total                                                                 14,998,816       14,750,620       6.56%  
TechInsights, Inc.                                                                             Ottawa,
Ontario
                                     
Term Loan     (5)(13)(22)
      First Lien       3M
L+6.00%
      1.00%       10.32%                8/16/2017       10/2/2023       High Tech
Industries
    $ 21,540,923       21,094,192       21,094,192       9.38%  
Time Manufacturing Acquisition,
LLC
                                                                            Waco, TX                                      
Term Loan     (6)
      Unsecured       11.50%                10.75%       0.75%       2/3/2017       8/3/2023       Capital
Equipment
    $ 6,385,182       6,285,876       6,129,775       2.73%  
Time Manufacturing Investments, LLC Class A Common Units     (4)
      Equity                               2/3/2017                   5,000 units       500,000       500,000       0.22%  
Total                                                                 6,785,876       6,629,775       2.95%  
TFH Reliability,
LLC
                                                                            Houston, TX                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+10.75%
      0.50%       13.56%                10/21/2016       4/21/2022       Chemicals,
Plastics, &
Rubber
    $ 5,875,000       5,794,016       5,875,000       2.61%  
TFH Reliability Group, LLC Class A Common Units     (4)
      Equity                               10/21/2016                   250,000
shares
      231,521       450,000       0.20%  
Total                                                                 6,025,537       6,325,000       2.81%  
U.S. Auto Sales, Inc.
et al
                                                                            Lawrenceville,
GA
                                     
Term Loan     (5)(12)
      Second
Lien
      1M
L+10.50%
      1.00%       12.85%                6/8/2015       6/8/2020       Finance     $ 4,500,000       4,484,478       4,500,000       2.00%  
USASF Blocker II, LLC Common
Units
    (4)(5)
      Equity                                           6/8/2015                         441 units       441,000       550,000       0.24%  
USASF Blocker III, LLC Series C Preferred Units     (4)(5)
      Equity                                           2/13/2018                         50 units       50,000       60,000       0.03  
USASF Blocker LLC Common Units     (4)(5)
      Equity                               6/8/2015                   9,000 units       9,000       10,000       0.00%  
Total                                                                 4,984,478       5,120,000       2.27%  
VRI Intermediate Holdings, LLC                                                                             Franklin, OH                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+9.25%
      1.00%       12.06%                5/31/2017       10/31/
2020
      Healthcare &
Pharmaceuticals
    $ 9,000,000       8,895,138       8,820,000       3.92%  
VRI Ultimate Holdings, LLC Class A Preferred Units     (4)
      Equity                               5/31/2017                   326,797
shares
      500,000       440,000       0.20%  
Total                                                                 9,395,138       9,260,000       4.12%  
Wise Holding Corporation                                                                             Salt
Lake City,
UT
                                     
Term Loan     (12)(20)
      Unsecured       3M
L+11.00%
      1.00%       0.00%                6/30/2016       12/31/2021       Beverage,
Food, &
Tobacco
    $ 1,250,000       1,238,210       0       0.00%  
Delayed Draw Term Loan     (12)(21)
      First Lien       1M
L+6.5%
      1.00%       0.00%                8/27/2018       6/30/2021              $ 253,906       253,906       93,945       0.04%  
Wise Parent Company, LLC Membership Units     (4)
      Equity                               6/30/2016                   1 units       58,594       0       0.00%  
Total                                                                 1,550,710       93,945       0.04%  

 
 
See accompanying notes to these consolidated financial statements.

SF-16


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Total Non-controlled, non-affiliated investments                                                               $ 502,691,464     $ 504,433,668       224.35%  
Net Investments                                                                 502,743,649       504,483,668       224.37%  
LIABILITIES IN EXCESS OF OTHER ASSETS                                                                       (279,638,661 )      (124.37)%  
NET ASSETS                                                                     $ 224,845,007       100.00%  

(1) See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2) Investments held by the SBIC subsidiary, which include $13,410,706 of cash and $214,114,498 of investments (at cost) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.
(3) Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $865,385, with an interest rate of LIBOR plus 7.50% and a maturity of June 30, 2023. This investment is accruing an unused commitment fee of 0.375% per annum.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 87% of the Company’s total assets as of December 31, 2018.
(6) Represents a PIK interest security. At the option of the issuer, interest can be paid in cash or cash and PIK interest. The percentage of PIK interest shown is the maximum PIK interest that can be elected by the issuer.
(7) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 5.75% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000, with an interest rate of LIBOR plus 5.75% and a maturity of August 8, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(9) Investment has been on non-accrual since November 30, 2018.
(10) Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $3,669,681 with an interest rate of LIBOR plus 5.50% and a maturity of October 18, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is not accruing an unused commitment fee.
(12) These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.

 
 
See accompanying notes to these consolidated financial statements.

SF-17


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2018

(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $5,357,143, with an interest rate of LIBOR plus 6.75% and a maturity of August 30, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(15) Investment has been on non-accrual since November 1, 2017.
(16) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 7.75% and a maturity of February 5, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(17) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 6.50% and a maturity of January 31, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(18) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $750,000, with an interest rate of LIBOR plus 7.50% and a maturity of April 13, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(19) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,222,494, with an interest rate of LIBOR plus 6.25% and a maturity of September 26, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(20) Investment has been on non-accrual since March 29, 2018.
(21) Investment has been on non-accrual since October 31, 2018.
(22) This loan is a unitranche investment.
(23) Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $1,662,592, with an interest rate of LIBOR plus 6.25% and a maturity of September 26, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(24) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000 with an interest rate of LIBOR plus 6.00% and a maturity of November 15, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

 
 
See accompanying notes to these consolidated financial statements.

SF-18


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR floor   Cash   PIK   Initial Investment Date   Maturity   Headquarters/ Industry   Principal Amount/ Shares   Amortized Cost   Fair Value(1)   % of Net Assets
Non-controlled, affiliated
investments
    (2)
                                                                                                             
Glori Energy Production Inc.                                                                             Houston, TX                                      
Glori Energy Production, LLC Class A Common Units     (4)
      Equity                               2/1/2017             Energy: Oil &
Gas
      1,000
shares
    $ 1,052,185     $ 990,000       0.45%  
Subtotal Non-controlled,
affiliated
investments
                                                                1,052,185       990,000       0.45%  
Non-controlled, non-affiliated investments     (2)
                                                                                                             
Abrasive Products & Equipment, LLC, et al                                                                             Deer Park, TX                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      3M
L+10.50%
      1.00%       12.20%                9/5/2014       3/5/2020       Chemicals,
Plastics, &
Rubber
    $ 5,325,237       5,272,397       5,220,000       2.37%  
APE Holdings, LLC Class A Common Units     (4)
      Equity                               9/5/2014                   375,000
units
      375,000       180,000       0.08%  
Total                                                                 5,647,397       5,400,000       2.45%  
Apex Environmental Resources Holdings, LLC                                                                             Amsterdam,
OH
                                     
Common Units     (4)
      Equity                                           10/30/2015                Environmental Industries       766 shares       766       579       0.00%  
Preferred Units     (4)
      Equity                               10/30/2015                   766 shares       765,676       579,421       0.26%  
Total                                                                 766,442       580,000       0.26%  
Atmosphere Aggregator Holdings II, LP                                                                             Atlanta, GA                                      
Common Units     (4)
      Equity                                           6/30/2015                Services:
Business
      254,250
units
      254,250       820,284       0.37%  
Atmosphere Aggregator Holdings, LP Common
Units
    (4)
      Equity                               6/30/2015                   750,000
units
      750,000       2,419,714       1.10%  
Total                                                                 1,004,250       3,239,998       1.47%  
ASC Communications, LLC     (7)
                                                                     Chicago, IL                                      
Term Loan (SBIC)     (2)(12)
      First Lien       3M
L+6.25%
      1.00%       7.94%                6/29/2017       6/29/2022       Healthcare &
Pharmaceuticals
    $ 6,879,167       6,816,044       6,879,167       3.12%  
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)     (2)(4)
      Equity                               6/29/2017                   73,529
shares
      500,000       620,000       0.28%  
Total                                                                 7,316,044       7,499,167       3.40%  
Beneplace, LLC                                                                             Austin TX                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      3M
L+10.00%
      1.00%       11.70%                3/27/2017       9/27/2022       Insurance     $ 5,000,000       4,910,226       5,000,000       2.27%  
Beneplace Holdings, LLC Preferred
Units
    (4)
      Equity                               3/27/2017                   500,000
units
      500,000       500,000       0.23%  
Total                                                                 5,410,226       5,500,000       2.50%  
Binder & Binder National Social Security Disability Advocates, LLC     (8)
                                                                     Hauppauge, NY                                      
Residual claim from Term Loan     (4)
      Unsecured                                           11/7/2012                Services:
Consumer
    $ 400,000       400,000       380,000       0.17%  
BW DME Acquisition, LLC                                                                             Tempe, AZ                                      
Term Loan
(SBIC)
    (2)(12)
(13)(17)
      First Lien       3M
L+6.00%
      1.00%       9.43%                8/24/2017       8/24/2022       Healthcare &
Pharmaceuticals
    $ 9,550,000       9,281,016       9,310,000       4.23%  
BW DME Holdings, LLC Class A Preferred
Units
    (4)
      Equity                               8/24/2017                   1,000,000
shares
      1,000,000       1,110,000       0.50%  
Total                                                                 10,281,016       10,420,000       4.73%  

 
 
See accompanying notes to these consolidated financial statements.

SF-19


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
C.A.R.S. Protection Plus, Inc.                                                                             Murrysville, PA                                      
Term Loan     (12)
      First Lien       3M
L+8.50%
      0.50%       9.74%                12/23/2015       12/31/2020       Automotive     $ 98,746     $ 97,451     $ 98,746       0.04%  
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+8.50%
      0.50%       9.74%                12/23/2015       12/31/2020              $ 7,702,191       7,601,191       7,700,000       3.50%  
CPP Holdings LLC Class A Common
Units
    (4)
      Equity                               12/23/2015                   149,828
shares
      149,828       260,000       0.12%  
Total                                                                 7,848,470       8,058,746       3.66%  
Catapult Learning, LLC et al                                                                             Camden, NJ                                      
Term Loan     (13)(17)
      First Lien       3M
L+6.50%
      1.00%       9.30%                8/6/2015       7/16/2020       Education     $ 12,335,526       12,264,670       12,335,526       5.60%  
Colford Capital Holdings, LLC                                                                             New York, NY
                                     
Preferred Units     (4)(5)
      Equity                                           8/20/2015                Finance       38,893
units
      497,388       470,000       0.21%  
Condor Borrower,
LLC
                                                                            Clifton, NJ                                      
Term Loan     (12)
      Second
Lien
      3M
L+8.75%
      1.00%       10.12%                10/27/2017       4/27/2025       Services:
Business
    $ 13,750,000       13,479,122       13,480,000       6.12%  
Condor Top Holdco Limited Convertible Preferred
Shares
    (4)
      Equity                                           10/27/2017                         500,000
shares
      442,197       442,197       0.20%  
Condor Holdings Limited Preferred Shares,
Class B
    (4)
      Equity                               10/27/2017                   500,000
shares
      57,804       57,804       0.03%  
Total                                                                 13,979,123       13,980,001       6.35%  
Douglas Products & Packaging Company, LLC                                                                             Liberty, MO                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+10.50%
      0.50%       12.20%                6/30/2015       12/31/2020       Chemicals,
Plastics, &
Rubber
    $ 9,000,000       8,902,087       9,000,000       4.09%  
Fumigation Holdings, Inc. Class A Common
Stock
    (4)
      Equity                               6/30/2015                   250 shares       250,000       530,000       0.24%  
Total                                                                 9,152,087       9,530,000       4.33%  
Dream II Holdings,
LLC
                                                                            Boca Raton, FL                                      
Class A Common Units     (4)
      Equity                                           10/20/2014                Services:
Consumer
      250,000
units
      242,304       420,000       0.19%  
Empirix Inc.                                                                             Billerica, MA                                      
Term Loan     (12)
      Second
Lien
      3M
L+9.50%
      1.00%       10.88%                11/1/2013       5/1/2020       Software     $ 11,657,850       11,554,734       11,657,850       5.29%  
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+9.50%
      1.00%       10.88%                5/14/2013       5/1/2020              $ 9,750,000       9,662,051       9,750,000       4.43%  
Empirix Holdings I, Inc. Common Shares,
Class A
    (4)
      Equity                                           11/1/2013                         1,304
shares
      1,304,232       831,600       0.38%  
Empirix Holdings I, Inc. Common Shares,
Class B
    (4)
      Equity                               11/1/2013                   1,317,406
shares
      13,174       8,400       0.00%  
Total                                                                 22,534,191       22,247,850       10.10%  
Energy Labs Inc.                                                                             Houston, TX                                      
Term Loan
(SBIC)
    (2)(13)(17)
      First Lien       3M
L+7.00%
      0.50%       11.58%                9/29/2016       9/29/2021       Energy: Oil &
Gas
    $ 5,300,000       5,214,783       5,300,000       2.41%  
Energy Labs Holding Corp. Common
Stock
    (4)
      Equity                               9/29/2016                   500
shares
      500,000       410,000       0.19%  
Total                                                                 5,714,783       5,710,000       2.60%  

 
 
See accompanying notes to these consolidated financial statements.

SF-20


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
EOS Fitness OPCO Holdings, LLC                                                                             Phoenix, AZ                                      
Term Loan
(SBIC)
    (2)(12)
      First Lien       1M
L+8.25%
      0.75%       9.62%                12/30/2014       12/30/2019       Hotel,
Gaming, &
Leisure
    $ 3,193,890     $ 3,164,255     $ 3,190,000       1.45%  
EOS Fitness Holdings, LLC Class A Preferred
Units
    (4)
      Equity                                           12/30/2014                         118
shares
      117,670       224,250       0.10%  
EOS Fitness Holdings, LLC Class B Common Units     (4)
      Equity                               12/30/2014                   3,017 shares       3,017       5,750       0.00%  
Total                                                                 3,284,942       3,420,000       1.55%  
Furniture Factory Outlet, LLC                                                                             Fort Smith,
AR
                                     
Term Loan     (12)
      First Lien       3M
L+9.00%
      0.50%       10.70%                6/10/2016       6/10/2021      
Consumer
Goods:
Durable
    $ 7,288,484       7,180,489       7,288,484       3.31%  
Furniture Factory Holdings, LLC Term Loan     (11)
      Unsecured       11.00%                                  6/10/2016       2/3/2021              $ 122,823       122,823       120,000       0.05%  
Sun Furniture Factory, LP Common Units     (4)
      Equity                               6/10/2016                   13,445 shares       94,569       210,000       0.10%  
Total                                                                 7,397,881       7,618,484       3.46%  
GK Holdings, Inc.                                                                             Cary, NC                                      
Term Loan     (12)
      Second
Lien
      3M
L+10.25%
      1.00%       11.94%                2/6/2015       1/30/2022      
Education
    $ 5,000,000       4,932,726       5,000,000       2.27%  
Good Source Solutions, Inc.                                                                             Carlsbad, CA                                      
Term Loan     (13)(17)
      First Lien       3M
L+7.25%
      0.50%       11.96%                7/15/2016       7/15/2021       Beverage,
Food, &
Tobacco
    $ 1,350,000       1,329,398       1,350,000       0.61%  
Term Loan
(SBIC)
    (2)(13)(17)
      First Lien       3M
L+7.25%
      0.50%       11.96%                7/15/2016       7/15/2021              $ 1,200,000       1,181,687       1,200,000       0.54%  
Good Source Holdings, LLC Class A Preferred
Units
    (4)
      Equity                                           7/15/2016                         159 shares       159,375       150,000       0.07%  
Good Source Holdings, LLC Class B Common Units     (4)
      Equity                               7/15/2016                   4,482 shares       0       0       0.00%  
Total                                                                 2,670,460       2,700,000       1.22%  
Grupo HIMA San Pablo, Inc., et al                                                                             San Juan, PR                                      
Term Loan     (3)
      First Lien       3M
L+7.00%
      1.50%       8.50%                2/1/2013       1/31/2018       Healthcare &
Pharmaceuticals
    $ 4,750,000       4,748,168       4,180,000       1.90%  
Term Loan     (15)
      Second
Lien
      13.75%             0.00%             2/1/2013       7/31/2018           $ 4,109,524       4,079,696       900,000       0.41%  
Total                                                                 8,827,864       5,080,000       2.31%  
Hostway Corporation                                                                             Chicago, IL                                      
Term Loan     (12)
      Second
Lien
      3M
L+10.00%
      1.25%       5.94%                12/27/2013       12/13/2020       High Tech
Industries
    $ 6,750,000       6,680,080       5,910,000       2.68%  
J.R. Watkins, LLC     (9)
                                                                     San
Francisco,
CA
                                     
Term Loan
(SBIC)
    (2)(12)
      First Lien       3M
L+6.50%
      1.25%       8.16%                12/22/2017       12/22/2022       Consumer
Goods:
non-durable
    $ 12,500,000       12,250,000       12,250,000       5.56%  
J.R. Watkins Holdings, Inc. Class A Preferred     (4)
      Equity                               12/22/2017                   1,000 shares       1,000,000       1,000,000       0.45%  
Total                                                                 13,250,000       13,250,000       6.01%  
Keais Records Service, LLC                                                                             Houston, TX                                      
Term Loan     (12)
      Second
Lien
      3M
L+10.50%
      0.50%       12.20%                6/30/2016       6/30/2022       Services:
Business
    $ 7,750,000       7,637,741       7,750,000       3.52%  
Keais Holdings, LLC Class A Units     (4)
      Equity                               6/30/2016                   148,335 units       765,600       780,000       0.35%  
Total                                                                 8,403,341       8,530,000       3.87%  

 
 
See accompanying notes to these consolidated financial statements.

SF-21


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
KidKraft, Inc.                                                                             Dallas, TX                                      
Term Loan     (6)
      Second
Lien
      12.00%                11.00%       1.00%       9/30/2016       3/30/2022       Consumer
Goods:
Durable
    $ 9,315,194     $ 9,162,066     $ 9,180,000       4.17%  
Livingston International,
Inc.
                                                                            Toronto,
Ontario
                                     
Term Loan     (5)(12)
      Second
Lien
      3M
L+8.25%
      1.25%       9.94%                4/23/2013       4/18/2020       Transportation:
Cargo
    $ 6,841,739       6,785,894       6,840,000       3.11%  
Madison Logic, Inc.                                                                             New York, NY
                                     
Term Loan
(SBIC)
    (2)(12)
      First Lien       1M
L+8.00%
      0.50%       9.57%                11/30/2016       11/30/2021       Media:
Broadcasting &
Subscription
    $ 4,875,000       4,835,088       4,875,000       2.21%  
Madison Logic Holdings, Inc. Common Stock (SBIC)     (2)(4)
      Equity                                           11/30/2016                         5,000
shares
      50,000       56,000       0.03%  
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)     (2)(4)
      Equity                               11/30/2016                   4,500
shares
      450,000       504,000       0.23%  
Total                                                                 5,335,088       5,435,000       2.47%  
Magdata Intermediate Holdings, LLC                                                                             Austin TX                                      
Term Loan     (12)
      Second
Lien
      3M
L+9.50%
      1.00%       11.20%                10/16/2017       4/16/2024       Software     $ 12,500,000       12,254,448       12,250,000       5.56%  
Mobileum, Inc.                                                                             Santa Clara,
CA
                                     
Term Loan     (12)
      Second
Lien
      3M
L+10.25%
      0.75%       11.95%                11/1/2016       5/1/2022       Software     $ 9,000,000       8,849,293       9,000,000       4.09%  
Mobile Acquisition Holdings, LP Class A-2 Common
Units
    (4)
      Equity                               11/1/2016                   750 units       750,000       980,000       0.44%  
Total                                                                 9,599,293       9,980,000       4.53%  
MBS Holdings, Inc.                                                                             Birmingham,
AL
                                     
Series E Preferred Stock     (4)
      Equity                                           3/10/2014                Media:
Broadcasting &
Subscription
      2,774,695
shares
      1,000,000       2,386,710       1.08%  
Series F Preferred Stock     (4)
      Equity                               12/21/2015                   399,308
shares
      206,682       493,290       0.22%  
Total                                                                 1,206,682       2,880,000       1.30%  
MTC Parent, L.P.                                                                             Oak Brook, IL                                      
Class A-2 Common Units     (4)
      Equity                                           12/1/2015                Finance       750,000
shares
      28,842       2,200,000       1.00%  
National Trench Safety, LLC,
et al
                                                                            Houston, TX                                      
Term Loan (SBIC)     (2)
      Second
Lien
      11.50%                11.50%                3/31/2017       3/31/2022       Construction &
Building
    $ 10,000,000       9,845,090       9,900,000       4.49%  
NTS Investors, LP Class A Common
Units
    (4)
      Equity                               3/31/2017                   2,335 units       500,000       350,000       0.16%  
Total                                                                 10,345,090       10,250,000       4.65%  
OGS Holdings, Inc.                                                                             Chantilly,
Virginia
                                     
Series A Convertible Preferred
Stock
    (4)
      Equity                                           4/22/2014                Services:
Government
      11,521
shares
      50,001       100,000       0.05%  
Protect America,
Inc.
                                                                            Austin TX                                      
Term Loan
(SBIC)
    (2)(6)(12)
      Second
Lien
      3M
L+9.75%
      1.00%       9.50%       2.00%       8/30/2017       10/30/2020       Services:
Consumer
    $ 17,617,786       17,220,312       17,270,000       7.84%  
Refac Optical Group, et al                                                                             Blackwood, NJ                                      
Revolver     (10)(12)
      First Lien       1M
L+8.00%
               9.56%                11/7/2012       9/30/2018       Retail     $ 880,000       880,000       880,000       0.40%  
Term A Loan     (12)
      First Lien       1M
L+8.00%
               9.56%                11/7/2012       9/30/2018              $ 943,367       943,367       940,000       0.43%  

 
 
See accompanying notes to these consolidated financial statements.

SF-22


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Term B Loan     (6)(12)
      First Lien       1M
L+10.75%
            10.56%       1.75%       11/7/2012       9/30/2018           $ 6,464,716     $ 6,464,716     $ 6,460,000       2.93%  
Total                                                                 8,288,083       8,280,000       3.76%  
Resolute Industrial, LLC     (14)
                                                                     Wheeling, IL                                      
Term Loan     (12)(16)(17)
      First Lien       3M
L+7.62%
      1.00%       8.95%                7/26/2017       7/26/2022       Capital
Equipment
    $ 3,797,222       3,731,397       3,740,000       1.70%  
Term Loan
(SBIC)
    (2)(12)
(16)(17)
      First Lien       3M
L+7.62%
      1.00%       8.95%                7/26/2017       7/26/2022              $ 13,290,278       13,059,850       13,090,000       5.94%  
Resolute Industrial Holdings, LLC Class A Preferred
Units
    (4)
      Equity                               7/26/2017                   601 units       750,000       760,000       0.35%  
Total                                                                 17,541,247       17,590,000       7.99%  
Roberts-Gordon,
LLC
                                                                            Buffalo, NY                                      
Term Loan     (12)
      Second
Lien
      3M
L+10.00%
      1.00%       11.70%                6/30/2017       1/1/2022       Construction &
Building
    $ 7,200,000       7,068,278       7,130,000       3.24%  
Specified Air Solutions, LLC Class A Common
Unites
    (4)
      Equity                               6/30/2017                   3,846 shares       500,045       600,000       0.27%  
Total                                                                 7,568,323       7,730,000       3.51%  
Sitel Worldwide Corporation                                                                             Nashville, TN                                      
Term Loan     (12)
      Second
Lien
      3M
L+9.50
      1.00%       10.88%                9/24/2015       9/18/2022       High Tech
Industries
    $ 10,000,000       9,848,614       9,950,000       4.52%  
Skopos Financial,
LLC
                                                                            Irving, TX
                                     
Term Loan     (5)
      Unsecured       12.00%                12.00%                1/31/2014       1/31/2019       Finance
    $ 20,000,000       19,886,350       19,800,000       8.99%  
Skopos Financial Group, LLC Class A Units     (4)(5)
      Equity                               1/31/2014                   1,120,684
units
      1,162,544       770,000       0.35%  
Total                                                                 21,048,894       20,570,000       9.34%  
SPM Capital, LLC                                                                             Bloomington,
MN
                                     
Term Loan     (12)
      First Lien       3M
L+6.50
      1.50%       8.19%                12/10/2012       10/31/2018       Healthcare &
Pharmaceuticals
    $ 5,421,770       5,421,770       5,420,000       2.46%  
SQAD, LLC                                                                             Tarrytown, NY
                                     
Term Loan
(SBIC)
    (2)
      First Lien       3M
L+6.50
      1.00%       8.16%                12/22/2017       12/22/2022       Media:
Broadcasting &
Subscription
    $ 15,000,000       14,919,983       14,920,000       6.77%  
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)     (2)(4)

      Equity                                           10/31/2013                         3,598
shares
      156,001       307,023       0.14%  
SQAD Holdco, Inc. Common Shares (SBIC)     (2)(4)
      Equity                               10/31/2013                   5,800
shares
      62,485       122,977       0.06%  
Total                                                                 15,138,469       15,350,000       6.97%  
TechInsights, Inc.                                                                             Ottawa,
Ontario
                                     
Term Loan     (5)(12)
(13)(17)
      First Lien       3M
L+6.50%
      1.00%       8.71%                8/16/2017       8/16/2022       High Tech
Industries
    $ 20,000,000       19,529,783       19,600,000       8.90%  
Time Manufacturing Acquisition,
LLC
                                                                            Waco, TX                                      
Term Loan     (6)
      Unsecured       11.50%                10.75%       0.75%       2/3/2017       8/3/2023       Capital
Equipment
    $ 6,373,100       6,258,780       6,250,000       2.84%  
Time Manufacturing Investments, LLC Class A Common
Units
    (4)
      Equity                               2/3/2017                   5,000 units       500,000       330,000       0.15%  
Total                                                                 6,758,780       6,580,000       2.99%  
TFH Reliability,
LLC
                                                                            Houston, TX                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+10.75%
      0.50%       12.45%                10/21/2016       4/21/2022       Chemicals,
Plastics, &
Rubber
    $ 5,875,000       5,775,974       5,875,000       2.67%  

 
 
See accompanying notes to these consolidated financial statements.

SF-23


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
TFH Reliability Group, LLC Class A Common
Units
    (4)
      Equity                               10/21/2016                   250,000
shares
    $ 250,000     $ 340,000       0.15%  
Total                                                                 6,025,974       6,215,000       2.82%  
U.S. Auto Sales, Inc. et al                                                                             Lawrenceville,
GA
                                     
Term Loan     (5)(12)
      Second
Lien
      1M
L+11.75%
      1.00%       13.12%                6/8/2015       6/8/2020       Finance     $ 4,500,000       4,474,973       4,500,000       2.04%  
USASF Blocker II, LLC Common Units     (4)(5)
      Equity                                           6/8/2015                         441 units       441,000       578,200       0.26%  
USASF Blocker LLC Common Units     (4)(5)
      Equity                               6/8/2015                   9,000 units       9,000       11,800       0.01%  
Total                                                                 4,924,973       5,090,000       2.31%  
VRI Intermediate Holdings, LLC                                                                             Franklin, OH                                      
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      3M
L+9.25%
      1.00%       10.95%                5/31/2017       10/31/2020       Healthcare &
Pharmaceuticals
    $ 9,000,000       8,846,185       8,910,000       4.05%  
VRI Ultimate Holdings, LLC Class A Preferred Units     (4)
      Equity                               5/31/2017                   326,797
shares
      500,000       500,000       0.23%  
Total                                                                 9,346,185       9,410,000       4.28%  
Wise Holding Corporation                                                                             Salt Lake City,
UT
                                     
Term Loan     (12)
      Unsecured       3M
L+11.00%
      1.00%       12.70%                6/30/2016       12/31/2021       Beverage,
Food, &
Tobacco
    $ 1,250,000       1,235,188       880,000       0.40%  
WCI Holdings LLC Class A Preferred
Units
    (4)
      Equity                                           6/30/2016                         56 units       55,550       0       0.00%  
WCI Holdings LLC Class B Common Units     (4)
      Equity                               6/30/2016                   3,044
units
      3,044       0       0.00%  
Total                                                                 1,293,782       880,000       0.40%  
Zemax, LLC                                                                             Redmond, WA
                                     
Term Loan
(SBIC)
    (2)(12)
      Second
Lien
      1M
L+10.00%
      1.00%       11.60%                10/23/2014       4/23/2020       Software     $ 3,962,500       3,922,743       3,960,000       1.80%  
Zemax Software Holdings, LLC Preferred Units (SBIC)     (2)(4)
      Equity                                           10/23/2014                         24,500
units
      5,000       11,200       0.01%  
Zemax Software Holdings, LLC Common Units (SBIC)     (2)(4)
      Equity                               10/23/2014                   5,000
shares
      245,000       548,800       0.25%  
Total                                                                 4,172,743       4,520,000       2.06%  
Total Non-controlled, non-affiliated investments                                                                 367,401,021       370,849,772       168.38%  
Net Investments                                                                 368,453,206       371,839,772       168.83%  
LIABILITIES IN EXCESS OF OTHER
ASSETS
                                                                      (151,592,530 )      (68.83)%  
NET ASSETS                                                                     $ 220,247,242       100.00%  

(1) See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2) Investments held by the SBIC Subsidiary, which include $5,258,500 of cash and $154,149,450 of investments (at cost) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.

 
 
See accompanying notes to these consolidated financial statements.

SF-24


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

(3) These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of December 31, 2017.
(6) Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.
(7) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8) In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.
(9) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(10) Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.
(12) These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(15) Investment has been on non-accrual since November 1, 2017.
(16) This loan is a last-out term loan with a set contractual rate that equals the current applicable LIBOR rate.
(17) This loan is a unitranche investment.

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

 
 
See accompanying notes to these consolidated financial statements.

SF-25


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Stellus Capital Investment Corporation (“we”, “us”, “our” and the “Company”) was formed as a Maryland corporation on May 18, 2012 (“Inception”) and is an externally managed, closed-end, non-diversified investment management company. The Company is applying the guidance of Accounting Standards Codification (“ASC”) Topic 946, Financial Services Investment Companies. The Company has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended (the “1940 Act”) and treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”) for U.S. federal income tax purposes. The Company’s investment activities are managed by our investment adviser Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).

As of December 31, 2018 the Company has issued a total of 15,953,810 shares and raised $235,742,980 in gross proceeds since inception, incurring $7,566,535 in offering expenses and sales load fees for net proceeds from offerings of $228,176,445. The Company’s shares are currently listed on the New York Stock Exchange under the symbol “SCM”. See Note 4 for further details.

The Company has established wholly owned subsidiaries: SCIC — Consolidated Blocker 1, Inc., SCIC — ICD Blocker 1, Inc., SCIC —  CC Blocker 1, Inc., SCIC — ERC Blocker 1, Inc., SCIC — SKP Blocker 1, Inc., SCIC — APE Blocker 1, Inc., and SCIC — Hollander Blocker 1, Inc., which are structured as Delaware entities, to hold equity or equity-like investments in portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities) (collectively, the “Taxable Subsidiaries”). The Taxable Subsidiaries are consolidated for U.S. generally accepted accounting principles (“U.S GAAP”) reporting purposes, and the portfolio investments held by them are included in the consolidated financial statements.

On June 14, 2013, we formed Stellus Capital SBIC LP (the “SBIC subsidiary”), a Delaware limited partnership, and its general partner, Stellus Capital SBIC GP, LLC., a Delaware limited liability company, as wholly owned subsidiaries of the Company. On June 20, 2014, the SBIC subsidiary received a license from the Small Business Administration (“SBA”) to operate as a Small Business Investment Company (“SBIC”) under Section 301(c) of the Small Business Investment Company Act of 1958. The SBIC subsidiary is consolidated for U.S. GAAP reporting purposes, and the portfolio investments held by it are included in the consolidated financial statements.

The SBIC license allows the SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed on a semi-annual basis at a market-driven spread over U.S. Treasury Notes with 10-year maturities. The SBA, as a creditor, will have a superior claim to the SBIC’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary upon an event of default. SBA regulations currently limit the amount that a single licensee may borrow to a maximum of $150,000,000 when it has at least $75,000,000 in regulatory capital, as such term is defined by the SBA, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of December 31, 2018 and 2017, the SBIC subsidiary had $75,000,000 and $67,500,000 of regulatory capital, respectively, as such term is defined by the

SF-26


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

SBA. As of December 31, 2018 and 2017, the SBIC subsidiary had $150,000,000 and $90,000,000 of SBA-guaranteed debentures outstanding, respectively. See footnote (2) of the Consolidated Schedule of Investments for additional information regarding the treatment of SBIC investments with respect to the Credit Facility.

As a BDC, we are required to comply with certain regulatory requirements. Prior to June 28, 2018, we were only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, was equal to at least 200% after giving effect to such leverage. On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

On April 4, 2018, the Company’s board of directors (the “Board”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, which was approved by shareholders at the Company’s 2018 annual meeting of stockholders. As a result, the asset coverage ratio test applicable to the Company was decreased from 200% to 150%, effective June 28, 2018. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

The Company’s investment objective is to maximize the total return to its stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies. The Company seeks to achieve its investment objective by originating and investing primarily in private U.S. middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien (including unitranche), second lien, and unsecured debt financing, with corresponding equity co-investments. It sources investments primarily through the extensive network of relationships that the principals of Stellus Capital have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries.

Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. GAAP and pursuant to the requirements for reporting on Form 10-K and Article 10 of regulation S-X.

In the opinion of management, the consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the periods included herein. Certain reclassifications have been made to certain prior period balances to conform with current presentation.

In accordance with Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments.

The accounting records of the Company are maintained in U.S. dollars.

SF-27


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Portfolio Investment Classification

The Company classifies its portfolio investments in accordance with the requirements of the 1940 Act as follows; (a) “Control Investments” are defined as investments in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation, (b) “Affiliate Investments” are defined as investments in which the Company owns between 5% and 25% of the voting securities and does not have rights to maintain greater than 50% of the board representation, and (c) “Non-controlled, non-affiliate investments” are defined as investments that are neither Control Investments or Affiliate Investments.

Cash and Cash Equivalents

At December 31, 2018, cash balances totaling $336,243 exceeded FDIC insurance protection levels of $250,000 by $86,243, subjecting the Company to risk related to the uninsured balance. In addition, at December 31, 2018, the Company held $17,130,903 in cash equivalents that were back by the full faith credit of the U.S. government. All of the Company’s cash and cash equivalents are held at large established high credit quality financial institutions and management believes that risk of loss associated with any uninsured balances is remote.

Cash consists of bank demand deposits. We deem certain U.S. Treasury Bills and other high-quality, short-term debt securities as cash equivalents. At the end of each fiscal quarter, we may take proactive steps to ensure we are in compliance with the RIC diversification requirements under Subchapter M of the Internal Revenue Code, which are dependent upon the composition of our total assets at quarter end. We may accomplish this in several ways, including purchasing U.S. Treasury Bills and closing out positions after quarter-end or temporarily drawing down on the Credit Facility (see footnote 9). At December 31, 2018 and December 31, 2017, we held no U.S. Treasury Bills.

Fair Value Measurements

We account for substantially all of our financial instruments at fair value in accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value, and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. We believe that the carrying amounts of our financial instruments such as cash, receivables and payables approximate the fair value of these items due to the short maturity of these instruments. This is considered a Level 1 valuation technique. The carrying values of our Credit Facility and SBA-guaranteed debentures approximate fair value because the interest rates adjusts to the market interest rates (Level 3 input). The carrying value of our 2022 Notes (as defined in Note 11 below) is based on the closing price of the security (level 2 input). See Note 6 to the consolidated financial statements for further discussion regarding the fair value measurements and hierarchy.

Consolidation

As permitted under Regulation S-X under the Exchange Act and ASC Topic 946, we generally do not consolidate our investment in a portfolio company other than an investment company subsidiary. Accordingly, we consolidated the results of the SBIC subsidiary and the Taxable Subsidiaries. All intercompany balances have been eliminated upon consolidation.

SF-28


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Use of Estimates

The preparation of the statement of assets and liabilities in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

Deferred Financing Costs

Deferred financing costs, prepaid loan fees on SBA-guaranteed debentures and prepaid loan structure fees consist of fees and expenses paid in connection with the closing of our Credit Facility, notes and SBA-guaranteed debentures and are capitalized at the time of payment. These costs are amortized using the straight line method over the term of the respective instrument and presented as an offset to the corresponding debt on the statement of Assets and Liabilities.

Offering Costs

Deferred offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s securities, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement. These costs are capitalized when incurred and recognized as a reduction of offering proceeds when the offering is consummated and shown on the Consolidated Statement of Changes in Net Assets and Liabilities as a reduction to Paid-in-Capital. During the year ended December 31, 2016, the Company determined that it was no longer likely to issue shares under its current shelf registration statement, as a result, the Company expensed $261,761 of previously capitalized deferred offering costs for the year ended December 31, 2016. During the year ended December 31, 2018, the Company incurred $18,673 of costs related to the preparation of a registration statement, which were capitalized and will be treated as discussed above in the event an offering is consummated.

Investments

As a BDC, the Company will generally invest in illiquid loans and securities including debt and equity securities of private middle-market companies. Under procedures established by our board of directors, the Company intends to value investments for which market quotations are readily available at such market quotations. The Company will obtain these market values from an independent pricing service or at the median between the bid and ask prices obtained from at least two brokers or dealers (if available, otherwise by a principal market maker or a primary market dealer). Debt and equity securities that are not publicly traded or whose market prices are not readily available will be valued at fair value as determined in good faith by our board of directors. Such determination of fair values may involve subjective judgments and estimates. The Company also engages independent valuation providers to review the valuation of each portfolio investment that does not have a readily available market quotation at least twice annually.

Investments purchased within approximately 90 days of the valuation date will be valued at cost plus accreted discount, or minus amortized premium, which approximates fair value. With respect to unquoted securities, our board of directors, will value each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the board of directors will use the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because the

SF-29


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Company expects that there will not be a readily available market for many of the investments in its portfolio, the Company expects to value most of its portfolio investments at fair value as determined in good faith by the board of directors using a documented valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

In following these approaches, the types of factors that will be taken into account in fair value pricing investments will include, as relevant, but not be limited to:

available current market data, including relevant and applicable market trading and transaction comparables;
applicable market yields and multiples;
security covenants;
call protection provisions;
information rights;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
comparisons of financial ratios of peer companies that are public;
comparable merger and acquisition transactions; and
the principal market and enterprise values.

Revenue Recognition

We record interest income on an accrual basis to the extent such interest is deemed collectible. Payment-in-kind (“PIK”) interest, represents contractual interest accrued and added to the loan balance that generally becomes due at maturity. Loan origination fees, original issue discount and market discount or premium are capitalized, and we then accrete or amortize such amounts using the effective interest method as interest income. Upon the prepayment of a loan or debt security, any unamortized loan origination fee is recorded as interest income. We record prepayment premiums on loans and debt securities as other income. Dividend income, if any, will be recognized on the ex-dividend date.

A presentation of the interest income we have received from Portfolio Companies for the years ended December 31, 2018, 2017 and 2016 is as follows:

     
  For the years ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Loan interest   $ 46,501,235     $ 34,890,298     $ 36,143,335  
PIK income     1,869,905       499,595       243,766  
Fee amortization income(1)     1,636,168       1,235,568       1,145,437  
Fee income acceleration(2)     1,455,725       1,445,988       644,079  
Total Interest Income   $ 51,463,033     $ 38,071,449     $ 38,176,617  

(1) Includes amortizations of upfront fees on unfunded commitments.

SF-30


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

(2) Unamortized loan origination fees recognized upon realization.

To maintain our status as a RIC, substantially all of this income must be paid out to stockholders in the form of dividends, even if we have not collected any cash.

We will not accrue any form of interest on loans and debt securities if we have reason to doubt our ability to collect such interest. Management considers portfolio specific circumstances as well as other economic factors in determining collectibility. As of December 31, 2018, we had four loans on non-accrual status, which represented approximately 3.9% of our loan portfolio at cost and 2.8% at fair value. As of December 31, 2017, we had two loans on non-accrual status, which represented approximately 1.2% of our loan portfolio at cost and 0.3% at fair value. As of December 31, 2018 and December 31, 2017, $1,856,272 and $1,145,014 of income from investments on non-accrual has not been accrued. If a loan or debt security's status significantly improves regarding the debtor's ability to service the debt or other obligations, or if a loan or debt security is sold or written off, we remove it from non-accrual status.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

Investment Transaction Costs

Costs that are material associated with an investment transaction, including legal expenses, are included in the cost basis of purchases and deducted from the proceeds of sales unless such costs are reimbursed by the borrower.

Receivables and Payables for Unsettled Securities Transaction

The Company records all investments on a trade date basis.

U.S. Federal Income Taxes

The Company has elected to be treated as a RIC under Subchapter M of the Code, and to operate in a manner so as to qualify for the tax treatment applicable to RICs. To qualify for tax treatment as a RIC, among other things, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. So long as the Company maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any net ordinary income or capital gains that it distributes at least annually to its stockholders as dividends. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s investors and will not be reflected in the consolidated financial statements of the Company.

To avoid a 4% U.S federal excise tax on undistributed earnings, the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending December 31 (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax or the Excise Tax Avoidance Requirement. For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate income tax for the tax

SF-31


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid). The Company, at its discretion, may choose not to distribute all of its taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If the Company chooses to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned. Included in income tax expense for the year ended December 31, 2018 is the 2018 excise tax estimate of $316,092, less refunds related to the estimated excise tax paid for the years ended December 31, 2017 and 2016 totaling $63,144. Included in other general and administrative expense for the year ended December 31, 2017 is the 2017 tax estimate of $27,717 and an additional estimate of $14,985 related to the excise tax for the year ended December 31, 2016. Included in other general and administrative expenses for the year ended December 31, 2016 is the 2016 tax estimate of $22,663.

The Company evaluates tax positions taken or expected to be taken in the course of preparing its tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax provision or expense in the applicable period. As of December 31, 2018 and December 31, 2017, the Company had not recorded a liability for any uncertain tax positions. Management’s evaluation of uncertain tax positions may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof. The Company’s policy is to include interest and penalties related to income taxes, if applicable, in income tax expense. Any such expenses for the year ended December 31, 2018 were de minimis.

On December 22, 2017, the “Tax Cuts and Jobs Act” legislation was signed into law. The Tax Cuts and Jobs Act includes significant changes to the U.S. corporate tax system, including a reduction in the U.S. corporate income tax rate from 35% to 21%. ASC 740, Income Taxes, requires the effect of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As such, we have accounted for the tax effects as a result of the Tax Cuts and Jobs Act beginning with the period ending December 31, 2017.

The Taxable Subsidiaries are direct wholly owned subsidiaries of the Company that have elected to be taxable entities. The Taxable Subsidiaries permit the Company to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in the Company’s consolidated financial statements.

The Taxable Subsidiaries use the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.

For the years ended December 31, 2018, 2017 and 2016, the Company recorded deferred income tax benefit (expense) of ($67,953), $8,593 and $373,131, respectively, related to the Taxable Subsidiaries. In addition, as of December 31, 2018 and December 31, 2017, the Company had a deferred tax liability of $67,953 and $0, respectively. See Note 13, Income Taxes, for a schedule of the deferred tax asset and valuation allowance reducing the deferred tax asset and the deferred tax liability.

Earnings per Share

Basic per share calculations are computed utilizing the weighted average number of shares of common stock outstanding for the period. The Company has no common stock equivalents. As a result, there is no difference between diluted earnings per share and basic per share amounts.

Paid In Capital

The Company records the proceeds from the sale of its common stock on a net basis to (i) capital stock and (ii) paid in capital in excess of par value, excluding all commissions and marketing support fees.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU supersedes the revenue recognition requirements in Revenue Recognition (Topic 605). Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The guidance was effective for the Company as of January 1, 2018. Note, the guidance exempts interest income from the above guidance, indicating recognition will remain the same. The Company will continue to recognize origination fees over the life of the loan. Repayment penalty fees will be recognized immediately if a repayment is made and miscellaneous fees such as administration fees will be recognized on the contract renewal date or other discrete point in time per the credit agreement. Substantially all of the Company’s income is not within the scope of ASU 2014-09. For those income items that are within the scope (primarily fee income), the Company has similar performance obligations as compared with deliverables and separate units of account previously identified. As a result, the Company’s timing of its income recognition remains the same and the adoption of the standard was not material.

In November 2015, the FASB issued ASU 2015-17 — Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. It simplifies the current guidance, which requires entities to separately present deferred tax assets and liabilities as current or noncurrent in a classified balance sheet. The guidance was effective for the Company as of January 1, 2017 and there has been no material impact on its consolidated financial statement.

In August 2016, the FASB issued ASU 2016-15 — Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to reduce

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

diversity in practice in how certain transactions are classified in the statement of cash flows. The new guidance addresses the classification of various transactions including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, distributions received from equity method investments, beneficial interests in securitization transactions, and others. The update is effective for annual periods beginning after December 31, 2017, and interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. The Company early adopted the guidance as of January 1, 2017 and there is no material impact of this new standard on our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13 — Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 is part of the disclosure framework project, which primarily focuses on improving the effectiveness of disclosures in the notes to financial statements. The amendments in this update remove, modify, and add certain disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The update is effective for annual periods beginning after December 31, 2019, and interim periods within those annual periods. The Company is currently assessing the impact of the guidance, however it does not expect any impact of this new guidance on its consolidated financial statements to be material.

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standards setting bodies that are adopted by the Company as of the specified effective date. We believe the impact of the recently issued standards and any that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.

NOTE 2 — RELATED PARTY ARRANGEMENTS

Investment Advisory Agreement

The Company has entered into an investment advisory agreement with Stellus Capital pursuant to which Stellus Capital serves as its investment adviser. Pursuant to this agreement, the Company has agreed to pay to Stellus Capital an annual base management fee of 1.75% of gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents, and an incentive fee.

For the years ended December 31, 2018, 2017 and 2016, the Company recorded an expense for base management fees of $8,154,842, $6,255,911, and $6,281,863 respectively. As of December 31, 2018 and December 31, 2017, respectively, $2,183,975 and $1,621,592 was payable to Stellus Capital, respectively.

The incentive fee has two components, investment income and capital gains, as follows:

Investment Income Incentive Fee

The income component (“Income Incentive Fee”) is calculated, and payable to the Advisor, quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The pre-incentive fee net investment income, which is expressed as a rate of return on the value of the Company’s net assets attributable to the Company’s common stock, for the immediately preceding calendar quarter, has a 2.0% hurdle rate (also referred to as the “Hurdle”). Pre-incentive fee net investment income means interest income, dividend income and any other income accrued during the calendar quarter, minus the Company’s operating

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

expenses for the quarter excluding the incentive fee. Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which the Company’s pre-incentive fee net investment income does not exceed the Hurdle. Subject to the cumulative total return requirement described below, the Advisor receives 100% of the Company’s pre-incentive fee net investment income for any calendar quarter with respect to that portion of the pre-incentive net investment income for such quarter, if any, that exceeds the Hurdle but is less than 2.5% of net assets (also referred to as the “Catch-up”) and 20.0% of the Company’s pre-incentive fee net investment income for such calendar quarter, if any, greater than 2.5% of net assets.

The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any Income Incentive Fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which the Company’s pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the Catch-up, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such incentive fee that is attributable to deferred interest until the Company actually receives such interest in cash.

For the years ended December 31, 2018, 2017 and 2016, the Company incurred $5,529,376, $2,911,392 and $4,275,436, respectively, of Investment Income Incentive Fees. As of December 31, 2018 and 2017, $1,936,538 and $371,647, respectively, of such incentive fees were payable to the Advisor, of which $1,675,804 and $175,738, respectively, were currently payable (as explained below). As of December 31, 2018 and December 31, 2017, $260,734 and $195,909, respectively, of incentive fees incurred but not paid by the Company were generated from deferred interest (i.e. PIK, certain discount accretion and deferred interest) and are not payable until such amounts are received by the Company in cash.

Capital Gains Incentive Fee

The Company also pays the Advisor an incentive fee based on capital gains (the “Capital Gains Incentive Fee”). The Capital Gains Incentive Fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). The Capital Gains Incentive Fee is equal to 20.0% of the Company’s cumulative aggregate realized capital gains from Inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid Capital Gains Incentive Fees is subtracted from such Capital Gains Incentive Fee calculated.

U.S. GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation and depreciation of investments or other financial instruments in the calculation, as an incentive fee would be payable if such unrealized

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

capital appreciation or depreciation were realized, even though such unrealized capital appreciation is not permitted to be considered in calculating the fee actually payable under the investment advisory agreement. There can be no assurance that unrealized appreciation or depreciation will be realized in the future. Accordingly, such fees, as calculated and accrued, may not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of incentive fees in subsequent periods. For the years ended December 31, 2018, and 2017, the Company incurred $81,038 and $0, respectively. As of December 31, 2018 and December 31, 2017, $81,038 and $0, respectively of Capital Gains Incentive Fees were payable to the Advisor.

The following tables summarize the components of the incentive fees discussed above:

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
Investment Income Incentive Fee Incurred   $ 5,529,376     $ 2,911,392     $ 4,275,436  
Capital Gains Incentive Fee Incurred     81,038           $  
Incentive Fee Expense   $ 5,610,414     $ 2,911,392     $ 4,275,436  

   
  December 31,
2018
  December 31,
2017
Investment Income Incentive Fee Currently Payable   $ 1,675,804     $ 175,738  
Investment Income Incentive Fee Deferred     260,734       195,909  
Capital Gains Incentive Fee Payable     81,038        
Incentive Fee Payable   $ 2,017,576     $ 371,647  

Director Fees

For the years ended December 31, 2018, 2017 and 2016, the Company recorded an expense relating to director fees of $317,000, $331,000, and $324,000, respectively. As of December 31, 2018 and 2017, the Company owed its independent directors no unpaid director fees.

Co-Investments

On October 23, 2013, the Company received an exemptive order (the “Prior Order’) from the SEC to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with the Company’s investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). On December 18, 2018, the Company received a new exemptive order (the “Order”) that supersedes the Prior Order and permits the Company greater flexibility to enter into co-investment transactions. The Order expands on the Prior Order and allows the Company to co-invest with additional types of private funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the conditions included therein. Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of the Company’s independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company or its stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of the Company’s stockholders and is consistent with the Company’s investment objectives and strategies. The Company co-invests, subject to the conditions included in the Order, with private credit funds managed by Stellus Capital Management that have an investment strategy that is

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

similar to or identical to the Company’s investment strategy, and the Company may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future. The Company believes that such co-investments may afford additional investment opportunities and an ability to achieve greater diversification.

Administrative Agent

The Company serves as the administrative agent on certain investment transactions, including co-investments with its affiliates under the exemptive relief order. As of December 31, 2018 and December 31, 2017, there was no cash due to other investment funds related to interest paid by a borrower to the Company as administrative agent. Any such amount would be included in “Other Accrued Expenses and Liabilities” on the Consolidated Statement of Assets and Liabilities.

License Agreement

The Company has entered into a license agreement with Stellus Capital under which Stellus Capital has agreed to grant the Company a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, the Company has a right to use the “Stellus Capital” name for so long as Stellus Capital or one of its affiliates remains its investment adviser. Other than with respect to this limited license, the Company has no legal right to the “Stellus Capital” name.

Administration Agreement

The Company entered into an administration agreement with Stellus Capital pursuant to which Stellus Capital will furnish the Company with office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under this administration agreement, Stellus Capital will perform, or oversee the performance of, its required administrative services, which includes, among other things, being responsible for the financial records which it is required to maintain and preparing reports to its stockholders and reports filed with the SEC.

For the years ended December 31, 2018, 2017 and 2016, the Company recorded expenses of $1,195,174, $1,117,011, and $922,531, respectively, related to the administration agreement. As of December 31, 2018 and December 31, 2017, $323,188 and $279,141, respectively, remained payable to Stellus Capital relating to the administration agreement.

Indemnification

The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the investment advisory agreement, Stellus Capital and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital’s services under the investment advisory agreement or otherwise as our investment adviser.

NOTE 3 — DISTRIBUTIONS

Distributions are generally declared by the Company’s board of directors each calendar quarter, paid monthly and recognized as distribution liabilities on the ex-dividend date. The Company intends to distribute net realized gains (i.e., net capital gains in excess of net capital

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 3 — DISTRIBUTIONS  – (continued)

losses), if any, at least annually. The stockholder distributions, if any, will be determined by the board of directors. Any distribution to stockholders will be declared out of assets legally available for distribution.

The following table reflects the Company’s distributions declared and paid or to be paid on its common stock since Inception:

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2012
                          
December 7, 2012     December 21, 2012       December 27, 2012     $ 0.1812  
Fiscal 2013
                          
March 7, 2013     March 21, 2013       March 28, 2013     $ 0.3400  
June 7, 2013     June 21, 2013       June 28, 2013     $ 0.3400  
August 21, 2013     September 5, 2013       September 27, 2013     $ 0.3400  
November 22, 2013     December 9, 2013       December 23, 2013     $ 0.3400  
Fiscal 2014
                          
December 27, 2013     January 15, 2014       January 24, 2014     $ 0.0650  
January 20, 2014     January 31, 2014       February 14, 2014     $ 0.1133  
January 20, 2014     February 28, 2014       March 14, 2014     $ 0.1133  
January 20, 2014     March 31, 2014       April 15, 2014     $ 0.1133  
April 17, 2014     April 30, 2014       May 15, 2014     $ 0.1133  
April 17, 2014     May 30, 2014       June 16, 2014     $ 0.1133  
April 17, 2014     June 30, 2014       July 15, 2014     $ 0.1133  
July 7, 2014     July 31, 2014       August 15, 2014     $ 0.1133  
July 7, 2014     August 29, 2014       September 15, 2014     $ 0.1133  
July 7, 2014     September 30, 2014       October 15, 2014     $ 0.1133  
October 15, 2014     October 31, 2014       November 14, 2014     $ 0.1133  
October 15, 2014     November 28, 2014       December 15, 2014     $ 0.1133  
October 15, 2014     December 31, 2014       January 15, 2015     $ 0.1133  
Fiscal 2015
                          
January 22, 2015     February 2, 2015       February 13, 2015     $ 0.1133  
January 22, 2015     February 27, 2015       March 13, 2015     $ 0.1133  
January 22, 2015     March 31, 2015       April 15, 2015     $ 0.1133  
April 15, 2015     April 30, 2015       May 15, 2015     $ 0.1133  
April 15, 2015     May 29, 2015       June 15, 2015     $ 0.1133  
April 15, 2015     June 30, 2015       July 15, 2015     $ 0.1133  
July 8, 2015     July 31, 2015       August 14, 2015     $ 0.1133  
July 8, 2015     August 31, 2015       September 15, 2015     $ 0.1133  
July 8, 2015     September 20, 2015       October 15, 2015     $ 0.1133  
October 14, 2015     October 30, 2015       November 13, 2015     $ 0.1133  
October 14, 2015     November 30, 2015       December 15, 2015     $ 0.1133  
October 14, 2015     December 31, 2015       January 15, 2016     $ 0.1133  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 3 — DISTRIBUTIONS  – (continued)

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2016
                          
January 13, 2016     January 29, 2016       February 15, 2016     $ 0.1133  
January 13, 2016     February 29, 2016       March 15, 2016     $ 0.1133  
January 13, 2016     March 31, 2016       April 15, 2016     $ 0.1133  
April 15, 2016     April 29, 2016       May 13, 2016     $ 0.1133  
April 15, 2016     May 31, 2016       June 15, 2016     $ 0.1133  
April 15, 2016     June 30, 2016       July 15, 2016     $ 0.1133  
July 7, 2016     July 29, 2016       August 15, 2016     $ 0.1133  
July 7, 2016     August 31, 2016       September 15, 2016     $ 0.1133  
July 7, 2016     September 30, 2016       October 14, 2016     $ 0.1133  
October 7, 2016     October 31, 2016       November 15, 2016     $ 0.1133  
October 7, 2016     November 30, 2016       December 15, 2016     $ 0.1133  
October 7, 2016     December 30, 2016       January 13, 2017     $ 0.1133  
Fiscal 2017
                          
January 13, 2017     January 31, 2017       February 15, 2017     $ 0.1133  
January 13, 2017     February 28, 2017       March 15, 2017     $ 0.1133  
January 13, 2017     March 31, 2017       April 14, 2017     $ 0.1133  
April 14, 2017     April 28, 2017       May 15, 2017     $ 0.1133  
April 14, 2017     May 31, 2017       June 15, 2017     $ 0.1133  
April 14, 2017     June 30, 2017       July 14, 2017     $ 0.1133  
July 7, 2017     July 31, 2017       August 15, 2017     $ 0.1133  
July 7, 2017     August 31, 2017       September 15, 2017     $ 0.1133  
July 7, 2017     September 29, 2017       October 13, 2017     $ 0.1133  
October 12, 2017     October 31, 2017       November 15, 2017     $ 0.1133  
October 12, 2017     November 30, 2017       December 15, 2017     $ 0.1133  
October 12, 2017     December 29, 2017       January 12, 2018     $ 0.1133  
Fiscal 2018
                          
January 11, 2018     January 31, 2018       February 15, 2018     $ 0.1133  
January 11, 2018     February 28, 2018       March 15, 2018     $ 0.1133  
January 11, 2018     March 29, 2018       April 13, 2018     $ 0.1133  
April 16, 2018     April 30, 2018       May 15, 2018     $ 0.1133  
April 16, 2018     May 31, 2018       June 15, 2018     $ 0.1133  
April 16, 2018     June 29, 2018       July 13, 2018     $ 0.1133  
July 12, 2018     July 31, 2018       August 15, 2018     $ 0.1133  
July 12, 2018     August 31, 2018       September 14, 2018     $ 0.1133  
July 12, 2018     September 28, 2018       October 15, 2018     $ 0.1133  
October 16, 2018     October 31, 2018       November 15, 2018     $ 0.1133  
October 16, 2018     November 29, 2018       December 14, 2018     $ 0.1133  
October 16, 2018     December 31, 2018       January 15, 2019     $ 0.1133  
Total               $ 8.4042  

The Company has adopted an “opt out” dividend reinvestment plan (“DRIP”) pursuant to which a stockholder whose shares are held in his own name will receive distributions in shares of the Company’s common stock under the Company’s DRIP unless it elects to receive distributions in cash. Shareholders whose shares are held in the name of a broker or the nominee of a broker may

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 3 — DISTRIBUTIONS  – (continued)

have distributions reinvested only if such service is provided by the broker or the nominee, or if the broker or the nominee permits participation in our DRIP. Shareholders whose shares are held in the name of a broker or other nominee should contact the broker or nominee for details. Although distributions paid in the form of additional shares of the Company’s common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in the Company’s DRIP will not receive any corresponding cash distributions with which to pay any such applicable taxes. Any distributions reinvested through the issuance of shares through the Company’s DRIP will increase the Company’s gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital. The Company issued 7,931 shares through the DRIP during the year ended December 31, 2018. No new shares were issued in connection with the DRIP during the year ended December 31, 2017.

NOTE 4 — EQUITY OFFERINGS AND RELATED EXPENSES

The table below illustrates the number of common stock shares the Company issued since inception through various equity offerings and pursuant to the Company’s DRIP.

           
Issuance of Common Stock   Number of Shares   Gross(1)(2)
Proceeds
  Underwriting fees   Offering Expenses   Net
Proceeds
  Offering Price
Year ended December 31, 2012     12,035,023     $ 180,522,093     $ 4,959,720     $ 835,500     $ 174,726,873     $ 14.90  
Year ended December 31, 2013     63,998       899,964                   899,964     $ 14.06  
Year ended December 31, 2014     380,936       5,485,780       75,510       29,904       5,380,366     $ 14.47  
Year ended December 31, 2015                                    
Year ended December 31, 2016                                    
Year ended December 31, 2017     3,465,922       48,741,406       1,358,880       307,021       47,075,505     $ 14.06  
Year ended December 31, 2018     7,931       93,737                   94,018     $ 11.85  
Total     15,953,810     $ 235,742,980     $ 6,394,110     $ 1,172,425     $ 228,176,445        

(1) Net of partial share redemptions. Such share redemptions reduced gross proceeds by $1,051, $142, $31 and $29 in 2018, 2017, 2016 and 2015, respectively.
(2) Includes common shares issued under the DRIP of $94,788 during the year ended December 31, 2018, $0 for the years ended 2017, 2016 and 2015, and $398,505, $930,385, $113,000 for the years ended 2014, 2013, and 2012, respectively.

The Company issued 7,931 shares through the DRIP during the year ended December 31, 2018. No new shares were issued in connection with the DRIP during the year ended December 31, 2017.

The Company issued 3,162,500 shares in a secondary offering and 303,422 shares in connection with the ATM program during the year ended December 31, 2017. Gross proceeds resulting from the secondary offering totaled $44,591,250 and underwriting and other expenses totaled $1,530,632. The per share offering price for the secondary offering was $14.10. Gross proceeds resulting from the ATM Program in 2017 totaled $4,150,299 and underwriting and other expenses totaled $135,270. The average per share offering price of shares issued in the ATM Program during 2017 was $13.68.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 5 — NET INCREASE IN NET ASSETS PER COMMON SHARE

The following information sets forth the computation of net increase in net assets resulting from operations per common share for the years ended December 31, 2018, 2017 and 2016.

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
Net increase in net assets resulting from operations   $ 26,194,578     $ 22,613,257     $ 23,199,062  
Weighted average common shares     15,953,571       14,870,981       12,479,959  
Basic and diluted earnings per common share   $ 1.64     $ 1.52     $ 1.86  

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE

In accordance with the authoritative guidance on fair value measurements and disclosures under U.S. GAAP, the Company discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1 —  Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 —  Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;
Level 3 —  Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.

The Company considers whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if the Company determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

At December 31, 2018, the Company had investments in 57 portfolio companies. The total cost and fair value of the investments were $502,743,649 and $504,483,668 respectively. The composition of our investments as of December 31, 2018 is as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 297,965,589     $ 292,004,982  
Senior Secured – Second Lien     155,382,612       149,661,220  
Unsecured Debt     25,436,237       23,697,466  
Equity     23,959,211       39,120,000  
Total Investments   $ 502,743,649     $ 504,483,668  

(1) Includes unitranche investments, which account for 20.6% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.

At December 31, 2017, the Company had investments in 48 portfolio companies. The total cost and fair value of the investments were $368,453,206 and $371,839,772 respectively. The composition of our investments as of December 31, 2017 was as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 140,915,106     $ 141,006,923  
Senior Secured – Second Lien     181,164,730       178,432,850  
Unsecured Debt     27,903,141       27,430,000  
Equity     18,470,229       24,969,999  
Total Investments   $ 368,453,206     $ 371,839,772  

(1) Includes unitranche investments, which account for 13.2% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.

The Company’s investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require the Company to provide funding when requested by portfolio companies in accordance with the terms of the underlying loan agreements. As of December 31, 2018 and December 31, 2017, the Company had eleven and four such investments with aggregate unfunded commitments of $21,213,962 and $8,686,667, respectively. The Company maintains sufficient liquidity to fund such unfunded loan commitments should the need arise.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2018 are as follows:

       
  Quoted Prices
in Active
Markets
for Identical
Securities
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
Senior Secured – First Lien   $         —     $         —     $ 292,004,982     $ 292,004,982  
Senior Secured – Second Lien                 149,661,220       149,661,220  
Unsecured Debt                 23,697,466       23,697,466  
Equity                 39,120,000       39,120,000  
Total Investments   $     $     $ 504,483,668     $ 504,483,668  

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2017 are as follows:

       
  Quoted Prices
in Active
Markets
for Identical
Securities
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
Senior Secured – First Lien   $           —     $         —     $ 141,006,923     $ 141,006,923  
Senior Secured – Second Lien                 178,432,850       178,432,850  
Unsecured Debt                 27,430,000       27,430,000  
Equity                 24,969,999       24,969,999  
Total Investments   $     $     $ 371,839,772     $ 371,839,772  

The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2018 are as follows:

         
  Senior Secured
Loans-First
Lien
  Senior Secured
Loans-Second
Lien
  Unsecured
Debt
  Equity   Total
Fair value at beginning of period   $ 141,006,923     $ 178,432,850     $ 27,430,000     $ 24,969,999     $ 371,839,772  
Purchases of investments     224,555,549       38,515,000       251,180       9,605,730       272,927,459  
Payment-in-kind interest     106,314       1,696,547       67,044             1,869,905  
Sales and Redemptions     (68,382,321 )      (66,658,090 )      (2,903,096 )      (9,657,263 )      (147,600,770 ) 
Realized Gains                       5,540,518       5,540,518  
Change in unrealized appreciation (depreciation) included in earnings     (6,052,424 )      (2,989,511 )      (1,265,630 )      8,661,016       (1,646,549 ) 
Amortization of premium and accretion of discount, net     770,941       664,424       117,968             1,553,333  
Fair value at end of period   $ 292,004,982     $ 149,661,220     $ 23,697,466     $ 39,120,000     $ 504,483,668  
Change in unrealized depreciation on Level 3 investments still held as of December 31, 2018   $ (5,820,453 )    $ (3,157,990 )    $ (1,285,630 )    $ 10,831,127     $ 567,054  

There were no Level 3 transfers during the twelve months ended December 31, 2018.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2017 are as follows:

         
  Senior Secured
Loans-First
Lien
  Senior Secured
Loans-Second
Lien
  Unsecured
Debt
  Equity   Total
Fair value at beginning of year   $ 113,482,205     $ 144,521,388     $ 70,725,412     $ 18,931,886     $ 347,660,891  
Purchases of investments     85,892,733       73,388,500       6,203,400       6,686,613       172,171,246  
Payment-in-kind interest     113,723       319,629       66,244             499,596  
Sales and redemptions     (57,242,106 )      (47,725,650 )      (49,578,812 )      (9,369,308 )      (163,915,876 ) 
Transfer from term loan to equity     (864,101 )                  864,101        
Net realized gain (loss)     (626,949 )                  5,367,925       4,740,976  
Change in unrealized appreciation (depreciation)     (126,190 )      (2,146,961 )      (278,564 )      2,488,782       (62,933 ) 
Amortization of premium and accretion of discount, net     377,608       525,944       292,320             1,195,872  
Transfer from Level 2           9,550,000                   9,550,000  
Fair value at end of year   $ 141,006,923     $ 178,432,850     $ 27,430,000     $ 24,969,999     $ 371,839,772  
Change in unrealized depreciation on Level 3 investments still held as of December 31, 2017   $ (498,183 )    $ (1,679,419 )    $ (278,567 )    $ 3,465,063     $ 1,008,894  

During the year ended December 31, 2017, there was one transfer from a Level 2 to a Level 3 because the observable inputs were not available. Transfers are reflected at the value of the securities at the beginning of the period.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2018:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Texas   $ 100,229,354     $ 97,474,226       19.32 % 
California     86,550,134       85,880,918       17.03 % 
New Jersey     43,513,698       41,473,072       8.22 % 
Ohio     36,209,514       36,273,224       7.19 % 
Illinois     19,941,053       29,880,018       5.92 % 
Canada     27,902,537       27,935,931       5.54 % 
Arizona     21,682,522       21,603,741       4.28 % 
South Carolina     20,871,587       20,385,325       4.04 % 
New York     20,446,690       20,287,086       4.02 % 
Tennessee     20,117,218       19,381,134       3.84 % 
Arkansas     17,696,537       18,013,941       3.57 % 
Pennsylvania     17,732,831       17,824,372       3.53 % 
Maryland     17,237,500       17,237,500       3.42 % 
Wisconsin     11,437,711       10,869,000       2.15 % 
Colorado     10,777,822       10,777,822       2.14 % 
Georgia     5,988,728       9,820,000       1.95 % 
Indiana     7,363,628       7,087,500       1.40 % 
Puerto Rico     8,797,954       5,029,913       1.00 % 
North Carolina     4,946,554       4,425,000       0.88 % 
Massachusetts     1,317,406       1,670,000       0.33 % 
Missouri     139,656       670,000       0.13 % 
Virginia     50,001       280,000       0.06 % 
Florida     242,304       110,000       0.02 % 
Utah     1,550,710       93,945       0.02 % 
     $ 502,743,649     $ 504,483,668       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
Texas   $ 109,043,496     $ 108,445,000       29.16 % 
New Jersey     34,531,876       34,595,527       9.30 % 
New York     28,939,268       29,365,000       7.90 % 
Canada     26,315,677       26,440,000       7.11 % 
California     25,519,753       25,930,000       6.97 % 
Illinois     24,250,169       25,700,000       6.91 % 
Massachusetts     22,534,191       22,247,850       5.98 % 
Arizona     13,565,958       13,840,000       3.72 % 
North Carolina     12,248,770       12,499,167       3.36 % 
Ohio     10,112,627       9,990,000       2.69 % 
Tennessee     9,848,614       9,950,000       2.68 % 
Missouri     9,152,087       9,530,000       2.56 % 
Georgia     5,929,223       8,329,998       2.24 % 
Pennsylvania     7,848,470       8,058,746       2.17 % 
Arkansas     7,397,881       7,618,484       2.05 % 
Minnesota     5,421,770       5,420,000       1.46 % 
Puerto Rico     8,827,864       5,080,000       1.37 % 
Washington     4,172,743       4,520,000       1.22 % 
Alabama     1,206,682       2,880,000       0.77 % 
Utah     1,293,782       880,000       0.24 % 
Florida     242,304       420,000       0.11 % 
Virginia     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of industry concentration of our investment portfolio as of December 31, 2018:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Services: Business   $ 60,784,467     $ 63,810,643       12.65 % 
Healthcare & Pharmaceuticals     58,682,811       54,785,327       10.86 % 
Consumer Goods: Durable     44,218,515       44,049,052       8.73 % 
Finance     34,208,412       41,910,000       8.30 % 
Software     37,427,547       38,026,250       7.54 % 
Media: Broadcasting & Subscription     38,137,844       37,733,004       7.48 % 
Retail     28,764,221       27,525,897       5.45 % 
Education     26,562,249       25,325,000       5.02 % 
High Tech Industries     21,094,192       21,094,192       4.18 % 
Beverage, Food, & Tobacco     20,709,134       18,213,945       3.61 % 
Services: Consumer     17,952,663       17,640,255       3.50 % 
Automotive     17,457,259       17,282,187       3.43 % 
Energy: Oil & Gas     14,312,328       15,542,102       3.08 % 
Consumer goods: non-durable     14,994,980       14,579,375       2.89 % 
Chemicals, Plastics, & Rubber     11,835,100       11,707,835       2.32 % 
Containers, Packaging, & Glass     11,437,711       10,869,000       2.15 % 
Construction & Building     10,374,827       10,280,000       2.04 % 
Utilities: Oil & Gas     9,853,435       9,853,435       1.95 % 
Capital Equipment     7,535,876       7,929,775       1.57 % 
Transportation: Cargo     6,808,345       6,841,739       1.36 % 
Insurance     5,425,301       5,460,000       1.08 % 
Hotel, Gaming, & Leisure     3,170,307       3,414,655       0.68 % 
Environmental Industries     946,124       330,000       0.07 % 
Services: Government     50,001       280,000       0.06 % 
     $ 502,743,649     $ 504,483,668       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total Investments
Software   $ 48,560,675     $ 48,997,850       13.18 % 
Healthcare & Pharmaceuticals     41,192,879       37,829,167       10.17 % 
High Tech Industries     36,058,477       35,460,000       9.54 % 
Finance     26,500,097       28,330,000       7.62 % 
Services: Business     23,386,714       25,749,999       6.93 % 
Capital Equipment     24,300,027       24,170,000       6.50 % 
Media: Broadcasting & Subscription     21,680,239       23,665,000       6.36 % 
Chemicals, Plastics, & Rubber     20,825,458       21,145,000       5.69 % 
Services: Consumer     17,862,616       18,070,000       4.86 % 
Construction & Building     17,913,413       17,980,000       4.84 % 
Education     17,197,396       17,335,526       4.66 % 
Consumer Goods: Durable     16,559,947       16,798,484       4.52 % 
Consumer goods: non-durable     13,250,000       13,250,000       3.56 % 
Retail     8,288,083       8,280,000       2.23 % 
Automotive     7,848,470       8,058,746       2.17 % 
Transportation: Cargo     6,785,894       6,840,000       1.84 % 
Energy: Oil & Gas     6,766,968       6,700,000       1.80 % 
Insurance     5,410,226       5,500,000       1.48 % 
Beverage, Food, & Tobacco     3,964,242       3,580,000       0.96 % 
Hotel, Gaming, & Leisure     3,284,942       3,420,000       0.92 % 
Environmental Industries     766,442       580,000       0.16 % 
Services: Government     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

The following provides quantitative information about Level 3 fair value measurements as of December 31, 2018:

       
Description   Fair Value   Valuation Technique   Unobservable Inputs   Range (Average)(1)
First lien debt   $ 292,004,982       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -1.03% to 2.59% (0.85%)
-5.62% to 6.64% (1.64%)
4x to 22x (10x)(4)
 
Second lien debt   $ 149,661,220       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -0.00% to 2.66% (0.93%)
-0.14% to 10.66% (1.70%)
2x to 17x (11x)(4)
 
Unsecured debt   $ 23,697,466       Income/Market
approach(2)
      HY credit spreads,
Risk free rates
Market multiples
      -1.03% to 0.57% (-0.01%)
-5.62% to 0.32% (-1.27%)
2x to 9x (3x)(4)
 
Equity investments   $ 39,120,000       Market approach(5)
      Underwriting
EBITDA Multiple
      2x to 15x (10x)  
Total Long Term Level 3
Investments
  $ 504,483,668                    

(1) Weighted average based on fair value as of December 31, 2018.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

(2) Inclusive of but not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3) The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for a first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -1.03% (-103 basis points) to 2.59% (259 basis points). The average of all changes was 0.85%.
(4) Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5) The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

The following provides quantitative information about Level 3 fair value measurements as of December 31, 2017:

       
Description   Fair Value   Valuation Technique   Unobservable Inputs   Range (Average)(1)(3)
First lien debt   $ 141,006,923       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -3.73% to 5.53%
(-0.81%)
-0.24% to 1.12% (0.54%)
11x to 13x (12x)(4)
 
Second lien debt   $ 178,432,850       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -2.52% to 4.78%
(-0.58%)
-0.28% to 1.01% (0.39%)
8x to 8x (8x)(4)
 
Unsecured debt   $ 27,430,000       Income/Market
approach(2)
      HY credit spreads,
Risk free rates
Market multiples
      -0.67% to 3.93% (0.89%)
0.12% to 1.18% (0.52%)
1x to 14x (13x)(4)
 
Equity investments   $ 24,969,999       Market approach(5)
      Underwriting multiple/
EBITDA Multiple
      1x to 15x (9x)  
Total Long Term Level 3
Investments
  $ 371,839,772                    

(1) Weighted average based on fair value as of December 31, 2017.
(2) Including but not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

(3) The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors could result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -3.73% (-373 basis points) to 5.53% (553 basis points). The average of all changes was — 0.81%.
(4) Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5) The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation could result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

NOTE 7 — COMMITMENTS AND CONTINGENCIES

The Company is currently not subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition or results of operations.

As of December 31, 2018, the Company had $21,213,961 of unfunded commitments to provide debt financing to eleven existing portfolio companies. As of December 31, 2017 the Company had $8,686,667 of unfunded commitments to provide debt financing to four existing portfolio companies. As of December 31, 2018, the Company had sufficient liquidity to fund such unfunded loan commitments should the need arise.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 8 — FINANCIAL HIGHLIGHTS

         
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
  For the year
ended
December 31,
2014
Per Share Data:(1)
                                            
Net asset value at beginning of
year/period
  $ 13.81     $ 13.69     $ 13.19     $ 13.94     $ 14.54  
Net investment income     1.42       1.21       1.39       1.33       1.34  
Change in unrealized appreciation (depreciation)     (0.11 )            1.49       (0.74 )      (0.53 ) 
Realized gain (loss)     0.35       0.31       (1.05 )      0.03       0.04  
Provision for taxes on realized gains     (0.02 )                         
Benefit (Provision) for taxes on unrealized appreciation                 0.03       (0.01 )      (0.02 ) 
Total from investment operations     1.64       1.52       1.86       0.61       0.83  
Sales Load              (0.09 )                  (0.01 ) 
Offering Costs              (0.02 )                   
Stockholder distributions from:
                                            
Net investment income     (1.03 )      (1.20 )      (1.36 )      (1.33 )      (1.31 ) 
Net realized capital gains     (0.33 )      (0.16 )            (0.03 )      (0.12 ) 
Other(2)(3)           0.07                   0.01  
Net asset value at the end of
year/period
  $ 14.09     $ 13.81     $ 13.69     $ 13.19     $ 13.94  
Per share market value at end of year/period   $ 12.95     $ 13.14     $ 12.06     $ 9.64     $ 11.78  
Total return based on market value(4)     8.68 %      20.29 %      42.83 %      (7.76 )%      (13.09 )% 
Weighted average shares outstanding at the end of period     15,953,571       14,870,981       12,479,959       12,479,961       12,281,178  
Ratio/Supplemental Data:
                                            
Net assets at the end of
year/period
  $ 224,845,007     $ 220,247,242     $ 170,881,785     $ 164,651,104     $ 173,949,452  
Weighted average net assets   $ 223,750,302     $ 195,211,550     $ 165,189,142     $ 173,453,813     $ 176,458,141  
Annualized ratio of gross operating expenses to net assets(7)(8)     13.72 %      11.10 %      13.20 %      11.16 %      9.92 % 
Annualized ratio of net operating expenses to net assets(7)(8)     13.72 %      11.10 %      13.20 %      10.78 %      9.12 % 
Annualized ratio of interest expense and other fees to net assets(9)     5.51 %      4.02 %      4.84 %      3.56 %      3.01 % 
Annualized ratio of net investment income before fee waiver to net assets(7)(8)     10.09 %      9.21 %      10.71 %      9.11 %      8.40 % 
Annualized ratio of net investment income to net assets(7)(8)     10.09 %      9.21 %      10.71 %      9.49 %      9.19 % 
Portfolio Turnover(5)     32 %      48 %      16 %      29 %      19 % 
Notes Payable   $ 48,875,000     $ 48,875,000     $ 25,000,000     $ 25,000,000     $ 25,000,000  
Credit Facility Payable   $ 99,550,000     $ 40,750,000     $ 116,000,000     $ 109,500,000     $ 106,500,000  
SBA-guaranteed debentures   $ 150,000,000     $ 90,000,000     $ 65,000,000     $ 65,000,000     $ 16,250,000  
Asset Coverage Ratio(6)     2.51x       3.46x       2.21x       2.22x       2.32x  

(1) Financial highlights are based on weighted average shares outstanding as of year/period ended.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 8 — FINANCIAL HIGHLIGHTS  – (continued)

(2) The per share impact of the Company’s reinvestment of stockholder distributions has an impact to net assets of less than $0.01 per share during the applicable period.
(3) Includes the impact of different share amounts as a result of calculating certain per share data based on weighted average shares outstanding during the period and certain per share data based on shares outstanding as of the period end.
(4) Total return on market value is based on the change in market price per share since the end of the prior quarter and includes dividends paid, which are assumed to be reinvested. The total returns are not annualized.
(5) Calculated as the lesser of purchases or paydowns divided by average portfolio balance and is not annualized.
(6) Asset coverage ratio is equal to total assets less all liabilities and indebtedness not represented by senior securities over the aggregate amount of the senior securities. SBA-guaranteed debentures are excluded from the numerator and denominator.
(7) These ratios include the impact of the benefit (provision) for income taxes related to net unrealized loss (gain) on certain investments of $(67,953), $8,593, and $373,131 for the years ended December 31, 2018, 2017 and 2016 respectively, which are not reflected in net investment income, gross operating expenses or net operating expenses. The benefit (provision) for income taxes related to net realized loss or unrealized loss (gain) on investments at taxable subsidiaries to net assets for the years ended December 31, 2018, 2017 and 2016 is less than (.03)%, (0.01)% and (0.23)%, respectively.
(8) Deferred offering costs of $261,761 for the year ended December 31, 2016 are not annualized.
(9) Excludes debt extinguishment costs of $416,725 for the year ended December 31, 2017. Including these costs, this ratio would be 4.24%.

NOTE 9 — CREDIT FACILITY

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120,000,000 on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. The Company terminated the Original Facility on October 11, 2017, in conjunction with securing and entering into a new senior secured revolving credit agreement, dated as of October 10, 2017, as amended on March 28, 2018 and August 2, 2018, with ZB, N.A., dba Amegy Bank and various other lenders (the “Credit Facility”).

The Credit Facility, as amended, provides for borrowings up to a maximum of $180,000,000 on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% (or 2.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) with no LIBOR floor, or (ii) 1.50% (or 1.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 9 — CREDIT FACILITY  – (continued)

plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021.

The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10,000,000, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 1.75 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of December 31, 2018, the Company was in compliance with these covenants.

As of December 31, 2018 and December 31, 2017, the outstanding balance under the Credit Facility was $99,550,000 and $40,750,000, respectively. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The fair values of the Credit Facility is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Credit Facility is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. The Company had previously incurred total costs of $3,117,715 in connection with obtaining, amending, and maintaining the Original Facility. The Company has incurred costs of $1,510,018 in connection with the current Credit Facility, which are being amortized over the life of the facility. Additionally, $341,979 of costs from the Original Facility will continue to be amortized over the remaining life of the Credit Facility. As of December 31, 2018 and 2017, $1,312,773 and $1,417,521 of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our consolidated statement of assets and liabilities as a deduction from the debt liability attributable to the Credit Facility as required by ASU No. 2015-3.

The following is a summary of the Credit Facility, net of prepaid loan structure fees:

   
  December 31, 2018   December 31, 2017
Credit Facility payable   $ 99,550,000     $ 40,750,000  
Prepaid loan structure fees     1,312,773       1,417,521  
Credit facility payable, net of prepaid loan structure fees   $ 98,237,227     $ 39,332,479  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 9 — CREDIT FACILITY  – (continued)

Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the years ended December 31, 2018, 2017, and 2016:

     
  For the years ended
     December 31, 2018   December 31, 2017   December 31, 2016
Interest expense   $ 3,737,735     $ 2,247,048     $ 3,383,572  
Loan fee amortization     415,179       416,612       471,501  
Commitment fees on unused portion     387,601       311,174       66,787  
Administration fees     40,972       39,282       52,335  
Total interest and financing expenses   $ 4,581,487     $ 3,014,116     $ 3,974,195  
Loss on extinguishment of debt   $     $ 113,993     $  
Weighted average interest rate     4.7 %      3.7 %      3.2 % 
Effective interest rate (including fee amortization)     5.7 %      5.0 %      3.7 % 
Average debt outstanding   $ 79,818,493     $ 60,053,425     $ 106,601,093  
Cash paid for interest and unused fees   $ 4,158,382     $ 2,476,340     $ 3,423,226  

NOTE 10 — SBA-GUARANTEED DEBENTURES

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, a single licensee can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. As of December 31, 2018 and 2017, the SBIC subsidiary had $75,000,000 and $67,500,000, respectively, in regulatory capital, as such term is defined by the SBA.

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the asset coverage test by permitting us to borrow up to $150,000,000 more than we would otherwise be able to absent the receipt of this exemptive relief.

On a stand-alone basis, the SBIC subsidiary held $225,525,663 and $161,992,327 in assets at December 31, 2018 and 2017, respectively, which accounted for approximately 42.9% and 40.4% of our total consolidated assets at December 31, 2018 and 2017, respectively.

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of December 31, 2018 and 2017, the SBIC subsidiary had $150,000,000 and $90,000,000 of the SBA-guaranteed debentures outstanding, respectively. SBA-guaranteed debentures incur upfront fees of 3.425%, which consists of a 1.00% commitment fee and a 2.425% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. Once pooled, which occurs in March and September each year, the SBA-guaranteed debentures bear interest at a fixed rate that is set to the current 10-year treasury rate plus a spread at each pooling date.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 10 — SBA-GUARANTEED DEBENTURES  – (continued)

The following table summarizes the SBIC subsidiary’s SBA-guaranteed debentures as of December 31, 2018:

       
Issuance Date   Maturity Date   Debenture Amount   Interest Rate   SBA Annual Charge
October 14, 2014     March 1, 2025     $ 6,500,000       2.52 %      0.36 % 
October 17, 2014     March 1, 2025       6,500,000       2.52 %      0.36 % 
December 24, 2014     March 1, 2025       3,250,000       2.52 %      0.36 % 
June 29, 2015     September 1,
2025
      9,750,000       2.83 %      0.36 % 
October 22, 2015     March 1, 2026       6,500,000       2.51 %      0.36 % 
October 22, 2015     March 1, 2026       1,500,000       2.51 %      0.74 % 
November 10, 2015     March 1, 2026       8,800,000       2.51 %      0.74 % 
November 18, 2015     March 1, 2026       1,500,000       2.51 %      0.74 % 
November 25, 2015     March 1, 2026       8,800,000       2.51 %      0.74 % 
December 16, 2015     March 1, 2026       2,200,000       2.51 %      0.74 % 
December 29, 2015     March 1, 2026       9,700,000       2.51 %      0.74 % 
November 28, 2017     March 1, 2028       25,000,000       3.19 %      0.22 % 
April 27, 2018     September 1,
2028
      40,000,000       3.55 %      0.22 % 
July 30, 2018     September 1,
2028
      17,500,000       3.55 %      0.22 % 
September 25, 2018     March 1, 2029       2,500,000       2.88 %(1)      0.22 % 
Total SBA-guaranteed
debentures
        $ 150,000,000              

(1) Debenture interest rate will be set as determined by the SBA when pooled on March 20, 2019

As of December 31, 2018 and 2017, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At December 31, 2018 and 2017, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

As of December 31, 2018, the Company has incurred $5,137,500 in financing costs related to the SBA-guaranteed debentures since receiving our license, which were recorded as prepaid loan fees. As of December 31, 2018 and 2017, $3,612,198 and $2,181,187 of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 10 — SBA-GUARANTEED DEBENTURES  – (continued)

The following is a summary of the SBA-guaranteed debentures, net of prepaid loan fees:

   
  December 31,
2018
  December 31,
2017
SBA debentures payable   $ 150,000,000     $ 90,000,000  
Prepaid loan fees     3,612,198       2,181,187  
SBA Debentures, net of prepaid loan fees   $ 146,387,802     $ 87,818,813  

The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the years ended December 31, 2018, 2017 and 2016:

     
  For the years ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Interest expense   $ 3,982,658     $ 2,067,308     $ 1,877,017  
Debenture fee amortization     623,989       333,027       326,191  
Total interest and financing expenses   $ 4,606,647     $ 2,400,335     $ 2,203,208  
Weighted average interest rate     3.2 %      3.1 %      2.9 % 
Effective interest rate (including fee amortization)     3.7 %      3.6 %      3.4 % 
Average debt outstanding   $ 125,390,411     $ 67,328,767     $ 65,000,000  
Cash paid for interest   $ 3,107,218     $ 2,019,095     $ 1,500,528  

NOTE 11 — NOTES

On May 5, 2014, the Company closed a public offering of $25,000,000 in aggregate principal amount of 6.50% notes (the “2019 Notes”) due April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The Company redeemed all $25,000,000 in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date. As a result of the redemption, the Company recognized a loss on the extinguishment of debt of $302,732 for the year ended December 31, 2017, due to the write off of the remaining deferred financing costs on the 2019 Notes.

The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for the years ended December 31, 2018, 2017, and 2016:

     
  For the year ended
     December 31,
2018
  December 31,
2017
  December 31,
2016
Interest expense   $       —     $ 1,169,097     $ 1,625,000  
Deferred financing costs           131,377       184,933  
Administration fees           5,000       4,850  
Total interest and financing expenses   $     $ 1,305,474     $ 1,814,783  
Loss on extinguishment of debt   $     $ 302,732     $  
Cash paid for interest   $     $ 1,376,736     $ 1,625,000  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 11 — NOTES  – (continued)

On August 21, 2017, the Company issued $42,500,000 in aggregate principal amount of 5.75% fixed-rate notes due 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6,375,000 in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

The Company used all of the net proceeds from the 2022 offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of December 31, 2018 and 2017, the aggregate carrying amount of all Notes was $48,875,000 and $25,000,000 and the fair value of the Notes was approximately $47,604,250 and $49,520,150, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1,688,961 of fees that are being amortized over the term of the 2022 Notes, of which $1,233,203 and $1,568,512 remained to be amortized as of December 31, 2018 and 2017, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the years ended December 31, 2018, 2017, 2016.

     
  For the year
ended
December 31,
2018
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
Interest expense   $ 2,810,312     $ 1,014,835     $       —  
Deferred financing costs     332,404       118,066        
Administration fees     7,905       2,383        
Total interest and financing expenses   $ 3,150,621     $ 1,135,284     $  
Cash paid for interest   $ 2,810,312     $ 889,932     $  

The following is a summary of the Notes Payable, net of deferred financing costs:

   
  December 31, 2018   December 31,
2017
Notes payable   $ 48,875,000     $ 48,875,000  
Deferred financing costs     1,233,203       1,568,512  
Notes payable, net of deferred financing costs   $ 47,641,797     $ 47,306,488  

The indenture and supplements thereto relating to the 2022 Notes contain certain covenants, including but not limited to (i) a requirement that the Company comply with the asset coverage requirements of the 1940 Act or any successor provisions, and (ii) a requirement to provide financial information to the holders of the notes and the trustee under the indenture if the Company should no longer be subject to the reporting requirements under the Exchange Act.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 12 — SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table sets forth the results of operations for the years ended December 31, 2018, 2017, and 2016. Results for any quarter are not necessarily indicative of results for the full year or for any future quarter.

       
  2018
     Qtr. 1   Qtr. 2   Qtr. 3   Qtr. 4
Total Investment Income   $ 10,911,781     $ 12,619,657     $ 14,487,623     $ 15,247,277  
Net Investment Income   $ 4,475,379     $ 4,727,236     $ 5,609,974     $ 7,823,948  
Net Increase in Net Assets from Operations   $ 7,343,929     $ 7,603,246     $ 8,884,517     $ 2,362,886  
Total Investment Income per share(1)   $ 0.68     $ 0.79     $ 0.91     $ 0.96  
Net Investment Income per
share(1)
  $ 0.28     $ 0.30     $ 0.35     $ 0.49  
Net Increase in Net Assets from Operations per share(1)   $ 0.46     $ 0.48     $ 0.56     $ 0.14  

       
  2017
     Qtr. 1   Qtr. 2   Qtr. 3   Qtr. 4
Total Investment Income   $ 9,863,980     $ 10,394,365     $ 9,978,345     $ 9,411,503  
Net Investment Income   $ 4,143,627     $ 4,938,459     $ 4,475,952     $ 4,412,722  
Net Increase in Net Assets from
Operations
  $ 6,024,752     $ 6,044,766     $ 5,636,598     $ 4,907,141  
Total Investment Income per share(1)   $ 0.79     $ 0.68     $ 0.64     $ 0.59  
Net Investment Income per share(1)   $ 0.33     $ 0.32     $ 0.29     $ 0.28  
Net Increase in Net Assets from Operations per share(1)   $ 0.48     $ 0.39     $ 0.36     $ 0.31  

       
  2016
     Qtr. 1   Qtr. 2   Qtr. 3   Qtr. 4
Total Investment Income   $ 9,467,833     $ 9,623,169     $ 10,202,753     $ 10,196,442  
Net Investment Income   $ 4,099,290     $ 3,945,102     $ 4,608,743     $ 4,659,066  
Net Increase in Net Assets from operations   $ 2,523,849     $ 5,029,920     $ 9,927,466     $ 5,717,827  
Total Investment Income per share(1)   $ 0.76     $ 0.77     $ 0.82     $ 0.82  
Net Investment Income per share(1)   $ 0.33     $ 0.32     $ 0.37     $ 0.37  
Net Increase in Net Assets from Operations per share(1)   $ 0.20     $ 0.41     $ 0.80     $ 0.45  

(1) Per share amounts are calculated using weighted average shares outstanding during the period.

NOTE 13 — INCOME TAXES

As of December 31, 2018 and December 31, 2017, the Company had $8,572,366 and $394,559, respectively, of undistributed ordinary income.(1) Undistributed capital gains were $700,000 and $723,753 for the periods ended December 31, 2018 and December 31, 2017, respectively. Undistributed qualified dividends were $31,504 and $0 for the years ended December 31, 2018 and 2017, respectively. The Company intends to distribute all of the undistributed ordinary income as of December 31, 2018 within the required period of time such that the Company will not have to pay corporate-level U.S. federal income tax for the year ended December 31, 2018. We will be

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 13 — INCOME TAXES  – (continued)

subject to a 4% nondeductible U.S. federal excise tax on our undistributed income to the extent we did not distribute an amount equal to at least 98% of our net ordinary income plus 98.2% of our capital gain net income attributable to the period. The Company has accrued $316,092 and $27,717 of U.S. federal excise tax for the tax years ended December 31, 2018 and December 31, 2017, respectively, independent of prior year adjustments. See Note 1 for further discussion of tax expense in each year.

Ordinary dividend distributions from a RIC do not qualify for the reduced maximum tax rate on qualified dividend income from domestic corporations, except to the extent that the RIC received the income in the form of qualifying dividends from domestic corporations and qualified foreign corporations. The tax character(2) of distributions paid in the years ended December 31, 2018 and 2017 was as follows:

   
  December 31,
2018
  December 31,
2017
Ordinary income   $ 15,492,724     $ 17,823,305  
Qualified dividends     250,000       1,500,000  
Distributions of long-term capital gains(2)     5,947,826       1,000,000  
Total distributions accrued or paid to common stockholders   $ 21,690,550     $ 20,323,305  

(1) The Company’s taxable income for each period is an estimate and will not be finally determined until the Company files its tax return for each year. Therefore, final taxable income earned in each period, and the undistributed ordinary income and capital gains for each period carried forward for distribution in the following period, may be different than this estimate.
(2) Distributions of long-term capital gains of $5,947,826 as of December 31, 2018 differs from distributions of net capital gains on the Consolidated Statement of Changes in Net Assets because certain long-term capital gains were recognized in Taxable Subsidiaries. The qualified dividend amount in 2018 derived from qualified dividends received by the Company from a portfolio company. The qualified dividend amount in 2017 is derived from a long-term capital gain transaction and represents a cash distribution from the Taxable Subsidiary to the Company. Additional differences arise because certain prepayment gains are characterized differently for tax reporting purposes.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 13 — INCOME TAXES  – (continued)

Listed below is a reconciliation of “Net increase in net assets resulting from operations” to taxable income and total distributions declared to common stockholders for the years ended December 31, 2018, 2017 and 2016:

     
  2018   2017   2016
Net increase in net assets resulting from operations (includes NII, realized gain/loss, unrealized gain/loss and taxes)   $ 26,194,578     $ 22,613,257     $ 23,199,062  
Net change in unrealized appreciation (depreciation)     1,646,549       22,072       (18,603,401 ) 
Income tax provision (benefit)     67,953       (8,593 )      (373,131 ) 
Pre-tax (income) expense, (gain) loss reported at Taxable Subsidiaries, not consolidated for tax purposes     416,203       (4,721,039 )      13,451,549  
Book income and tax income differences, including debt origination, interest accrual, income from pass-through investments, dividends, realized gains (losses) and changes in estimates     1,524,556       1,835,779       583,041  
Estimated taxable income   $ 29,849,839     $ 19,741,476     $ 18,257,120  
Taxable income earned in prior year and carried forward for distribution in current year     (662,990 )      (106,530 )      (1,395,300 ) 
Taxable income earned prior to period end and carried forward for distribution next period     (9,303,869 )      (1,118,312 )      (1,307,452 ) 
Distribution payable as of period end and paid in following period     1,807,570       1,806,671       1,413,982  
Total distributions accrued or paid to common stockholders   $ 21,690,550     $ 20,323,305     $ 16,968,350  

The aggregate gross unrealized appreciation and depreciation, the net unrealized appreciation, and the aggregate cost of the Company’s portfolio company securities for federal income tax purposes as of December 31, 2018 and December 31, 2017 were as follows:

   
  2018   2017
Aggregate cost of portfolio securities for federal income tax purposes   $ 503,079,738     $ 368,453,206  
Gross unrealized appreciation of portfolio company securities     18,423,224       10,263,285  
Gross unrealized depreciation of portfolio company securities     (16,683,205 )      (6,876,717 ) 
Net unrealized appreciation of portfolio company securities   $ 1,740,019     $ 3,386,568  

As of December 31, 2018, the Taxable Subsidiaries had generated unrealized losses in investments, net operating loss (“NOL”) carryovers and capital loss carryovers creating a net deferred tax asset equal to $1,282,487, as reflected below. As of December 31, 2018, for U.S. federal income tax purposes, the Taxable Subsidiaries had capital loss carryforwards totaling $7,189,833, which, if unused, will expire in the taxable year 2021. As of December 31, 2018, for U.S. federal income tax purposes, the Taxable Subsidiaries had net operating loss carryforwards totaling $1,615,912 which, if unused, will expire during the tax years 2034 through 2037. Due to the nature of the Taxable Subsidiaries’ holdings, a valuation allowance was established when management

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 13 — INCOME TAXES  – (continued)

determined it is more likely than not that some of the deferred tax assets will not be realized prior to expiration. Although our future projections indicate that we may be able to realize some of these deferred tax assets, due to the degree of uncertainty of these projections, management has recorded a deferred tax asset valuation allowance of $1,350,441.

The deferred tax asset and deferred tax liability amounts, before valuation allowance, reflected below, take into account the reduction in corporate income tax rate from 35% to 21% as enacted by the Tax Cuts and Jobs Act of 2017 (“Tax Reform”) as of the year ended December 31, 2017. Before the effect of Tax Reform, the ending net deferred tax asset at December 31, 2017 would have been approximately $2,612,000, compared to the reflected ending net deferred tax asset of $1,567,062, before valuation allowance. Therefore the reduction in corporate tax rates had the effect of reducing the Taxable Subsidiaries’ net deferred tax asset by approximately $1,045,000 for the year ended December 31, 2017. This reduction also resulted in a reduction in the required valuation allowance in an equal amount, resulting in $0 net change in tax expense arising as a result of the Tax Reform rate reduction.

   
  2018   2017
Deferred Tax Asset   $ 2,930,694     $ 2,779,563  
Deferred Tax Liability     (1,648,207 )      (1,212,501 ) 
Total Deferred Tax Asset before valuation allowance   $ 1,282,487     $ 1,567,062  
Deferred tax valuation allowance   $ (1,350,440 )    $ (1,567,062 ) 
Net Deferred Tax Liability   $ (67,953 )    $  

In connection with the gain realized from the exit of its equity investment in Eating Recovery Center, LLC, the Company recorded an income tax provision on realized gains of $267,975 for the year ended December 31, 2018. No income tax provision was recorded on realized gains from the exit of equity investments for the years ended December 31, 2017 and 2016.

Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The 2015, 2016 and 2017 federal tax years for the Company remain subject to examination by the Internal Revenue Service.

NOTE 14 — SUBSEQUENT EVENTS

Investment Portfolio

On January 4, 2019, the Company received full repayment on the first lien term loan of EOS Fitness OPCO Holdings, LLC for total proceeds of $3,064,655. The Company also received a distribution related to our equity of $126,190.

On January 7, 2019, the Company received $278,428 in full realization on the equity of OGS Holdings, Inc., resulting in a realized gain $228,427.

On February 4, 2019, the Company invested $8,500,000 in the first lien term loan of ASC Communications, LLC, an existing portfolio company.

On February 8, 2019, the Company invested $12,250,000 in the first lien term loan of Exacta Land Surveyors LLC, a provider of land surveys and field management services used to facilitate the purchasing, selling, and development of residential real estate in the U.S. Additionally, the Company committed $1,500,000 in the unfunded revolver, $4,000,000 million in the unfunded delayed draw term loan, and the Company invested $904,250 in the equity of the company.

On February 15, 2019, the Company received $52,562 in full realization on the equity of Glori Energy Production, LLC.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2018

NOTE 14 — SUBSEQUENT EVENTS  – (continued)

On February 28, 2019, the Company invested $1,428,571 in the first lien term loan of Convergence Technologies, Inc., an existing portfolio company. Additionally, we funded $5.4 million under the existing delayed draw term loan and an additional $54,614 in the equity of the company.

Credit Facility

The outstanding balance under the Credit Facility as of March 4, 2019 was $112,800,000.

SBA-guaranteed Debentures

The total balance of SBA-guaranteed debentures outstanding as of March 4, 2019 was $150,000,000.

Dividend Declared

On January 11, 2019, the Company’s board of directors declared a regular monthly dividend for each of January, February and March 2019 as follows:

       
Declared   Ex-Dividend
Date
  Record
Date
  Payment
Date
  Amount per Share
1/11/2019     1/30/2019       1/31/2019       2/15/2019     $ 0.1133  
1/11/2019     2/27/2019       2/28/2019       3/15/2019     $ 0.1133  
1/11/2019     3/28/2019       3/29/2019       4/15/2019     $ 0.1133  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
Consolidated Schedule of Investments in and Advances to Affiliates
December 31, 2018
(dollars in thousands)

This schedule should be read in conjunction with Stellus’s consolidated financial statements, including the consolidated schedule of investments and notes to the consolidated financial statements.

               
               
Company   Investment(1)   December 31,
2017
Fair Value
  Amount of
Realized
Gain/(Loss)
  Amount of
Unrealized
Gain/(Loss)
  Amount of
Interest,
Fees or
Dividends
Credit to
Income(2)
  Gross
Additions(3)
  Gross
Reductions(4)
  December 31,
2018
Fair Value
Non-control Investments
                                                                       
Affiliate investments
                                                                       
Glori Energy Production Inc.     Class A Common
Units
    $ 990     $   —     $ 60     $   —     $   —     $ (1,000 )    $ 50  
Total Non-Control/Affiliate investments         $ 990     $     $ 60     $     $     $ (1,000 )    $ 50  

(1) The principal amount and ownership detail for equity investments is included in the consolidated schedule of investments.
(2) Represents the total amount of interest, fees and dividends credited to income for the portion of the period for which an investment was included in Control or Affiliate categories, respectively. For investments transferred between Control and Affiliate categories during the period, any income or investment balances related to the time period it was in the category other than the one shown at period end is included in “Amounts from investments transferred from other 1940 Act classifications during the period.”
(3) Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on investments and accrued PIK interest, and the exchange of one or more existing securities for one or more new securities. Gross additions also include the movement of an existing portfolio company into this category and out of a different category.
(4) Gross reductions include decreases in the cost basis of investments resulting from principal repayments or sales and the exchange of one or more existing securities for one or more new securities. Gross reductions also include the movement of an existing portfolio company out of this category and into a different category. During the year ended December 31, 2018, all gross reductions on our affiliated investment were repayments of our investment.

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PROSPECTUS

Stellus Capital Investment Corporation

Common Stock
Preferred Stock
Subscription Rights
Debt Securities
Warrants

We may offer, from time to time in one or more offerings, up to $200,000,000 of our common stock, preferred stock, subscription rights, debt securities or warrants to purchase common stock, preferred stock or debt securities, which we refer to, collectively, as the “securities.” There is $102,383,451 of securities available for issuance under this prospectus as a result of our issuance of $48,875,000 in aggregate principal amount of 5.75% notes in August 2017, $44,591,250 of shares of our common stock in April 2016 and $4,150,299 of shares of common stock through an at-the-market sales program during 2017. Our securities may be offered at prices and on terms to be disclosed in one or more supplements to this prospectus. You should read this prospectus and the applicable prospectus supplement carefully before you invest in our securities.

Our securities may be offered directly to one or more purchasers through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to the offering will identify any agents or underwriters involved in the sale of our securities, and will disclose any applicable purchase price, fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “Plan of Distribution.” We may not sell any of our securities through agents, underwriters or dealers without delivery of a prospectus supplement describing the method and terms of the offering of such securities.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended, or the 1940 Act. Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating below investment grade (i.e., below BBB or Baa), which are often referred to as “junk.”

On June 25, 2018, the last reported sale price of our common stock on the New York Stock Exchange was $13.22. We are required to determine the net asset value per share of our common stock on a quarterly basis. On March 31, 2018, our net asset value per share was $13.93.

Shares of closed-end investment companies, including business development companies, frequently trade at a discount to their net asset value. If our shares trade at a discount to our net asset value, it will likely increase the risk of loss for purchasers in this offering. We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below then-current net asset value per share of our common stock if our board of directors determines that such sale is in our best interests, and if our stockholders approve such sale. At our 2017 annual meeting of stockholders, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one-year anniversary of the date of the Company’s 2017 Annual Meeting of Stockholders and the date of the Company’s 2018 Annual Meeting of Stockholders. The proposal approved by our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. We are seeking similar approval at our 2018 Annual Meeting of Stockholders, scheduled for June 28, 2018. We cannot issue shares of our common stock below net asset value unless our board of directors determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In addition, continuous sales of common stock below net asset value may have a negative impact on total returns and could have a negative impact on the market price of our shares of common stock. See “Sales of Common Stock Below Net Asset Value.”

Investing in our common stock involves a high degree of risk. Before buying any shares, you should read the discussion of the material risks of investing in our common stock in “Risk Factors” beginning on page 17 of this prospectus.

This prospectus and the accompanying prospectus supplement contain important information you should know before investing in our common stock. Please read this prospectus and the accompanying prospectus supplement before you invest and keep it for future reference. We file annual, quarterly and current reports, proxy statements and other information about us with the Securities and Exchange Commission, or SEC. The SEC also maintains a website at http://www.sec.gov that contains such information. This information is also available free of charge by contacting us at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, Attention: Investor Relations, or by calling us collect at (713) 292-5400 or on our website at www.stelluscapital.com (under the Public Investors section). Information contained on our website is not incorporated by reference into this prospectus, and you should not consider that information to be part of this prospectus or the accompanying prospectus supplement.

The Securities and Exchange Commission has not approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

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PROSPECTUS SUMMARY     1  
THE OFFERING     9  
FEES AND EXPENSES     13  
SELECTED FINANCIAL DATA     16  
RISK FACTORS     17  
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS     47  
USE OF PROCEEDS     48  
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS     49  
RATIOS OF EARNINGS TO FIXED CHARGES     52  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     53  
SENIOR SECURITIES     71  
THE COMPANY     73  
PORTFOLIO COMPANIES     86  
MANAGEMENT     96  
MANAGEMENT AGREEMENTS     105  
RELATED PARTY TRANSACTIONS AND CERTAIN RELATIONSHIPS     115  
CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS     117  
DETERMINATION OF NET ASSET VALUE     119  
SALES OF COMMON STOCK BELOW NET ASSET VALUE     122  
DIVIDEND REINVESTMENT PLAN     127  
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS     129  
DESCRIPTION OF OUR COMMON STOCK     136  
DESCRIPTION OF OUR PREFERRED STOCK     142  
DESCRIPTION OF OUR SUBSCRIPTION RIGHTS     143  
DESCRIPTION OF OUR DEBT SECURITIES     145  
DESCRIPTION OF OUR WARRANTS     158  
REGULATION     160  
PLAN OF DISTRIBUTION     165  
CUSTODIAN, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR     166  
BROKERAGE ALLOCATION AND OTHER PRACTICES     166  
LEGAL MATTERS     166  
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM     167  
AVAILABLE INFORMATION     167  
INDEX TO FINANCIAL STATEMENTS     F-1  

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ABOUT THIS PROSPECTUS

This prospectus is part of a registration statement that we have filed with the SEC using the “shelf” registration process. Under the shelf registration process, we may offer, from time to time, up to $200,000,000 of our securities on terms to be determined at the time of the offering. This prospectus provides you with a general description of the securities that we may offer. Each time we use this prospectus to offer securities, we will provide a prospectus supplement that will contain specific information about the terms of that offering. The prospectus supplement may also add, update or change information contained in this prospectus. Please carefully read this prospectus and any accompanying prospectus supplement together with the additional information described under “Risk Factors” and “Available Information” before you make an investment decision.

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus or any accompanying supplement to this prospectus. You must not rely on any unauthorized information or representations not contained in this prospectus or any accompanying prospectus supplement as if we had authorized it. This prospectus and any accompanying prospectus supplement do not constitute an offer to sell or a solicitation of any offer to buy any security other than the registered securities to which they relate, nor do they constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such an offer or solicitation in such jurisdiction. The information contained in this prospectus and any accompanying prospectus supplement is accurate as of the dates on their covers. Our financial condition, results of operations and prospects may have changed since that date. To the extent required by law, we will amend or supplement the information contained in this prospectus and any accompanying prospectus supplement to reflect any material changes to such information subsequent to the date of the prospectus and any accompanying prospectus supplement and prior to the completion of any offering pursuant to the prospectus and any accompanying prospectus supplement.

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PROSPECTUS SUMMARY

This summary highlights some of the information in this prospectus. It is not complete and may not contain all of the information that you may want to consider. You should read the more detailed information set forth under “Risk Factors” and the other information included in this prospectus and any prospectus supplement carefully.

Except as otherwise indicated, the terms “we,” “us,” “our,” and the “Company” refer to Stellus Capital Investment Corporation; and “Stellus Capital Management” refers to our investment adviser and administrator, Stellus Capital Management, LLC.

Stellus Capital Investment Corporation

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company, or “BDC”, under the Investment Company Act of 1940, or the “1940 Act.” We originate and invest primarily in private middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, with corresponding equity co-investments. Unitranche debt is typically structured as first lien loans with certain risk characteristics of mezzanine debt. Mezzanine debt includes senior unsecured and subordinated loans.

Our investment activities are managed by our investment adviser, Stellus Capital Management, an investment advisory firm led by Robert T. Ladd and its other senior investment professionals. We source investments primarily through the extensive network of relationships that the senior investment professionals of Stellus Capital Management have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating which is often referred to as “junk.”

Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation. We seek to achieve our investment objective by:

accessing the extensive origination channels that have been developed and established by the Stellus Capital Management investment professionals that include long-standing relationships with private equity firms, commercial banks, investment banks and other financial services firms;
investing in what we believe to be companies with strong business fundamentals, generally within our core middle-market company focus;
focusing on a variety of industry sectors, including business services, energy, general industrial, government services, healthcare, software and specialty finance;
focusing primarily on directly originated transactions;
applying the disciplined underwriting standards that the Stellus Capital Management investment professionals have developed over their extensive investing careers; and
capitalizing upon the experience and resources of the Stellus Capital Management investment team to monitor our investments.

In addition, we received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We intend to co-invest, subject to the conditions included in the exemptive order we received from

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the SEC, with private credit funds managed by Stellus Capital Management that have an investment strategy that is identical to our investment strategy. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

As a BDC, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to continue to, finance our investments through borrowings.

Prior to March 23, 2018, Section 61(a) of the 1940 Act (which incorporates the requirements of Sections 18(a)(1) and 18(a)(2) of the 1940 Act) did not permit a BDC to issue senior securities unless, at the time of issuance, the BDC had an asset coverage ratio of at least 200%, taking into account that issuance of senior securities (the “Asset Coverage Ratio”). However, on March 23, 2018, the Small Business Credit Availability Act (the “SBCA”) was signed into law by the President. The SBCA, among other things, permits BDCs to be subject to a minimum Asset Coverage Ratio of 150% (the “150% Asset Coverage”), if specific conditions are satisfied, when issuing senior securities. In other words, prior to the enactment of the SBCA, a BDC could borrow $1 for investment purposes for every $1 of investor equity. Now, for those BDCs that satisfy the Act’s approval and disclosure requirements, the BDC can borrow $2 for investment purposes for every $1 of investor equity.

The SBCA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% Asset Coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal, which would become effective one year after the date of such approval (the “Board Effective Date”), or (ii) obtain stockholder approval (of more than 50% of the votes cast for the proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.

On April 4, 2018, our board of directors (the “Board”), including a majority of the non-interested directors who have no financial interest in this proposal, deemed it in the best interests of the Company and its stockholders for the Company to be subject to 150% Asset Coverage. Our Board believes that having the flexibility for the Company to incur additional leverage in certain instances is in the best interests of stockholders. In connection with this determination, our Board approved a resolution permitting the Company to be subject to 150% Asset Coverage, to be effective on the Board Effective Date, or April 4, 2019. This approval will allow us to incur twice as much debt as we could have without such approval after the 150% Asset Coverage becomes effective.

In addition, the Board also approved and recommended that stockholders vote “for” a proposal to authorize the Company to be subject to 150% Asset Coverage at our 2018 Annual Meeting, scheduled for June 28, 2018. If our stockholders approve this proposal, the reduced Asset Coverage Ratio would be effective the day after the 2018 Annual Meeting. Because we have received Board approval, if the proposal does not receive approval of the majority of the votes cast at the meeting, we will be subject to the reduced Asset Coverage Ratio beginning on April 4, 2019.

The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of our securities and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowings. For more information about the expected amount of and costs associated with our borrowings, see “Fees and Expenses” in this prospectus.

We have elected and qualified to be treated for federal income tax purposes as a regulated investment company, or “RIC,” under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders as dividends if we meet certain source-of-income, distribution and asset diversification requirements.

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SBIC License

Our wholly owned subsidiary holds a license to operate as a small business investment company, or SBIC. Our wholly-owned SBIC subsidiary’s SBIC license allows it to obtain leverage by issuing SBA-guaranteed debentures up to a maximum of $150 million under current SBIC regulations, subject to required capitalization of the SBIC subsidiary and other requirements. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. We believe that the SBA-guaranteed debentures are an attractive source of debt capital.

We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the asset coverage ratio we are required to maintain under the 1940 Act. This exemptive relief allows us increased flexibility under the asset coverage test by allowing us to borrow up to $150.0 million more than we would otherwise be able to borrow absent the receipt of this exemptive relief based on regulatory capital of $75.0 million at March 31, 2018.

Portfolio Composition

Our investments generally range in size from $5.0 million to $30.0 million, and we may also selectively invest in larger positions. We generally expect that the size of our positions will increase in proportion to the size of our capital base. Pending such investments, we may reduce our outstanding indebtedness or invest in cash, cash equivalents, U.S. government securities and other high-quality debt investments with a maturity of one year or less. In the future, we may adjust opportunistically the percentage of our assets held in various types of loans, our principal loan sources and the industries to which we have greatest exposure, based on market conditions, the credit cycle, available financing and our desired risk/return profile.

The following table provides a summary of our portfolio investments as of March 31, 2018:

 
  As of
March 31,
2018
($ in millions)
Number of investments     52  
Fair value(a)   $ 431.3  
Cost   $ 426.4  
% of portfolio at fair value – first lien debt(c)     46.2 % 
% of portfolio at fair value – second lien debt     41.2 % 
% of portfolio at fair value – mezzanine debt     6.2 % 
% of portfolio at fair value – equity     6.4 % 
Weighted-average annual yield(b)     11.1 % 

(a) As of March 31, 2018, $383.9 million of our debt investments at fair value were at floating interest rates, which represented approximately 89% of our total portfolio of debt investments at fair value. As of March 31, 2018, $47.4 million of our debt investments at fair value were at fixed interest rates, which represented approximately 11% of our total portfolio of debt investments at fair value.
(b) The weighted average yield on all of our debt investments as of March 31, 2018, was approximately 11.1%, of which approximately 10.3% was current cash interest. The weighted average yield of our debt investments on accrual is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investments, which represents the interest rate on our debt investment restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as including accretion of original issue discount. There can be no assurance that the weighted average yield will remain at their current level.
(c) Includes unitranche investments, which account for 16.1% of our investment portfolio at fair value.

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Leverage

Credit Facility.   We have entered into a senior secured revolving credit agreement, dated as of October 10, 2017, with ZB, N.A., dba Amegy Bank and various other leaders (the “Credit Facility”). The Credit Facility provides for borrowings up to a maximum of $140.0 million on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to 195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. We pay unused commitment fees of 0.50% per annum on the unused lender commitments. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 1, 2021. Our obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. As of March 31, 2018, we had approximately $118.3 million outstanding under the Credit Facility.

5.75% Notes.  On August 21, 2017, we issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due 2022 (the “2022 Notes”) and issued an additional $6.4 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. As of March 31, 2018, we had $48.9 million of 2022 Notes outstanding.

SBA-guaranteed Debentures.  Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. As of March 31, 2018, the SBIC subsidiary had $90.0 million of SBA-guaranteed debentures outstanding.

Stellus Capital Management

Stellus Capital Management manages our investment activities and is responsible for analyzing investment opportunities, conducting research and performing due diligence on potential investments, negotiating and structuring our investments, originating prospective investments and monitoring our investments and portfolio companies on an ongoing basis.

The senior investment professionals of Stellus Capital Management have an average of over 28 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing loans and debt securities through market cycles. The Stellus Capital Management investment professionals continue to provide investment sub-advisory services to D. E. Shaw & Co., L.P. and its associated investment funds (the “D. E. Shaw group”) with respect to an approximately $90.0 million investment portfolio (as of March 31, 2018) in middle-market companies pursuant to sub-advisory arrangements.

In addition to serving as our investment adviser and the sub-advisor to the D. E. Shaw group as noted above, Stellus Capital Management currently manages a private credit fund that has an investment strategy that is identical to our investment strategy and energy private equity funds. We received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management (other than the D. E. Shaw group funds) where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification. We will not co-invest with the energy private equity funds, as the energy private equity funds focus on predominantly equity-related investments, and we focus on predominantly credit-related investments.

Stellus Capital Management is headquartered in Houston, Texas, and also maintains offices in the Washington, D.C. area and Charlotte, North Carolina.

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Market Opportunity

We originate and invest primarily in private middle-market companies through first lien, second lien, unitranche and mezzanine debt financing, with a corresponding equity co-investment. We believe the environment for investing in middle-market companies is attractive for several reasons, including:

Robust Demand for Debt Capital.  We believe that private equity firms have significant committed but uncalled capital, a large portion of which is still available for investment in the United States. We expect the large amount of uninvested capital commitments will drive buyout activity over the next several years, which should, in turn, create lending opportunities for us. In addition to increased buyout activity, a high volume of senior secured and high yield debt was originated in the calendar years 2011 through 2013 and will come due in the near term and, accordingly, we believe that new financing opportunities will increase as many companies seek to refinance this indebtedness.

Reduced Availability of Capital for Middle-Market Companies.  We believe there are fewer providers of, and less capital available for financing to middle-market companies, as compared to the time period prior to the economic downturn that began in December 2007. We believe that, as a result of that downturn, many financing providers have chosen to focus on large, liquid corporate loans and managing capital markets transactions rather than lending to middle-market businesses. In addition, we believe regulatory changes, including the adoption of the Dodd-Frank Act and the introduction of the international capital and liquidity requirements under the Basel III Accords, or “Basel III,” have caused banks to curtail their lending to middle-market-companies. As a result, we believe that less competition will facilitate higher quality deal flow and allow for greater selectivity throughout the investment process.

Attractive Deal Pricing and Structures.  We believe that the pricing of middle-market debt investments is higher, and the terms of such investments are more conservative, compared to larger liquid, public debt financings, due to the more limited universe of lenders as well as the highly negotiated nature of these financings. These transactions tend to offer stronger covenant packages, higher interest rates, lower leverage levels and better call protection compared to larger financings. In addition, middle-market loans typically offer other investor protections such as default penalties, lien protection, change of control provisions and information rights for lenders.

Specialized Lending Requirements.  Lending to middle-market companies requires in-depth diligence, credit expertise, restructuring experience and active portfolio management. We believe that several factors render many U.S. financial institutions ill-suited to lend to middle-market companies. For example, based on the experience of Stellus Capital Management’s investment professionals, lending to middle-market companies in the United States (a) is generally more labor intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of the information available with respect to such companies, (b) requires specialized due diligence and underwriting capabilities, and (c) may also require more extensive ongoing monitoring by the lender. We believe that, through Stellus Capital Management, we have the experience and expertise to meet these specialized lending requirements.

Competitive Strengths

We believe that the following competitive strengths will allow us to achieve positive returns for our investors:

Experienced Investment Team.  Through our investment adviser, Stellus Capital Management, we have access to the experience and expertise of the Stellus Capital Management investment professionals, including its senior investment professionals who have an average of over 28 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing loans and debt securities through market cycles. We believe the members of Stellus Capital Management’s investment professionals are proven and experienced, with extensive capabilities in leveraged credit investing, having participated in these markets for the predominant portion of their careers. We believe that the experience and demonstrated ability of the Stellus Capital Management investment team to complete transactions enhances the quantity and quality of investment opportunities available to us.

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Established, Rigorous Investment and Monitoring Process.  The Stellus Capital Management investment professionals have developed an extensive review and credit analysis process. Each investment that is reviewed by Stellus Capital Management is brought through a structured, multi-stage approval process. In addition, Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management. Stellus Capital Management’s investment and monitoring process and the depth and experience of its investment professionals should allow it to conduct the type of due diligence and monitoring that enables it to identify and evaluate risks and opportunities.

Demonstrated Ability to Structure Investments Creatively.  Stellus Capital Management has the expertise and ability to structure investments across all levels of a company’s capital structure. Furthermore, we believe that current market conditions will allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, payment-in-kind, or “PIK,” interest or some form of equity securities.

Resources of Stellus Capital Management Platform.  We have access to the resources and capabilities of Stellus Capital Management, which has 17 investment professionals, including Robert T. Ladd, Dean D’Angelo, Joshua T. Davis and Todd A. Overbergen, who are supported by six managing directors, two principals, two vice presidents and three analysts. These individuals have developed long-term relationships with middle-market companies, management teams, financial sponsors, lending institutions and deal intermediaries by providing flexible financing throughout the capital structure. We believe that these relationships provide us with a competitive advantage in identifying investment opportunities in our target market. We also expect to benefit from Stellus Capital Management’s due diligence, credit analysis, origination and transaction execution experience and capabilities, including the support provided with respect to those functions by Mr. Huskinson, who serves as our chief financial officer and chief compliance officer, and his staff of eight finance and operations professionals.

Risk Factors

An investment in our securities is subject to risks. The following is a summary of the principal risks that you should carefully consider before investing in our securities. In addition, see “Risk Factors” beginning on page 17 of this prospectus to read about factors you should consider before deciding to invest in our securities.

We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.
Our business model depends to a significant extent upon strong referral relationships. Any inability of Stellus Capital Management to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
Our financial condition, results of operations and cash flows will depend on our ability to manage our business effectively.
There are significant potential conflicts of interest that could negatively affect our investment returns.
The incentive fee structure we have with Stellus Capital Management may create incentives that are not fully aligned with the interests of our stockholders.
We will be subject to corporate-level income tax and may default under our revolving credit facility with various lenders (the “Credit Facility”) if we are unable to maintain our qualification as a RIC under Subchapter M of the Code.
Regulations governing our operation as a BDC affect our ability to and the way in which we raise additional capital and, as a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.
Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.

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Because we use debt to finance our investments, changes in interest rates will affect our cost of capital and net investment income.
Adverse developments in the credit markets may impair our ability to borrow money.
Most of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.
Our ability to enter into transactions with our affiliates will be restricted, which may limit the scope of investments available to us.
The involvement of our interested directors in the valuation process may create conflicts of interest.
There are conflicts related to other arrangements with Stellus Capital Management.
If we fail to maintain our status as a BDC, our business and operating flexibility could be significantly reduced.
Because we have received Board approval, and have submitted a proposal to a stockholder vote at our 2018 Annual Meeting, we will be subject to 150% Asset Coverage beginning on April 4, 2019 or following our 2018 Annual Meeting if we receive stockholder approval. This approval will allow us to incur twice as much debt as we could have without such approval, potentially heightening the risks associated with leverage described above.
The effect of global climate change may impact the operations of our portfolio companies.
Existing stockholders may incur dilution if, in the future, we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock.

Conflicts of Interests

We may have conflicts of interest arising out of the investment advisory activities of Stellus Capital Management, including those described below.

Our investment strategy includes investments in secured debt (including first lien, second lien and unitranche) and mezzanine debt (including senior unsecured and subordinated debt), as well as related equity securities of private middle-market companies. Stellus Capital Management also manages, and in the future may manage, other investment funds, accounts or investment vehicles that invest or may invest in assets eligible for purchase by us. For example, Stellus Capital Management currently manages private credit funds that have an investment strategy that is identical to our investment strategy. Stellus Capital Management also provides non-discretionary advisory services to the D. E. Shaw group, pursuant to sub-advisory arrangements, with respect to a private investment fund and a strategy of a private multi-strategy investment fund (collectively with the D. E. Shaw group fund, the “D. E. Shaw group funds”) to which the D. E. Shaw group serves as investment adviser that have an investment strategy similar to our investment strategy. Our investment policies, fee arrangements and other circumstances may vary from those of other investment funds, accounts or investment vehicles managed by Stellus Capital Management.

We have received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management (other than the D. E. Shaw group funds), where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We intend to co-invest, subject to the conditions included in the exemptive order we received from the SEC, with the private credit funds managed by Stellus Capital

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Management that have an investment strategy that is identical to our investment strategy. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

In the course of our investing activities, we pay management and incentive fees to Stellus Capital Management. We have entered into an investment advisory agreement with Stellus Capital Management that provides that these fees are based on the value of our gross assets. Because these fees are based on the value of our gross assets, Stellus Capital Management will benefit when we incur debt or use leverage. This fee structure may encourage Stellus Capital Management to cause us to borrow money to finance additional investments. Our board of directors is charged with protecting our interests by monitoring how Stellus Capital Management addresses these and other conflicts of interests associated with its management services and compensation. While our board of directors is not expected to review or approve each investment decision, borrowing or incurrence of leverage, our independent directors will periodically review Stellus Capital Management’s services and fees as well as its portfolio management decisions and portfolio performance. See “Risk Factors — The incentive fee structure we have with Stellus Capital Management may create incentives that are not fully aligned with the interests of our stockholders.”

Stellus Capital Management may from time to time incur expenses in connection with investments to be made on our behalf and on behalf of other investment funds, accounts and investment vehicles managed by Stellus Capital Management. Stellus Capital Management will allocate such expenses on a pro rata basis according to the participation in a transaction, subject to oversight by our board of directors.

Corporate Information

Our principal executive offices are located at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, and our telephone number is (713) 292-5400. We maintain a website located at www.stelluscapital.com (under the Public Investors section). Information on our website is not incorporated into or a part of this prospectus or any accompanying prospectus supplement and you should not consider information on our website to be part of this prospectus or any accompanying prospectus.

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THE OFFERING

We may offer, from time to time, up to $200,000,000 of our securities, on terms to be determined at the time of the offering. Our securities may be offered at prices and on terms to be disclosed in one or more prospectus supplements.

Our securities may be offered directly to one or more purchasers by us or through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to the offering will disclose the terms of the offering, including the name or names of any agents or underwriters involved in the sale of our securities by us, the purchase price, and any fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “Plan of Distribution.” We may not sell any of our securities directly or through agents, underwriters or dealers without delivery of a prospectus supplement describing the method and terms of the offering of our securities.

Set forth below is additional information regarding the offering of our securities:

Use of Proceeds    
    We plan to use the net proceeds of this offering to make new investments in portfolio companies in accordance with our investment objective and strategies as described in this prospectus and for general working capital purposes. We may also use a portion of the net proceeds to reduce any of our outstanding borrowings. Pending such use, we will invest the net proceeds primarily in high quality, short-term debt securities consistent with our BDC election and our election to be taxed as a RIC. See “Use of Proceeds.”
Investment Advisory Agreement    
    We will pay Stellus Capital Management a fee for its services under the investment advisory agreement. This fee consists of two components: a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 1.75% of our gross assets, including assets purchased with borrowed funds or other forms of leverage (including preferred stock, public and private debt issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and excluding cash and cash equivalents. The base management fee will be payable quarterly in arrears.
   
    The incentive fee, which provides Stellus Capital Management with a share of the income that it generates for us, consists of two parts. The first part, which is calculated and payable quarterly in arrears, equals 20.0% of our “pre-incentive fee net investment income” for the immediately preceding quarter, subject to a hurdle rate of 2.0% per quarter for the benefit of Stellus Capital Management, and is subject to a “catch-up” feature for the benefit of Stellus Capital Management. The second part is calculated and payable in arrears as of the end of each calendar year (or, upon termination of the investment advisory agreement, as of the termination date) and equals 20.0% of our aggregate cumulative realized capital gains from inception through the end of each calendar year, computed net of aggregate cumulative realized capital losses and aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid capital gain incentive fees. See “Management Agreements — Management Fee and Incentive Fee.”

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    Pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under our administration agreement, and any interest expense and any distributions paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, or OID, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. However, the portion of such incentive fee that is attributable to deferred interest (such as PIK interest or OID) will be paid to Stellus Capital Management, together with interest thereon from the date of deferral to the date of payment, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Stellus Capital Management has agreed to permanently waive any interest accrued on the portion of the incentive fee attributable to deferred interest (such as PIK interest or OID).
New York Stock Exchange symbol    
    “SCM” (common stock)
“SCA” (5.75% notes due 2022)
Trading at a discount    
    Shares of closed-end investment companies, including business development companies, frequently trade in the secondary market at a discount to their net asset values. The risk that our shares may trade at a discount to our net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our shares will trade above, at or below net asset value. See “Risk Factors — Shares of closed-end investment companies, including business development companies, frequently trade at a discount from their net asset value.”
Leverage    
    We expect to continue to use leverage to make investments. As a result, we may continue to be exposed to the risks of leverage, which include that leverage may be considered a speculative investment technique. The use of leverage magnifies the potential for gain and loss on amounts we invest and therefore, indirectly, increases the risks associated with investing in shares of our common stock. See “Risk Factors.”
    Our current borrowings include:
   

•  

our 2022 Notes, of which $48.9 million were outstanding as of March 31, 2018;

   

•  

our Credit Facility, of which $118.3 million was outstanding as of March 31, 2018; and

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•  

our SBA-Guaranteed debentures, of which $90.0 million were outstanding as of March 31, 2018.

Distributions    
    We generally intend to pay monthly distributions to our stockholders out of assets legally available for distribution. Our monthly distributions, if any, will be determined by our board of directors.
Taxation    
    We have elected to be treated for U.S. federal income tax purposes as a RIC. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders as dividends. To maintain our qualification as a RIC and the associated tax benefits, we must meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our net ordinary income and net short-term capital gains, if any, in excess of our net long-term capital losses. See “Distributions.”
Dividend reinvestment plan    
    We have adopted a dividend reinvestment plan for our stockholders, which is an “opt out” dividend reinvestment plan. Under this plan, if we declare a cash distribution to our stockholders, the amount of such distribution will be automatically reinvested in additional shares of our common stock unless a stockholder specifically “opts out” of our dividend reinvestment plan. If a stockholder opts out, that stockholder will receive cash distributions. Stockholders who receive distributions in the form of shares of common stock generally will be subject to the same U.S. federal, state and local tax consequences as stockholders who elect to receive their distributions in cash, but will not receive any corresponding cash distributions with which to pay any applicable taxes. See “Dividend Reinvestment Plan.”
Administration Agreement    
    The administration agreement requires us to reimburse Stellus Capital Management for our allocable portion (subject to the review of our board of directors) of overhead and other expenses, including furnishing us with office facilities and equipment and providing clerical, bookkeeping, record keeping and other administrative services at such facilities, and our allocable portion of the cost of our chief financial officer and chief compliance officer and their respective staffs. To the extent that Stellus Capital Management outsources any of its functions, we will pay the fees associated with such functions on a direct basis, without incremental profit to Stellus Capital Management. See “Management Agreements — Administration Agreement.”
License arrangements    
    We have entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has granted us a non-exclusive, royalty-free license to use the name “Stellus Capital.” For a description of the license agreement, see “Management Agreements — License Agreement.”

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Custodian and transfer agent    
    ZB, N.A., dba Amegy Bank, serves as our custodian and our transfer and distribution paying agent and registrar. See “Custodian, Transfer and Dividend Paying Agent and Registrar.”
Anti-takeover provisions    
    Our charter and bylaws, as well as certain statutory and regulatory requirements, contain certain provisions that may have the effect of discouraging a third party from making an acquisition proposal for us. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price for our common stock. See “Description of Capital Stock.”
Available information    
    We are required to file periodic reports, proxy statements and other information with the SEC. This information is available at the SEC’s public reference room at 100 F. Street, N.E., Washington, D.C. 20549 and on the SEC’s website at http://www.sec.gov. Information on the operation of the SEC’s public reference room may be obtained by calling the SEC at 1-800-SEC-0330.
   
    We maintain a website at www.stelluscapital.com (under the Public Investors section) and make all of our annual, quarterly and current reports, proxy statements and other information available, free of charge, on or through our website. Information on our website is not incorporated into or part of this prospectus or any prospectus supplement and should not be relied upon as such. You may also obtain such information free of charge by contacting us in writing at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, Attention: Investor Relations.

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FEES AND EXPENSES

The following table is intended to assist you in understanding the costs and expenses that an investor in our common stock will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Moreover, the information set forth below does not include any transaction costs and expenses that investors will incur in connection with each offering of our securities pursuant to this prospectus. As a result, investors are urged to read the “Fees and Expenses” table contained in any corresponding prospectus supplement to fully understand the actual transaction costs and expenses they will incur in connection with each such offering. Except where the context suggests otherwise, whenever this prospectus contains a reference to fees or expenses paid by “us” or that “we” will pay fees or expenses, common stockholders will indirectly bear such fees or expenses.

 
Stockholder Transaction Expenses:
        
Sales load (as a percentage of offering price)     %(1) 
Offering expenses (as a percentage of offering price)     %(2) 
Dividend reinvestment plan expenses     (3) 
Total Stockholder Transaction Expenses (as a percentage of offering price)     %(4) 
Annual Expenses (as percentage of net assets attributable to common stock):
        
Base management fees     3.15 %(5) 
Incentive fees payable under the investment advisory agreement     1.74 %(6) 
Interest payments on borrowed funds     5.46 %(7) 
Other expenses     2.78 %(8) 
Total annual expenses     13.13 % 

(1) In the event that our securities are sold to or through underwriters, a corresponding prospectus supplement will disclose the applicable sales load.
(2) In the event that we conduct an offering of our securities, a corresponding prospectus supplement will disclose the estimated offering expenses. Our common stockholders will bear, directly or indirectly, the expenses of any offering of our securities, including debt securities.
(3) The expenses of the dividend reinvestment plan are included in “Other expenses.” See “Dividend Reinvestment Plan.”
(4) Total stockholder transaction expenses may include sales load and will be disclosed in a future prospectus supplement, if any.
(5) Our base management fee, payable quarterly in arrears, is 1.75% of our gross assets, including assets purchased with borrowed amounts or other forms of leverage (including traditional and effective leverage such as preferred stock, public and private debt issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and excluding cash and cash equivalents and is based on the base management fee incurred for the three months ended March 31, 2018 annualized for a full year.
(6) This item represents the incentive fee payable to Stellus Capital Management based on the actual amounts earned on our “pre-incentive fee net investment income” for the three months ended March 31, 2018 annualized for a full year.

The incentive fee consists of two components, ordinary income and capital gains:

The ordinary income component, which is payable quarterly in arrears, equals 20.0% of the excess, if any, of our “pre-incentive fee net investment income” over a 2.0% quarterly hurdle rate, expressed as a rate of return on the value of our net assets attributable to our common stock, and a “catch-up” provision, measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, our investment adviser receives no incentive fee until our net investment income equals the hurdle rate of 2.0% but then receives, as a “catch-up,” 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5% subject to a total return requirement and deferral of non-cash amounts. The effect of the “catch-up” provision is that, subject to the total return and deferral provisions discussed below, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, Stellus Capital

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Management will receive 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. The ordinary income component of the incentive fee is computed on income that may include interest that is accrued but not yet received in cash. The foregoing ordinary income component of the incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations (as defined below) over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter will be limited to the lesser of (i) 20.0% of the amount by which our pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20.0% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding calendar quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters.

For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the portion of such incentive fee that is attributable to deferred interest (sometimes referred to as payment-in-kind interest, or PIK, or original issue discount, or OID) will be paid to Stellus Capital Management, together with interest thereon from the date of deferral to the date of payment, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such accounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possibly elimination of the incentive fees for such quarter. There is no accumulation of amounts on the hurdle rate from quarter to quarter, and accordingly, there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle, and there is no delay of payment if prior quarters are below the quarterly hurdle.

The capital gains component of the incentive fee equals 20.0% of our “Incentive Fee Capital Gains,” if any, which equals our aggregate cumulative realized capital gains from inception through the end of each calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation, less the aggregate amount of any previously paid capital gain incentive fees. The second component of the incentive fee is payable, in arrears, at the end of each calendar year (or upon termination of the investment advisory agreement, as of the termination date). We will record an expense accrual relating to the capital gains component of the incentive fee payable by us to Stellus Capital Management when the unrealized gains on our investments exceed all realized capital losses on our investments given the fact that a capital gains incentive fee would be owed to Stellus Capital Management if we were to liquidate our investment portfolio at such time. The actual incentive fee payable to our investment adviser related to capital gains is determined and payable in arrears at the end of each fiscal year and includes only realized capital gains for the period. See “Management Agreements — Management Fee and Incentive Fee.”

(7) Interest payments on borrowed funds represent our estimated annual interest payments based on the effective interest rate of borrowings under our Credit Facility, the SBA-guaranteed debentures and the 2022 Notes as of March 31, 2018, and assuming that we increase our borrowings to the following levels over the next twelve months: $150.0 million outstanding under the Credit Facility, $117.0 million of Notes outstanding and $150.0 million in SBA-guranteed debentures. Interest expense is calculated based upon the amounts outstanding on our Credit Facility bearing interest at a weighted average interest rate of 4.4%, amounts outstanding on our notes payable at an interest rate of 5.75% and our SBA-guaranteed debentures bearing interest at a weighted average interest rate of 2.9%, each as of March 31, 2018. Non-use commitment fees of 0.50% related to our Credit Facility is based upon unused commitments as of March 31, 2018. The amount of leverage that we employ, and our interest expenses on such leverage, at any particular time will depend on, among other things, our board of directors’ assessment of market and other factors at the time of any proposed borrowing.

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(8) Includes our overhead expenses, including payments under the administration agreement based on our allocable portion of overhead and other expenses incurred by Stellus Capital Management. See “Management Agreements — Administration Agreement.”

Example

The following example demonstrates the projected dollar amount of total cumulative expenses over various periods with respect to a hypothetical investment in us. In calculating the following expense amounts, we have assumed that our annual operating expenses would remain at the levels set forth in the table above. The examples assume no sales load. In the event that shares to which this prospectus relates are sold to or through underwriters, a corresponding prospectus supplement will restate this example to reflect the applicable sales load.

       
  1 Year   3 Years   5 Years   10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return (none of which is subject to a capital gains incentive fee)   $ 110     $ 310     $ 485     $ 833  

While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%. The incentive fee under the investment management agreement, which, assuming a 5% annual return, would either not be payable or would have a de minimis effect, is not included in the example. If we achieve sufficient returns on our investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, our expenses, and returns to our investors, would be higher. For example, if we assumed that we received our 5.0% annual return completely in the form of net realized capital gains on our investments, which results in a capital gains incentive fee earned, the projected dollar amount of total cumulative expenses set forth in the above illustration and the capital gains incentive fee would be as follows:

       
  1 Year   3 Years   5 Years   10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return (all of which is subject to capital gains incentive fee)   $ 126     $ 348     $ 536     $ 887  

While the examples assume reinvestment of all distributions at net asset value, participants in our dividend reinvestment plan will receive a number of shares of our common stock, determined by dividing the total dollar amount of the distribution payable to a participant by (a) 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our board of directors or (b) the average purchase price of all shares of common stock purchased by the administrator of the dividend reinvestment plan in the event shares are purchased in the open market to satisfy the share requirements of the dividend reinvestment plan, which may be at, above or below net asset value.

This example and the expenses in the table above should not be considered a representation of our future expenses, and actual expenses (including the cost of debt, if any, and other expenses) may be greater or less than those shown.

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SELECTED FINANCIAL DATA

The following selected financial data for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 was derived from our financial statements which have been audited by Grant Thornton, LLP, our independent registered public accounting firm and the selected financial data for the three months ended March 31, 2018 and 2017 is derived from our unaudited financial statements but, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) that are necessary to present fairly the financial condition and operating results for such interim periods. Interim results as of and for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. The data should be read in conjunction with our financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

             
Statement of Operations Data:   For the three
months ended
March 31,
2018
  For the three
months ended
March 31,
2017
  For the
year ended
December 31,
2017
  For the
year ended
December 31,
2016
  For the
year ended
December 31,
2015
  For the
year ended
December 31,
2014
  For the
year ended
December 31,
2013
Total investment income   $ 10,911,783     $ 9,863,980     $ 39,648,193     $ 39,490,197     $ 35,158,559     $ 32,324,847     $ 29,400,736  
Total expenses, net of fee waiver   $ 6,436,402     $ 5,720,353     $ 21,677,433     $ 22,177,996     $ 18,611,431     $ 15,812,750     $ 13,389,007  
Net investment income   $ 4,475,379     $ 4,143,627     $ 17,970,760     $ 17,312,201     $ 16,547,128     $ 16,512,097     $ 16,011,729  
Net increase in net assets resulting from operations   $ 7,343,929     $ 6,024,752     $ 22,613,257     $ 23,199,062     $ 7,670,536     $ 10,179,142     $ 17,544,997  
Per Share Data:
                                                              
Net asset value   $ 13.93     $ 13.84     $ 13.81     $ 13.69     $ 13.19     $ 13.94     $ 14.54  
Net investment income   $ 0.28     $ 0.33     $ 1.21     $ 1.39     $ 1.33     $ 1.34     $ 1.33  
Net increase in net assets resulting from operations   $ 0.46     $ 0.48     $ 1.52     $ 1.86     $ 0.61     $ 0.83     $ 1.45  
Distributions declared   $ 0.34     $ 0.34     $ 1.36     $ 1.36     $ 1.36     $ 1.43     $ 1.33  

             
             
Balance Sheet Data:   At
March 31,
2018
  At
March 31,
2017
  At
December 31,
2017
  At
December 31,
2016
  At
December 31,
2015
  At
December 31,
2014
  At
December 31,
2013
Investments at fair value   $ 431,299,720     $ 351,720,745     $ 371,839,772     $ 365,625,891     $ 349,017,697     $ 315,965,434     $ 277,504,510  
Cash and cash equivalents   $ 45,494,363     $ 11,488,905     $ 25,110,718     $ 9,194,129     $ 10,875,790     $ 2,046,563     $ 13,663,542  
Total assets(2)   $ 480,943,867     $ 368,027,553     $ 400,260,855     $ 379,878,729     $ 365,368,412     $ 323,776,402     $ 296,541,900  
Total liabilities(2)   $ 258,680,735     $ 195,362,919     $ 180,013,613     $ 208,996,944     $ 200,717,308     $ 149,826,950     $ 120,650,386  
Total net assets   $ 222,263,132     $ 172,664,634     $ 220,247,242     $ 170,881,785     $ 164,651,104     $ 173,949,452     $ 175,891,514  
Other Data:
                                                              
Number of portfolio companies at period end     52       46       48       45       39       32       26  
Weighted average yield on debt investments at period end(1)(3)     11.1 %      11.3 %      10.8 %      11.0 %      10.6 %      10.9 %      11.4 % 

(1) Computed using the effective interest rates for all of our debt investments, including accretion of original issue discount.
(2) ASU No. 2015-03 — Simplifying the Presentation of Debt Issuance Costs was effective for the quarter ended March 31, 2016. Total assets and total liabilities for the periods prior to the effective date have been modified from their respective filings to conform to this presentation.
(3) The weighted average yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investment restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion of original issue discount.

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RISK FACTORS

Investing in our securities involves a number of significant risks. Before you invest in our securities, you should be aware of various risks, including those described below. You should carefully consider these risk factors, together with all of the other information included in this prospectus and any accompanying prospectus supplement, before you decide whether to make an investment in our securities. Because we are a BDC, there may be special risks associated with investing in our securities, including risks associated with investing in a portfolio of small and developing or financially troubled businesses. The risks below include risks associated with investments in the Company specifically, as well as risks generally associated with investment in a company with investment objectives, investment policies, capital structure, or trading markets similar to the Company’s. The risks set out below are not the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us may also impair our operations and performance. If any of the following events occur, our business, financial condition, results of operations and cash flows could be materially and adversely affected. In such case, our net asset value and the trading price of our securities could decline, and you may lose all or part of your investment.

Risks Relating to our Business and Structure

We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.

We depend on the diligence, skill and network of business contacts of the investment professionals of Stellus Capital Management to achieve our investment objective. Stellus Capital Management’s team of investment professionals evaluates, negotiates, structures, closes and monitors our investments in accordance with the terms of our investment advisory agreement. We can offer no assurance, however, that Stellus Capital Management’s investment professionals will continue to provide investment advice to us.

Stellus Capital Management’s investment committee, which provides oversight over our investment activities, is provided to us by Stellus Capital Management under the investment advisory agreement. Stellus Capital Management’s investment committee consists of five members, including Messrs. Ladd, D’Angelo and Davis, each a member of our board of directors, Mr. Huskinson, our chief financial officer and chief compliance officer and the chief financial officer of Stellus Capital Management, and Mr. Overbergen, an investment professional of Stellus Capital Management. The loss of any member of Stellus Capital Management’s investment committee may limit our ability to achieve our investment objective and operate our business. This could have a material adverse effect on our financial condition, results of operations and cash flows.

Our business model depends to a significant extent upon strong referral relationships. Any inability of Stellus Capital Management to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.

We depend upon Stellus Capital Management to maintain its relationships with private equity sponsors, placement agents, investment banks, management groups and other financial institutions, and we rely to a significant extent upon these relationships to provide us with potential investment opportunities. If Stellus Capital Management fails to maintain such relationships, or to develop new relationships with other sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom Stellus Capital Management has relationships are not obligated to provide us with investment opportunities, and we can offer no assurance that these relationships will generate investment opportunities for us in the future.

Our financial condition, results of operations and cash flows will depend on our ability to manage our business effectively.

Our ability to achieve our investment objective will depend on our ability to manage our business and to grow our investments and earnings. This will depend, in turn, on Stellus Capital Management’s ability to identify, invest in and monitor portfolio companies that meet our investment criteria. The achievement of our investment objective on a cost-effective basis will depend upon Stellus Capital Management’s execution of our

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investment process, its ability to provide competent, attentive and efficient services to us and, to a lesser extent, our access to financing on acceptable terms. Stellus Capital Management’s investment professionals will have substantial responsibilities in connection with the management of other investment funds, accounts and investment vehicles. The personnel of Stellus Capital Management may be called upon to provide managerial assistance to our portfolio companies. These activities may distract them from sourcing new investment opportunities for us or slow our rate of investment. Any failure to manage our business and our future growth effectively could have a material adverse effect on our business, financial condition, results of operations and cash flows.

There are significant potential conflicts of interest that could negatively affect our investment returns.

The members of Stellus Capital Management’s investment committee serve, or may serve, as officers, directors, members, or principals of entities that operate in the same or a related line of business as we do, or of investment funds, accounts, or investment vehicles managed by Stellus Capital Management. Similarly, Stellus Capital Management may have other clients with similar, different or competing investment objectives. In serving in these multiple capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in the best interests of us or our stockholders. For example, Stellus Capital Management currently manages private credit funds that have an investment strategy that is identical to our investment strategy, and with which we intend to co-invest. Stellus Capital Management also provides sub-advisory services to the D. E. Shaw group with respect to a private investment fund and a strategy of a private multi-strategy investment fund to which the D. E. Shaw group serves as investment adviser that have an investment strategy similar to our investment strategy.

In addition, there may be times when Stellus Capital Management, members of its investment committee or its other investment professionals have interests that differ from those of our stockholders, giving rise to a conflict of interest. In particular, private investment funds for which Stellus Capital Management provides investment advisory services hold minority equity interests in certain of the portfolio companies in which we hold debt investments. As a result, Stellus Capital Management, members of its investment committee or its other investment professionals may face conflicts of interest in connection with making business decisions for these portfolio companies to the extent that such decisions affect the debt and equity holders in these portfolio companies differently. In addition, Stellus Capital Management may face conflicts of interests in connection with making investment or other decisions, including granting loan waivers or concessions, on our behalf with respect to these portfolio companies given that they also provide investment advisory services to a private investment fund that holds the equity interests in these portfolio companies. Although our investment adviser will endeavor to handle these investment and other decisions in a fair and equitable manner, we and the holders of the shares of our common stock could be adversely affected by these decisions. Moreover, given the subjective nature of the investment and other decisions made by our investment adviser on our behalf, we are unable to monitor these potential conflicts of interest between us and our investment adviser; however, our board of directors, including the independent directors, reviews conflicts of interest in connection with its review of the performance of our investment adviser.

The senior investment professionals and other investment team members of Stellus Capital Management may, from time to time, possess material non-public information, limiting our investment discretion.

The senior investment professionals and other investment team members of Stellus Capital Management, including members of Stellus Capital Management’s investment committee, may serve as directors of, or in a similar capacity with, portfolio companies in which we invest, the securities of which are purchased or sold on our behalf. In the event that material nonpublic information is obtained with respect to such companies, or we become subject to trading restrictions under the internal trading policies of those companies or as a result of applicable law or regulations, we could be prohibited for a period of time from purchasing or selling the securities of such companies, and this prohibition may have an adverse effect on us.

Our management and incentive fees may induce Stellus Capital Management to incur additional leverage.

Generally, the management and incentive fees payable by us to Stellus Capital Management may create an incentive for Stellus Capital Management to use the additional available leverage if this proposal is approved. For example, the fact that the base management fee that we pay to Stellus Capital Management is

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payable based upon our gross assets (which includes any borrowings for investment purposes) may encourage Stellus Capital Management to use leverage to make additional investments. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during cyclical economic downturns. Under certain circumstances, the use of additional leverage may increase the likelihood of our default on our borrowings, which would disfavor holders of our common stock.

In addition, because the incentive fee on net investment income is calculated as a percentage of our net assets subject to a hurdle, having additional leverage available may encourage Stellus Capital Management to use leverage to increase the leveraged return on our investment portfolio. To the extent additional leverage is available at favorable rates, Stellus Capital Management could use leverage to increase the size of our investment portfolio to generate additional income, which may make it easier to meet the incentive fee hurdle. Our adoption of the reduced minimum asset coverage will allow us to incur additional leverage above the previous 1940 Act limitations. As a result, the incentives for Stellus Capital Management to cause us to use additional leverage may be greater.

Our board of directors is charged with protecting our interests by monitoring how Stellus Capital Management addresses these and other conflicts of interests associated with its management services and compensation. While our board of directors is not expected to review or approve each investment decision, borrowing or incurrence of leverage, our independent directors will periodically review Stellus Capital Management’s services and fees as well as its portfolio management decisions and portfolio performance. In connection with these reviews, our independent directors will consider whether our fees and expenses (including those related to leverage) remain appropriate.

Our incentive fee may induce Stellus Capital Management to make speculative investments.

We pay Stellus Capital Management an incentive fee based, in part, upon net capital gains realized on our investments. Unlike that portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. Additionally, under the incentive fee structure, Stellus Capital Management may benefit when capital gains are recognized and, because Stellus Capital Management will determine when to sell a holding, Stellus Capital Management will control the timing of the recognition of such capital gains. As a result, Stellus Capital Management may have a tendency to invest more capital in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.

We may be obligated to pay Stellus Capital Management incentive compensation even if we incur a loss and may pay more than 20.0% of our net capital gains because we cannot recover payments made in previous years.

Stellus Capital Management is entitled to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our investment income for that quarter (before deducting incentive compensation) above a threshold return for that quarter and subject to a total return requirement. The general effect of this total return requirement is to prevent payment of the foregoing incentive compensation except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. Consequently, we may pay an incentive fee if we incurred losses more than three years prior to the current calendar quarter even if such losses have not yet been recovered in full. Thus, we may be required to pay Stellus Capital Management incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter. If we pay an incentive fee of 20.0% of our realized capital gains (net of all realized capital losses and unrealized capital depreciation on a cumulative basis) and thereafter experience additional realized capital losses or unrealized capital depreciation, we will not be able to recover any portion of the incentive fee previously paid.

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We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.

A number of entities compete with us to make the types of investments that we make. We compete with public and private funds, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some of our competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or the source-of-income, asset diversification and distribution requirements we must satisfy to maintain our RIC qualification. The competitive pressures we face may have a material adverse effect on our business, financial condition, results of operations and cash flows. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we may not be able to identify and make investments that are consistent with our investment objective.

With respect to the investments we make, we do not seek to compete based primarily on the interest rates we offer, and we believe that some of our competitors may make loans with interest rates that are lower than the rates we offer. With respect to all investments, we may lose some investment opportunities if we do not match our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we may experience decreased net interest income, lower yields and increased risk of credit loss. We may also compete for investment opportunities with investment funds, accounts and investment vehicles managed by Stellus Capital Management. Although Stellus Capital Management will allocate opportunities in accordance with its policies and procedures, allocations to such investment funds, accounts and investment vehicles will reduce the amount and frequency of opportunities available to us and may not be in the best interests of us and our stockholders.

We will be subject to corporate-level income tax and may default under our revolving credit facility if we are unable to maintain our tax treatment as a RIC under Subchapter M of the Code.

To maintain our tax treatment as a RIC under Subchapter M of the Code, we must meet certain source-of-income, asset diversification and distribution requirements. The distribution requirement for a RIC is satisfied if we distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Because we incur debt, we will be subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to maintain our tax treatment as a RIC. If we are unable to obtain cash from other sources, we may fail to maintain our tax treatment as a RIC and, thus, may be subject to corporate-level income tax. To maintain our tax treatment as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of our tax treatment as a RIC. Because most of our investments are in private or thinly-traded public companies, any such dispositions may be made at disadvantageous prices and may result in substantial losses. No certainty can be provided, that we will satisfy the asset diversification requirements or the other requirements necessary to maintain our qualification and tax treatment as a RIC. If we fail to maintain our tax treatment as a RIC for any reason and become subject to corporate income tax, the resulting corporate income taxes could substantially reduce our net assets, the amount of income available for distributions to our stockholders and the amount of funds available for new investments. Furthermore, if we fail to maintain our tax treatment as a RIC, we may be in default under the terms of the Credit Facility. Such a failure could have a material adverse effect on us and our stockholders.

We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.

For U.S. federal income tax purposes, we include in income certain amounts that we have not yet received in cash, such as the accrual of original issue discount. This may arise if we receive warrants in connection with the making of a loan and in other circumstances, or through contracted PIK interest, which

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represents contractual interest added to the loan balance and due at the end of the loan term. Such original issue discount, which could be significant relative to our overall investment activities, and increases in loan balances as a result of contracted PIK arrangements are included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we will not receive in cash.

Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to maintain our tax treatment as a RIC. In such a case, we may have to sell some of our investments at times we would not consider advantageous or raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements. If we are not able to obtain such cash from other sources, we may fail to maintain our tax treatment as a RIC and thus be subject to corporate-level income tax. See “Material U.S. Federal Income Tax Considerations — Taxation as a RIC.”

PIK interest payments we receive will increase our assets under management and, as a result, will increase the amount of base management fees and incentive fees payable by us to Stellus Capital Management.

Certain of our debt investments may contain provisions providing for the payment of PIK interest. Because PIK interest results in an increase in the size of the loan balance of the underlying loan, the receipt by us of PIK interest will have the effect of increasing our assets under management. As a result, because the base management fee that we pay to Stellus Capital Management is based on the value of our gross assets, the receipt by us of PIK interest will result in an increase in the amount of the base management fee payable by us. In addition, any such increase in a loan balance due to the receipt of PIK interest will cause such loan to accrue interest on the higher loan balance, which will result in an increase in our pre-incentive fee net investment income and, as a result, an increase in incentive fees that are payable by us to Stellus Capital Management.

Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.

We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, we are permitted as a BDC to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 200% (or 150% if certain requirements are met) of our gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we would not be able to borrow additional funds until we were able to comply with the asset coverage ratio under the 1940 Act. Also, any amounts that we use to service our indebtedness would not be available for distributions to our common stockholders. If we issue senior securities, we will be exposed to typical risks associated with leverage, including an increased risk of loss.

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below then-current net asset value per share of our common stock if our board of directors determines that such sale is in our best interests, and if our stockholders approve such sale. At our 2017 Annual Meeting of Stockholders, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one-year anniversary of the date of the Company’s 2017 Annual Meeting of Stockholders and the date of the Company’s 2018 Annual Meeting of Stockholders. Our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. We are seeking similar approval at our 2018 Annual Meeting of Stockholders scheduled for June 28, 2018. We cannot issue shares of our common stock below net asset value unless our board of directors determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In

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addition, continuous sales of common stock below net asset value may have a negative impact on total returns and could have a negative impact on the market price of our shares of common stock. If we raise additional funds by issuing common stock, then the percentage ownership of our stockholders at that time will decrease, and you may experience dilution.

Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.

The use of leverage magnifies the potential for gain or loss on amounts invested. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. If we continue to use leverage to partially finance our investments through banks, insurance companies and other lenders, you will experience increased risks of investing in our common stock. Lenders of these funds have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect such lenders to seek recovery against our assets in the event of a default. We, through our SBIC subsidiary, intend to issue debt securities guaranteed by the SBA and sold in the capital markets. Upon any such issuance of debt securities and as a result of its guarantee of the debt securities, if any, the SBA would also have fixed dollar claims on the assets of our SBIC subsidiary that are superior to the claims of our common stockholders.

Upon the issuance of any debt securities guaranteed by the SBA, if we are unable to meet the financial obligations under the 2022 Notes or the Credit Facility, the SBA, as a creditor, would have a superior claim to the assets of our SBIC subsidiary over our stockholders in the event we liquidate or the SBA exercises its remedies under such debentures as the result of a default by us.

In addition, under the terms of the Credit Facility and any borrowing facility or other debt instrument we may enter into, we are likely to be required to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed under such facility or instrument before applying such net proceeds to any other uses. If the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged, thereby magnifying losses or eliminating our stake in a leveraged investment. Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would also negatively affect our ability to make distributions with respect to our common stock. Our ability to service any debt depends largely on our financial performance and is subject to prevailing economic conditions and competitive pressures. Moreover, as the base management fee payable to Stellus Capital Management is payable based on the value of our gross assets, including those assets acquired through the use of leverage, Stellus Capital Management will have a financial incentive to incur leverage, which may not be consistent with our stockholders’ interests. In addition, our common stockholders bear the burden of any increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the base management fee payable to Stellus Capital Management.

As a BDC, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock that we may issue in the future, of at least 200% (or 150% if certain requirements are met). If this ratio declines below the threshold applicable to us, we will not be able to incur additional debt until we are able to comply with the asset coverage ratio under the 1940 Act. This could have a material adverse effect on our operations, and we may not be able to make distributions. The amount of leverage that we employ will depend on Stellus Capital Management’s and our board of directors’ assessment of market and other factors at the time of any proposed borrowing. We cannot assure you that we will be able to obtain credit at all or on terms acceptable to us.

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Illustration.  The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual results may be higher or lower than those appearing below.

Assumed Return on Our Portfolio(1)
(net of expenses)

         
  -10.0%   -5.0%   0.0%   5.0%   10.0%
Corresponding net return to common stockholder     -26.1 %      -15.3 %      -4.5 %      6.3 %      17.1 % 

(1) Assumes $480.9 million in total assets, $117.0 million in debt outstanding, $222.2 million in net assets, and an average cost of funds of 4.0%. Actual interest payments may be different.

We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act. This relief allows us increased flexibility under the 200% asset coverage test by allowing us to borrow up to $150.0 million more than we would otherwise be able to borrow absent the receipt of this exemptive relief, based on regulatory capital of $75.0 million at March 31, 2018.

In addition, our debt facilities may impose financial and operating covenants that restrict our business activities, including limitations that hinder our ability to finance additional loans and investments or to make the distributions required to maintain our qualification as a RIC under the Code.

Substantially all of our assets are subject to security interests under the Credit Facility or claims of the SBA with respect to SBA-guaranteed debentures we may issue and, if we default on our obligations thereunder, we may suffer adverse consequences, including foreclosure on our assets.

As of March 31, 2018, substantially all of our assets were pledged as collateral under the Credit Facility or are subject to a superior claim over the holders of our common stock or the 2022 Notes by the SBA pursuant to the SBA-guaranteed debentures. If we default on our obligations under the Credit Facility or the SBA-guaranteed debentures the lenders and/or the SBA may have the right to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests or their superior claim. In such event, we may be forced to sell our investments to raise funds to repay our outstanding borrowings in order to avoid foreclosure and these forced sales may be at times and at prices we would not consider advantageous. Moreover, such deleveraging of our company could significantly impair our ability to effectively operate our business in the manner in which we have historically operated. As a result, we could be forced to curtail or cease new investment activities and lower or eliminate the dividends that we have historically paid to our stockholders.

In addition, if the lenders exercise their right to sell the assets pledged under the Credit Facility, such sales may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash available to us after repayment of the amounts outstanding under the Credit Facility.

Because we use debt to finance our investments and may in the future issue senior securities including preferred stock and debt securities, if market interest rates were to increase, our cost of capital could increase, which could reduce our net investment income.

Because we borrow money to make investments and may in the future issue senior securities including preferred stock and debt securities, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates would not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates to the extent permitted by the 1940 Act. For example, to the extent any such instruments were to constitute senior securities under the 1940 Act, we would have to and will

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comply with the asset coverage requirements thereunder or, as permitted in lieu thereof, place certain assets in a segregated account to cover such instruments in accordance with SEC guidance, including, for example, Investment Company Act Release No. IC-10666, as applicable. There is otherwise no limit as to our ability to enter into such derivative transactions. In addition, a rise in the general level of interest rates typically leads to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates may result in an increase of the amount of our pre-incentive fee net investment income and, as a result, an increase in incentive fees payable to Stellus Capital Management. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations.

Provisions in the Credit Facility or any other future borrowing facility may limit our discretion in operating our business.

The Credit Facility is, and any future borrowing facility may be, backed by all or a portion of our loans and securities on which the lenders will or, in the case of a future facility, may have a security interest. We may pledge up to 100% of our assets and may grant a security interest in all of our assets under the terms of any debt instrument we enter into with lenders. We expect that any security interests we grant will be set forth in a guarantee and security agreement and evidenced by the filing of financing statements by the agent for the lenders. In addition, we expect that the custodian for our securities serving as collateral for such loan would include in its electronic systems notices indicating the existence of such security interests and, following notice of occurrence of an event of default, if any, and during its continuance, will only accept transfer instructions with respect to any such securities from the lender or its designee. If we were to default under the terms of any debt instrument, the agent for the applicable lenders would be able to assume control of the timing of disposition of any or all of our assets securing such debt, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.

In addition, any security interests as well as negative covenants under the Credit Facility or any other borrowing facility may limit our ability to incur additional liens or debt and may make it difficult for us to restructure or refinance indebtedness at or prior to maturity or obtain additional debt or equity financing. For example, under the terms of the Credit Facility, we have generally agreed to not incur any additional secured indebtedness, other than certain indebtedness that we may incur, in accordance with the Credit Facility, to allow us to purchase investments in U.S. Treasury Bills. In addition, we have agreed not to incur any additional indebtedness that has a maturity date prior to the maturity date of the Credit Facility. Further, if our borrowing base under the Credit Facility or any other borrowing facility were to decrease, we would be required to secure additional assets in an amount equal to any borrowing base deficiency. In the event that all of our assets are secured at the time of such a borrowing base deficiency, we could be required to repay advances under the Credit Facility or any other borrowing facility or make deposits to a collection account, either of which could have a material adverse impact on our ability to fund future investments and to make stockholder distributions.

In addition, under the Credit Facility or any other borrowing facility, we may be subject to limitations as to how borrowed funds may be used, which may include restrictions on geographic and industry concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings, as well as regulatory restrictions on leverage which may affect the amount of funding that may be obtained. There may also be certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, a violation of which could limit further advances and, in some cases, result in an event of default. Furthermore, we expect that the terms of the Credit Facility will contain a covenant requiring us to maintain compliance with RIC provisions at all times, subject to certain remedial provisions. Thus, a failure to maintain compliance with RIC provisions could result in an event of default under the Credit Facility. An event of default under the Credit Facility or any other borrowing facility could result in an accelerated maturity date for all amounts outstanding thereunder, which could have a material adverse effect on our business and financial condition. This could reduce our revenues and, by delaying any cash payment allowed to us under the Credit Facility or any other borrowing facility until the lenders have been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our qualification as a RIC.

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Because we have received Board approval, and have submitted a proposal to a stockholder vote at our 2018 Annual Meeting, we will be subject to 150% Asset Coverage beginning on April 4, 2019 or following our 2018 Annual Meeting if we receive stockholder approval.

The SBCA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% Asset Coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal, which would become effective one year after the date of such approval (the “Board Effective Date”), or (ii) obtain stockholder approval (of more than 50% of the votes cast for the proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval. Because our Board has approved the adoption of 150% Asset Coverage, we will be able to incur twice as much indebtedness as we could have without such approval beginning on April 4, 2019. In addition, the Board also approved and recommended that stockholders vote “for” a proposal to authorize the Company to be subject to 150% Asset Coverage. If our stockholders approve this proposal, the reduced Asset Coverage Ratio would be effective the day after the Meeting. Incurring additional indebtedness could increase the risk of investing in our company. See “Risk Factors — Risks Relating to our Business and Structure — Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.”

We may in the future determine to fund a portion of our investments with preferred stock, which would magnify the potential for gain or loss and the risks of investing in us in the same way as our borrowings.

Preferred stock, which is another form of leverage, has the same risks to our common stockholders as borrowings because the dividends on any preferred stock we issue must be cumulative. Payment of such dividends and repayment of the liquidation preference of such preferred stock must take preference over any dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated preference.

Adverse developments in the credit markets may impair our ability to enter into any other future borrowing facility.

During the economic downturn in the United States that began in mid-2007, many commercial banks and other financial institutions stopped lending or significantly curtailed their lending activity. In addition, in an effort to stem losses and reduce their exposure to segments of the economy deemed to be high risk, some financial institutions limited refinancing and loan modification transactions and reviewed the terms of existing facilities to identify bases for accelerating the maturity of existing lending facilities. If these conditions recur (for example, as a result of a broadening of the current Euro zone credit crisis), it may be difficult for us to enter into a new borrowing facility, obtain other financing to finance the growth of our investments, or refinance any outstanding indebtedness on acceptable economic terms, or at all.

Most of our portfolio investments are recorded at fair value as determined in good faith by our board of directors and, as a result, there may be uncertainty as to the value of our portfolio investments.

Most of our portfolio investments will take the form of securities that are not publicly traded. The fair value of loans, securities and other investments that are not publicly traded may not be readily determinable, and we value these investments at fair value as determined in good faith by our board of directors, including to reflect significant events affecting the value of our investments. Most, if not all, of our investments (other than cash and cash equivalents) are classified as Level 3 under ASC Topic 820. This means that our portfolio valuations are based on unobservable inputs and our own assumptions about how market participants would price the asset or liability in question. Inputs into the determination of fair value of our portfolio investments require significant management judgment or estimation. Even if observable market data is available, such information may be the result of consensus pricing information or broker quotes, which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimers materially reduces the reliability of such information. We have retained the services of independent service providers to review the valuation of these loans and securities. The types of factors that the board of directors may take into account in determining the

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fair value of our investments generally include, as appropriate, comparison to publicly traded securities including such factors as yield, maturity and measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these loans and securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such loans and securities.

We adjust quarterly the valuation of our portfolio to reflect our 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.

We may expose ourselves to risks if we engage in hedging transactions.

We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Use of these hedging instruments may expose us to counter-party credit risk. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is generally anticipated at an acceptable price.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.

Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations. In addition, any testing by us conducted in connection with Section 404 of the Sarbanes-Oxley Act, or the subsequent testing by our independent registered public accounting firm (when undertaken, as noted below), may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive changes to our consolidated financial statements or identify other areas for further attention or improvement. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.

We are required to disclose changes made in our internal control and procedures on a quarterly basis and our management is required to assess the effectiveness of these controls annually. An independent assessment of the effectiveness of our internal controls could detect problems that our management’s assessment might not. Undetected material weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.

Efforts to comply with Section 404 of the Sarbanes-Oxley Act involve significant expenditures, and non-compliance with Section 404 of the Sarbanes-Oxley Act may adversely affect us and the market price of our common stock.

In an effort to comply with Section 404 of the Sarbanes-Oxley Act, we expect to incur additional expenses, which may negatively impact our financial performance and our ability to make distributions to our stockholders. This process also may result in a diversion of management’s time and attention. We cannot be

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certain as to the timing of completion of any evaluation, testing and remediation actions or the impact of the same on our operations, and we are not able to ensure that the process is effective or that our internal control over financial reporting is or will continue to be effective in a timely manner. In the event that we are unable to maintain or achieve compliance with Section 404 of the Sarbanes-Oxley Act and related rules, we and, consequently, the market price of our common stock may be adversely affected.

New or modified laws or regulations governing our operations may adversely affect our business.

We and our portfolio companies are subject to regulation by laws at the U.S. federal, state and local levels. These laws and regulations, as well as their interpretation, may change from time to time, and new laws, regulations and interpretations may also come into effect. Any such new or changed laws or regulations could have a material adverse effect on our business.

Additionally, changes to the laws and regulations governing our operations related to permitted investments may cause us to alter our investment strategy in order to avail ourselves of new or different opportunities. Such changes could result in material differences to the strategies and plans set forth in this prospectus and may shift our investment focus from the areas of expertise of Stellus Capital Management to other types of investments in which Stellus Capital Management may have little or no expertise or experience. Any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment.

Legislative or other actions relating to taxes could have a negative effect on us.

The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department. The U.S. House of Representatives and U.S. Senate recently passed tax reform legislation, which the President signed into law. Such legislation makes many changes to the Internal Revenue Code, including, among other things, significant changes to the taxation of business entities, the deductibility of interest expense, and the tax treatment of capital investment. We cannot predict with certainty how any changes in the tax laws might affect us, investors or our portfolio investments. New legislation and any U.S. Treasury regulations, administrative interpretations or court decisions interpreting such legislation could significantly and negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax consequences to us and our investors of such qualification, or could have other adverse consequences. Investors are urged to consult with their tax advisor regarding tax legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our securities.

The impact on us of recent financial reform legislation, including the Dodd-Frank Act, is uncertain.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, as amended, or the Dodd-Frank Act, institutes a wide range of reforms that will have an impact on financial institutions. Many of the requirements called for in the Dodd-Frank Act are expected to be implemented over time, most of which will likely be subject to implementing regulations over the course of several years. However, the presidential administration has announced its intention to repeal, amend, or replace certain portions of Dodd-Frank and the regulations implemented thereunder. Given the uncertainty associated with the manner in which and whether the provisions of the Dodd-Frank Act will be implemented, repealed, amended or replaced, the full impact such requirements will have on our business, results of operations or financial condition is unclear. The changes resulting from the Dodd-Frank Act or any changes to the regulations already implemented thereunder may require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements. Failure to comply with any such laws, regulations or principles, or changes thereto, may negatively impact our business, results of operations and financial condition. While we cannot predict what effect any changes in the laws or regulations or their interpretations would have on us as a result of recent financial reform legislation, these changes could be materially adverse to us and our stockholders.

On November 16, 2017, a bipartisan group of U.S. Senators, led by the Senate Banking Committee Chairman, introduced the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Senate Regulatory Relief Bill”). The Senate Regulatory Relief Bill would revise various post-crisis regulatory

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requirements and provide targeted regulatory relief to certain financial institutions. Among the most significant of its proposed amendments to the Dodd-Frank Act are a substantial increase in the $50 billion asset threshold for automatic regulation of bank holding companies as “systemically important financial institutions” or “SIFIs,” an exemption from the Volcker Rule for insured depository institutions with less than $10 billion in consolidated assets and lower levels of trading assets and liabilities, as well as amendments to the liquidity leverage ratio and supplementary leverage ratio requirements. On December 5, 2017, the Senate Banking Committee approved the Senate Regulatory Relief Bill. If the legislation is adopted in the Senate, it remains unclear whether and how it would be reconciled with its House-passed counterpart, which is substantially different in scope and substance, and ultimately approved by both chambers of Congress. At this time it is unclear what impact this or other pending legislation and developments will have on regulations that affect our, our competitors’ and our portfolio companies’ businesses.

Any failure to comply with SBA regulations could have an adverse effect on our SBIC subsidiary’s operations.

On June 20, 2014, our wholly-owned subsidiary, Stellus Capital SBIC LP, received a license from the SBA to operate as an SBIC. The SBA places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBIC requirements may cause our SBIC subsidiary to forgo attractive investment opportunities that are not permitted under SBA regulations.

Further, SBA regulations require that an SBIC be examined by the SBA to determine its compliance with the relevant SBA regulations at least every two years. The SBA prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of an SBIC. If our SBIC subsidiary fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiary is our wholly-owned subsidiary.

Risks Related to Our Operations

Because we intend to distribute substantially all of our income to our stockholders to maintain our status as a RIC, we will continue to need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow may be impaired.

We will need additional capital to fund new investments and grow our portfolio of investments. We intend to access the capital markets periodically to issue debt or equity securities or borrow from financial institutions in order to obtain such additional capital. Unfavorable economic conditions could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. A reduction in the availability of new capital could limit our ability to grow. In addition, we are required to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders to maintain our qualification as a RIC. As a result, these earnings will not be available to fund new investments. An inability on our part to access the capital markets successfully could limit our ability to grow our business and execute our business strategy fully and could decrease our earnings, if any, which would have an adverse effect on the value of our shares of common stock.

As a BDC, we are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities and excluding SBA-guaranteed debentures as permitted by exemptive relief obtained from the SEC, to total senior securities, which includes all of our borrowings with the exception of SBA-guaranteed debentures, of at least 200% (or 150% if certain requirements are met). This requirement limits the amount that we may borrow. Since we continue to need capital to grow our investment portfolio, these limitations may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so. While we expect that we will be able to borrow and to issue additional debt

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securities and expect that we will be able to issue additional equity securities, which would in turn increase the equity capital available to us, we cannot assure you that debt and equity financing will be available to us on favorable terms, or at all. In addition, as a BDC, we generally are not permitted to issue equity securities priced below net asset value without stockholder approval. If additional funds are not available us, we may be forced to curtail or cease new investment activities, and our net asset value could decline.

Our wholly-owned SBIC subsidiary may be unable to make distributions to us that will enable us to maintain RIC tax treatment, which could result in the imposition of an entity-level tax.

In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we are required to distribute substantially all of our net taxable income and net capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC subsidiary. We are partially dependent on our SBIC subsidiary for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiary may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiary to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver and if our SBIC subsidiary is unable to obtain a waiver, compliance with the SBA regulations may result in loss of RIC tax treatment and a consequent imposition of an entity-level tax on us.

Our ability to enter into transactions with our affiliates is restricted, which may limit the scope of investments available to us.

We are prohibited under the 1940 Act from participating in certain transactions with our affiliates without the prior approval of our independent directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act, and we are generally prohibited from buying or selling any security from or to such affiliate without the prior approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include concurrent investments in the same portfolio company, without prior approval of our independent directors and, in some cases, of the SEC. We are prohibited from buying or selling any security from or to any person that controls us or who owns more than 25% of our voting securities or certain of that person’s affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC. As a result of these restrictions, we may be prohibited from buying or selling any security (other than any security of which we are the issuer) from or to any portfolio company of a private fund managed by Stellus Capital Management or its affiliates without the prior approval of the SEC, which may limit the scope of investment opportunities that would otherwise be available to us.

We have received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management (other than the D. E. Shaw group funds, as defined below) where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies.

The involvement of our interested directors in the valuation process may create conflicts of interest.

We make many of our portfolio investments in the form of loans and securities that are not publicly traded and for which no market based price quotation is available. As a result, our board of directors determines the fair value of these loans and securities in good faith as described elsewhere in this prospectus. In connection with that determination, investment professionals from Stellus Capital Management may provide our board of directors with valuations based upon the most recent portfolio company financial statements available and projected financial results of each portfolio company. While the valuation for each portfolio investment is reviewed by an independent valuation firm at least twice annually, the ultimate determination of

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fair value is made by our board of directors, including our interested directors, and not by such third party valuation firm. In addition, Messrs. Ladd, D’Angelo and Davis, each an interested member of our board of directors, has a direct pecuniary interest in Stellus Capital Management. The participation of Stellus Capital Management’s investment professionals in our valuation process, and the pecuniary interest in Stellus Capital Management by certain members of our board of directors, could result in a conflict of interest as Stellus Capital Management’s management fee is based, in part, on the value of our gross assets, and incentive fees are based, in part, on realized gains and realized and unrealized losses.

There are conflicts related to other arrangements with Stellus Capital Management.

We have entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” In addition, we have entered into an administration agreement with Stellus Capital Management pursuant to which we are required to pay to Stellus Capital Management our allocable portion of overhead and other expenses incurred by Stellus Capital Management in performing its obligations under such administration agreement, such as rent and our allocable portion of the cost of our chief financial officer and chief compliance officer and his staff. This will create conflicts of interest that our board of directors will monitor. For example, under the terms of the license agreement, we will be unable to preclude Stellus Capital Management from licensing or transferring the ownership of the “Stellus Capital” name to third parties, some of whom may compete against us. Consequently, we will be unable to prevent any damage to goodwill that may occur as a result of the activities of Stellus Capital Management or others. Furthermore, in the event the license agreement is terminated, we will be required to change our name and cease using “Stellus Capital” as part of our name. Any of these events could disrupt our recognition in the market place, damage any goodwill we may have generated and otherwise harm our business.

The investment advisory agreement and the administration agreement with Stellus Capital Management were not negotiated on an arm’s length basis and may not be as favorable to us as if they had been negotiated with an unaffiliated third party.

The investment advisory agreement and the administration agreement were negotiated between related parties. Consequently, their terms, including fees payable to Stellus Capital Management, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our ongoing relationship with Stellus Capital Management and its affiliates. Any such decision, however, would breach our fiduciary obligations to our stockholders.

The time and resources that Stellus Capital Management devote to us may be diverted, and we may face additional competition due to the fact that Stellus Capital Management and its affiliates are not prohibited from raising money for, or managing, another entity that makes the same types of investments that we target.

Stellus Capital Management and some of its affiliates, including our officers and our non-independent directors, are not prohibited from raising money for, or managing, another investment entity that makes the same types of investments as those we target. For example, Stellus Capital Management currently manages a private credit fund that will have an investment strategy that is identical to our investment strategy and with which we intend to co-invest. In addition, pursuant to sub-advisory arrangements, Stellus Capital Management provides non-discretionary advisory services to the D. E. Shaw group related to a private investment fund and a strategy of a private multi-strategy investment fund to which the D. E. Shaw group serves as investment adviser. As a result, the time and resources they could devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities.

Our incentive fee arrangements with Stellus Capital Management may vary from those of other investment funds, account or investment vehicles managed by Stellus Capital Management, which may create an incentive for Stellus Capital Management to devote time and resources to a higher fee-paying fund.

If Stellus Capital Management is paid a higher performance-based fee from any of its other funds, it may have an incentive to devote more research and development or other activities, and/or recommend the allocation of investment opportunities, to such higher fee-paying fund. For example, to the extent Stellus

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Capital Management’s incentive compensation is not subject to a hurdle or total return requirement with respect to another fund, it may have an incentive to devote time and resources to such other fund.

Stellus Capital Management’s liability is limited under the investment advisory agreement and we have agreed to indemnify Stellus Capital Management against certain liabilities, which may lead Stellus Capital Management to act in a riskier manner on our behalf than it would when acting for its own account.

Under the investment advisory agreement, Stellus Capital Management has not assumed any responsibility to us other than to render the services called for under that agreement. It will not be responsible for any action of our board of directors in following or declining to follow Stellus Capital Management’s advice or recommendations. Under the investment advisory agreement, Stellus Capital Management, its officers, members and personnel, and any person controlling or controlled by Stellus Capital Management will not be liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the investment advisory agreement, except those resulting from acts constituting gross negligence, willful misfeasance, bad faith or reckless disregard of the duties that Stellus Capital Management owes to us under the investment advisory agreement. In addition, as part of the investment advisory agreement, we have agreed to indemnify Stellus Capital Management and each of its officers, directors, members, managers and employees from and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority granted by the investment advisory agreement, except where attributable to gross negligence, willful misfeasance, bad faith or reckless disregard of such person’s duties under the investment advisory agreement. These protections may lead Stellus Capital Management to act in a riskier manner when acting on our behalf than it would when acting for its own account.

Stellus Capital Management can resign as our investment adviser or administrator upon 60 days’ notice and we may not be able to find a suitable replacement within that time, or at all, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.

Stellus Capital Management has the right under the investment advisory agreement to resign as our investment adviser at any time upon 60 days’ written notice, whether we have found a replacement or not. Similarly, Stellus Capital Management has the right under the administration agreement to resign at any time upon 60 days’ written notice, whether we have found a replacement or not. If Stellus Capital Management was to resign, we may not be able to find a new investment adviser or administrator or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions to our stockholders are likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management and investment or administrative activities, as applicable, is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by Stellus Capital Management. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.

If we fail to maintain our status as a BDC, our business and operating flexibility could be significantly reduced.

We qualify as a BDC under the 1940 Act. The 1940 Act imposes numerous constraints on the operations of BDCs. For example, BDCs are required to invest at least 70.0% of their total assets in specified types of securities, primarily in private companies or thinly-traded U.S. public companies, cash, cash equivalents, U.S. government securities and other high quality debt investments that mature in one year or less. Failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an enforcement action against us and/or expose us to claims of private litigants. In addition, upon approval of a majority of our stockholders, we may elect to withdraw their respective election as a BDC. If we decide to withdraw our election, or if we otherwise fail to qualify, or maintain our qualification, as a BDC, we may be

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subject to the substantially greater regulation under the 1940 Act as a closed-end investment company. Compliance with these regulations would significantly decrease our operating flexibility and could significantly increase our cost of doing business.

If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to maintain our qualification as a BDC or be precluded from investing according to our current business strategy.

As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets.

We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe to be attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in existing portfolio companies (which could result in the dilution of our position).

If we do not maintain our status as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act. As a registered closed-end investment company, we would be subject to substantially more regulatory restrictions under the 1940 Act which would significantly decrease our operating flexibility.

We may experience fluctuations in our annual and quarterly operating results.

We could experience fluctuations in our annual and quarterly operating results due to a number of factors, including the interest rate payable on the loans and debt securities we acquire, the default rate on such loans and securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. In light of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

Our board of directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.

Our board of directors has the authority, except as otherwise provided in the 1940 Act, to modify or waive certain of our operating policies and strategies without prior notice and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and the market price of our common stock. Nevertheless, any such changes could adversely affect our business and impair our ability to make distributions to our stockholders.

Our board of directors is authorized to reclassify any unissued shares of common stock into one or more classes of preferred stock, which could convey special rights and privileges to its owners.

Under Maryland General Corporation Law and our charter, our board of directors is authorized to classify and reclassify any authorized but unissued shares of stock into one or more classes of stock, including preferred stock. Prior to issuance of shares of each class or series, the board of directors will be required by Maryland law and our charter to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to stockholder distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our common stock or that otherwise might be in their best interest. The cost of any such reclassification would be borne by our common stockholders. Certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock. For example, the 1940 Act provides that holders of preferred stock are entitled to vote separately from holders of common stock to elect two preferred stock directors. We currently have no plans to issue preferred stock. The issuance of preferred shares convertible into shares of common stock may

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also reduce the net income and net asset value per share of our common stock upon conversion, provided, that we will only be permitted to issue such convertible preferred stock to the extent we comply with the requirements of Section 61 of the 1940 Act, including obtaining common stockholder approval. These effects, among others, could have an adverse effect on your investment in our common stock.

Provisions of the Maryland General Corporation Law and of our charter and bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.

The Maryland General Corporation Law and our charter and bylaws contain provisions that may discourage, delay or make more difficult a change in control of Stellus Capital Investment Corporation or the removal of our directors. We are subject to the Maryland Business Combination Act, subject to any applicable requirements of the 1940 Act. Our board of directors has adopted a resolution exempting from the Business Combination Act any business combination between us and any other person, subject to prior approval of such business combination by our board of directors, including approval by a majority of our independent directors. If the resolution exempting business combinations is repealed or our board of directors does not approve a business combination, the Business Combination Act may discourage third parties from trying to acquire control of us and increase the difficulty of consummating such an offer. Our bylaws exempt from the Maryland Control Share Acquisition Act acquisitions of our stock by any person. If we amend our bylaws to repeal the exemption from the Control Share Acquisition Act, the Control Share Acquisition Act also may make it more difficult for a third party to obtain control of us and increase the difficulty of consummating such a transaction.

We have also adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our charter classifying our board of directors in three classes serving staggered three-year terms, and authorizing our board of directors to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our stock, to amend our charter without stockholder approval and to increase or decrease the number of shares of stock that we have authority to issue. These provisions, as well as other provisions of our charter and bylaws, may delay, defer or prevent a transaction or a change in control that might otherwise be in the best interests of our stockholders. See “Description of our Capital Stock — Certain Provisions of the Maryland General Corporation Law and Our Charter and Bylaws.”

We are highly dependent on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to make distributions to our stockholders.

Our business is highly dependent on the communications and information systems of Stellus Capital Management. In addition, certain of these systems are provided to Stellus Capital Management by third party service providers. Any failure or interruption of such systems, including as a result of the termination of an agreement with any such third party service provider, could cause delays or other problems in our activities. This, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to make distributions to our stockholders.

The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.

The occurrence of a disaster such as a cyber attack, a natural catastrophe, an industrial accident, a terrorist attack or war, events unanticipated in our disaster recovery systems, or a support failure from external providers, could have an adverse effect on our ability to conduct business and on our results of operations and financial condition, particularly if those events affect the Company’s computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a significant number of our managers were unavailable in the event of a disaster, our ability to effectively conduct its business could be severely compromised.

We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems could be subject to cyber attacks and

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unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other companies, we may experience threats to its data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could result in damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer dissatisfaction or loss.

Risks Related to Economic Conditions

Global economic, political and market conditions may adversely affect our business, results of operations and financial condition, including our revenue growth and profitability.

The U.S. and global capital markets experienced extreme volatility and disruption during the economic downturn that began in mid-2007, and the U.S. economy was in a recession for several consecutive calendar quarters during the same period. In 2010, a financial crisis emerged in Europe, triggered by high budget deficits and rising direct and contingent sovereign debt, which created concerns about the ability of certain nations to continue to service their sovereign debt obligations. Risks resulting from such debt crisis and any future debt crisis in Europe or any similar crisis elsewhere could have a detrimental impact on the global economic recovery, sovereign and non-sovereign debt in certain countries and the financial condition of financial institutions generally. In July and August 2015, Greece reached agreements with its creditors for bailouts that provide aid in exchange for certain austerity measures. These and similar austerity measures may adversely affect world economic conditions and have an adverse impact on our business and that of our portfolio companies. In the second quarter of 2015, stock prices in China experienced a significant drop, resulting primarily from continued sell-off of shares trading in Chinese markets. In August 2015, Chinese authorities sharply devalued China’s currency.

In June 2016, the United Kingdom held a referendum in which voters approved an exit from the European Union, and the implications of the United Kingdom’s pending withdrawal from the European Union are unclear at present. In November 2016, voters in the United States elected a new president and the implications of a new presidential administration are unclear at present. These market and economic disruptions affected, and these and other similar market and economic disruptions may in the future affect, the U.S. capital markets, which could adversely affect our business and that of our portfolio companies and the broader financial and credit markets and have reduced the availability of debt and equity capital for the market as a whole and to financial firms, in particular. At various times, these disruptions resulted in, and may in the future result, a lack of liquidity in parts of the debt capital markets, significant write-offs in the financial services sector and the repricing of credit risk.

These conditions may reoccur for a prolonged period of time again or materially worsen in the future, including as a result of U.S. government shutdowns or further downgrades to the U.S. government’s sovereign credit rating or the perceived credit worthiness of the United States or other large global economies. Unfavorable economic conditions, including future recessions, also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. We may in the future have difficulty accessing debt and equity capital on attractive terms, or at all, and a severe disruption and instability in the global financial markets or deteriorations in credit and financing conditions may cause us to reduce the volume of loans we originate and/or fund, adversely affect the value of our portfolio investments or otherwise have a material adverse effect on our business, financial condition, results of operations and cash flows.

Risks Related to our Investments

Our investments in software companies are subject to many risks, including regulatory concerns, litigation risks and intense competition.

As of March 31, 2018, our investments in software companies represented 10.93% of our total portfolio, at fair value. Our investments in software companies are subject to substantial risks. For example, our portfolio companies face intense competition since their businesses are rapidly evolving and intensely

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competitive, and are subject to changing technology, shifting user needs, and frequent introductions of new products and services. Software companies have many competitors in different industries, including general purpose search engines, vertical search engines and e-commerce sites, social networking sites, traditional media companies, and providers of online products and services. Potential competitors to our portfolio companies in the software industries range from large and established companies to emerging start-ups. Further, such companies are subject to laws that were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. The laws that do reference the Internet are being interpreted by the courts, but their applicability and scope remain uncertain. For example, the laws relating to the liability of providers of online services are currently unsettled both within the United States, and abroad. Claims have been threatened and filed under both U.S. and foreign laws for defamation, invasion of privacy and other tort claims, unlawful activity, copyright and trademark infringement, or other theories based on the nature and content of the materials searched and the ads posted by a company’s users, a company’s products and services, or content generated by a company’s users. Further, the growth of software companies into a variety of new fields implicate a variety of new regulatory issues and may subject such companies to increased regulatory scrutiny, particularly in the United States and Europe. As a result, these portfolio company investments face considerable risk. This could, in turn, materially adversely affect the value of the software companies in our portfolio.

Changes in healthcare laws and other regulations applicable to some of our portfolio companies’ businesses may constrain their ability to offer their products and services.

Changes in healthcare or other laws and regulations applicable to the businesses of some of our portfolio companies may occur that could increase their compliance and other costs of doing business, require significant systems enhancements, or render their products or services less profitable or obsolete, any of which could have a material adverse effect on their results of operations. There has also been an increased political and regulatory focus on healthcare laws in recent years, and new legislation could have a material effect on the business and operations of some of our portfolio companies.

Economic recessions or downturns could impair our portfolio companies, which would harm our operating results.

Many of the portfolio companies in which we make, and expect to make, investments, including those currently included in our portfolio, are likely to be susceptible to economic slowdowns or recessions and may be unable to repay our loans during such periods. Therefore, the number of our non-performing assets is likely to increase and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions may decrease the value of collateral securing some of our loans and debt securities and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investments and harm our operating results.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the loans and debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, lenders in certain cases can be subject to lender liability claims for actions taken by them when they become too involved in the borrower’s business or exercise control over a borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken if we render significant managerial assistance to the borrower. Furthermore, if one of our portfolio companies were to file for bankruptcy protection, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to claims of other creditors, even though we may have structured our investment as senior secured debt. The likelihood of such a re-characterization would depend on the facts and circumstances, including the extent to which we provided managerial assistance to that portfolio company.

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Our investments in leveraged portfolio companies may be risky, and we could lose all or part of our investment.

Investment in leveraged companies involves a number of significant risks. Leveraged companies in which we invest may have limited financial resources and may be unable to meet their obligations under their loans and debt securities that we hold. Such developments may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in connection with our investment. Smaller leveraged companies also may have less predictable operating results and may require substantial additional capital to support their operations, finance their expansion or maintain their competitive position.

We may hold the loans and debt securities of leveraged companies that may, due to the significant operating volatility typical of such companies, enter into bankruptcy proceedings.

Leveraged companies may experience bankruptcy or similar financial distress. The bankruptcy process has a number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversary proceedings and are beyond the control of the creditors. A bankruptcy filing by a portfolio company may adversely and permanently affect that company. If the proceeding is converted to a liquidation, the value of the portfolio company may not equal the liquidation value that was believed to exist at the time of the investment. The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on investment can be adversely affected by delays until the plan of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for example, claims for taxes) may be substantial.

Our investments in private and middle-market portfolio companies are risky, and we could lose all or part of our investment.

Investment in private and middle-market companies involves a number of significant risks. Generally, little public information exists about these companies, and we rely on the ability of Stellus Capital Management’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. Middle-market companies may have limited financial resources and may be unable to meet their obligations under their loans and debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing any guarantees we may have obtained in connection with our investment. In addition, such companies typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. Additionally, middle-market companies are more likely to depend on the management talents and efforts of a small group of persons. Therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on one or more of the portfolio companies we invest in and, in turn, on us. Middle-market companies also may be parties to litigation and may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence. In addition, our executive officers, directors and investment adviser may, in the ordinary course of business, be named as defendants in litigation arising from our investments in portfolio companies.

The lack of liquidity in our investments may adversely affect our business.

Most of our assets are invested in illiquid loans and securities, and a substantial portion of our investments in leveraged companies are subject to legal and other restrictions on resale or are otherwise less liquid than more broadly traded public securities. The illiquidity of these investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our

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portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. Also, as noted above, we may be limited or prohibited in our ability to sell or otherwise exit certain positions in our portfolio as such a transaction could be considered a joint transaction prohibited by the 1940 Act.

Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.

As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by our board of directors. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair value of our investments:

available current market data, including relevant and applicable market trading and transaction comparables;
applicable market yields and multiples;
security covenants;
call protection provisions;
information rights;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
comparisons of financial ratios of peer companies that are public;
comparable merger and acquisition transactions; and
the principal market and enterprise values.

When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our valuation. We record decreases in the market values or fair values of our investments as unrealized depreciation. Declines in prices and liquidity in the corporate debt markets may result in significant net unrealized depreciation in our portfolio. The effect of all of these factors on our portfolio may reduce our net asset value by increasing net unrealized depreciation in our portfolio. Depending on market conditions, we could incur substantial realized losses and may suffer additional unrealized losses in future periods, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we are not limited with respect to the proportion of our assets that may be invested in securities of a single issuer.

We are classified as a non-diversified investment company within the meaning of the 1940 Act, which means that we are not limited by the 1940 Act with respect to the proportion of our assets that we may invest in securities of a single issuer. Beyond the asset diversification requirements associated with our qualification as a RIC under the Code, we do not have fixed guidelines for diversification. To the extent that we assume large positions in the securities of a small number of issuers or our investments are concentrated in relatively few industries, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company.

Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.

Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on” investments, in seeking to:

increase or maintain in whole or in part our position as a creditor or equity ownership percentage in a portfolio company;

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exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or
preserve or enhance the value of our investment.

We have discretion to make follow-on investments, subject to the availability of capital resources. Failure on our part to make follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to increase our level of risk, because we prefer other opportunities or because we are inhibited by compliance with BDC requirements of the 1940 Act or the desire to maintain our qualification as a RIC. Our ability to make follow-on investments may also be limited by our compliance with the conditions under the exemptive relief order we received from the SEC related to co-investments with investment funds managed by Stellus Capital Management or Stellus Capital Management’s allocation policy.

Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.

We do not hold controlling equity positions in any of the portfolio companies included in our portfolio and, although we may do so in the future, we do not currently intend to hold controlling equity positions in our portfolio companies (including those included in our portfolio). As a result, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity investments that we hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore suffer a decrease in the value of our investments.

Defaults by our portfolio companies will harm our operating results.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets. This could trigger cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations under the loans or debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.

Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and ability to make stockholder distributions and result in a decline in the market price of our shares.

We are subject to the risk that the debt investments we make in our portfolio companies may be repaid prior to maturity. We expect that our investments will generally allow for repayment at any time subject to certain penalties. When this occurs, we intend to generally reinvest these proceeds in temporary investments, pending their future investment in accordance with our investment strategy. These temporary investments will typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our ability to make, or the amount of, stockholder distributions with respect to our common stock, which could result in a decline in the market price of our shares.

The interest rates of our floating-rate loans to our portfolio companies that extend beyond 2021 might be subject to change based on recent regulatory changes.

LIBOR, the London Interbank Offered Rate, is the basic rate of interest used in lending transactions between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally. We typically use LIBOR as a reference rate in floating-rate loans we extend to portfolio

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companies such that the interest due to us pursuant to a term loan extended to a portfolio company is calculated using LIBOR. The terms of our debt investments generally include minimum interest rate floors which are calculated based on LIBOR.

On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time whether LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short term repurchase agreements, backed by Treasury securities. The future of LIBOR at this time is uncertain. If LIBOR ceases to exist, we may need to renegotiate the credit agreements extending beyond 2021 with our portfolio companies that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established.

The effect of global climate change may impact the operations of our portfolio companies.

There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs of customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or services is material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition, through decreased revenues. Extreme weather conditions in general require more system backup, adding to costs, and can contribute to increased system stresses, including service interruptions. In December 2015, the United Nations, of which the U.S. is a member, adopted a climate accord with the long-term goal of limiting global warming and the short-term goal of significantly reducing greenhouse gas emissions. As a result, our portfolio companies, particularly those operating in the energy sector, may be subject to new or strengthened regulations or legislation which could increase their operating costs and/or decrease their revenues.

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

We invest a portion of our capital in second lien and subordinated loans issued by our portfolio companies. The portfolio companies usually have, or may be permitted to incur, other debt that ranks equally with, or senior to, the loans in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the loans in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying senior creditors, a portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with loans in which we invest, we would have to share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.

Additionally, certain loans that we make to portfolio companies may be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The holders of obligations secured by first priority liens on the collateral will generally control the liquidation of, and be entitled to receive proceeds from, any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first

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priority liens on the collateral. If such proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the portfolio company’s remaining assets, if any.

We may also make unsecured loans to portfolio companies, meaning that such loans will not benefit from any interest in collateral of such companies. Liens on such portfolio companies’ collateral, if any, will secure the portfolio company’s obligations under its outstanding secured debt and may secure certain future debt that is permitted to be incurred by the portfolio company under its secured loan agreements. The holders of obligations secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their obligations in full before us. In addition, the value of such collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding secured loan obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.

The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of such senior debt. Under a typical intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens:

the ability to cause the commencement of enforcement proceedings against the collateral;
the ability to control the conduct of such proceedings;
the approval of amendments to collateral documents;
releases of liens on the collateral; and
waivers of past defaults under collateral documents.

We may not have the ability to control or direct such actions, even if our rights are adversely affected.

We may be exposed to special risks associated with bankruptcy cases.

One or more of our portfolio companies may be involved in bankruptcy or other reorganization or liquidation proceedings. Many of the events within a bankruptcy case are adversarial and often beyond the control of the creditors. While creditors generally are afforded an opportunity to object to significant actions, we cannot assure you that a bankruptcy court would not approve actions that may be contrary to our interests. There also are instances where creditors can lose their ranking and priority if they are considered to have taken over management of a borrower.

To the extent that portfolio companies in which we have invested through a unitranche facility are involved in bankruptcy proceedings, the outcome of such proceedings may be uncertain. For example, it is unclear whether a bankruptcy court would enforce an agreement among lenders which sets the priority of payments among unitranche lenders. In such a case, the “first out” lenders in the unitranche facility may not receive the same degree of protection as they would if the agreement among lenders was enforced.

The reorganization of a company can involve substantial legal, professional and administrative costs to a lender and the borrower. It is subject to unpredictable and lengthy delays and during the process a company’s competitive position may erode, key management may depart and a company may not be able to invest adequately. In some cases, the debtor company may not be able to reorganize and may be required to liquidate assets. The debt of companies in financial reorganization will, in most cases, not pay current interest, may not accrue interest during reorganization and may be adversely affected by an erosion of the issuer’s fundamental value.

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In addition, lenders can be subject to lender liability claims for actions taken by them where they become too involved in the borrower’s business or exercise control over the borrower. For example, we could become subject to a lender liability claim (alleging that we misused our influence on the borrower for the benefit of its lenders), if, among other things, the borrower requests significant managerial assistance from us and we provide that assistance. To the extent we and an affiliate both hold investments in the same portfolio company that are of a different character, we may also face restrictions on our ability to become actively involved in the event that portfolio company becomes distressed as a result of the restrictions imposed on transactions involving affiliates under the 1940 Act. In such cases, we may be unable to exercise rights we may otherwise have to protect our interests as security holders in such portfolio company.

If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash flow to service their debt obligations to us.

We may make subordinated investments that rank below other obligations of the obligor in right of payment. Subordinated investments are subject to greater risk of default than senior obligations as a result of adverse changes in the financial condition of the obligor or economic conditions in general. If we make a subordinated investment in a portfolio company, the portfolio company may be highly leveraged, and its relatively high debt-to-equity ratio may create increased risks that its operations might not generate sufficient cash flow to service all of its debt obligations.

The disposition of our investments may result in contingent liabilities.

Substantially all of our investments involve loans and private securities. In connection with the disposition of an investment in loans and private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to potential liabilities. These arrangements may result in contingent liabilities that ultimately result in funding obligations that we must satisfy through our return of distributions previously made to us.

We may not realize gains from our equity investments.

When we invest in loans and debt securities, we may acquire warrants or other equity securities of portfolio companies as well. We may also invest in equity securities directly. To the extent we hold equity investments, we will attempt to dispose of them and realize gains upon our disposition of them. However, the equity interests we receive may not appreciate in value and, may decline in value. As a result, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.

Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies and, in turn, harm us.

There has been on-going discussion and commentary regarding potential significant changes to United States trade policies, treaties and tariffs. The current administration, along with Congress, has created significant uncertainty about the future relationship between the United States and other countries with respect to the trade policies, treaties and tariffs. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and have a material adverse effect on their business, financial condition and results of operations, which in turn would negatively impact us.

Risks Relating to an Offering of Our Securities

We may be unable to invest a significant portion of the net proceeds raised from our offerings on acceptable terms, which would harm our financial condition and operating results.

Delays in investing the net proceeds raised in our offerings may cause our performance to be worse than that of other fully invested BDCs or other lenders or investors pursuing comparable investment strategies. We

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cannot assure you that we will be able to identify any investments that meet our investment objective or that any investment that we make will produce a positive return. We may be unable to invest the net proceeds from any offering on acceptable terms within the time period that we anticipate or at all, which could harm our financial condition and operating results. We anticipate that, depending on market conditions, it may take a substantial period of time to invest substantially all of the net proceeds of any offering in securities meeting our investment objective. During such a period, we will continue to invest the net proceeds of any offering primarily in cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, which may produce returns that are significantly lower than the returns which we expect to achieve when our portfolio is fully invested in securities meeting our investment objective, and given our expense ratio and the prevailing interest rate climate, there is a possible risk of losing money on the offering proceeds of certain securities, such as debt securities during this interval. As a result, any distributions that we pay during such period may be substantially lower than the distributions that we may be able to pay when our portfolio is fully invested in securities meeting our investment objective. In addition, until such time as the net proceeds of any offering are invested in securities meeting our investment objective, the market price for our securities may decline. Thus, the return on your investment may be lower than when, if ever, our portfolio is fully invested in securities meeting our investment objective.

There is a risk that you may not receive distributions or that our distributions may not grow over time and a portion of our distributions may be a return of capital.

We intend to make distributions on a monthly basis to our stockholders out of assets legally available for distribution (i.e., not subject to any legal restrictions under Maryland law on the distribution thereof). We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. All distributions will be made at the discretion of our board of directors and will depend on our earnings, financial condition, maintenance of RIC status, compliance with applicable BDC, SBA regulations and such other factors as our board of directors may deem relative from time to time. We cannot assure you that we will make distributions to our stockholders in the future.

Our ability to pay distributions might be adversely affected by the impact of one or more of the risk factors described in this prospectus. Due to the asset coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make distributions. In addition, restrictions and provisions in our Credit Facility, the Notes and any future credit facilities, as well as in the terms of any debt securities we issue, may limit our ability to make distributions in certain circumstances.

When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain. See “Material U.S. Federal Income Tax Considerations.”

We may allocate the net proceeds from an offering in ways with which you may not agree.

We will have significant flexibility in investing the net proceeds of an offering and may use the net proceeds from an offering in ways with which you may not agree or for purposes other than those contemplated at the time of the offering. In addition, we can provide you with no assurance that by increasing the size of our available equity capital our expense ratio or debt ratio will be lowered.

Stockholders may experience dilution in their ownership percentage if they do not participate in our dividend reinvestment plan.

All distributions declared in cash payable to stockholders that are participants in our dividend reinvestment plan are generally automatically reinvested in shares of our common stock. As a result, stockholders that do not participate in the dividend reinvestment plan may experience dilution over time. Stockholders who receive distributions in shares of common stock may experience accretion to the net asset value of their shares if our shares are trading at a premium and dilution if our shares are trading at a discount.

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The level of accretion or discount would depend on various factors, including the proportion of our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and the amount of the distribution payable to a stockholder.

Existing stockholders may incur dilution if, in the future, we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock.

The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value per share of such stock, with certain exceptions. One such exception is prior stockholder approval of issuances below net asset value provided that our board of directors makes certain determinations. At our 2017 annual meeting of stockholders, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one-year anniversary of the date of the Company’s 2017 Annual Meeting of Stockholders and the date of the Company’s 2018 Annual Meeting of Stockholders. The proposal approved by our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. We are seeking similar approval at our 2018 Annual Meeting of Stockholders, scheduled for June 28, 2018. If we receive such stockholder approval, any decision to sell shares of our common stock below the then current net asset value per share of our common stock would be subject to the determination by our board of directors that such issuance is in our and our stockholders' best interests.

If we were to sell shares of our common stock below net asset value per share, such sales would result in an immediate dilution to the net asset value per share. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance.

Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted; however, the example below illustrates the effect of dilution to existing stockholders resulting from the sale of common stock at prices below the net asset value of such shares. Please see “Sales of Common Stock Below Net Asset Value” for a more complete discussion of the potentially dilutive impacts of an offering at a price less than net asset value per share.

Illustration: Example of Dilutive Effect of the Issuance of Shares Below Net Asset Value. Assume that Company XYZ has 16,000,000 total shares outstanding, $370,000,000 in total assets and $220,000,000 in total liabilities. The net asset value per share of the common stock of Company XYZ is $13.75. The following table illustrates the reduction to net asset value, or net asset value, and the dilution experienced by Stockholder A following the sale of 1,600,000 shares of the common stock of Company XYZ at $12.24 per share, a price below its net asset value per share.

     
  Prior to Sale
Below NAV
  Following Sale
Below NAV
  Percentage
Change
Reduction to NAV
                          
Total Shares Outstanding     16,000,000       17,600,000       10 % 
NAV per share   $ 13.75     $ 13.63       -0.9 % 
Dilution to Existing Stockholder
                          
Shares Held by Stockholder A     160,000       160,000(1)       0.0 % 
Percentage Held by Stockholder A     1.00 %      0.91 %      -9.0 % 
Total Interest of Stockholder A in NAV   $ 2,200,000     $ 2,180,000       -0.9 % 

(1) Assumes that Stockholder A does not purchase additional shares in the sale of shares below NAV.

Our shares might trade at premiums that are unsustainable or at discounts from net asset value.

Shares of BDCs like us may, during some periods, trade at prices higher than their net asset value per share and, during other periods, as frequently occurs with closed-end investment companies, trade at prices lower than their net asset value per share. The perceived value of our investment portfolio may be affected by

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a number of factors including perceived prospects for individual companies we invest in, market conditions for common stock generally, for initial public offerings and other exit events for venture capital backed companies, and the mix of companies in our investment portfolio over time. Negative or unforeseen developments affecting the perceived value of companies in our investment portfolio could result in a decline in the trading price of our common stock relative to our net asset value per share.

The possibility that our shares will trade at a discount from net asset value or at premiums that are unsustainable are risks separate and distinct from the risk that our net asset value per share will decrease. The risk of purchasing shares of a BDC that might trade at a discount or unsustainable premium is more pronounced for investors who wish to sell their shares in a relatively short period of time because, for those investors, realization of a gain or loss on their investments is likely to be more dependent upon changes in premium or discount levels than upon increases or decreases in net asset value per share.

Investing in our securities may involve an above average degree of risk.

The investments we make in accordance with our investment objective may result in a higher amount of risk, and higher volatility or loss of principal, than alternative investment options. Our investments in portfolio companies may be speculative and, therefore, an investment in our securities may not be suitable for someone with lower risk tolerance.

The market price of our securities may fluctuate significantly.

The market price and liquidity of the market for our securities may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:

significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies;
changes in regulatory policies or tax guidelines, particularly with respect to RICs, BDCs and SBICs;
loss of our qualification as a RIC or BDC or the status of our SBIC subsidiary as SBIC;
changes in earnings or variations in operating results;
changes in the value of our portfolio of investments;
changes in accounting guidelines governing valuation of our investments;
any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
departure of Stellus Capital Management’s key personnel;
operating performance of companies comparable to us; and
general economic trends and other external factors.

Sales of substantial amounts of our common stock may have an adverse effect on the market price of our common stock.

As of March 31, 2018 we had 15,953,811 shares of common stock outstanding. When effective, our registration statement on Form N-2 will allow us to offer, from time to time, up to $200 million worth of our common stock, preferred stock, subscription rights, debt securities, or warrants representing rights to purchase shares of our common stock, preferred stock or debt securities on terms to be determined at the time of the offering. Sales of substantial amounts of our common stock, or the availability of shares for sale, could adversely affect the prevailing market price of our common stock. If this occurs and continues, it could impair our ability to raise additional capital through the sale of equity securities should we desire to do so.

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If we issue preferred stock and/or debt securities, the net asset value and market value of our common stock may become more volatile.

We cannot assure you that the issuance of preferred stock and/or debt securities would result in a higher yield or return to the holders of our common stock. The issuance of preferred stock and/or debt securities would likely cause the net asset value and market value of our common stock to become more volatile. If the distribution rate on the preferred stock, or the interest rate on the debt securities, were to approach the net rate of return on our investment portfolio, the benefit of leverage to the holders of our common stock would be reduced. If the distribution rate on the preferred stock, or the interest rate on the debt securities, were to exceed the net rate of return on our portfolio, the use of leverage would result in a lower rate of return to the holders of common stock than if we had not issued the preferred stock and/or debt securities. Any decline in the net asset value of our investment would be borne entirely by the holders of our common stock. Therefore, if the market value of our portfolio were to decline, the leverage would result in a greater decrease in net asset value to the holders of our common stock than if we were not leveraged through the issuance of preferred stock and/or debt securities. This decline in net asset value would also tend to cause a greater decline in the market price for our common stock.

There is also a risk that, in the event of a sharp decline in the value of our net assets, we would be in danger of failing to maintain required asset coverage ratios which may be required by the preferred stock and/or debt securities or of a downgrade in the ratings of the preferred stock and/or debt securities or our current investment income might not be sufficient to meet the distribution requirements on the preferred stock or the interest payments on the debt securities. In order to counteract such an event, we might need to liquidate investments in order to fund redemption of some or all of the preferred stock and/or debt securities. In addition, we would pay (and the holders of our common stock would bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred stock and/or debt securities. Holders of preferred stock and/or debt securities may have different interests than holders of common stock and may at times have disproportionate influence over our affairs.

The trading market or market value of our debt securities or any convertible debt securities, if issued to the public, may be volatile.

Our debt securities or any convertible debt securities, if issued to the public, may or may not have an established trading market. We cannot assure investors that a trading market for our debt securities or any convertible debt securities, if issued to the public, would develop or be maintained if developed. In addition to our creditworthiness, many factors may materially adversely affect the trading market for, and market value of, our publicly issued debt securities or any convertible debt securities. These factors include, but are not limited to, the following:

the time remaining to the maturity of these debt securities;
the outstanding principal amount of debt securities with terms identical to these debt securities;
the general economic environment;
the supply of debt securities trading in the secondary market, if any;
the redemption, repayment or convertible features, if any, of these debt securities;
the level, direction and volatility of market interest rates generally; and
market rates of interest higher or lower than rates borne by the debt securities.

There also may be a limited number of buyers for our debt securities. This too may materially adversely affect the market value of the debt securities or the trading market for the debt securities. Our debt securities may include convertible features that cause them to more closely bear risks associated with an investment in our common stock.

Terms relating to redemption may materially adversely affect the return on any debt securities.

If we issue any debt securities or any convertible debt securities that are redeemable at our option, we may choose to redeem the debt securities at times when prevailing interest rates are lower than the interest

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rate paid on the debt securities. In addition, if the debt securities are subject to mandatory redemption, we may be required to redeem the debt securities at times when prevailing interest rates are lower than the interest rate paid on the debt securities. In this circumstance, a holder of our debt securities may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the debt securities being redeemed.

The issuance of subscription rights, warrants or convertible debt that are exchangeable for our common stock, will cause your interest in us to be diluted as a result of any such rights, warrants or convertible debt offering.

Stockholders who do not fully exercise rights, warrants or convertible debt issued to them in any offering of subscription rights, warrants or convertible debt to purchase our common stock should expect that they will, at the completion of the offering, own a smaller proportional interest in us than would otherwise be the case if they fully exercised their rights, warrants or convertible debt. We cannot state precisely the amount of any such dilution in share ownership because we do not know what proportion of the common stock would be purchased as a result of any such offering.

In addition, if the subscription price, warrant price or convertible debt price is less than our net asset value per share of common stock at the time of such offering, then our stockholders would experience an immediate dilution of the aggregate net asset value of their shares as a result of the offering. The amount of any such decrease in net asset value is not predictable because it is not known at this time what the subscription price, warrant price, convertible debt price or net asset value per share will be on the expiration date of such offering or what proportion of our common stock will be purchased as a result of any such offering. The risk of dilution is greater if there are multiple rights offerings. However, our board of directors will make a good faith determination that any offering of subscription rights, warrants or convertible debt would result in a net benefit to existing stockholders.

Future offerings of debt securities, which would be senior to our common stock upon liquidation, or equity securities, which could dilute our existing stockholders and may be senior to our common stock for the purposes of distributions, may harm the value of our common stock.

In the future, we may attempt to increase our capital resources by making offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock, subject to the restrictions of the 1940 Act. Upon a liquidation of our company, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings would receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings by us may dilute the holdings of our existing stockholders or reduce the value of our common stock, or both. Any preferred stock we may issue would have a preference on distributions that could limit our ability to make distributions to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us. In addition, proceeds from a sale of common stock will likely be used to increase our total assets or to pay down our borrowings, among other uses. This would increase our asset coverage ratio and permit us to incur additional leverage under rules pertaining to business development companies by increasing our borrowings or issuing senior securities such as preferred stock or additional debt securities.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements in this prospectus and the accompanying prospectus supplement, if any constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this prospectus and the accompanying prospectus supplement, if any involve risks and uncertainties, including statements as to:

our future operating results;
our business prospects and the prospects of our portfolio companies;
the effect of investments that we expect to make;
our contractual arrangements and relationships with third parties;
actual and potential conflicts of interest with Stellus Capital Management;
the dependence of our future success on the general economy and its effect on the industries in which we invest;
the ability of our portfolio companies to achieve their objectives;
the use of borrowed money to finance a portion of our investments;
the adequacy of our financing sources and working capital;
the timing of cash flows, if any, from the operations of our portfolio companies;
the ability of Stellus Capital Management to locate suitable investments for us and to monitor and administer our investments;
the ability of Stellus Capital Management to attract and retain highly talented professionals;
our ability to qualify and maintain our qualification as a RIC and as a BDC; and
the effect of future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to business development companies or RICs.

Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words.

We have based the forward-looking statements included in this prospectus and the accompanying prospectus supplement, if any on information available to us on the date of this prospectus and the accompanying prospectus supplement, if any, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or SEC rule or regulation. You are advised to consult any additional disclosures that we may make directly to you, including in the form of a prospectus supplement or post-effective amendment to the registration statement to which this prospectus relates, or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

You should understand that, under Sections 27A(b)(2)(B) of the Securities Act and Section 21E(b)(2)B of the Exchange Act, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 do not apply to statements made in connection with any offering of securities pursuant to this prospectus and the accompanying prospectus supplement, if any.

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USE OF PROCEEDS

Unless otherwise specified in any prospectus supplement accompanying this prospectus, we intend to use the net proceeds of this offering, to make new investments in portfolio companies in accordance with our investment objective and strategies as described in this prospectus, to reduce a portion of our outstanding borrowings under the Credit Facility or the Notes and for general working capital purposes. Pending such use, we will invest the net proceeds primarily in high quality, short-term debt securities consistent with our BDC election and our election to be taxed as a RIC. We do not intend to use any portion of the net proceeds of this offering to fund distributions to our shareholders.

We estimate that it will take less than six months for us to substantially invest the net proceeds of any offering made pursuant to this prospectus, depending on the availability of attractive opportunities, market conditions and the amount raised. However, we can offer no assurance that we will be able to achieve this goal.

Proceeds not immediately used for new investments or the temporary repayment of debt will be invested primarily in cash, cash equivalents, U.S. government securities and other high-quality investments that mature in one year or less from the date of investment. These securities may have lower yields than the types of investments we would typically make in accordance with our investment objective and, accordingly, may result in lower distributions, if any, during such period.

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PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

Our common stock is traded on the New York Stock Exchange, or NYSE, under the symbol “SCM.” In connection with our initial public offering, our shares of common stock began trading on November 8, 2012, and before that date, there was no established trading market for our common stock.

The following table sets forth, for each fiscal quarter of the two most recent fiscal years and most recent interim period, the range of high and low closing prices of our common stock as reported on the NYSE, the sales price as a percentage of our net asset value, or NAV, and the dividends declared by us.

         
Fiscal Year Ended   NAV Per
Share(1)
  Closing Sales Price(2)   Premium or
Discount of High
Sales to NAV(3)
  Premium or
Discount of Low
Sales to NAV(3)
  High   Low
December 31, 2018
                                            
Second Quarter (through June 25, 2018)       $ 13.60     $ 11.56          
First Quarter   $ 13.93     $ 13.00     $ 11.34       -6.68 %      -18.59 % 
December 31, 2017
                                            
Fourth Quarter   $ 13.81     $ 14.29     $ 12.19       3.48 %      -11.73 % 
Third Quarter   $ 13.85     $ 13.85     $ 13.30             3.97 % 
Second Quarter   $ 13.81     $ 14.55     $ 13.25       5.36 %      4.05 % 
First Quarter   $ 13.84     $ 14.57     $ 12.09       5.27 %      -12.64 % 
December 31, 2016
                                            
Fourth Quarter     13.69     $ 12.33     $ 10.35       -9.93 %      -24.40 % 
Third Quarter   $ 13.57     $ 11.54     $ 10.35       -14.96 %      -23.73 % 
Second Quarter   $ 13.12     $ 10.59     $ 9.82       -19.28 %      -25.15 % 
First Quarter   $ 13.06     $ 10.22     $ 7.85       -21.75 %      -39.89 % 

(1) NAV is determined as of the last date in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low sales prices. The NAVs shown are based on outstanding shares at the end of each period.
(2) Closing sales price is determined as the high or low closing sales price noted within the respective quarter, not adjusted for dividends.
(3) Calculated as of the respective high or low sales price divided by the quarter end NAV.
* Not determinable at the time of filing.

On June 25, 2018, the last reported sales price of our common stock was $13.22 per share. As of June 25, 2018, we had 10 stockholders of record, which did not include stockholders for whom shares are held in nominee or street name.

Shares of business development companies may trade at a market price that is less than the value of the net assets attributable to those shares. The possibility that our shares of common stock will trade at a discount from net asset value or at premiums that are unsustainable over the long term are separate and distinct from the risk that our net asset value will decrease. Since they began trading on November 8, 2012, in connection with our initial public offering, our shares of common stock have traded at times at a discount to the net assets attributable to those shares.

To the extent that we have income available, we intend to make quarterly distributions to our stockholders. Our quarterly stockholder distributions, if any, will be determined by our board of directors. Any stockholder distribution to our stockholders will be declared out of assets legally available for distribution.

We have elected to be treated as a RIC under the Code. To maintain RIC tax treatment, we must distribute at least 90% of our net ordinary income and net short-term capital gains in excess of our net long-term capital losses, if any, to our stockholders. In order to avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least equal to the sum of: (a) 98% of our net ordinary income for such calendar year; (b) 98.2% of our capital gain net income for the one-year

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period ending on October 31 of the calendar year; and (c) any net ordinary income and capital gain net income for preceding years that were not distributed during such years and on which we previously paid no U.S. federal income tax.

We currently intend to distribute net capital gains (i.e., net long-term capital gains in excess of net short-term capital losses), if any, at least annually out of the assets legally available for such distributions. However, we may decide in the future to retain such capital gains for investment and elect to treat such gains as deemed distributions to you. If this happens, you will be treated for U.S. federal income tax purposes as if you had received an actual distribution of the capital gains that we retain and reinvested the net after tax proceeds in us. In this situation, you would be eligible to claim a tax credit (or in certain circumstances a tax refund) equal to your allocable share of the tax we paid on the capital gains deemed distributed to you. See “Material U.S. Federal Income Tax Considerations.” We cannot assure you that we will achieve results that will permit us to pay any cash distributions, and if we issue senior securities, we may be prohibited from making distributions if doing so would cause us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if such distributions are limited by the terms of any of our borrowings.

We have adopted an “opt out” dividend reinvestment plan for our common stockholders. Unless you elect to receive your distributions in cash, we intend to make such distributions in additional shares of our common stock under our dividend reinvestment plan. Although distributions paid in the form of additional shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in our dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes. If you hold shares of our common stock in the name of a broker or financial intermediary, you should contact such broker or financial intermediary regarding your election to receive distributions in cash in lieu of shares of our common stock. Any distributions reinvested through the issuance of shares through our dividend reinvestment plan will increase our gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital Management. See “Dividend Reinvestment Plan.”

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2012
                          
December 7, 2012     December 21, 2012       December 27, 2012     $ 0.1812  
Fiscal 2013(1)
                          
various     various       various     $ 1.3600  
Fiscal 2014(2)(3)
                          
various     various       various     $ 1.4246  
Fiscal 2015(2)
                          
various     various       various     $ 1.3596  
Fiscal 2016(2)
                          
various     various       various     $ 1.3596  
Fiscal 2017(2)
                          
January 13, 2017     January 31, 2017       February 15, 2017     $ 0.1133  
January 13, 2017     February 28, 2017       March 15, 2017     $ 0.1133  
January 13, 2017     March 31, 2017       April 14, 2017     $ 0.1133  
April 14, 2017     April 28, 2017       May 15, 2017     $ 0.1133  
April 14, 2017     May 31, 2017       June 15, 2017     $ 0.1133  
April 14, 2017     June 30, 2017       July 14, 2017     $ 0.1133  
July 7, 2017     July 31, 2017       August 15, 2017     $ 0.1133  
July 7, 2017     August 31, 2017       September 15, 2017     $ 0.1133  
July 7, 2017     September 29, 2017       October 13, 2017     $ 0.1133  
October 12, 2017     October 31, 2017       November 15, 2017     $ 0.1133  
October 12, 2017     November 30, 2017       December 15, 2017     $ 0.1133  
October 12, 2017     December 29, 2017       January 12, 2018     $ 0.1133  

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Date Declared   Record Date   Payment Date   Per Share
Fiscal 2018(2)
                          
January 11, 2018     January 31, 2018       February 15, 2018     $ 0.1133  
January 11, 2018     February 28, 2018       March 15, 2018     $ 0.1133  
January 11, 2018     March 29, 2018       April 13, 2018     $ 0.1133  
April 16, 2018     April 30, 2018       May 15, 2018     $ 0.1133  
April 16, 2018     May 31, 2018       June 15, 2018     $ 0.1133  
April 16, 2018     June 29, 2018       July 13, 2018     $ 0.1133  
Total               $ 7.7244  

(1) Distributions made quarterly
(2) Distributions made monthly
(3) Includes special distribution of $0.065 per share in addition to monthly distributions

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RATIOS OF EARNINGS TO FIXED CHARGES

The following table contains our ratio of earnings to fixed charges for the periods indicated, computed as set forth below. You should read these ratios of earnings to fixed charges in connection with our Consolidated Financial Statements, including the notes to those statements, included in this prospectus.

           
  For the three
months ended
March 31,
2018
  For the
Year Ended
December 31,
2017
  For the
Year Ended
December 31,
2016
  For the
Year Ended
December 31,
2015
  For the
Year Ended
December 31,
2014
  For the
Year Ended
December 31,
2013
Earnings to Fixed Charges(1)     4.0       3.9       4.0       2.2       2.8       6.6  

(1) Earnings include net realized and unrealized gains or losses. Net realized and unrealized gains or losses can vary substantially from period to period.

For purposes of computing the ratios of earnings to fixed charges, earnings represent net increase in net assets resulting from operations plus (or minus) income tax expense (benefit) including excise tax expense plus fixed charges. Fixed charges include interest and credit facility fees expense and amortization of debt issuance costs.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We were organized as a Maryland corporation on May 18, 2012, and formally commenced operations on November 7, 2012. Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies.

We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. Our investment activities are managed by our investment advisor, Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).

As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we may not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets. Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes private operating companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized and with their principal of business in the United States.

We have elected to be treated for U.S. federal tax purposes as a RIC under Subchapter M of the Code. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As of March 31, 2018, we were in compliance with the RIC requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income we distribute to our stockholders.

Portfolio Composition and Investment Activity

Portfolio Composition

We originate and invest primarily in privately-held middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, often times with a corresponding equity investment.

As of March 31, 2018, we had $431.3 million (at fair value) invested in 52 portfolio companies. As of March 31, 2018, our portfolio included approximately 46% of first lien debt, 41% of second lien debt, 6% of mezzanine debt and 6% of equity investments at fair value. The composition of our investments at cost and fair value as of March 31, 2018 was as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 198,445,230     $ 199,372,307  
Senior Secured – Second Lien     180,292,855       177,644,589  
Unsecured Debt     27,147,168       26,732,823  
Equity     20,494,618       27,550,001  
Total Investments   $ 426,379,871     $ 431,299,720  

(1) Includes unitranche investments, which account for 16.1% of our portfolio at fair value.

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As of December 31, 2017, we had $371.8 million (at fair value) invested in 48 portfolio companies. As of December 31, 2017, our portfolio included approximately 38% of first lien debt, 48% of second lien debt, 7% of mezzanine debt and 7% of equity investments at fair value. The composition of our investments at cost and fair value as of December 31, 2017 was as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 140,915,106     $ 141,006,923  
Senior Secured – Second Lien     181,164,730       178,432,850  
Unsecured Debt     27,903,141       27,430,000  
Equity     18,470,229       24,969,999  
Total Investments   $ 368,453,206     $ 371,839,772  

(1) Includes unitranche investments, which account for 13.2% of our portfolio at fair value.

Our investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require us to provide funding when requested by portfolio companies in accordance with the terms and conditions of the underlying loan agreements. As of March 31, 2018 and December 31, 2017, we had six and four such investments, respectively, with aggregate unfunded commitments of $11.2 million and $8.7 million, respectively. As of March 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments should the need arise.

The following is a summary of geographical concentration of our investment portfolio as of March 31, 2018:

     
  Cost   Fair Value   % of Total Investments
Texas   $ 111,024,052     $ 110,713,387       25.67 % 
California     45,368,765       45,800,000       10.62 % 
New Jersey     34,281,271       34,319,692       7.96 % 
New York     28,581,847       28,913,750       6.70 % 
Canada     26,340,678       26,641,739       6.18 % 
Illinois     24,256,766       25,580,000       5.93 % 
Arizona     21,414,850       22,190,812       5.15 % 
Massachusetts     22,552,094       22,187,850       5.14 % 
Ohio     21,660,379       21,760,000       5.05 % 
South Carolina     21,100,842       21,090,000       4.89 % 
Arkansas     15,364,791       15,678,106       3.64 % 
North Carolina     11,841,982       12,032,500       2.79 % 
Tennessee     9,854,786       10,000,000       2.32 % 
Georgia     5,981,496       8,650,000       2.01 % 
Pennsylvania     7,855,929       8,010,938       1.86 % 
Minnesota     5,130,946       5,130,946       1.19 % 
Puerto Rico     8,842,160       5,080,000       1.18 % 
Alabama     1,206,682       3,300,000       0.77 % 
Washington     2,132,745       2,560,000       0.59 % 
Utah     1,294,505       880,000       0.20 % 
Florida     242,304       380,000       0.09 % 
Missouri           300,000       0.07 % 
Virginia     50,001       100,000       0.02 % 
     $ 426,379,871     $ 431,299,720       100.00 % 

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The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total Investments
Texas   $ 109,043,496     $ 108,445,000       29.16 % 
New Jersey     34,531,876       34,595,527       9.30 % 
New York     28,939,268       29,365,000       7.90 % 
Canada     26,315,677       26,440,000       7.11 % 
California     25,519,753       25,930,000       6.97 % 
Illinois     24,250,169       25,700,000       6.91 % 
Massachusetts     22,534,191       22,247,850       5.98 % 
Arizona     13,565,958       13,840,000       3.72 % 
North Carolina     12,248,770       12,499,167       3.36 % 
Ohio     10,112,627       9,990,000       2.69 % 
Tennessee     9,848,614       9,950,000       2.68 % 
Missouri     9,152,087       9,530,000       2.56 % 
Georgia     5,929,223       8,329,998       2.24 % 
Pennsylvania     7,848,470       8,058,746       2.17 % 
Arkansas     7,397,881       7,618,484       2.05 % 
Minnesota     5,421,770       5,420,000       1.46 % 
Puerto Rico     8,827,864       5,080,000       1.37 % 
Washington     4,172,743       4,520,000       1.22 % 
Alabama     1,206,682       2,880,000       0.77 % 
Utah     1,293,782       880,000       0.24 % 
Florida     242,304       420,000       0.11 % 
Virginia     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

The following is a summary of industry concentration of our investment portfolio as of March 31, 2018:

     
  Cost   Fair Value   % of Total Investments
Software   $ 46,552,172     $ 47,127,850       10.93 % 
Healthcare & Pharmaceuticals     48,406,241       45,493,446       10.55 % 
Services: Business     34,916,431       37,560,001       8.71 % 
Finance     36,356,619       37,510,000       8.70 % 
High Tech Industries     36,089,266       35,810,000       8.30 % 
Retail     29,289,480       29,278,638       6.79 % 
Consumer Goods: Durable     24,556,850       24,778,106       5.74 % 
Capital Equipment     24,346,104       24,580,000       5.70 % 
Media: Broadcasting & Subscription     21,616,409       24,053,750       5.58 % 
Services: Consumer     17,681,579       18,010,000       4.18 % 
Construction & Building     17,926,928       17,780,000       4.12 % 
Automotive     17,410,929       17,570,938       4.07 % 
Education     17,043,239       17,171,053       3.98 % 
Consumer goods: non-durable     13,229,563       13,220,000       3.07 % 
Chemicals, Plastics, & Rubber     11,683,058       12,065,000       2.80 % 
Energy: Oil & Gas     9,040,642       9,068,387       2.10 % 
Transportation: Cargo     6,791,312       6,841,739       1.59 % 
Insurance     5,413,835       5,510,000       1.28 % 
Beverage, Food, & Tobacco     3,967,191       3,600,000       0.83 % 
Hotel, Gaming, & Leisure     3,245,580       3,400,812       0.79 % 
Environmental Industries     766,442       770,000       0.18 % 
Services: Government     50,001       100,000       0.02 % 
     $ 426,379,871     $ 431,299,720       100.00 % 

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The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total Investments
Software   $ 48,560,675     $ 48,997,850       13.18 % 
Healthcare & Pharmaceuticals     41,192,879       37,829,167       10.17 % 
High Tech Industries     36,058,477       35,460,000       9.54 % 
Finance     26,500,097       28,330,000       7.62 % 
Services: Business     23,386,714       25,749,999       6.93 % 
Capital Equipment     24,300,027       24,170,000       6.50 % 
Media: Broadcasting & Subscription     21,680,239       23,665,000       6.36 % 
Chemicals, Plastics, & Rubber     20,825,458       21,145,000       5.69 % 
Services: Consumer     17,862,616       18,070,000       4.86 % 
Construction & Building     17,913,413       17,980,000       4.84 % 
Education     17,197,396       17,335,526       4.66 % 
Consumer Goods: Durable     16,559,947       16,798,484       4.52 % 
Consumer goods: non-durable     13,250,000       13,250,000       3.56 % 
Retail     8,288,083       8,280,000       2.23 % 
Automotive     7,848,470       8,058,746       2.17 % 
Transportation: Cargo     6,785,894       6,840,000       1.84 % 
Energy: Oil & Gas     6,766,968       6,700,000       1.80 % 
Insurance     5,410,226       5,500,000       1.48 % 
Beverage, Food, & Tobacco     3,964,242       3,580,000       0.96 % 
Hotel, Gaming, & Leisure     3,284,942       3,420,000       0.92 % 
Environmental Industries     766,442       580,000       0.16 % 
Services: Government     50,001       100,000       0.03 % 
     $ 368,453,206       371,839,772       100.00 % 

At March 31, 2018, our average portfolio company investment at amortized cost and fair value was approximately $8.2 million and $8.3 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $22.6 million and $22.2 million, respectively. At December 31, 2017, our average portfolio company investment at amortized cost and fair value was approximately $7.7 million and $7.4 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $22.5 million and $22.2 million, respectively.

At March 31, 2018, 89% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 11% bore interest at fixed rates. At December 31, 2017, 87% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 13% bore interest at fixed rates.

The weighted average yield on all of our debt investments as of March 31, 2018 and December 31, 2017 was 11.1% and 10.8%, respectively. The weighted average yield was computed using the effective interest rates for all of our debt investments, including accretion of original issue discount. The weighted average yield of our debt investments is not the same as a return on investment for our stockholder, but, rather relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses.

As of March 31, 2018 and December 31, 2017, we had cash and cash equivalents of $45.5 million and $25.1 million, respectively.

Investment Activity

During the three months ended March 31, 2018, we made an aggregate of $71.7 million of investments in four new portfolio companies and four existing portfolio companies. During the three months ended March 31, 2018, we received an aggregate of $15.6 million in proceeds from repayments of our investments.

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Our level of investment activity can vary substantially from period to period depending on many factors, including the amount of debt and equity capital required by middle-market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.

Asset Quality

In addition to various risk management and monitoring tools, Stellus Capital uses an investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our investment portfolio. This investment rating system uses a five-level numeric scale. The following is a description of the conditions associated with each investment category:

Investment Category 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.
Investment Category 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.
Investment Category 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.
Investment Category 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of return but no loss of principal is expected.
Investment Category 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.

           
  As of March 31, 2018   As of December 31, 2017
     (dollars in millions)   (dollars in millions)
Investment Category   Fair Value   % of Total Portfolio   Number of Portfolio Companies(1)   Fair Value   % of Total Portfolio   Number of Portfolio Companies
1   $ 21.3       5 %      8     $ 25.9       7 %      5  
2     372.5       86 %      37       306.7       82 %      36  
3     36.5       9 %      5       37.0       10 %      5  
4     1.0       %      2       1.9       1 %      1  
5           %      1       0.4       %      1  
Total   $ 431.3       100 %      53     $ 371.9       100 %      48  

(1) One portfolio company appears in two categories as of March 31, 2018

Loans and Debt Securities on Non-Accrual Status

We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. As of March 31, 2018, we had two loans on non-accrual status which represented approximately 1.0% of our loan portfolio at cost and 0.2% at fair value. As of December 31, 2017, we had two loans on non-accrual status, which represented approximately 1.2% of our loan portfolio at cost and 0.3% at fair value.

Results of Operations

An important measure of our financial performance is net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, dividends, fees and other investment income and our operating expenses including interest on borrowed funds.

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Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

Comparison of the three months ended March 31, 2018 and 2017

Revenues

We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, on investment securities that we may acquire in portfolio companies. Our debt investments typically have a term of five to seven years and bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments may pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the total dollar amount of interest and any dividend income that we earn will increase as the size of our investment portfolio increases. In addition, we may generate revenue in the form of prepayment fees, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.

The following shows the breakdown of investment income for the three months ended March 31, 2018 and 2017 (in millions).

   
  Three months
ended
March 31,
2018
  Three months
ended
March 31,
2017
Interest income   $ 10.5     $ 9.4  
PIK Interest     0.2       0.1  
Miscellaneous fees     0.2       0.4  
Total   $ 10.9     $ 9.9  

The increase in interest income from the respective periods was due to the growth in the overall investment portfolio.

Expenses

Our primary operating expenses include the payment of fees to Stellus Capital under the investment advisory agreement, our allocable portion of overhead expenses under the administration agreement and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which may include:

organization and offering expenses;
Expenses incurred in valuing our assets and calculating our net asset value (including the cost and expenses of any independent valuation firm);
fees and expenses incurred by Stellus Capital or payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments;
interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts;
offerings of our common stock and other securities;
base management and incentive fees;

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administration fees and expenses, if any, payable under the administration agreement (including our allocable portion of Stellus Capital’s overhead in performing its obligations under the administration agreement, including rent and the allocable portion of the cost of our chief compliance officer, chief financial officer and their respective staffs);
transfer agent and custodial fees and expenses;
U.S. federal and state registration fees;
all costs of registration and listing our shares on any securities exchange;
U.S. federal, state and local taxes;
independent directors’ fees and expenses;
costs of preparing and filing reports or other documents required by the SEC or other regulators;
costs of any reports, proxy statements or other notices to stockholders, including printing costs;
costs associated with individual or group stockholders;
costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
direct costs and expenses of administration and operation, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs; and
all other expenses incurred by us or Stellus Capital in connection with administering our business.

The following shows the breakdown of operating expenses for the three months ended March 31, 2018 and 2017 (in millions).

   
  Three months
ended
March 31,
2018
  Three months
ended
March 31,
2017
Operating Expenses
                 
Management fees   $ 1.7     $ 1.6  
Valuation Fees     0.1       0.2  
Administrative services expenses     0.3       0.3  
Incentive fees     1.0       1.0  
Professional fees     0.5       0.2  
Directors’ fees     0.1       0.1  
Insurance expense     0.1       0.1  
Interest expense and other fees     2.5       2.1  
Other general and administrative     0.1       0.1  
Total Operating Expenses   $ 6.4     $ 5.7  

The increase in operating expenses for the respective periods was primarily due to 1) an increase in management fees, directly related to the growth of our portfolio, 2) increased interest expense due to our additional 2022 Notes and SBA-guaranteed debentures outstanding during the period, and 3) an increase in professional fees, primarily related to increased costs of Sarbanes-Oxley compliance.

Net Investment Income

For the three months ended March 31, 2018, net investment income was $4.5 million, or $0.28 per common share (based on 15,952,841 weighted-average common shares outstanding at March 31, 2018).

For the three months ended March 31, 2017, net investment income was $4.1 million, or $0.33 per common share (based on 12,479,957 weighted-average common shares outstanding at March 31, 2017).

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Net Realized Gains and Losses

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.

Repayments of investments and amortization of other investments and a non-cash conversion of debt to equity for the three months ended March 31, 2018 totaled $15.6 million and net realized gain totaled $1.3 million.

Repayments of investments and amortization of other investments for the three months ended March 31, 2017 totaled $39.3 million and net realized loss totaled $0.8 million.

Net Change in Unrealized Appreciation/(Depreciation) of Investments

Net change in unrealized appreciation (depreciation) primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.

Net change in unrealized appreciation on investments and cash equivalents for the three months ended March 31, 2018 and 2017 totaled $1.5 million and $2.6 million, respectively.

The net change in unrealized appreciation between the respective periods was due to a general tightening of credit spreads. The quarter ending March 31, 2018 did not have as significant of a reversal of previously recorded depreciation as was experienced in the quarter ending March 31, 2017 when one of our debt investments converted into equity.

Provision for Taxes on Unrealized Appreciation on Investments

We have direct wholly owned subsidiaries that have elected to be taxable entities (the “Taxable Subsidiaries”). The Taxable Subsidiaries permit us to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with us for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in our consolidated financial statements. For the three months ended March 31, 2018 and 2017, we recognized a benefit for income tax on unrealized investments of $0 and $8.0 thousand for the Taxable Subsidiaries, respectively. As of March 31, 2018 and December 31, 2017, there was no deferred tax liability or asset on the Consolidated Statement of Assets and Liabilities.

Net Increase in Net Assets Resulting from Operations

For the three months ended March 31, 2018, net increase in net assets resulting from operations totaled $7.3 million, or $0.46 per common share (based on 15,952,841 weighted-average common shares outstanding at March 31, 2018).

For the three months ended March 31, 2017, net increase in net assets resulting from operations totaled $6.0 million, or $0.48 per common share (based on 12,479,957 weighted-average common shares outstanding at March 31, 2017).

The increase in the net increase in net assets between the respective periods was due a higher net investment income during the three months ended March 31, 2018, as well as a realized gain during the period.

Comparison of the Years ended December 31, 2017, 2016, and 2015

Revenues

We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, on investment securities that we may acquire in portfolio companies. Our debt investments typically have a term of five to seven years and bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In

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some cases, our debt investments may pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the total dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases. In addition, we may generate revenue in the form of prepayment fees, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.

The following shows the breakdown of investment income for the years ended December 31, 2017, 2016, and 2015 (in millions).

     
  Year Ended
December 31,
2017
  Year Ended
December 31,
2016
  Year Ended
December 31,
2015
     (dollars in millions)
Interest Income   $ 37.6     $ 38.0     $ 34.3  
PIK Income     0.5       0.2       0.4  
Miscellaneous fees     1.6       1.3       0.5  
     $ 39.7     $ 39.5     $ 35.2  

The increase in interest income from the respective periods were due primarily to growth in the overall investment portfolio.

Expenses

Our primary operating expenses include the payment of fees to Stellus Capital Management under the investment advisory agreement, our allocable portion of overhead expenses under the administration agreement and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which may include:

the cost of calculating our net asset value, including the cost of any third-party valuation services;
the cost of effecting sales and repurchases of shares of our common stock and other securities;
fees payable to third parties relating to making investments, including out-of-pocket fees and expenses (such as travel expenses) associated with performing due diligence and reviews of prospective investments;
transfer agent and custodial fees;
out-of-pocket fees and expenses associated with marketing efforts;
federal and state registration fees and any stock exchange listing fees;
U.S. federal, state and local taxes;
independent directors’ fees and expenses;
brokerage commissions;
fidelity bond, directors’ and officers’ liability insurance and other insurance premiums;
direct costs, such as printing, mailing, long distance telephone and staff;
fees and expenses associated with independent audits and outside legal costs;
costs associated with our reporting and compliance obligations under the 1940 Act and other applicable U.S. federal and state securities laws; and
other expenses incurred by Stellus Capital Management or us in connection with administering our business, including payments under the administration agreement that are based upon our allocable portion of overhead (subject to the review of our board of directors).

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The following shows the breakdown of operating expenses for the years ended December 31, 2017, 2016 and 2015 (in millions).

     
  Year Ended
December 31,
2017
  Year Ended
December 31,
2016
  Year Ended
December 31,
2015
Operating Expenses
              
Management Fees   $ 6.3     $ 6.3     $ 5.8  
Valuation Fees     0.3       0.4       0.4  
Administrative services expenses     1.3       1.0       1.0  
Incentive fees     2.9       4.3       4.0  
Professional fees     1.3       0.7       0.6  
Directors’ fees     0.3       0.3       0.3  
Insurance expense     0.4       0.5       0.5  
Interest expense and other fees     7.9       8.0       6.2  
Deferred offering costs           0.3        
Other general and administrative     0.6       0.4       0.4  
Total Operating Expenses   $ 21.3     $ 22.2     $ 19.2  
Loss on extinguishment of debt     0.4              
Waiver of Incentive Fees                 (0.6 ) 
Total Expenses, net of fee waivers   $ 21.7     $ 22.2     $ 18.6  

The decrease in operating expense from 2016 to 2017 was due to: 1) lower incentive fees, due to an increase in net assets, which increased the pre-incentive fee net investment income threshold needed to reach the hurdle rate (see Note 2 for discussion on incentive fee calculation), 2) the offset of an increase in professional fees, primarily related to increased costs of Sarbanes-Oxley compliance and 3) the offset of a one-time loss on extinguishment from our Credit Facility modification and payoff of our 6.50% Notes (“the 2019 Notes”). See Notes 9 and 11 for discussion on debt modifications during 2017.

The increase in operating expense from 2015 to 2016 was due to: 1) increased interest and fees on our SBA-guaranteed debentures, which were fully drawn in the fourth quarter of 2015, 2) an increase in management and incentive fees due to portfolio growth and 3) deferred offering costs, which were fully expensed in the second quarter of 2016.

While under no obligation to do so, the Advisor waived incentive fees of $646,333 for the year ended December 31, 2015 to support an annualized dividend yield of 9.0% based on the $15.00 price per share of our common stock in the Offering. Such waiver in no way implies that the Advisor will waive incentive fees in any future period. The Advisor did not waive incentive fees during the years ended December 31, 2017 and 2016.

Net Investment Income

Net investment income was $18.0 million, or $1.21 per common share based on 14,870,981 weighted-average common shares outstanding at December 31, 2017. Net investment income was $17.3 million, or $1.39 per common share based on 12,479,959 weighted-average common shares outstanding at December 31, 2016. Net investment income was $16.5 million, or $1.33 per common share based on 12,479,961 weighted-average common shares outstanding at December 31, 2015.

Net investment income for the year ended December 31, 2017 increased compared to the year ended December 31, 2016 as a result of lower incentive fees which declined year over year due to higher net assets, which makes it more difficult to clear the incentive fee hurdle.

Net Realized Gains and Losses

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or other disposition and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.

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Proceeds from repayments of investments and amortization of other certain investments for the year ended December 31, 2017 totaled $172.3 million and net realized gain totaled $4.7 million. Proceeds from repayments of investments and amortization of other certain investments for the year ended December 31, 2016 totaled $55.9 million and net realized loss totaled $13.1 million, $12.2 million of which is related to the realized loss of our term loan in Binder and Binder. Proceeds from the sales and repayments of investments and amortization of other certain investments for the year ended December 31, 2015 totaled $93.3 million and net realized gains totaled $0.4 million.

Net Change in Unrealized Appreciation (Depreciation) of Investments

Net change in unrealized appreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.

Net change in unrealized appreciation (depreciation) on investments and cash equivalents for the year ended December 31, 2017, 2016 and 2015 totaled ($0.02) million, $18.6 million, and ($9.2) million, respectively.

There was relatively no change in unrealized appreciation (depreciation) in 2017. The change in unrealized appreciation in 2016 was due primarily to two factors: (1) the reversal of $8.3 million of unrealized depreciation accrued in prior years resulting from realized losses and (2) $10.3 million from tightening interest rate spreads in 2016. The change in unrealized depreciation in 2015 was due primarily to unrealized depreciation on our one non-accrual investment as well as unrealized depreciation on other investments in the portfolio due to a widening of market interest rate spreads.

Provision for Taxes on Unrealized Appreciation on Investments

We have direct wholly owned subsidiaries that have elected to be taxable entities (the “Taxable Subsidiaries”). The Taxable Subsidiaries permit us to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with us for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in our consolidated financial statements. For the year ended December 31, 2017, 2016 and 2015, we recognized a benefit (provision) for income tax at our taxable subsidiaries of $9.0 thousand, $0.4 million, and $(0.1) million. As of December 31, 2017 and 2016, a deferred tax liability of $0 and $8.0 thousand, respectively, were included on the Consolidated Statement of Assets and Liabilities.

Net Increase in Net Assets Resulting from Operations

Net increase in net assets resulting from operations totaled $22.6 million, or $1.52 per common share based on weighted-average shares of 14,870,981 for the year ended December 31, 2017, as compared to $23.2 million, or $1.86 per common share based on weighted-average shares of 12,479,959 common shares outstanding for the year ended December 31, 2016, as compared to $7.7 million, or $0.61 per common share based on weighted-average shares of 12,479,961 common shares outstanding for the year ended December 31, 2015.

The decrease in net assets resulting from operations for the year ended December 31, 2017 as compared to the year ended December 31, 2016 was due primarily to a higher unrealized appreciation in 2016 partially offset by realized gains and increased net investment income in 2017. Similarly, the increase in net assets resulting from operations for the year ended December 31, 2016 as compared to the year ended December 31, 2015 was due primarily to higher unrealized appreciation in 2016.

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Financial condition, liquidity and capital resources

Cash Flows from Operating and Financing Activities

Our operating activities used net cash of $51.8 million for the three months ended March 31, 2018, primarily in connection with the purchase and origination of new portfolio investments, some of which was offset by the sales and repayments on our investments. Our financing activities for the three months ended March 31, 2018 provided cash of $72.2 million due to net borrowings under the Credit Facility during the period.

Our operating activities provided cash of $20.1 million for the three months ended March 31, 2017, primarily in connection with cash interest received and repayments of our investments, much of which was offset by the purchase and origination of new portfolio investments. Our financing activities for the three months ended March 31, 2017 used cash of $17.8 million due to distributions to stockholders and net repayments of the Original Credit Facility during the period.

Liquidity and Capital Resources

Our liquidity and capital resources are derived from the Credit Facility, the 2022 Notes, SBA-guaranteed debentures and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and other operating expenses we incur, as well as the payment of dividends to the holders of our common stock. We used, and expect to continue to use, these capital resources as well as proceeds from turnover within our portfolio and from public and private offerings of securities to finance our investment activities.

Although we expect to fund the growth of our investment portfolio through the net proceeds from future public and private equity offerings and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, if our common stock trades at a price below our then-current net asset value per share, we may be limited in our ability to raise equity capital given that we cannot sell our common stock at a price below net asset value per share unless our stockholders approve such a sale and our board of directors makes certain determinations in connection therewith. A proposal, approved by our stockholders at our 2017 annual stockholders meeting, authorizes us to sell shares equal to up to 25% of our outstanding common stock of our common stock below the then current net asset value per share of our common stock in one or more offerings. This authorization will expire on the earlier of May 24, 2018, the one year anniversary of our 2017 annual stockholders meeting. We would need similar future approval from our stockholders to issue shares below the then current net asset value per share any time after the expiration of the current approval. In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

Also, as a BDC, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200% (or 150% if certain requirements are met). This requirement limits the amount that we may borrow. We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the asset coverage test under the 1940 Act. We were in compliance with the asset coverage ratios at all times. As of March 31, 2018 and December 31, 2017, our asset coverage ratio was 233% and 346%, respectively. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. For more information about the expected amount of and costs associated with our borrowings, see “Fees and

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Expenses” in this prospectus. As of March 31, 2018 and December 31, 2017, we had cash and cash equivalents of $45.5 million and $25.1 million, respectively.

Credit Facility

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120.0 million on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. The Company terminated the Original Facility on October 11, 2017, in conjunction with securing and entering into a new senior secured revolving credit agreement, dated as of October 10, 2017 and as amended on March 28, 2018, with ZB, N.A., dba Amegy Bank and various other leaders (the “Credit Facility”).

The Credit Facility provides for borrowings up to a maximum of $140.0 million on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021. This represents an interest rate reduction of 12.5 basis points and a three year extension of maturity over the Original Facility.

The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10.0 million, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 2.0 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of March 31, 2018, the Company was in compliance with these covenants.

As of March 31, 2018 and December 31, 2017, $118.3 and $40.8 million, respectively, was outstanding under the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The Company incurred total costs of $3.1 million in connection with obtaining, amending, and maintaining the Original Facility. The Company incurred costs of $1.2 million in connection with the Credit Facility, which are being amortized over the life of the facility. Additionally, $0.3 million of costs from the Original Facility will continue to be amortized over the remaining life of the Credit Facility. As of both March 31, 2018 and December 31, 2017, $1.4 million of such prepaid loan structure fees and administration fees had yet to be amortized. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

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Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the three months ended March 31, 2018 and 2017 (in millions):

   
  For the three months ended
     March 31,
2018
  March 31,
2017
Interest expense   $ 0.7     $ 0.9  
Loan fee amortization     0.1       0.1  
Commitment fees on unused portion     0.1        
Total interest and financing expenses   $ 0.9     $ 1.0  
Weighted average interest rate     4.4 %      3.5 % 
Effective interest rate     5.6 %      4.0 % 
Average debt outstanding   $ 68.2     $ 104.7  
Cash paid for interest and unused fees   $ 0.6     $ 1.0  

SBA-Guaranteed Debentures

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, an SBIC can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. The 2016 omnibus spending bill approved by the U.S. Congress and signed into law by the President increased the amount of SBA-guaranteed debentures that affiliated SBIC funds can have outstanding from $225.0 million to $350.0 million, subject to SBA approval. As of March 31, 2018 and December 31, 2017, the SBIC subsidiary had $75.0 million and $67.5 million in regulatory capital, as such term is defined by the SBA.

As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our 200% asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the 200% asset coverage test by permitting us to borrow up to $150.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.

On a stand-alone basis, the SBIC subsidiary held $210.3 and $162.0 million in assets at March 31, 2018 and December 31, 2017, respectively, which accounted for approximately 43.7% and 40.4% of our total consolidated assets, respectively.

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of both March 31, 2018 and December 31, 2017, the SBIC subsidiary had $90.0 million of SBA-guaranteed debentures outstanding. See Note 10 for further detail on the SBA-guaranteed debentures outstanding.

As of March 31, 2018 and December 31, 2017, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At March 31, 2018 and December 31, 2017 the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

As of March 31, 2018, the Company has incurred $3.1 million in financing costs related to the SBA-guaranteed debentures since receiving our license, which were recorded as prepaid loan fees. As of

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March 31, 2018 and December 31, 2017, $2.1 and $2.2 million of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

Interest is paid semi-annually, in March and September. The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the three ended March 31, 2018 and 2017 (in millions):

   
  For the three months ended
     March 31,
2018
  March 31,
2017
Interest expense   $ 0.6     $ 0.5  
Debenture fee amortization     0.1       0.1  
Total interest and financing expenses   $ 0.7     $ 0.6  
Weighted average interest rate     2.9 %      3.1 % 
Effective interest rate     3.3 %      3.6 % 
Average debt outstanding   $ 90.0     $ 65.0  
Cash paid for interest   $ 1.2     $ 1.0  

Notes Offering

On May 5, 2014, the Company closed a public offering of $25.0 million in aggregate principal amount of 6.50% notes (the “2019 Notes”), due on April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The Company redeemed all $25.0 million in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date.

The Company incurred no costs on the 2019 Notes for the three months ended March 31, 2018, and incurred interest and fee expense on the Notes of $0.5 million, of which $0.4 million was interest expense and the remainder was amortization of loan fees paid on the Notes and administration fees, for the three months ended March 31, 2017. The Company paid $0 and $0.4 million in interest expense on the 2019 Notes during the respective periods ended March 31, 2018 and 2017.

On August 21, 2017, the Company issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due September 15, 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6.4 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

The Company used all of the net proceeds from this offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of March 31, 2018 and December 31, 2017, the aggregate carrying amount of the 2022 Notes was approximately $48.9 million for both periods and the fair value of the Notes was approximately $49.1 million and $49.5 million, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1.7 million of fees which are being amortized over the term of the 2022 Notes, of which $1.5 million and $1.6 million remains to be amortized as of March 31, 2018 and December 31, 2017, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

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For the three months ended March 31, 2018, the Company incurred interest and fee expense on the 2022 Notes of $0.8 million, of which $0.7 million was interest expense and the remainder was amortization of loan fees paid on the 2022 Notes and administration fees. The Company paid $0.7 million in interest expense on the 2022 Notes during the period. The Company neither incurred nor paid any costs associated with the 2022 Notes during the three months ended March 31, 2017.

Off-Balance Sheet Arrangements

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of March 31, 2018 and December 31, 2017, our off-balance sheet arrangements consisted of unfunded commitments to provide debt financing to six and four of our portfolio companies respectively totaling $11.2 million and $8.7 million, respectively. As of March 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments (through cash on hand and available borrowings under the Credit Facility) should the need arise.

Regulated Investment Company Status and Dividends

We have elected to be treated as a RIC under Subchapter M of the Code. So long as we maintain our status as a RIC, we will not be 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 stockholders 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 until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.

To qualify for RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). If we maintain our qualification as a RIC, we must also satisfy certain distribution requirements each calendar year in order to avoid a federal excise tax on our undistributed earnings of a RIC.

We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, the covenants contained in the Credit Facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital 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, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in the Credit Facility. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.

In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder

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electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.

Recent Accounting Pronouncements

See Note 1 to the consolidated financial statements contained herein for a description of recent accounting pronouncements, if any, including the expected dates of adoption and the anticipated impact on the financial statements.

Critical Accounting Policies

See Note 1 to the consolidated financial statements contained herein for a description of critical accounting policies.

Subsequent Events

Investment Portfolio

On April 2, 2018, the Company invested $7.9 million in the first lien term loan and $0.9 million in the unfunded revolver of BFC SolmeteX LLC, a leading provider of filtration products in the U.S. and Canada. The Company also invested $1.2 million in a first lien term loan of Bonded Filter Co. LLC, a subsidiary of BFC Solmetex LLC.

On April 13, 2018, the Company invested $16.4 million in the first lien term loan and a $0.75 million in the unfunded revolver of DTE Enterprises, Inc., a provider of industrial powertrain repair and maintenance services for the oil & gas and mining sectors. Additionally, the Company invested $1.5 million in the equity of the Company.

On April 13, 2018, the Company made an additional investment of $12.5 million in the 2nd lien term loan of Mobileum, Inc., an existing portfolio company.

On April 24, 2018, the Company received full repayment of the first lien term loan of Catapult Learning, LLC for total proceeds of $12.1 million.

On April 30, 2018, the Company received full repayment of the unsecured term loan of Binder & Binder National Social Security Disability Advocates, LLC for total proceeds of $0.1 million.

On May 2, 2018, the Company invested $4.5 million in the second lien term loan of General LED OPCO, LLC, a provider of LED lighting systems and modules.

Credit Facilities

The outstanding balance under the Credit Facility as of May 4, 2018 was $66.1 million.

SBA-guaranteed Debentures

On April 25, 2018, the Company drew $40.0 million of SBA-guaranteed debentures, bringing the total balance of SBA-guaranteed Debentures outstanding to $130.0 million as of May 4, 2018.

Legislative Changes

On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

On April 4, 2018, the board of directors (the “Board”) of Stellus Capital Investment Corporation (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified

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asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective April 4, 2019 unless approved earlier by a vote of the Company’s stockholders. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act at the Company’s 2018 annual meeting of stockholders.

Dividend Declared

On April 16, 2018, the Company’s board of directors declared a regular monthly dividend for each of April, May and June 2018 as follows:

       
Declared   Ex-Dividend Date   Record Date   Payment Date   Amount
per Share
4/16/2018     4/27/2018       4/30/2018       5/15/2018     $ 0.1133  
4/16/2018     5/30/2018       5/31/2018       6/15/2018     $ 0.1133  
4/16/2018     6/28/2018       6/29/2018       7/13/2018     $ 0.1133  

Quantitative and Qualitative Disclosures About Market Risk

We are subject to financial market risks, including changes in interest rates. For the three months ended March 31, 2018 and 2017, 89% and 77% of the loans in our portfolio bore interest at floating rates, respectively. These floating rate loans typically bear interest in reference to LIBOR, which are indexed to 30-day or 90-day LIBOR rates, subject to an interest rate floor. As of March 31, 2018 and 2017, the weighted average interest rate floor on our floating rate loans was 0.94% and 0.86%, respectively.

Assuming that the Statement of Assets and Liabilities as of March 31, 2018 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, hypothetical 1% increase in LIBOR would increase our interest income approximately $3.6 million on an annualized basis. A hypothetical 1% decrease in LIBOR would decrease our interest income by $3.3 million on an annualized basis, considering interest rate floors where applicable.

Changes in interest rates will also affect our cost of funding. Our interest expense will be affected by changes in the published LIBOR rate in connection with the Credit Facility. At March 31, 2018, based on our applicable levels of our Credit Facility, a 1% increase in interest rates would decrease our annual net investment income by $1.2 million.

Although we believe 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 may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contacts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our portfolio of investments. For the three months ended March 31, 2018 and 2017, we did not engage in hedging activities.

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SENIOR SECURITIES

Information about our senior securities is shown in the following table as of March 31, 2018 and for the fiscal years ended December 31, 2017, 2016, 2015, 2014, 2013 and 2012. The report of Grant Thornton LLP, our independent registered public accountants, on the senior securities table as of December 31, 2017, is attached as an exhibit to the registration statement of which this prospectus is a part.

       
Class and Year   Total Amount
Outstanding
Exclusive of
Treasury
Securities(1)
  Asset
Coverage
per Unit(2)
  Involuntary
Liquidating
Preference
per Unit(3)
  Average
Market
Value
per Unit(4)
     (Dollars in
thousands)
SBA Debentures
                                   
Fiscal 2014   $ 16,250       N/A (6)            N/A  
Fiscal 2015     65,000       N/A (6)            N/A  
Fiscal 2016     65,000       N/A (6)            N/A  
Fiscal 2017   $ 90,000       N/A (6)            N/A  
Fiscal 2018 (through March 31, 2018)   $ 90,000       N/A (6)            N/A  
Original Credit Facility(7)
                                   
Fiscal 2012   $ 38,000     $ 3,090             N/A  
Fiscal 2013     110,000       2,470             N/A  
Fiscal 2014     106,500       2,320 (6)            N/A  
Fiscal 2015     109,500       2,220 (6)            N/A  
Fiscal 2016   $ 116,000     $ 2,210 (6)            N/A  
Credit Facility
                                   
Fiscal 2017   $ 40,750     $ 3,460 (6)             N/A  
Fiscal 2018 (through March 31, 2018)   $ 118,300     $ 2,330 (6)             N/A  
5.75% Notes due 2022                                    
Fiscal 2017   $ 48,875     $ 3,460 (6)           $ 25.34  
Fiscal 2018 (through March 31, 2018)   $ 48,875     $ 2,330 (6)           $ 25.23  
6.50% Notes due 2019(7)
                                   
Fiscal 2014   $ 25,000     $ 2,320 (6)          $ 25.41  
Fiscal 2015     25,000       2,220 (6)            25.27  
Fiscal 2016     25,000       2,210 (6)          $ 25.11  
Short-Term Loan(5)
                                   
Fiscal 2012   $ 45,000     $ 3,090             N/A  
Fiscal 2013   $ 9,000     $ 2,470             N/A  

(1) Total amount of senior securities outstanding at the end of the period presented.
(2) Asset coverage per unit is the ratio of the carrying value of our total assets, less all liabilities and indebtedness not represented by senior securities, in relation to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtedness.
(3) The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it. The “—” indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities.
(4) Average market value per unit for the Notes represents the average of the daily closing prices as reported on the NYSE during the period presented. Average market value per unit for our SBA Debentures and Credit Facility are not applicable because these are not registered for public trading.

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(5) Refers to short-term loans that the Company obtained from Raymond James and repaid in full on January 2, 2013 and January 2, 2014, respectively.
(6) We have excluded our SBA-guaranteed debentures from the asset coverage calculation as of December 31, 2017, 2016, 2015 and 2014 pursuant to the exemptive relief granted by the SEC in August 2014 that permits us to exclude such debentures from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act.
(7) Such senior securities were retired during the 2017 fiscal year.

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THE COMPANY

Stellus Capital Investment Corporation

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a BDC under the Investment Company Act of 1940, or the “1940 Act.” We originate and invest primarily in private middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, with corresponding equity co-investments. Unitranche debt is typically structured as first lien loans with certain risk characteristics of mezzanine debt. Mezzanine debt includes senior unsecured and subordinated loans.

Our investment activities are managed by our investment adviser, Stellus Capital Management, an investment advisory firm led by Robert T. Ladd and its other senior investment professionals. We source investments primarily through the extensive network of relationships that the senior investment professionals of Stellus Capital Management have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating which is often referred to as “junk.”

Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation. We seek to achieve our investment objective by:

accessing the extensive origination channels that have been developed and established by the Stellus Capital Management investment professionals that include long-standing relationships with private equity firms, commercial banks, investment banks and other financial services firms;
investing in what we believe to be companies with strong business fundamentals, generally within our core middle-market company focus;
focusing on a variety of industry sectors, including business services, energy, general industrial, government services, healthcare, software and specialty finance;
focusing primarily on directly originated transactions;
applying the disciplined underwriting standards that the Stellus Capital Management investment professionals have developed over their extensive investing careers; and
capitalizing upon the experience and resources of the Stellus Capital Management investment team to monitor our investments.

In addition, we received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We intend to co-invest, subject to the conditions included in the exemptive order we received from the SEC, with private credit funds managed by Stellus Capital Management that have an investment strategy that is identical to our investment strategy. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

As a BDC, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to continue to, finance our investments through borrowings.

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Prior to March 23, 2018, Section 61(a) of the 1940 Act (which incorporates the requirements of Sections 18(a)(1) and 18(a)(2) of the 1940 Act) did not permit a BDC to issue senior securities unless, at the time of issuance, the BDC had an Asset Coverage Ratio of at least 200%, taking into account that issuance of senior securities. However, on March 23, 2018, the SBCA was signed into law by the President. The SBCA, among other things, permits BDCs to be subject to 150% Asset Coverage, if specific conditions are satisfied, when issuing senior securities. In other words, prior to the enactment of the SBCA, a BDC could borrow $1 for investment purposes for every $1 of investor equity. Now, for those BDCs that satisfy the Act’s approval and disclosure requirements, the BDC can borrow $2 for investment purposes for every $1 of investor equity.

The SBCA provides that in order for a BDC whose common stock is traded on a national securities exchange to be subject to 150% Asset Coverage, the BDC must either obtain: (i) approval of the required majority of its non-interested directors who have no financial interest in the proposal, which would become effective on the Board Effective Date, or (ii) obtain stockholder approval (of more than 50% of the votes cast for the proposal at a meeting in which quorum is present), which would become effective on the first day after the date of such stockholder approval.

On April 4, 2018, our Board, including a majority of the non-interested directors who have no financial interest in this proposal, deemed it in the best interests of the Company and its stockholders for the Company to be subject to 150% Asset Coverage. Our Board believes that having the flexibility for the Company to incur additional leverage in certain instances is in the best interests of stockholders. In connection with this determination, our Board approved a resolution permitting the Company to be subject to 150% Asset Coverage, to be effective on the Board Effective Date, or April 4, 2019. This approval will allow us to incur twice as much debt as we could have without such approval after the 150% Asset Coverage becomes effective.

In addition, the Board also approved and recommended that stockholders vote “for” a proposal to authorize the Company to be subject to 150% Asset Coverage at our 2018 Annual Meeting, scheduled for June 28, 2018. If our stockholders approve this proposal, the reduced Asset Coverage Ratio would be effective the day after the 2018 Annual Meeting. Because we have received Board approval, if the proposal does not receive approval of the majority of the votes cast at the meeting, we will be subject to the reduced Asset Coverage Ratio beginning on April 4, 2019.

The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of our securities and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowings.

We have elected and qualified to be treated for federal income tax purposes as a regulated investment company, or “RIC,” under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders as dividends if we meet certain source-of-income, distribution and asset diversification requirements.

Our principal executive office is currently located at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, and our telephone number is (713) 292-5400. We maintain a website on the Internet at www.stelluscapital.com (under the Public Investors section). Information contained on our website is not incorporated by reference into Prospectus and you should not consider information contained on our website to be part of this Prospectus.

SBIC License

Our wholly owned subsidiary holds a license to operate as a small business investment company, or SBIC. Our wholly owned SBIC subsidiary’s SBIC license allows it to obtain leverage by issuing SBA-guaranteed debentures up to a maximum of $150 million under current SBIC regulations, subject to required capitalization of the SBIC subsidiary and other requirements. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. We believe that the SBA-guaranteed debentures are an attractive source of debt capital.

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We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the asset coverage ratio we are required to maintain under the 1940 Act. This relief allows us increased flexibility under the asset coverage test by allowing us to borrow up to $150.0 million more than we would otherwise be able to borrow absent the receipt of this exemptive relief based on regulatory capital of $75.0 million of March 31, 2018.

Portfolio Composition

Our investments generally range in size from $5.0 million to $30.0 million, and we may also selectively invest in larger positions, and we generally expect that the size of our positions will increase in proportion to the size of our capital base. Pending such investments, we may reduce our outstanding indebtedness or invest in cash, cash equivalents, U.S. government securities and other high-quality debt investments with a maturity of one year or less. In the future, we may adjust opportunistically the percentage of our assets held in various types of loans, our principal loan sources and the industries to which we have greatest exposure, based on market conditions, the credit cycle, available financing and our desired risk/return profile.

The following table provides a summary of our portfolio investments as of March 31, 2018:

 
  As of
March 31,
2018
($ in millions)
Number of investments     52  
Fair value(a)   $ 431.3  
Cost   $ 426.4  
% of portfolio at fair value – first lien debt(c)     46.2 % 
% of portfolio at fair value – second lien debt     41.2 % 
% of portfolio at fair value – mezzanine debt     6.2 % 
% of portfolio at fair value – equity     6.4 % 
Weighted-average annual yield(b)     11.1 % 

(a) As of March 31, 2018, $383.9 million of our debt investments at fair value were at floating interest rates, which represented approximately 89% of our total portfolio of debt investments at fair value. As of March 31, 2018, $47.4 million of our debt investments at fair value were at fixed interest rates, which represented approximately 11% of our total portfolio of debt investments at fair value.
(b) The weighted average yield on all of our debt investments as of March 31, 2018, was approximately 11.1%, of which approximately 10.3% was current cash interest. The weighted average yield of our debt investments on accrual is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investments, which represents the interest rate on our debt investment restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion of original issue discount. There can be no assurance that the weighted average yield will remain at their current level.
(c) Includes unitranche investments, which account for 16.1% of our portfolio investments at fair value.

Leverage

Credit Facility.   We have entered the Credit Facility. The Credit Facility provides for borrowings up to a maximum of $140.0 million on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to 195.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 1, 2021. Our obligations to the lenders are secured by a first priority security interest in its portfolio of securities

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and cash not held at the SBIC subsidiary, but excluding short term investments. As of March 31, 2018, we had approximately $118.3 million outstanding under the Credit Facility.

5.75% Notes.  On August 21, 2017, we issued $42.5 million in aggregate principal amount (the 2022 Notes) and issued an additional $6.4 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. As of March 31, 2018, we had $48.9 million of 2022 Notes outstanding.

SBA-guaranteed Debentures.  Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. As of March 31, 2018, the SBIC subsidiary had $90.0 million of SBA-guaranteed debentures outstanding.

Stellus Capital Management

Stellus Capital Management manages our investment activities and is responsible for analyzing investment opportunities, conducting research and performing due diligence on potential investments, negotiating and structuring our investments, originating prospective investments and monitoring our investments and portfolio companies on an ongoing basis.

The senior investment professionals of Stellus Capital Management have an average of over 28 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing loans and debt securities through market cycles. The Stellus Capital Management investment professionals continue to provide investment sub-advisory services to the D. E. Shaw & Co., L.P. and its associated investment funds (the “D. E. Shaw group”) with respect to an approximately $90.0 million investment portfolio (as of March 31, 2018) in middle-market companies pursuant to sub-advisory arrangements.

In addition to serving as our investment adviser and the sub-advisor to the D. E. Shaw group as noted above, Stellus Capital Management currently manages a private credit fund that has an investment strategy that is identical to our investment strategy and energy private equity funds. We received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management (other than the D. E. Shaw group funds) where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification. We will not co-invest with the energy private equity funds, as the energy private equity funds focus on predominantly equity-related investments, and we focus on predominantly credit-related investments.

Stellus Capital Management is headquartered in Houston, Texas, and also maintains offices in the Washington, D.C. area and Charlotte, North Carolina.

Market Opportunity

We originate and invest primarily in private middle-market companies through first lien, second lien, unitranche and mezzanine debt financing, with a corresponding equity co-investment. We believe the environment for investing in middle-market companies is attractive for several reasons, including:

Robust Demand for Debt Capital.  We believe that private equity firms have significant committed but uncalled capital, a large portion of which is still available for investment in the United States. We expect the large amount of uninvested capital commitments will drive buyout activity over the next several years, which should, in turn, create lending opportunities for us. In addition to increased buyout activity, a high volume of senior secured and high yield debt was originated in the calendar years 2011 through 2013 and will come due in the near term and, accordingly, we believe that new financing opportunities will increase as many companies seek to refinance this indebtedness.

Reduced Availability of Capital for Middle-Market Companies.  We believe there are fewer providers of, and less capital available for financing to middle-market companies, as compared to the time period prior to the economic downturn that began in December 2007. We believe that, as a result of that downturn, many

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financing providers have chosen to focus on large, liquid corporate loans and managing capital markets transactions rather than lending to middle-market businesses. In addition, we believe regulatory changes, including the adoption of the Dodd-Frank Act and the introduction of the international capital and liquidity requirements under the Basel III Accords, or “Basel III,” have caused banks to curtail their lending to middle-market-companies. As a result, we believe that less competition will facilitate higher quality deal flow and allow for greater selectivity throughout the investment process.

Attractive Deal Pricing and Structures.  We believe that the pricing of middle-market debt investments is higher, and the terms of such investments are more conservative, compared to larger liquid, public debt financings, due to the more limited universe of lenders as well as the highly negotiated nature of these financings. These transactions tend to offer stronger covenant packages, higher interest rates, lower leverage levels and better call protection compared to larger financings. In addition, middle-market loans typically offer other investor protections such as default penalties, lien protection, change of control provisions and information rights for lenders.

Specialized Lending Requirements.  Lending to middle-market companies requires in-depth diligence, credit expertise, restructuring experience and active portfolio management. We believe that several factors render many U.S. financial institutions ill-suited to lend to middle-market companies. For example, based on the experience of Stellus Capital Management’s investment professionals, lending to middle-market companies in the United States (a) is generally more labor intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of the information available with respect to such companies, (b) requires specialized due diligence and underwriting capabilities, and (c) may also require more extensive ongoing monitoring by the lender. We believe that, through Stellus Capital Management, we have the experience and expertise to meet these specialized lending requirements.

Competitive Strengths

We believe that the following competitive strengths will allow us to achieve positive returns for our investors:

Experienced Investment Team.  Through our investment adviser, Stellus Capital Management, we have access to the experience and expertise of the Stellus Capital Management investment team, including its senior investment professionals who have an average of over 28 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing loans and debt securities through market cycles. We believe the members of Stellus Capital Management’s investment professionals are proven and experienced, with extensive capabilities in leveraged credit investing, having participated in these markets for the predominant portion of their careers. We believe that the experience and demonstrated ability of the Stellus Capital Management investment team to complete transactions enhances the quantity and quality of investment opportunities available to us.

Established, Rigorous Investment and Monitoring Process.  The Stellus Capital Management investment professionals have developed an extensive review and credit analysis process. Each investment that is reviewed by Stellus Capital Management is brought through a structured, multi-stage approval process. In addition, Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management. Stellus Capital Management’s investment and monitoring process and the depth and experience of its investment professionals should allow it to conduct the type of due diligence and monitoring that enables it to identify and evaluate risks and opportunities.

Demonstrated Ability to Structure Investments Creatively.  Stellus Capital Management has the expertise and ability to structure investments across all levels of a company’s capital structure. Furthermore, we believe that current market conditions will allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, payment-in-kind, or “PIK,” interest or some form of equity securities.

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Resources of Stellus Capital Management Platform.  We have access to the resources and capabilities of Stellus Capital Management, which has 17 investment professionals, including Messrs. Robert T. Ladd, Dean D’Angelo, Joshua T. Davis, W. Todd Huskinson and Todd A. Overbergen, who are supported by six managing directors, two principals, two vice presidents and three analysts. These individuals have developed long-term relationships with middle-market companies, management teams, financial sponsors, lending institutions and deal intermediaries by providing flexible financing throughout the capital structure. We believe that these relationships provide us with a competitive advantage in identifying investment opportunities in our target market. We also expect to benefit from Stellus Capital Management’s due diligence, credit analysis, origination and transaction execution experience and capabilities, including the support provided with respect to those functions by Mr. Huskinson, who serves as our chief financial officer and chief compliance officer, and his staff of eight finance and operations professionals.

Investment Strategy

The Stellus Capital Management investment professionals employ an opportunistic and flexible investing approach, combined with strong risk management processes, which we believe will yield a highly diversified portfolio across companies, industries, and investment types. We seek direct origination opportunities of first lien, second lien, unitranche and mezzanine debt financing, with corresponding equity co-investments, in middle-market companies. We believe that businesses in this size range often have limited access to public financial markets, and will benefit from Stellus Capital Management’s reliable lending partnership. Many financing providers have chosen to focus on large corporate clients and managing capital markets transactions rather than lending to middle-market businesses. Further, many financial institutions and traditional lenders are faced with constrained balance sheets and are requiring existing borrowers to reduce leverage.

With an average of over 28 years of investing, corporate finance, restructuring, consulting and accounting experience, the senior investment professionals of Stellus Capital Management has demonstrated investment expertise throughout the balance sheet and in a variety of situations, including financial sponsor buyouts, growth capital, debt refinancings, balance sheet recapitalizations, rescue financings, distressed opportunities, and acquisition financings. Our investment philosophy emphasizes capital preservation through superior credit selection and risk mitigation. We expect our portfolio to provide downside protection through conservative cash flow and asset coverage requirements, priority in the capital structure and information requirements. We also anticipate benefiting from equity participation through warrants and other equity instruments structured as part of our investments. This flexible approach enables Stellus Capital Management to respond to market conditions and offer customized lending solutions.

Stellus Capital Management invests across a wide range of industries with deep expertise in select verticals including, but not limited to, business services, retail, general industrial, government services, healthcare, software and specialty finance. Our typical transactions include providing financing for leveraged buyouts, acquisitions, recapitalizations, growth opportunities, rescue financings, distressed or turnaround situations and bridge loans. We seek to maintain a diversified portfolio of investments as a method to manage risk and capitalize on specific sector trends. In addition, we intend to co-invest with private credit funds managed by Stellus Capital Management that have an identical investment strategy as us and where doing so is consistent with conditions of the exemptive order issued by the SEC.

Our objective is to act as the lead or largest investor in transactions, generally investing between $5 million and $30 million per transaction. We expect the average investment holding period to be between two and four years, depending upon portfolio company objectives and conditions in the capital markets.

We focus on middle-market companies with between $5 million and $50 million of EBITDA in a variety of industry sectors with positive long-term dynamics and dependable cash flows. We seek businesses with management teams with demonstrated track records and economic incentives in strong franchises and sustainable competitive advantages with dependable and predictable cash flows.

We employ leverage prudently and within the limitations of the applicable laws and regulations for BDCs. Any decision on our part to use leverage will depend upon our assessment of the attractiveness of available investment opportunities in relation to the costs and perceived risks of such leverage.

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Transaction Sourcing

As access to investment opportunities is highly relationship-driven, the senior investment team and other investment professionals of Stellus Capital Management spend considerable time developing and maintaining contacts with key deal sources, including private equity firms, investment banks and senior lenders. The senior investment team and other investment professionals of Stellus Capital Management have been actively investing in the middle-market for the past decade and have focused on extensive calling and marketing efforts via speaking engagements, sponsorships, industry events and referrals to broaden their relationship network. Existing relationships are constantly cultivated through transactional work and other personal contacts.

In addition to financial sponsors, Stellus Capital Management has developed a network of other deal sources, including:

management teams and entrepreneurs;
portfolio companies of private equity firms;
other investment firms that have similar strategies to Stellus Capital Management and are seeking co-investors;
placement agents and investment banks representing financial sponsors and issuers;
corporate operating advisers and other financial advisers; and
consultants, attorneys and other service providers to middle-market companies and financial sponsors.

We believe that Stellus Capital Management’s broad network of deal origination contacts will afford us with a continuous source of investment opportunities.

These origination relationships provide access not only to potential investment opportunities but also to market intelligence on trends across the credit markets. Since inception, Stellus Capital Management has completed financing transactions with more than 130 equity sponsors and completed multiple financing transactions with 29 of those equity sponsors.

We believe that, over the past decade, the senior investment team and other investment professionals of Stellus Capital Management have built a reputation as a thoughtful and disciplined provider of capital to middle-market companies and a preferred financing source for private equity sponsors and management teams. We believe these factors give Stellus Capital Management a competitive advantage in sourcing investment opportunities, which are put to use for our benefit.

Investment Structuring

Stellus Capital Management believes that each investment has unique characteristics that must be considered, understood and analyzed. Stellus Capital Management structures investment terms based on the business, the credit profile, the outlook for the industry in which a potential portfolio company operates, the competitive landscape, the products or services which the company sells and the management team and ownership of the company, among other factors. Stellus Capital Management relies upon the analysis conducted and information gathered through the investment process to evaluate the appropriate structure for our investments.

We invest primarily in the debt securities of middle-market companies. Our investments typically carry a high level of cash pay interest and may incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, PIK interest and some form of equity participation, including preferred stock, common stock, warrants and other forms of equity participation. We expect that a typical debt investment in which we invest will have a term at origination of between five and seven years. We expect to hold most of our investments to maturity or repayment, but we may sell some of our investments earlier if a liquidity event occurs, such as a sale, recapitalization or worsening of the credit quality of the portfolio company.

Stellus Capital Management negotiates covenants in connection with debt investments that provide protection for us but allow appropriate flexibility for the portfolio company. Such covenants may include

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affirmative and negative covenants, default penalties, lien protection and change of control provisions. Stellus Capital Management requires comprehensive information rights including access to management, financial statements and budgets and, in some cases, membership on the board of directors or board of directors observation rights. Additionally, Stellus Capital Management generally requires financial covenants and terms that restrict an issuer’s use of leverage and limitations on asset sales and capital expenditures.

Secured Debt

Secured debt, including first lien, second lien and unitranche financing, has liens on the assets of the borrower that serve as collateral in support of the repayment of such loans.

First Lien Debt.  First lien debt is structured with first-priority liens on the assets of the borrower that serve as collateral in support of the repayment of such loans. First lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity.

Second Lien Debt.  Second lien debt is structured as junior, secured loans, with second priority liens on an issuer’s assets. These loans typically provide for moderate loan amortization in the initial years of the loan, with the majority of the amortization deferred until loan maturity.

Unitranche Debt.  Unitranche debt typically is structured as first lien loans with certain risk characteristics of second lien debt. Unitranche debt typically provides for moderate loan amortization in the initial years of the debt, with the majority of the principal payment deferred until loan maturity. Since unitranche debt generally allows the borrower to make a large lump sum payment of principal at the end of the loan term, there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. In some cases, we will be the sole lender, or we together with our affiliates will be the sole lender, of unitranche debt, which can provide us with more influence interacting with a borrower in terms of monitoring and, if necessary, remediation in the event of underperformance.

Mezzanine Debt

Mezzanine debt, including senior unsecured and subordinated loans, is not secured by any collateral and is effectively subordinated to the borrower’s secured indebtedness (to the extent of the collateral securing such indebtedness), including pursuant to one or more intercreditor agreements that we enter into with holders of a borrower’s senior debt.

Senior Unsecured Loans.  Senior unsecured loans are structured as loans that rank senior in right of payment to any of the borrower’s unsecured indebtedness that is contractually subordinated to such loans. These loans generally provide for fixed interest rates and amortize evenly over the term of the loan. Senior unsecured loans are generally less volatile than subordinated loans due to their priority over subordinated loans.

Subordinated Loans.  Subordinated loans are structured as unsecured, subordinated loans that provide for relatively high, fixed interest rates that provide us with significant current interest income. These loans typically have interest-only payments (often representing a combination of cash pay and PIK interest) in the early years, with amortization of principal deferred to maturity. Subordinated loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. Subordinated loans are generally more volatile than secured loans and senior unsecured loans and may involve a greater risk of loss of principal as compared to other types of loans. Subordinated loans often include a PIK feature, which effectively operates as negative amortization of loan principal, thereby increasing credit risk exposure over the life of the loan.

Equity Securities

In connection with some of our debt investments, we may also invest in preferred or common stock or receive nominally priced warrants or options to buy an equity interest in the portfolio company. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure such equity investments and warrants to include provisions protecting our rights as a minority-interest holder, as well as a “put,” or right to sell such securities back to the issuer, upon the

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occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights.

Investment Process

Through the resources of Stellus Capital Management, we have access to significant research resources, experienced investment professionals, internal information systems and a credit analysis framework and investment process. Stellus Capital Management has designed a highly involved and interactive investment management process, which is the core of its culture and the basis for what we believe is a strong track record of investment returns. The investment process seeks to select only those investments which it believes have the most attractive risk/reward characteristics. The process involves several levels of review and is coordinated in an effort to identify risks in potential investments. Stellus Capital Management applies its expertise to screen our investment opportunities as described below. This rigorous process, combined with our broad origination capabilities, has allowed the Stellus Capital Management team to be prudent in selecting opportunities in which to make an investment.

All potential investment opportunities undergo an initial informal review by Stellus Capital Management’s investment professionals. Each potential investment opportunity that an investment professional determines merits consideration is presented and evaluated at a weekly meeting in which Stellus Capital Management’s investment professionals discuss the merits and risks of a potential investment opportunity as well as the due diligence process and the pricing and structure. If Stellus Capital Management’s investment professionals believe an investment opportunity merits further review, the deal team prepares and presents to the investment committee for initial review a prescreen memorandum that generally describes the potential transaction and includes a description of the risks, due diligence process and proposed structure and pricing for the proposed investment opportunity.

Prior to making an investment, Stellus Capital Management conducts rigorous diligence on each investment opportunity. In connection with its due diligence on a potential investment opportunity, Stellus Capital Management utilizes its internal diligence resources which include its internally developed credit analytical framework, subscriptions to third party research resources, discussions with industry experts, internal information sharing systems and the analytical expertise of its investment professionals. Stellus Capital Management typically reviews the company’s historical financials; industry drivers and outlook, competitive threats, customer concentration, asset coverage, projected financials and credit metrics; management background checks; and, if applicable, the track record and funding capabilities of the private equity sponsor.

Upon review of the prescreen memorandum, if the investment committee determines to proceed with the review of an investment opportunity, the deal team continues its diligence and deal structuring plans, and prepares a credit approval memorandum for review by the investment committee. The credit approval memorandum, updates the prescreen memorandum with more deal specific detail, including an update to the diligence process and any changes in the structure and pricing of the proposed investment. Upon unanimous approval by the investment committee of the proposed investment as presented in the credit approval memorandum, Stellus Capital Management’s Chief Investment Officer reviews any amendments before finalizing and closing negotiations with the prospective portfolio company.

Investment Committee

Each new investment opportunity is unanimously approved by Stellus Capital Management’s investment committee. Follow-on investments in existing portfolio companies require the investment committee’s approval beyond that obtained when the initial investment in the company was made. The purpose of Stellus Capital Management’s investment committee is to evaluate and approve all of our investments, subject at all times to the oversight and approval of our board of directors. The investment committee process is intended to bring the diverse experience and perspectives of the committee’s members to the analysis and consideration of each investment. The investment committee consists of Messrs. Ladd, D’Angelo, Davis, Overbergen and Huskinson. The investment committee serves to provide investment consistency and adherence to our core investment philosophy and policies. The investment committee also determines appropriate investment sizing and suggests ongoing monitoring requirements.

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In addition to reviewing investments, investment committee meetings serve as a forum to discuss credit views and outlooks. Potential transactions and deal flow are reviewed on a regular basis. Members of the investment team are encouraged to share information and views on credits with the investment committee early in their analysis. We believe this process improves the quality of the analysis and assists the deal team members to work more efficiently.

Each transaction is presented to the investment committee in a formal written report. All of our new investments require unanimous approval by the investment committee. Each member of the investment committee performs a similar role for other accounts managed by Stellus Capital Management. In certain instances, including in connection with co-investments under our exemptive order, approval of the Board may also be required prior to the making of an investment.

Monitoring Investments

In most cases, we do not have board influence over portfolio companies. In some instances, Stellus Capital Management’s investment professionals may obtain board representation or observation rights in conjunction with our investments. Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management. The monitoring process begins with structuring terms and conditions, which require the timely delivery and access to critical financial and business information on portfolio companies.

Specifically, Stellus Capital Management’s monitoring system consists of the following activities:

Regular Investment Committee Updates.  Key portfolio company developments are discussed each week as part of the standard investment committee meeting agenda.

Written Reports.  The deal teams provide periodic written updates as appropriate for key events that impact portfolio company performance or valuation. In addition, deal teams provide written updates following each portfolio company board meeting.

Quarterly Full Portfolio Review.  Stellus Capital Management’s Chief Investment Officer and our Chief Compliance Officer perform a quarterly comprehensive review of every portfolio company with the deal teams. This process includes a written performance and valuation update, and credit-specific discussion on each of our portfolio companies. In addition, pursuant to our valuation policy, quarterly valuations are reviewed by our independent third party valuation firm.

As part of the monitoring process, Stellus Capital Management also tracks developments in the broader marketplace. Stellus Capital Management’s investment professionals have a wealth of information on the competitive landscape, industry trends, relative valuation metrics, and analyses that assist in the execution of our investment strategy. In addition, Stellus Capital Management’s extensive communications with brokers and dealers allows its investment professionals to monitor market and industry trends that could affect portfolio investments. Stellus Capital Management may provide ongoing strategic, financial and operational guidance to some portfolio companies either directly or by recommending its investment professionals or other experienced representatives to participate on the board of directors. Stellus Capital Management maintains an extensive network of strategic and operational advisers to call upon for industry expertise or to supplement existing management teams.

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Asset Quality

In addition to various risk management and monitoring tools, Stellus Capital Management uses an investment ranking system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment ranking system uses a five-level numeric scale. The following is a description of the conditions associated with each investment category:

Investment Category 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.

Investment Category 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.

Investment Category 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.

Investment Category 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of contractual return but no loss of principal is expected.

Investment Category 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.

In the event that Stellus Capital Management determines that an investment is underperforming, or circumstances suggest that the risk associated with a particular investment has significantly increased, Stellus Capital Management will increase its monitoring intensity and prepare regular updates for the investment committee, summarizing current operating results and material impending events and suggesting recommended actions. While the investment ranking system identifies the relative risk for each investment, the ranking alone does not dictate the scope and/or frequency of any monitoring that is performed. The frequency of Stellus Capital Management’s monitoring of an investment is determined by a number of factors, including, but not limited to, the trends in the financial performance of the portfolio company, the investment structure and the type of collateral securing the investment.

Determination of Net Asset Value and Portfolio Valuation Process

The net asset value per share of our outstanding shares of common stock is determined quarterly by dividing the value of total assets minus liabilities by the total number of shares outstanding.

In calculating the value of our total assets, investment transactions will be recorded on the trade date. Realized gains or losses will be computed using the specific identification method. Investments for which market quotations are readily available are valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our board of directors based on the input of our management and audit committee. In addition, our board of directors retains one or more independent valuation firms to review at least twice annually, the valuation of each portfolio investment for which a market quotation is not readily available. We also have adopted Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurements and Disclosures, or “ASC 820.” This accounting statement requires us to assume that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the market in which we can exit portfolio investments with the greatest volume and level activity is considered our principal market.

A readily available market value is not expected to exist for most of the investments in our portfolio, and we value these portfolio investments at fair value as determined in good faith by our board of directors under our valuation policy and process. The types of factors that our board of directors may take into account in

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determining the fair value of our investments generally include, as appropriate, comparisons of financial ratios portfolio company to peer companies that are public, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, and other relevant factors.

When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we consider the pricing indicated by the external event to corroborate our valuation. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the investments may differ materially from the values that would have been used had a readily available market value existed for such investments. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently assigned.

With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:

our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals of Stellus Capital Management responsible for the portfolio investment;
preliminary valuation conclusions are then documented and discussed with our senior investment professionals and Stellus Capital Management;
at least twice annually, the valuation for each portfolio investment is reviewed by an independent valuation firm;
the audit committee of our board of directors then reviews these preliminary valuations and makes a recommendation to our board of directors; and
the board of directors then discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of Stellus Capital Management, the independent valuation firm and the audit committee.

In following these approaches, the types of factors that are taken into account in fair value pricing our investments include, as relevant, but are not limited to:

available current market data, including relevant and applicable market trading and transaction comparables;
applicable market yields and multiples;
security covenants;
call protection provisions;
information rights;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
comparisons of financial ratios of peer companies that are public;
comparable merger and acquisition transactions; and
the principal market and enterprise values.

Realization of Investments

The potential exit scenarios of a portfolio company play an important role in evaluating investment decisions. As such, Stellus Capital Management formulates specific exit strategies at the time of investment. Our debt-orientation provides for increased potential exit opportunities, including (a) the sale of investments in the private markets, (b) the refinancing of investments held, often due to maturity or recapitalizations, and

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(c) other liquidity events including the sale or merger of the portfolio company. Since we seek to maintain a debt orientation in our investments, we expect to receive interest income over the course of the investment period, resulting in a significant return on invested capital well in advance of final exit.

Derivatives

We may utilize hedging techniques such as interest rate swaps to mitigate potential interest rate risk on our indebtedness. Such interest rate swaps would principally be used to protect us against higher costs on our indebtedness resulting from increases in both short-term and long-term interest rates. We also may use various hedging and other risk management strategies to seek to manage various risks, including changes in currency exchange rates and market interest rates. Such hedging strategies would be utilized to seek to protect the value of our portfolio investments, for example, against possible adverse changes in the market value of securities held in our portfolio.

Managerial Assistance

As a BDC, we offer, and must provide upon request, managerial assistance to our portfolio companies. This assistance could involve monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. Stellus Capital Management or an affiliate of Stellus Capital Management provides such managerial assistance on our behalf to portfolio companies that request this assistance. We may receive fees for these services and will reimburse Stellus Capital Management or an affiliate of Stellus Capital Management for its allocated costs in providing such assistance, subject to the review by our board of directors, including our independent directors.

Competition

Our primary competitors in providing financing to middle-market companies include public and private funds, other BDCs, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or to the distribution and other requirements we must satisfy to maintain our qualification as a RIC.

We use the expertise of the investment professionals of Stellus Capital Management to which we have access to assess investment risks and determine appropriate pricing for our investments in portfolio companies. In addition, we believe that the relationships of the investment professionals of Stellus Capital Management enable us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in the industries in which we invest.

Employees

We do not have any direct employees, and our day-to-day investment operations are managed by Stellus Capital Management. We have a chief executive officer and president and a chief financial officer and chief compliance officer. To the extent necessary, our board of directors may hire additional personnel going forward. Our officers are employees of Stellus Capital Management and our allocable portion of the cost of our chief financial officer and chief compliance officer and his staff is paid by us pursuant to the administration agreement that we have entered into with Stellus Capital Management.

Properties

We do not own any real estate or other physical properties materially important to our operation. Our headquarters are located at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027. All locations are provided to us by Stellus Capital Management pursuant to the administration agreement. We believe that our office facilities are suitable and adequate for our business as we contemplate conducting it.

Legal Proceedings

We and Stellus Capital Management are not currently subject to any material legal proceedings.

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PORTFOLIO COMPANIES

The following table sets forth certain unaudited information as of March 31, 2018, for the portfolio companies in which we had a debt or equity investment. Other than these investments, our only formal relationships with our portfolio companies are the managerial assistance ancillary to our investments and the board observer or participation rights we may receive in connection with our investment. We do not “control” any of our portfolio companies, as defined in the 1940 Act. In general, under the 1940 Act, we would “control” a portfolio company if we owned more than 25.0% of its voting securities and would be an “affiliate” of a portfolio company if we owned 5.0% or more of its voting securities.

               
               
Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
Non-controlled, affiliated investments
                                                                       
Glori Energy Production Inc.
Productions, Inc. 4315
South Drive,
Houston, TX 77053
                                                        
Glori Energy Production Inc.     Energy: Oil & Gas       Class A Common
Shares(4)
                  1,000 shares     $ 135,519     $ 140,000       16.7 % 
Subtotal Non-controlled, affiliated investments                                                  135,519       140,000           
Non-controlled, non-affiliated investments
                                                                       
Abrasive Products & Equipment, LLC, et al
302 Deerwood Glen Dr., Deerpark, TX 77536
                                                                       
Term Loan (SBIC)     Chemicals, Plastics,
& Rubber
      Second Lien(2)(12)
      L+10.50%
with 1.00%
Libor floor
      3/5/2020     $ 5,325,237       5,277,775       5,250,000        
APE Holdings, LLC           Class A, LLC
Units(4)
                  375,000 units       375,000       130,000       0.5 % 
Total                                   5,652,775       5,380,000        
Apex Environmental Resources Holdings, LLC
11 County Road Suite 78
P. O. Box 157,
Amsterdam, OH 43903
                                                                       
Apex Environmental Resources Holdings, LLC     Environmental
Industries
      Common Units(4)
                        766 shares       766       769       4.7 % 
Apex Environmental Resources Holdings, LLC           Preferred Units(4)
                  766 shares       765,676       769,231       4.7 % 
Total                                   766,442       770,000        
Atmosphere Aggregator Holdings II, LP
2 Crossroads Dr.,
Bedminster Township,
NJ 07921
                                                                       
Atmosphere Aggregator Holdings II, LP     Services: Business       Common Units(4)
                        254,250 units       254,250       916,490       0.3 % 
Atmosphere Aggregator Holdings, LP           Common Units(4)
                  750,000 units       750,000       2,703,510       0.3 % 
Total                                   1,004,250       3,620,000        

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
ASC Communications, LLC
35 E Upper Wacker Dr, Chicago, IL 60601
                                                                       
Term Loan (SBIC)     Healthcare &
Pharmaceuticals
      First Lien(2)(12)
      L+6.25%
with 1.00%
Libor floor
      6/29/2022     $ 6,462,500     $ 6,405,939     $ 6,462,500        
ASC Communications Holdings, LLC           Class A, LLC
Units(2)(4)
                  73,529 shares       500,000       570,000       0.7 % 
Total                                   6,905,939       7,032,500        
Beneplace, LLC
9420 Research Boulevard, Echelon III Suite 100,
Austin, TX 78759
                                                                       
Term Loan (SBIC)     FIRE: Insurance       Second Lien(2)(12)
      L+10.00%
with 1.00%
Libor floor
      9/27/2022     $ 5,000,000       4,913,835       5,000,000        
Beneplace Holdings, LLC           Preferred Units(4)
                  500,000 units       500,000       510,000       0.9 % 
Total                                   5,413,835       5,510,000        
Binder & Binder National Social Security Disability Advocates, LLC
300 Rabro Drive,
Hauppauge, NY 11788
                                                        
Residual Claim From Term
Loan
    Services: Consumer       Unsecured(4)
                $ 100,000       100,000       100,000        
BW DME Acquisition, LLC
2130 East University Drive,
Tempe, AZ 85281
                                                                       
Term Loan (SBIC)     Healthcare &
Pharmaceuticals
      First Lien(2)(12)
      L+6.00%
with 1.00%
Libor floor
      8/24/2022     $ 16,695,804       16,232,009       16,610,000        
BW DME Holdings, LLC           Class A Preferred
Units(4)
                  1,937,261 shares       1,937,261       2,180,000       2.3 % 
Total                                   18,169,270       18,790,000        
C.A.R.S. Protection Plus, Inc.
                                                                       
4431 William Penn Hwy # 1,
Murrysville, PA 15668
                                                                       
Term Loan     Automotive       First Lien(12)
      L+8.50%
with .50%
floor
      12/31/2020     $ 98,746       97,546       98,746        
Term Loan (SBIC)              First Lien(2)(12)
      L+8.50%
with .50%
floor
      12/31/2020     $ 7,702,191       7,608,556       7,702,191        
CPP Holdings LLC           Class A Common
Units(4)
                  149,828 shares       149,828       210,000       1.0 % 
Total                                   7,855,930       8,010,937        
Catapult Learning, LLC et al
                                                                       
2 Aquarium Drive, Suite 100,
Camden, NJ 08103
                                                        
Term Loan     Education       First Lien(12)(13)
      L+6.50%
with 1.00%
floor
      7/16/2020     $ 12,171,053       12,107,195       12,171,053        
Colford Capital Holdings, LLC
156 W 56th St, New York, NY 10019
                                                        
CC Blocker I, LLC     Finance       Preferred
Units(4)(5)
                  38,893 units       497,388       470,000       1.0%  

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
Condor Borrower, LLC
1255 Broad Street,
Clifton, NJ 07013
                                                                       
Term Loan     Services: Business       Second Lien(12)
      L+8.75%
with 1.00%
Libor floor
      4/7/2025     $ 13,750,000     $ 13,485,438     $ 13,480,000        
Condor Top Holdco Limited              Convertible
Preferred
Shares(4)
                        500,000 shares       442,197       424,510       0.2 % 
Condor Holdings Limited           Class B Preferred
Shares(4)
                  500,000 shares       57,804       55,491       0.2 % 
Total                                   13,985,439       13,960,001        
Dream II Holdings, LLC
6501 Congress Avenue,
Suite 300,
Boca Raton, FL 33487
                                                        
Dream II Holdings, LLC     Services: Consumer       Class A Common
Units(4)
                  250,000 units       242,304       380,000       0.3 % 
Empirix Inc.
600 Technology Park Drive,
Suite 100,
Billerica, MA 01821
                                                                       
Term Loan     Software       Second Lien(12)
      L+9.50%
with 1.00%
Libor floor
      5/1/2020     $ 11,657,850       11,564,571       11,657,850        
Term Loan (SBIC)              Second Lien(2)(12)
      L+9.50%
with 1.00%
Libor floor
      5/1/2020     $ 9,750,000       9,670,117       9,750,000        
Empirix Holdings I, Inc.              Class A Common
Shares(4)
                        1,304 shares       1,304,232       772,200       1.5 % 
Empirix Holdings I, Inc.           Class B Common
Shares(4)
                  1,317,406 shares       13,174       7,800       1.5 % 
Total                                   22,552,094       22,187,850        
Energy Labs, Inc
8850 Interchange Drive, Houston, TX 77054
                                                                       
Term Loan (SBIC)     Energy: Oil & Gas       First Lien(2)(12)
      L+7.00%
with .50%
Libor floor
      9/29/2021     $ 8,548,387       8,405,123       8,548,387        
Energy Labs Holding Corp           Common
Shares(4)
                  500 shares       500,000       380,000       0.8 % 
Total                                   8,905,123       8,928,387        
EOS Fitness OPCO Holdings, LLC
15445 Metcalf,
Overland Park, KS 66223
                                                                       
Term Loan (SBIC)     Hotel, Gaming, &
Leisure
      First Lien(2)(12)
      L+8.25%
with .75%
Libor floor
      12/30/2019     $ 3,150,812       3,124,893       3,150,812        
EOS Fitness Holdings, LLC              Class A Preferred
Shares(4)
                        118 shares       117,670       243,750       0.2 % 
EOS Fitness Holdings, LLC           Class B Common
Shares(4)
                  3,017 shares       3,017       6,250       0.2 % 
Total                                   3,245,580       3,400,812  

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
Fast Growing Tree, LLC
2621 Old Nation Rd.,
Fort Mill, SC 29715
                                                                       
Term Loan (SBIC)     Retail       First Lien(2)(12)
      L+7.75%
with 1.00%
Libor floor
      2/5/2023     $ 20,500,000     $ 20,100,842     $ 20,090,000        
SP FGT Holdings, LLC           Class A Common
Shares(4)
                  1,000,000 shares       1,000,000       1,000,000       1.7 % 
Total                                   21,100,842       21,090,000        
Fumigation Holdings, Inc.
1550 E. Old 210 Highway,
Liberty, MO 64068
                                                        
Fumigation Holdings, Inc.     Chemicals, Plastics, & Rubber       Class A Common
Stock(4)
                  250 shares       0       300,000       0.5 % 
Furniture Factory Outlet, LLC
6500 Jenny Lind Rd.,
Fort Smith, AR 72908
                                                                       
Term Loan     Consumer goods:
non-durable
      First Lien(12)
      L+9.00%
with .50%
Libor floor
      6/10/2021     $ 15,405,284       15,147,399       15,405,284        
Furniture Factory Holdings, LLC Term Loan              Unsecured(11)
      11.00 %      2/3/2021     $ 122,823       122,823       122,823        
Sun Furniture Factory, LP           LP Common
Shares(4)
                  13,445 shares       94,569       150,000       1.3 % 
Total                                   15,364,791       15,678,107        
GK Holdings, Inc.
                                                                       
9000 Regency Parkway,
Suite 400,
Cary, NC 27518-8520
                                                        
Term Loan     Services: Education       Second Lien(12)
      L+10.25%
with 1.00%
Libor floor
      1/30/2022     $ 5,000,000       4,936,044       5,000,000        
Good Source Solutions, Inc.
3115 Melrose Drive, Suite 160, Carlsbad, CA 92010
                                                                       
Term Loan     Beverage, Food, &
Tobacco
      First Lien(12)(13)
      L+7.25%
with .50%
Libor floor
      7/15/2021     $ 1,350,000       1,330,576       1,350,000        
Term Loan (SBIC)              First Lien(2)(12)(13)
      L+7.25%
with .50%
Libor floor
      7/15/2021     $ 1,200,000       1,182,734       1,200,000        
Good Source Holding, LLC              Class A Preferred
Units(4)
                        159 shares       159,375       170,000       0.4 % 
Good Source Holding, LLC           Class B Common
Units(4)
                  4,482 shares       0       0       0.4 % 
Total                                   2,672,685       2,720,000        
Grupo HIMA San Pablo, Inc., et al
Pablo, Inc. P.O. Box 4980, Caguas, PR 00726
                                                                       
Term Loan     Healthcare &
Pharmaceuticals
      First Lien(12)
      L+7.00%
with 1.50%
Libor floor
      1/31/2018     $ 4,750,000       4,750,000       4,180,000        
Term Loan           Second Lien(15)
      13.75 %      7/31/2018     $ 4,109,524       4,092,160       900,000        
Total                                   8,842,160       5,080,000        

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
Hostway Corporation
100 N. Riverside, Suite 800, Chicago, IL 60606
                                                        
Term Loan     High Tech
Industries
      Second Lien(12)
      L+4.25%
with 1.25%
Libor floor
      12/13/2020     $ 6,750,000       6,685,113       6,010,000        
J.R. Watkins, LLC
101 Mission Street, Suite 1900,
San Francisco, CA 94105
                                                                       
Term Loan (SBIC)     Consumer goods:
non-durable
      First Lien(2)(12)
      L+6.50%
with 1.25%
Libor floor
      12/22/2022     $ 12,468,750     $ 12,229,560     $ 12,220,000        
J.R. Watkins Holdings, Inc.           Class A
Preferred(4)
                  1,000 shares       1,000,000       1,000,000       1.7 % 
Total                                   13,229,560       13,220,000        
ICD Intermediate Holdco 2, LLC
580 California Street, Suite 1335,
San Francisco, CA 94104
                                                                       
Term Loan (SBIC)     Finance       Second Lien(2)(12)
      L+9.00%
with 1.00%
Libor floor
      7/1/2024     $ 10,000,000       9,805,457       9,800,000        
ICD Holdings, LLC           Class A
Preferred(4)
                  9,962 shares       500,000       500,000       0.3 % 
Total                                   10,305,457       10,300,000        
Kelleyamerit Holdings, Inc.
1331 North California Blvd,
Suite 150,
Walnut Creek, CA 94596
                                                        
Term Loan     Automotive       First Lien(12)(13)
      L+7.50%
with 3.84%
Libor floor
      3/30/2023     $ 9,750,000       9,555,000       9,560,000        
Keais Records Service, LLC
1010 Lamar St #1800,
Houston, TX 77002
                                                                       
Term Loan     Services: Business       Second Lien(12)
      L+10.50%
with .50%
Libor floor
      6/30/2022     $ 7,750,000       7,642,494       7,750,000        
Keais Holding, LLC           Class A Units(4)
                  148,335 units       748,239       700,000       0.8 % 
Total                                   8,390,733       8,450,000        
KidKraft, Inc.
4630 Olin Road,
Dallas, TX 75244
                                                        
Term Loan     Consumer Goods:
Durable
      Second Lien(6)
      12.00% cash, 1.00% PIK       3/30/2022     $ 9,338,418       9,192,061       9,100,000        
Livingston International, Inc.
International, Inc. 405
The West Maill, Suite 400
Toronto, Ontario, Canada
                                                        
Term Loan     Transportation:
Cargo
      Second Lien(5)(12)
      L+8.25%
with 1.25%
Libor floor
      4/18/2020     $ 6,841,739       6,791,312       6,841,739        

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
Madison Logic, Inc.
257 Park Avenue South
5th Floor,
New York, NY 10016
                                                                       
Term Loan (SBIC)     Media:
Broadcasting and
Subscription
      First Lien(2)(12)
      L+8.00%
with 0.50%
Libor floor
      11/30/2021     $ 4,843,750       4,806,241       4,843,750        
Madison Logic Holdings, Inc. (SBIC)              Common
Stock(2)(4)
                        5,000 shares       50,000       67,000       0.8 % 
Madison Logic Holdings, Inc. (SBIC)           Series A Preferred
Stock(2)(4)
                  4,500 shares       450,000       603,000       0.8 % 
Total                                   5,306,241       5,513,750        
Magdata Intermediate Holdings, LLC
515 Congress Avenue,
Suite 1510,
Austin, TX 78701
                                                        
Term Loan     Software       Second Lien(12)
      L+9.50%
with 1.00%
Libor floor
      4/16/2024     $ 12,500,000     $ 12,261,274     $ 12,380,000        
MBS Holdings, Inc.
2700 Corporate Drive
Suite 200,
Birmingham, AL 35242
                                                                       
MBS Holdings, Inc.     Media:
Broadcasting &
Subscription
      Series E Preferred
Stock(4)
                        2,774,695 shares       1,000,000       2,734,772       0.8 % 
MBS Holdings, Inc.           Series F Preferred
Stock(4)
                  399,308 shares       206,682       565,228       0.8 % 
Total                                   1,206,682       3,300,000        
Mobileum, Inc.
2880 Lakeside Drive, Suite 135 Santa Clara, CA 95054
                                                                       
Term Loan     Software       Second Lien(12)
      L+10.25%
with 0.75%
Libor floor
      5/1/2022     $ 9,000,000       8,856,059       9,000,000        
Mobile Acquisition Holdings, LP           Class A-2
Common Units(4)
                  750 units       750,000       1,000,000       0.8 % 
Total                                   9,606,059       10,000,000        
MTC Intermediate Holdco, Inc.
2001 Spring Road, Suite 700,
Oak Brook, IL 60523
                                                        
MTC Parent, LP     Finance       Class A-2
Common Units(4)
                  750,000 shares       0       1,670,000       0.8 % 
National Trench Safety, LLC, et al
260 North Sam Houston
Pkwy E #200, Houston, TX 77060
                                                                       
Term Loan (SBIC)     Construction &
Building
      Second Lien(2)
      11.50 %      3/31/2022     $ 10,000,000       9,852,196       9,850,000        
NTS Investors, LP           Class A Common
Units(4)
                  2,335 units       500,000       340,000       0.5 % 
Total                                   10,352,196       10,190,000        
OG Systems, LLC
14291 Park Meadow Drive,
Suite 100,
Chantilly, VA 20151
                                                        
OGS Holdings, Inc.     Services:
Government
      Series A
Convertible
Preferred Stock(4)
                  11,521 shares       50,001       100,000       0.1 % 

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
Price for Profit, LLC
6140 Parkland Blvd, Suite 200, Cleveland, OH 44124
                                                                       
Term Loan (SBIC)     Services: Business       First Lien(2)(12)
      L+6.50%
with 1.00%
Libor floor
      1/31/2023     $ 11,000,000       10,786,010       10,780,000        
I2P Holdings, LLC           Series A
Preferred(4)
                  750,000 shares       750,000       750,000       1.9 % 
Total                                   11,536,010       11,530,000        
Protect America, Inc.
3800 Quick Hill Rd,
Austin, TX 78728
                                                        
Term Loan (SBIC)     Services: Consumer       Second
Lien(2)(6)(12)
      L+9.75%
with 1.00%
Libor floor
      10/30/2020     $ 17,705,875     $ 17,339,275     $ 17,530,000        
Refac Optical Group, et al
1 Harmon Drive,
Blackwood, NJ 08012
                                                                       
Revolver     Retail       First Lien(10)(12)
      L+8.00 %      9/30/2018     $ 880,000       880,000       880,000        
Term A Loan              First Lien(12)
      L+8.00 %      9/30/2018     $ 825,767       825,767       825,767        
Term B Loan           First Lien(6)(12)
      L+10.75%
cash with
1.75% PIK
      9/30/2018     $ 6,482,871       6,482,871       6,482,871        
Total                                   8,188,638       8,188,638        
Resolute Industrial, LLC
298 West Messner Drive,
Wheeling, IL 60090
                                                                       
Term Loan     Capital Equipment       First Lien(12)
      L+7.62%
with 1.00%
Libor floor
      7/26/2022     $ 3,797,222       3,738,154       3,780,000        
Term Loan (SBIC)              First Lien(2)(12)
      L+7.62%
with 1.00%
Libor floor
      7/26/2022     $ 13,290,278       13,083,499       13,220,000        
Resolute Industrial Holdings, LLC           Class A Preferred
Units(4)
                  601 units       750,000       900,000       0.9 % 
Total                                   17,571,653       17,900,000        
Roberts-Gordon, LLC
1250 William Street
P.O. Box 44,
Buffalo, NY 14240-0044
                                                                       
Term Loan     Construction &
Building
      Second Lien(12)
      L+10.00%
with 1.00%
Libor floor
      1/1/2022     $ 7,200,000       7,074,687       7,160,000        
Specified Air Solutions, LLC           Class A Common
Units(4)
                  3,846 shares       500,045       430,000       0.7 % 
Total                                   7,574,732       7,590,000        
Sitel Worldwide Corporation
Two American Center
3102 West End Avenue,
Suite 900 Nashville, TN 37203
                                                        
Term Loan     High Tech
Industries
      First Lien(12)
      L+9.50
with 1.00%
Libor floor
      9/18/2022     $ 10,000,000       9,854,786       10,000,000        
Skopos Financial, LLC
P.O. Box 143454,
Irving, TX 75014-1867
                                                                       
Term Loan     Finance       Unsecured(5)
      12.00 %      1/31/2019     $ 19,500,000       19,413,984       19,310,000        
Skopos Financial Group, LLC           Class A Units(4)(5)
                  1,120,684 units       1,162,544       730,000        
Total                                   20,576,528       20,040,000       1.1 % 

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
SPM Capital, LLC
5775 W. Old Shakopee Road, Suite 90,
Bloomington, MN 55437
                                                        
Term Loan     Healthcare &
Pharmaceuticals
      First Lien(3)
      L+6.50
with 1.00%
Libor floor
      10/31/2018     $ 5,130,946       5,130,946       5,130,946        
SQAD, LLC
303 S. Broadway, Suite 130,
Tarrytown, NY 10591
                                                                       
Term Loan (SBIC)     Media:
Broadcasting &
Subscription
      First Lien(2)(12)
      L+6.50
with 1.00%
Libor floor
      12/22/2022     $ 14,961,500     $ 14,884,999     $ 14,880,000        
SQAD Holdco, Inc. (SBIC)              Preferred Shares,
Series A(2)(4)
                        3,598 shares       156,001       257,043       2.0 % 
SQAD Holdco, Inc. (SBIC)           Common
Shares(2)(4)
                  5,800 shares       62,485       102,957       2.0 % 
Total                                   15,103,485       15,240,000        
TechInsights, Inc.
1891 Robertson Road, Suite 500, Ottawa, ON K2H 5B7 Canada
                                                        
Term Loan     High Tech
Industries
      First Lien(5)(12)(13)
      L+6.50%
with 1.00%
Libor floor
      8/16/2022     $ 20,000,000       19,549,367       19,800,000        
Time Manufacturing Acquisition, LLC
7601 Imperial Drive
P.O. Box 20368,
Waco, TX 76702-0368
                                                                       
Term Loan     Capital Equipment       Unsecured(6)
      11.50 %      8/3/2023     $ 6,385,182       6,274,450       6,320,000        
Time Manufacturing Investments, LLC           Class A Common
Units(4)
                  5,000 units       500,000       360,000       0.6 % 
Total                                   6,774,450       6,680,000        
TFH Reliability, LLC
4405 Directors Row,
Houston, TX 77092
                                                                       
Term Loan     Chemicals, Plastics
& Rubber
      Second Lien(2)(12)
      L+10.75%
with 0.50%
Libor floor
      4/21/2022     $ 5,875,000       5,780,283       5,875,000        
TFH Reliability Group, LLC           Class A Units(4)
                  250,000 shares       250,000       510,000       0.4 % 
Total                                   6,030,283       6,385,000        
U.S. Auto Sales, Inc. et al
2875 University Parkway, Lawrenceville, GA 30043
                                                                       
Term Loan     Finance       Second Lien(5)(12)
      L+10.50%
with 1.00%
Libor floor
      6/8/2020     $ 4,500,000       4,477,246       4,500,000        
USASF Blocker II, LLC              Common
Units(4)(5)
                        441 units       441,000       420,000       0.4 % 
USASF Blocker III, LLC              Common
Units(4)(5)
                        50 Units       50,000       100,000       0.4 % 
USASF Blocker LLC           Common
Units(4)(5)
                  9,000 units       9,000       10,000       0.4 % 
Total                                   4,977,246       5,030,000        

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Description   Industry   Type of
Investment
  Interest(1)   Maturity   Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value
  Percentage of
Fully Diluted
Equity Held
VRI Intermediate Holdings, LLC
1400 Commerce Center Drive, Franklin, OH 45005
                                                                       
Term Loan (SBIC)     Healthcare &
Pharmaceuticals
      Second Lien(2)(12)
      L+9.25%
with 1.00%
Libor floor
      10/31/2020     $ 9,000,000       8,857,928       8,910,000        
VRI Ultimate Holdings, LLC           Class A Preferred
Units(4)
                  326,797 shares       500,000       550,000       0.4 % 
Total                                   9,357,928       9,460,000        
Wise Holding Corporation
3676 California Ave, B100,
Salt Lake City, UT 84104
                                                                       
Term Loan     Beverage, Food, &
Tobacco
      Unsecured(12)
      L+11.00%

with 1.00%
Libor floor
      12/31/2021     $ 1,250,000     $ 1,235,911     $ 880,000        
WCI Holdings, LLC              Class A Preferred
LP/LLC Units(4)
                        56 units       55,550       0       0.1 % 
WCI Holdings, LLC           Class B LP/LLC
Common Units(4)
                  3,044 units       3,044       0       0.1 % 
Total                                   1,294,505       880,000        
Zemax, LLC
10230 NE Points Dr., Suite 540, Kirkland, WA 98033
                                                              
Term Loan (SBIC)     Software       Second Lien(2)(12)
      L+10.00%
with 1.00%
Libor floor
      4/23/2020     $ 1,900,000       1,882,745       1,900,000        
Zemax Software Holdings, LLC (SBIC)              Preferred LLC
Units(2)(4)
                        24,500 units       5,000       13,200       0.8 % 
Zemax Software Holdings, LLC (SBIC)           Common LLC
Units(2)(4)
                  5,000 shares       245,000       646,800       0.8 % 
Total                                   2,132,745       2,560,000        
Total Non-controlled, non-affiliated investments                                   426,244,352       431,159,720        
Net Investments                                   426,379,871       431,299,720        
LIABILITIES IN EXCESS OF OTHER ASSETS                                         -209,036,588        
NET ASSETS                                         222,263,132        

(1) See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2) Investments held by the SBIC subsidiary, which include $12,433,557 of cash and $196,848,571 of investments (at par) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.
(3) These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any nonqualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of March 31, 2018.
(6) Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.
(7) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8) In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s

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fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.
(9) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(10) Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.
(12) These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(15) Investment has been on non-accrual since November 1, 2017.
(16) Excluded from the investment is an undrawn commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 7.75% and a maturity of February 5, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(17) Excluded from the investment is an undrawn commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 6.50% and a maturity of January 31, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.

Abbreviation Legend

PIK — Payment-In-Kind

L — LIBOR

Euro — Euro Dollar

Set forth below is a brief description of each portfolio company in which the fair value of our investment represents greater than 5% of our total assets as of March 31, 2018.

Empirix Inc. provides customer experience and contact center assurance solutions through network testing, monitoring, analytics, and intelligence. The company was founded in 1992 and is based in Billerica, Massachusetts.

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MANAGEMENT

Board of Directors and Its Leadership Structure

Our business and affairs are managed under the direction of our Board. The Board consists of seven members, four of whom are not “interested persons” of the Company, or its affiliates as defined in Section 2(a)(19) of the 1940 Act. We refer to these individuals as our “independent directors.” The Board elects our officers, who serve at the discretion of the Board. The responsibilities of the Board include quarterly valuation of our assets, corporate governance activities, oversight of our financing arrangements and oversight of our investment activities.

Oversight of our investment activities extends to oversight of the risk management processes employed by Stellus Capital Management as part of its day-to-day management of our investment activities. The Board reviews risk management processes at both regular and special board meetings throughout the year, consulting with appropriate representatives of Stellus Capital Management as necessary and periodically requesting the production of risk management reports or presentations. The goal of the Board’s risk oversight function is to ensure that the risks associated with our investment activities are accurately identified, thoroughly investigated and responsibly addressed. Stockholders should note, however, that the Board’s oversight function cannot eliminate all risks or ensure that particular events do not adversely affect the value of investments.

The Board has established an audit committee, a compensation committee and a nominating and corporate governance committee, and may establish additional committees from time to time as necessary. The scope of the responsibilities assigned to each of these committees is discussed in greater detail below. Mr. Ladd serves as Chief Executive Officer, Chairman of the Board and a member of Stellus Capital Management’s investment committee and Messrs. D’Angelo and Davis are each a member of Stellus Capital Management’s investment committee and a member of our Board. We believe that Mr. Ladd’s history with Stellus Capital Management, his familiarity with its investment platform, and his extensive knowledge of and experience in the financial services industry qualify him to serve as the Chairman of our Board.

The Board does not have a lead independent director. We are aware of the potential conflicts that may arise when a non-independent director is Chairman of the Board, but believe these potential conflicts are offset by our strong corporate governance practices. Our corporate governance practices include regular meetings of the independent directors in executive session without the presence of interested directors and management, the establishment of an audit committee and a nominating and corporate governance committee, each of which is comprised solely of independent directors, and the appointment of a Chief Compliance Officer, with whom the independent directors meet without the presence of interested directors and other members of management, for administering our compliance policies and procedures. The Chairman of the Audit Committee or his designee will preside over the executive sessions of our independent directors.

The Board believes that its leadership structure is appropriate in light of our characteristics and circumstances because the structure allocates areas of responsibility among the individual directors and the committees in a manner that affords effective oversight. Specifically, the Board believes that the relationship of Messrs. Ladd, D’Angelo and Davis with Stellus Capital Management provides an effective bridge between the Board and management, and encourages an open dialogue between management and our Board, ensuring that these groups act with a common purpose. The Board also believes that its small size creates a highly efficient governance structure that provides ample opportunity for direct communication and interaction between our management, Stellus Capital Management and the Board.

We have adopted provisions in our articles of incorporation that divide our board into three classes. At each annual meeting, directors will be elected for staggered terms of three years (other than the initial terms, which extend for up to three years), with the term of office of only one of these three classes of directors expiring each year. Each director will hold office for the term to which he or she is elected and until his or her successor is duly elected and qualifies.

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Information regarding the board of directors is as follows:

       
Name   Year of
Birth
  Position   Director
Since
  Term
Expires
Interested Directors
                   
Robert T. Ladd   1956   Chairman, Chief Executive Officer and President   2012   2018
Dean D’Angelo   1967   Director   2012   2019
Joshua T. Davis   1972   Director   2012   2020
Independent Directors
                   
J. Tim Arnoult   1949   Director   2012   2018
Bruce R. Bilger   1952   Director   2012   2020
Paul Keglevic   1954   Director   2012   2018
William C. Repko   1949   Director   2012   2019

The address for each of our directors is c/o Stellus Capital Investment Corporation, 4400 Post Oak Parkway, Suite 2200, Houston, Texas 77027.

Executive Officers Who Are Not Directors

Information regarding our executive officers who are not directors is as follows:

   
Name   Year of
Birth
  Position
W. Todd Huskinson   1964   Chief Financial Officer, Chief Compliance Officer, Treasurer and Secretary

The address for each of our executive officers is c/o Stellus Capital Investment Corporation, 4400 Post Oak Parkway, Suite 2200, Houston, Texas 77027.

Biographical Information

The Board considered whether each of the directors is qualified to serve as a director, based on a review of the experience, qualifications, attributes and skills of each director, including those described below. The Board will also consider whether each director has significant experience in the investment or financial services industries and has held management, board or oversight positions in other companies and organizations. For the purposes of this presentation, our directors have been divided into two groups — independent directors and interested directors. Interested directors are “interested persons” as defined in the 1940 Act.

Independent Directors

J. Tim Arnoult has served as a member of our Board since 2012. Mr. Arnoult has over 35 years of banking and financial services experience. From 1979 to 2006, Mr. Arnoult served in various positions at Bank of America, including its predecessors, including president of Global Treasury Services from 2005 – 2006, president of Global Technology and Operations from 2000 to 2005, president of Central U.S. Consumer and Commercial Banking from 1996 to 2000 and president of Global Private Banking from 1991 to 1996. Mr. Arnoult is also experienced in mergers and acquisitions, having been directly involved in significant transactions such as the mergers of NationsBank and Bank of America in 1998 and Bank of America and FleetBoston in 2004. Mr. Arnoult currently serves on the board of directors of Cardtronics Inc. (NasdaqGM: CATM) and AgileCraft, LLC and has served on a variety of boards throughout his career, including the board of Visa USA before it became a public company. Mr. Arnoult holds a B.A. in Psychology and a M.B.A. from the University of Texas at Austin. We believe Mr. Arnoult’s extensive banking and financial services experience bring important and valuable skills to our Board.

Bruce R. Bilger has served as a member of our Board since 2012. Mr. Bilger has over 38 years of providing advice on mergers and acquisitions, financings, and restructurings, particularly in the energy industry. Mr. Bilger retired in March 2018 from his role as a senior advisor at Lazard Frerès & Co. LLC, a leading investment bank, where he began in January 2008 as managing director, chairman and head of Global Energy, and co-head of the

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Southwest Investment Banking region. Prior to joining Lazard Frerès & Co. LLC, Mr. Bilger was a partner at the law firm of Vinson & Elkins LLP, where he was head of its 400-plus-attorney Energy Practice Group and co-head of its 175-plus-attorney corporate and transactional practice. Mr. Bilger is or has been a board or committee member with numerous charitable and civic organizations, including the Greater Houston Partnership, the Greater Houston Community Foundation, Reasoning Mind, Positive Coaching Alliance, Texas Children’s Hospital, Asia Society Texas Center, St. Luke’s United Methodist Church, St. John’s School, Dartmouth College and the University of Virginia. Mr. Bilger graduated Phi Beta Kappa from Dartmouth College and has an M.B.A. and law degree from the University of Virginia. We believe Mr. Bilger’s extensive merger and acquisition, financing, and restructuring experience bring important and valuable skills to our Board.

Paul Keglevic has served as a member of our board of directors since 2012. Mr. Keglevic has over 40 years of experience with public companies across several industry sectors, including utilities, telecom, transportation and real estate. Mr. Keglevic currently serves as the Chief Executive Officer of Energy Future Holdings Corp., (“EFH”). Previously he served as executive vice president and chief financial officer for EFH from June 2008-October 2016. Mr. Keglevic was a partner at PricewaterhouseCoopers (“PWC”), an accounting firm, where he worked from July 2002-July 2008. At PWC he was the U.S. utility sector leader for six years and the clients and sector assurance leader for one year. Prior to PWC, Mr. Keglevic led the utilities practice for Arthur Andersen, where he was a partner for 15 years. Mr. Keglevic has served as a member of the board of directors of several subsidiaries of EFH and the Dallas and state of California Chambers of Commerce and several other charitable and advisory boards. Mr. Keglevic is an experienced board member and currently serves as an independent director on several public company boards across a variety of industries, including Bonanza Creek Energy, Inc. (NYSE: BCEI), and Clear Channel Outdoor Holdings, Inc. (NYSE: CCO), and previously served as a member of the board of directors of Cobalt International Energy, Inc. (OTCMKTS: CIEIQ). In 2011, Mr. Keglevic was named CFO of the Year by the Dallas Business Journal and received a Distinguished Alumni Award in accounting from Northern Illinois University. Mr. Keglevic received his B.S. in accounting from Northern Illinois University and is a certified public accountant. We believe Mr. Keglevic’s extensive experience with public companies and knowledge of accounting and regulatory issues brings important and valuable skills to our Board.

William C. Repko has served as a member of our Board since 2012. Mr. Repko has over 40 years of investing, finance and restructuring experience. Mr. Repko retired from Evercore Partners in February 2014, where he had served as a senior advisor, senior managing director and was a co-founder of the firm’s Restructuring and Debt Capital Markets Group since September 2005. Prior to joining Evercore Partners Inc., Mr. Repko served as chairman and head of the Restructuring Group at J.P. Morgan Chase, a leading investment banking firm, where he focused on providing comprehensive solutions to clients’ liquidity and reorganization challenges. In 1973, Mr. Repko joined Manufacturers Hanover Trust Company, a commercial bank, which after a series of mergers became part of J.P. Morgan Chase. Mr. Repko has been named to the Turnaround Management Association (TMA)-sponsored Turnaround, Restructuring and Distressed Investing industry Hall of Fame. Mr. Repko received his B.S. in Finance from Lehigh University. We believe Mr. Repko’s extensive investing, finance, and restructuring experience bring important and valuable skills to our Board.

Interested Directors

Robert T. Ladd has served as the Chairman of our Board and Chief Executive Officer and President since 2012. Mr. Ladd is the managing partner and Chief Investment Officer of Stellus Capital Management, the external investment manager of the Company. Mr. Ladd has more than 36 years of investing, finance, and restructuring experience. Prior to joining Stellus Capital Management, he had been with the D. E. Shaw group, a global investment and technology development firm, where he led the D. E. Shaw group’s Direct Capital Group from February 2004 to January 2012. Prior to joining the D. E. Shaw group, Mr. Ladd served as the president of Duke Energy North America, LLC, a merchant energy subsidiary of Duke Energy Corporation, and president and chief executive officer of Duke Capital Partners, LLC, a merchant banking subsidiary of Duke Energy Corporation, from September 2000 to February 2004. From February 1993 to September 2000, Mr. Ladd was a partner of Arthur Andersen LLP where he last served as worldwide managing partner for Arthur Andersen’s corporate restructuring practice and U.S. managing partner for that firm’s corporate finance practice. Before joining Arthur Andersen, from June 1980 to February 1993, Mr. Ladd

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served in various capacities for First City Bancorporation of Texas, Inc., a bank holding company, and its subsidiaries, including serving as president of First City Asset Servicing Company, an asset management business and executive vice president for the Texas Banking Division. He serves on the Board of Trustees of Rice University and is a board member of Rice Management Company which oversees Rice University’s endowment. He is a member of the Council of Overseers of the Jesse H. Jones Graduate School of Business of Rice University, as well as a member of the University of Texas Health Science Center Development Board and the University of Texas Medical School of Houston Advisory Council. Mr. Ladd received a B.A. in managerial studies and economics from Rice University, and an M.B.A. from The University of Texas at Austin, where he was a Sord Scholar and recipient of the Dean’s Award for Academic Achievement. We believe Mr. Ladd’s extensive investing, finance, and restructuring experience bring important and valuable skills to our Board.

Dean D’Angelo has served as a member of our Board since 2012. Mr. D’Angelo is a founding partner of Stellus Capital Management, the external investment manager of the Company, and co-head of its Private Credit strategy and serves on its investment committee. He has over 25 years of experience in investment banking and principal investing. From August 2005 to January 2012, Mr. D’Angelo was a director in the Direct Capital Group at the D. E. Shaw group, a global investment and technology development firm. Prior to joining the D. E. Shaw group, Mr. D’Angelo was a principal of Allied Capital Corporation, a publicly-traded BDC, where he focused on making debt and equity investments in middle-market companies from May 2003 to August 2005. From September 2000 to April 2003, Mr. D’Angelo served as a principal of Duke Capital Partners, LLC, a merchant banking subsidiary of Duke Energy Corporation, where he focused on providing mezzanine, equity, and senior debt financing to businesses in the energy sector. From January 1998 to September 2000, Mr. D’Angelo was a product specialist for Banc of America Securities, LLC where he provided banking services to clients principally in the energy sector. Mr. D’Angelo began his career in the bankruptcy and consulting practice of Coopers & Lybrand L.L.P. in Washington, D.C. Mr. D’Angelo received his B.B.A. in accounting from The College of William and Mary, his M.A. in international economics and relations from The Paul H. Nitze School of Advanced International Studies at The Johns Hopkins University, and his M.B.A., with a concentration in finance, from the Wharton School of the University of Pennsylvania. We believe Mr. D’Angelo’s extensive investment banking and principal investing experience bring important and valuable skills to our Board.

Joshua T. Davis has served as a member of our Board since 2012. Mr. Davis is a founding partner of Stellus Capital Management, the external investment manager of the Company and co-head of its Private Credit strategy and serves on its investment committee. He has more than 20 years of investing, finance, and restructuring experience. Prior to joining Stellus Capital Management, Mr. Davis was a director in the Direct Capital Group at the D. E. Shaw group, a global investment and technology development firm, since March 2004. Prior to joining the D. E. Shaw group, Mr. Davis served as a managing director at Milestone Merchant Partners, LLC, a boutique merchant bank from May 2003 to February 2004 and a vice president of Duke Capital Partners, LLC, a merchant banking subsidiary of Duke Energy Corporation, from May 2002 to May 2003. Mr. Davis also served as a director of Arthur Andersen LLP, a consulting firm, from May 1995 to May 2002. Mr. Davis received a B.B.A. in accounting and finance from Texas A&M University. We believe Mr. Davis’ extensive investing, finance, and restructuring experience bring important and valuable skills to our Board.

Executive Officers Who Are Not Directors

W. Todd Huskinson has served as our Chief Financial Officer, Chief Compliance Officer, Treasurer and Secretary since 2012. Mr. Huskinson is also a founding partner of Stellus Capital Management, the external investment manager of the Company. He has over 29 years of experience in finance, accounting and operations. From August 2005 to January 2012, Mr. Huskinson was a director in the D. E. Shaw group’s Direct Capital Group, a global investment and technology development firm. Prior to joining the D. E. Shaw group, Mr. Huskinson was a Managing Director at BearingPoint (formerly KPMG Consulting), a management consulting firm, where he led the Houston office’s middle-market management consulting practice from July 2002 to July 2005. Prior to BearingPoint, Mr. Huskinson was a partner of Arthur Andersen, LLP, an

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accounting firm, where he served clients in the audit, corporate finance and consulting practices from December 1987 to June 2002. Mr. Huskinson received a B.B.A in accounting from Texas A&M University and is a certified public accountant.

Board Meetings

Our Board met seven times during 2017. Each director attended at least 75% of the total number of meetings of the Board and committees on which the director served that were held while the director was a member. The Board’s standing committees are set forth below. We require each director to make a diligent effort to attend all Board and committee meetings, as well as each Annual Meeting of Stockholders. All of the Board members attended, in person or via teleconference, the Company’s 2017 Annual Meeting of Stockholders.

Audit Committee

The members of the audit committee are Messrs. Keglevic, Bilger and Repko, each of whom meets the independence standards established by the SEC and the New York Stock Exchange (the “NYSE”) for audit committees and is independent for purposes of the 1940 Act. Mr. Keglevic serves as chairman of the audit committee. Our Board has determined that Mr. Keglevic is an “audit committee financial expert” as that term is defined under Item 407 of Regulation S-K of the Securities Exchange Act of 1934, as amended. The Board has adopted a charter of the audit committee, which is available in print to any stockholder who requests it and it is also available on the Company’s website at www.stelluscapital.com (under the Public Investors section). The audit committee met six times during 2017.

The audit committee is responsible for approving our independent accountants, reviewing with our independent accountants the plans and results of the audit engagement, approving professional services provided by our independent accountants, reviewing the independence of our independent accountants and reviewing the adequacy of our internal accounting controls. The audit committee is also responsible for aiding our Board in fair value pricing debt and equity securities that are not publicly traded or for which current market values are not readily available. The Board and audit committee utilizes the services of an independent valuation firm to help them determine the fair value of these securities.

Nominating and Corporate Governance Committee

The members of the nominating and corporate governance committee are Messrs. Arnoult, Bilger and Keglevic, each of whom is independent for purposes of the 1940 Act and the NYSE corporate governance regulations. Mr. Arnoult serves as chairman of the nominating and corporate governance committee. The nominating and corporate governance committee met twice during 2017. The nominating and corporate governance committee is responsible for selecting, researching and nominating directors for election by our stockholders, selecting nominees to fill vacancies on the Board or a committee of the Board, developing and recommending to the Board a set of corporate governance principles and overseeing the evaluation of the Board and our management. The Board has adopted a charter of the nominating and corporate governance committee, which is available in print to any stockholder who requests it and it is also available on the Company’s website at www.stelluscapital.com (under the Public Investors section).

The nominating and corporate governance committee will consider nominees to the Board recommended by a stockholder if such stockholder complies with the advance notice provisions of our bylaws. Our bylaws provide that a stockholder who wishes to nominate a person for election as a director at a meeting of stockholders must deliver written notice to our corporate secretary. This notice must contain, as to each nominee, all of the information relating to such person as would be required to be disclosed in a proxy statement meeting the requirements of Regulation 14A under the Securities Exchange Act of 1934, as amended, and certain other information set forth in the bylaws. In order to be eligible to be a nominee for election as a director by a stockholder, such potential nominee must deliver to our corporate secretary a written questionnaire providing the requested information about the background and qualifications of such person, and would be in compliance with all of our publicly disclosed corporate governance, conflict of interest, confidentiality and stock ownership and trading policies and guidelines.

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The nominating and corporate governance committee seeks candidates who possess the background, skills and expertise to make a significant contribution to the Board, the Company and its stockholders. In considering possible candidates for election as a director, the nominating committee will take into account, in addition to such other factors as it deems relevant, the desirability of selecting directors who:

are of high character and integrity and have an inquiring mind, vision, a willingness to ask hard questions and the ability to work well with others;
are free of any conflict of interest that would violate applicable law or regulation or interfere with the proper performance of the responsibilities of a director;
are willing and able to devote sufficient time to the affairs of the Company and be diligent in fulfilling the responsibilities of a member of the Board of Directors and a member of any committees thereof (including developing and maintaining sufficient knowledge of the Company and the specialty finance industry in general; reviewing and analyzing reports and other information important to responsibilities of the Board of Directors and any committee thereof; preparing for, attending and participating in meetings of the Board of Directors and meetings of any committee thereof; and satisfying appropriate orientation and continuing education guidelines); and
have the capacity and desire to represent the balanced, best interests of the stockholders of the Company as a whole and not primarily a special interest group or constituency.

The nominating and corporate governance committee has not adopted a formal policy with regard to the consideration of diversity in identifying individuals for election as members of the Board, but the committee will consider such factors as it may deem are in our best interests and those of our stockholders. Those factors may include a person’s differences of viewpoint, professional experience, education and skills, as well as his or her race, gender and national origin. In addition, as part of the board’s annual self-assessment, the members of the nominating and corporate governance committee will evaluate the membership of the Board and whether the board maintains satisfactory policies regarding membership selection.

Compensation Committee

The members of the Compensation Committee are Messrs. Repko, Bilger and Arnoult, each of whom is independent for purposes of the 1940 Act and the NYSE corporate governance regulations. Mr. Repko serves as chairman of the Compensation Committee. The compensation committee met twice during 2017. The compensation committee is responsible for overseeing our compensation policies generally and making recommendations to the Board with respect to evaluating executive officer performance, overseeing and setting compensation for our directors and, as applicable, our executive officers and, as applicable, preparing the report on executive officer compensation that SEC rules require to be included in our annual proxy statement. Currently, none of our executive officers is compensated by us and as such the compensation committee is not required to produce a report on executive officer compensation for inclusion in our annual proxy statement.

The compensation committee has the sole authority to retain and terminate any compensation consultant assisting the compensation committee, including sole authority to approve all such compensation consultants’ fees and other retention terms. The compensation committee may delegate its authority to subcommittees or the chairman of the compensation committee when it deems appropriate and in our best interests. The Board has adopted a charter of the compensation committee, which is available in print to any stockholder who requests it and it is also available on the Company’s website at www.stelluscapital.com (under the Public Investors section).

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Compensation of Directors

The following table shows information regarding the compensation received by our independent directors for the calendar year ending December 31, 2017. No compensation is paid to directors who are “interested persons” for their service as directors.

   
Name   Aggregate Cash
Compensation from
Stellus Capital
Investment Company(1)
  Total Compensation from
Stellus Capital
Investment Company
Paid to Director(1)
Interested Directors
                 
Robert T. Ladd   $     —     $     —  
Dean D’Angelo   $     —     $     —  
Joshua T. Davis   $     —     $     —  
Independent Directors
                 
J. Tim Arnoult   $ 80,000     $ 80,000  
Bruce R. Bilger   $ 80,000     $ 80,000  
Paul Keglevic   $ 88,000     $ 88,000  
William C. Repko   $ 83,000     $ 83,000  

(1) For a discussion of the independent directors’ compensation, see below. We do not have a profit-sharing or retirement plan, and directors do not receive any pension or retirement benefits.

The independent directors receive an annual fee of $55,000. They also receive $2,500 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending in person or telephonically each regular Board meeting and each special telephonic Board meeting. They also receive $1,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with each committee meeting attended in person and each telephonic committee meeting. The chairmen of the audit committee, the compensation committee and the nominating and corporate governance committee receive an annual fee of $10,000, $5,000 and $5,000, respectively. We have obtained directors’ and officers’ liability insurance on behalf of our directors and officers. Independent directors have the option of having their directors’ fees paid in shares of our common stock issued at a price per share equal to the greater of NAV per share or the market price at the time of payment. No compensation is paid to directors who are “interested persons.”

Corporate Governance

Corporate Governance Documents

We maintain a corporate governance webpage at the “Corporate Governance” link under the “Stellus Capital Investment Corporation” link at www.stelluscapital.com (under the Public Investors section).

Our Corporate Governance Policy, Code of Business Conduct, Code of Ethics and Board committee charters are available at our corporate governance webpage at www.stelluscapital.com (under the Public Investors section) and are also available to any stockholder who requests them by writing to our Secretary, W. Todd Huskinson, at Stellus Capital Investment Corporation, 4400 Post Oak Parkway, Suite 2200, Houston, Texas 77027.

Director Independence

In accordance with rules of the NYSE, the Board annually determines the independence of each director. No director is considered independent unless the Board has determined that he or she has no material relationship with the Company. The Company monitors the status of its directors and officers through the activities of the Company’s Nominating and Corporate Governance Committee and through a questionnaire to be completed by each director no less frequently than annually, with updates periodically if information provided in the most recent questionnaire has changed.

In order to evaluate the materiality of any such relationship, the Board uses the definition of director independence set forth in the NYSE Listed Company Manual. Section 303A.00 of the NYSE Listed Company Manual provides that BDCs, such as the Company, are required to comply with all of the provisions of

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Section 303A applicable to domestic issuers other than Sections 303A.02, the section that defines director independence. Section 303A.00 provides that a director of a BDC shall be considered to be independent if he or she is not an “interested person” of the Company, as defined in Section 2(a)(19) of the 1940 Act. Section 2(a)(19) of the 1940 Act defines an “interested person” to include, among other things, any person who has, or within the last two years had, a material business or professional relationship with the Company.

The Board has determined that each of the directors is independent and has no relationship with the Company, except as a director and stockholder of the Company, with the exception of Messrs. Ladd, D’Angelo and Davis, who are interested persons of the Company due to their positions as officers of the Company and/or Stellus Capital Management, our external investment manager.

Annual Evaluation

Our directors perform an evaluation, at least annually, of the effectiveness of the Board and its committees. This evaluation may include a questionnaire and/or Board and committee discussion.

Communication with the Board

We believe that communications between our Board, our stockholders and other interested parties are an important part of our corporate governance process. Stockholders with questions about the Company are encouraged to contact our Secretary, W. Todd Huskinson, at (713) 292-5400. However, if stockholders believe that their questions have not been addressed, they may communicate with the Company’s Board by sending their communications to Stellus Capital Investment Corporation, 4400 Post Oak Parkway, Suite 2200, Houston, Texas 77027, Attn.: Board of Directors. All stockholder communications received in this manner will be delivered to one or more members of the Board.

All communications involving accounting, internal accounting controls and auditing matters, possible violations of, or non-compliance with, applicable legal and regulatory requirements or policies, or retaliatory acts against anyone who makes such a complaint or assists in the investigation of such a complaint, will be referred to our Audit Committee.

The acceptance and forwarding of a communication to any director does not imply that the director owes or assumes any fiduciary duty to the person submitting the communication, all such duties being only as prescribed by applicable law.

Code of Business Conduct and Ethics

Our code of ethics, which is signed by directors and executive officers of the Company, requires that directors and executive officers avoid any conflict, or the appearance of a conflict, between an individual’s personal interests and the interests of the Company. Pursuant to the code of ethics which is available on our website under the “Corporate Governance” link under the “Stellus Capital Investment Corporation” link at www.stelluscapital.com (under the Public Investors section), each director and executive officer must disclose any conflicts of interest, or actions or relationships that might give rise to a conflict, to the Audit Committee. Certain actions or relationships that might give rise to a conflict of interest are reviewed and approved by the Board.

Compensation Committee Interlocks and Insider Participation

All members of the Compensation Committee are independent directors and none of the members are present or past employees of the Company. No member of the Compensation Committee: (i) has had any relationship with the Company requiring disclosure under Item 404 of Regulation S-K under the Securities Exchange Act of 1934, as amended; or (ii) is an executive officer of another entity, at which one of our executive officers serves on the Board.

Investment Committee

The investment committee of Stellus Capital Management meets regularly to consider our investments, direct our strategic initiatives and supervise the actions taken by Stellus Capital Management on our behalf. In addition, the investment committee reviews and determines by unanimous vote whether to make prospective investments identified by Stellus Capital Management and monitors the performance of our investment

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portfolio. Stellus Capital Management’s investment committee consists of Messrs. Ladd, D’Angelo, Davis, Overbergen and Huskinson. Stellus Capital Management may, however, increase the size of its investment committee from time to time.

Information regarding the member of Stellus Capital Management’s investment committee who is not also a director or executive officer is as follows:

Todd A. Overbergen is a founding partner of Stellus Capital Management and head of the Energy Private Equity strategy. He has more than 23 years of investing, finance, and restructuring experience. Prior to joining Stellus Capital Management, Mr. Overbergen served as a director in the Direct Capital Group of the D. E. Shaw group, a global investment and technology development firm, since February 2004. Prior to joining the D. E. Shaw group, Mr. Overbergen was a founding principal of Duke Capital Partners, LLC, a merchant banking subsidiary of Duke Energy Corporation, from December 2000 to April 2003. From 1998 to December 2000, Mr. Overbergen was a director in Arthur Andersen LLP’s Global Corporate Finance group. Mr. Overbergen received a B.B.A. in accounting and finance from Texas A&M University.

Portfolio Management

Each investment opportunity requires the unanimous approval of Stellus Capital Management’s investment committee, which is comprised of Messrs. Ladd, D’Angelo, Davis, Huskinson and Overbergen. Follow-on investments in existing portfolio companies require the investment committee’s approval beyond that obtained when the initial investment in the company was made. In addition, temporary investments, such as those in cash equivalents, U.S. government securities and other high quality debt investments that mature in one year or less, may require approval by the investment committee. The day-to-day management of investments approved by the investment committee is overseen by Messrs. D’Angelo and Davis. Biographical information with respect to Messrs. D’Angelo and Davis is set out under “— Biographical Information.”

The members of our investment committee receive compensation by Stellus Capital Management that may include an annual base salary, an annual individual performance bonus, contributions to 401(k) plans, and a portion of the incentive fee or carried interest earned in connection with their services.

Each of Messrs. Ladd, D’Angelo, Davis, Huskinson and Overbergen has a direct ownership and financial interests in, and may receive compensation and/or profit distributions from, Stellus Capital Management. None of Messrs. Ladd, D’Angelo, Davis, Overbergen and Huskinson receives any direct compensation from us. Messrs. Ladd, D’Angelo, Davis, Overbergen and Huskinson are also primarily responsible for the day-to-day management of other pooled investment vehicles and other accounts in which their affiliates receive incentive fees. See “Related Party Transactions and Certain Relationships.”

The table below shows the dollar range of shares of our common stock to be beneficially owned by the members of the Investment Committee and our investment team.

 
Name of Portfolio Manager/Investment Support Team   Dollar Range of Equity
Securities Beneficially
Owned(1)(2)(3)
Robert T. Ladd     over $1,000,000  
Joshua T. Davis     over $1,000,000  
Dean D’Angelo     over $1,000,000  
W. Todd Huskinson   $ 100,001 – $500,000  
Todd A. Overbergen   $ 100,001 – $500,000  

(1) Beneficial ownership has been determined in accordance with Rule 16a-1(a)(2) of the Securities Exchange Act of 1934, or the “Exchange Act.”
(2) The dollar range of equity securities beneficially owned in us is based on the closing price for our common stock of $13.22 on June 25, 2018 on the NYSE.
(3) The dollar range of equity securities beneficially owned are: none, $1 – $10,000, $10,001 – $50,000, $50,001 – $100,000, $100,001 – $500,000, $500,001 – $1,000,000, or over $1,000,000.

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MANAGEMENT AGREEMENTS

Stellus Capital Management serves as our investment adviser and is registered as an investment adviser under the Investment Advisers Act of 1940 as amended, or the Advisers Act.

Investment Advisory Agreement

Subject to the overall supervision of our board of directors and in accordance with the 1940 Act, Stellus Capital Management manages our day-to-day operations and provides investment advisory services to us. Under the terms of the investment advisory agreement, Stellus Capital Management:

determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;
identifies, evaluates and negotiates the structure of the investments we make;
executes, closes, services and monitors the investments we make;
determines the securities and other assets that we will purchase, retain or sell;
performs due diligence on prospective portfolio companies; and
provides us with such other investment advisory, research and related services as we may, from time to time, reasonably require for the investment of our funds.

Pursuant to the investment advisory agreement, we have agreed to pay Stellus Capital Management a fee for investment advisory and management services consisting of two components — a base management fee and an incentive fee. The cost of both the base management fee and the incentive fee is ultimately be borne by our stockholders.

Management Fee

The base management fee is calculated at an annual rate of 1.75% of our gross assets, including assets purchased with borrowed funds or other forms of leverage (including preferred stock, public and private debt issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and excluding cash and cash equivalents. For services rendered under the investment advisory agreement, the base management fee is payable quarterly in arrears. The base management fee is calculated based on the average value of our gross assets, excluding cash and cash equivalents, at the end of the two most recently completed calendar quarters. Base management fees for any partial month or quarter are appropriately pro-rated.

Incentive Fee

We pay Stellus Capital Management an incentive fee. Incentive fees are calculated as below and payable quarterly in arrears. The incentive fee, which provides Stellus Capital Management with a share of the income that it generates for us, has two components, ordinary income and capital gains, calculated as follows:

The ordinary income component is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a total return requirement, and deferral of non-cash amounts, and is 20.0% of the amount, if any, by which our pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets attributable to our common stock, for the immediately preceding calendar quarter, exceeds a 2.0% hurdle rate and a “catch-up” provision, for the benefit of Stellus Capital Management, measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, Stellus Capital Management receives no incentive fee until our pre-incentive fee net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%.

The effect of the “catch-up” provision is that, subject to the total return provision discussed below, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, Stellus Capital Management receives 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial

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assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement (as described below), and any interest expense and any distributions paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income will be payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter will be limited to the lesser of (i) 20.0% of the amount by which our pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20.0% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding calendar quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters.

For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the portion of such incentive fee that is attributable to deferred interest (such as PIK interest or OID) will be paid to Stellus Capital Management, without any interest thereon, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such amounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possible elimination of the incentive fees for such quarter. There is no accumulation of amounts on the hurdle rate from quarter to quarter, and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle, and there is no delay of payment if prior quarters are below the quarterly hurdle. Stellus Capital Management has agreed to permanently waive any interest accrued on the portion of the incentive fee attributable to deferred interest (such as PIK interest or OID).

Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where we incur a loss, subject to the total return requirement. For example, if we receive pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, we will pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized and unrealized capital losses. Our net investment income used to calculate this component of the incentive fee is also included in the amount of our gross assets used to calculate the 1.75% base management fee. These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter.

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The following is a graphical representation of the calculation of the income-related portion of the incentive fee:

Quarterly Incentive Fee Based on Net Investment Income
Pre-Incentive Fee Net Investment Income
(expressed as a percentage of the value of net assets)

[GRAPHIC MISSING]

Percentage of Pre-incentive Fee Net Investment Income
Allocated to Income-Related Portion of Incentive Fee

The capital gains component of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement, as of the termination date), is equal to 20.0% of our cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid capital gains incentive fees. If such amount is negative, then no capital gains incentive fee will be payable for such year. Additionally, if the investment advisory agreement is terminated as of a date that is not a calendar year end, the termination date will be treated as though it were a calendar year end for purposes of calculating and paying the capital gains incentive fee.

Examples of Quarterly Incentive Fee Calculation

Example 1: Income Related Portion of Incentive Fee before Total Return Requirement Calculation:

Alternative 1

Assumptions

Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses)) = 0.6125%
Pre-incentive fee net investment income does not exceed hurdle rate, therefore there is no income-related incentive fee.

Alternative 2

Assumptions

Investment income (including interest, dividends, fees, etc.) = 2.9%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses)) = 2.2625%
Incentive fee = 100% × Pre-incentive fee net investment income (subject to “catch-up”)(4)
= 100% × (2.2625% - 2.0%)
= 0.2625%
Pre-incentive fee net investment income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision, therefore the income related portion of the incentive fee is 0.2625%.

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Alternative 3

Assumptions

Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income (investment income – (management fee + other expenses)) = 2.8625%
Incentive fee = 100% × Pre-incentive fee net investment income (subject to “catch-up”)(4)
Incentive fee = 100% × “catch-up” + (20.0% × (Pre-Incentive Fee Net Investment Income – 2.5%))
“Catch-up” = 2.5% – 2.0%

= 0.5%

Incentive fee = (100% × 0.5%) + (20.0% × (2.8625% – 2.5%))

= 0.5% + (20.0% × 0.3625%)
= 0.5% + 0.0725%
= 0.5725%

Pre-incentive fee net investment income exceeds the hurdle rate, and fully satisfies the “catch-up” provision, therefore the income related portion of the incentive fee is 0.5725%.

(1) Represents 8.0% annualized hurdle rate.
(2) Represents 1.75% annualized base management fee.
(3) Excludes organizational and offering expenses.
(4) The “catch-up” provision is intended to provide Stellus Capital Management with an incentive fee of 20.0% on all pre-incentive fee net investment income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter.

Example 2: Income Portion of Incentive Fee with Total Return Requirement Calculation:

Alternative 1:

Assumptions

Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar
quarters = $9,000,000
20.0% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $8,000,000

Although our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% (as shown in Alternative 3 of Example 1 above), no incentive fee is payable because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters did not exceed the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters.

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Alternative 2:

Assumptions

Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.2%
Pre-incentive fee net investment income
(investment income – (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar
quarters = $9,000,000
20.0% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $10,000,000

Because our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% and because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters, an incentive fee would be payable, as shown in Alternative 3 of Example 1 above.

(1) Represents 8.0% annualized hurdle rate.
(2) Represents 1.75% annualized base management fee.
(3) Excludes organizational and offering expenses.
(4) The “catch-up” provision is intended to provide Stellus Capital Management with an incentive fee of 20.0% on all pre-incentive fee net investment income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter.

Example 3: Capital Gains Portion of Incentive Fee(*):

Alternative 1:

Assumptions

Year 1: $2.0 million investment made in Company A (“Investment A”), and $3.0 million investment made in Company B (“Investment B”)

Year 2: Investment A sold for $5.0 million and fair market value (“FMV”) of Investment B determined to be $3.5 million

Year 3: FMV of Investment B determined to be $2.0 million

Year 4: Investment B sold for $3.25 million

The capital gains portion of the incentive fee would be:

Year 1: None

Year 2: Capital gains incentive fee of $0.6 million – ($3.0 million realized capital gains on sale of Investment A multiplied by 20.0%)

Year 3: None – $0.4 million (20.0% multiplied by ($3.0 million cumulative capital gains less $1.0 million cumulative capital depreciation)) less $0.6 million (previous capital gains fee paid in Year 2)

Year 4: Capital gains incentive fee of $50,000 – $0.65 million ($3.25 million cumulative realized capital gains multiplied by 20.0%) less $0.6 million (capital gains incentive fee taken in Year 2)

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Alternative 2

Assumptions

Year 1: $2.0 million investment made in Company A (“Investment A”), $5.25 million investment made in Company B (“Investment B”) and $4.5 million investment made in Company C (“Investment C”)

Year 2: Investment A sold for $4.5 million, FMV of Investment B determined to be $4.75 million and FMV of Investment C determined to be $4.5 million

Year 3: FMV of Investment B determined to be $5.0 million and Investment C sold for $5.5 million

Year 4: FMV of Investment B determined to be $6.0 million

Year 5: Investment B sold for $4.0 million

The capital gains incentive fee, if any, would be:

Year 1: None

Year 2: $0.4 million capital gains incentive fee – 20.0% multiplied by $2.0 million ($2.5 million realized capital gains on Investment A less $0.5 million unrealized capital depreciation on Investment B)

Year 3: $0.25 million capital gains incentive fee(1) – $0.65 million (20.0% multiplied by $3.25 million ($3.5 million cumulative realized capital gains less $0.25 million unrealized capital depreciation)) less $0.4 million capital gains incentive fee received in Year 2

Year 4: $0.05 million capital gains incentive fee – $0.7 million ($3.50 million cumulative realized capital gains multiplied by 20.0%) less $0.65 million cumulative capital gains incentive fee paid in Year 2 and Year 3

Year 5: None – $0.45 million (20.0% multiplied by $2.25 million (cumulative realized capital gains of $3.5 million less realized capital losses of $1.25 million)) less $0.7 million cumulative capital gains incentive fee paid in Year 2, Year 3 and Year 4(2)

* The hypothetical amounts of returns shown are based on a percentage of our total net assets and assume no leverage. There is no guarantee that positive returns will be realized and actual returns may vary from those shown in this example.
(1) As illustrated in Year 3 of Alternative 1 above, if a portfolio company were to be wound up on a date other than its fiscal year end of any year, it may have paid aggregate capital gains incentive fees that are more than the amount of such fees that would be payable if such portfolio company had been wound up on its fiscal year end of such year.
(2) As noted above, it is possible that the cumulative aggregate capital gains fee received by Stellus Capital Management ($0.70 million) is effectively greater than $0.45 million (20.0% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($2.25 million)).

Payment of Our Expenses

All investment professionals of Stellus Capital Management, when and to the extent engaged in providing investment advisory and management services to us, and the compensation and routine overhead expenses of personnel allocable to these services to us, are provided and paid for by Stellus Capital Management and not by us. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without limitation, those relating to:

organization and offering;
calculating our net asset value (including the cost and expenses of any independent valuation firm);
fees and expenses payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments;

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interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts;
offerings of our common stock and other securities;
base management and incentive fees;
administration fees and expenses, if any, payable under the administration agreement (including our allocable portion of Stellus Capital Management’s overhead in performing its obligations under the administration agreement, including rent and the allocable portion of the cost of our chief compliance officer, chief financial officer and their respective staffs);
transfer agent, dividend agent and custodial fees and expenses;
U.S. federal and state registration fees;
all costs of registration and listing our shares on any securities exchange;
U.S. federal, state and local taxes;
independent directors’ fees and expenses;
costs of preparing and filing reports or other documents required by the SEC or other regulators;
costs of any reports, proxy statements or other notices to stockholders, including printing costs;
costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs;
proxy voting expenses; and
all other expenses incurred by us or Stellus Capital Management in connection with administering our business.

Duration and Termination

Unless terminated earlier as described below, the investment advisory agreement will continue in effect from year to year if approved annually by our board of directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, and, in either case, if also approved by a majority of our directors who are not “interested persons.” The investment advisory agreement automatically terminates in the event of its assignment, as defined in the 1940 Act, by Stellus Capital Management and may be terminated by either party without penalty upon 60 days’ written notice to the other. The holders of a majority of our outstanding voting securities may also terminate the investment advisory agreement without penalty upon 60 days’ written notice. See “Risk Factors — Risks Relating to our Business and Structure.” We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.

Indemnification

The investment advisory agreement provides that Stellus Capital Management and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital Management’s services under the investment advisory agreement or otherwise as our investment adviser. Our obligation to provide indemnification under the investment advisory agreement, however, is limited by the 1940 Act and Investment Company Act Release No. 11330, which, among other things, prohibit us from indemnifying any director, officer or other individual from any liability resulting directly from the willful misconduct, bad faith, gross negligence in the performance of duties or reckless disregard of applicable obligations and duties of the directors, officers or other individuals and require us to set forth reasonable and fair means for determining whether indemnification shall be made.

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Board Approval of the Investment Advisory Agreement

Our board of directors, including a majority of our independent directors, approved the investment advisory agreement at its first meeting, held on September 24, 2012, and most recently approved the annual continuation of the investment advisory agreement on January 11, 2018. In its consideration of the investment advisory agreement, the board of directors focused on information it had received relating to, among other things: (a) the nature, quality and extent of the advisory and other services to be provided to us by our investment adviser; (b) comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment objectives; (c) our projected operating expenses and expense ratio compared to BDCs with similar investment objectives; (d) any existing and potential sources of indirect income to our investment adviser from its relationships with us and the profitability of those relationships; (e) information about the services to be performed and the personnel performing such services under the investment advisory agreement; (f) the organizational capability and financial condition of our investment adviser; and (g) various other factors.

In voting to approve the investment advisory agreement, our board of directors, including all of the directors who are not “interested persons,” of the Company, made the following conclusions:

Nature, Extent and Quality of Services. Our board of directors considered the nature, extent and quality of the advisory and other services to be provided by Stellus Capital Management, including the investment performance of Stellus Capital Management’s investment team. Our board of directors also considered the investment selection process expected to be employed by Stellus Capital Management, including the flow of transaction opportunities resulting from its investment team’s significant experience in originating, structuring and managing loans and debt securities through market cycles; the employment of Stellus Capital Management’s investment strategy, rigorous due diligence process, investment structuring, and ongoing relationships with and monitoring of portfolio companies, in light of the investment objective of the Company. Our board of directors also considered Stellus Capital Management’s personnel and their prior experience in connection with the types of investments made by us, including such personnel’s corporate relationships and relationships with private equity firms, investment banks, restructuring advisors, law firms, boutique advisory firms and distressed/specialty lenders. In addition, our board of directors considered the other terms and conditions of the investment advisory agreement, including the fact that we have the ability to terminate the investment advisory agreement without penalty upon 60 days’ notice to Stellus Capital Management. As a result, our board of directors determined that the substantive terms of the investment advisory agreement (other than the fees payable thereunder, which our board of directors reviewed separately), including the services to be provided, are similar to those of comparable BDCs described in the available market data and in the best interests of our stockholders. Moreover, our board of directors concluded that although the substantive terms of the Investment Advisory Agreement, including the services to be provided, are generally the same as those of comparable BDCs described in the market data then available, it would be difficult to obtain similar services from other third-party service providers in light of the nature, quality and extent of the advisory and other services provided to us by Stellus Capital Management.
Projected Costs of the Services Provided to the Company. Our board of directors considered (i) comparative data based on publicly available information with respect to services rendered and the advisory fees (including the base management fee and incentive fees) of other externally managed BDCs that invest in similar securities, our total expenses, and expense ratios compared to other BDCs of similar size and with similar investment objectives and (ii) the administrative services that Stellus Capital Management will provide to us at cost pursuant to the administration agreement. Based upon its review, our board of directors concluded that the fees to be paid under the investment advisory agreement are generally comparable to or more favorable than those payable under agreements of comparable BDCs and reasonable in relation to the services expected to be provided by Stellus Capital Management.
Projected Profitability of Stellus Capital Management. Our board of directors considered information about Stellus Capital Management, including the anticipated costs of the services to be

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provided by Stellus Capital Management and the anticipated profits to be realized by it, including as a result of our investment performance, which would generally be equal or similar to the profitability of investment advisers managing comparable BDCs. Our board of directors reviewed our investment performance, as well as comparative data with respect to the investment performance of other externally-managed BDCs, as it relates to the management and incentive fees we pay Stellus Capital Management. As a result of this review, our board of directors determined that our investment performance supported the renewal of the investment advisory agreement.
Economies of Scale. Our board of directors considered the extent to which economies of scale would be realized as the Company grows, and whether the fees payable under the investment advisory agreement reflect these economies of scale for the benefit of the our stockholders. Taking into account such information, our board of directors determined that the advisory fee structure under the investment advisory agreement was reasonable with respect to any economies of scale that may be realized as the Company grows.
Limited Potential for Additional Benefits Derived by Stellus Capital Management. Our board of directors considered existing and potential sources of indirect income Stellus Capital Management would receive as a result of the relationship with us, and whether there would be potential for additional benefits to be derived by Stellus Capital Management as a result of our relationship, and was advised any such potential would be limited.

Conclusions. In view of the wide variety of factors that our board of directors considered in connection with its evaluation of the investment advisory agreement, it is not practical to quantify, rank or otherwise assign relative weights to the specific factors it considered in reaching its decision. Our board of directors did not undertake to make any specific determination as to whether any particular factor, or any aspect of any particular factor, was favorable or unfavorable to the ultimate determination of our board of directors. Rather, our board of directors based its approval on the totality of information presented to, and the investigation conducted by, it. In considering the factors discussed above, individual directors may have given different weights to different factors.

Based on the information reviewed and the discussions, the board of directors, including a majority of the non-interested directors, concluded that the investment management fee rates and terms are reasonable in relation to the services to be provided and approved the investment advisory agreement as being in the best interests of our stockholders.

Administration Agreement

Under the administration agreement, Stellus Capital Management furnishes us with office facilities and equipment and will provide us with clerical, bookkeeping, recordkeeping and other administrative services at such facilities. Stellus Capital Management also performs, or oversees the performance of, our required administrative services, which include being responsible for the financial and other records that we are required to maintain and preparing reports to our stockholders and reports and other materials filed with the SEC. In addition, Stellus Capital Management assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports and other materials to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the administration agreement, Stellus Capital Management also provides managerial assistance on our behalf to those portfolio companies that have accepted our offer to provide such assistance.

Payments under the administration agreement are equal to an amount based upon our allocable portion (subject to the review of our board of directors) of Stellus Capital Management’s overhead in performing its obligations under the administration agreement, including rent, the fees and expenses associated with performing compliance functions and our allocable portion of the cost of our chief financial officer and chief compliance officer and their respective staffs. In addition, if requested to provide significant managerial assistance to our portfolio companies, Stellus Capital Management will be paid an additional amount based on the services provided, which shall not exceed the amount we receive from such portfolio companies for providing this assistance. The administration agreement has an initial term of two years and may be renewed with the approval of our board of directors. The administration agreement may be terminated by either party

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without penalty upon 60 days’ written notice to the other party. To the extent that Stellus Capital Management outsources any of its functions, we will pay the fees associated with such functions on a direct basis without any incremental profit to Stellus Capital Management. Stockholder approval is not required to amend the administration agreement.

Indemnification

The administration agreement provides that Stellus Capital Management, its affiliates and their respective, officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital Management’s services under the administration agreement or otherwise as our administrator. Our obligation to provide indemnification under the administration agreement, however, is limited by the 1940 Act and Investment Company Act Release No. 11330, which, among other things, prohibit us from indemnifying any director, officer or other individual from any liability resulting directly from the willful misconduct, bad faith, gross negligence in the performance of duties or reckless disregard of applicable obligations and duties of the directors, officers or other individuals and require us to set forth reasonable and fair means for determining whether indemnification shall be made.

License Agreement

We have entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, we have a right to use the “Stellus Capital” name for so long as Stellus Capital Management or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have no legal right to the “Stellus Capital” name. This license agreement will remain in effect for so long as the investment advisory agreement with Stellus Capital Management is in effect.

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RELATED PARTY TRANSACTIONS AND CERTAIN RELATIONSHIPS

The Company has procedures in place for the review, approval and monitoring of transactions involving the Company and certain persons related to the Company. As a BDC, the 1940 Act generally restricts the Company’s ability to participate in transactions with persons affiliated with the Company, including our officers, directors, and employees and any person controlling or under common control with us.

We received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management (other than D. E. Shaw & Co., L.P. and its associated investment funds and affiliated entities) where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We intend to co-invest, subject to the conditions included in the exemptive order we received from the SEC, with private credit funds managed by Stellus Capital Management that have an investment strategy that is identical to our investment strategy. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

In order to ensure that we do not engage in any prohibited transactions with any persons affiliated with the Company, our officers screen each of our transactions for any possible affiliations, close or remote, between the proposed portfolio investment, the Company, companies controlled by us and our employees and directors.

The Company will not enter into any agreements unless and until we are satisfied that no affiliations prohibited by the 1940 Act exist or, if such affiliations exist, the Company has taken appropriate actions to seek Board review and approval or additional exemptive relief from the SEC for such transaction.

Investment Advisory Agreement

We have entered into an investment advisory agreement with Stellus Capital Management. Pursuant to this agreement, we have agreed to pay to Stellus Capital Management a management fee and incentive fee. Messrs. Ladd, D’Angelo and Davis, each an interested member of our board of directors, have a direct or indirect pecuniary interest in Stellus Capital Management. See “Management Agreements.” The incentive fee is computed and paid on income that we may not have yet received in cash at the time of payment. This fee structure may create an incentive for Stellus Capital Management to invest in certain types of speculative securities. Additionally, we rely on investment professionals from Stellus Capital Management to assist our board of directors with the valuation of our portfolio investments. Stellus Capital Management’s management fee and incentive fee is based on the value of our investments and, therefore, there may be a conflict of interest when personnel of Stellus Capital Management are involved in the valuation process for our portfolio investments.

License Agreement

We have entered into a license agreement with Stellus Capital Management pursuant to which Stellus Capital Management has granted us a non-exclusive, royalty-free license to use the name “Stellus Capital.”

Administration Agreement

We have entered into an administration agreement with Stellus Capital Management pursuant to which Stellus Capital Management furnishes us with office facilities and equipment and provides us with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under this administration agreement, Stellus Capital Management performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for the financial records which we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. The beneficial interests in Stellus Capital Management are indirectly owned by Messrs. Ladd, D’Angelo,

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Davis, Overbergen and Huskinson. See “Management Agreements.” We reimburse Stellus Capital Management for the allocable portion (subject to the review of our board of directors) of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including rent, the fees and expenses associated with performing compliance functions, and our allocable portion of the cost of our chief financial officer and chief compliance officer and their respective staffs.

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CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS

The following table sets forth, as of June 25, 2018, the beneficial ownership of each current director, each nominee for director, the Company’s executive officers, each person known to us to beneficially own 5% or more of the outstanding shares of our common stock, and the executive officers and directors as a group.

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission (the “SEC”) and includes voting or investment power with respect to the securities. Shares of common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of June 25, 2018 are deemed to be outstanding and beneficially owned by the person holding such options or warrants. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Percentage of ownership is based on 15,953,811 shares of common stock outstanding as of June 25, 2018.

Unless otherwise indicated, to our knowledge, each stockholder listed below has sole voting and investment power with respect to the shares beneficially owned by the stockholder, except to the extent authority is shared by their spouses under applicable law. Unless otherwise indicated, the address of all executive officers and directors is c/o Stellus Capital Investment Corporation, 4400 Post Oak Parkway, Suite 2200, Houston, Texas 77027.

The Company’s directors are divided into two groups — interested directors and independent directors. Interested directors are “interested persons” as defined in Section 2(a)(19) of the 1940 Act.

   
Name and Address of Beneficial Owner   Number of
Shares
Owned
Beneficially(1)
  Percentage
of Class
Interested Directors
                 
Robert T. Ladd     406,165       2.6 % 
Joshua T. Davis     217,769       1.4 % 
Dean D’Angelo     147,292       1.0 % 
Independent Directors
                 
J. Tim Arnoult     10,876      
Bruce R. Bilger     76,327      
Paul Keglevic     8,579      
William C. Repko     10,000      
Executive Officers
                 
W. Todd Huskinson     16,328             *  
Executive officers and directors as a group     893,336       5.6 % 
5% Holders
 
None            

* Less than 1%
(1) Beneficial ownership has been determined in accordance with Rule 13d-3 of the Securities Exchange Act of 1934, as amended.

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The following table sets forth as of June 25, 2018, the dollar range of our securities owned by our directors and executive officers.

 
Name   Dollar Range of Equity
Securities Beneficially
Owned(1)(2)(3)
Interested Director:
        
Robert T. Ladd     over $100,000  
Dean D’Angelo     over $100,000  
Joshua T. Davis     over $100,000  
Independent Directors:
        
J. Tim Arnoult     over $100,000  
Bruce R. Bilger     over $100,000  
Paul Keglevic     over $100,000  
William C. Repko     over $100,000  
Executive Officers:
        
W. Todd Huskinson     over $100,000  

(1) Beneficial ownership has been determined in accordance with Rule 16a-1(a)(2) of the Securities Exchange Act of 1934, as amended.
(2) The dollar range of the equity securities beneficially owned is based on the closing price per share of the Company’s common stock of $13.22 on June 25, 2018 on the New York Stock Exchange.
(3) The dollar ranges of equity securities beneficially owned are: none; $1 – $10,000; $10,001 – $50,000; $50,001 – $100,000; and over $100,000.

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DETERMINATION OF NET ASSET VALUE

The net asset value per share of our outstanding shares of common stock is determined quarterly by dividing the value of total assets minus liabilities by the total number of shares outstanding.

In calculating the value of our total assets, investment transactions are recorded on the trade date. Realized gains or losses are computed using the specific identification method. Investments for which market quotations are readily available will be valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our board of directors based on the input of our management and audit committee. In addition, our board of directors retains one or more independent valuation firms to review the valuation of each portfolio investment for which a market quotation is not available at least quarterly. We also have adopted SFAS 157 (ASC Topic 820). This accounting statement requires us to assume that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with SFAS 157 (ASC Topic 820), the market in which we can exit portfolio investments with the greatest volume and level activity is considered our principal market.

The valuation process is conducted at the end of each fiscal quarter, with all of our valuations of portfolio companies without market quotations subject to review by one or more independent valuation firm each quarter. When an external event with respect to one of our portfolio companies, such as a purchase transaction, public offering or subsequent equity sale occurs, we consider the pricing indicated by the external event to corroborate our valuation.

A readily available market value is not expected to exist for most of the investments in our portfolio, and we value these portfolio investments at fair value as determined in good faith by our board of directors under our valuation policy and process. The types of factors that our board of directors may take into account in determining the fair value of our investments generally include, as appropriate, comparisons of financial ratios of the portfolio companies that issued such private equity securities to peer companies that are public, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the company considers the pricing indicated by the external event to corroborate the private equity valuation. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently assigned. See “Risk Factors — Risks Related to our Investments — Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.”

With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:

our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals of Stellus Capital Management responsible for the portfolio investment;
preliminary valuation conclusions are then documented and discussed with our senior investment professionals and Stellus Capital Management;
the audit committee of our board of directors then reviews these preliminary valuations;
at least once quarterly, the valuation for each portfolio investment is reviewed by an independent valuation firm; and

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the board of directors then discusses valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of Stellus Capital Management, the independent valuation firm and the audit committee.

In following these approaches, the types of factors that are taken into account in fair value pricing investments include, as relevant, but not be limited to:

available current market data, including relevant and applicable market trading and transaction comparables;
applicable market yields and multiples;
security covenants;
call protection provisions;
information rights;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
comparisons of financial ratios of peer companies that are public;
comparable merger and acquisition transactions; and
the principal market and enterprise values.

Determination of fair values involves subjective judgments and estimates not susceptible to substantiation by auditing procedures. Under current auditing standards, the notes to our financial statements refer to the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.

Determinations in Connection with Offerings

In connection with future offering of shares of our common stock, our board of directors or an authorized committee thereof will be required to make a good faith determination that it is not selling shares of our common stock at a price below the then current net asset value of our common stock at the time at which the sale is made. Our board of directors or an authorized committee thereof will consider the following factors, among others, in making such determination:

the net asset value per share of our common stock disclosed in the most recent periodic report that we filed with the SEC;
our management’s assessment of whether any material change in the net asset value per share of our common stock has occurred (including through the realization of gains on the sale of our portfolio securities) during the period beginning on the date of the most recently disclosed net asset value per share of our common stock and ending as of a time within 48 hours (excluding Sundays and holidays) of the sale of our common stock; and
the magnitude of the difference between (i) a value that our Board of Directors or an authorized committee thereof has determined reflects the current (as of a time within 48 hours, excluding Sundays and holidays) net asset value of our common stock, which is based upon the net asset value of our common stock disclosed in the most recent periodic report that we filed with the SEC, as adjusted to reflect our management’s assessment of any material change in the net asset value of our common stock since the date of the most recently disclosed net asset value of our common stock, and (ii) the offering price of the shares of our common stock in the proposed offering.

Moreover, to the extent that there is even a remote possibility that we may (i) issue shares of our common stock at a price per share below the then current net asset value per share of our common stock at the time at which the sale is made or (ii) trigger the undertaking (which we provide in certain registration statements we file with the SEC) to suspend the offering of shares of our common stock if the net asset value

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per share of our common stock fluctuates by certain amounts in certain circumstances until the prospectus is amended, our board of directors will elect, in the case of clause (i) above, either to postpone the offering until such time that there is no longer the possibility of the occurrence of such event or to undertake to determine the net asset value per share of our common stock within two days prior to any such sale to ensure that such sale will not be below our then current net asset value per share, and, in the case of clause (ii) above, to comply with such undertaking or to undertake to determine the net asset value per share of our common stock to ensure that such undertaking has not been triggered.

These processes and procedures are part of our compliance policies and procedures. Records will be made contemporaneously with all determinations described in this section and these records will be maintained with other records that we are required to maintain under the 1940 Act.

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SALES OF COMMON STOCK BELOW NET ASSET VALUE

Our stockholders may from time to time vote to allow us to issue common stock at a price below the net asset value, or NAV, per share of our common stock. In such an approval, our stockholders may not specify a maximum discount below net asset value at which we are able to issue our common stock. In order to sell shares pursuant to this authorization:

a majority of our independent directors who have no financial interest in the sale must have approved the sale; and
a majority of such directors, who are not interested persons of the Company, in consultation with the underwriter or underwriters of the offering if it is to be underwritten, must have determined in good faith, and as of a time immediately prior to the first solicitation by us or on our behalf of firm commitments to purchase such shares or immediately prior to the issuance of such shares, that the price at which such shares are to be sold is not less than a price which closely approximates the market value of those shares, less any underwriting commission or discount.

We are also permitted to sell shares of common stock below net asset value per share in rights offerings. Any offering of common stock below net asset value per share will be designed to raise capital for investment in accordance with our investment objectives and business strategies.

In making a determination that an offering below net asset value per share is in our and our stockholders' best interests, our board of directors would consider a variety of factors including:

the effect that an offering below net asset value per share would have on our stockholders, including the potential dilution they would experience as a result of the offering;
the amount per share by which the offering price per share and the net proceeds per share are less than the most recently determined net asset value per share;
the relationship of recent market prices of our common stock to net asset value per share and the potential impact of the offering on the market price per share of our common stock;
whether the proposed offering price would closely approximate the market value of our shares;
the potential market impact of being able to raise capital during the current financial market difficulties;
the nature of any new investors anticipated to acquire shares in the offering;
the anticipated rate of return on and quality, type and availability of investments to be funded with the proceeds from the offering, if any; and
the leverage available to us, both before and after any offering, and the terms thereof.

At our 2017 annual meeting of stockholders, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period ending on the earlier of the one-year anniversary of the date of the Company’s 2017 Annual Meeting of Stockholders and the date of the Company’s 2018 Annual Meeting of Stockholders. Our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. We are seeking similar approval at our 2018 Annual Meeting of Stockholders, scheduled for June 28, 2018.

Sales by us of our common stock at a discount from net asset value pose potential risks for our existing stockholders whether or not they participate in the offering, as well as for new investors who participate in the offering.

The following three headings and accompanying tables will explain and provide hypothetical examples on the impact of an offering at a price less than net asset value per share on three different sets of investors:

existing stockholders who do not purchase any shares in the offering;

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existing stockholders who purchase a relatively small amount of shares in the offering or a relatively large amount of shares in the offering; and
new investors who become stockholders by purchasing shares in the offering.

Impact on Existing Stockholders who do not Participate in the Offering

Our existing stockholders who do not participate in an offering below net asset value per share or who do not buy additional shares in the secondary market at the same or lower price we obtain in the offering (after expenses and commissions) face the greatest potential risks. These stockholders will experience an immediate decrease (often called dilution) in the net asset value of the shares they hold and their net asset value per share. These stockholders will also experience a disproportionately greater decrease in their participation in our earnings and assets and their voting power than the increase we will experience in our assets, potential earning power and voting interests due to the offering. These stockholders may also experience a decline in the market price of their shares, which often reflects to some degree announced or potential decreases in net asset value per share. This decrease could be more pronounced as the size of the offering and level of discount to net asset value increases.

The following table illustrates the level of net asset value dilution that would be experienced by a nonparticipating stockholder in four different hypothetical offerings of different sizes and levels of discount from net asset value per share. Actual sales prices and discounts may differ from the presentation below.

The examples assume that Company XYZ has 16,000,000 common shares outstanding, $400,000,000 in total assets and $180,000,000 in total liabilities. The current net asset value and net asset value per share are thus $220,000,000 and $13.75. The table illustrates the dilutive effect on nonparticipating Stockholder A of (1) an offering of 1,600,000 shares (10% of the outstanding shares) at $12.38 per share after offering expenses and commissions (a 10% discount from net asset value), (2) an offering of 4,000,000 shares (25% of the outstanding shares) at $11.69 per share after offering expenses and commissions (a 15% discount from net asset value) and (3) an offering of 4,00,000 shares (25% of the outstanding shares) at $0.00 per share after offering expenses and commissions (a 100% discount from net asset value).

             
  Prior to Sale
Below NAV
Per Share
  Example 1 – 10%
Offering at 10%
Discount
  Example 2 – 25%
Offering at 15%
Discount
  Example 3 – 25%
Offering at 100%
Discount
  Following
Sale
  Percent
Change
  Following
Sale
  Percent
Change
       Percent
Change
Offering Price
                                                              
Price per Share to Public           13.03             12.30             0.00        
Net Proceeds per Share to Issuer           12.38             11.69             0.00        
Increase in Shares and Decrease to NAV Per Share
                                                              
Total Shares Outstanding     16,000,000       17,600,000       10 %      20,000,000       25 %      20,000,000       25 % 
NAV per Share   $ 13.75     $ 13.63       -0.91 %    $ 13.34       -3.00 %    $ 11.00       -20.00 % 
Dilution to Nonparticipating Stockholder A
                                                              
Share Dilution
                                                              
Shares Held by Stockholder A     160,000       160,000             160,000             160,000        
Percentage of Shares Held by Stockholder A     1 %      0.91 %      9.0 %      0.80 %      20.0 %      0.80 %      20.0 % 
NAV Dilution
                                                              
Total NAV Held by Stockholder A   $ 2,200,000     $ 2,180,000       -0.91 %    $ 2,134,000       -5.00 %    $ 1,760,000       -20.00 % 
Total Investment by Stockholder A (Assumed to Be $13.60 per Share)   $ 2,200,000     $ 2,200,000           $ 2,200,000           $ 2,200,000        
Total Dilution to Stockholder A (Change in Total NAV Held By Stockholder)           -$20,000             -$66,000             -$440,000        

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  Prior to Sale
Below NAV
Per Share
  Example 1 – 10%
Offering at 10%
Discount
  Example 2 – 25%
Offering at 15%
Discount
  Example 3 – 25%
Offering at 100%
Discount
  Following
Sale
  Percent
Change
  Following
Sale
  Percent
Change
       Percent
Change
NAV Dilution Per Share
                                                              
NAV per Share Held by Stockholder A         $ 13.63           $ 13.34           $ 11.00        
Investment per Share Held by Stockholder A     13.75     $ 13.75           $ 13.75           $ 13.75        
NAV Dilution per Share Experienced by Stockholder A (NAV per Share Less Investment per Share)           -$0.13                -$0.41                -$2.75           
Percentage NAV Dilution Experienced by Stockholder A (NAV Dilution per Share Divided by Investment per Share)                 -0.91 %            -3.00 %            -20.00 % 

(1) Assumes a 5% selling compensation and expenses paid by us.

Impact on Existing Stockholders who do Participate in the Offering

Our existing stockholders who participate in an offering below net asset value per share or who buy additional shares in the secondary market at the same or lower price as we obtain in the offering (after expenses and commissions) will experience the same types of net asset value dilution as the nonparticipating stockholders, albeit at a lower level, to the extent they purchase less than the same percentage of the discounted offering as their interest in our shares immediately prior to the offering. The level of net asset value dilution to such stockholders will decrease as the number of shares such stockholders purchase increases. Existing stockholders who buy more than their proportionate percentage will experience net asset value dilution but will, in contrast to existing stockholders who purchase less than their proportionate share of the offering, experience an increase (often called accretion) in net asset value per share over their investment per share and will also experience a disproportionately greater increase in their participation in our earnings and assets and their voting power than our increase in assets, potential earning power and voting interests due to the offering. The level of accretion will increase as the excess number of shares purchased by such stockholder increases. Even a stockholder who over-participates will, however, be subject to the risk that we may make additional discounted offerings in which such stockholder does not participate, in which case such a stockholder will experience net asset value dilution as described above in such subsequent offerings. These stockholders may also experience a decline in the market price of their shares, which often reflects to some degree announced or potential decreases in net asset value per share. This decrease could be more pronounced as the size of the offering and the level of discount to net asset value increases.

The following chart illustrates the level of dilution and accretion in the hypothetical 25% offering at a 15% discount from the prior chart (Example 2) for a stockholder that acquires shares equal to (1) 50% of its proportionate share of the offering (i.e., 20,000 shares, which is 0.5% of an offering of 4,000,000 shares rather than its 1.0% proportionate share) and (2) 150% of such percentage (i.e., 60,000 shares, which is 1.5% of an offering of 4,000,000 shares rather than its 1.0% proportionate share). It is not possible to predict the level of market price decline that may occur.

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    50% Participation   150% Participation
     Prior to Sale Below NAV   Following
Sale
  Percent
Change
  Following
Sale
  Percent
Change
Offering Price
                                            
Price per Share to Public         $ 12.30           $ 12.30        
Net Proceeds per Share to Issuer         $ 11.69           $ 11.69        
Increase in Shares and Decrease to NAV
                                            
Total Shares Outstanding     16,000,000       20,000,000       25 %      20,000,000       25 % 
NAV per Share     13.75       13.34       -3.00 %      13.34       -3.00 % 
Dilution/Accretion to Participating Stockholder A
                                            
Share Dilution/Accretion
                                            
Shares Held by Stockholder A     160,000       180,000             220,000        
Percentage of Shares Held by Stockholder A     1 %      0.90 %            1.10 %       
NAV Dilution/Accretion
                                            
Total NAV Held by Stockholder A     2,200,000     $ 2,400,750       9.13 %      2,934,250       33.38 % 
Total Investment by Stockholder A (Assumed to be $13.75 per Share on Shares Held Prior to Sale)     2,200,000     $ 2,446,053           $ 2,938,158        
Total Dilution/Accretion to Stockholder A (Total NAV Less Total Investment)         $ -45,303           $ -3,908        
NAV Dilution/Accretion per Share
                                            
NAV per Share Held by Stockholder A           13.34             13.34        
Investment per Share Held by Stockholder A (Assumed to be $13.75 per Share on Shares Held Prior to Sale)     14.43       13.59             13.36        
NAV Dilution/Accretion per Share Experienced by Stockholder A (NAV per Share Less Investment per Share)           -0.25                -0.02           
Percentage NAV Dilution/ Accretion Experienced by Stockholder A (NAV Dilution/Accretion per Share Divided by Investment per Share)                 -1.85 %            -0.13 % 

Impact on New Investors

Investors who are not currently stockholders, but who participate in an offering below net asset value and whose investment per share is greater than the resulting net asset value per share due to selling compensation and expenses paid by us will experience an immediate decrease, albeit small, in the net asset value of their shares and their net asset value per share compared to the price they pay for their shares (Example 1 below). On the other hand, investors who are not currently stockholders, but who participate in an offering below net asset value per share and whose investment per share is also less than the resulting net asset value per share will experience an immediate increase in the net asset value of their shares and their net asset value per share compared to the price they pay for their shares (Examples 2, 3 and 4 below). These latter investors will experience a disproportionately greater participation in our earnings and assets and their voting power than our increase in assets, potential earning power and voting interests. These investors will, however, be subject to the risk that we may make additional discounted offerings in which such new stockholder does not participate, in which case such new stockholder will experience dilution as described above in such subsequent offerings. These investors may also experience a decline in the market price of their shares, which often reflects to some

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degree announced or potential decreases in net asset value per share. This decrease could be more pronounced as the size of the offering and level of discount to net asset value increases.

The following chart illustrates the level of dilution or accretion for new investors that would be experienced by a new investor in the same hypothetical discounted offerings as described in the first chart above. The illustration is for a new investor who purchases the same percentage (1.00%) of the shares in the offering as Stockholder A in the prior examples held immediately prior to the offering. The prospectus supplement pursuant to which any discounted offering is made will include a chart for these examples based on the actual number of shares in such offering and the actual discount from the most recently determined net asset value per share.

             
             
    Example 1
10% Offering at
10% Discount
  Example 2
25% Offering at
15% Discount
  Example 3
25% Offering at
100% Discount
     Prior to Sale
Below NAV
  Following Sale   Percent
Change
  Following Sale   Percent
Change
  Following
Sale
  Percent
Change
Offering Price
                                            
Price per Share to Public           13.03             12.30             0.00        
Net Proceeds per Share to Issuer           12.38             11.69             0.00        
Increase in Shares and Decrease to NAV
                                                              
Total Shares Outstanding     16,000,000       17,600,000       10 %      20,000,000       25 %      20,000,000       25 % 
NAV per Share     13.75       13.63       -0.91 %      13.34       -3.00 %      11.00       -20.00 % 
Dilution/Accretion to Participating Investor A
                                            
Share Dilution/Accretion
                                                              
Shares Held by Investor A     0       16,000             40,000             40,000        
Percentage of Shares Held by Investor A     0.00 %      0.09 %            0.20 %            0.20 %       
NAV Dilution/Accretion                                             
Total NAV Held by Investor A     0       218,000             533,500             440,000        
Total Investment by Investor A (At Price to Public)     0       208,421             492,105             0        
Total Dilution/Accretion to Investor A (Total NAV Less Total Investment)           9,579             41,395             440,000        
NAV Dilution/Accretion per Share
                                            
NAV per Share Held by Investor A           13.63             13.34             11.00        
Investment per Share Held by Investor A           13.03             12.30             0.00        
NAV Dilution per Share Experienced by Investor A (NAV per Share Less Investment per Share)           0.60                1.03                11.00           
Percentage NAV Dilution Experienced by Investor A (NAV Dilution per Share Divided by Investment per Share)                 4.60 %            8.41 %             

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DIVIDEND REINVESTMENT PLAN

We have adopted a dividend reinvestment plan that provides for reinvestment of our stockholder distributions, unless a stockholder elects to receive cash as provided below. As a result, if our board of directors authorizes, and we declare, a cash distribution, then our stockholders who have not “opted out” of such dividend reinvestment plan will have their cash distribution automatically reinvested in additional shares of our common stock, rather than receiving the cash distribution.

No action is required on the part of a registered stockholder to have its cash distribution reinvested in shares of our common stock. A registered stockholder may elect to receive an entire distribution in cash by notifying State Street Bank and Trust Company, the plan administrator and our transfer agent, registrar and distribution disbursing agent, in writing so that such notice is received by the plan administrator no later than five (5) days prior to the record date for distributions to stockholders. The plan administrator will set up an account for shares acquired through the plan for each stockholder and hold such shares in non-certificated form. Upon request by a stockholder participating in the plan, received in writing not less than five (5) days prior to the record date, the plan administrator will, instead of crediting shares to the participant’s account, issue a certificate registered in the participant’s name for the number of whole shares of our common stock and a check for any fractional share. The plan administrator is authorized to deduct a $15.00 transaction fee plus a brokerage commission from the proceeds of the sale of any fractional share.

Those stockholders whose shares are held by a broker or other financial intermediary may receive distributions in cash by notifying their broker or nominee of their election.

We expect to use primarily newly issued shares to implement the plan, whether our shares are trading at a premium or at a discount to net asset value. Under such circumstances, the number of shares to be issued to a stockholder is determined by dividing the total dollar amount of the distribution payable to such stockholder by 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our board of directors. Market price per share on that date will be the closing price for such shares on the NYSE or, if no sale is reported for such day, at the average of their reported bid and asked prices. We reserve the right to purchase shares in the open market in connection with our implementation of the plan. Shares purchased in open market transactions by the plan administrator will be allocated to a stockholder based on the average purchase price, excluding any brokerage charges or other charges, of all shares of common stock purchased in the open market.

There are no brokerage charges or other charges to stockholders who participate in the plan. The plan administrator’s fees are paid by us. If a participant elects by written notice to the plan administrator prior to termination of his or her account to have the plan administrator sell part or all of the shares held by the plan administrator in the participant’s account and remit the proceeds to the participant, the plan administrator is authorized to deduct a $15.00 transaction fee plus a brokerage commission from the proceeds.

Stockholders who receive distributions in the form of stock are generally subject to the same U.S. federal, state and local tax consequences as are stockholders who elect to receive their distributions in cash. However, since a participating stockholder’s cash distributions will be reinvested, such stockholder will not receive cash with which to pay any applicable taxes on reinvested distributions. A stockholder’s basis for determining gain or loss upon the sale of stock received in a distribution from us will generally be equal to the total dollar amount of the distribution payable to the stockholder. Any stock received in a distribution will have a new holding period for tax purposes commencing on the day following the day on which the shares are credited to the U.S. stockholder’s account.

Participants may terminate their accounts under the plan by notifying the plan administrator by filling out the transaction request form located at the bottom of the participant’s statement and sending it to the plan administrator at the address below.

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Those stockholders whose shares are held by a broker or other nominee who wish to terminate his or her account under the plan may do so by notifying his or her broker or nominee.

The plan may be terminated by us upon notice in writing mailed to each participant at least 30 days prior to any record date for the payment of any stockholder distribution by us. All correspondence concerning the plan should be directed to the plan administrator by mail at Stellus Capital Investment Corporation, c/o State Street Bank and Trust Company, 200 Clarendon Street, JHT1651, Boston, Massachusetts 02145.

If you withdraw or the plan is terminated, you will receive the number of whole shares in your account under the plan and a cash payment for any fraction of a share in your account.

If you hold your common stock with a brokerage firm that does not participate in the plan, you will not be able to participate in the plan and any distribution reinvestment may be effected on different terms than those described above. Consult your financial advisor for more information.

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CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is a general summary of certain U.S. federal income tax considerations applicable to us and to an investment in our common stock. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. For example, we have not described tax consequences that we assume to be generally known by investors or certain considerations that may be relevant to certain types of holders subject to special treatment under U.S. federal income tax laws, including stockholders subject to the alternative minimum tax, tax-exempt organizations, insurance companies, dealers in securities, pension plans and trusts, and financial institutions. This summary assumes that investors hold our common stock as capital assets (within the meaning of the Code). The discussion is based upon the Code, Treasury regulations, and administrative and judicial interpretations, each as in effect as of the date of this registration statement and all of which are subject to change, possibly retroactively, which could affect the continuing validity of this discussion. We have not sought and will not seek any ruling from the Internal Revenue Service regarding this offering. This summary does not discuss any aspects of U.S. estate or gift tax or foreign, state or local tax. It does not discuss the special treatment under U.S. federal income tax laws that could result if we invested in tax-exempt securities or certain other investment assets in which we do not currently intend to invest.

This summary does not discuss the consequences of an investment in shares of our preferred stock, debt securities or warrants representing rights to purchase shares of our common stock, preferred stock or debt securities. The U.S. federal income tax consequences of such an investment will be discussed in a relevant prospectus supplement.

A “U.S. stockholder” generally is a beneficial owner of shares of our common stock who is for U.S. federal income tax purposes:

a citizen or individual resident of the United States including an alien individual who is a lawful permanent resident of the United States or meets the “substantial presence” test under Section 7701(b) of the Code;
a corporation or other entity taxable as a corporation, for U.S. federal income tax purposes, created or organized in or under the laws of the United States, any state thereof, or the District of Columbia;
a trust, if a court in the United States has primary supervision over its administration and one or more U.S. persons have the authority to control all decisions of the trust, or the trust has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person; or
an estate, the income of which is subject to U.S. federal income taxation regardless of its source.

A “non-U.S. stockholder” is a beneficial owner of shares of our common stock that is an individual, corporation, trust or estate and is not a U.S. stockholder.

If a partnership (including an entity treated as a partnership for U.S. federal income tax purposes) holds shares of our common stock, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. A prospective stockholder who is a partner of a partnership holding shares of our common stock should consult its tax advisors with respect to the purchase, ownership and disposition of shares of our common stock.

Tax matters are very complicated and the tax consequences to an investor of an investment in our shares will depend on the facts of its particular situation. We encourage investors to consult their own tax advisors regarding the specific consequences of such an investment, including tax reporting requirements, the applicability of federal, state, local and foreign tax laws, eligibility for the benefits of any applicable tax treaty and the effect of any possible changes in the tax laws.

Election to be Taxed as a RIC

As a BDC, we have elected to be treated, and intend to qualify annually, as a RIC under Subchapter M of the Code, beginning with our 2010 taxable year. As a RIC, we generally will not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our stockholders as dividends. To continue to maintain our qualification as a RIC, we must, among other things,

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meet certain source-of-income and asset diversification requirements (as described below). In addition, to qualify for RIC tax treatment we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses (the “Annual Distribution Requirement”).

Taxation as a RIC

For any taxable year in which we:

qualify as a RIC; and
satisfy the Annual Distribution Requirement;

We will not be subject to U.S. federal income tax on the portion of our income we distribute (or deem as distributed) to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) to our stockholders.

We will be subject to a 4% nondeductible U.S. federal excise tax on our undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (a) 98% of our net ordinary income for each calendar year, (b) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar year and (c) any income realized, but not distributed, in the preceding year and on which we paid no U.S. federal income tax, or the Excise Tax Avoidance Requirement. For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid). We currently intend to make sufficient distributions each taxable year to satisfy the Excise Tax Avoidance Requirement.

In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:

continue to qualify as a BDC under the 1940 Act at all times during each year;
derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities, and net income derived from interests in “qualified publicly traded partnerships” (which generally are partnerships that are traded on an established securities market or tradable on a secondary market, other than partnerships that derive 90% of their income from interest, dividends and other permitted RIC income), or the 90% Income Test; and
diversify our holdings so that at the end of each quarter of the taxable year:
at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and
no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer or of two or more issuers that are controlled, as determined under applicable tax rules, by us and that are engaged in the same or similar or related trades or businesses or in the securities of one or more qualified publicly traded partnerships, or the Diversification Tests.

We may invest in partnerships, including qualified publicly traded partnerships, which may result in our being subject to state, local or foreign income, franchise or withholding liabilities.

We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, with increasing interest rates or issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us

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in the same taxable year. Because any original issue discount accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. If we are not able to obtain sufficient cash from other sources to satisfy the Annual Distribution Requirement, we may fail to maintain our tax treatment as a RIC and become subject to corporate-level U.S. federal income taxes on all of our taxable income without the benefit of the dividends-paid deduction.

Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order to satisfy (i) the Annual Distribution Requirements and to otherwise eliminate our liability for U.S. federal income and excise taxes and/or (ii) the Diversification Tests. However, under the 1940 Act, we are not permitted in certain circumstances to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. See Item 1A. “Regulation as a Business Development Company — Senior Securities.” Moreover, our ability to dispose of assets to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Test may be limited by (a) the illiquid nature of our portfolio and/or (b) other requirements relating to our qualifications as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests, we may make such dispositions at times that, from an investment standpoint, are not advantageous.

In addition, we have formed and operate a SBIC subsidiary, and are partially dependent on the SBIC subsidiary for cash distributions to enable us to meet the RIC distribution requirements. The SBIC subsidiary may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to maintain our tax treatment as a RIC. We may have to request a waiver of the SBA’s restrictions for the SBIC subsidiary to make certain distributions to maintain our RIC tax treatment. We cannot assure you that the SBA will grant such waiver. If the SBIC subsidiary is unable to obtain a waiver, compliance with the SBA regulations may cause us to fail to maintain our tax treatment as a RIC, which would result in us becoming subject to corporate-level federal income tax.

Certain of our investment practices may be subject to special and complex U.S. federal income tax provisions that may, among other things, (a) treat dividends that would otherwise constitute qualified dividend income as non-qualified dividend income, (b) treat dividends that would otherwise be eligible for the corporate dividends received deduction as ineligible for such treatment, (c) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (d) convert lower-taxed long term capital gain into higher-taxed short-term capital gain or ordinary income, (e) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (f) cause us to recognize income or gain without a corresponding receipt of cash, (g) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (h) adversely alter the characterization of certain complex financial transactions and (i) produce income that will not be qualifying income for purposes of the 90% Income Test. We intend to monitor our transactions and may make certain tax elections to mitigate the effect of these provisions and prevent our disqualification as a RIC.

Gain or loss realized by us from warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such capital gain or loss generally will be long term or short term, depending on how long we held a particular warrant. Some of the income and fees that we may recognize will not satisfy the 90% Income Test. In order to ensure that such income and fees do not disqualify us as a RIC for a failure to satisfy the 90% Income Test, we may hold assets that generate such income and provide services that generate such fees indirectly through one or more entities treated as corporations for U.S. federal income tax purposes. Such corporations will be required to pay U.S. federal corporate income tax on their earnings, which ultimately will reduce our return on such income and fees.

Failure to Maintain our Qualification as a RIC

If we are unable to qualify for tax treatment as a RIC, and if certain remedial provisions are not available, we would be subject to tax on all of our taxable income at regular corporate rates. We would not be able to deduct distributions to stockholders, nor would they be required to be made. Distributions, including distributions of net long-term capital gain, would generally be taxable to our stockholders as ordinary dividend

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income to the extent of our current and accumulated earnings and profits. Subject to certain limitations under the Code, corporate stockholders would be eligible to claim a dividends received deduction with respect to such distributions; non-corporate stockholders would be able to treat such dividend income as “qualified dividend income,” which is subject to reduced rates of U.S. federal income tax. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. If we fail to qualify as a RIC for a period greater than two taxable years, to requalify as a RIC in a subsequent year we may be subject to regular corporate tax on any net built-in gains with respect to certain of our assets (i.e., the excess of the aggregate gains, including items of income, over aggregate losses that would have been realized with respect to such assets if we had been liquidated) that we elect to recognize on requalification or when recognized over the next five years.

The remainder of this discussion assumes that we will maintain our qualification as a RIC and will satisfy the Annual Distribution Requirement.

Tax on Investment Income

Individuals with modified adjusted gross incomes in excess of $200,000 ($250,000 in the case of married individuals filing jointly) and certain estates and trusts are subject to an additional 3.8% tax on their “net investment incomes,” which generally includes net income from interest, dividends, annuities, royalties, and rents, and net capital gains (other than certain amounts earned from trades or businesses).

Taxation of U.S. Stockholders

Distributions by us generally are taxable to U.S. stockholders as ordinary income or capital gains. Distributions of our “investment company taxable income” (which is, generally, our net ordinary income plus net short-term capital gains in excess of net long-term capital losses) will be taxable as ordinary income to U.S. stockholders to the extent of our current and accumulated earnings and profits, whether paid in cash or reinvested in additional shares of our common stock. To the extent such distributions paid by us to non-corporate stockholders (including individuals) are attributable to dividends from U.S. corporations and certain qualified foreign corporations and if certain holding period requirements are met, such distributions generally will be treated as qualified dividend income and will be eligible for a maximum U.S. federal income tax rate of 20%. In this regard, it is anticipated that distributions paid by us will generally not be attributable to dividends and, therefore, generally will not qualify for the 20% maximum U.S. federal income tax rate. Distributions of our net capital gains (which is generally our realized net long-term capital gains in excess of realized net short-term capital losses) properly reported by us as “capital gain dividends” will be taxable to a U.S. stockholder as long-term capital gains (currently at a maximum U.S. federal income tax rate of 20%) in the case of individuals, trusts or estates, regardless of the U.S. stockholder’s holding period for his, her or its common stock and regardless of whether paid in cash or reinvested in additional shares of common stock. Distributions in excess of our earnings and profits first will reduce a U.S. stockholder’s adjusted tax basis in such stockholder’s common stock and, after the adjusted basis is reduced to zero, will constitute capital gains to such U.S. stockholder. U.S. stockholders receiving distributions in the form of additional shares of our common stock purchased in the market should be treated for U.S. federal income tax purposes as receiving a distribution in an amount equal to the amount of money that the stockholders receiving cash distributions will receive, and should have a cost basis in the shares received equal to such amount. A U.S. stockholder receiving a distribution in newly issued shares of our common stock will be treated as receiving a distribution equal to the value of the shares received, and should have a cost basis of such amount.

Although we currently intend to distribute any net long-term capital gains at least annually, we may in the future decide to retain some or all of our net long-term capital gains but designate the retained amount as a “deemed distribution.” In that case, among other consequences, we will pay tax on the retained amount, each U.S. stockholder will be required to include its share of the deemed distribution in income as if it had been distributed to the U.S. stockholder, and the U.S. stockholder will be entitled to claim a credit equal its allocable share of the tax paid on the deemed distribution by us. The amount of the deemed distribution net of such tax will be added to the U.S. stockholder’s tax basis for their shares of common stock. Since we expect to pay tax on any retained capital gains at our regular corporate tax rate, and since that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual

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U.S. stockholders will be treated as having paid and for which they will receive a credit will exceed the tax they owe on the retained net capital gain. Such excess generally may be claimed as a credit against the U.S. stockholder’s other U.S. federal income tax obligations or may be refunded to the extent it exceeds a stockholder’s liability for U.S. federal income tax. A stockholder that is not subject to U.S. federal income tax or otherwise required to file a U.S. federal income tax return would be required to file a U.S. federal income tax return on the appropriate form in order to claim a refund for the taxes we paid. In order to utilize the deemed distribution approach, we must provide written notice to our stockholders prior to the expiration of 60 days after the close of the relevant taxable year. We cannot treat any of our investment company taxable income as a “deemed distribution.”

For purposes of determining (a) whether the Annual Distribution Requirement is satisfied for any year and (b) the amount of capital gain dividends paid for that year, we may, under certain circumstances, elect to treat a dividend that is paid during the following taxable year as if it had been paid during the taxable year in question. If we make such an election, the U.S. stockholder will still be treated as receiving the dividend in the taxable year in which the distribution is made. However, any dividend declared by us in October, November or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following year, will be treated as if it had been received by our stockholders on December 31 of the year in which the dividend was declared.

If an investor purchases shares of our common stock shortly before the record date of a distribution, the price of the shares of our common stock will include the value of the distribution and the investor will be subject to tax on the distribution even though it represents a return of their investment.

A U.S. stockholder generally will recognize taxable gain or loss if the stockholder sells or otherwise disposes of their shares of our common stock. Any gain arising from such sale or disposition generally will be treated as long-term capital gain or loss if the stockholder has held their shares of common stock for more than one year. Otherwise, it would be classified as short-term capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares. In addition, all or a portion of any loss recognized upon a disposition of shares of our common stock may be disallowed if other shares of our common stock are purchased (whether through reinvestment of distributions or otherwise) within 30 days before or after the disposition. In such a case, the basis of the common stock acquired will be increased to reflect the disallowed loss.

In general, individual U.S. stockholders currently are subject to a maximum U.S. federal income tax rate of 20% on their net capital gain, (i.e., the excess of realized net long-term capital gain over realized net short-term capital loss for a taxable year), including a long-term capital gain derived from an investment in our shares of common stock. Such rate is lower than the maximum rate on ordinary income currently payable by individuals. Corporate U.S. stockholders currently are subject to U.S. federal income tax on net capital gain at the maximum 21% rate also applied to ordinary income. Non-corporate stockholders with net capital losses for a year (i.e., net capital losses in excess of net capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year; any net capital losses of a non-corporate stockholder in excess of $3,000 generally may be carried forward and used in subsequent years as provided in the Code. Corporate stockholders generally may not deduct any net capital losses for a year, but may carryback such losses for three years or carry forward such losses for five years.

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We or the applicable withholding agent will send to each of our U.S. stockholders, as promptly as possible after the end of each calendar year, a notice reporting the amounts includible in such U.S. stockholder’s taxable income for such year as ordinary income and as long-term capital gain. In addition, the U.S. federal income tax status of each year’s distributions generally will be reported to the IRS. Distributions may also be subject to additional state, local and foreign taxes depending on a U.S. stockholder’s particular situation. Dividends distributed by us generally will not be eligible for the dividends-received deduction or the lower tax rates applicable to certain qualified dividends.

We may be required to withhold U.S. federal income tax (“backup withholding”) from all distributions to any non-corporate U.S. stockholder (a) who fails to furnish us with a correct taxpayer identification number or a certificate that such stockholder is exempt from backup withholding or (b) with respect to whom the IRS notifies us that such stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individual’s taxpayer identification number is his or her social security number. Any amount withheld under backup withholding is allowed as a credit against the U.S. stockholder’s U.S. federal income tax liability and may entitle such stockholder to a refund, provided that proper information is timely provided to the IRS.

Taxation of Non-U.S. Stockholders

Whether an investment in the shares of our common stock is appropriate for a Non-U.S. stockholder will depend upon that person’s particular circumstances. Non-U.S. stockholders should consult their tax advisors before investing in our common stock.

Distributions of our “investment company taxable income” to Non-U.S. stockholders (including interest income, net short-term capital gain or foreign-source dividend and interest income, which generally would be free of withholding if paid to Non-U.S. stockholders directly) will be subject to withholding of U.S. federal income tax at a 30% rate (or lower rate provided by an applicable treaty) to the extent of our current and accumulated earnings and profits unless the distributions are effectively connected with a U.S. trade or business of the Non-U.S. stockholder, and, if an income tax treaty applies, attributable to a permanent establishment in the United States, in which case the distributions will be subject to U.S. federal income tax at the rates applicable to U.S. persons. In that case, we will not be required to withhold U.S. federal income tax if the Non-U.S. stockholder complies with applicable certification and disclosure requirements. Special certification requirements apply to a Non-U.S. stockholder that is a foreign partnership or a foreign trust, and such entities are urged to consult their tax advisors.

We or the applicable withholding agent generally are not required to withhold any amounts with respect to certain distributions of (i) U.S. source interest income, and (ii) net short term capital gains in excess of net long term capital losses, in each case to the extent we properly report such distributions as “interest-related dividends” or “short-term capital gain dividends” and certain other requirements were satisfied. We anticipate that a portion of our distributions will be eligible for this exemption from withholding; however, we cannot determine what portion of our distributions (if any) will be eligible for this exception until after the end of our taxable year. No certainty can be provided that any of our distributions will be reported as eligible for this exception.

Actual or deemed distributions of our net capital gains to a Non-U.S. stockholder, and gains realized by a Non-U.S. stockholder upon the sale of our common stock, will not be subject to U.S. federal withholding tax and generally will not be subject to U.S. federal income tax unless the distributions or gains, as the case may be, are effectively connected with a U.S. trade or business of the Non-U.S. stockholder and, if an income tax treaty applies, are attributable to a permanent establishment maintained by the Non-U.S. stockholder in the United States or, in the case of an individual Non-U.S. stockholder, the stockholder is present in the United States for 183 days or more during the year of the sale or capital gain dividend and certain other conditions are met.

If we distribute our net capital gains in the form of deemed rather than actual distributions (which we may do in the future), a Non-U.S. stockholder will be entitled to a U.S. federal income tax credit or tax refund equal to the stockholder’s allocable share of the tax we pay on the capital gains deemed to have been distributed. In order to obtain the refund, the Non-U.S. stockholder must obtain a U.S. taxpayer identification number and file a U.S. federal income tax return even if the Non-U.S. stockholder would not otherwise be

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required to obtain a U.S. taxpayer identification number or file a U.S. federal income tax return. For a corporate Non-U.S. stockholder, distributions (both actual and deemed), and gains realized upon the sale of our common stock that are effectively connected with a U.S. trade or business may, under certain circumstances, be subject to an additional “branch profits tax” at a 30% rate (or at a lower rate if provided for by an applicable treaty).

A Non-U.S. stockholder who is a non-resident alien individual, and who is otherwise subject to withholding of U.S. federal income tax, may be subject to information reporting and backup withholding of U.S. federal income tax on dividends unless the Non-U.S. stockholder provides us or the distribution paying agent with an IRS Form W-8BEN (or an acceptable substitute form) or otherwise meets documentary evidence requirements for establishing that it is a Non-U.S. stockholder or otherwise establishes an exemption from backup withholding.

A Non-U.S. stockholder who is a non-resident alien individual, and who is otherwise subject to withholding of U.S. federal income tax, may be subject to information reporting and backup withholding of U.S. federal income tax on dividends unless the Non-U.S. stockholder provides us or the distribution paying agent with an IRS Form W-8BEN, W-8BEN-E (or an acceptable substitute form) or otherwise meets documentary evidence requirements for establishing that it is a Non-U.S. stockholder or otherwise establishes an exemption from backup withholding.

An investment in shares by a non-U.S. person may also be subject to U.S. estate tax. Non-U.S. persons should consult their tax advisors with respect to the U.S. federal income tax and withholding tax, U.S. estate tax and state, local and foreign tax consequences of an investment in the shares of our common stock.

Non-U.S. persons should consult their own tax advisers with respect to the U.S. federal income tax and withholding tax, and state, local and foreign tax consequences of an investment in the shares.

Foreign Account Tax Compliance Act

Legislation commonly referred to as the “Foreign Account Tax Compliance Act,” or “FATCA,” generally imposes a 30% withholding tax on payments of certain types of income to foreign financial institutions (“FFIs”) unless such FFIs either (i) enter into an agreement with the U.S. Treasury to report certain required information with respect to accounts held by U.S. persons (or held by foreign entities that have U.S. persons as substantial owners) or (ii) reside in a jurisdiction that has entered into an intergovernmental agreement (“IGA”) with the United States to collect and share such information and are in compliance with the terms of such IGA and any enabling legislation or regulations. The types of income subject to the tax include U.S. source interest and dividends and the gross proceeds from the sale of any property that could produce U.S.-source interest or dividends received after December 31, 2018. The information required to be reported includes the identity and taxpayer identification number of each account holder that is a U.S. person and transaction activity within the holder’s account. In addition, subject to certain exceptions, this legislation also imposes a 30% withholding on payments to foreign entities that are not FFIs unless the foreign entity certifies that it does not have a greater than 10% U.S. owner or provides the withholding agent with identifying information on each greater than 10% U.S. owner. Depending on the status of a stockholder and the status of the intermediaries through which it holds its units, a stockholder could be subject to this 30% withholding tax with respect to distributions on our stock and proceeds from the sale of our stock. Under certain circumstances, a Non-U.S. stockholder might be eligible for refunds or credits of such taxes.

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DESCRIPTION OF OUR COMMON STOCK

The following description is based on relevant portions of the Maryland General Corporation Law and our articles of incorporation and bylaws. This summary is not necessarily complete, and we refer you to the Maryland General Corporation Law and our articles of incorporation and bylaws for a more detailed description of the provisions summarized below.

Our authorized stock consists of 100,000,000 shares of stock, par value $0.001 per share, all of which are initially designated as common stock. Our common stock is listed on the New York Stock Exchange under the ticker symbol “SCM.” There are no outstanding options or warrants to purchase our stock. No stock has been authorized for issuance under any equity compensation plans. Our fiscal year-end is December 31st. Under Maryland law, our stockholders generally are not personally liable for our debts or obligations.

The following presents our outstanding classes of securities as of March 31, 2018.

     
(1)
Title of Class
  (2)
Amount
Authorized
  (3)
Amount Held by
Us or for Our
Account
  (4)
Amount
Outstanding
Exclusive of
Amounts Shown
Under Column 3
Common Stock     100,000,000             15,953,811  

Under our charter, our board of directors is authorized to classify and reclassify any unissued shares of stock into other classes or series of stock without obtaining stockholder approval. As permitted by the Maryland General Corporation Law, our charter provides that the board of directors, without any action by our stockholders, may amend the charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have authority to issue.

All shares of our common stock have equal rights as to earnings, assets, voting, and distributions and, when they are issued, will be duly authorized, validly issued, fully paid and nonassessable. Distributions may be paid to the holders of our common stock if, as and when authorized by our board of directors and declared by us out of assets legally available therefor. Shares of our common stock have no preemptive, conversion or redemption rights and are freely transferable, except where their transfer is restricted by federal and state securities laws or by contract. In the event of our liquidation, dissolution or winding up, each share of our common stock would be entitled to share ratably in all of our assets that are legally available for distribution after we pay all debts and other liabilities and subject to any preferential rights of holders of our preferred stock, if any preferred stock is outstanding at such time. Each share of our common stock is entitled to one vote on all matters submitted to a vote of stockholders, including the election of directors. Except as provided with respect to any other class or series of stock, the holders of our common stock possess exclusive voting power. There is no cumulative voting in the election of directors, which means that holders of a majority of the outstanding shares of common stock can elect all of our directors, and holders of less than a majority of such shares will be unable to elect any director.

Limitation on Liability of Directors and Officers; Indemnification and Advance of Expenses

Maryland law permits a Maryland corporation to include in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (a) actual receipt of an improper benefit or profit in money, property or services or (b) active and deliberate dishonesty established by a final judgment and which is material to the cause of action. Our charter contains such a provision which eliminates directors’ and officers’ liability to the maximum extent permitted by Maryland law, subject to the requirements of the 1940 Act.

Our charter authorizes us, to the maximum extent permitted by Maryland law and subject to the requirements of the 1940 Act, to indemnify any present or former director or officer or any individual who, while a director and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner or trustee, from and against any claim or liability to which that person may become subject or which that person may incur by reason of his or her status as a present or former director or officer and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. Our bylaws obligate us, to the

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maximum extent permitted by Maryland law and subject to the requirements of the 1940 Act, to indemnify any present or former director or officer or any individual who, while a director and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner or trustee and who is made a party to the proceeding by reason of his service in that capacity from and against any claim or liability to which that person may become subject or which that person may incur by reason of his or her status as a present or former director or officer and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. The charter and bylaws also permit us to indemnify and advance expenses to any person who served a predecessor of us in any of the capacities described above and any of our employees or agents or any employees or agents of our predecessor. In accordance with the 1940 Act, we will not indemnify any person for any liability to which such person would be subject by reason of such person’s willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office.

Maryland law requires a corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful in the defense of any proceeding to which he or she is made a party by reason of his or her service in that capacity. Maryland law permits a corporation to indemnify its present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made a party by reason of their service in those or other capacities unless it is established that (a) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (1) was committed in bad faith or (2) was the result of active and deliberate dishonesty, (b) the director or officer actually received an improper personal benefit in money, property or services or (c) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under Maryland law, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation or for a judgment of liability on the basis that a personal benefit was improperly received, unless in either case a court orders indemnification, and then only for expenses. In addition, Maryland law permits a corporation to advance reasonable expenses to a director or officer upon the corporation’s receipt of (a) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the corporation and (b) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed by the corporation if it is ultimately determined that the standard of conduct was not met.

Our insurance policy does not currently provide coverage for claims, liabilities and expenses that may arise out of activities that our present or former directors or officers have performed for another entity at our request. There is no assurance that such entities will in fact carry such insurance. However, we note that we do not expect to request our present or former directors or officers to serve another entity as a director, officer, partner or trustee unless we can obtain insurance providing coverage for such persons for any claims, liabilities or expenses that may arise out of their activities while serving in such capacities.

Certain Provisions of the Maryland General Corporation Law and Our Charter and Bylaws

The Maryland General Corporation Law and our charter and bylaws contain provisions that could make it more difficult for a potential acquirer to acquire us by means of a tender offer, proxy contest or otherwise. These provisions are expected to discourage certain coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of us to negotiate first with our board of directors. We believe that the benefits of these provisions outweigh the potential disadvantages of discouraging any such acquisition proposals because, among other things, the negotiation of such proposals may improve their terms.

Classified Board of Directors

Our board of directors is divided into three classes of directors serving staggered three-year terms. Upon expiration of their terms, directors of each class will be elected to serve for three-year terms and until their successors are duly elected and qualify and each year one class of directors will be elected by the stockholders. A classified board may render a change in control of us or removal of our incumbent management more difficult. We believe, however, that the longer time required to elect a majority of a classified board of directors will help to ensure the continuity and stability of our management and policies.

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Election of Directors

Our charter and bylaws provide that the affirmative vote of the holders of a plurality of the outstanding shares of stock entitled to vote in the election of directors cast at a meeting of stockholders duly called and at which a quorum is present will be required to elect a director. Pursuant to our charter our board of directors may amend the bylaws to alter the vote required to elect directors.

Number of Directors; Vacancies; Removal

Our charter provides that the number of directors will be set only by the board of directors in accordance with our bylaws. Our bylaws provide that a majority of our entire board of directors may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of directors may never be less than one or more than nine. Our charter provides that, at such time as we have at least three independent directors and our common stock is registered under the Securities Exchange Act of 1934, as amended, we elect to be subject to the provision of Subtitle 8 of Title 3 of the Maryland General Corporation Law regarding the filling of vacancies on the board of directors. Accordingly, at such time, except as may be provided by the board of directors in setting the terms of any class or series of preferred stock, any and all vacancies on the board of directors may be filled only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy will serve for the remainder of the full term of the directorship in which the vacancy occurred and until a successor is elected and qualifies, subject to any applicable requirements of the 1940 Act.

Our charter provides that a director may be removed only for cause, as defined in our charter, and then only by the affirmative vote of at least two-thirds of the votes entitled to be cast in the election of directors.

Action by Stockholders

Under the Maryland General Corporation Law, stockholder action can be taken only at an annual or special meeting of stockholders or (unless the charter provides for stockholder action by less than unanimous written consent, which our charter does not) by unanimous written consent in lieu of a meeting. These provisions, combined with the requirements of our bylaws regarding the calling of a stockholder-requested special meeting of stockholders discussed below, may have the effect of delaying consideration of a stockholder proposal until the next annual meeting.

Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals

Our bylaws provide that with respect to an annual meeting of stockholders, nominations of persons for election to the board of directors and the proposal of business to be considered by stockholders may be made only (a) pursuant to our notice of the meeting, (b) by the board of directors or (c) by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice procedures of our bylaws. With respect to special meetings of stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of persons for election to the board of directors at a special meeting may be made only (1) pursuant to our notice of the meeting, (2) by the board of directors or (3) provided that the board of directors has determined that directors will be elected at the meeting, by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice provisions of the bylaws. The purpose of requiring stockholders to give us advance notice of nominations and other business is to afford our board of directors a meaningful opportunity to consider the qualifications of the proposed nominees and the advisability of any other proposed business and, to the extent deemed necessary or desirable by our board of directors, to inform stockholders and make recommendations about such qualifications or business, as well as to provide a more orderly procedure for conducting meetings of stockholders. Although our bylaws do not give our board of directors any power to disapprove stockholder nominations for the election of directors or proposals recommending certain action, they may have the effect of precluding a contest for the election of directors or the consideration of stockholder proposals if proper procedures are not followed and of discouraging or deterring a third party from conducting a solicitation of proxies to elect its own slate of directors or to approve its own proposal without regard to whether consideration of such nominees or proposals might be harmful or beneficial to us and our stockholders.

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Calling of Special Meetings of Stockholders

Our bylaws provide that special meetings of stockholders may be called by our board of directors and certain of our officers. Additionally, our bylaws provide that, subject to the satisfaction of certain procedural and informational requirements by the stockholders requesting the meeting, a special meeting of stockholders will be called by the secretary of the corporation upon the written request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast at such meeting.

Approval of Extraordinary Corporate Action; Amendment of Charter and Bylaws

Under Maryland law, a Maryland corporation generally cannot dissolve, amend its charter, merge, sell all or substantially all of its assets, engage in a share exchange or engage in similar transactions outside the ordinary course of business, unless approved by the affirmative vote of stockholders entitled to cast at least two-thirds of the votes entitled to be cast on the matter. However, a Maryland corporation may provide in its charter for approval of these matters by a lesser percentage, but not less than a majority of all of the votes entitled to be cast on the matter. Our charter generally provides for approval of charter amendments and extraordinary transactions by the stockholders entitled to cast at least a majority of the votes entitled to be cast on the matter. Our charter also provides that certain charter amendments, any proposal for our conversion, whether by charter amendment, merger or otherwise, from a closed-end company to an open-end company and any proposal for our liquidation or dissolution requires the approval of the stockholders entitled to cast at least 80% of the votes entitled to be cast on such matter. However, if such amendment or proposal is approved by a majority of our continuing directors (in addition to approval by our board of directors), such amendment or proposal may be approved by a majority of the votes entitled to be cast on such a matter. In either event, in accordance with the requirements of the 1940 Act, any such amendment or proposal that would have the effect of changing the nature of our business so as to cause us to cease to be, or to withdraw our election as, a BDC would be required to be approved by a majority of our outstanding voting securities, as defined under the 1940 Act. The “continuing directors” are defined in our charter as (a) our current directors, (b) those directors whose nomination for election by the stockholders or whose election by the directors to fill vacancies is approved by a majority of our current directors then on the board of directors or (c) any successor directors whose nomination for election by the stockholders or whose election by the directors to fill vacancies is approved by a majority of continuing directors or the successor continuing directors then in office.

Our charter and bylaws provide that the board of directors have the exclusive power to make, alter, amend or repeal any provision of our bylaws.

No Appraisal Rights

Except with respect to appraisal rights arising in connection with the Control Share Act discussed below, as permitted by the Maryland General Corporation Law, our charter provides that stockholders will not be entitled to exercise appraisal rights unless a majority of the board of directors shall determine such rights apply.

Control Share Acquisitions

The Maryland General Corporation Law provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, or the Control Share Act. Shares owned by the acquirer, by officers or by directors who are employees of the corporation are excluded from shares entitled to vote on the matter. Control shares are voting shares of stock which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquirer to exercise voting power in electing directors within one of the following ranges of voting power:

one-tenth or more but less than one-third;
one-third or more but less than a majority; or
a majority or more of all voting power.

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The requisite stockholder approval must be obtained each time an acquirer crosses one of the thresholds of voting power set forth above. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval. A control share acquisition means the acquisition of control shares, subject to certain exceptions.

A person who has made or proposes to make a control share acquisition may compel the board of directors of the corporation to call a special meeting of stockholders to be held within 50 days of demand to consider the voting rights of the shares. The right to compel the calling of a special meeting is subject to the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, the corporation may itself present the question at any stockholders meeting.

If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as required by the statute, then the corporation may redeem for fair value any or all of the control shares, except those for which voting rights have previously been approved. The right of the corporation to redeem control shares is subject to certain conditions and limitations, including, as provided in our bylaws, compliance with the 1940 Act. Fair value is determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquirer or of any meeting of stockholders at which the voting rights of the shares are considered and not approved. If voting rights for control shares are approved at a stockholders meeting and the acquirer becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights. The fair value of the shares as determined for purposes of appraisal rights may not be less than the highest price per share paid by the acquirer in the control share acquisition.

The Control Share Act does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b) to acquisitions approved or exempted by the charter or bylaws of the corporation. Our bylaws contain a provision exempting from the Control Share Act any and all acquisitions by any person of our shares of stock. There can be no assurance that such provision will not be amended or eliminated at any time in the future. However, we will amend our bylaws to be subject to the Control Share Act only if the board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the Control Share Act does not conflict with the 1940 Act.

Business Combinations

Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder, or the Business Combination Act. These business combinations include a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as:

any person who beneficially owns 10% or more of the voting power of the corporation’s outstanding voting stock; or
an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of then outstanding voting stock of the corporation.

A person is not an interested stockholder under this statute if the board of directors approved in advance the transaction by which the stockholder otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board.

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After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:

80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.

These super-majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares.

The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors before the time that the interested stockholder becomes an interested stockholder. Our board of directors has adopted a resolution that any business combination between us and any other person is exempted from the provisions of the Business Combination Act, provided that the business combination is first approved by the board of directors, including a majority of the directors who are not interested persons as defined in the 1940 Act. This resolution may be altered or repealed in whole or in part at any time; however, our board of directors will adopt resolutions so as to make us subject to the provisions of the Business Combination Act only if the board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the Business Combination Act does not conflict with the 1940 Act. If this resolution is repealed, or the board of directors does not otherwise approve a business combination, the statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.

Conflict with 1940 Act

Our bylaws provide that, if and to the extent that any provision of the Maryland General Corporation Law, including the Control Share Act (if we amend our bylaws to be subject to such Act) and the Business Combination Act, or any provision of our charter or bylaws conflicts with any provision of the 1940 Act, the applicable provision of the 1940 Act will control.

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DESCRIPTION OF OUR PREFERRED STOCK

Our articles of incorporation authorize our board of directors to classify and reclassify any unissued shares of stock into other classes or series of stock, including preferred stock. Prior to issuance of shares of each class or series, the board of directors is required by Maryland law and by our articles of incorporation to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our securities or otherwise be in their best interest. You should note, however, that any issuance of preferred stock must comply with the requirements of the 1940 Act. The 1940 Act requires, among other things, that (a) immediately after issuance and before any dividend or other distribution is made with respect to our securities and before any purchase of securities is made, such preferred stock together with all other senior securities must not exceed an amount equal to 50.0% of our total assets after deducting the amount of such dividend, distribution or purchase price, as the case may be, and (b) the holders of shares of preferred stock, if any are issued, must be entitled as a class to elect two directors at all times and to elect a majority of the directors if distributions on such preferred stock are in arrears by two years or more. Certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock. For example, holders of preferred stock would vote separately from the holders of common stock on a proposal to cease operations as a BDC. Further, the 1940 Act requires that any distributions we make on preferred stock be cumulative. We believe that the availability for issuance of preferred stock will provide us with increased flexibility in structuring future financings and acquisitions.

For any series of preferred stock that we may issue, our board of directors will determine and the prospectus supplement relating to such series will describe:

the designation and number of shares of such series;
the rate and time at which, and the preferences and conditions under which, any dividends will be paid on shares of such series, as well as whether such dividends are participating or non-participating;
any provisions relating to convertibility or exchangeability of the shares of such series;
the rights and preferences, if any, of holders of shares of such series upon our liquidation, dissolution or winding up of our affairs;
the voting powers, if any, of the holders of shares of such series;
any provisions relating to the redemption of the shares of such series;
any limitations on our ability to pay dividends or make distributions on, or acquire or redeem, other securities while shares of such series are outstanding;
any conditions or restrictions on our ability to issue additional shares of such series or other securities;
if applicable, a discussion of certain U.S. federal income tax considerations; and
any other relative power, preferences and participating, optional or special rights of shares of such series, and the qualifications, limitations or restrictions thereof.

All shares of preferred stock that we may issue will be identical and of equal rank except as to the particular terms thereof that may be fixed by our board of directors, and all shares of each series of preferred stock will be identical and of equal rank except as to the dates from which cumulative dividends, if any, thereon will be cumulative.

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DESCRIPTION OF OUR SUBSCRIPTION RIGHTS

We may issue subscription rights to purchase common stock. Subscription rights may be issued independently or together with any other offered security and may or may not be transferable by the person purchasing or receiving the subscription rights. In connection with any subscription rights offering to our stockholders, we may enter into a standby underwriting or other arrangement with one or more underwriters or other persons pursuant to which such underwriters or other persons would purchase any offered securities remaining unsubscribed for after such subscription rights offering. We will not offer transferable subscription rights to our stockholders at a price equivalent to less than the then current net asset value per share of common stock, excluding underwriting commissions, unless we first file a post-effective amendment that is declared effective by the SEC with respect to such issuance and the common stock to be purchased in connection with the rights represents no more than one-third of our outstanding common stock at the time such rights are issued. In connection with a subscription rights offering to our stockholders, we would distribute certificates evidencing the subscription rights and a prospectus supplement to our stockholders on the record date that we set for receiving subscription rights in such subscription rights offering. Our common stockholders will indirectly bear the expenses of such subscription rights offerings, regardless of whether our common stockholders exercise any subscription rights.

The applicable prospectus supplement would describe the following terms of subscription rights in respect of which this prospectus is being delivered:

the title of such subscription rights;
the exercise price or a formula for the determination of the exercise price for such subscription rights;
the number or a formula for the determination of the number of such subscription rights issued to each stockholder;
the extent to which such subscription rights are transferable;
if applicable, a discussion of the material U.S. federal income tax considerations applicable to the issuance or exercise of such subscription rights;
the date on which the right to exercise such subscription rights would commence, and the date on which such rights shall expire (subject to any extension);
the extent to which such subscription rights include an over-subscription privilege with respect to unsubscribed securities;
if applicable, the material terms of any standby underwriting or other purchase arrangement that we may enter into in connection with the subscription rights offering; and
any other terms of such subscription rights, including terms, procedures and limitations relating to the exchange and exercise of such subscription rights.

Exercise of Subscription Rights

Each subscription right would entitle the holder of the subscription right to purchase for cash such amount of shares of common stock or other securities at such exercise price as shall in each case be set forth in, or be determinable as set forth in, the prospectus supplement relating to the subscription rights offered thereby or another report filed with the SEC. Subscription rights may be exercised at any time up to the close of business on the expiration date for such subscription rights set forth in the applicable prospectus supplement. After the close of business on the expiration date, all unexercised subscription rights would become void. We have not previously completed such an offering of subscription rights.

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Subscription rights may be exercised as set forth in the prospectus supplement relating to the subscription rights offered thereby. Upon receipt of payment and the subscription rights certificate properly completed and duly executed at the corporate trust office of the subscription rights agent or any other office indicated in the prospectus supplement, we will forward, as soon as practicable, the shares of common stock or other securities purchasable upon such exercise. We may determine to offer any unsubscribed offered securities directly to stockholders, persons other than stockholders, to or through agents, underwriters or dealers or through a combination of such methods, including pursuant to standby underwriting or other arrangements, as set forth in the applicable prospectus supplement.

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DESCRIPTION OF OUR DEBT SECURITIES

We may issue debt securities in one or more series. The specific terms of each series of debt securities will be described in the particular prospectus supplement relating to that series. The prospectus supplement may or may not modify the general terms found in this prospectus and will be filed with the SEC. For a complete description of the terms of a particular series of debt securities, you should read both this prospectus and the prospectus supplement relating to that particular series.

As required by federal law for all bonds and notes of companies that are publicly offered, the debt securities are governed by a document called an “indenture.” An indenture is a contract between us and the financial institution acting as trustee on your behalf, and is subject to and governed by the Trust Indenture Act of 1939, as amended. The trustee has two main roles. First, the trustee can enforce your rights against us if we default. There are some limitations on the extent to which the trustee acts on your behalf, described in the second paragraph under “— Events of Default — Remedies if an Event of Default Occurs.” Second, the trustee performs certain administrative duties for us with respect to our debt securities.

This section includes a description of the material provisions of the indenture. Because this section is a summary, however, it does not describe every aspect of the debt securities and the indenture. We urge you to read the indenture because it, and not this description, defines your rights as a holder of debt securities. A copy of the form of indenture is attached as an exhibit to the registration statement of which this prospectus is a part. We will file a supplemental indenture with the SEC in connection with any debt offering, at which time the supplemental indenture would be publicly available. See “Available Information” for information on how to obtain a copy of the indenture.

The prospectus supplement, which will accompany this prospectus, will describe the particular series of debt securities being offered by including:

the designation or title of the series of debt securities;
the total principal amount of the series of debt securities;
the percentage of the principal amount at which the series of debt securities will be offered;
the date or dates on which principal will be payable;
the rate or rates (which may be either fixed or variable) and/or the method of determining such rate or rates of interest, if any;
the date or dates from which any interest will accrue, or the method of determining such date or dates, and the date or dates on which any interest will be payable;
whether any interest may be paid by issuing additional securities of the same series in lieu of cash (and the terms upon which any such interest may be paid by issuing additional securities);
the terms for redemption, extension or early repayment, if any;
the currencies in which the series of debt securities are issued and payable;
whether the amount of payments of principal, premium or interest, if any, on a series of debt securities will be determined with reference to an index, formula or other method (which could be based on one or more currencies, commodities, equity indices or other indices) and how these amounts will be determined;
the place or places, if any, other than or in addition to the Borough of Manhattan in the City of New York, of payment, transfer, conversion and/or exchange of the debt securities;
the denominations in which the offered debt securities will be issued (if other than $1,000 and any integral multiple thereof);
the provision for any sinking fund;
any restrictive covenants;
any Events of Default (as defined in “Events of Default” below);

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whether the series of debt securities are issuable in certificated form;
any provisions for defeasance or covenant defeasance;
any special federal income tax implications, including, if applicable, federal income tax considerations relating to original issue discount;
whether and under what circumstances we will pay additional amounts in respect of any tax, assessment or governmental charge and, if so, whether we will have the option to redeem the debt securities rather than pay the additional amounts (and the terms of this option);
any provisions for convertibility or exchangeability of the debt securities into or for any other securities;
whether the debt securities are subject to subordination and the terms of such subordination;
whether the debt securities are secured and the terms of any security interest;
the listing, if any, on a securities exchange; and
any other terms.

The debt securities may be secured or unsecured obligations. Unless the prospectus supplement states otherwise, principal (and premium, if any) and interest, if any, will be paid by us in immediately available funds.

We are permitted, under specified conditions, to issue multiple classes of indebtedness if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance after giving effect to any exemptive relief granted to us by the SEC. For a discussion of the risks associated with leverage, see “Risk Factors — Risks Relating to Our Business and Structure — Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.”

General

The indenture provides that any debt securities proposed to be sold under this prospectus and the accompanying prospectus supplement (“offered debt securities”) and any debt securities issuable upon the exercise of warrants or upon conversion or exchange of other offered securities (“underlying debt securities”) may be issued under the indenture in one or more series.

For purposes of this prospectus, any reference to the payment of principal of, or premium or interest, if any, on, debt securities will include additional amounts if required by the terms of the debt securities.

The indenture does not limit the amount of debt securities that may be issued thereunder from time to time. Debt securities issued under the indenture, when a single trustee is acting for all debt securities issued under the indenture, are called the “indenture securities.” The indenture also provides that there may be more than one trustee thereunder, each with respect to one or more different series of indenture securities. See “— Resignation of Trustee” below. At a time when two or more trustees are acting under the indenture, each with respect to only certain series, the term “indenture securities” means the one or more series of debt securities with respect to which each respective trustee is acting. In the event that there is more than one trustee under the indenture, the powers and trust obligations of each trustee described in this prospectus will extend only to the one or more series of indenture securities for which it is trustee. If two or more trustees are acting under the indenture, then the indenture securities for which each trustee is acting would be treated as if issued under separate indentures.

Except as described under “— Events of Default” and “— Merger or Consolidation” below, the indenture does not contain any provisions that give you protection in the event we issue a large amount of debt or we are acquired by another entity.

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We refer you to the prospectus supplement for information with respect to any deletions from, modifications of or additions to the Events of Default or our covenants that are described below, including any addition of a covenant or other provision providing event risk protection or similar protection.

We have the ability to issue indenture securities with terms different from those of indenture securities previously issued and, without the consent of the holders thereof, to reopen a previous issue of a series of indenture securities and issue additional indenture securities of that series unless the reopening was restricted when that series was created.

Conversion and Exchange

If any debt securities are convertible into or exchangeable for other securities, the prospectus supplement will explain the terms and conditions of the conversion or exchange, including the conversion price or exchange ratio (or the calculation method), the conversion or exchange period (or how the period will be determined), if conversion or exchange will be mandatory or at the option of the holder or us, provisions for adjusting the conversion price or the exchange ratio and provisions affecting conversion or exchange in the event of the redemption of the underlying debt securities. These terms may also include provisions under which the number or amount of other securities to be received by the holders of the debt securities upon conversion or exchange would be calculated according to the market price of the other securities as of a time stated in the prospectus supplement.

Issuance of Securities in Registered Form

We may issue the debt securities in registered form, in which case we may issue them either in book-entry form only or in “certificated” form. Debt securities issued in book-entry form will be represented by global securities. We expect that we will usually issue debt securities in book-entry only form represented by global securities.

Book-Entry Holders

We will issue registered debt securities in book-entry form only, unless we specify otherwise in the applicable prospectus supplement. This means debt securities will be represented by one or more global securities registered in the name of a depositary that will hold them on behalf of financial institutions that participate in the depositary’s book-entry system. These participating institutions, in turn, hold beneficial interests in the debt securities held by the depositary or its nominee. These institutions may hold these interests on behalf of themselves or customers.

Under the indenture, only the person in whose name a debt security is registered is recognized as the holder of that debt security. Consequently, for debt securities issued in book-entry form, we will recognize only the depositary as the holder of the debt securities and we will make all payments on the debt securities to the depositary. The depositary will then pass along the payments it receives to its participants, which in turn will pass the payments along to their customers who are the beneficial owners. The depositary and its participants do so under agreements they have made with one another or with their customers; they are not obligated to do so under the terms of the debt securities.

As a result, investors will not own debt securities directly. Instead, they will own beneficial interests in a global security, through a bank, broker or other financial institution that participates in the depositary’s book-entry system or holds an interest through a participant. As long as the debt securities are represented by one or more global securities, investors will be indirect holders, and not holders, of the debt securities.

Street Name Holders

In the future, we may issue debt securities in certificated form or terminate a global security. In these cases, investors may choose to hold their debt securities in their own names or in “street name.” Debt securities held in street name are registered in the name of a bank, broker or other financial institution chosen by the investor, and the investor would hold a beneficial interest in those debt securities through the account he or she maintains at that institution.

For debt securities held in street name, we will recognize only the intermediary banks, brokers and other financial institutions in whose names the debt securities are registered as the holders of those debt securities,

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and we will make all payments on those debt securities to them. These institutions will pass along the payments they receive to their customers who are the beneficial owners, but only because they agree to do so in their customer agreements or because they are legally required to do so. Investors who hold debt securities in street name will be indirect holders, and not holders, of the debt securities.

Legal Holders

Our obligations, as well as the obligations of the applicable trustee and those of any third parties employed by us or the applicable trustee, run only to the legal holders of the debt securities. We do not have obligations to investors who hold beneficial interests in global securities, in street name or by any other indirect means. This will be the case whether an investor chooses to be an indirect holder of a debt security or has no choice because we are issuing the debt securities only in book-entry form.

For example, once we make a payment or give a notice to the holder, we have no further responsibility for the payment or notice even if that holder is required, under agreements with depositary participants or customers or by law, to pass it along to the indirect holders but does not do so. Similarly, if we want to obtain the approval of the holders for any purpose (for example, to amend an indenture or to relieve us of the consequences of a default or of our obligation to comply with a particular provision of an indenture), we would seek the approval only from the holders, and not the indirect holders, of the debt securities. Whether and how the holders contact the indirect holders is up to the holders.

When we refer to you in this Description of Our Debt Securities, we mean those who invest in the debt securities being offered by this prospectus, whether they are the holders or only indirect holders of those debt securities. When we refer to your debt securities, we mean the debt securities in which you hold a direct or indirect interest.

Special Considerations for Indirect Holders

If you hold debt securities through a bank, broker or other financial institution, either in book-entry form or in street name, we urge you to check with that institution to find out:

how it handles securities payments and notices;
whether it imposes fees or charges;
how it would handle a request for the holders’ consent, if ever required;
whether and how you can instruct it to send you debt securities registered in your own name so you can be a holder, if that is permitted in the future for a particular series of debt securities;
how it would exercise rights under the debt securities if there were a default or other event triggering the need for holders to act to protect their interests; and
if the debt securities are in book-entry form, how the depositary’s rules and procedures will affect these matters.

Global Securities

As noted above, we usually will issue debt securities as registered securities in book-entry form only. A global security represents one or any other number of individual debt securities. Generally, all debt securities represented by the same global securities will have the same terms.

Each debt security issued in book-entry form will be represented by a global security that we deposit with and register in the name of a financial institution or its nominee that we select. The financial institution that we select for this purpose is called the depositary. Unless we specify otherwise in the applicable prospectus supplement, The Depository Trust Company, New York, New York, known as DTC, will be the depositary for all debt securities issued in book-entry form.

A global security may not be transferred to or registered in the name of anyone other than the depositary or its nominee, unless special termination situations arise. We describe those situations below under “— Termination of a Global Security.” As a result of these arrangements, the depositary, or its nominee, will be the sole registered owner and holder of all debt securities represented by a global security, and investors

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will be permitted to own only beneficial interests in a global security. Beneficial interests must be held by means of an account with a broker, bank or other financial institution that in turn has an account with the depositary or with another institution that has an account with the depositary. Thus, an investor whose security is represented by a global security will not be a holder of the debt security, but only an indirect holder of a beneficial interest in the global security.

Special Considerations for Global Securities

As an indirect holder, an investor’s rights relating to a global security will be governed by the account rules of the investor’s financial institution and of the depositary, as well as general laws relating to securities transfers. The depositary that holds the global security will be considered the holder of the debt securities represented by the global security.

If debt securities are issued only in the form of a global security, an investor should be aware of the following:

an investor cannot cause the debt securities to be registered in his or her name and cannot obtain certificates for his or her interest in the debt securities, except in the special situations we describe below;
an investor will be an indirect holder and must look to his or her own bank or broker for payments on the debt securities and protection of his or her legal rights relating to the debt securities, as we describe under “— Issuance of Securities in Registered Form” above;
an investor may not be able to sell interests in the debt securities to some insurance companies and other institutions that are required by law to own their securities in non-book-entry form;
an investor may not be able to pledge his or her interest in a global security in circumstances where certificates representing the debt securities must be delivered to the lender or other beneficiary of the pledge in order for the pledge to be effective;
the depositary’s policies, which may change from time to time, will govern payments, transfers, exchanges and other matters relating to an investor’s interest in a global security. We and the trustee have no responsibility for any aspect of the depositary’s actions or for its records of ownership interests in a global security. We and the trustee also do not supervise the depositary in any way;
if we redeem less than all the debt securities of a particular series being redeemed, DTC’s practice is to determine by lot the amount to be redeemed from each of its participants holding that series;
an investor is required to give notice of exercise of any option to elect repayment of its debt securities, through its participant, to the applicable trustee and to deliver the related debt securities by causing its participant to transfer its interest in those debt securities, on DTC’s records, to the applicable trustee;
DTC requires that those who purchase and sell interests in a global security deposited in its book-entry system use immediately available funds, your broker or bank may also require you to use immediately available funds when purchasing or selling interests in a global security; and
financial institutions that participate in the depositary’s book-entry system, and through which an investor holds its interest in a global security, may also have their own policies affecting payments, notices and other matters relating to the debt securities; there may be more than one financial intermediary in the chain of ownership for an investor; we do not monitor and are not responsible for the actions of any of those intermediaries.

Termination of a Global Security

If a global security is terminated for any reason, interests in it will be exchanged for certificates in non-book-entry form (certificated securities). After that exchange, the choice of whether to hold the certificated debt securities directly or in street name will be up to the investor. Investors must consult their own banks or brokers to find out how to have their interests in a global security transferred on termination to their own names, so that they will be holders. We have described the rights of legal holders and street name investors under “— Issuance of Securities in Registered Form” above.

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The prospectus supplement may list situations for terminating a global security that would apply only to the particular series of debt securities covered by the prospectus supplement. If a global security is terminated, only the depositary, and not we or the applicable trustee, is responsible for deciding the investors in whose names the debt securities represented by the global security will be registered and, therefore, who will be the holders of those debt securities.

Payment and Paying Agents

We will pay interest to the person listed in the applicable trustee’s records as the owner of the debt security at the close of business on a particular day in advance of each due date for interest, even if that person no longer owns the debt security on the interest due date. That day, usually about two weeks in advance of the interest due date, is called the “record date.” Because we will pay all the interest for an interest period to the holders on the record date, holders buying and selling debt securities must work out between themselves the appropriate purchase price. The most common manner is to adjust the sales price of the debt securities to prorate interest fairly between buyer and seller based on their respective ownership periods within the particular interest period. This prorated interest amount is called “accrued interest.”

Payments on Global Securities

We will make payments on a global security in accordance with the applicable policies of the depositary as in effect from time to time. Under those policies, we will make payments directly to the depositary, or its nominee, and not to any indirect holders who own beneficial interests in the global security. An indirect holder’s right to those payments will be governed by the rules and practices of the depositary and its participants, as described under “— Special Considerations for Global Securities.”

Payments on Certificated Securities

We will make payments on a certificated debt security as follows. We will pay interest that is due on an interest payment date to the holder of debt securities as shown on the trustee’s records as of the close of business on the regular record date at our office and/or at other offices that may be specified in the prospectus supplement. We will make all payments of principal and premium, if any, by check at the office of the applicable trustee and/or at other offices that may be specified in the prospectus supplement or in a notice to holders against surrender of the debt security.

Alternatively, at our option, we may pay any cash interest that becomes due on the debt security by mailing a check to the holder at his, her or its address shown on the trustee’s records as of the close of business on the regular record date or by transfer to an account at a bank in the United States, in either case, on the due date.

Payment When Offices Are Closed

If any payment is due on a debt security on a day that is not a business day, we will make the payment on the next day that is a business day. Payments made on the next business day in this situation will be treated under the indenture as if they were made on the original due date, except as otherwise indicated in the attached prospectus supplement. Such payment will not result in a default under any debt security or the indenture, and no interest will accrue on the payment amount from the original due date to the next day that is a business day.

Book-entry and other indirect holders should consult their banks or brokers for information on how they will receive payments on their debt securities.

Events of Default

You will have rights if an Event of Default occurs in respect of the debt securities of your series and is not cured, as described later in this subsection.

The term “Event of Default” in respect of the debt securities of your series means any of the following:

we do not pay the principal of, or any premium on, a debt security of the series within five days of its due date;
we do not pay interest on a debt security of the series within 30 days of its due date;

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we do not deposit any sinking fund payment in respect of debt securities of the series within five days of its due date;
we remain in breach of a covenant in respect of debt securities of the series for 60 days after we receive a written notice of default stating we are in breach (the notice must be sent by either the trustee or holders of at least 25% of the principal amount of the outstanding debt securities of the series);
we file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and remain undischarged or unstayed for a period of 90 days;
the series of debt securities has an asset coverage, as such term is defined in the 1940 Act, of less than 100 per centum on the last business day of each of twenty-four consecutive calendar months, giving effect to any exemptive relief granted to the Company by the SEC; or
any other Event of Default in respect of debt securities of the series described in the prospectus supplement occurs.

An Event of Default for a particular series of debt securities does not necessarily constitute an Event of Default for any other series of debt securities issued under the same or any other indenture. The trustee may withhold notice to the holders of debt securities of any default, except in the payment of principal, premium, interest, or sinking or purchase fund installment, if it in good faith considers the withholding of notice to be in the interest of the holders.

Remedies if an Event of Default Occurs

If an Event of Default has occurred and is continuing, the trustee or the holders of not less than 25% in principal amount of the outstanding debt securities of the affected series may (and the trustee shall at the request of such holders) declare the entire principal amount of all the debt securities of that series to be due and immediately payable. This is called a declaration of acceleration of maturity. A declaration of acceleration of maturity may be canceled by the holders of a majority in principal amount of the outstanding debt securities of the affected series if (1) we have deposited with the trustee all amounts due and owing with respect to the securities (other than principal that has become due solely by reason of such acceleration) and certain other amounts, and (2) any other Events of Default have been cured or waived.

The trustee is not required to take any action under the indenture at the request of any holders unless the holders offer the trustee protection from expenses and liability reasonably satisfactory to it (called an “indemnity”). If indemnity reasonably satisfactory to the trustee is provided, the holders of a majority in principal amount of the outstanding debt securities of the relevant series may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any remedy available to the trustee. The trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or remedy will be treated as a waiver of that right, remedy or Event of Default.

Before you are allowed to bypass your trustee and bring your own lawsuit or other formal legal action or take other steps to enforce your rights or protect your interests relating to the debt securities, the following must occur:

you must give the trustee written notice that an Event of Default with respect to the relevant series of debt securities has occurred and remains uncured;
the holders of at least 25% in principal amount of all outstanding debt securities of the relevant series must make a written request that the trustee take action because of the default and must offer the trustee indemnity, security or both reasonably satisfactory to it against the costs, expenses and other liabilities of taking that action;
the trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity and/or security; and
the holders of a majority in principal amount of the outstanding debt securities of that series must not have given the trustee a direction inconsistent with the above notice during that 60-day period.

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However, you are entitled at any time to bring a lawsuit for the payment of money due on your debt securities on or after the due date.

Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make a request of the trustee and how to declare or cancel an acceleration of maturity.

Each year, we will furnish to each trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with the indenture and the debt securities, or else specifying any default.

Waiver of Default

Holders of a majority in principal amount of the outstanding debt securities of the affected series may waive any past defaults other than a default

in the payment of principal, any premium or interest; or
in respect of a covenant that cannot be modified or amended without the consent of each holder.

Merger or Consolidation

Under the terms of the indenture, we are generally permitted to consolidate or merge with another entity. We are also permitted to sell all or substantially all of our assets to another entity. However, we may not take any of these actions unless all the following conditions are met:

where we merge out of existence or sell substantially all our assets, the resulting entity or transferee must agree to be legally responsible for our obligations under the debt securities;
the merger or sale of assets must not cause a default on the debt securities and we must not already be in default (unless the merger or sale would cure the default). For purposes of this no-default test, a default would include an Event of Default that has occurred and has not been cured, as described under “Events of Default” above. A default for this purpose would also include any event that would be an Event of Default if the requirements for giving us a notice of default or our default having to exist for a specific period of time were disregarded;
we must deliver certain certificates and documents to the trustee; and
we must satisfy any other requirements specified in the prospectus supplement relating to a particular series of debt securities.

Modification or Waiver

There are three types of changes we can make to the indenture and the debt securities issued thereunder.

Changes Requiring Your Approval

First, there are changes that we cannot make to your debt securities without your specific approval. The following is a list of those types of changes:

change the stated maturity of the principal of or interest on a debt security or the terms of any sinking fund with respect to any security;
reduce any amounts due on a debt security;
reduce the amount of principal payable upon acceleration of the maturity of an original issue discount or indexed security following a default or upon the redemption thereof or the amount thereof provable in a bankruptcy proceeding;
adversely affect any right of repayment at the holder’s option;
change the place or currency of payment on a debt security (except as otherwise described in the prospectus or prospectus supplement);
impair your right to sue for payment;

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adversely affect any right to convert or exchange a debt security in accordance with its terms;
modify the subordination provisions in the indenture in a manner that is adverse to outstanding holders of the debt securities;
reduce the percentage of holders of debt securities whose consent is needed to modify or amend the indenture;
reduce the percentage of holders of debt securities whose consent is needed to waive compliance with certain provisions of the indenture or to waive certain defaults;
modify any other aspect of the provisions of the indenture dealing with supplemental indentures with the consent of holders, waiver of past defaults, changes to the quorum or voting requirements or the waiver of certain covenants; and
change any obligation we have to pay additional amounts.

Changes Not Requiring Approval

The second type of change does not require any vote by the holders of the debt securities. This type is limited to clarifications, establishment of the form or terms of new securities of any series as permitted by the indenture and certain other changes that would not adversely affect holders of the outstanding debt securities in any material respect. We also do not need any approval to make any change that affects only debt securities to be issued under the indenture after the change takes effect.

Changes Requiring Majority Approval

Any other change to the indenture and the debt securities would require the following approval:

if the change affects only one series of debt securities, it must be approved by the holders of a majority in principal amount of that series; and
if the change affects more than one series of debt securities issued under the same indenture, it must be approved by the holders of a majority in principal amount of all of the series affected by the change, with all affected series voting together as one class for this purpose.

In each case, the required approval must be given by written consent.

The holders of a majority in principal amount of a series of debt securities issued under the indenture, voting together as one class for this purpose, may waive our compliance with some of our covenants applicable to that series of debt securities. However, we cannot obtain a waiver of a payment default or of any of the matters covered by the bullet points included above under “— Changes Requiring Your Approval.”

Further Details Concerning Voting

When taking a vote, we will use the following rules to decide how much principal to attribute to a debt security:

for original issue discount securities, we will use the principal amount that would be due and payable on the voting date if the maturity of these debt securities were accelerated to that date because of a default;
for debt securities whose principal amount is not known (for example, because it is based on an index), we will use the principal face amount at original issuance or a special rule for that debt security described in the prospectus supplement; and
for debt securities denominated in one or more foreign currencies, we will use the U.S. dollar equivalent.

Debt securities will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their payment or redemption or if we, any other obligor, or any affiliate of us or any obligor own such debt securities. Debt securities will also not be eligible to vote if they have been fully defeased as described later under “— Defeasance — Full Defeasance.”

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We will generally be entitled to set any day as a record date for the purpose of determining the holders of outstanding indenture securities that are entitled to vote or take other action under the indenture. However, the record date may not be more than 30 days before the date of the first solicitation of holders to vote on or take such action. If we set a record date for a vote or other action to be taken by holders of one or more series, that vote or action may be taken only by persons who are holders of outstanding indenture securities of those series on the record date and must be taken within eleven months following the record date.

Book-entry and other indirect holders should consult their banks or brokers for information on how approval may be granted or denied if we seek to change the indenture or the debt securities or request a waiver.

Defeasance

The following provisions will be applicable to each series of debt securities unless we state in the applicable prospectus supplement that the provisions of covenant defeasance and full defeasance will not be applicable to that series.

Covenant Defeasance

Under current U.S. federal tax law and the indenture, we can make the deposit described below and be released from some of the restrictive covenants in the indenture under which the particular series was issued. This is called “covenant defeasance.” In that event, you would lose the protection of those restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay your debt securities. If we achieved covenant defeasance and your debt securities were subordinated as described under “— Indenture Provisions — Subordination” below, such subordination would not prevent the trustee under the indenture from applying the funds available to it from the deposit described in the first bullet below to the payment of amounts due in respect of such debt securities for the benefit of the subordinated debt holders. In order to achieve covenant defeasance, we must do the following:

we must deposit in trust for the benefit of all holders of a series of debt securities a combination of cash (in such currency in which such securities are then specified as payable at stated maturity) or government obligations applicable to such securities (determined on the basis of the currency in which such securities are then specified as payable at stated maturity) that will generate enough cash to make interest, principal and any other payments on the debt securities on their various due dates and any mandatory sinking fund payments or analogous payments;
we must deliver to the trustee a legal opinion of our counsel confirming that, under current U.S. federal income tax law, we may make the above deposit without causing you to be taxed on the debt securities any differently than if we did not make the deposit;
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, as amended, and a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied with;
defeasance must not result in a breach or violation of, or result in a default under, of the indenture or any of our other material agreements or instruments;
no default or event of default with respect to such debt securities shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days; and
satisfy the conditions for covenant defeasance contained in any supplemental indentures.

If we accomplish covenant defeasance, you can still look to us for repayment of the debt securities if there were a shortfall in the trust deposit or the trustee is prevented from making payment. For example, if one of the remaining Events of Default occurred (such as our bankruptcy) and the debt securities became immediately due and payable, there might be such a shortfall. However, there is no assurance that we would have sufficient funds to make payment of the shortfall.

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Full Defeasance

If there is a change in U.S. federal tax law or we obtain an IRS ruling, as described in the second bullet below, we can legally release ourselves from all payment and other obligations on the debt securities of a particular series (called “full defeasance”) if we put in place the following other arrangements for you to be repaid:

we must deposit in trust for the benefit of all holders of a series of debt securities a combination of cash (in such currency in which such securities are then specified as payable at stated maturity) or government obligations applicable to such securities (determined on the basis of the currency in which such securities are then specified as payable at stated maturity) that will generate enough cash to make interest, principal and any other payments on the debt securities on their various due dates and any mandatory sinking fund payments or analogous payments;
we must deliver to the trustee a legal opinion confirming that there has been a change in current U.S. federal tax law or an IRS ruling that allows us to make the above deposit without causing you to be taxed on the debt securities any differently than if we did not make the deposit. Under current U.S. federal tax law, the deposit and our legal release from the debt securities would be treated as though we paid you your share of the cash and notes or bonds at the time the cash and notes or bonds were deposited in trust in exchange for your debt securities and you would recognize gain or loss on the debt securities at the time of the deposit;
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940 Act, as amended, and a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied with;
defeasance must not result in a breach or violation of, or constitute a default under, of the indenture or any of our other material agreements or instruments;
no default or event of default with respect to such debt securities shall have occurred and be continuing and no defaults or events of default related to bankruptcy, insolvency or reorganization shall occur during the next 90 days; and
satisfy the conditions for full defeasance contained in any supplemental indentures.

If we ever did accomplish full defeasance, as described above, you would have to rely solely on the trust deposit for repayment of the debt securities. You could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from claims of our lenders and other creditors if we ever became bankrupt or insolvent. If your debt securities were subordinated as described later under “— Indenture Provisions — Subordination”, such subordination would not prevent the trustee under the indenture from applying the funds available to it from the deposit referred to in the first bullet of the preceding paragraph to the payment of amounts due in respect of such debt securities for the benefit of the subordinated debt holders.

Form, Exchange and Transfer of Certificated Registered Securities

If registered debt securities cease to be issued in book-entry form, they will be issued:

only in fully registered certificated form;
without interest coupons; and
unless we indicate otherwise in the prospectus supplement, in denominations of $1,000 and amounts that are multiples of $1,000.

Holders may exchange their certificated securities for debt securities of smaller denominations or combined into fewer debt securities of larger denominations, as long as the total principal amount is not changed and as long as the denomination is greater than the minimum denomination for such securities.

Holders may exchange or transfer their certificated securities at the office of the trustee. We have appointed the trustee to act as our agent for registering debt securities in the names of holders transferring debt securities. We may appoint another entity to perform these functions or perform them ourselves.

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Holders will not be required to pay a service charge to transfer or exchange their certificated securities, but they may be required to pay any tax or other governmental charge associated with the transfer or exchange. The transfer or exchange will be made only if our transfer agent is satisfied with the holder’s proof of legal ownership.

If we have designated additional transfer agents for your debt security, they will be named in the prospectus supplement. We may appoint additional transfer agents or cancel the appointment of any particular transfer agent. We may also approve a change in the office through which any transfer agent acts.

If any certificated securities of a particular series are redeemable and we redeem less than all the debt securities of that series, we may block the transfer or exchange of those debt securities during the period beginning 15 days before the day we mail the notice of redemption and ending on the day of that mailing, in order to freeze the list of holders to prepare the mailing. We may also refuse to register transfers or exchanges of any certificated securities selected for redemption, except that we will continue to permit transfers and exchanges of the unredeemed portion of any debt security that will be partially redeemed.

If a registered debt security is issued in book-entry form, only the depositary will be entitled to transfer and exchange the debt security as described in this subsection, since it will be the sole holder of the debt security.

Resignation of Trustee

Each trustee may resign or be removed with respect to one or more series of indenture securities provided that a successor trustee is appointed to act with respect to these series and has accepted such appointment. In the event that two or more persons are acting as trustee with respect to different series of indenture securities under the indenture, each of the trustees will be a trustee of a trust separate and apart from the trust administered by any other trustee.

Indenture Provisions — Subordination

Upon any distribution of our assets upon our dissolution, winding up, liquidation or reorganization, the payment of the principal of (and premium, if any) and interest, if any, on any indenture securities denominated as subordinated debt securities is to be subordinated to the extent provided in the indenture in right of payment to the prior payment in full of all Senior Indebtedness (as defined below), but our obligation to you to make payment of the principal of (and premium, if any) and interest, if any, on such subordinated debt securities will not otherwise be affected. In addition, no payment on account of principal (or premium, if any), sinking fund or interest, if any, may be made on such subordinated debt securities at any time unless full payment of all amounts due in respect of the principal (and premium, if any), sinking fund and interest on Senior Indebtedness has been made or duly provided for in money or money’s worth.

In the event that, notwithstanding the foregoing, any payment by us is received by the trustee in respect of subordinated debt securities or by the holders of any of such subordinated debt securities, upon our dissolution, winding up, liquidation or reorganization before all Senior Indebtedness is paid in full, the payment or distribution received by the trustee in respect of such subordinated debt securities or by the holders of any of such subordinated debt securities must be paid over to the holders of the Senior Indebtedness or on their behalf for application to the payment of all the Senior Indebtedness remaining unpaid until all the Senior Indebtedness has been paid in full, after giving effect to any concurrent payment or distribution to the holders of the Senior Indebtedness. Subject to the payment in full of all Senior Indebtedness upon this distribution by us, the holders of such subordinated debt securities will be subrogated to the rights of the holders of the Senior Indebtedness to the extent of payments made to the holders of the Senior Indebtedness out of the distributive share of such subordinated debt securities.

By reason of this subordination, in the event of a distribution of our assets upon our insolvency, certain of our senior creditors may recover more, ratably, than holders of any subordinated debt securities or the holders of any indenture securities that are not Senior Indebtedness. The indenture provides that these subordination provisions will not apply to money and securities held in trust under the defeasance provisions of the indenture.

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Senior Indebtedness is defined in the indenture as the principal of (and premium, if any) and unpaid interest on:

our indebtedness (including indebtedness of others guaranteed by us), whenever created, incurred, assumed or guaranteed, for money borrowed, that we have designated as “Senior Indebtedness” for purposes of the indenture and in accordance with the terms of the indenture (including any indenture securities designated as Senior Indebtedness), and
renewals, extensions, modifications and refinancings of any of this indebtedness.

If this prospectus is being delivered in connection with the offering of a series of indenture securities denominated as subordinated debt securities, the accompanying prospectus supplement will set forth the approximate amount of our Senior Indebtedness and of our other Indebtedness outstanding as of a recent date.

Secured Indebtedness and Ranking

Certain of our indebtedness, including certain series of indenture securities, may be secured. The prospectus supplement for each series of indenture securities will describe the terms of any security interest for such series and will indicate the approximate amount of our secured indebtedness as of a recent date. Any unsecured indenture securities will effectively rank junior to any secured indebtedness, including any secured indenture securities, that we incur in the future to the extent of the value of the assets securing such future secured indebtedness. The debt securities, whether secured or unsecured, of the Company will rank structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries, financing vehicles or similar facilities.

In the event of our bankruptcy, liquidation, reorganization or other winding up, any of our assets that secure secured debt will be available to pay obligations on unsecured debt securities only after all indebtedness under such secured debt has been repaid in full from such assets. We advise you that there may not be sufficient assets remaining to pay amounts due on any or all unsecured debt securities then outstanding after fulfillment of this obligation. As a result, the holders of unsecured indenture securities may recover less, ratably, than holders of any of our secured indebtedness.

The Trustee under the Indenture

U.S. Bank National Association serves as the trustee under the indenture.

Certain Considerations Relating to Foreign Currencies

Debt securities denominated or payable in foreign currencies may entail significant risks. These risks include the possibility of significant fluctuations in the foreign currency markets, the imposition or modification of foreign exchange controls and potential illiquidity in the secondary market. These risks will vary depending upon the currency or currencies involved and will be more fully described in the applicable prospectus supplement.

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DESCRIPTION OF OUR WARRANTS

The following is a general description of the terms of the warrants we may issue from time to time. Particular terms of any warrants we offer will be described in the prospectus supplement relating to such warrants.

We may issue warrants to purchase shares of our common stock, shares of our preferred stock or debt securities. Such warrants may be issued independently or together with shares of common or preferred stock or a specified principal amount of debt securities and may be attached or separate from such securities. We will issue each series of warrants under a separate warrant agreement to be entered into between us and a warrant agent. The warrant agent will act solely as our agent and will not assume any obligation or relationship of agency for or with holders or beneficial owners of warrants.

A prospectus supplement will describe the particular terms of any series of warrants we may issue, including the following:

the title of such warrants;
the aggregate number of such warrants;
the price or prices at which such warrants will be issued;
the currency or currencies, including composite currencies, in which the price of such warrants may be payable;
if applicable, the designation and terms of the securities with which the warrants are issued and the number of warrants issued with each such security or each principal amount of such security;
in the case of warrants to purchase debt securities, the principal amount of debt securities purchasable upon exercise of one warrant and the price at which and the currency or currencies, including composite currencies, in which this principal amount of debt securities may be purchased upon such exercise;
in the case of warrants to purchase common stock or preferred stock, the number of shares of common stock or preferred stock, as the case may be, purchasable upon exercise of one warrant and the price at which and the currency or currencies, including composite currencies, in which these shares may be purchased upon such exercise;
the date on which the right to exercise such warrants shall commence and the date on which such right will expire;
whether such warrants will be issued in registered form or bearer form;
if applicable, the minimum or maximum amount of such warrants which may be exercised at any one time;
if applicable, the date on and after which such warrants and the related securities will be separately transferable;
information with respect to book-entry procedures, if any;
the terms of the securities issuable upon exercise of the warrants;
if applicable, a discussion of certain U.S. federal income tax considerations; and
any other terms of such warrants, including terms, procedures and limitations relating to the exchange and exercise of such warrants.

We and the warrant agent may amend or supplement the warrant agreement for a series of warrants without the consent of the holders of the warrants issued thereunder to effect changes that are not inconsistent with the provisions of the warrants and that do not materially and adversely affect the interests of the holders of the warrants.

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Prior to exercising their warrants, holders of warrants will not have any of the rights of holders of the securities purchasable upon such exercise, including, in the case of warrants to purchase debt securities, the right to receive principal, premium, if any, or interest payments, on the debt securities purchasable upon exercise or to enforce covenants in the applicable indenture or, in the case of warrants to purchase common stock or preferred stock, the right to receive distributions, if any, or payments upon our liquidation, dissolution or winding up or to exercise any voting rights.

Under the 1940 Act, we may generally only offer warrants provided that (1) the warrants expire by their terms within ten years; (2) the exercise or conversion price is not less than the current market value at the date of issuance; (3) our stockholders authorize the proposal to issue such warrants, and our board of directors approves such issuance on the basis that the issuance is in our best interests and our stockholders; and (4) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them has been publicly distributed.

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REGULATION

We are a BDC under the 1940 Act that has elected to be treated as a RIC under the Code. The 1940 Act contains prohibitions and restrictions relating to transactions between business development companies and their affiliates (including any investment advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities.

We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act. Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition financing or other investments. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances. We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, we generally cannot acquire more than 3% of the voting stock of any registered investment company, invest more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of the value of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses. None of these policies is fundamental and may be changed without stockholder approval upon 60 days’ prior written notice to stockholders.

Qualifying Assets

Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred to as “qualifying assets,” unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our proposed business are the following:

(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. Under the 1940 Act and the rules thereunder, “eligible portfolio companies” include (1) private domestic operating companies, (2) public domestic operating companies whose securities are not listed on a national securities exchange (e.g., the New York Stock Exchange) or registered under the Exchange Act, and (3) public domestic operating companies having a market capitalization of less than $250 million. Public domestic operating companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC are not listed on a national securities exchange and therefore are eligible portfolio companies.
(2) Securities of any eligible portfolio company which we control.
(3) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident to such a private transaction, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.
(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

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(5) Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights relating to such securities.
(6) Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one year or less from the date of investment.

The regulations defining qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take advantage of any regulatory, legislative, administrative or judicial actions in this area.

Managerial Assistance to Portfolio Companies

In order to count portfolio securities as qualifying assets for the purpose of the 70% test, a BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities significant managerial assistance. However, when the BDC purchases securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available managerial assistance means any arrangement whereby the BDC, through its directors, officers, employees or agents, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. Stellus Capital Management will provide such managerial assistance on our behalf to portfolio companies that request this assistance.

Temporary Investments

Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt investments that mature in one year or less from the date of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets or temporary investments. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, so long as the agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the Diversification Tests in order to maintain our qualification as a RIC for U.S. federal income tax purposes. Accordingly, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Stellus Capital Management will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.

Senior Securities

We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. However, recent legislation has modified the 1940 Act by allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met. We are permitted to increase our leverage capacity if shareholders representing at least a majority of the votes cast, when quorum is met, approve a proposal to do so. If we receive such shareholder approval, we would be permitted to increase our leverage capacity on the first day after such approval. Alternatively, we pay increase the maximum amount of leverage we may incur to an asset coverage ratio of 150% if the “required majority” of our independent directors as defined in Section 57(o) of the 1940 Act approve such increase with such approval becoming effective after one year. In either case, we would be required to make certain disclosures on our website and in SEC filings regarding, among other things, the receipt of approval to increase our leverage, our leverage capacity and usage, and risks related to leverage. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see “Risk Factors — Risks Relating to our Business and Structure — Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.”

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Common Stock

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock at a price below the current net asset value of the common stock if our board of directors determines that such sale is in our best interests and that of our stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities (less any distributing commission or discount). We would need approval from our stockholders to issue shares below the then current net asset value per share. We may also make rights offerings to our stockholders at prices per share less than the net asset value per share, subject to applicable requirements of the 1940 Act. See “Risk Factors — Risks Relating to this Offering — Stockholders may incur dilution if we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock.”

Codes of Ethics

We and Stellus Capital Management have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to each such code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with such code’s requirements. You may read and copy our code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090. In addition, each code of ethics is available on the EDGAR Database on the SEC’s website at www.sec.gov. You may also obtain copies of each code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.

Proxy Voting Policies and Procedures

We have delegated our proxy voting responsibility to Stellus Capital Management. The Proxy Voting Policies and Procedures of Stellus Capital Management are set out below. The guidelines will be reviewed periodically by Stellus Capital Management and our directors who are not “interested persons,” and, accordingly, are subject to change.

Introduction

As an investment adviser registered under the Advisers Act, Stellus Capital Management has a fiduciary duty to act solely in our best interests. As part of this duty, Stellus Capital Management recognizes that it must vote our securities in a timely manner free of conflicts of interest and in our best interests.

Stellus Capital Management’s policies and procedures for voting proxies for its investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.

Proxy Policies

Stellus Capital Management votes proxies relating to our portfolio securities in what it perceives to be the best interest of our stockholders. Stellus Capital Management reviews on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities we hold. In most cases Stellus Capital Management will vote in favor of proposals that Stellus Capital Management believes are likely to increase the value of the portfolio securities we hold. Although Stellus Capital Management will generally vote against proposals that may have a negative effect on our portfolio securities, Stellus Capital Management may vote for such a proposal if there exist compelling long-term reasons to do so.

Stellus Capital Management has established a proxy voting committee and adopted proxy voting guidelines and related procedures. The proxy voting committee establishes proxy voting guidelines and procedures, oversees the internal proxy voting process, and reviews proxy voting issues. To ensure that Stellus Capital Management’s vote is not the product of a conflict of interest, Stellus Capital Management requires that (1) anyone involved in the decision-making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party

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regarding a proxy vote; and (2) employees involved in the decision-making process or vote administration are prohibited from revealing how Stellus Capital Management intends to vote on a proposal in order to reduce any attempted influence from interested parties. Where conflicts of interest may be present, Stellus Capital Management will disclose such conflicts to us, including our independent directors and may request guidance from us on how to vote such proxies.

Proxy Voting Records

You may obtain information about how Stellus Capital Management voted proxies by making a written request for proxy voting information to: Stellus Capital Investment Corporation, Attention: Investor Relations, 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, or by calling us collect at (310) 235-5900. The SEC also maintains a website at www.sec.gov that contains this information.

Privacy Principles

We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.

Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party administrator).

We restrict access to nonpublic personal information about our stockholders to employees of Stellus Capital Management and its affiliates with a legitimate business need for the information. We intend to maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.

Other

We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

We and Stellus Capital Management are each required to adopt and implement written policies and procedures reasonably designed to prevent violation of relevant federal securities laws, review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and designate a chief compliance officer to be responsible for administering the policies and procedures.

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. The SEC has interpreted the BDC prohibition on transactions with affiliates to prohibit all “joint transactions” between entities that share a common investment adviser. The staff of the SEC has granted no-action relief permitting purchases of a single class of privately placed securities provided that the adviser negotiates no term other than price and certain other conditions are met. As a result, we only expect to co-invest on a concurrent basis with investment funds, accounts or investment vehicles managed by Stellus Capital Management when each of us and such investment fund, account or investment vehicle will own the same securities of the issuer and when no term is negotiated other than price. Any such investment would be made, subject to compliance with existing regulatory guidance, applicable regulations and our allocation procedures. If opportunities arise that would otherwise be appropriate for us and for an investment fund, account or investment vehicle managed by Stellus Capital Management to invest in different securities of the same issuer, Stellus Capital Management will need to decide which fund will proceed with the investment. Moreover, except in certain circumstances, we will be unable to invest in any issuer in which an investment fund, account or investment vehicle managed by Stellus Capital Management has previously invested.

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Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us. For example:

pursuant to Rule 13a-14 under the Exchange Act, our principal executive officer and principal financial officer must certify the accuracy of the financial statements contained in our periodic reports;
pursuant to Item 307 under Regulation S-K, our periodic reports must disclose our conclusions about the effectiveness of our disclosure controls and procedures;
pursuant to Rule 13a-15 under the Exchange Act, our management must prepare an annual report regarding its assessment of our internal control over financial reporting; and
pursuant to Item 308 of Regulation S-K and Rule 13a-15 under the Exchange Act, our periodic reports must disclose whether there were significant changes in our internal controls over financial reporting or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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PLAN OF DISTRIBUTION

We may offer, from time to time, in one or more offerings or series, up to $200,000,000 of our common stock, preferred stock, debt securities, subscription rights or warrants to purchase common stock, preferred stock or debt securities, in one or more underwritten public offerings, at-the-market offerings, negotiated transactions, block trades, best efforts offerings or a combination of these methods. We may sell the securities through underwriters or dealers, directly to one or more purchasers through agents or through a combination of any such methods of sale. Any underwriter or agent involved in the offer and sale of the securities will be named in the applicable prospectus supplement.

The distribution of our securities may be effected from time to time in one or more transactions at a fixed price or prices, which may be changed, at prevailing market prices at the time of sale, at prices related to such prevailing market prices, or at negotiated prices, provided, however, that the offering price per share of our securities less any underwriting commissions or discounts must equal or exceed the net asset value per share of our securities except that we may sell shares of our securities at a price below net asset value per share if holders of a majority of the number of shares of our stock have approved such a sale or if the following conditions are met: (i) holders of a majority of our stock and a majority of our stock not held by affiliated persons have approved issuance at less than net asset value per share during the one year period prior to such sale; (ii) a majority of our directors who have no financial interest in the sale and a majority of such directors who are not interested persons of us have determined that such sale would be in our best interest and in the best interests of our stockholders; and (iii) a majority of our directors who have no financial interest in the sale and a majority of such directors who are not interested persons of us, in consultation with the underwriter or underwriters of the offering if it is to be underwritten, have determined in good faith, and as of a time immediately prior to the first solicitation by or on behalf of us of firm commitments to purchase such securities or immediately prior to the issuance of such securities, that the price at which such securities are to be sold is not less than a price which closely approximates the market value of those securities, less any distributing commission or discount.

In connection with the sale of our securities, underwriters or agents may receive compensation from us or from purchasers of our securities, for whom they may act as agents, in the form of discounts, concessions or commissions. Underwriters may sell our securities to or through dealers and such dealers may receive compensation in the form of discounts, concessions or commissions from the underwriters and/or commissions from the purchasers for whom they may act as agents. Underwriters, dealers and agents that participate in the distribution of our securities may be deemed to be underwriters under the Securities Act, and any discounts and commissions they receive from us and any profit realized by them on the resale of our securities may be deemed to be underwriting discounts and commissions under the Securities Act. Any such underwriter or agent will be identified and any such compensation received from us will be described in the applicable prospectus supplement.

We may enter into derivative transactions with third parties, or sell securities not covered by this prospectus to third parties in privately negotiated transactions. If the applicable prospectus supplement indicates, in connection with those derivatives, the third parties may sell securities covered by this prospectus and the applicable prospectus supplement, including in short sale transactions. If so, the third party may use securities pledged by us or borrowed from us or others to settle those sales or to close out any related open borrowings of stock, and may use securities received from us in settlement of those derivatives to close out any related open borrowings of stock. The third parties in such sale transactions will be underwriters and, if not identified in this prospectus, will be identified in the applicable prospectus supplement (or a post-effective amendment).

Any of our common stock sold pursuant to a prospectus supplement will be listed on the New York Stock Exchange, or another exchange on which our common stock is traded.

Under agreements into which we may enter, underwriters, dealers and agents who participate in the distribution of our securities may be entitled to indemnification by us against certain liabilities, including liabilities under the Securities Act. Underwriters, dealers and agents may engage in transactions with, or perform services for, us in the ordinary course of business.

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If so indicated in the applicable prospectus supplement, we will authorize underwriters or other persons acting as our agents to solicit offers by certain institutions to purchase our securities from us pursuant to contracts providing for payment and delivery on a future date. Institutions with which such contracts may be made include commercial and savings banks, insurance companies, pension funds, investment companies, educational and charitable institutions and others, but in all cases such institutions must be approved by us. The obligations of any purchaser under any such contract will be subject to the condition that the purchase of our securities shall not at the time of delivery be prohibited under the laws of the jurisdiction to which such purchaser is subject. The underwriters and such other agents will not have any responsibility in respect of the validity or performance of such contracts. Such contracts will be subject only to those conditions set forth in the prospectus supplement, and the prospectus supplement will set forth the commission payable for solicitation of such contracts.

In order to comply with the securities laws of certain states, if applicable, our securities offered hereby will be sold in such jurisdictions only through registered or licensed brokers or dealers. In addition, in certain states, our securities may not be sold unless they have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and is complied with.

The maximum commission or discount to be received by any member of the Financial Industry Regulatory Authority, Inc. will not be greater than 10.0% for the sale of any securities being registered.

We will pay customary costs and expenses of the registration of the shares of common stock pursuant to the registration rights agreement, including SEC filing fees and expenses of compliance with state securities or “blue sky” laws.

CUSTODIAN, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR

Our securities are held by ZB, N.A., dba Amegy Bank, pursuant to a custody agreement. State Street Bank and Trust Company will also serve as our transfer agent, distribution paying agent and registrar. The principal business address of State Street Bank and Trust Company is 225 Franklin Street, Boston, Massachusetts 02110. The principal address of Amegy Bank is 1717 West Loop South, 23rd Floor, Houston, Texas 77027.

BROKERAGE ALLOCATION AND OTHER PRACTICES

Since we will acquire and dispose of many of our investments in privately negotiated transactions, many of the transactions that we engage in will not require the use of brokers or the payment of brokerage commissions. Subject to policies established by our board of directors, Stellus Capital Management will be primarily responsible for selecting brokers and dealers to execute transactions with respect to the publicly traded securities portion of our portfolio transactions and the allocation of brokerage commissions. Stellus Capital Management does not expect to execute transactions through any particular broker or dealer but will seek to obtain the best net results for us under the circumstances, taking into account such factors as price (including the applicable brokerage commission or dealer spread), size of order, difficulty of execution and operational facilities of the firm and the firm’s risk and skill in positioning blocks of securities. Stellus Capital Management generally will seek reasonably competitive trade execution costs but will not necessarily pay the lowest spread or commission available. Subject to applicable legal requirements and consistent with Section 28(e) of the Exchange Act, Stellus Capital Management may select a broker based upon brokerage or research services provided to Stellus Capital Management and us and any other clients. In return for such services, we may pay a higher commission than other brokers would charge if Stellus Capital Management determines in good faith that such commission is reasonable in relation to the services provided.

LEGAL MATTERS

Certain legal matters regarding the securities offered by this prospectus will be passed upon for us by Eversheds Sutherland (US) LLP, Washington, DC 20001. Certain legal matters will be passed upon for the underwriters, if any, by the counsel named in the prospectus supplement, if any.

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INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The financial statements, financial highlights and senior securities table of Stellus Capital Investment Corporation included in this prospectus and elsewhere in the registration statement have been so included in reliance upon the reports of Grant Thornton LLP. Grant Thornton LLP, located at principal business address 171 N. Clark Street, Chicago, Illinois 60601, serves as the Company’s independent registered public accounting firm, providing audit services and review of certain documents to be filed with the U.S. Securities and Exchange Commission.

AVAILABLE INFORMATION

We have filed with the SEC a registration statement on Form N-2, together with all amendments and related exhibits, under the Securities Act, with respect to our shares of common stock offered by this prospectus. The registration statement contains additional information about us and our shares of common stock being offered by this prospectus.

We also file with or submit to the SEC annual, quarterly and current reports, proxy statements and other information meeting the informational requirements of the Exchange Act. You may inspect and copy these reports, proxy statements and other information, as well as the registration statement and related exhibits and schedules, at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549-0102. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090.

We maintain a website at www.stelluscapital.com (under the Public Investors section) and make all of our annual, quarterly and current reports, proxy statements and other publicly filed information available, free of charge, on or through our website. Information contained on our website is not incorporated into this prospectus, and you should not consider information on our website to be part of this prospectus. You may also obtain such information by contacting us in writing at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, Attention: Investor Relations. The SEC maintains a website that contains reports, proxy and information statements and other information we file with the SEC at www.sec.gov. Copies of these reports, proxy and information statements and other information may also be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549-0102.

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Index to Financial Statements

 
  Page
Audited Financial Statements
        
Reports of Independent Registered Public Accounting Firm     F-2  
Consolidated Statements of Assets and Liabilities as of December 31, 2017 and December 31, 2016     F-5  
Consolidated Statements of Operations for the years ended December 31, 2017, 2016 and 2015     F-6  
Consolidated Statements of Changes in Net Assets for the years ended December 31, 2017, 2016 and 2015     F-7  
Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015     F-8  
Consolidated Schedule of Investments as of December 31, 2017 and December 31, 2016     F-10  
Notes to Consolidated Financial Statements     F-23  

 
Unaudited Financial Statements
        
Consolidated Statements of Assets and Liabilities as of March 31, 2018 (unaudited) and December 31, 2017     F-56  
Consolidated Statements of Operations for the three-month periods ended March 31, 2018 and March 31, 2017 (unaudited)     F-57  
Consolidated Statements of Changes in Net Assets for the three-month periods ended March 31, 2018 and March 31, 2017 (unaudited)     F-58  
Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2018 and March 31, 2017 (unaudited)     F-59  
Consolidated Schedules of Investments as of March 31, 2018 (unaudited) and December 31 2017     F-60  
Notes to Unaudited Financial Statements     F-74  

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[GRAPHIC MISSING]   Grant Thornton LLP
1717 Main Street, Suite 1800
Dallas, TX 75201
T 214.561.2300
F 214.561.2370
www.GrantThornton.com

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders
Stellus Capital Investment Corporation

Opinion on the financial statements

We have audited the accompanying consolidated statements of assets and liabilities of Stellus Capital Investment Corporation (a Maryland corporation) and subsidiaries (the “Company”), including the consolidated schedules of investments, as of December 31, 2017 and 2016, the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes, schedule and financial highlights (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 6, 2018 expressed an unqualified opinion.

Basis for opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ GRANT THORNTON LLP

We have served as the Company’s auditor since 2012.

Dallas, Texas
March 6, 2018

 
 
Grant Thornton LLP
U.S. member firm of Grant Thornton International Ltd

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[GRAPHIC MISSING]   Grant Thornton LLP
1717 Main Street, Suite 1800
Dallas, TX 75201
T 214.561.2300
F 214.561.2370
www.GrantThornton.com

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders
Stellus Capital Investment Corporation

Opinion on internal control over financial reporting

We have audited the internal control over financial reporting of Stellus Capital Investment Corporation (a Maryland corporation) and subsidiaries (the “Company”) as of December 31, 2017, based on criteria established in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in the 2013 Internal Control — Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2017, and our report dated March 6, 2018 expressed an unqualified opinion on those financial statements.

Basis for opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and limitations of internal control over financial reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 
 
Grant Thornton LLP
U.S. member firm of Grant Thornton International Ltd

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[GRAPHIC MISSING]

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ GRANT THORNTON LLP

Dallas, Texas
March 6, 2018

 
 
Grant Thornton LLP
U.S. member firm of Grant Thornton International Ltd

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PART I — FINANCIAL INFORMATION
STELLUS CAPITAL INVESTMENT CORPORATION
  
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

   
  December 31,
2017
  December 31,
2016
ASSETS
                 
Non-Controlled, affiliated investments, at fair value (amortized cost of $1,052,185 and $0, respectively)   $ 990,000     $  
Non-controlled, non-affiliated investments, at fair value (amortized cost of $367,401,021 and $362,217,251, respectively)     370,849,772       365,625,891  
Cash and cash equivalents     25,110,718       9,194,129  
Receivable for sales and repayments of investments     26,891        
Interest receivable     2,922,204       4,601,742  
Accounts receivable           748  
Prepaid expenses     361,270       456,219  
Total Assets   $ 400,260,855     $ 379,878,729  
LIABILITIES
                 
Notes payable   $ 47,306,488     $ 24,565,891  
Credit facility payable     39,332,479       115,171,208  
SBA-guaranteed debentures     87,818,813       63,342,036  
Dividends payable     1,806,671       1,413,982  
Base management fees payable     1,621,592       1,608,295  
Incentive fees payable     371,647       1,353,271  
Interest payable     1,021,173       973,812  
Unearned revenue     139,304       19,955  
Administrative services payable     327,033       272,511  
Deferred tax liability           8,593  
Other accrued expenses and liabilities     268,413       267,390  
Total Liabilities   $ 180,013,613     $ 208,996,944  
Commitments and contingencies (Note 7)
                 
Net Assets   $ 220,247,242     $ 170,881,785  
NET ASSETS
                 
Common Stock, par value $0.001 per share (200,000,000 and 100,000,000 shares authorized, 15,945,879 and 12,479,959 shares issued and outstanding, respectively)   $ 15,946     $ 12,480  
Paid-in capital     228,066,762       180,994,723  
Accumulated net realized loss from investments, net of cumulative dividends of $4,251,819, and $1,899,274, respectively     (10,786,240 )      (13,089,671 ) 
Distributions in excess of net investment income     (435,794 )      (435,794 ) 
Net Unrealized appreciation on investments and cash equivalents, net of provision for taxes of $0 and $8,593, respectively.(1)     3,386,568       3,400,047  
NET ASSETS   $ 220,247,242     $ 170,881,785  
Total Liabilities and Net Assets   $ 400,260,855     $ 379,878,729  
Net Asset Value Per Share   $ 13.81     $ 13.69  

(1) See Note 13 for a discussion of Deferred Taxes.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF OPERATIONS

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
INVESTMENT INCOME
                          
Interest income   $ 38,071,449     $ 38,176,617     $ 34,643,791  
Other income     1,576,744       1,313,580       514,768  
Total Investment Income   $ 39,648,193     $ 39,490,197     $ 35,158,559  
OPERATING EXPENSES
                          
Management fees   $ 6,255,911     $ 6,281,863     $ 5,841,267  
Valuation fees     336,300       397,330       356,971  
Administrative services expenses     1,245,727       1,045,648       1,029,368  
Incentive fees     2,911,392       4,275,436       3,975,198  
Professional fees     1,274,066       712,524       596,357  
Directors’ fees     331,000       324,000       333,000  
Insurance expense     429,897       471,427       473,963  
Interest expense and other fees     7,855,211       7,992,185       6,177,015  
Deferred offering costs           261,761        
Other general and administrative expenses     621,204       415,822       474,625  
Total Operating Expenses   $ 21,260,708     $ 22,177,996     $ 19,257,764  
Loss on extinguishment of debt     416,725              
Waiver of Incentive Fee                 (646,333 ) 
Total Operating Expenses, net of fee waivers   $ 21,677,433     $ 22,177,996     $ 18,611,431  
Net Investment Income   $ 17,970,760     $ 17,312,201     $ 16,547,128  
Net Realized Gain on Investments and Cash Equivalents   $ 4,655,976     $ (13,089,671 )    $ 421,726  
Net Change in Unrealized Appreciation (Depreciation) on Investments and Cash Equivalents   $ (22,072 )    $ 18,603,401     $ (9,204,717 ) 
Benefit (provision) for taxes on unrealized gain on investments   $ 8,593     $ 373,131     $ (93,601 ) 
Net Increase in Net Assets Resulting from Operations   $ 22,613,257     $ 23,199,062     $ 7,670,536  
Net Investment Income Per Share   $ 1.21     $ 1.39     $ 1.33  
Net Increase in Net Assets Resulting from Operations Per Share   $ 1.52     $ 1.86     $ 0.61  
Weighted Average Shares of Common Stock Outstanding     14,870,981       12,479,959       12,479,961  
Distributions Per Share   $ 1.36     $ 1.36     $ 1.36  

F-6


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Increase in Net Assets Resulting from Operations
                          
Net investment income   $ 17,970,760     $ 17,312,201     $ 16,547,128  
Net realized gain on investments and cash equivalents     4,655,976       (13,089,671 )      421,726  
Net change in unrealized appreciation on investments and cash equivalents     (22,072 )      18,603,401       (9,204,717 ) 
Benefit (provision) for taxes on unrealized appreciation on investments     8,593       373,131       (93,601 ) 
Net Increase in Net Assets Resulting from
Operations
  $ 22,613,257     $ 23,199,062     $ 7,670,536  
Stockholder distributions from:
                          
Net investment income     (17,970,760 )      (16,968,350 )      (16,547,158 ) 
Net realized capital gains     (2,352,545 )            (421,726 ) 
Total Distributions   $ (20,323,305 )    $ (16,968,350 )    $ (16,968,884 ) 
Capital share transactions
                          
Issuance of common stock     48,741,549              
Partial share redemption     (142 )      (31 )       
Sales load     (1,358,880 )             
Offering costs     (307,022 )             
Net increase in net assets resulting from capital share transactions   $ 47,075,505     $ (31 )    $  
Total increase (decrease) in net assets   $ 49,365,457     $ 6,230,681     $ (9,298,348 ) 
Net assets at beginning of period   $ 170,881,785     $ 164,651,104     $ 173,949,452  
Net assets at end of period (includes $435,794, $435,794 and $779,643 of distributions in excess of net investment income, respectively)   $ 220,247,242     $ 170,881,785     $ 164,651,104  

F-7


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Cash flows from operating activities
                          
Net increase in net assets resulting from operations   $ 22,613,257     $ 23,199,062     $ 7,670,536  
Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:
                          
Purchases of investments     (172,171,246 )      (65,661,034 )      (133,661,491 ) 
Proceeds from sales and repayments of investments     172,260,541       55,949,177       93,289,529  
Net change in unrealized appreciation (depreciation) on investments     22,072       (18,603,401 )      9,204,717  
Deferred tax benefit     (8,593 )      (373,130 )      93,601  
Increase in investments due to PIK     (499,596 )      (243,766 )      (439,052 ) 
Amortization of premium and accretion of discount, net     (1,196,566 )      (1,128,511 )      (1,034,240 ) 
Amortization of loan structure fees     455,893       523,835       472,003  
Amortization of deferred financing costs     251,826       326,190       210,064  
Loss on extinguishment of debt     416,725              
Amortization of loan fees on SBA-guaranteed debentures     333,027       184,783       204,980  
Net realized (gain)/loss on investments     (4,655,976 )      13,089,341       (421,726 ) 
Deferred offering costs           261,761        
Changes in other assets and liabilities
                          
Decrease in interest receivable     1,679,538       118,289       362,634  
Decrease in receivable for affiliated transaction                  
(Increase) decrease in accounts receivable     748       6,936       (6,988 ) 
(Increase) decrease in prepaid expenses and fees     94,949       19,230       (56,166 ) 
Increase in management fees payable     13,297       89,516       158,760  
Increase (decrease) in incentive fees payable     (981,624 )      745,315       (513,600 ) 
Increase (decrease) in administrative services payable     54,522       (125,288 )      (193,945 ) 
Increase in interest payable     47,361       403,623       223,985  
Increase (decrease) in unearned revenue     119,349       (16,922 )      (120,526 ) 
Increase in dividend payable     392,689              
Increase in other accrued expenses and
liabilities
    1,022       71,714       112,224  
Net cash provided by operating activities   $ 19,243,216     $ 8,836,720     $ (24,444,701 ) 

F-8


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS – (continued)

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Cash flows from financing activities
                          
Proceeds from notes issued     48,875,000              
Proceeds from SBA-guaranteed debentures     25,000,000             47,567,813  
Financing costs paid on notes issued     (1,688,961 )             
Financing costs paid on Credit Facility     (1,158,616 )      (50,000 )       
Financing costs paid on SBA-guaranteed debentures     (856,250 )            (325,000 ) 
Proceeds from the issuance of common stock     48,741,549              
Sales load for common stock issued     (1,358,880 )             
Offering costs paid for common stock issued     (307,022 )             
Stockholder distributions paid     (20,323,305 )      (16,968,350 )      (16,968,885 ) 
Borrowings under credit facility     194,250,000       56,500,000       105,000,000  
Repayments of credit facility     (269,500,000 )      (50,000,000 )      (102,000,000 ) 
Repayments of Notes issued     (25,000,000 )             
Partial Share Redemption     (142 )      (31 )       
Net cash provided by (used in) financing activities   $ (3,326,627 )    $ (10,518,381 )    $ 33,273,928  
Net increase (decrease) in cash and cash equivalents     15,916,589       (1,681,661 )      8,829,227  
Cash and cash equivalents balance at beginning of period     9,194,129       10,875,790       2,046,563  
Cash and cash equivalents balance at end of period   $ 25,110,718     $ 9,194,129     $ 10,875,790  
Non-cash operating activities
                          
Conversion from debt to equity   $ 864,101     $     $  
Non-cash purchase of investment through repayment of investment   $     $     $ 4,251,032  
Supplemental financing activities
                          
Excise tax paid   $ 37,648     $     $  
Fees paid on SBA-guaranteed debentures through proceeds   $ 856,250     $     $ 1,182,187  
Cash paid for interest expense   $ 6,762,104     $ 6,548,754     $ 5,010,984  

F-9


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
December 31, 2017

                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Non-controlled, affiliated investments     (2)
                                                                               
Glori Energy Production Inc.                                               Houston, TX                                      
Glori Energy Production, LLC Class A Common Units     (4)
      Equity                                     Energy: Oil & Gas       1,000
shares
    $ 1,052,185     $ 990,000       0.45%  
Subtotal Non-controlled, affiliated investments                                                           1,052,185       990,000       0.45%  
Non-controlled, non-affiliated investments     (2)
                                                                               
Abrasive Products & Equipment, LLC, et al                                               Deer Park, TX                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+10.50%       1.00%       12.20%                3/5/2020       Chemicals, Plastics,
& Rubber
    $ 5,325,237       5,272,397       5,220,000       2.37%  
APE Holdings, LLC Class A Common Units     (4)
      Equity                                           375,000
units
      375,000       180,000       0.08%  
Total                                                           5,647,397       5,400,000       2.45%  
Apex Environmental Resources Holdings,
LLC
                                              Amsterdam, OH
                                     
Common Units     (4)
      Equity                                     Environmental
Industries
      766
shares
      766       579       0.00%  
Preferred Units     (4)
      Equity                                           766
shares
      765,676       579,421       0.26%  
Total                                                           766,442       580,000       0.26%  
Atmosphere Aggregator Holdings II, LP                                               Atlanta, GA                                      
Common Units     (4)
      Equity                                     Services: Business       254,250
units
      254,250       820,284       0.37%  
Atmosphere Aggregator Holdings, LP Common Units     (4)
      Equity                                           750,000
units
      750,000       2,419,714       1.10%  
Total                                                           1,004,250       3,239,998       1.47%  
ASC Communications, LLC     (7)
                                          Chicago, IL                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.25%       1.00%       7.94%                6/29/2022       Healthcare &
Pharmaceuticals
    $ 6,879,167       6,816,044       6,879,167       3.12%  
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)     (2)(4)
      Equity                                           73,529
shares
      500,000       620,000       0.28%  
Total                                                           7,316,044       7,499,167       3.40%  
Beneplace, LLC                                               Austin TX                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+10.00%       1.00%       11.70%                9/27/2022       Insurance
    $ 5,000,000       4,910,226       5,000,000       2.27%  
Beneplace Holdings, LLC Preferred Units     (4)
      Equity                                           500,000
units
      500,000       500,000       0.23%  
Total                                                           5,410,226       5,500,000       2.50%  
Binder & Binder National Social Security Disability Advocates, LLC     (8)
                                          Hauppauge, NY                                      
Residual claim from Term Loan     (4)
      Unsecured                                     Services: Consumer
    $ 400,000       400,000       380,000       0.17%  
BW DME Acquisition, LLC                                               Tempe, AZ                                      
Term Loan (SBIC)     (2)(12)(13)
      First Lien       L+6.00%       1.00%       9.43%                8/24/2022       Healthcare &
Pharmaceuticals
    $ 9,550,000       9,281,016       9,310,000       4.23%  
BW DME Holdings, LLC Class A Preferred Units     (4)
      Equity                                           1,000,000
shares
      1,000,000       1,110,000       0.50%  
Total                                                           10,281,016       10,420,000       4.73%  

F-10


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
C.A.R.S. Protection Plus, Inc.                                               Murrysville, PA
                                     
Term Loan     (12)
      First Lien       L+8.50%       0.50%       9.74%                12/31/2020       Automotive     $ 98,746     $ 97,451     $ 98,746       0.04%  
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.50%       0.50%       9.74%                12/31/2020           $ 7,702,191       7,601,191       7,700,000       3.50%  
CPP Holdings LLC Class A Common Units     (4)
      Equity                                           149,828
shares
      149,828       260,000       0.12%  
Total                                                           7,848,470       8,058,746       3.66%  
Catapult Learning, LLC et al                                               Camden, NJ                                      
Term Loan     (13)
      First Lien       L+6.50%       1.00%       9.30%                7/16/2020       Education     $ 12,335,526       12,264,670       12,335,526       5.60%  
Colford Capital Holdings, LLC                                               New York, NY                                      
Preferred Units     (4)(5)
      Equity                                     Finance       38,893 units       497,388       470,000       0.21%  
Total                                                                             %  
Condor Borrower, LLC                                               Clifton, NJ                                      
Term Loan     (12)
      Second
Lien
      L+8.75%       1.00%       10.12%                4/7/2025       Services:
Business
    $ 13,750,000       13,479,122       13,480,000       6.12%  
Condor Top Holdco Limited Convertible Preferred Shares     (4)
      Equity                                           500,000 shares       442,197       442,197       0.20%  
Condor Holdings Limited Preferred Shares, Class B     (4)
      Equity                                           500,000 shares       57,804       57,804       0.03%  
Total                                                           13,979,123       13,980,001       6.35%  
Douglas Products & Packaging Company, LLC                                               Liberty, MO                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+10.50%       0.50%       12.20%                12/31/2020       Chemicals,
Plastics,
& Rubber
    $ 9,000,000       8,902,087       9,000,000       4.09%  
Fumigation Holdings, Inc. Class A Common Stock     (4)
      Equity                                           250 shares       250,000       530,000       0.24%  
Total                                                           9,152,087       9,530,000       4.33%  
Dream II Holdings, LLC                                               Boca Raton, FL                                      
Class A Common Units     (4)
      Equity                                     Services:
Consumer
      250,000 units       242,304       420,000       0.19%  
Empirix Inc.                                               Billerica, MA                                      
Term Loan     (12)
      Second
Lien
      L+9.50%       1.00%       10.88%                5/1/2020       Software     $ 11,657,850       11,554,734       11,657,850       5.29%  
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+9.50%       1.00%       10.88%                5/1/2020           $ 9,750,000       9,662,051       9,750,000       4.43%  
Empirix Holdings I, Inc. Common Shares, Class A     (4)
      Equity                                           1,304 shares       1,304,232       831,600       0.38%  
Empirix Holdings I, Inc. Common Shares, Class B     (4)
      Equity                                           1,317,406
shares
      13,174       8,400       0.00%  
Total                                                           22,534,191       22,247,850       10.10%  
Energy Labs Inc.                                               Houston, TX                                      
Term Loan (SBIC)     (2)(13)
      First Lien       L+7.00%       0.50%       11.58%                9/29/2021       Energy:
Oil & Gas
    $ 5,300,000       5,214,783       5,300,000       2.41%  
Energy Labs Holding Corp. Common Stock     (4)
      Equity                                           500 shares       500,000       410,000       0.19%  
Total                                                           5,714,783       5,710,000       2.60%  
EOS Fitness OPCO Holdings, LLC                                               Phoenix, AZ                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.25%       0.75%       9.62%                12/30/2019       Hotel,
Gaming, &
Leisure
    $ 3,193,890       3,164,255       3,190,000       1.45%  
EOS Fitness Holdings, LLC Class A Preferred Units     (4)
      Equity                                           118 shares       117,670       224,250       0.10%  

F-11


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
EOS Fitness Holdings, LLC Class B Common Units     (4)
      Equity                                           3,017 shares     $ 3,017     $ 5,750       0.00%  
Total                                                           3,284,942       3,420,000       1.55  
Furniture Factory Outlet, LLC                                               Fort Smith, AR                                      
Term Loan     (12)
      First Lien       L+9.00%       0.50%       10.70%                6/10/2021       Consumer
Goods:
Durable
    $ 7,288,484       7,180,489       7,288,484       3.31%  
Furniture Factory Holdings, LLC Term Loan     (11)
      Unsecured       11.00%                                  2/3/2021           $ 122,823       122,823       120,000       0.05%  
Sun Furniture Factory, LP Common Units     (4)
      Equity                                           13,445 shares       94,569       210,000       0.10%  
Total                                                           7,397,881       7,618,484       3.46%  
GK Holdings, Inc.                                               Cary, NC                                      
Term Loan     (12)
      Second
Lien
      L+10.25%       1.00%       11.94%                1/30/2022       Education     $ 5,000,000       4,932,726       5,000,000       2.27%  
Good Source Solutions, Inc.                                               Carlsbad, CA                                      
Term Loan     (13)
      First Lien       L+7.25%       0.50%       11.96%                7/15/2021       Beverage,
Food, & Tobacco
    $ 1,350,000       1,329,398       1,350,000       0.61%  
Term Loan (SBIC)     (2)(13)
      First Lien       L+7.25%       0.50%       11.96%                7/15/2021           $ 1,200,000       1,181,687       1,200,000       0.54%  
Good Source Holdings, LLC Class A Preferred Units     (4)
      Equity                                           159 shares       159,375       150,000       0.07%  
Good Source Holdings, LLC Class B Common Units     (4)
      Equity                                           4,482 shares       0       0       0.00%  
Total                                                           2,670,460       2,700,000       1.22%  
Grupo HIMA San Pablo, Inc., et al                                               San Juan, PR                                      
Term Loan     (3)
      First Lien       L+7.00%       1.50%       8.50%                1/31/2018       Healthcare &
Pharmaceuticals
    $ 4,750,000       4,748,168       4,180,000       1.90%  
Term Loan     (15)
      Second
Lien
      13.75%             0.00%             7/31/2018           $ 4,109,524       4,079,696       900,000       0.41%  
Total                                                           8,827,864       5,080,000       2.31%  
Hostway Corporation                                               Chicago, IL                                      
Term Loan     (4)(6)(12)
      Second
Lien
      L+10.00%       1.25%       5.94%                12/13/2020       High Tech
Industries
    $ 6,750,000       6,680,080       5,910,000       2.68%  
J.R. Watkins, LLC     (9)
                                          San Francisco, CA                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.50%       1.25%       8.16%                12/22/2022       Consumer Goods:
non-durable
    $ 12,500,000       12,250,000       12,250,000       5.56%  
J.R. Watkins Holdings, Inc. Class A Preferred     (4)
      Equity                                           1,000 shares       1,000,000       1,000,000       0.45%  
Total                                                           13,250,000       13,250,000       6.01%  
Keais Records Service, LLC                                               Houston, TX                                      
Term Loan     (12)
      Second
Lien
      L+10.50%       0.50%       12.20%                6/30/2022       Services: Business     $ 7,750,000       7,637,741       7,750,000       3.52%  
Keais Holdings, LLC Class A Units     (4)
      Equity                                           148,335 units       765,600       780,000       0.35%  
Total                                                           8,403,341       8,530,000       3.87%  
KidKraft, Inc.                                               Dallas, TX                                      
Term Loan     (6)
      Second
Lien
      12.00%                11.00%       1.00%       3/30/2022       Consumer Goods:
Durable
    $ 9,315,194       9,162,066       9,180,000       4.17%  
Livingston International, Inc.                                               Toronto, Ontario                                      
Term Loan     (5)(12)
      Second
Lien
      L+8.25%       1.25%       9.94%                4/18/2020       Transportation:
Cargo
    $ 6,841,739       6,785,894       6,840,000       3.11%  

F-12


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Madison Logic, Inc.                                               New York, NY                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.00%       0.50%       9.57%                11/30/2021       Media: Broadcasting
& Subscription
    $ 4,875,000     $ 4,835,088     $ 4,875,000       2.21%  
Madison Logic Holdings, Inc. Common Stock (SBIC)     (2)(4)
      Equity                                           5,000 shares       50,000       56,000       0.03%  
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)     (2)(4)
      Equity                                           4,500 shares       450,000       504,000       0.23%  
Total                                                           5,335,088       5,435,000       2.47%  
Magdata Intermediate Holdings, LLC                                               Austin TX                                      
Term Loan     (12)
      Second

Lien
      L+9.50%       1.00%       11.20%                4/16/2024       Software     $ 12,500,000       12,254,448       12,250,000       5.56%  
Mobileum, Inc.                                               Santa Clara, CA                                      
Term Loan     (12)
      Second
Lien
      L+10.25%       0.75%       11.95%                5/1/2022       Software     $ 9,000,000       8,849,293       9,000,000       4.09%  
Mobile Acquisition Holdings, LP Class A-2 Common Units     (4)
      Equity                                           750 units       750,000       980,000       0.44%  
Total                                                           9,599,293       9,980,000       4.53%  
MBS Holdings, Inc.                                               Birmingham, AL                                      
Series E Preferred Stock     (4)
      Equity                                     Media: Broadcasting
& Subscription
      2,774,695
shares
      1,000,000       2,386,710       1.08%  
Series F Preferred Stock     (4)
      Equity                                           399,308 shares       206,682       493,290       0.22%  
Total                                                           1,206,682       2,880,000       1.30%  
MTC Parent, L.P.                                               Oak Brook, IL                                      
Class A-2 Common Units     (4)
      Equity                                     Finance       750,000 shares       28,842       2,200,000       1.00%  
National Trench Safety, LLC, et al                                               Houston, TX                                      
Term Loan (SBIC)     (2)
      Second
Lien
      11.50%                11.50%                3/31/2022       Construction &
Building
    $ 10,000,000       9,845,090       9,900,000       4.49%  
NTS Investors, LP Class A Common Units     (4)
      Equity                                           2,335 units       500,000       350,000       0.16%  
Total                                                           10,345,090       10,250,000       4.65%  
OGS Holdings, Inc.                                               Chantilly, Virginia                                      
Series A Convertible Preferred Stock     (4)
      Equity                                     Services: Government       11,521 shares       50,001       100,000       0.05%  
Protect America, Inc.                                               Austin TX                                      
Term Loan (SBIC)     (2)(6)(12)
      Second
Lien
      L+9.75%       1.00%       9.50%       2.00%       10/30/2020       Services: Consumer
    $ 17,617,786       17,220,312       17,270,000       7.84%  
Refac Optical Group, et al                                               Blackwood, NJ                                      
Revolver     (10)(12)
      First Lien       L+8.00%                9.56%                9/30/2018       Retail     $ 880,000       880,000       880,000       0.40%  
Term A Loan     (12)
      First Lien       L+8.00%                9.56%                9/30/2018           $ 943,367       943,367       940,000       0.43%  
Term B Loan     (6)(12)
      First Lien       L+10.75%             10.56%       1.75%       9/30/2018           $ 6,464,716       6,464,716       6,460,000       2.93%  
Total                                                           8,288,083       8,280,000       3.76  
Resolute Industrial, LLC     (14)
                                          Wheeling, IL                                      
Term Loan     (12)
      First Lien       L+7.62%       1.00%       8.95%                7/26/2022       Capital Equipment     $ 3,797,222       3,731,397       3,740,000       1.70%  
Term Loan (SBIC)     (2)(12)
      First Lien       L+7.62%       1.00%       8.95%                7/26/2022           $ 13,290,278       13,059,850       13,090,000       5.94%  
Resolute Industrial Holdings, LLC Class A Preferred Units     (4)
      Equity                                           601 units       750,000       760,000       0.35%  
Total                                                           17,541,247       17,590,000       7.99%  
Roberts-Gordon, LLC                                               Buffalo, NY                                      
Term Loan     (12)
      Second
Lien
      L+10.00%       1.00%       11.70%                1/1/2022       Construction &
Building
    $ 7,200,000       7,068,278       7,130,000       3.24%  

F-13


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Specified Air Solutions, LLC Class A Common Unites     (4)
      Equity                                           3,846 shares     $ 500,045     $ 600,000       0.27%  
Total                                                           7,568,323       7,730,000       3.51%  
Sitel Worldwide Corporation                                               Nashville, TN                                      
Term Loan     (12)
      Second
Lien
      L+9.50       1.00%       10.88%                9/18/2022       High Tech
Industries
    $ 10,000,000       9,848,614       9,950,000       4.52%  
Skopos Financial, LLC                                               Irving, TX                                      
Term Loan     (5)
      Unsecured       12.00%                12.00%                1/31/2019       Finance     $ 20,000,000       19,886,350       19,800,000       8.99%  
Skopos Financial Group, LLC Class A Units     (4)(5)
      Equity                                           1,120,684 units       1,162,544       770,000       0.35%  
Total                                                           21,048,894       20,570,000       9.34%  
SPM Capital, LLC                                               Bloomington, MN                                      
Term Loan     (12)
      First Lien       L+6.50       1.50%       8.19%                10/31/2018       Healthcare &
Pharmaceuticals
    $ 5,421,770       5,421,770       5,420,000       2.46%  
SQAD, LLC                                               Tarrytown, NY                                      
Term Loan (SBIC)     (2)
      First Lien       L+6.50       1.00%       8.16%                12/22/2022       Media: Broadcasting
& Subscription
    $ 15,000,000       14,919,983       14,920,000       6.77%  
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)     (2)(4)
      Equity                                           3,598 shares       156,001       307,023       0.14%  
SQAD Holdco, Inc. Common Shares
(SBIC)
    (2)(4)
      Equity                                           5,800 shares       62,485       122,977       0.06%  
Total                                                           15,138,469       15,350,000       6.97%  
TechInsights, Inc.                                               Ottawa, Ontario                                      
Term Loan     (5)(12)(13)
      First Lien       L+6.50%       1.00%       8.71%                8/16/2022       High Tech
Industries
    $ 20,000,000       19,529,783       19,600,000       8.90%  
Time Manufacturing Acquisition, LLC                                               Waco, TX                                      
Term Loan     (6)
      Unsecured       11.50%                10.75%       0.75%       8/3/2023       Capital Equipment     $ 6,373,100       6,258,780       6,250,000       2.84%  
Time Manufacturing Investments, LLC Class A Common
Units
    (4)
      Equity                                           5,000 units       500,000       330,000       0.15%  
Total                                                           6,758,780       6,580,000       2.99%  
TFH Reliability, LLC                                               Houston, TX                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+10.75%       0.50%       12.45%                4/21/2022       Chemicals, Plastics,
& Rubber
    $ 5,875,000       5,775,974       5,875,000       2.67%  
TFH Reliability Group, LLC Class A Common Units     (4)
      Equity                                           250,000 shares       250,000       340,000       0.15%  
Total                                                           6,025,974       6,215,000       2.82%  
U.S. Auto Sales, Inc. et al                                               Lawrenceville, GA                                      
Term Loan     (5)(12)
      Second
Lien
      L+11.75%       1.00%       13.12%                6/8/2020       Finance     $ 4,500,000       4,474,973       4,500,000       2.04%  
USASF Blocker II, LLC Common Units     (4)(5)
      Equity                                           441 units       441,000       578,200       0.26%  
USASF Blocker LLC Common Units     (4)(5)
      Equity                                           9,000 units       9,000       11,800       0.01%  
Total                                                           4,924,973       5,090,000       2.31%  
VRI Intermediate Holdings, LLC                                               Franklin, OH                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+9.25%       1.00%       10.95%                10/31/2020       Healthcare &
Pharmaceuticals
    $ 9,000,000       8,846,185       8,910,000       4.05%  
VRI Ultimate Holdings, LLC Class A Preferred Units     (4)
      Equity                                           326,797 shares       500,000       500,000       0.23%  
Total                                                           9,346,185       9,410,000       4.28%  

F-14


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Wise Holding Corporation                                               Salt Lake City, UT                                      
Term Loan     (12)
      Unsecured       L+11.00%       1.00%       12.70%                12/31/2021       Beverage, Food, &

Tobacco
    $ 1,250,000     $ 1,235,188     $ 880,000       0.40%  
WCI Holdings LLC Class A Preferred Units     (4)
      Equity                                           56 units       55,550       0       0.00%  
WCI Holdings LLC Class B Common Units     (4)
      Equity                                           3,044 units       3,044       0       0.00%  
Total                                                           1,293,782       880,000       0.40%  
Zemax, LLC                                               Redmond, WA                                      
Term Loan (SBIC)     (2)(12)
      Second
Lien
      L+10.00%       1.00%       11.60%                4/23/2020       Software     $ 3,962,500       3,922,743       3,960,000       1.80%  
Zemax Software Holdings, LLC Preferred Units (SBIC)     (2)(4)
      Equity                                           24,500 units       5,000       11,200       0.01%  
Zemax Software Holdings, LLC Common Units (SBIC)     (2)(4)
      Equity                                           5,000 shares       245,000       548,800       0.25%  
Total                                                           4,172,743       4,520,000       2.06%  
Total Non-controlled, non-affiliated
investments
                                                          367,401,021       370,849,772       168.38%  
Net Investments                                                           368,453,206       371,839,772       168.83%  
LIABILITIES IN EXCESS OF OTHER ASSETS                                                                 (151,592,530 )      (68.83)%  
NET ASSETS                                                               $ 220,247,242       100.00%  

(1) See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2) Investments held by the SBIC Subsidiary, which include $5,258,500 of cash and $155,769,170 of investments (at par) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.
(3) These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of December 31, 2017.
(6) Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.
(7) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8) In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.
(9) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.

F-15


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

(10) Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.
(12) These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(15) Investment has been on non-accrual since November 1, 2017.

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

F-16


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
December 31, 2016

                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Non-controlled, non-affiliated investments     (2)
                                                                                                    
Abrasive Products & Equipment, LLC, et al                                                                    Deer Park, TX                                      
Term Loan (SBIC)     (2)(3)
      Second
Lien
      L+10.50%       1.00%       11.50%                3/5/2020       Chemicals, Plastics,
& Rubber
    $ 5,325,237     $ 5,252,426     $ 5,277,059       3.09%  
APE Holdings, LLC Class A Units     (4)
      Equity                                           375,000 units       375,000       399,550       0.23%  
Total                                                           5,627,426       5,676,609       3.32%  
Apex Environmental Resources Holdings, LLC                                                                    Amsterdam, OH                                      
Common Units     (4)
      Equity                                                    Environmental Industries       517 shares       517       525       0.00%  
Preferred Units     (4)
      Equity                                           517 shares       517,439       524,911       0.31%  
Total                                                           517,956       525,436       0.31%  
Atkins Nutritionals Holdings II, Inc.                                                                    Denver, CO                                      
Term Loan     (3)
      Second Lien       L+8.50%       1.25 %      9.75 %               4/3/2019       Beverage, Food, & Tobacco     $ 8,000,000       7,928,373       8,000,000       4.68%  
Binder & Binder National Social Security Disability Advocates, LLC                                                                    Hauppauge, NY                                      
Residual Claim From Term Loan     (4)(14)
      Unsecured                                                    Services: Consumer     $ 1,000,000       1,000,000       722,059       0.42%  
Calero Software, LLC et al                                                                    Rochester, NY                                      
Term Loan     (3)
      Second Lien       L+9.50%       1.00 %      10.50 %               6/5/2019       Telecommunications     $ 7,500,000       7,422,928       7,441,535       4.35%  
Managed Mobility Holdings, LLC Partnership Units     (4)
      Equity                                           8,932 units       525,000       152,855       0.09%  
Total                                                           7,947,928       7,594,390       4.44%  
C.A.R.S. Protection Plus, Inc                                                                    Murrysville, PA                                      
Term Loan     (12)
      First Lien       L+8.50%       0.50 %      9.03 %               12/31/2020       Automotive     $ 101,911       100,207       101,911       0.06%  
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.50%       0.50 %      9.03 %               12/31/2020              $ 7,949,027       7,785,147       7,949,027       4.65%  
CPP Holdings LLC Class A Common Units     (4)
      Equity                                           149,828 shares       149,828       250,166       0.15%  
Total                                                           8,035,182       8,301,104       4.86%  
Catapult Learning, LLC et al                                                                    Camden, NJ                                      
Term Loan     (13)
      First Lien       L+6.50%       1.00 %      8.99 %               7/16/2020       Education     $ 12,500,000       12,404,725       12,498,701       7.31%  
Colford Capital Holdings, LLC                                                                    New York, NY                                      
Delay Draw Term Loan #1     (5)
      Unsecured       12.00 %               12.00 %               5/31/2018       Finance     $ 12,500,000       12,401,505       12,477,883       7.30%  
Delay Draw Term Loan #2     (5)
      Unsecured       12.00 %               12.00 %               5/31/2018              $ 2,000,000       1,980,173       1,996,461       1.17%  
Delay Draw Term Loan #4     (5)
      Unsecured       12.00 %               12.00 %               5/31/2018              $ 5,000,000       4,960,146       4,991,153       2.92%  
CC Blocker 1, LLC Preferred Units     (4)(5)
      Equity                                           38,893 units       557,143       671,462       0.39%  
Total                                                           19,898,967       20,136,959       11.78%  
Doskocil Manufacturing Company, Inc.                                                                    Arlington, TX                                      
Term Loan (SBIC)     (2)(13)
      First Lien       L+6.00%       1.00 %      9.40 %               11/10/2020       Consumer goods: non-durable     $ 8,750,000       8,626,143       8,750,000       5.12%  
Douglas Products & Packaging Company, LLC                                                                    Liberty, MO                                      
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.50%       0.50 %      11.50 %               12/31/2020       Chemicals, Plastics, & Rubber     $ 9,000,000       8,876,203       9,000,000       5.27%  
Fumigation Holdings, Inc. Class A Common Stock     (4)
      Equity                                           250 shares       250,000       478,950       0.28%  
Total                                                           9,126,203       9,478,950       5.55%  

F-17


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2016

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Eating Recovery Center, LLC                                                                    Denver, CO                                      
Term Loan     (6)
      Unsecured       13.00 %               12.00 %      1.00 %      6/28/2018       Healthcare & Pharmaceuticals     $ 18,400,000     $ 18,271,406     $ 18,348,093       10.74%  
ERC Group Holdings LLC Class A Units     (4)
      Equity                                           17,820 units       1,655,274       2,631,558       1.54%  
Total                                                           19,926,680       20,979,651       12.28%  
Empirix Inc.                                                                    Billerica, MA                                      
Term Loan     (3)
      Second Lien       L+9.50%
      1.00 %      10.50 %               5/1/2020       Software     $ 11,657,850       11,517,953       11,582,173       6.78%  
Term Loan (SBIC)     (2)(3)
      Second Lien       L+9.50%
      1.00 %      10.50 %               5/1/2020              $ 9,750,000       9,631,895       9,686,708       5.67%  
Empirix Holdings I, Inc. Common Shares, Class A     (4)
      Equity                                                             1,304 shares       1,304,232       1,659,024       0.97%  
Empirix Holdings I, Inc. Common Shares, Class B     (4)
      Equity                                           1,317,406 shares       13,174       16,758       0.01%  
Total                                                           22,467,254       22,944,663       13.43%  
Energy Labs Inc.                                                                    Houston, TX                                      
Term Loan (SBIC)     (2)(13)
      First Lien       L+7.00%
      0.50 %      11.03 %               9/29/2021       Energy: Oil & Gas     $ 5,300,000       5,197,928       5,290,561       3.10%  
Energy Labs Holding Corp. Common Stock     (4)
      Equity                                           500 shares       500,000       500,000       0.29%  
Total                                                           5,697,928       5,790,561       3.39%  
EOS Fitness OPCO Holdings, LLC                                                                    Phoenix, AZ                                      
Term Loan (SBIC)     (2)(3)
      First Lien       L+8.75%
      0.75 %      9.50 %               12/30/2019       Hotel, Gaming, & Leisure     $ 3,331,184       3,287,412       3,331,184       1.95%  
EOS Fitness Holdings, LLC Class A Preferred Units     (4)
      Equity                                                             118 shares       117,670       77,414       0.05%  
EOS Fitness Holdings, LLC Class B Common Units     (4)
      Equity                                           3,017 shares       3,017       1,985       0.00%  
Total                                                           3,408,099       3,410,583       2.00  
Furniture Factory Outlet, LLC                                                                    Fort Smith, AR                                      
Term Loan     (12)
      First Lien       L+9.00%
      0.50 %      10.00 %               6/10/2021       Consumer goods: Durable     $ 9,875,000       9,695,423       9,809,056       5.74%  
Furniture Factory Holdings, LLC Term Loan     (15)
      Unsecured       11.00 %                                 2/3/2021              $ 122,823       122,823       122,823       0.07%  
Sun Furniture Factory, LP Common Units     (4)
      Equity                                           13,445 shares       94,569       170,404       0.10%  
Total                                                           9,912,815       10,102,283       5.91%  
GK Holdings, Inc.                                                                    Cary, NC                                      
Term Loan     (3)
      Second Lien       L+9.50%
      1.00 %      10.50 %               1/30/2022       Education     $ 5,000,000       4,920,321       5,000,000       2.93%  
Glori Energy Production Inc.                                                                    Houston, TX                                      
Term Loan     (3)(4)(6) (7)(8)
      First Lien       L+12.00%
      1.00 %      11.00 %      2.00 %      3/14/2017       Energy: Oil & Gas     $ 1,624,250       1,622,130       864,101       0.51%  
Good Source Solutions, Inc.                                                                    Carlsbad, CA                                      
Term Loan     (13)
      First Lien       L+7.25%
      0.50 %      11.38 %               7/15/2021       Beverage, Food, & Tobacco     $ 1,350,000       1,325,011       1,346,203       0.79%  
Term Loan (SBIC)     (2)(13)
      First Lien       L+7.25%
      0.50 %      11.38 %               7/15/2021              $ 1,200,000       1,177,788       1,196,625       0.70%  
Good Source Holdings, LLC Class A Preferred Units     (4)
      Equity                                                             159 shares
      159,375       136,633       0.08%  
Good Source Holdings, LLC Class B Common Units     (4)
      Equity                                           4,482 shares       0       0       0.00%  
Total                                                           2,662,174       2,679,461       1.57%  

F-18


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2016

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Grupo HIMA San Pablo, Inc., et al                                                                    San Juan, PR                                      
Term Loan     (3)
      First Lien       L+7.00%
      1.50 %      8.50 %               1/31/2018       Healthcare & Pharmaceuticals     $ 4,812,500     $ 4,787,801     $ 4,693,463       2.75%  
Term Loan              Second Lien       13.75 %               13.75 %               7/31/2018              $ 4,000,000       3,924,736       3,535,591       2.07%  
Total                                                           8,712,537       8,229,054       4.82%  
Hollander Sleep Products, LLC                                                                    Boca Raton, FL                                      
Term Loan     (3)
      First Lien       L+8.00%
      1.00 %      9.00 %               10/21/2020       Services: Consumer     $ 7,286,790       7,211,543       7,286,790       4.26%  
Dream II Holdings, LLC Class A Common Units     (4)
      Equity                                           250,000 units       242,304       145,030       0.08%  
Total                                                           7,453,847       7,431,820       4.34%  
Hostway Corporation                                                                    Chicago, IL                                      
Term Loan     (3)
      Second Lien       L+8.75%
      1.25 %      10.00 %               12/13/2020       High Tech Industries     $ 6,750,000       6,661,202       5,832,000       3.41%  
HUF Worldwide, LLC                                                                    Los Angeles, CA                                      
Revolver     (9)(12)
      First Lien       L+9.00%
      0.50 %      9.85 %               10/22/2019       Retail     $ 375,000       375,000       375,000       0.22%  
Term Loan     (12)
      First Lien       L+9.00%
      0.50 %      9.85 %               10/22/2019              $ 3,651,709       3,603,959       3,651,709       2.14%  
Term Loan (SBIC)     (2)(12)
      First Lien       L+9.00%
      0.50 %      9.85 %               10/22/2019              $ 6,138,648       6,063,652       6,138,648       3.59%  
HUF Holdings, LLC Common Class A Units     (4)
      Equity                                           616,892 units       624,427       624,427       0.37%  
Total                                                           10,667,038       10,789,784       6.32%  
Keais Records Service, LLC                                                                    Houston, TX                                      
Term Loan     (12)
      Second Lien       L+10.50%
      0.50 %      11.50 %               6/30/2022       Services: Business     $ 7,750,000       7,620,000       7,620,000       4.46%  
Keais Holdings, LLC Class A Units     (4)
      Equity                                                             148,335 units       775,000       775,000       0.45%  
Total                                                           8,395,000       8,395,000       4.91%  
KidKraft, Inc.                                                                    Dallas, TX                                      
Term Loan     (6)
      Second Lien       12.00 %               11.00 %      1.00 %      3/30/2022       Consumer Goods: Durable     $ 9,222,874       9,044,671       9,044,671       5.29%  
Livingston International, Inc.                                                                    Toronto, Ontario                                      
Term Loan     (3)(5)
      Second Lien       L+8.25%
      1.25 %      9.50 %               4/18/2020       Transportation: Cargo     $ 6,841,739       6,765,448       6,692,648       3.92%  
Madison Logic, Inc.                                                                    New York, NY                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.00%
      0.50 %      8.76 %               11/30/2021       Media: Broadcasting & Subscription     $ 5,000,000       4,950,667       4,950,667       2.90%  
Madison Logic Holdings, Inc. Common Stock (SBIC)     (2)(4)
      Equity                                                             5,000 shares       50,000       50,000       0.03%  
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)     (2)(4)
      Equity                                           4,500 shares       450,000       450,000       0.26%  
Total                                                           5,450,667       5,450,667       3.19%  
Mobileum, Inc.                                                                    Santa Clara, CA                                      
Term Loan     (12)
      Second Lien       L+10.25%
      0.75 %      11.25 %               5/1/2022       Software     $ 9,000,000       8,823,965       8,823,965       5.16%  
Mobile Acquisition Holdings, LP Class A-2 Common Units     (4)
      Equity
                                          750 units
      750,000       750,000       0.44%  
Total                                                           9,573,965       9,573,965       5.60%  
Momentum Telecom Inc., et al                                                                    Birmingham, AL                                      
Term Loan     (3)
      First Lien       L+8.50%
      1.00 %      9.50 %               3/10/2019       Media: Broadcasting & Subscription     $ 6,468,196       6,395,759       6,403,563       3.75%  
Term Loan (SBIC)     (2)(3)
      First Lien       L+8.50%
      1.00 %      9.50 %               3/10/2019              $ 8,687,486       8,589,400       8,600,676       5.03%  
MBS Holdings, Inc. Series E Preferred Stock     (4)
      Equity                                                             2,774,695 shares       1,000,000       1,309,492       0.77%  

F-19


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2016

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
MBS Holdings, Inc. Series F Preferred Stock     (4)
      Equity                                           399,308 shares     $ 206,682     $ 270,648       0.16%  
Total                                                           16,191,841       16,584,379       9.71%  
MTC Intermediate Holdco, Inc.                                                                    Oak Brook, IL                                      
Term Loan     (3)
      Second Lien       L+9.50%
      1.00 %      10.50 %               5/31/2022       Finance     $ 575,000       564,899       575,000       0.34%  
Term Loan (SBIC)     (2)(3)
      Second Lien       L+9.50%
      1.00 %      10.50 %               5/31/2022              $ 9,750,000       9,578,720       9,750,000       5.71%  
MTC Parent, L.P. Class A-2 Common Units     (4)
      Equity                                                             750,000 shares       750,000       1,433,281       0.84%  
Total                                                           10,893,619       11,758,281       6.89%  
OG Systems, LLC                                                                    Chantilly, Virginia                                      
Term Loan     (3)(6)
      Unsecured       L+11.00%
      1.00 %      11.00 %      1.00 %      1/22/2020       Services: Government     $ 4,028,288       3,979,529       3,992,337       2.34%  
OGS Holdings, Inc. Series A Convertible Preferred Stock     (4)
      Equity                                           11,521 shares       50,001       68,182       0.04%  
Total                                                           4,029,530       4,060,519       2.38%  
Refac Optical Group, et al                                                                    Blackwood, NJ                                      
Revolver     (10)(12)
      First Lien       L+8.00%
               8.77 %               9/30/2018       Retail     $ 400,000       400,000       400,000       0.23%  
Term A Loan     (11)(12)
      First Lien       L+8.00%
               8.77 %               9/30/2018              $ 1,502,736       1,502,736       1,502,736       0.88%  
Term B Loan     (6)(11)(12)
      First Lien       L+10.75%
            9.77 %      1.75 %      9/30/2018           $ 6,403,267       6,403,267       6,403,267       3.75%  
Total                                                           8,306,003       8,306,003       4.86  
Securus Technologies Holdings, Inc.                                                                    Dallas, TX                                      
Term Loan     (3)
      Second Lien       L+7.75
      1.25 %      9.00 %               4/30/2021       Telecommunications     $ 8,500,000       8,455,863       8,415,000       4.92%  
Sitel Worldwide Corporation                                                                    Nashville, TN                                      
Term Loan     (3)
      Second Lien       L+9.50       1.00 %      10.50 %               9/18/2022       High Tech Industries     $ 10,000,000       9,825,536       9,550,000       5.59%  
Skopos Financial, LLC                                                                    Irving, TX                                      
Term Loan     (5)
      Unsecured       12.00 %               12.00 %               1/31/2019       Finance     $ 20,000,000       19,791,938       19,618,086       11.48%  
Skopos Financial Group, LLC Class A Units     (4)(5)
      Equity                                           1,120,684 units       1,162,544       1,012,266       0.59%  
Total                                                           20,954,482       20,630,352       12.07%  
SPM Capital, LLC                                                                    Bloomington, MN                                      
Term Loan     (3)
      First Lien       L+5.50
      1.50 %      7.00 %               10/31/2017       Healthcare & Pharmaceuticals     $ 6,387,916       6,362,834       6,374,800       3.73%  
SQAD, LLC                                                                    Tarrytown, NY                                      
Term Loan (SBIC)     (2)(6)
      Unsecured       12.25 %               11.00 %      1.25 %      4/30/2019       Media: Broadcasting & Subscription     $ 7,245,241       7,179,977       7,206,517       4.22%  
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)     (2)(4)
      Equity                                                             5,624 shares       562,368       738,067       0.43%  
SQAD Holdco, Inc. Common Shares (SBIC)     (2)(4)
      Equity                                           5,800 shares       62,485       82,007       0.05%  
Total                                                           7,804,830       8,026,591       4.70%  
Stratose Intermediate Holdings, II, LLC                                                                    Atlanta, GA                                      
Term Loan     (3)
      Second Lien       L+9.50%
      1.00 %      10.50 %               7/26/2022       Services: Business     $ 15,000,000       14,705,967       15,000,000       8.78%  
Atmosphere Aggregator Holdings II, LP Common Units     (4)
      Equity                                                             254,250 units       254,250       630,373       0.37%  
Atmosphere Aggregator Holdings, LP Common Units     (4)
      Equity                                           750,000 units       750,000       1,859,506       1.09%  
Total                                                           15,710,217       17,489,879       10.24%  

F-20


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2016

                       
                       
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
360 Holdings III Corp                                                                    Irvine, CA                                      
Term Loan     (3)
      First Lien       L+9.00%
      1.00 %      10.00 %               10/1/2021       Consumer goods: non-durable     $ 3,950,000     $ 3,811,652     $ 3,950,000       2.31%  
Telecommunications Management, LLC                                                                    Sikeston, MO                                      
Term Loan     (3)
      Second Lien       L+8.00%
      1.00 %      9.00 %               10/30/2020       Media: Broadcasting & Subscription     $ 5,000,000       4,970,522       4,962,649       2.90%  
TFH Reliability, LLC                                                              Houston, TX                                      
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.75%
      0.50 %      11.75 %               4/21/2022       Chemicals, Plastics, & Rubber     $ 5,875,000       5,759,983       5,759,983       3.37%  
TFH Reliability Group, LLC Class A Common Units     (4)
      Equity                                           250,000 shares       250,000       250,000       0.15%  
Total                                                           6,009,983       6,009,983       3.52%  
U.S. Auto Sales, Inc. et al                                                                    Lawrenceville, GA                                      
Term Loan     (3)(5)
      Second Lien       L+11.75%
      1.00 %      12.75 %               6/8/2020       Finance     $ 4,500,000       4,466,518       4,500,000       2.63%  
USASF Blocker II, LLC Common Units     (4)(5)
      Equity                                                             441 units       441,000       469,751       0.27%  
USASF Blocker LLC Common Units     (4)(5)
      Equity                                           9,000 units       9,000       9,587       0.01%  
Total                                                           4,916,518       4,979,338       2.91%  
Vandelay Industries Finance, LLC, et al                                                                    La Vergne, TN                                      
                                                                                                        
Term Loan     (6)
      Second Lien       11.75 %               10.75 %      1.00 %      11/12/2019       Construction & Building     $ 2,500,000       2,485,347       2,495,701       1.46%  
Vision Media Management & Fulfillment, LLC                                                                    Valencia, CA                                      
Term Loan (SBIC)     (2)(13)
      First Lien       L+8.50%
      1.00 %      10.22 %               1/27/2021       Media: Broadcasting & Subscription     $ 1,613,517       1,584,016       1,613,517       0.94%  
Wise Holding Corporation                                                                    Salt Lake City, UT                                      
Term Loan     (3)
      Unsecured       L+10.00%
      1.00 %      11.00 %               12/31/2021       Beverage, Food, & Tobacco     $ 1,250,000       1,232,489       250,000       0.73%  
WCI Holdings LLC Class A Preferred Units     (4)
      Equity                                                             56 units       55,550       58,579       0.03%  
WCI Holdings LLC Class B Common Units     (4)
      Equity                                           3,044 units       3,044       3,210       0.00%  
Total                                                           1,291,083       1,311,789       0.76%  
Zemax, LLC                                                                    Redmond, WA                                      
Term Loan (SBIC)     (2)(3)
      Second Lien       L+10.00%
      1.00 %      11.00 %               4/23/2020       Software     $ 3,962,500       3,908,696       3,941,705       2.31%  
Zemax Software Holdings, LLC Preferred Units (SBIC)     (2)(4)
      Equity                                                             24,500 units       5,000       5,406       0.00%  
Zemax Software Holdings, LLC Common Units (SBIC)     (2)(4)
      Equity                                           5,000 shares       245,000       264,879       0.16%  
Total                                                           4,158,696       4,211,990       2.47%  
Total Non-controlled, non-affiliated investments                                                         $ 362,217,251     $ 365,625,891       214%  
Net Investments                                                         $ 362,217,251     $ 365,625,891       185.52%  
LIABILITIES IN EXCESS OF OTHER ASSETS                                                                 (194,744,106 )      (85.52)%  
NET ASSETS                                                               $ 170,881,785       100.00%  

(1) See Note 1 of the Notes to Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.

F-21


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2016

(2) The Company’s obligations to the lenders of the Credit Facility are secured by a first priority security interest in all non-controlled nonaffiliated investments and cash and cash equivalents, but exclude $3,457,351 of cash and cash equivalents and $100,252,693 of investments (at par) that are held by Stellus Capital SBIC LP. See Note 1 of the Notes to the Consolidated Financial Statements for discussion.
(3) These loans have LIBOR or Euro Floors which are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 85% of the Company’s total assets.
(6) Represents a payment-in-kind security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.
(7) Investment has been on non-accrual since December 1, 2016.
(8) Investment is in payment default.
(9) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $875,000, with an interest rate of LIBOR plus 9.00% and a maturity of October 22, 2019. This investment is accruing an unused commitment fee of 0.50% per annum.
(10) Excluded from the investment is an undrawn commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Variable rate loans bear interest at a rate that may be determined by reference to either LIBOR (which can include one-, two-, three- or six month LIBOR) or an alternate base rate (which can include the Federal Funds Effective Rate or the Prime Rate), at the borrower’s option, which rates reset periodically based on the terms of the loan agreement.
(12) These loans have LIBOR floors which are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) In the fourth quarter of 2016 Binder, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s cost has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time we do not expect to receive any additional repayment other than what the court has awarded.
(15) Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

F-22


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Stellus Capital Investment Corporation (“we”, “us”, “our” and the “Company”) was formed as a Maryland corporation on May 18, 2012 (“Inception”) and is an externally managed, closed-end, non-diversified investment management company. The Company is applying the guidance of Accounting Standards Codification (“ASC”) Topic 946, Financial Services Investment Companies. The Company has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended (the “1940 Act”) and treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”) for U.S. federal income tax purposes. The Company’s investment activities are managed by our investment adviser Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).

As of December 31, 2017 the Company has issued a total of 15,945,879 shares and raised $235,649,244 in gross proceeds since inception, incurring $7,566,536 in offering expenses and sales load fees for net proceeds from offerings of $228,082,708. The Company’s shares are currently listed on the New York Stock Exchange under the symbol “SCM”. See Note 4 for further details.

The Company has established wholly owned subsidiaries: SCIC — Consolidated Blocker 1, Inc., SCIC — CC Blocker 1, Inc., SCIC — ERC Blocker 1, Inc., SCIC — SKP Blocker 1, Inc. and SCIC — APE Blocker 1, Inc., and SCIC — Hollander Blocker 1, Inc., which are structured as Delaware entities, to hold equity or equity-like investments in portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities) (collectively, the “Taxable Subsidiaries”). The Taxable Subsidiaries are consolidated for U.S. generally accepted accounting principles (“U.S GAAP”) reporting purposes, and the portfolio investments held by them are included in the consolidated financial statements.

On June 14, 2013, we formed Stellus Capital SBIC LP (the “SBIC subsidiary”), a Delaware limited partnership, and its general partner, Stellus Capital SBIC GP, LLC., a Delaware limited liability company, as wholly owned subsidiaries of the Company. On June 20, 2014, the SBIC subsidiary received a license from the Small Business Administration (“SBA”) to operate as a Small Business Investment Company (“SBIC”) under Section 301(c) of the Small Business Investment Company Act of 1958. The SBIC subsidiary is consolidated for U.S. GAAP reporting purposes, and the portfolio investments held by it are included in the consolidated financial statements.

The SBIC license allows the SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed on a semi-annual basis at a market-driven spread over U.S. Treasury Notes with 10-year maturities. The SBA, as a creditor, will have a superior claim to the SBIC’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary upon an event of default. See footnote (2) of the Consolidated Schedule of Investments. SBA regulations currently limit the amount that an SBIC may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital, as such term is defined by the SBA, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of December 31, 2017, the SBIC subsidiary had $67.5 million of regulatory capital, as such term is defined by the SBA, and has received commitments from the SBA of $90.0 million. As December 31, 2017 and December 31, 2016, the SBIC subsidiary had $90.0 million and $65.0 million of SBA-guaranteed debentures outstanding, respectively.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

The Company’s investment objective is to maximize the total return to its stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies. The Company seeks to achieve its investment objective by originating and investing primarily in private U.S. middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, with corresponding equity co-investments. It sources investments primarily through the extensive network of relationships that the principals of Stellus Capital have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries.

Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the requirements for reporting on Form 10-K and Article 10 of regulation S-X.

In the opinion of management, the consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the periods included herein. Certain reclassifications have been made to certain prior period balances to conform with current presentation.

In accordance with Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments.

The accounting records of the Company are maintained in U.S. dollars.

Portfolio Investment Classification

The Company classifies its portfolio investments with the requirements of the 1940 Act, (a) “Control Investments” are defined as investments in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation, (b) “Affiliate Investments” are defined as investments in which the Company owns between 5% and 25% of the voting securities and does not have rights to maintain greater than 50% of the board representation, and (c) “Non-controlled, non-affiliate investments” are defined as investments that are neither Control Investments or Affiliate Investments.

Cash and Cash Equivalents

At December 31, 2017, cash balances held at two seperate institutions totaling $4,058,467 and $927,976 exceeded FDIC insurance protection levels of $250,000 by $3,808,467 and $677,976, subjecting the Company to risk related to the uninsured balance. In addition, at December 31, 2017, the Company held $20,124,275 in cash equivalents which are carried at cost, which approximates fair value. All of the Company’s cash and cash equivalents are held at large established high credit quality financial institutions and management believes that risk of loss associated with any uninsured balances is remote.

Cash consists of bank demand deposits. We deem certain U.S. Treasury Bills and other high-quality, short-term debt securities as cash equivalents. At the end of each fiscal quarter, we may take proactive steps to ensure we are in compliance with the RIC diversification requirements under Subchapter M of the Internal Revenue Code, which are dependent upon the composition of our total assets at quarter end. We may accomplish this in several ways, including purchasing U.S. Treasury Bills and closing out positions after quarter-end or temporarily drawing down on the Credit Facility (see footnote 9). On December 31, 2017 and December 31, 2016, we held no U.S. Treasury Bills.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Fair Value Measurements

We account for substantially all of our financial instruments at fair value in accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value, and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. We believe that the carrying amounts of our financial instruments such as cash, receivables and payables approximate the fair value of these items due to the short maturity of these instruments. This is considered a Level 1 valuation technique. The carrying values of our Credit Facility and SBIC debentures approximate fair value because the interest rates adjusts to the market interest rates (Level 3 input). The carrying value of our Notes is based on the closing price of the security (level 2 input). See Note 6 to the consolidated financial statements for further discussion regarding the fair value measurements and hierarchy.

Consolidation

As permitted under Securities and Exchange Commission (“SEC”) Regulation S-X and ASC Topic 946, we generally do not consolidate our investment in a portfolio company other than an investment company subsidiary. Accordingly, we consolidated the results of the SBIC subsidiary and the Taxable Subsidiaries. All intercompany balances have been eliminated upon consolidation.

Use of Estimates

The preparation of the statement of assets and liabilities in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

Deferred Financing Costs

Deferred financing costs, prepaid loan fees on SBA-guaranteed debentures and prepaid loan structure fees consist of fees and expenses paid in connection with the closing of our Credit Facility, notes and SBA-guaranteed debentures and are capitalized at the time of payment. These costs are amortized using the straight line method over the term of the respective instrument.

Offering Costs

Offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s common stock and bonds, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement. These costs are capitalized when incurred and recognized as a reduction of offering proceeds when the offering is consummated. During the second quarter ended June 30, 2016, the Company determined that it was no longer likely to issue shares under its current shelf registration statement, as a result, the Company expense $261,761 of previously capitalized deferred offering costs for the year ended December 31, 2016. The Company incurred $307,022 in connection with the offering of our common stock in a public offering in April 2017 (the “April Offering”) and the At-the-Market (ATM) offering program that began in August 2017 (the “ATM Program”). These costs are shown on the Consolidated Statement of Changes in Net Assets and Liabilities as a reduction to Paid-in Capital as of December 31, 2017. See Note 4 for further discussion.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Investments

As a business development company (“BDC”), the Company will generally invest in illiquid loans and securities including debt and equity securities of middle-market companies. Under procedures established by the board of directors, the Company intends to value investments for which market quotations are readily available at such market quotations. The Company will obtain these market values from an independent pricing service or at the median between the bid and ask prices obtained from at least two brokers or dealers (if available, otherwise by a principal market maker or a primary market dealer). Debt and equity securities that are not publicly traded or whose market prices are not readily available will be valued at fair value as determined in good faith by our board of directors. Such determination of fair values may involve subjective judgments and estimates. The Company also engages independent valuation providers to review the valuation of each portfolio investment that does not have a readily available market quotation at least twice annually.

Investments purchased within 90 days of maturity will be valued at cost plus accreted discount, or minus amortized premium, which approximates value. With respect to unquoted securities, our board of directors, together with our independent valuation advisors, will value each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the board will use the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because the Company expects that there will not be a readily available market for many of the investments in our portfolio, the Company expects to value most of our portfolio investments at fair value as determined in good faith by the board of directors using a documented valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

In following these approaches, the types of factors that will be taken into account in fair value pricing investments will include, as relevant, but not be limited to:

available current market data, including relevant and applicable market trading and transaction comparables;
applicable market yields and multiples;
security covenants;
call protection provisions;
information rights;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
comparisons of financial ratios of peer companies that are public;
comparable merger and acquisition transactions; and
the principal market and enterprise values.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Revenue Recognition

We record interest income on an accrual basis to the extent such interest is deemed collectible. Payment-in-kind (“PIK”) interest, represents contractual interest accrued and added to the loan balance that generally becomes due at maturity. We will not accrue any form of interest on loans and debt securities if we have reason to doubt our ability to collect such interest. Loan origination fees, original issue discount and market discount or premium are capitalized, and we then accrete or amortize such amounts using the effective interest method as interest income. Upon the prepayment of a loan or debt security, any unamortized loan origination fee is recorded as interest income. We record prepayment premiums on loans and debt securities as other income. Dividend income, if any, will be recognized on the ex-dividend date.

In order to maintain our status as a RIC, substantially all of this income must be paid out to stockholders in the form of dividends, even if we have not collected any cash.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

Investment Transaction Costs

Costs that are material associated with an investment transaction, including legal expenses, are included in the cost basis of purchases and deducted from the proceeds of sales unless such costs are reimbursed by the borrower.

Receivables and Payables for Unsettled Securities Transaction

The Company records all investments on a trade date basis.

U.S. Federal Income Taxes

The Company has elected to be treated as a RIC under subchapter M of the Internal Revenue Code of 1986, as amended, and to operate in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify for tax treatment as a RIC, among other things, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. So long as the Company maintains its tax treatment as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as dividends. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s investors and will not be reflected in the financial statements of the Company.

To avoid a 4% U.S federal excise tax on undistributed earnings, the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending December 31 (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax or the Excise Tax Avoidance Requirement. For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid). The Company, at its discretion, may choose not to distribute all of its taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If the Company chooses to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

that it’s estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned. For the years ended December 31, 2017 and December 31, 2016, the Company incurred an excise tax expense of $42,402 and $22,663 respectively.

The Company evaluates tax positions taken or expected to be taken in the course of preparing its tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax provision or expense in the applicable period.

As of December 31, 2017 and December 31, 2016, the Company had not recorded a liability for any uncertain tax positions. Management’s evaluation of uncertain tax positions may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof. The Company’s policy is to include interest and penalties related to income taxes, if applicable, in general and administrative expenses. Any such expenses for the year ended December 31, 2017 were de minimis.

On December 22, 2017, the “Tax Cuts and Jobs Act” legislation was signed into law. The Tax Cuts and Jobs Act includes significant changes to the U.S. corporate tax system, including a reduction in the U.S. corporate income tax rate from 35% to 21%. ASC 740, Income Taxes, requires the effect of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As such, we have incorporated the effect of the change in tax rate, which impacts our Taxable Subsidiaries, as of December 31, 2017.

The Taxable Subsidiaries are direct wholly owned subsidiaries of the Company that have elected to be taxable entities. The Taxable Subsidiaries permit the Company to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in the Company’s consolidated financial statements.

The Taxable Subsidiaries use the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.

For the years ended December 31, 2017, 2016 and 2015, the Company recorded deferred income tax benefit (expense) of $8,593, $373,131 and $(93,601), respectively, related to the Taxable Subsidiaries. In addition, as of December 31, 2017 and December 31, 2016, the Company had a deferred tax liability of $0 and $8,593, respectively. See Note 13, Income Taxes, for a schedule of the deferred tax asset and valuation allowance reducing the deferred tax asset and the deferred tax liability.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Earnings per Share

Basic per share calculations are computed utilizing the weighted average number of shares of common stock outstanding for the period. The Company has no common stock equivalents. As a result, there is no difference between diluted earnings per share and basic per share amounts.

Paid In Capital

The Company records the proceeds from the sale of its common stock on a net basis to (i) capital stock and (ii) paid in capital in excess of par value, excluding all commissions and marketing support fees.

Recently Issued Accounting Standards

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU supersedes the revenue recognition requirements in Revenue Recognition (Topic 605). Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty or revenue that is recognized. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarified the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarified the implementation guidance regarding performance obligations and licensing arrangements. In May 2016 the FASB issued ASU No. 2016-12, Revenue from Contracts with customers (Topic 606) — Narrow-Scope Improvements and Practical Expedients, which clarified guidance on assessing collectability, presenting sales tax, measuring noncash consideration, and certain transition matters. In December 2016, the FASB issued ASU No. 2016-20, Revenue from Contacts with Customers (Topic 606) — Technical Corrections and Improvements, which provided disclosure relief, and clarified the scope and application of the revenue standard and related cost guidance. The new guidance will be effective for the annual reporting period beginning after December 15, 2017, including interim periods within that reporting period. Note, the guidance exempts interest income from the above guidance, indicating recognition will remain the same. We have completed our analysis on the above guidance and has concluded on the recognition treatment of other income streams such as repayment penalty fees, origination fees, miscellaneous fees etc. Stellus will continue to recognize origination fees over the life of the loan. Repayment penalty fees will be recognized immediately if a repayment is made and miscellaneous fees such as administration fees will be recognized on the contract renewal date or other discrete point in time per the credit agreement. Per the Topic 606 update, Stellus’ timing of its revenue recognition will remain the same for the identified revenue streams as previously reported.

In August 2014, the FASB issued ASU No. 2014-15 — Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. In connection with the preparation of interim and annual reports, the Company’s management will evaluate whether conditions or events exist that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date the financial statements are available to be issued, when applicable), and, if so, disclose that fact. Additionally, the Company’s management must evaluate and disclose whether its plans will alleviate that doubt. The guidance was effective for the Company beginning January 1, 2016. The Company has adopted the guidance as of January 1, 2016 and there is no impact on its consolidated financial statements.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

In November 2015, the FASB issued ASU 2015-17 — Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. It simplifies the current guidance, which required entities to separately present deferred tax assets and liabilities as current or noncurrent in a classified balance sheet. The guidance was effective for the Company January 1, 2017. The Company has adopted the guidance as of January 1, 2017 and there is no material impact on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15 — Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The new guidance addresses the classification of various transactions including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, distributions received from equity method investments, beneficial interests in securitization transactions, and others. The update is effective for annual periods beginning after December 31, 2017, and interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. The Company early adopted the guidance as of January 1, 2017 and there is no material impact of this new standard on our consolidated financial statements.

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standards setting bodies that are adopted by the Company as of the specified effective date. We believe the impact of the recently issued standards and any that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.

NOTE 2 — RELATED PARTY ARRANGEMENTS

Investment Advisory Agreement

The Company entered into an investment advisory agreement with Stellus Capital. Pursuant to this agreement, the Company has agreed to pay to Stellus Capital a base annual fee of 1.75% of gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents, and an annual incentive fee.

For the years ended December 31, 2017, 2016 and 2015, the Company recorded an expense for base management fees of $6,255,911, $6,281,863, and $5,841,267 respectively. As of December 31, 2017 and December 31, 2016, respectively, $1,621,592 and $1,608,295 were payable to Stellus Capital.

The incentive fee has two components, investment income and capital gains, as follows:

Investment Income Incentive Fee

The investment income component (“Investment Income Incentive Fee”) is calculated, and payable, quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The pre-incentive fee net investment income, which is expressed as a rate of return on the value of the Company’s net assets attributable to the Company’s common stock, for the immediately preceding calendar quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as the “Hurdle”). Pre-incentive fee net investment income means interest income, dividend income and any other income accrued during the calendar quarter, minus the Company’s operating expenses for the quarter excluding the incentive fee. Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which the Company’s pre-incentive fee net investment income does not exceed the Hurdle. Subject to the cumulative total return requirement described below, the Advisor receives 100% of

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

the Company’s pre-incentive fee net investment income for any calendar quarter with respect to that portion of the pre-incentive net investment income for such quarter, if any, that exceeds the Hurdle but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the “Catch-up”) and 20.0% of the Company’s pre-incentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets.

The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any Investment Income Incentive Fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which the Company’s pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the Catch-up, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such incentive fee that is attributable to deferred interest until the Company actually receives such interest in cash.

For the years ended December 31, 2017, 2016 and 2015, the Company incurred $2,911,392, $4,275,436, and $3,975,198, respectively, of Investment Income Incentive Fees. As of December 31, 2017 and 2016, $371,647 and $1,353,271, respectively, of such incentive fees were payable to the Advisor, of which $175,738 and $1,162,714, respectively, were currently payable (as explained below). As of December 31, 2017 and December 31, 2016, $195,909 and $190,557, respectively, of incentive fees incurred but not paid by the Company were generated from deferred interest (i.e. PIK, certain discount accretion and deferred interest) and are not payable until such amounts are received in cash.

While under no obligation to do so, the Advisor waived incentive fees of $646,333 for the year ended December 31, 2015 to support an annualized dividend yield of 9.0% based on the $15.00 price per share of our common stock in the Offering. Such waiver in no way implies that the Advisor will waive incentive fees in any future period. The Advisor did not waive incentive fees during the years ended December 31, 2016 and 2017.

Capital Gains Incentive Fee

The Company also pays the Advisor an incentive fee based on capital gains (the “Capital Gains Incentive Fee”). The Capital Gains Incentive Fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). The Capital Gains Incentive Fee is equal to 20.0% of the Company’s cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid Capital Gains Incentive Fees is subtracted from such Capital Gains Incentive Fee calculated.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

U.S. GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation or depreciation of investments or other financial instruments in the calculation, as an incentive fee would be payable if such realized gains and losses and unrealized capital appreciation or depreciation were realized, even though such realized gains and losses and unrealized capital appreciation or depreciation is not permitted to be considered in calculating the fee actually payable under the investment management agreement (the “Capital Gains Incentive Fee”). There can be no assurance that unrealized appreciation or depreciation will be realized in the future. Accordingly, such fee, as calculated and accrued, would not necessarily be payable under the investment management agreement, and may never be paid based upon the computation of incentive fees in subsequent periods. For the years ended December 31, 2017, and 2016, the Company incurred no Capital Gains Incentive Fee. As of December 31, 2017 and December 31, 2016, no Capital Gains Incentive Fees were payable to the Advisor.

The following tables summarize the components of the incentive fees discussed above:

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Investment Income Incentive Fee Incurred   $ 2,911,392     $ 4,275,436     $ 3,975,198  
Investment Income Incentive Fee Waived                 (646,333 ) 
Net Incentive Fee Expense   $ 2,911,392     $ 4,275,436     $ 3,328,865  

     
  December 31, 2017   December 31,
2016
 
Investment Income Incentive Fee Currently Payable   $ 175,738     $ 1,162,714           
Investment Income Incentive Fee Deferred     195,909       190,557        
Incentive Fee Payable   $ 371,647     $ 1,353,271        

Director Fees

For the years ended December 31, 2017, 2016 and 2015, the Company recorded an expense relating to director fees of $331,000, $324,000, and $333,000, respectively. As of December 31, 2017 and 2016, the Company owed its independent directors no unpaid director fees.

Co-Investments

We received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We intend to co-invest, subject to the conditions included in the exemptive order we received from the SEC, with a private credit fund managed by Stellus Capital Management that has an investment strategy that is identical to our investment strategy. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

License Agreement

We have entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, we have a right to use the “Stellus Capital” name for so long as Stellus Capital Management or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have no legal right to the “Stellus Capital” name. This license agreement will remain in effect for so long as the investment advisory agreement with Stellus Capital Management is in effect.

Administration Agreement

The Company entered into an administration agreement with Stellus Capital Management pursuant to which Stellus Capital Management will furnish the Company with office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under this administration agreement, Stellus Capital Management will perform, or oversee the performance of, its required administrative services, which includes, among other things, being responsible for the financial records which it is required to maintain and preparing reports to its stockholders and reports filed with the SEC.

For the years ended December 31, 2017, 2016 and 2015, the Company recorded expenses of $1,117,011, $922,531, and $744,657, respectively, related to the administration agreement. These are included in the Administrative Services expenses line on the Consolidated Statement of Operations. As of December 31, 2017 and December 31, 2016, $279,141 and $232,169, respectively, remained payable to Stellus Capital relating to the administration agreement.

Indemnification

The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the investment advisory agreement, Stellus Capital Management and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital Management’s services under the investment advisory agreement or otherwise as our investment adviser.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 3 — DISTRIBUTIONS

Distributions are generally declared by the Company’s board of directors each calendar quarter and recognized as distribution liabilities on the ex-dividend date. The Company intends to distribute net realized gains (i.e., net capital gains in excess of net capital losses), if any, at least annually. The stockholder distributions, if any, will be determined by the board of directors. Any distribution to stockholders will be declared out of assets legally available for distribution. The following table reflects the Company’s dividends declared and paid or to be paid on its common stock:

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2012
                          
December 7, 2012     December 21, 2012       December 27, 2012     $ 0.1812  
Fiscal 2013
                          
March 7, 2013     March 21, 2013       March 28, 2013     $ 0.3400  
June 7, 2013     June 21, 2013       June 28, 2013     $ 0.3400  
August 21, 2013     September 5, 2013       September 27, 2013     $ 0.3400  
November 22, 2013     December 9, 2013       December 23, 2013     $ 0.3400  
Fiscal 2014
                          
December 27, 2013     January 15, 2014       January 24, 2014     $ 0.0650  
January 20, 2014     January 31, 2014       February 14, 2014     $ 0.1133  
January 20, 2014     February 28, 2014       March 14, 2014     $ 0.1133  
January 20, 2014     March 31, 2014       April 15, 2014     $ 0.1133  
April 17, 2014     April 30, 2014       May 15, 2014     $ 0.1133  
April 17, 2014     May 30, 2014       June 16, 2014     $ 0.1133  
April 17, 2014     June 30, 2014       July 15, 2014     $ 0.1133  
July 7, 2014     July 31, 2014       August 15, 2014     $ 0.1133  
July 7, 2014     August 29, 2014       September 15, 2014     $ 0.1133  
July 7, 2014     September 30, 2014       October 15, 2014     $ 0.1133  
October 15, 2014     October 31, 2014       November 14, 2014     $ 0.1133  
October 15, 2014     November 28, 2014       December 15, 2014     $ 0.1133  
October 15, 2014     December 31, 2014       January 15, 2015     $ 0.1133  
Fiscal 2015
                          
January 22, 2015     February 2, 2015       February 13, 2015     $ 0.1133  
January 22, 2015     February 27, 2015       March 13, 2015     $ 0.1133  
January 22, 2015     March 31, 2015       April 15, 2015     $ 0.1133  
April 15, 2015     April 30, 2015       May 15, 2015     $ 0.1133  
April 15, 2015     May 29, 2015       June 15, 2015     $ 0.1133  
April 15, 2015     June 30, 2015       July 15, 2015     $ 0.1133  
July 8, 2015     July 31, 2015       August 14, 2015     $ 0.1133  
July 8, 2015     August 31, 2015       September 15, 2015     $ 0.1133  
July 8, 2015     September 20, 2015       October 15, 2015     $ 0.1133  
October 14, 2015     October 30, 2015       November 13, 2015     $ 0.1133  
October 14, 2015     November 30, 2015       December 15, 2015     $ 0.1133  
October 14, 2015     December 31, 2015       January 15, 2016     $ 0.1133  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 3 — DISTRIBUTIONS  – (continued)

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2016
                          
January 13, 2016     January 29, 2016       February 15, 2016     $ 0.1133  
January 13, 2016     February 29, 2016       March 15, 2016     $ 0.1133  
January 13, 2016     March 31, 2016       April 15, 2016     $ 0.1133  
April 15, 2016     April 29, 2016       May 13, 2016     $ 0.1133  
April 15, 2016     May 31, 2016       June 15, 2016     $ 0.1133  
April 15, 2016     June 30, 2016       July 15, 2016     $ 0.1133  
July 7, 2016     July 29, 2016       August 15, 2016     $ 0.1133  
July 7, 2016     August 31, 2016       September 15, 2016     $ 0.1133  
July 7, 2016     September 30, 2016       October 14, 2016     $ 0.1133  
October 7, 2016     October 31, 2016       November 15, 2016     $ 0.1133  
October 7, 2016     November 30, 2016       December 15, 2016     $ 0.1133  
October 7, 2016     December 30, 2016       January 13, 2017     $ 0.1133  
Fiscal 2017
                          
January 13, 2017     January 31, 2017       February 15, 2017     $ 0.1133  
January 13, 2017     February 28, 2017       March 15, 2017     $ 0.1133  
January 13, 2017     March 31, 2017       April 14, 2017     $ 0.1133  
April 14, 2017     April 28, 2017       May 15, 2017     $ 0.1133  
April 14, 2017     May 31, 2017       June 15, 2017     $ 0.1133  
April 14, 2017     June 30, 2017       July 14, 2017     $ 0.1133  
July 7, 2017     July 31, 2017       August 15, 2017     $ 0.1133  
July 7, 2017     August 31, 2017       September 15, 2017     $ 0.1133  
July 7, 2017     September 29, 2017       October 13, 2017     $ 0.1133  
October 12, 2017     October 31, 2017       November 15, 2017     $ 0.1133  
October 12, 2017     November 30, 2017       December 15, 2017     $ 0.1133  
October 12, 2017     December 29, 2017       January 12, 2018     $ 0.1133  
Total               $ 7.0446  

Unless the stockholder elects to receive its distributions in cash, the Company intends to make such distributions in additional shares of the Company’ common stock under the Company’s dividend reinvestment plan. Although distributions paid in the form of additional shares of the Company’s common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in the Company’s dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes. Any distributions reinvested through the issuance of shares through the Company’s dividend reinvestment plan will increase the Company’s gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital. No new shares were issued in connection with the distributions made during the years ended December 31, 2017 and 2016.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 4 — EQUITY OFFERINGS AND RELATED EXPENSES

The table below illustrates the number of common stock shares the Company issued since inception through various equity offerings.

           
Issuance of Common Stock   Number of Shares   Gross
Proceeds(1)
  Underwriting fees   Offering Expenses   Net
Proceeds
  Offering
Price
Year ended December 31, 2012     12,035,023     $ 180,522,093     $ 4,959,720     $ 835,500     $ 174,726,873     $ 14.90  
Year ended December 31, 2013     63,998       899,964                   899,964     $ 14.06  
Year ended December 31, 2014     380,936       5,485,780       75,510       29,904       5,380,366     $ 14.47  
Year ended December 31, 2015                                    
Year ended December 31, 2016                                    
Year ended December 31, 2017     3,465,922       48,741,407       1,358,880       307,022       47,075,505     $ 14.06  
Total     15,945,879     $ 235,649,244     $ 6,394,110     $ 1,172,426     $ 228,082,708        

(1) Net of partial share redemptions. Such share redemptions reduced gross proceeds by 142, 29 and 31 in 2017, 2016, and 2015, respectively.

The Company issued no shares of common stock during the years ended December 31, 2017 and 2016 in connection with the DRIP.

The Company issued 3,162,500 and 303,422 additional shares of common stock during the year ended December 31, 2017 in connection with the April Offering and ATM Program, respectively. Gross proceeds resulting from the April Offering totaled $44,591,250 and underwriting and other expenses related to the April Offering totaled $1,530,632. The average offering price for the April Offering was $14.10. Gross proceeds resulting from the ATM Program totaled $4,150,299 and underwriting and other expenses related to the offering totaled $135,270. The average offering price of shares issued in the ATM Program was $13.68.

NOTE 5 — NET INCREASE IN NET ASSETS PER COMMON SHARE

The following information sets forth the computation of net increase in net assets resulting from operations per common share for the years ended December 31, 2017, 2016 and 2015.

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Net increase in net assets resulting from operations   $ 22,613,257     $ 23,199,062     $ 7,670,536  
Weighted average common shares     14,870,981       12,479,959       12,479,961  
Basic and diluted earnings per common share   $ 1.52     $ 1.86     $ 0.61  

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE

In accordance with the authoritative guidance on fair value measurements and disclosures under GAAP, the Company discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1 —  Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 —  Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

Level 3 —  Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.

The Company considers whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if the Company determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.

At December 31, 2017, the Company had investments in 48 portfolio companies. The total cost and fair value of the investments were $368,453,206 and $371,839,772 respectively. The composition of our investments as of December 31, 2017 is as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 140,915,106     $ 141,006,923  
Senior Secured – Second Lien     181,164,730       178,432,850  
Unsecured Debt     27,903,141       27,430,000  
Equity     18,470,229       24,969,999  
Total Investments   $ 368,453,206     $ 371,839,772  

(1) Includes unitranche investments, which account for 13.2% of our investment portfolio at fair value.

At December 31, 2016, the Company had investments in 45 portfolio companies. The total cost and fair value of the investments were $362,217,251 and $365,625,891, respectively. The composition of our investments as of December 31, 2016 is as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 113,264,200     $ 113,482,205  
Senior Secured – Second Lien     163,112,172       162,486,388  
Unsecured Debt     70,919,986       70,725,412  
Equity     14,920,893       18,931,886  
Total Investments   $ 362,217,251     $ 365,625,891  

(1) Includes unitranche investments, which account for 8.4% of our investment portfolio at fair value.

The Company’s investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require the Company to provide funding when requested by portfolio companies in accordance with the terms of the underlying loan agreements. As of December 31, 2017 and December 31, 2016, the Company had four and two such investments with aggregate unfunded commitments of $8,686,667 and $1,875,000, respectively. The Company maintains sufficient liquidity to fund such unfunded loan commitments should the need arise.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2017 are as follows:

       
  Quoted Prices in
Active Markets
for Identical
Securities
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
Senior Secured – First Lien   $     $     $ 141,006,923     $ 141,006,923  
Senior Secured – Second Lien                 178,432,850       178,432,850  
Unsecured Debt                 27,430,000       27,430,000  
Equity                 24,969,999       24,969,999  
Total Investments   $         —     $     —     $ 371,839,772     $ 371,839,772  

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2016 are as follows:

       
  Quoted Prices in
Active Markets
for Identical
Securities
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
Senior Secured – First Lien   $     $     $ 113,482,205     $ 113,482,205  
Senior Secured – Second Lien           17,965,000       144,521,388       162,486,388  
Unsecured Debt                 70,725,412       70,725,412  
Equity                 18,931,886       18,931,886  
Total Investments   $         —     $ 17,965,000     $ 347,660,891     $ 365,625,891  

The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2017 are as follows:

         
  Senior Secured
Loans-First
Lien
  Senior Secured
Loans-Second
Lien
  Unsecured
Debt
  Equity   Total
Fair value at beginning of period   $ 113,482,205     $ 144,521,388     $ 70,725,412     $ 18,931,886     $ 347,660,891  
Purchases of investments     85,892,733       73,388,500       6,203,400       6,686,613       172,171,246  
Payment-in-kind interest     113,723       319,629       66,244             499,596  
Sales and Redemptions     (57,242,106 )      (47,725,650 )      (49,578,812 )      (9,369,308 )      (163,915,876 ) 
Transfer from Term Loan to Equity     (864,101 )                  864,101        
Net Realized Losses     (626,949 )                  5,367,925       4,740,976  
Change in unrealized depreciation
                                            
included in earnings     (126,190 )      (2,146,961 )      (278,564 )      2,488,782       (62,933 ) 
Amortization of premium and accretion of discount, net     377,608       525,944       292,320             1,195,872  
Transfer from Level 2           9,550,000                   9,550,000  
Fair value at end of period   $ 141,006,923     $ 178,432,850     $ 27,430,000     $ 24,969,999     $ 371,839,772  
Change in unrealized depreciation on Level 3 investments still held as of December 31, 2017   $ (498,183 )    $ (1,679,419 )    $ (278,567 )    $ 3,465,063     $ 1,008,894  

During the year ended December 31, 2017, there was one transfer from Level 2 to Level 3 because the observable inputs were not available in 2017. During the year ended December 31, 2016, there were two transfers from Level 3 to Level 2 as additional broker quotes became available. Transfers are reflected at the value of the securities at the beginning of the period.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2016 are as follows:

         
  Senior Secured
Loans-First
Lien
  Senior Secured
Loans-Second
Lien
  Unsecured
Debt
  Equity   Total
Fair value at beginning of period   $ 131,908,961     $ 131,972,581     $ 72,212,282     $ 12,923,873     $ 349,017,697  
Purchases of investments     25,009,310       35,664,883       1,354,073       3,632,768       65,661,034  
Payment-in-kind interest     112,952       22,874       107,940             243,766  
Sales and Redemptions     (44,947,647 )      (9,850,061 )      (122,094 )      (1,019,375 )      (55,939,177 ) 
Net Realized Losses     (674,702 )            (12,200,353 )      (214,286 )      (13,089,341 ) 
Change in unrealized depreciation included in earnings     1,653,933       2,684,245       9,085,283       3,608,906       17,032,367  
Amortization of premium and accretion of discount, net     419,398       392,196       288,281             1,099,875  
Transfer to Level 2           (16,365,330 )                  (16,365,330 ) 
Fair value at end of period   $ 113,482,205     $ 144,521,388     $ 70,725,412     $ 18,931,886     $ 347,660,891  
Change in unrealized depreciation on Level 3 investments still held as of December 31, 2016   $ 1,399,408     $ 2,588,122     $ 9,084,789     $ 3,686,972     $ 16,759,291  

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Texas   $ 109,043,496     $ 108,445,000       29.16 % 
New Jersey     34,531,876       34,595,527       9.30 % 
New York     28,939,268       29,365,000       7.90 % 
Canada     26,315,677       26,440,000       7.11 % 
California     25,519,753       25,930,000       6.97 % 
Illinois     24,250,169       25,700,000       6.91 % 
Massachusetts     22,534,191       22,247,850       5.98 % 
Arizona     13,565,958       13,840,000       3.72 % 
North Carolina     12,248,770       12,499,167       3.36 % 
Ohio     10,112,627       9,990,000       2.69 % 
Tennessee     9,848,614       9,950,000       2.68 % 
Missouri     9,152,087       9,530,000       2.56 % 
Georgia     5,929,223       8,329,998       2.24 % 
Pennsylvania     7,848,470       8,058,746       2.17 % 
Arkansas     7,397,881       7,618,484       2.05 % 
Minnesota     5,421,770       5,420,000       1.46 % 
Puerto Rico     8,827,864       5,080,000       1.37 % 
Washington     4,172,743       4,520,000       1.22 % 
Alabama     1,206,682       2,880,000       0.77 % 
Utah     1,293,782       880,000       0.24 % 
Florida     242,304       420,000       0.11 % 
Virginia     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.0 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2016:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Texas   $ 74,433,626     $ 73,576,277       20.12 % 
New York     42,102,392       41,930,666       11.47 % 
Colorado     27,855,053       28,979,651       7.93 % 
California     28,298,845       28,606,727       7.81 % 
Massachusetts     22,467,254       22,944,663       6.28 % 
Georgia     20,626,735       22,469,217       6.15 % 
New Jersey     20,710,728       20,804,704       5.69 % 
Illinois     17,554,821       17,590,281       4.81 % 
Alabama     16,191,841       16,584,379       4.54 % 
Missouri     14,096,725       14,441,599       3.95 % 
Tennessee     12,310,883       12,045,701       3.29 % 
Arkansas     9,912,815       10,102,283       2.76 % 
Pennsylvania     8,035,182       8,301,104       2.27 % 
Puerto Rico     8,712,537       8,229,054       2.25 % 
Florida     7,453,847       7,431,820       2.03 % 
Canada     6,765,448       6,692,648       1.83 % 
Minnesota     6,362,834       6,374,800       1.74 % 
North Carolina     4,920,321       5,000,000       1.37 % 
Washington     4,158,696       4,211,990       1.15 % 
Virginia     4,029,530       4,060,519       1.11 % 
Arizona     3,408,099       3,410,583       0.93 % 
Utah     1,291,083       1,311,789       0.36 % 
Ohio     517,956       525,436       0.14 % 
     $ 362,217,251     $ 365,625,891       100.0 % 

The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Software   $ 48,560,675     $ 48,997,850       13.18 % 
Healthcare & Pharmaceuticals     41,192,879       37,829,167       10.17 % 
High Tech Industries     36,058,477       35,460,000       9.54 % 
Finance     26,500,097       28,330,000       7.62 % 
Services: Business     23,386,714       25,749,999       6.93 % 
Capital Equipment     24,300,027       24,170,000       6.50 % 
Media: Broadcasting & Subscription     21,680,239       23,665,000       6.36 % 
Chemicals, Plastics, & Rubber     20,825,458       21,145,000       5.69 % 
Services: Consumer     17,862,616       18,070,000       4.86 % 
Construction & Building     17,913,413       17,980,000       4.84 % 
Education     17,197,396       17,335,526       4.66 % 
Consumer Goods: Durable     16,559,947       16,798,484       4.52 % 
Consumer goods: non-durable     13,250,000       13,250,000       3.56%  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

     
  Cost   Fair Value   % of Total
Investments
at fair value
Retail     8,288,083       8,280,000       2.23 % 
Automotive     7,848,470       8,058,746       2.17 % 
Transportation: Cargo     6,785,894       6,840,000       1.84 % 
Energy: Oil & Gas     6,766,968       6,700,000       1.80 % 
Insurance     5,410,226       5,500,000       1.48 % 
Beverage, Food, & Tobacco     3,964,242       3,580,000       0.96 % 
Hotel, Gaming, & Leisure     3,284,942       3,420,000       0.92 % 
Environmental Industries     766,442       580,000       0.16 % 
Services: Government     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.0 % 

The following is a summary of industry concentration of our investment portfolio as of December 31, 2016:

     
  Cost   Fair Value   % of Total
Investments
at fair value
Finance   $ 56,663,586     $ 57,504,930       15.73 % 
Software     36,199,915       36,730,618       10.06 % 
Media: Broadcasting & Subscription     36,001,876       36,637,803       10.02 % 
Healthcare & Pharmaceuticals     35,002,051       35,583,505       9.73 % 
Services: Business     24,105,217       25,884,879       7.08 % 
Consumer goods: non-durable     20,763,612       21,165,542       5.79 % 
Chemicals, Plastics, & Rubber     18,957,486       19,146,954       5.24 % 
Retail     18,973,041       19,095,787       5.22 % 
Education     17,325,046       17,498,701       4.79 % 
Telecommunications     16,403,791       16,009,390       4.38 % 
High Tech Industries     16,486,738       15,382,000       4.21 % 
Beverage, Food, & Tobacco     12,437,795       12,700,000       3.47 % 
Consumer Goods: Durable     11,881,630       11,991,250       3.28 % 
Automotive     8,035,182       8,301,104       2.27 % 
Services: Consumer     8,453,847       8,153,879       2.23 % 
Transportation: Cargo     6,765,448       6,692,648       1.83 % 
Energy: Oil & Gas     7,320,058       6,654,662       1.82 % 
Services: Government     4,029,530       4,060,519       1.11 % 
Hotel, Gaming, & Leisure     3,408,099       3,410,583       0.93 % 
Construction & Building     2,485,347       2,495,701       0.68 % 
Environmental Industries     517,956       525,436       0.14 % 
     $ 362,217,251     $ 365,625,891       100.0 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following provides quantitative information about Level 3 fair value measurements as of December 31, 2017:

       
Description:   Fair Value   Valuation Technique   Unobservable Inputs   Range (Average)(1)(3)
First lien debt   $ 141,006,923       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -3.73% to 5.53% (-0.81%)
0.24% to 1.12% (0.54%)
11x to 13x (12x)(4)
 
Second lien debt   $ 178,432,850       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -2.52% to 4.78% (-0.58%)
-0.28% to 1.01% (0.39%)
8x to 8x (8x)(4)
 
Unsecured debt   $ 27,430,000       Income/Market
approach(2)
      HY credit spreads,
Risk free rates
Market multiples
      -0.67% to 3.93% (0.89%)
0.12% to 1.18% (0.52%)
1x to 14x (13x)(4)
 
Equity investments   $ 24,969,999       Market approach(5)
      Underwriting
EBITDA Multiple
      1x to 15x (9x)  
Total Long Term Level 3 Investments   $ 371,839,772                    

(1) Weighted average based on fair value as of December 31, 2017.
(2) Inclusive of but not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3) The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for a first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -3.73% (-373 basis points) to 5.53% (553 basis points). The average of all changes was -0.81%.
(4) Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5) The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following provides quantitative information about Level 3 fair value measurements as of December 31, 2016:

       
Description:   Fair Value   Valuation Technique   Unobservable Inputs   Range (Average)(1)(3)
First lien debt   $ 113,482,205       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -2.01% to 0.69% (-0.66%)
-0.21% to 0.83% (0.16%)
7x to 14x (10x)(4)
 
Second lien debt   $ 144,521,388       Income/Market(2)
approach
      HY credit spreads,
Risk free rates
Market multiples
      -7.34% to 6.67% (0.00%)
-0.60% to 0.79% (0.00%)
5x to 19x (11x)(4)
 
Unsecured debt   $ 70,725,412       Income/Market
approach(2)
      HY credit spreads,
Risk free rates
Market multiples
      -0.91% to 0.03% (-0.36%)
-0.36% to 0.95% (0.10%)
7x to 13x (10x)(4)
 
Equity investments   $ 18,931,886       Market approach(5)
      Underwriting
EBITDA Multiple
      1x to 13x (9x)  
Total Long Term Level 3 Investments   $ 347,660,891                    

(1) Weighted average based on fair value as of December 31, 2016.
(2) Inclusive of but not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3) The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for second lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -2.01% (201 basis points) to 0.69% (69 basis points). The average of all changes was -0.66%.
(4) Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5) The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

NOTE 7 — COMMITMENTS AND CONTINGENCIES

The Company is currently not subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition or results of operations.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 7 — COMMITMENTS AND CONTINGENCIES  – (continued)

As of December 31, 2017, the Company had $8,686,667 of unfunded commitments to provide debt financing to four existing portfolio companies. As of December 31, 2016 the Company had $1,875,000 of unfunded commitments to provide debt financing to two existing portfolio companies. The Company maintains sufficient liquidity to fund such unfunded loan commitments should the need arise.

NOTE 8 — FINANCIAL HIGHLIGHTS

         
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
  For the year
ended
December 31,
2014
  For the year
ended
December 31,
2013
Per Share Data:(1)
                                            
Net asset value at beginning of year/period   $ 13.69     $ 13.19     $ 13.94     $ 14.54     $ 14.45  
Net investment income     1.21       1.39       1.33       1.34       1.33  
Change in unrealized appreciation (depreciation)           1.49       (0.74 )      (0.53 )      0.03  
Realized gain (loss)     0.31       (1.05 )      0.03       0.04       0.09  
Benefit (Provision) for taxes on unrealized appreciation           0.03       (0.01 )      (0.02 )          
Total from investment operations     1.52       1.86       0.61       0.83       1.45  
Sales Load     (0.09 )                  (0.01 )       
Offering Costs     (0.02 )                         
Stockholder distributions from:
                                            
Net investment income     (1.20 )      (1.36 )      (1.33 )      (1.31 )      (1.36 ) 
Net realized capital gains     (0.16 )            (0.03 )      (0.12 )       
Other(3)     0.07                   0.01        
Net asset value at the end of year/period   $ 13.81     $ 13.69     $ 13.19     $ 13.94     $ 14.54  
Per share market value at end of year/period   $ 13.14     $ 12.06     $ 9.64     $ 11.78     $ 14.95  
Total return based on market
value(4)
    20.29 %      42.83 %      (7.76 )%      (13.09 )%      0.42 % 
Weighted average shares outstanding at the end of period     14,870,981       12,479,959       12,479,961       12,281,178       12,059,293  
Ratio/Supplemental Data:
                                            
Net assets at the end of year/period   $ 220,247,242     $ 170,881,785     $ 164,651,104     $ 173,949,452     $ 175,891,514  
Weighted average net assets   $ 195,211,550     $ 165,189,142     $ 173,453,813     $ 176,458,141     $ 175,398,660  
Annualized ratio of gross operating expenses to net assets(7)(8)     11.10 %      13.20 %      11.16 %      9.92 %      8.65 % 
Annualized ratio of net operating expenses to net assets(7)(8)     11.10 %      13.20 %      10.78 %      9.12 %      7.63 % 
Annualized ratio of interest expense and other fees to net assets(9)     4.02 %      4.84 %      3.56 %      3.01 %      1.78 % 
Annualized ratio of net investment income before fee waiver to net assets(7)     9.21 %      10.71 %      9.11 %      8.40 %      8.11 % 
Annualized ratio of net investment income to net assets(7)     9.21 %      10.71 %      9.49 %      9.19 %      9.13 % 
Portfolio Turnover(5)     48 %      16 %      29 %      19 %      41 % 
Notes Payable     48,875,000       25,000,000       25,000,000       25,000,000       110,000,000  
Credit Facility Payable     40,750,000       116,000,000       109,500,000       106,500,000       9,000,000  
SBA-guaranteed debentures     90,000,000       65,000,000       65,000,000       16,250,000        
Asset Coverage Ratio(6)     3.46x       2.21x       2.22x       2.32x       2.48x  

(1) Financial highlights are based on weighted average shares outstanding as of year/period ended.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 8 — FINANCIAL HIGHLIGHTS  – (continued)

(2) The per share impact of the Company’s reinvestment of stockholder distributions has an impact to net assets of less than $0.01 per share during the applicable period.
(3) Includes the impact of different share amounts as a result of calculating certain per share data based on weighted average shares outstanding during the period and certain per share data based on shares outstanding as of the period end.
(4) Total return on market value is based on the change in market price per share since the end of the prior quarter and includes dividends paid. The total returns are not annualized.
(5) Calculated as the lesser of purchases or paydowns divided by average portfolio balance and is not annualized.
(6) Asset coverage ratio is equal to (i) the sum of (a) net assets at the end of the period and (b) total debt outstanding at the end of the period, divided by (ii) total debt outstanding at the end of the period. SBA-guaranteed debentures are excluded from the numerator and denominator.
(7) These ratios include the impact of the benefit (provision) for income taxes related to net unrealized loss (gain) on certain investments of $8,593, $373,131, and ($93,601) for the years ended December 31, 2017, 2016 and 2015 respectively, which are not reflected in net investment income, gross operating expenses or net operating expenses. The benefit (provision) for income taxes related to net realized loss or unrealized loss (gain) on investments at taxable subsidiaries to net assets for the years ended December 31, 2017, 2016 and 2015 is less than (0.01)%, (0.23)%, and 0.05%, respectively.
(8) Deferred offering costs of $261,761 for the year ended December 31, 2016 are not annualized.
(9) Excludes debt extinguishment costs of $416,725 for the year ended December 31, 2017. Including these costs, this ratio would be 4.24%.

NOTE 9 — CREDIT FACILITIES

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120,000,000 on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase, and other customary conditions. The Company terminated the Original Facility on October 11, 2017 in conjunction with securing and entering into the Credit Facility as defined below.

On October 11, 2017, the Company entered in to a new senior secured revolving credit agreement, dated as of October 10, 2017, with ZB, N.A., dba Amegy Bank and various other leaders (the “Credit Facility”). The Credit Facility provides for borrowings up to a maximum of $140,000,000 on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 9 — CREDIT FACILITIES  – (continued)

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021. This represents an interest rate reduction of 12.5 basis points and a three year extension of maturity over the Original Facility. The following table explains the modifications:

       
  Original Facility     Credit Facility  
Agent     SunTrust                Amegy           
Term     Dec 2012 – Oct 2017                Oct 2017 – Oct 2021           
Principal     Commitment     $ 120,000,000       Commitment     $ 140,000,000  
Interest     LIBOR Margin:
ABR Margin:
Unused Fee:
      2.625%
1.625%
0.50
%      LIBOR Margin:
ABR Margin:
Unused Fee:
      2.50%
1.50%
0.50
% 
Fees     Admin Fee:     $ 50,000/Annual       Admin Fee:     $ 35,000/Annual  

The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Original Facility contained certain affirmative and negative covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least 85% of adjusted borrowing base, (ii) maintaining an asset coverage ratio of at least 2.0 to 1.0, and (iii) maintaining a minimum shareholder’s equity. The Original Facility required that the Company meet certain conditions in connection with incurring additional indebtedness, including that the Company have a minimum asset coverage ratio of 2.2 to 1.0 after giving effect to such borrowing. Additional conditions stated that (i) the aggregate amount of PIK interest during the most recently ended fiscal quarter of the borrower did not exceed 2% of the aggregate amount of interest income that the borrower had received on all investments in the borrowing base during such fiscal quarter; (ii) the sum of the value of all non-accrual investments did not exceed 5% of the value of all investments in the borrowing base and (iii) the borrower maintained a minimum liquidity test of at least 80% of adjusted borrowing base. The Company met these conditions while the Original Facility was outstanding.

The Credit Facility no longer provides advances on non-performing assets or equity positions. The Credit Facility also does not require a minimum asset coverage test to incur additional indebtedness nor does it have a maximum of PIK interest or non-accrual investments allowable under the borrowing base. Other changes under the Credit Facility include: a) the amendment of the minimum liquidity test to $10,000,000, including cash, liquid investments, and undrawn availability b) the addition of a minimum interest coverage ratio of 2.0 to 1.0 at all times. As of December 31, 2017, these conditions were met.

As of December 31, 2017 and December 31, 2016, the outstanding balance under the Credit Facility and Original Facility was $40,750,000 and $116,000,000 respectively. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The Company incurred total costs of $3,067,715 in connection with obtaining, amending, and maintaining the Original Facility. The Company incurred costs of $1,158,616 in connection with the Credit Facility, which are being amortized over the life of the facility. Additionally, $341,979 of costs from the Original Facility will continue to be amortized over the remaining life of the Revised Facility. The Company expensed $113,993 of fees related to the modification in the year ended December 31, 2017 as a loss on extinguishment of debt, which represents a proportionate amount of fees attributable to SunTrust bank exiting the Original Facility. As of December 31, 2017 and December 31, 2016, $1,417,521 and $828,792 of such prepaid loan structure fees and administration fees had

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 9 — CREDIT FACILITIES  – (continued)

yet to be amortized, respectively. These prepaid loan fees are presented on our consolidated statement of assets and liabilities as a deduction from the debt liability attributable to the Credit Facility as required by ASU No. 2015-3.

The following is a summary of the amounts outstanding for the Facilities, net of prepaid loan structure fees:

   
  December 31, 2017   December 31,
2016
Credit Facility payable   $ 40,750,000     $ 116,000,000  
Prepaid loan structure fees     1,417,521       828,792  
Credit facility payable, net of prepaid loan structure fees   $ 39,332,479     $ 115,171,208  

For the year ended December 31, 2017, the weighted average effective interest rate under the Credit Facility and the Original Facility was approximately 3.7% (approximately 5.0% including commitment fees and other loan fees, but excluding $113,994 of loss on extinguishment of debt). The average borrowings under the Credit Facility and the Original Facility for the year ended December 31, 2017 were $60,053,425.

For the year ended December 31, 2016, the weighted average effective interest rate under the Original Facility was approximately 3.2% (approximately 3.7% including commitment fees and other loan fees). The average borrowings under the Original Facility for the year ended December 31, 2016 were $106,601,093.

For the year ended December 31, 2015, the weighted average effective interest rate under the Original Facility was approximately 2.9% (approximately 3.5% including commitment fees and other loan fees). The average borrowings under the Original Facility for the year ended December 31, 2015 were $102,800,824.

Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility and Original Facility for the years ended December 31, 2017, 2016, and 2015:

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Interest expense   $ 2,247,048     $ 3,383,572     $ 2,962,885  
Loan fee amortization     416,612       471,501       473,398  
Commitment fees on unused portion     311,174       66,787       87,052  
Administration fees     39,282       52,335       48,605  
Total interest and financing expenses   $ 3,014,116     $ 3,974,195     $ 3,571,940  
Loss on extinguishment of debt     113,993              
Cash paid for interest and unused fees   $ 2,476,340     $ 3,423,226     $ 3,096,966  

NOTE 10 — SBA-GUARANTEED DEBENTURES

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, an SBIC can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. As of December 31, 2017 and December 31, 2016, the SBIC subsidiary had $67,500,000 and $38,000,000, respectively, in regulatory capital, as such term is defined by the SBA.

As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 10 — SBA-GUARANTEED DEBENTURES  – (continued)

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our 200% asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the 200% asset coverage test by permitting us to borrow up to $135,000,000 more than we would otherwise be able to absent the receipt of this exemptive relief.

On a stand-alone basis, the SBIC subsidiary held $161,992,327 and $104,622,902 in assets at December 31, 2017 and December 31, 2016, respectively, which accounted for approximately 40.4% and 27.5% of our total consolidated assets at December 31, 2017 and December 31, 2016, respectively.

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of December 31, 2017 and December 31, 2016, the SBIC subsidiary had $90,000,000 and $65,000,000, respectively, of SBA-guaranteed debentures outstanding, which mature ten years from issuance. The first maturity related to the SBIC-guaranteed debentures does not occur until 2025, and the remaining weighted average duration of all of our outstanding SBA-guaranteed debentures is approximately 8.5 years as of December 31, 2017.

As of December 31, 2017 and December 31, 2016, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At December 31, 2017 and December 31, 2016 the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

As of December 31, 2017, the Company has incurred $3,082,500 since receiving our license in 2014 in financing costs related to SBA-guaranteed debentures. As of December 31, 2017 and December 31, 2016, $2,181,187 and $1,657,964 of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

The following is a summary of the SBA-guaranteed debentures, net of prepaid loan fees:

   
  December 31,
2017
  December 31,
2016
SBA-guaranteed debentures payable   $ 90,000,000     $ 65,000,000  
Prepaid loan fees     2,181,187       1,657,964  
SBA-guaranteed debentures, net of prepaid loan fees   $ 87,818,813     $ 63,342,036  

For the year ended December 31, 2017, the weighted average effective interest rate for the SBA-guaranteed debentures was approximately 3.1% (approximately 3.6% including loan fees). The average borrowings of SBA-guaranteed debentures for the year ended December 31, 2017 were $67,328,767.

For the year ended December 31, 2016, the weighted average effective interest rate for the SBA-guaranteed debentures was approximately 2.9% (approximately 3.4% including loan fees). The average borrowings of SBA-guaranteed debentures for the year ended December 31, 2016 were $65,000,000.

For the year ended December 31, 2015, the weighted average effective interest rate for the SBA-guaranteed debentures was approximately 2.2% (approximately 3.0% including loan fees). The average borrowings of SBA-guaranteed debentures for the year ended December 31, 2015 were $25,437,671.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 10 — SBA-GUARANTEED DEBENTURES  – (continued)

The following table summarizes the interest expenses incurred and paid on the SBA-guaranteed debentures for the years ended December 31, 2017, 2016, and 2015:

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Interest expense   $ 2,067,308     $ 1,877,017     $ 560,031  
Debenture fee amortization     333,027       326,191       204,980  
Total interest and financing expenses   $ 2,400,335     $ 2,203,208     $ 765,011  
Cash paid for interest   $ 2,019,095     $ 1,500,528     $ 289,018  

NOTE 11 — NOTES

On May 5, 2014, the Company closed a public offering of $25,000,000 in aggregate principal amount of 6.50% notes (the “2019 Notes”) due April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The Company redeemed all $25,000,000 in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date. As a result of the redemption, the Company recognized a loss on the extinguishment of debt of $302,732 for the year ended December 31, 2017, due to the write off of the remaining deferred financing costs on the 2019 Notes.

The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for the years ended December 31, 2017, 2016 and 2015:

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Interest expense   $ 1,169,097     $ 1,625,000     $ 1,625,000  
Deferred financing costs     131,377       184,933       209,703  
Administration fees     5,000       4,850       5,361  
Total interest and financing expenses   $ 1,305,474     $ 1,814,783     $ 1,840,064  
Loss on extinguishment of debt     302,732              
Cash paid for interest   $ 1,376,736     $ 1,625,000     $ 1,625,000  

On August 21, 2017, the Company issued $42,500,000 in aggregate principal amount of 5.75% fixed-rate notes due 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6,375,000 in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

The Company used all of the net proceeds from this offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of December 31, 2017 and 2016, the aggregate carrying amount of all Notes was $48,875,000 and $25,000,000. If the Company had adopted the fair value option under ASC 825, the fair value of the Notes would be approximately $49,520,150 and $25,200,000, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 11 — NOTES  – (continued)

“SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1,688,961 of fees which are being amortized over the term of the 2022 Notes, of which $1,568,512 remains to be amortized as of December 31, 2017. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the years ended December 31, 2017, 2016 and 2015:

     
  For the year
ended
December 31,
2017
  For the year
ended
December 31,
2016
  For the year
ended
December 31,
2015
Interest expense   $ 1,014,835     $     $  
Deferred financing costs     118,066              
Administration fees     2,383              
Total interest and financing expenses   $ 1,135,284     $     $  
Cash paid for interest   $ 889,932     $           —     $           —  

The following is a summary of the Notes Payable, net of deferred financing costs:

   
  December 31,
2017
  December 31,
2016
Notes payable   $ 48,875,000     $ 25,000,000  
Deferred financing costs     1,568,512       434,109  
Notes payable, net of deferred financing costs   $ 47,306,488     $ 24,565,891  

The indenture and supplements thereto relating to each of the 2019 Notes and 2022 Notes contain certain covenants, including but not limited to (i) a requirement that the Company comply with the asset coverage requirements of the 1940 Act or any successor provisions, and (ii) a requirement to provide financial information to the holders of the notes and the trustee under the indenture if the Company should no longer be subject to the reporting requirements under the Exchange Act.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 12 — SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table sets forth the results of operations for the years ended December 31, 2017, 2016, and 2015. Results for any quarter are not necessarily indicative of results for the full year or for any future quarter.

       
  2017
     Qtr. 1   Qtr. 2   Qtr. 3   Qtr. 4
Total Investment Income   $ 9,863,980     $ 10,394,365     $ 9,978,345     $ 9,411,503  
Net Investment Income   $ 4,143,627     $ 4,938,459     $ 4,475,952     $ 4,412,722  
Net Increase in Net Assets from Operations   $ 6,024,752     $ 6,044,766     $ 5,636,598     $ 4,907,141  
Total Investment Income per share(1)   $ 0.79     $ 0.68     $ 0.64     $ 0.59  
Net Investment Income per share(1)   $ 0.33     $ 0.32     $ 0.29     $ 0.28  
Net Increase in Net Assets from Operations per share(1)   $ 0.48     $ 0.39     $ 0.36     $ 0.31  

       
  2016
     Qtr. 1   Qtr. 2   Qtr. 3   Qtr. 4
Total Investment Income   $ 9,467,833     $ 9,623,169     $ 10,202,753     $ 10,196,442  
Net Investment Income   $ 4,099,290     $ 3,945,102     $ 4,608,743     $ 4,659,066  
Net Increase in Net Assets from operations   $ 2,523,849     $ 5,029,920     $ 9,927,466     $ 5,717,827  
Total Investment Income per share(1)   $ 0.76     $ 0.77     $ 0.82     $ 0.82  
Net Investment Income per share(1)   $ 0.33     $ 0.32     $ 0.37     $ 0.37  
Net Increase in Net Assets from Operations per share(1)   $ 0.20     $ 0.41     $ 0.80     $ 0.45  

       
  2015
     Qtr. 1   Qtr. 2   Qtr. 3   Qtr. 4
Total Investment Income   $ 8,714,091     $ 8,690,462     $ 8,602,813     $ 9,151,193  
Net Investment Income   $ 3,843,415     $ 3,995,487     $ 3,819,631     $ 4,888,595  
Net Increase in Net Assets from Operations     5,393,374     $ 4,000,993     $ (624,337 )    $ (1,099,494 ) 
Total Investment Income per share(1)   $ 0.70     $ 0.70     $ 0.69     $ 0.73  
Net Investment Income per share(1)   $ 0.31     $ 0.32     $ 0.31     $ 0.39  
Net Increase in Net Assets from Operations per share(1)   $ 0.43     $ 0.32     $ (0.05 )    $ (0.09 ) 

(1) Per share amounts are calculated using weighted average shares outstanding during the period.

NOTE 13 — INCOME TAXES

As of December 31, 2017 and December 31, 2016, the Company had $394,559 and $1,307,452, respectively, of undistributed ordinary income.(1) Undistributed capital gains were $723,753 and $0 for the periods ended December 31, 2017 and December 31, 2016, respectively. All of the undistributed ordinary income as of December 31, 2017 will have been distributed within the required period of time such that the Company will not have to pay corporate-level U.S. federal income tax for the year ended December 31, 2017. We will be subject to a 4% nondeductible U.S. federal excise tax on our undistributed income to the extent we did not distribute an amount equal to at least 98% of our net ordinary income plus 98.2% of our capital gain net income attributable to the period. The Company has accrued $42,402 and $22,663 of U.S. federal excise tax for the years ended December 31, 2017 and December 31, 2016, respectively.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 13 — INCOME TAXES  – (continued)

Ordinary dividend distributions from a RIC do not qualify for the reduced maximum tax rate on qualified dividend income from domestic corporations, except to the extent that the RIC received the income in the form of qualifying dividends from domestic corporations and qualified foreign corporations. The tax character(2) of distributions paid in the years ended December 31, 2017 and 2016 was as follows:

   
  December 31,
2017
  December 31,
2016
Ordinary income   $ 17,823,305     $ 16,968,350  
Qualified dividends     1,500,000        
Distributions of long-term capital gains(2)     1,000,000        
Total distributions accrued or paid to common stockholders   $ 20,323,305     $ 16,968,350  

(1) The Company’s taxable income for each period is an estimate and will not be finally determined until the Company files its tax return for each year. Therefore, final taxable income earned in each period, and the undistributed ordinary income and capital gains for each period carried forward for distribution in the following period, may be different than this estimate.
(2) Distributions of long-term capital gains of $1,000,000 as of December 31, 2017 differs from distributions of net capital gains on the Consolidated Statement of Changes in Net Assets because certain long-term capital gains were recognized in Taxable Subsidiaries. The qualified dividend amount equal to $1,500,000 is derived from a long-term capital gain transaction and represents a cash distribution from the Taxable Subsidiary to the Company. Additional differences arise because certain prepayment gains are characterized differently for tax reporting purposes.

Listed below is a reconciliation of “Net increase in net assets resulting from operations” to taxable income and total distributions declared to common stockholders for the years ended December 31, 2017, 2016 and 2015.

     
  December 31,
2017
  December 31,
2016
  December 31,
2015
Net increase in net assets resulting from operations (includes NII, Realized Gain/(Loss), Unrealized Gain/(Loss) and Taxes)   $ 22,613,257     $ 23,199,062     $ 7,670,536  
Net change in net unrealized appreciation (depreciation)     22,072       (18,603,401 )      9,204,717  
Income tax provision (benefit)     (8,593 )      (373,131 )      93,601  
Pre-tax (income) expense, (gain) loss reported at Taxable Subsidiaries, not consolidated for tax purposes     (4,721,039 )      13,451,549        
Book income and tax income differences, including debt origination, interest accrual, income from pass-through investments, dividends, realized gains (losses) and changes in estimates     1,835,779       583,041       (73,772 ) 
Estimated taxable income   $ 19,741,476     $ 18,257,120     $ 16,895,082  
Taxable income earned in prior year and carried
forward for distribution in current year
    (106,530 )      (1,395,300 )      (1,321,498 ) 
Taxable income earned prior to period end and
carried forward for distribution next period
    (1,118,312 )      (1,307,452 )      (18,682 ) 
Dividend payable as of period end and paid in
following period
    1,806,671       1,413,982       1,413,982  
Total distributions accrued or paid to common
stockholders
  $ 20,323,305     $ 16,968,350     $ 16,968,884  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 13 — INCOME TAXES  – (continued)

The aggregate gross unrealized appreciation and depreciation, the net unrealized appreciation, and the aggregate cost of the Company’s portfolio company securities for federal income tax purposes as of December 31, 2017 and December 31, 2016 were as follows:

   
  2017   2016
Aggregate cost of portfolio securities for federal income tax purposes   $ 368,453,206     $ 362,217,251  
Gross unrealized appreciation of portfolio company securities     10,263,285       7,011,949  
Gross unrealized depreciation of portfolio company securities     (6,876,717 )      (3,603,309 ) 
Net unrealized appreciation (depreciation) of portfolio
company securities, before tax
  $ 3,386,568     $ 3,408,640  

As of December 31, 2017, the Taxable Subsidiaries had generated unrealized losses in investments, net operating loss (“NOL”) carryovers and capital loss carryovers creating a net deferred tax asset equal to $1,567,062, as reflected below. Due to the nature of the Taxable Subsidiaries’ holdings, a valuation allowance was established when management determined it is more likely than not that some of the deferred tax assets will not be realized prior to expiration. Although our future projections indicate that we may be able to realize some of these deferred tax assets, due to the degree of uncertainty of these projections, management has recorded a deferred tax asset valuation allowance of $1,567,062. The deferred tax asset and deferred tax liability amounts, before valuation allowance, reflected below, take into account the reduction in corporate income tax rate from 35% to 21% as enacted by the Tax Cuts and Jobs Act of 2017 (“Tax Reform”). Before the effect of Tax Reform, the ending net deferred tax asset would have been approximately $2,612,000, compared to the reflected ending net deferred tax asset of $1,567,062, before valuation allowance. Therefore the reduction in corporate tax rates had the effect of reducing the Taxable Subsidiaries’ net deferred tax asset by approximately $1,045,000. This reduction also resulted in a reduction in the required valuation allowance in an equal amount, resulting in $0 net change in tax expense arising as a result of the Tax Reform rate reduction.

   
  2017   2016
Deferred Tax Asset   $ 2,779,563     $ 4,529,046  
Deferred Tax Liability   $ (1,212,501 )    $ (392,922 ) 
Total Deferred Tax Asset (Liability) before Valuation Allowance     1,567,062       4,136,124  
Deferred Tax Valuation Allowance   $ (1,567,062 )    $ (4,144,717 ) 
Net Deferred Tax Asset (Liability)   $ 0     $ (8,593 ) 

Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The 2014, 2015 and 2016 federal income tax and excise tax returns for the Company remain subject to examination by the Internal Revenue Service.

NOTE 14 — SUBSEQUENT EVENTS

Investment Portfolio

On January 2, 2018, the Company invested $10.0 million in the second lien term loan of ICD Intermediate Holdco 2, LLC, a financial company which connects corporate treasury departments with money market and short duration bond funds. Additionally, the Company invested $0.5 million in the equity of the company.

On January 26, 2018, the Company made an additional investment of $7.1 million in the first lien term loan of BW DME Acquisition LLC, (StateServ Medical, LLC).

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017

NOTE 14 — SUBSEQUENT EVENTS  – (continued)

On January 30, 2018, the Company received a dividend of $1.35 million from MTC Parent, L.P. (Millennium Trust).

On January 31, 2018, the Company invested $11.0 million in the first lien term loan of Price for Profit, LLC, an advisory services and specialized technology platform services company. We also committed to fund a $1.5 million revolver. Additionally, the Company invested $0.8 million in the equity of the company.

On January 31, 2018, the Company made an additional investment of $3.2 million in the first lien term loan of Energy Labs Inc.

On February 5, 2018, the Company invested $20.5 million in the first lien term loan of Fast Growing Trees, LLC, an online provider of hybrid trees and plants. We also committed to fund a $1.0 million revolver. Additionally, the Company invested $1.0 million in the equity of the company.

On February 6, 2018, the Company made an additional investment of $8.3 million in the first lien debt of Furniture Factory Holdings, LLC.

Credit Facility

The outstanding balance under the Credit Facility as of March 2, 2018 was $83.1 million.

SBIC Subsidiary

On January 2, 2018, the Company contributed $7.5 million to the SBIC Subsidiary, bringing total contributed capital to $75 million.

Dividend Redistribution Investment Program (DRIP)

Since December 31, 2017, the Company has issued 7,932 shares through the DRIP.

Dividend Declared

On January 11, 2018, the Company’s board of directors declared a regular monthly dividend for each of January 2018, February 2018 and March 2018 as follows:

       
Declared   Ex-Dividend Date   Record Date   Payment Date   Amount per Share
1/11/2018     1/30/2018       1/31/2018       2/15/2018     $ 0.1133  
1/11/2018     2/27/2018       2/28/2018       3/15/2018     $ 0.1133  
1/11/2018     3/28/2018       3/29/2018       4/13/2018     $ 0.1133  

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TABLE OF CONTENTS

Schedule 12-14

STELLUS CAPITAL INVESTMENT CORPORATION

Consolidated Schedule of Investments in and Advances to Affiliates
December 31, 2017
(dollars in thousands)

               
               
Company   Investment(1)   December 31,
2016
Fair Value
  Amount of Realized
Gain / (Loss)
  Amount of Unrealized Gain / (Loss)   Amount of Interest, Fees or Dividends Credit to
Income(2)
  Gross Additions(3)   Gross Reductions(4)   December 31, 2017
Fair Value
Non-controlled Investments
                                                                       
Affiliate investments
                                                                       
Glori Energy Production Inc.(5)     LIBOR Plus 10.0%     $ 864     $ (760 )    $  —     $  —     $  —     $ 1,010     $  —  
       Class A Common Units     $       —     $  —     $ (62 )    $  —     $ 188     $  —     $ 990  
Other
                                                                       
Amounts related to investments transferred to or from other 1940 Act Classification during the period               $ (760 )    $ (62 )    $  —     $       188     $     1,010     $       990  
Total Non-Control / Non-Affiliate investments               $ 5,416     $ 40     $  —                    
Total Portfolio               $     4,656     $     (22 )    $     —                    

This schedule should be read in conjunction with Stellus’s consolidated financial statements, including the consolidated schedule of investments and notes to the consolidated financial statements.

(1) The principal amount, the ownership detail for equity investments accrual status is included in the consolidated schedule of investments.
(2) Represents the total amount of interest, fees and dividends credited to income for the portion of the period for which an investment was included in Control or Affiliate categories, respectively. For investments transferred between Control and Affiliate categories during the period, any income or investment balances related to the time period it was in the category other than the one shown at period end is included in “Amounts from investments transferred from other 1940 Act classifications during the period.”
(3) Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on investments and accrued PIK interest, 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 net unrealized depreciation as well as the movement of an existing portfolio company into this category and out of a different category.
(4) Gross reductions include decreases in the cost basis of investments resulting from principal 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 net unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.
(5) On February 1, 2017, the Company’s first lien term in Glori Energy Production, Inc. was converted to a non-controlled, affiliated equity position.

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TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

   
  March 31,
2018
(unaudited)
  December 31,
2017
ASSETS
                 
Non-controlled, affiliated investments, at fair value (amortized cost of $135,519 and $1,052,185, respectively)   $ 140,000     $ 990,000  
Non-controlled, non-affiliated investments, at fair value (amortized cost of $426,244,352 and $367,401,021, respectively)     431,159,720       370,849,772  
Cash and cash equivalents     45,494,363       25,110,718  
Receivable for sales and repayments of investments     26,891       26,891  
Interest receivable     3,787,060       2,922,204  
Other receivables     37,647        
Prepaid expenses     298,186       361,270  
Total Assets   $ 480,943,867     $ 400,260,855  
LIABILITIES
                 
Notes payable   $ 47,389,684     $ 47,306,488  
Credit facility payable     116,948,703       39,332,479  
SBA-guaranteed debentures     87,919,481       87,818,813  
Dividends payable     1,807,570       1,806,671  
Management fees payable     1,575,366       1,621,592  
Incentive fees payable     1,164,735       371,647  
Interest payable     683,980       1,021,173  
Unearned revenue     175,989       139,304  
Administrative services payable     361,727       327,033  
Other accrued expenses and liabilities     653,500       268,413  
Total Liabilities   $ 258,680,735     $ 180,013,613  
Commitments and contingencies (Note 7)
                 
Net Assets   $ 222,263,132     $ 220,247,242  
NET ASSETS
                 
Common Stock, par value $0.001 per share (200,000,000 and 100,000,000 shares authorized; 15,953,810 and 15,945,879 shares issued and outstanding, respectively)   $ 15,954     $ 15,946  
Paid-in capital     228,161,215       228,066,762  
Accumulated net realized loss from investments, net of cumulative dividends of $4,246,819 for both periods     (9,450,971 )      (10,786,240 ) 
Distributions in excess of net investment income     (1,382,915 )      (435,794 ) 
Net Unrealized appreciation on investments and cash equivalents, net of provision for taxes of $0 for both periods     4,919,849       3,386,568  
Net Assets   $ 222,263,132     $ 220,247,242  
Total Liabilities and Net Assets   $ 480,943,867     $ 400,260,855  
Net Asset Value Per Share   $ 13.93     $ 13.81  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

   
  For the three months
ended
March 31,
2018
  For the three months
ended
March 31,
2017
INVESTMENT INCOME
                 
Interest income   $ 10,730,748     $ 9,476,252  
Other income     181,033       387,728  
Total Investment Income   $ 10,911,781     $ 9,863,980  
OPERATING EXPENSES
                 
Management fees   $ 1,748,896     $ 1,564,528  
Valuation fees     134,410       166,089  
Administrative services expenses     351,229       309,098  
Incentive fees     968,826       1,021,227  
Professional fees     469,138       227,677  
Directors’ fees     92,000       92,000  
Insurance expense     85,697       109,252  
Interest expense and other fees     2,464,980       2,068,630  
Other general and administrative expenses     121,226       161,852  
Total Operating Expenses   $ 6,436,402     $ 5,720,353  
Net Investment Income   $ 4,475,379     $ 4,143,627  
Net Realized Gain (Loss) on Investments and Cash Equivalents   $ 1,335,269     $ (712,051 ) 
Net Change in Unrealized Appreciation on Investments and Cash Equivalents   $ 1,533,281     $ 2,584,583  
Benefit for taxes on unrealized gain on investments   $     $ 8,593  
Net Increase in Net Assets Resulting from Operations   $ 7,343,929     $ 6,024,752  
Net Investment Income Per Share   $ 0.28     $ 0.33  
Net Increase in Net Assets Resulting from Operations Per Share   $ 0.46     $ 0.48  
Weighted Average Shares of Common Stock Outstanding     15,952,841       12,479,957  
Distributions Per Share   $ 0.34     $ 0.34  

F-57


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS (unaudited)

   
  For the three months
ended
March 31,
2018
  For the three months
ended
March 31,
2017
Increase in Net Assets Resulting from Operations
                 
Net investment income   $ 4,475,379     $ 4,143,627  
Net realized gain/(loss) on investments and cash equivalents     1,335,269       (712,051 ) 
Net change in unrealized appreciation on investments and cash equivalents     1,533,281       2,584,583  
Benefit for taxes on unrealized appreciation on investments           8,593  
Net Increase in Net Assets Resulting from Operations   $ 7,343,929     $ 6,024,752  
Stockholder distributions from
                 
Net investment income     (5,422,500 )      (4,241,903 ) 
Total Distributions   $ (5,422,500 )    $ (4,241,903 ) 
Capital share transactions
                 
Issuance of common stock     94,788        
Partial Share Redemption     (327 )       
Net increase in net assets resulting from capital share transactions   $ 94,461     $  
Total increase in net assets   $ 2,015,890     $ 1,782,849  
Net assets at beginning of period   $ 220,247,242     $ 170,881,785  
Net assets at end of period (includes $1,382,915 and $435,794 of distributions in excess of net investment income, respectively)   $ 222,263,132     $ 172,664,634  

F-58


 
 

TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

   
  For the three months
ended
March 31,
2018
  For the three months
ended
March 31,
2017
Cash flows from operating activities
                 
Net Increase in net assets resulting from operations   $ 7,343,929     $ 6,024,752  
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by operating activities:
                 
Purchases of investments     (71,713,787 )      (23,151,902 ) 
Proceeds from sales and repayments of investments     15,618,134       39,279,309  
Net change in unrealized appreciation on investments     (1,533,281 )      (2,584,583 ) 
Deferred tax benefit           (8,593 ) 
Increase in investments due to PIK     (152,006 )      (82,119 ) 
Amortization of premium and accretion of discount, net     (343,739 )      (267,611 ) 
Amortization of loan structure fees     66,224       122,908  
Amortization of deferred financing costs     83,196       46,669  
Amortization of loan fees on SBA-guaranteed debentures     100,668       80,211  
Net realized loss (gain) on investments     (1,335,269 )      712,051  
Changes in other assets and liabilities
                 
Decrease (increase) in interest receivable     (864,856 )      329,975  
Increase in other receivable     (37,647 )      (7,294 ) 
Decrease (increase) in prepaid expenses     63,084       (62 ) 
Decrease in management fees payable     (46,226 )      (43,767 ) 
Increase (decrease) in incentive fees payable     793,088       (129,650 ) 
Increase in administrative services payable     34,694       31,358  
Decrease in interest payable     (337,193 )      (550,338 ) 
Increase (decrease) in unearned revenue     36,685       (1,786 ) 
Increase in dividend payable     899        
Increase in other accrued expenses and liabilities     385,087       318,964  
Net cash provided by (used in) operating activities   $ (51,838,316 )    $ 20,118,492  
Cash flows from financing activities
                 
Proceeds from the issuance of common stock            
Offering costs paid for common stock issued           (81,813 ) 
Stockholder distributions paid     (5,327,712 )      (4,241,903 ) 
Borrowings under credit facility     86,550,000       9,000,000  
Repayments of credit facility     (9,000,000 )      (22,500,000 ) 
Partial Share Redemption     (327 )       
Net cash provided by (used in) financing activities   $ 72,221,961     $ (17,823,716 ) 
Net increase in cash and cash equivalents   $ 20,383,645     $ 2,294,776  
Cash and cash equivalents balance at beginning of period     25,110,718       9,194,129  
Cash and cash equivalents balance at end of period   $ 45,494,363     $ 11,488,905  
Supplemental and non-cash financing activities
                 
Interest expense paid     2,512,086       2,369,181  
Excise tax paid     27,717       37,648  
Shares issued pursuant to Dividend Reinvestment Plan     94,788        
Conversion from debt to equity           864,101  

F-59


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
March 31, 2018

                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Non-controlled, affiliated investments     (2)
                                                                                                       
Glori Energy Production Inc.                                                              Houston, TX                                   
Glori Energy Production, LLC Class A Common Units     (4)
      Equity                               2/1/2017             Energy: Oil & Gas       1,000 shares     $ 135,519     $ 140,000       0.06 % 
Subtotal Non-controlled, affiliated investments                                                                 135,518       140,000       0.06 % 
Non-controlled, non-affiliated investments     (2)
                                                                                           
Abrasive Products & Equipment, LLC,
et al
                                                             Deer Park, TX                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.50 %      1.00 %      12.80 %               9/5/2014       3/5/2020       Chemicals, Plastics, & Rubber     $ 5,325,237       5,277,775       5,250,000       2.36 % 
APE Holdings, LLC Class A Common Units     (4)
      Equity                               9/5/2014                   375,000 units       375,000       130,000       0.06 % 
Total                                                                 5,652,775       5,380,000       2.42 % 
Apex Environmental Resources Holdings, LLC                                                              Amsterdam, OH                                   
Common Units     (4)
      Equity                                        10/30/2015             Environmental Industries       766 shares       766       769       0.00 % 
Preferred Units     (4)
      Equity                                                 766 shares       765,676       769,231       0.35 % 
Total                                         10/30/2015                         766,442       770,000       0.35 % 
Atmosphere Aggregator Holdings II, LP                                                              Atlanta, GA                                   
Common Units     (4)
      Equity                                        6/30/2015             Services: Business       254,250 units       254,250       916,490       0.41 % 
Atmosphere Aggregator Holdings, LP Common Units     (4)
      Equity                               6/30/2015                   750,000 units       750,000       2,703,510       1.22 % 
Total                                                                 1,004,250       3,620,000       1.63 % 
ASC Communications, LLC     (7)
                                                         Chicago, IL                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.25 %      1.00 %      8.13 %               6/29/2017       6/29/2022       Healthcare & Pharmaceuticals     $ 6,462,500       6,405,939       6,462,500       2.91 % 
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)     (2)(4)
      Equity                               6/29/2017                   73,529 shares       500,000       570,000       0.26 % 
Total                                                                 6,905,939       7,032,500       3.17 % 
Beneplace, LLC                                                              Austin TX                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.00 %      1.00 %      12.30 %               3/27/2017       9/27/2022       FIRE: Insurance     $ 5,000,000       4,913,835       5,000,000       2.25 % 
Beneplace Holdings, LLC Preferred Units     (4)
      Equity                               3/27/2017                   500,000 units       500,000       510,000       0.23 % 
Total                                                                 5,413,835       5,510,000       2.48 % 
Binder & Binder National Social Security Disability Advocates, LLC     (8)
                                                         Hauppauge, NY                                   
Residual claim from Term Loan     (4)
      Unsecured                                        11/7/2012             Services: Consumer     $ 100,000       100,000       100,000       0.04 % 
BW DME Acquisition, LLC                                                              Tempe, AZ                                   
Term Loan (SBIC)     (2)(12)(13)
      First Lien       L+6.00 %      1.00 %      10.03 %               8/24/2017       8/24/2022       Healthcare & Pharmaceuticals     $ 16,695,804       16,232,009       16,610,000       7.47 % 
BW DME Holdings, LLC Class A Preferred Units     (4)
      Equity                               8/24/2017                   1,937,261 shares       1,937,261       2,180,000       0.98 % 
Total                                                                 18,169,270       18,790,000       8.45 % 

F-60


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
March 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value (1)
  % of
Net
Assets
C.A.R.S. Protection Plus, Inc.                                                              Murrysville, PA                                   
Term Loan     (12)
      First Lien       L+8.50 %      0.50 %      10.07 %               12/23/2015       12/31/2020       Automotive     $ 98,746     $ 97,546     $ 98,746       0.04 % 
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.50 %      0.50 %      10.07 %               12/23/2015       12/31/2020           $ 7,702,191       7,608,556       7,702,191       3.47 % 
CPP Holdings LLC Class A Common Units     (4)
      Equity                               12/23/2015                   149,828 shares       149,828       210,000       0.09 % 
Total                                                                 7,855,930       8,010,937       3.60 % 
Catapult Learning, LLC et al                                                              Camden, NJ                                   
Term Loan     (12)(13)
      First Lien       L+6.50 %      1.00 %      9.69 %               8/6/2015       7/16/2020       Education     $ 12,171,053       12,107,195       12,171,053       5.48 % 
Colford Capital Holdings, LLC                                                              New York, NY                                   
Preferred Units     (4)(5)
      Equity                                        8/20/2015             Finance       38,893 units       497,388       470,000       0.21 % 
Total                                                                                           
Condor Borrower, LLC                                                              Clifton, NJ                                   
Term Loan     (12)
      Second Lien       L+8.75 %      1.00 %      10.51 %               10/27/2017       4/27/2025       Services: Business     $ 13,750,000       13,485,438       13,480,000       6.06 % 
Condor Top Holdco Limited Convertible Preferred Shares     (4)
      Equity                                        10/27/2017                   500,000 shares       442,197       424,510       0.19 % 
Condor Holdings Limited Preferred Shares, Class B     (4)
      Equity                               10/27/2017                   500,000 shares       57,804       55,491       0.02 % 
Total                                                                 13,985,439       13,960,001       6.27 % 
Dream II Holdings,
LLC
                                                             Boca Raton, FL                                   
Class A Common Units     (4)
      Equity                                        10/20/2014             Services: Consumer       250,000 units       242,304       380,000       0.17 % 
Empirix Inc.                                                              Billerica, MA                                   
Term Loan     (12)
      Second Lien       L+9.50 %      1.00 %      11.25 %               11/1/2013       5/1/2020       Software     $ 11,657,850       11,564,571       11,657,850       5.25 % 
Term Loan (SBIC)     (2)(12)
      Second Lien       L+9.50 %      1.00 %      11.25 %               11/1/2013       5/1/2020           $ 9,750,000       9,670,117       9,750,000       4.39 % 
Empirix Holdings I, Inc. Common Shares, Class A     (4)
      Equity                                        11/1/2013                   1,304 shares       1,304,232       772,200       0.35 % 
Empirix Holdings I, Inc. Common Shares, Class B     (4)
      Equity                               11/1/2013                   1,317,406 shares       13,174       7,800       0.00 % 
Total                                                                 22,552,094       22,187,850       9.99 % 
Energy Labs Inc.                                                              Houston, TX                                   
Term Loan (SBIC)     (2)(12)(13)
      First Lien       L+7.00 %      0.50 %      12.16 %               9/29/2016       9/29/2021       Energy: Oil & Gas     $ 8,548,387       8,405,123       8,548,387       3.85 % 
Energy Labs Holding Corp. Common
Stock
    (4)
      Equity                               9/29/2016                   500 shares       500,000       380,000       0.17 % 
Total                                                                 8,905,123       8,928,387       4.02 % 
EOS Fitness OPCO Holdings, LLC                                                              Phoenix, AZ                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.25 %      0.75 %      9.92 %               12/30/2014       12/30/2019       Hotel, Gaming, & Leisure     $ 3,150,812       3,124,893       3,150,812       1.42 % 
EOS Fitness Holdings, LLC Class A Preferred Units     (4)
      Equity                                        12/30/2014                   118 shares       117,670       243,750       0.11 % 
EOS Fitness Holdings, LLC Class B Common Units     (4)
      Equity                               12/30/2014                   3,017 shares       3,017       6,250       0.00 % 
Total                                                                 3,245,580       3,400,812       1.53%  

F-61


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
March 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value (1)
  % of
Net
Assets
Fast Growing Trees,
LLC
    (16)
                                                         Fort Mill, SC                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+7.75 %      1.00 %      9.54 %               2/5/2018       02/05/23       Retail     $ 20,500,000     $ 20,100,842     $ 20,090,000       9.04 % 
SP FGT Holdings, LLC, Class A Common     (4)
      Equity                               2/5/2018                   1,000,000 shares       1,000,000       1,000,000       0.45 % 
Total                                                                 21,100,842       21,090,000       9.49 % 
Fumigation Holdings, Inc.                                                              Liberty, MO                                   
Class A Common Stock     (4)
      Equity                                        6/30/2015             Chemicals, Plastics, & Rubber       250 shares       0       300,000       0.13 % 
Furniture Factory Outlet, LLC                                                              Fort Smith, AR                                   
Term Loan     (12)
      First Lien       L+9.00 %      0.50 %      11.30 %               6/10/2016       6/10/2021       Consumer Goods: Durable     $ 15,405,284       15,147,399       15,405,284       6.93 % 
Furniture Factory Holdings, LLC Term Loan     (11)
      Unsecured       11.00 %                                 6/10/2016       2/3/2021           $ 122,823       122,823       122,823       0.06 % 
Sun Furniture Factory, LP Common Units     (4)
      Equity                               6/10/2016                   13,445 shares       94,569       150,000       0.07 % 
Total                                                                 15,364,791       15,678,107       7.06 % 
GK Holdings, Inc.                                                              Cary, NC                                   
Term Loan     (12)
      Second Lien       L+10.25 %      1.00 %      12.55 %               2/6/2015       1/30/2022       Education     $ 5,000,000       4,936,044       5,000,000       2.25 % 
Good Source Solutions, Inc.                                                              Carlsbad, CA                                   
Term Loan     (12)(13)
      First Lien       L+7.25 %      0.50 %      12.53 %               7/15/2016       7/15/2021       Beverage, Food, & Tobacco     $ 1,350,000       1,330,576       1,350,000       0.61 % 
Term Loan (SBIC)     (2)(12)(13)
      First Lien       L+7.25 %      0.50 %      12.53 %               7/15/2016       7/15/2021           $ 1,200,000       1,182,734       1,200,000       0.54 % 
Good Source Holdings, LLC Class A Preferred Units     (4)
      Equity                                        7/15/2016                   159 shares       159,375       170,000       0.08 % 
Good Source Holdings, LLC Class B Common Units     (4)
      Equity                               7/15/2016                   4,482 shares       0       0       0.00 % 
Total                                                                 2,672,685       2,720,000       1.23 % 
Grupo HIMA San Pablo, Inc., et al                                                              San Juan, PR                                   
Term Loan     (12)
      First Lien       L+7.00 %      1.50 %      8.84 %               2/1/2013       1/31/2018       Healthcare & Pharmaceuticals     $ 4,750,000       4,750,000       4,180,000       1.88 % 
Term Loan     (15)
      Second Lien       13.75 %            0.00 %            2/1/2013       7/31/2018           $ 4,109,524       4,092,160       900,000       0.40 % 
Total                                                                 8,842,160       5,080,000       2.28 % 
Hostway Corporation                                                              Chicago, IL                                   
Term Loan     (12)
      Second Lien       L+4.25 %      1.25 %      6.13 %               12/27/2013       12/13/2020       High Tech Industries     $ 6,750,000       6,685,113       6,010,000       2.70 % 
J.R. Watkins, LLC     (9)
                                                         San Francisco, CA                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.50 %      1.25 %      8.80 %               12/22/2017       12/22/2022       Consumer Goods: non-durable     $ 12,468,750       12,229,561       12,220,000       5.50 % 
J.R. Watkins Holdings, Inc. Class A
Preferred
    (4)
      Equity                               12/22/2017                   1,000 shares       1,000,000       1,000,000       0.45 % 
Total                                                                 13,229,561       13,220,000       5.95 % 
ICD Intermediate Holdco 2, LLC                                                              San Francisco, CA                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+9.00 %      1.00 %      11.30 %               1/1/2018       7/1/2024       Finance     $ 10,000,000       9,805,457       9,800,000       4.41 % 
ICD Holdings, LLC, Class A Preferred     (4)
      Equity                               1/1/2018                   9,962 shares       500,000       500,000       0.22 % 
Total                                                                 10,305,457       10,300,000       4.63 % 
Kelleyamerit Holdings, Inc.                                                              Walnut Creek, CA                                   
Term Loan     (12)(13)
      First Lien       L+7.50 %      1.00 %      10.54 %               3/30/2018       3/30/2023       Automotive     $ 9,750,000       9,555,000       9,560,000       4.30%  

F-62


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
March 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value (1)
  % of
Net
Assets
Keais Records Service, LLC                                                              Houston, TX                                   
Term Loan     (12)
      Second Lien       L+10.50 %      0.50 %      12.80 %               6/30/2016       6/30/2022       Services: Business     $ 7,750,000     $ 7,642,494     $ 7,750,000       3.49 % 
Keais Holdings, LLC Class A Units     (4)
      Equity                               6/30/2016                   148,335 units       748,239       700,000       0.31 % 
Total                                                                 8,390,733       8,450,000       3.80 % 
KidKraft, Inc.                                                              Dallas, TX                                   
Term Loan     (6)
      Second Lien       12.00 %               11.00 %      1.00 %      9/30/2016       3/30/2022       Consumer Goods: Durable     $ 9,338,418       9,192,061       9,100,000       4.09 % 
Livingston International, Inc.                                                              Toronto, Ontario                                   
Term Loan     (5)(12)
      Second Lien       L+8.25 %      1.25 %      10.55 %               4/23/2013       4/18/2020       Transportation: Cargo     $ 6,841,739       6,791,312       6,841,739       3.08 % 
Madison Logic, Inc.                                                              New York, NY                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.00 %      0.50 %      9.88 %               11/30/2016       11/30/2021       Media: Broadcasting & Subscription     $ 4,843,750       4,806,241       4,843,750       2.18 % 
Madison Logic Holdings, Inc. Common Stock (SBIC)     (2)(4)
      Equity                                        11/30/2016                   5,000 shares       50,000       67,000       0.03 % 
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)     (2)(4)
      Equity                               11/30/2016                   4,500 shares       450,000       603,000       0.27 % 
Total                                                                 5,306,241       5,513,750       2.48 % 
Magdata Intermediate Holdings, LLC                                                              Austin TX                                   
Term Loan     (12)
      Second Lien       L+9.50 %      1.00 %      11.80 %               10/16/2017       4/16/2024       Software     $ 12,500,000       12,261,274       12,380,000       5.57 % 
MBS Holdings, Inc.                                                              Birmingham, AL                                   
Series E Preferred
Stock
    (4)
      Equity                                        3/10/2014             Media: Broadcasting & Subscription       2,774,695 shares       1,000,000       2,734,772       1.23 % 
Series F Preferred
Stock
    (4)
      Equity                               3/10/2014                   399,308 shares       206,682       565,228       0.25 % 
Total                                                                 1,206,682       3,300,000       1.48 % 
Mobileum, Inc.                                                              Santa Clara, CA                                   
Term Loan     (12)
      Second Lien       L+10.25 %      0.75 %      12.55 %               11/1/2016       5/1/2022       Software     $ 9,000,000       8,856,059       9,000,000       4.05 % 
Mobile Acquisition Holdings, LP Class A-2 Common Units     (4)
      Equity                               11/1/2016                   750 units       750,000       1,000,000       0.45 % 
Total                                                                 9,606,059       10,000,000       4.50 % 
MTC Parent, L.P.                                                              Oak Brook, IL                                   
Class A-2 Common Units     (4)
      Equity                                        12/1/2015             Finance       750,000 shares       0       1,670,000       0.75 % 
National Trench Safety, LLC, et al                                                              Houston, TX                                   
Term Loan (SBIC)     (2)
      Second Lien       11.50 %               11.50 %               3/31/2017       3/31/2022       Construction & Building     $ 10,000,000       9,852,196       9,850,000       4.43 % 
NTS Investors, LP Class A Common Units     (4)
      Equity                               3/31/2017                   2,335 units       500,000       340,000       0.15 % 
Total                                                                 10,352,196       10,190,000       4.58 % 
OGS Holdings, Inc.                                                              Chantilly, Virginia                                   
Series A Convertible Preferred Stock     (4)
      Equity                                        4/22/2014             Services: Government       11,521 shares       50,001       100,000       0.04 % 
Price for Profit, LLC     (17)
                                                         Cleveland, OH                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.50 %      1.00 %      8.80 %               1/31/2018       1/31/2023       Services: Business     $ 11,000,000       10,786,010       10,780,000       4.85 % 
I2P Holdings, LLC, Series A Preferred     (4)
      Equity                               1/31/2018                   750,000 shares       750,000       750,000       0.34 % 
Total                                                                 11,536,010       11,530,000       5.19%  

F-63


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
March 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value (1)
  % of
Net
Assets
Protect America, Inc.                                                              Austin TX                                   
Term Loan (SBIC)     (2)(6)(12)
      Second Lien       L+9.75 %      1.00 %      10.06 %      2.00 %      8/30/2017       10/30/2020       Services: Consumer     $ 17,705,875     $ 17,339,275     $ 17,530,000       7.89 % 
Refac Optical Group, et al                                                              Blackwood, NJ                                   
Revolver     (10)(12)
      First Lien       L+8.00 %               9.88 %               11/7/2012       9/30/2018       Retail     $ 880,000       880,000       880,000       0.40 % 
Term A Loan     (12)
      First Lien       L+8.00 %               9.88 %               11/7/2012       9/30/2018           $ 825,767       825,767       825,767       0.37 % 
Term B Loan     (6)(12)
      First Lien       L+10.75 %            10.88 %      1.75 %      11/7/2012       9/30/2018           $ 6,482,871       6,482,871       6,482,871       2.92 % 
Total                                                                 8,188,638       8,188,638       3.69  
Resolute Industrial,
LLC
    (14)
                                                         Wheeling, IL                                   
Term Loan     (12)
      First Lien       L+7.62 %      1.00 %      9.31 %               7/26/2017       7/26/2022       Capital Equipment     $ 3,797,222       3,738,154       3,780,000       1.70 % 
Term Loan (SBIC)     (2)(12 )      First Lien       L+7.62 %      1.00 %      9.31 %               7/26/2017       7/26/2022           $ 13,290,278       13,083,499       13,220,000       5.95 % 
Resolute Industrial Holdings, LLC Class A Preferred Units     (4)
      Equity                               7/26/2017                   601 units       750,000       900,000       0.40 % 
Total                                                                 17,571,653       17,900,000       8.05 % 
Roberts-Gordon, LLC                                                              Buffalo, NY                                   
Term Loan     (12)
      Second Lien       L+10.00 %      1.00 %      12.30 %               6/30/2017       1/1/2022       Construction & Building     $ 7,200,000       7,074,687       7,160,000       3.22 % 
Specified Air Solutions, LLC Class A Common Unites     (4)
      Equity                               6/30/2017                   3,846 shares       500,045       430,000       0.19 % 
Total                                                                 7,574,732       7,590,000       3.41 % 
Sitel Worldwide Corporation                                                              Nashville, TN                                   
Term Loan     (12)
      Second Lien       L+9.50       1.00 %      11.25 %               9/24/2015       9/18/2022       High Tech Industries     $ 10,000,000       9,854,786       10,000,000       4.50 % 
Skopos Financial, LLC                                                              Irving, TX                                   
Term Loan     (5)
      Unsecured       12.00%                12.00 %               1/31/2014       1/31/2019       Finance     $ 19,500,000       19,413,984       19,310,000       8.69 % 
Skopos Financial Group, LLC Series A Common Units     (4)(5)
      Equity                               1/31/2014                   1,120,684 units       1,162,544       730,000       0.33 % 
Total                                                                 20,576,528       20,040,000       9.02 % 
SPM Capital, LLC                                                              Bloomington, MN                                   
Term Loan     (12)
      First Lien       L+6.50       1.50 %      8.38 %               12/10/2012       10/31/2018       Healthcare & Pharmaceuticals     $ 5,130,946       5,130,946       5,130,946       2.31 % 
SQAD, LLC                                                              Tarrytown, NY                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.50       1.00 %      8.81 %               12/22/2017       12/22/2022       Media: Broadcasting & Subscription     $ 14,961,500       14,884,999       14,880,000       6.69 % 
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)     (2)(4)
      Equity                                        10/31/2013                   3,598 shares       156,001       257,043       0.12 % 
SQAD Holdco, Inc. Common Shares (SBIC)     (2)(4)
      Equity                               10/31/2013                   5,800 shares       62,485       102,957       0.05 % 
Total                                                                 15,103,485       15,240,000       6.86 % 
TechInsights, Inc.                                                              Ottawa, Ontario                                   
Term Loan     (5)(12)(13)
      First Lien       L+6.50 %      1.00 %      9.30 %               8/16/2017       8/16/2022       High Tech Industries     $ 20,000,000       19,549,367       19,800,000       8.91 % 
Time Manufacturing Acquisition, LLC                                                              Waco, TX                                   
Term Loan     (6)
      Unsecured       11.50 %               10.75 %      0.75 %      2/3/2017       8/3/2023       Capital Equipment     $ 6,385,182       6,274,450       6,320,000       2.84 % 
Time Manufacturing Investments, LLC Class A Common Units     (4)
      Equity                               2/3/2017                   5,000 units       500,000       360,000       0.16 % 
Total                                                                 6,774,450       6,680,000       3.00 % 
TFH Reliability, LLC                                                              Houston, TX                                

F-64


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
March 31, 2018

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value (1)
  % of
Net
Assets
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.75 %      0.50 %      13.05 %               10/20/2016       4/21/2022       Chemicals, Plastics, & Rubber     $ 5,875,000     $ 5,780,283     $ 5,875,000       2.64 % 
TFH Reliability Group, LLC Class A Common Units     (4)
      Equity                               10/20/2016                   250,000 shares       250,000       510,000       0.23 % 
Total                                                                 6,030,283       6,385,000       2.87 % 
U.S. Auto Sales, Inc.
et al
                                                             Lawrenceville, GA                                   
Term Loan     (5)(12)
      Second Lien       L+10.50 %      1.00 %      12.17 %               6/8/2015       6/8/2020       Finance     $ 4,500,000       4,477,246       4,500,000       2.02 % 
USASF Blocker II, LLC Common Units     (4)(5)
      Equity                                        6/8/2015                   441 units       441,000       420,000       0.19 % 
USASF Blocker III, LLC Series C Preferred Units     (4)(5)
      Equity                                        2/13/2018                   50 Units       50,000       100,000       0.04  
USASF Blocker LLC Common Units     (4)(5)
      Equity                               6/8/2015                   9,000 units       9,000       10,000       0.00 % 
Total                                                                 4,977,246       5,030,000       2.25 % 
VRI Intermediate Holdings, LLC et al                                                              Franklin, OH                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+9.25 %      1.00 %      11.55 %               5/31/2017       10/31/2020       Healthcare & Pharmaceuticals     $ 9,000,000       8,857,928       8,910,000       4.01 % 
VRI Ultimate Holdings, LLC Class A Preferred Units     (4)
      Equity                               5/31/2017                   326,797 shares       500,000       550,000       0.25 % 
Total                                                                 9,357,928       9,460,000       4.26 % 
Wise Holding Corporation                                                              Salt Lake City, UT                                   
Term Loan     (12)
      Unsecured       L+11.00 %      1.00 %      13.30 %               6/30/2016       12/31/2021       Beverage, Food, & Tobacco     $ 1,250,000       1,235,911       880,000       0.40 % 
WCI Holdings LLC Class A Preferred Units     (4)
      Equity                                        6/30/2016                   56 units       55,550       0       0.00 % 
WCI Holdings LLC Class B Common Units     (4)
      Equity                               6/30/2016                   3,044 units       3,044       0       0.00 % 
Total                                                                 1,294,505       880,000       0.40 % 
Zemax, LLC                                                              Redmond, WA                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.00 %      1.00 %      11.88 %               10/23/2014       4/23/2020       Software     $ 1,900,000       1,882,745       1,900,000       0.85 % 
Zemax Software Holdings, LLC Preferred Units (SBIC)     (2)(4)
      Equity                                        10/23/2014                   24,500 units       5,000       13,200       0.01 % 
Zemax Software Holdings, LLC Common Units (SBIC)     (2)(4)
      Equity                               10/23/2014                   5,000 shares       245,000       646,800       0.29 % 
Total                                                                 2,132,745       2,560,000       1.15 % 
Total Non-controlled, non-affiliated investments                                                                 426,244,352       431,159,720       193.99 % 
Net Investments                                                                 426,379,871       431,299,720       194.05 % 
LIABILITIES IN EXCESS OF OTHER ASSETS                                                                       (209,036,588 )      (94.05 )% 
NET ASSETS                                                                       222,263,132       100.00 % 

(1) See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2) Investments held by the SBIC subsidiary, which include $12,433,557 of cash and $196,848,571 of investments (at par) are excluded from the obligations to the lenders of the Credit Facility. The

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Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
March 31, 2018

Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.
(3) These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of March 31, 2018.
(6) Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.
(7) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8) In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter 11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.
(9) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(10) Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.
(12) These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(15) Investment has been on non-accrual since November 1, 2017.
(16) Excluded from the investment is an undrawn commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 7.75% and a maturity of February 5, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(17) Excluded from the investment is an undrawn commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 6.50% and a maturity of January 31, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

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TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Non-controlled, affiliated investments     (2)
                                                                                           
Glori Energy Production Inc.                                                              Houston, TX                                   
Glori Energy Production, LLC Class A Common Units     (4)
      Equity                               2/1/2017             Energy: Oil & Gas       1,000 shares     $ 1,052,185     $ 990,000       0.45 % 
Subtotal Non-controlled, affiliated investments                                                                 1,052,185       990,000       0.45 % 
Non-controlled, non-affiliated investments     (2)
                                                                                           
Abrasive Products & Equipment, LLC,
et al
                                                             Deer Park, TX                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.50 %      1.00 %      12.20 %               9/5/2014       3/5/2020       Chemicals, Plastics, & Rubber     $ 5,325,237       5,272,397       5,220,000       2.37 % 
APE Holdings, LLC Class A Common Units     (4)
      Equity                               9/5/2014                   375,000 units       375,000       180,000       0.08 % 
Total                                                                 5,647,397       5,400,000       2.45 % 
Apex Environmental Resources Holdings, LLC                                                              Amsterdam, OH                                   
Common Units     (4)
      Equity                                        10/30/2015             Environmental Industries       766 shares       766       579       0.00 % 
Preferred Units     (4)
      Equity                               10/30/2015                   766 shares       765,676       579,421       0.26 % 
Total                                                                 766,442       580,000       0.26 % 
Atmosphere Aggregator Holdings II, LP                                                              Atlanta, GA                                   
Common Units     (4)
      Equity                                        6/30/2015             Services: Business       254,250 units       254,250       820,284       0.37 % 
Atmosphere Aggregator Holdings, LP Common Units     (4)
      Equity                               6/30/2015                   750,000 units       750,000       2,419,714       1.10 % 
Total                                                                 1,004,250       3,239,998       1.47 % 
ASC Communications, LLC     (7)
                                                         Chicago, IL                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.25 %      1.00 %      7.94 %               6/29/2017       6/29/2022       Healthcare & Pharmaceuticals     $ 6,879,167       6,816,044       6,879,167       3.12 % 
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)     (2)(4)
      Equity                               6/29/2017                   73,529 shares       500,000       620,000       0.28 % 
Total                                                                 7,316,044       7,499,167       3.40 % 
Beneplace, LLC                                                              Austin TX                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.00 %      1.00 %      11.70 %               3/27/2017       9/27/2022       Insurance     $ 5,000,000       4,910,226       5,000,000       2.27 % 
Beneplace Holdings, LLC Preferred Units     (4)
      Equity                               3/27/2017                   500,000 units       500,000       500,000       0.23 % 
Total                                                                 5,410,226       5,500,000       2.50 % 
Binder & Binder National Social Security Disability Advocates, LLC     (8)
                                                         Hauppauge, NY                                   
Residual claim from Term Loan     (4)
      Unsecured                                        11/7/2012             Services: Consumer     $ 400,000       400,000       380,000       0.17 % 
BW DME Acquisition, LLC                                                              Tempe, AZ                                   
Term Loan (SBIC)     (2)(12)(13)
      First Lien       L+6.00 %      1.00 %      9.43 %               8/24/2017       8/24/2022       Healthcare & Pharmaceuticals     $ 9,550,000       9,281,016       9,310,000       4.23 % 
BW DME Holdings, LLC Class A Preferred Units     (4)
      Equity                               8/24/2017                   1,000,000 shares       1,000,000       1,110,000       0.50 % 
Total                                                                 10,281,016       10,420,000       4.73 % 

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TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
C.A.R.S. Protection Plus, Inc.                                                              Murrysville, PA                                   
Term Loan     (12 )      First Lien       L+8.50 %      0.50 %      9.74 %               12/23/2015       12/31/2020       Automotive     $ 98,746     $ 97,451     $ 98,746       0.04 % 
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.50 %      0.50 %      9.74 %               12/23/2015       12/31/2020           $ 7,702,191       7,601,191       7,700,000       3.50 % 
CPP Holdings LLC Class A Common Units     (4)
      Equity                               12/23/2015                   149,828 shares       149,828       260,000       0.12 % 
Total                                                                 7,848,470       8,058,746       3.66 % 
Catapult Learning, LLC et al                                                              Camden, NJ                                   
Term Loan     (13)
      First Lien       L+6.50 %      1.00 %      9.30 %               8/6/2015       7/16/2020       Education     $ 12,335,526       12,264,670       12,335,526       5.60 % 
Colford Capital Holdings, LLC                                                              New York, NY                                   
Preferred Units     (4)(5)
      Equity                                        8/20/2015             Finance       38,893 units       497,388       470,000       0.21 % 
Condor Borrower, LLC                                                              Clifton, NJ                                   
Term Loan     (12)
      Second Lien       L+8.75 %      1.00 %      10.12 %               10/27/2017       4/27/2025       Services: Business     $ 13,750,000       13,479,122       13,480,000       6.12 % 
Condor Top Holdco Limited Convertible Preferred Shares     (4)
      Equity                                        10/27/2017                   500,000 shares       442,197       442,197       0.20 % 
Condor Holdings Limited Preferred Shares, Class B     (4)
      Equity                               10/27/2017                   500,000 shares       57,804       57,804       0.03 % 
Total                                                                 13,979,123       13,980,001       6.35 % 
Douglas Products & Packaging Company, LLC                                                              Liberty, MO                                   
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.50 %      0.50 %      12.20 %               6/30/2015       12/31/2020       Chemicals, Plastics, & Rubber     $ 9,000,000       8,902,087       9,000,000       4.09 % 
Fumigation Holdings, Inc. Class A Common Stock     (4)
      Equity                               6/30/2015                   250 shares       250,000       530,000       0.24 % 
Total                                                                 9,152,087       9,530,000       4.33 % 
Dream II Holdings,
LLC
                                                             Boca Raton, FL                                   
Class A Common Units     (4)
      Equity                                        10/20/2014             Services: Consumer       250,000 units       242,304       420,000       0.19 % 
Empirix Inc.                                                              Billerica, MA                                   
Term Loan     (12)
      Second Lien       L+9.50 %      1.00 %      10.88 %               11/1/2013       5/1/2020       Software     $ 11,657,850       11,554,734       11,657,850       5.29 % 
Term Loan (SBIC)     (2)(12)
      Second Lien       L+9.50 %      1.00 %      10.88 %               11/1/2013       5/1/2020           $ 9,750,000       9,662,051       9,750,000       4.43 % 
Empirix Holdings I, Inc. Common Shares, Class A     (4)
      Equity                                        11/1/2013                   1,304 shares       1,304,232       831,600       0.38 % 
Empirix Holdings I, Inc. Common Shares, Class B     (4)
      Equity                               11/1/2013                   1,317,406 shares       13,174       8,400       0.00 % 
Total                                                                 22,534,191       22,247,850       10.10 % 
Energy Labs Inc.                                                              Houston, TX                                   
Term Loan (SBIC)     (2)(13)
      First Lien       L+7.00 %      0.50 %      11.58 %               9/29/2016       9/29/2021       Energy: Oil & Gas     $ 5,300,000       5,214,783       5,300,000       2.41 % 
Energy Labs Holding Corp. Common
Stock
    (4)
      Equity                               9/29/2016                   500 shares       500,000       410,000       0.19 % 
Total                                                                 5,714,783       5,710,000       2.60 % 
EOS Fitness OPCO Holdings, LLC                                                              Phoenix, AZ                                   
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.25 %      0.75 %      9.62 %               12/30/2014       12/30/2019       Hotel, Gaming, & Leisure     $ 3,193,890       3,164,255       3,190,000       1.45 % 
EOS Fitness Holdings, LLC Class A Preferred Units     (4)
      Equity                                        12/30/2014                   118 shares       117,670       224,250       0.10%  

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TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
EOS Fitness Holdings, LLC Class B Common Units     (4)
      Equity                               12/30/2014                   3,017 shares     $ 3,017     $ 5,750       0.00 % 
Total                                                                 3,284,942       3,420,000       1.55  
Furniture Factory Outlet, LLC                                                              Fort Smith, AR                                      
Term Loan     (12)
      First Lien       L+9.00 %      0.50 %      10.70 %               6/10/2016       6/10/2021       Consumer Goods: Durable     $ 7,288,484       7,180,489       7,288,484       3.31 % 
Furniture Factory Holdings, LLC Term Loan     (11)
      Unsecured       11.00 %                                 6/10/2016       2/3/2021           $ 122,823       122,823       120,000       0.05 % 
Sun Furniture Factory, LP Common Units     (4)
      Equity                               6/10/2016                   13,445 shares       94,569       210,000       0.10 % 
Total                                                                 7,397,881       7,618,484       3.46 % 
GK Holdings, Inc.                                                              Cary, NC                                      
Term Loan     (12)
      Second Lien       L+10.25 %      1.00 %      11.94 %               2/6/2015       1/30/2022       Education     $ 5,000,000       4,932,726       5,000,000       2.27 % 
Good Source Solutions, Inc.                                                              Carlsbad, CA                                      
Term Loan     (13)
      First Lien       L+7.25 %      0.50 %      11.96 %               7/15/2016       7/15/2021       Beverage, Food, & Tobacco     $ 1,350,000       1,329,398       1,350,000       0.61 % 
Term Loan (SBIC)     (2)(13)
      First Lien       L+7.25 %      0.50 %      11.96 %               7/15/2016       7/15/2021           $ 1,200,000       1,181,687       1,200,000       0.54 % 
Good Source Holdings, LLC Class A Preferred Units     (4)
      Equity                                        7/15/2016                   159 shares       159,375       150,000       0.07 % 
Good Source Holdings, LLC Class B Common Units     (4)
      Equity                               7/15/2016                   4,482 shares       0       0       0.00 % 
Total                                                                 2,670,460       2,700,000       1.22 % 
Grupo HIMA San Pablo, Inc., et al                                                              San Juan, PR                                      
Term Loan     (3)
      First Lien       L+7.00 %      1.50 %      8.50 %               2/1/2013       1/31/2018       Healthcare & Pharmaceuticals     $ 4,750,000       4,748,168       4,180,000       1.90 % 
Term Loan     (15)
      Second Lien       13.75 %            0.00 %            2/1/2013       7/31/2018           $ 4,109,524       4,079,696       900,000       0.41 % 
Total                                                                 8,827,864       5,080,000       2.31 % 
Hostway Corporation                                                              Chicago, IL                                      
Term Loan     (4)(6)(12)
      Second Lien       L+10.00 %      1.25 %      5.94 %               12/27/2013       12/13/2020       High Tech Industries     $ 6,750,000       6,680,080       5,910,000       2.68 % 
J.R. Watkins, LLC     (9)
                                                         San Francisco, CA                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+6.50 %      1.25 %      8.16 %               12/22/2017       12/22/2022       Consumer Goods: non-durable     $ 12,500,000       12,250,000       12,250,000       5.56 % 
J.R. Watkins Holdings, Inc. Class A
Preferred
    (4)
      Equity                               12/22/2017                   1,000 shares       1,000,000       1,000,000       0.45 % 
Total                                                                 13,250,000       13,250,000       6.01 % 
Keais Records Service, LLC                                                              Houston, TX                                      
Term Loan     (12)
      Second Lien       L+10.50 %      0.50 %      12.20 %               6/30/2016       6/30/2022       Services: Business     $ 7,750,000       7,637,741       7,750,000       3.52 % 
Keais Holdings, LLC Class A Units     (4)
      Equity                               6/30/2016                   148,335 units       765,600       780,000       0.35 % 
Total                                                                 8,403,341       8,530,000       3.87 % 
KidKraft, Inc.                                                              Dallas, TX                                      
Term Loan     (6)
      Second Lien       12.00 %               11.00 %      1.00 %      9/30/2016       3/30/2022       Consumer Goods: Durable     $ 9,315,194       9,162,066       9,180,000       4.17 % 
Livingston International, Inc.                                                              Toronto, Ontario                                      
Term Loan     (5)(12)
      Second Lien       L+8.25 %      1.25 %      9.94 %               4/23/2013       4/18/2020       Transportation: Cargo     $ 6,841,739       6,785,894       6,840,000       3.11%  

F-69


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Madison Logic, Inc.                                                              New York, NY                                      
Term Loan (SBIC)     (2)(12)
      First Lien       L+8.00 %      0.50 %      9.57 %               11/30/2016       11/30/2021       Media: Broadcasting & Subscription     $ 4,875,000     $ 4,835,088     $ 4,875,000       2.21 % 
Madison Logic Holdings, Inc. Common Stock (SBIC)     (2)(4)
      Equity                                        11/30/2016                   5,000 shares       50,000       56,000       0.03 % 
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)     (2)(4)
      Equity                               11/30/2016                   4,500 shares       450,000       504,000       0.23 % 
Total                                                                 5,335,088       5,435,000       2.47 % 
Magdata Intermediate Holdings, LLC                                                              Austin TX                                      
Term Loan     (12)
      Second Lien       L+9.50 %      1.00 %      11.20 %               10/16/2017       4/16/2024       Software     $ 12,500,000       12,254,448       12,250,000       5.56 % 
Mobileum, Inc.                                                              Santa Clara, CA                                      
Term Loan     (12)
      Second Lien       L+10.25 %      0.75 %      11.95 %               11/1/2016       5/1/2022       Software     $ 9,000,000       8,849,293       9,000,000       4.09 % 
Mobile Acquisition Holdings, LP Class A-2 Common Units     (4)
      Equity                               11/1/2016                   750 units       750,000       980,000       0.44 % 
Total                                                                 9,599,293       9,980,000       4.53 % 
MBS Holdings, Inc.                                                              Birmingham, AL                                      
Series E Preferred
Stock
    (4)
      Equity                                        3/10/2014             Media: Broadcasting & Subscription       2,774,695 shares       1,000,000       2,386,710       1.08 % 
Series F Preferred
Stock
    (4)
      Equity                               3/10/2014                   399,308 shares       206,682       493,290       0.22 % 
Total                                                                 1,206,682       2,880,000       1.30 % 
MTC Parent, L.P.                                                              Oak Brook, IL                                      
Class A-2 Common Units     (4)
      Equity                                        12/1/2015             Finance       750,000 shares       28,842       2,200,000       1.00 % 
National Trench Safety, LLC, et al                                                              Houston, TX                                      
Term Loan (SBIC)     (2)
      Second Lien       11.50 %               11.50 %               3/31/2017       3/31/2022       Construction & Building     $ 10,000,000       9,845,090       9,900,000       4.49 % 
NTS Investors, LP Class A Common Units     (4)
      Equity                               3/31/2017                   2,335 units       500,000       350,000       0.16 % 
Total                                                                 10,345,090       10,250,000       4.65 % 
OGS Holdings, Inc.                                                              Chantilly, Virginia                                      
Series A Convertible Preferred Stock     (4)
      Equity                                        4/22/2014             Services: Government       11,521 shares       50,001       100,000       0.05 % 
Protect America, Inc.                                                              Austin TX                                      
Term Loan (SBIC)     (2)(6)(12)
      Second Lien       L+9.75 %      1.00 %      9.50 %      2.00 %      8/30/2017       10/30/2020       Services: Consumer     $ 17,617,786       17,220,312       17,270,000       7.84 % 
Refac Optical Group, et al                                                              Blackwood, NJ                                      
Revolver     (10)(12)
      First Lien       L+8.00 %               9.56 %               11/7/2012       9/30/2018       Retail     $ 880,000       880,000       880,000       0.40 % 
Term A Loan     (12)
      First Lien       L+8.00 %               9.56 %               11/7/2012       9/30/2018           $ 943,367       943,367       940,000       0.43 % 
Term B Loan     (6)(12)
      First Lien       L+10.75 %            10.56 %      1.75 %      11/7/2012       9/30/2018           $ 6,464,716       6,464,716       6,460,000       2.93 % 
Total                                                                 8,288,083       8,280,000       3.76  
Resolute Industrial,
LLC
    (14)
                                                         Wheeling, IL                                      
Term Loan     (12)
      First Lien       L+7.62 %      1.00 %      8.95 %               7/26/2017       7/26/2022       Capital Equipment     $ 3,797,222       3,731,397       3,740,000       1.70 % 
Term Loan (SBIC)     (2)(12)
      First Lien       L+7.62 %      1.00 %      8.95 %               7/26/2017       7/26/2022           $ 13,290,278       13,059,850       13,090,000       5.94 % 
Resolute Industrial Holdings, LLC Class A Preferred Units     (4)
      Equity                               7/26/2017                   601 units       750,000       760,000       0.35 % 
Total                                                                 17,541,247       17,590,000       7.99%  

F-70


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
Roberts-Gordon, LLC                                                              Buffalo, NY                                      
Term Loan     (12)
      Second Lien       L+10.00 %      1.00 %      11.70 %               6/30/2017       1/1/2022       Construction & Building     $ 7,200,000     $ 7,068,278     $ 7,130,000       3.24 % 
Specified Air Solutions, LLC Class A Common Unites     (4)
      Equity                               6/30/2017                   3,846 shares       500,045       600,000       0.27 % 
Total                                                                 7,568,323       7,730,000       3.51 % 
Sitel Worldwide Corporation                                                              Nashville, TN                                      
Term Loan     (12)
      Second Lien       L+9.50       1.00 %      10.88 %               9/24/2015       9/18/2022       High Tech Industries     $ 10,000,000       9,848,614       9,950,000       4.52 % 
Skopos Financial, LLC                                                              Irving, TX                                      
Term Loan     (5 )      Unsecured       12.00 %               12.00 %               1/31/2014       1/31/2019       Finance     $ 20,000,000       19,886,350       19,800,000       8.99 % 
Skopos Financial Group, LLC Class A Units     (4)(5)
      Equity                               1/31/2014                   1,120,684 units       1,162,544       770,000       0.35 % 
Total                                                                 21,048,894       20,570,000       9.34 % 
SPM Capital, LLC                                                              Bloomington, MN                                      
Term Loan     (12)
      First Lien       L+6.50       1.50 %      8.19 %               12/10/2012       10/31/2018       Healthcare & Pharmaceuticals     $ 5,421,770       5,421,770       5,420,000       2.46 % 
SQAD, LLC                                                              Tarrytown, NY                                      
Term Loan (SBIC)     (2)
      First Lien       L+6.50       1.00 %      8.16 %               12/22/2017       12/22/2022       Media: Broadcasting & Subscription     $ 15,000,000       14,919,983       14,920,000       6.77 % 
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)     (2)(4)
      Equity                                        10/31/2013                   3,598 shares       156,001       307,023       0.14 % 
SQAD Holdco, Inc. Common Shares (SBIC)     (2)(4)
      Equity                               10/31/2013                   5,800 shares       62,485       122,977       0.06 % 
Total                                                                 15,138,469       15,350,000       6.97 % 
TechInsights, Inc.                                                              Ottawa, Ontario                                      
Term Loan     (5)(12)(13)
      First Lien       L+6.50 %      1.00 %      8.71 %               8/16/2017       8/16/2022       High Tech Industries     $ 20,000,000       19,529,783       19,600,000       8.90 % 
Time Manufacturing Acquisition, LLC                                                              Waco, TX                                      
Term Loan     (6)
      Unsecured       11.50 %               10.75 %      0.75 %      2/3/2017       8/3/2023       Capital Equipment     $ 6,373,100       6,258,780       6,250,000       2.84 % 
Time Manufacturing Investments, LLC Class A Common Units     (4)
      Equity                               2/3/2017                   5,000 units       500,000       330,000       0.15 % 
Total                                                                 6,758,780       6,580,000       2.99 % 
TFH Reliability, LLC                                                              Houston, TX                                      
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.75 %      0.50 %      12.45 %               10/26/2016       4/21/2022       Chemicals, Plastics, & Rubber     $ 5,875,000       5,775,974       5,875,000       2.67 % 
TFH Reliability Group, LLC Class A Common Units     (4)
      Equity                               10/26/2016                   250,000 shares       250,000       340,000       0.15 % 
Total                                                                 6,025,974       6,215,000       2.82 % 
U.S. Auto Sales, Inc.
et al
                                                             Lawrenceville, GA                                      
Term Loan     (5)(12)
      Second Lien       L+11.75 %      1.00 %      13.12 %               6/8/2015       6/8/2020       Finance     $ 4,500,000       4,474,973       4,500,000       2.04 % 
USASF Blocker II, LLC Common Units     (4)(5)
      Equity                                        6/8/2015                   441 units       441,000       578,200       0.26 % 
USASF Blocker LLC Common Units     (4)(5)
      Equity                               6/8/2015                   9,000 units       9,000       11,800       0.01 % 
Total                                                                 4,924,973       5,090,000       2.31 % 
VRI Intermediate Holdings, LLC                                                              Franklin, OH                                      
Term Loan (SBIC)     (2)(12)
      Second Lien       L+9.25 %      1.00 %      10.95 %               5/31/2017       10/31/2020       Healthcare & Pharmaceuticals     $ 9,000,000       8,846,185       8,910,000       4.05 % 

F-71


 
 

TABLE OF CONTENTS

Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

                         
                         
Investments   Footnotes   Security   Coupon   LIBOR
floor
  Cash   PIK   Initial
Investment
Date
  Maturity   Headquarters/
Industry
  Principal
Amount/
Shares
  Amortized
Cost
  Fair
Value(1)
  % of
Net
Assets
VRI Ultimate Holdings, LLC Class A Preferred Units     (4)
      Equity                               5/31/2017                   326,797 shares     $ 500,000     $ 500,000       0.23 % 
Total                                                                 9,346,185       9,410,000       4.28 % 
Wise Holding Corporation                                                              Salt Lake City, UT                                      
Term Loan     (12)
      Unsecured       L+11.00 %      1.00 %      12.70 %               6/30/2016       12/31/2021       Beverage, Food, & Tobacco     $ 1,250,000       1,235,188       880,000       0.40 % 
WCI Holdings LLC Class A Preferred Units     (4)
      Equity                                        6/30/2016                   56 units       55,550       0       0.00 % 
WCI Holdings LLC Class B Common Units     (4)
      Equity                               6/30/2016                   3,044 units       3,044       0       0.00 % 
Total                                                                 1,293,782       880,000       0.40 % 
Zemax, LLC                                                              Redmond, WA                                      
Term Loan (SBIC)     (2)(12)
      Second Lien       L+10.00 %      1.00 %      11.60 %               10/23/2014       4/23/2020       Software     $ 3,962,500       3,922,743       3,960,000       1.80 % 
Zemax Software Holdings, LLC Preferred Units (SBIC)     (2)(4)
      Equity                                        10/23/2014                   24,500 units       5,000       11,200       0.01 % 
Zemax Software Holdings, LLC Common Units (SBIC)     (2)(4)
      Equity                                        10/23/2014                   5,000 shares       245,000       548,800       0.25 % 
Total                                                                 4,172,743       4,520,000       2.06 % 
Total Non-controlled, non-affiliated investments                                                                 367,401,021       370,849,772       168.38 % 
Net Investments                                                                 368,453,206       371,839,772       168.83 % 
LIABILITIES IN EXCESS OF OTHER ASSETS                                                                       (151,592,530 )      (68.83 )% 
NET ASSETS                                                                     $ 220,247,242       100.00 % 

(1) See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2) Investments held by the SBIC Subsidiary, which include $5,258,500 of cash and $155,769,170 of investments (at par) are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility, as defined in Note 9, are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC Subsidiary.
(3) These loans have LIBOR or Euro Floors that are higher than the current applicable LIBOR or Euro rates; therefore, the floors are in effect.
(4) Security is non-income producing.
(5) The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 86% of the Company’s total assets as of December 31, 2017.
(6) Represents a PIK security. At the option of the issuer, interest can be paid in cash or cash and PIK. The percentage of PIK shown is the maximum PIK that can be elected by the issuer.
(7) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8) In the fourth quarter of 2016, Binder & Binder National Social Security Disability, emerged from Chapter

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Stellus Capital Investment Corporation
 
Consolidated Schedule of Investments – (continued)
December 31, 2017

11 Bankruptcy in the U.S. Bankruptcy Court, Southern District of New York. The investment’s fair value has been adjusted to reflect the court-approved unsecured claim distribution proceeds that have been awarded to the Company. As of this time, the Company does not expect to receive any additional repayment other than the court awarded amount.
(9) Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,750,000, with an interest rate of LIBOR plus 6.50% and a maturity of December 22, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(10) Excluded from the investment is an undrawn commitment in an amount not to exceed $520,000, with an interest rate of LIBOR plus 8.00% and a maturity of September 30, 2018. This investment is accruing an unused commitment fee of 0.50% per annum.
(11) Interest compounds annually on this loan at a rate of 11%. The interest does not increase the principal balance.
(12) These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13) These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14) Excluded from the investment is an undrawn commitment in an amount not to exceed $5,750,000, with an interest rate of LIBOR plus 7.62% and a maturity of July 26, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(15) Investment has been on non-accrual since November 1, 2017.

Abbreviation Legend
PIK — Payment-In-Kind
L — LIBOR
Euro — Euro Dollar

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Stellus Capital Investment Corporation (“we”, “us”, “our” and the “Company”) was formed as a Maryland corporation on May 18, 2012 (“Inception”) and is an externally managed, closed-end, non-diversified investment management company. The Company is applying the guidance of Accounting Standards Codification (“ASC”) Topic 946, Financial Services Investment Companies. The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), and treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), for U.S. federal income tax purposes. The Company’s investment activities are managed by our investment adviser, Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).

As of March 31, 2018, the Company had issued a total of 15,953,810 shares and raised $235,743,704 in gross proceeds since Inception, incurring $7,566,535 in offering expenses and sales load fees for net proceeds from offerings of $228,177,169. The Company’s shares are currently listed on the New York Stock Exchange under the symbol “SCM”. See Note 4 for further details.

The Company has established wholly owned subsidiaries: SCIC — Consolidated Blocker 1, Inc., SCIC — ICD Blocker 1, Inc., SCIC — CC Blocker 1, Inc., SCIC — ERC Blocker 1, Inc., SCIC — SKP Blocker 1, Inc. and SCIC — APE Blocker 1, Inc. and SCIC — Hollander Blocker 1, Inc., which are structured as Delaware entities, to hold equity or equity-like investments in portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities) (collectively, the “Taxable Subsidiaries”). The Taxable Subsidiaries are consolidated for U.S. generally accepted accounting principles (“U.S. GAAP”) reporting purposes, and the portfolio investments held by them are included in the consolidated financial statements.

On June 14, 2013, we formed Stellus Capital SBIC, LP (the “SBIC subsidiary”), a Delaware limited partnership, and its general partner, Stellus Capital SBIC GP, LLC, a Delaware limited liability company, as wholly owned subsidiaries of the Company. On June 20, 2014, the SBIC subsidiary received a license from the U.S. Small Business Administration (“SBA”) to operate as a Small Business Investment Company (“SBIC”) under Section 301(c) of the Small Business Investment Company Act of 1958, as amended. The SBIC subsidiary and its general partner are consolidated for U.S. GAAP reporting purposes, and the portfolio investments held by it are included in the consolidated financial statements.

The SBIC license allows the SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed on a semi-annual basis at a market-driven spread over U.S. Treasury Notes with 10-year maturities. The SBA, as a creditor, will have a superior claim to the SBIC’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary upon an event of default. SBA regulations currently limit the amount that a single licensee may borrow to a maximum of $150,000,000 when it has at least $75,000,000 in regulatory capital, as such term is defined by the SBA, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of March 31, 2018 and December 31, 2017, the SBIC subsidiary had $75,000,000 and $67,500,000 of regulatory capital, respectively, as such term is defined by the SBA, and has received commitments from the SBA of $90,000,000. As of both March 31, 2018 and December 31, 2017, the SBIC subsidiary had $90,000,000 of SBA-guaranteed debentures outstanding. See footnote (2) of the Consolidated Schedule of Investments for additional information regarding the treatment of SBIC investments with respect to the Credit Facility.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

The Company’s investment objective is to maximize the total return to its stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies. The Company seeks to achieve its investment objective by originating and investing primarily in private U.S. middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and mezzanine debt financing, with corresponding equity co-investments. It sources investments primarily through the extensive network of relationships that the principals of Stellus Capital have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries.

Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying the annual financial statements prepared in accordance with U.S. GAAP are omitted. The unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.

In the opinion of management, the unaudited consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of the financial statements for the interim periods included herein. The results of operations for the three months ended March 31, 2018 and March 31, 2017 are not necessarily indicative of the operating results to be expected for the full year. Also, the unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2017. In accordance with Regulation S-X under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments. The accounting records of the Company are maintained in U.S. dollars.

Portfolio Investment Classification

The Company classifies its portfolio investments in accordance with the requirements of the 1940 Act as follows: (a) “Control Investments” are defined as investments in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation, (b) “Affiliate Investments” are defined as investments in which the Company owns between 5% and 25% of the voting securities and does not have rights to maintain greater than 50% of the board representation, and (c) “Non-controlled, non-affiliate investments” are defined as investments that are neither Control Investments or Affiliate Investments.

Cash and Cash Equivalents

At March 31, 2018, cash balances held at two separate institutions totaling $2,203,127 and $590,148 exceeded FDIC insurance protection levels of $250,000 by $1,953,127 and $340,148, subjecting the Company to risk related to the uninsured balance. In addition, at March 31, 2018, the Company held $42,701,088 in cash equivalents, which are carried at cost, which approximates fair value. All of the Company’s cash deposits are held at large established high credit quality financial institutions and management believes that risk of loss associated with any uninsured balances is remote.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

Cash consists of bank demand deposits. We deem certain U.S. Treasury Bills and other high-quality, short-term debt securities as cash equivalents. At the end of each fiscal quarter, we may take proactive steps to ensure we are in compliance with the RIC diversification requirements under Subchapter M of the Code, which are dependent upon the composition of our total assets at quarter end. We may accomplish this in several ways, including purchasing U.S. Treasury Bills and closing out positions after quarter-end or temporarily drawing down on the Credit Facility (see Note 9). On March 31, 2018 and December 31, 2017, we held no U.S. Treasury Bills.

Fair Value Measurements

We account for substantially all of our financial instruments at fair value in accordance with ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value, and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. We believe that the carrying amounts of our financial instruments such as cash, receivables and payables approximate the fair value of these items due to the short maturity of these instruments. This is considered a Level 1 valuation technique. The carrying values of our Credit Facility and SBIC debentures approximate fair value because the interest rates adjusts to the market interest rates (Level 3 input). The carrying value of our Notes is based on the closing price of the security (level 2 input). See Note 6 to the consolidated financial statements for further discussion regarding the fair value measurements and hierarchy.

Consolidation

As permitted under Regulation S-X under the Exchange Act and ASC Topic 946, we generally do not consolidate our investment in a portfolio company other than an investment company subsidiary. Accordingly, we consolidated the results of the SBIC subsidiary and the Taxable Subsidiaries. All intercompany balances have been eliminated upon consolidation.

Use of Estimates

The preparation of the consolidated statements of assets and liabilities in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

Deferred Financing Costs, Prepaid Loan Fees on SBA-Guaranteed Debentures and Prepaid Loan Structure Fees

Deferred financing costs, prepaid loan fees on SBA-guaranteed debentures and prepaid loan structure fees consist of fees and expenses paid in connection with the closing of our Notes, Credit Facility, and SBA-guaranteed debentures and are capitalized at the time of payment. These costs are presented as a direct deduction to the carrying amount of the respective liability and amortized using the straight line method over the term of the respective instrument.

Offering Costs

Deferred offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s common stock, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement. These costs are capitalized when

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

incurred and recognized as a reduction of offering proceeds when the offering is consummated and shown on the Consolidated Statement of Changes in Net Assets and Liabilities as a reduction to Paid-in-Capital. No such costs were incurred during the quarter ended March 31, 2018. During the quarter ended March 31, 2017, the Company incurred costs related to the preparation of a shelf registration statement. As a result, the Company capitalized $81,813 related to the offering that was consummated in April 2017. See Note 4 for further discussion.

Investments

As a BDC, the Company will generally invest in illiquid loans and securities including debt and equity securities of middle-market companies. Under procedures established by the board of directors, the Company intends to value investments for which market quotations are readily available at such market quotations. The Company will obtain these market values from an independent pricing service or at the median between the bid and ask prices obtained from at least two brokers or dealers (if available, otherwise by a principal market maker or a primary market dealer). Debt and equity securities that are not publicly traded or whose market prices are not readily available will be valued at fair value as determined in good faith by our board of directors. Such determination of fair values may involve subjective judgments and estimates. The Company also engages independent valuation providers to review the valuation of each portfolio investment that does not have a readily available market quotation at least twice annually.

Investments purchased within approximately 90 days of the valuation date will be valued at cost plus accreted discount, or minus amortized premium, which approximates fair value. With respect to unquoted securities, our board of directors, together with our independent valuation advisors, will value each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the board of directors will use the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because the Company expects that there will not be a readily available market for many of the investments in our portfolio, the Company expects to value most of our portfolio investments at fair value as determined in good faith by the board of directors using a documented valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

In following these approaches, the types of factors that will be taken into account in fair value pricing investments will include, as relevant, but not be limited to:

available current market data, including relevant and applicable market trading and transaction comparables;
applicable market yields and multiples;
security covenants;
call protection provisions;
information rights;
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
comparisons of financial ratios of peer companies that are public;

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

comparable merger and acquisition transactions; and
the principal market and enterprise values.

Revenue Recognition

We record interest income on an accrual basis to the extent such interest is deemed collectible. For loan and debt securities with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, we do not accrue PIK interest if the portfolio company valuation indicates that such PIK interest is not collectible. We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. Loan origination fees, original issue discount and market discount or premium are capitalized, and we then accrete or amortize such amounts using the effective interest method as interest income. Upon the prepayment of a loan or debt security, any unamortized loan origination fee is recorded as interest income. We record prepayment premiums on loans and debt securities as other income. Dividend income, if any, will be recognized on the ex-dividend date.

To maintain our treatment as a RIC, substantially all of this income must be paid to stockholders in the form of distributions, even if we have not collected any cash.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

Investment Transaction Costs

Costs that are material associated with an investment transaction, including legal expenses, are included in the cost basis of purchases and deducted from the proceeds of sales unless such costs are reimbursed by the borrower.

Receivables and Payables for Unsettled Securities Transaction

The Company records all investments on a trade date basis.

U.S. Federal Income Taxes

The Company has elected to be treated as a RIC under Subchapter M of the Code, and to operate in a manner so as to qualify for the tax treatment applicable to RICs. To qualify for tax treatment as a RIC, among other things, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. So long as the Company maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as dividends. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s investors and will not be reflected in the consolidated financial statements of the Company.

To avoid a 4% U.S federal excise tax on undistributed earnings, the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending December 31 (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax or the Excise Tax Avoidance Requirement. For this purpose, however, any net ordinary income or capital gain net income retained by us

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

that is subject to corporate income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid). The Company, at its discretion, may choose not to distribute all of its taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If the Company chooses to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned. Deducted from excise tax expense for the three months ended March 31, 2018 is a refund of the estimated excise tax paid relating to the year ended December 31, 2016 of $37,648.

The Company evaluates tax positions taken or expected to be taken in the course of preparing its tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the applicable period.

As of March 31, 2018 and December 31, 2017, the Company had not recorded a liability for any unrecognized tax positions. Management’s evaluation of uncertain tax positions may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof. The Company’s policy is to include interest and penalties related to income taxes, if applicable, in general and administrative expenses. Any expenses for the three months ended March 31, 2018 and 2017 were de minimis.

On December 22, 2017, the “Tax Cuts and Jobs Act” legislation was signed into law. The Tax Cuts and Jobs Act includes significant changes to the U.S. corporate tax system, including a reduction in the U.S. corporate income tax rate from 35% to 21%. ASC 740, Income Taxes, requires the effect of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted. As such, we have accounted for the tax effects as a result of the Tax Cuts and Jobs Act beginning with the period ending December 31, 2017.

The Taxable Subsidiaries are direct wholly owned subsidiaries of the Company that have elected to be taxable entities. The Taxable Subsidiaries permit the Company to hold equity investments in portfolio companies which are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in the Company’s consolidated financial statements.

The Taxable Subsidiaries use the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

For the three months ended March 31, 2018 and 2017, the Company recorded deferred income tax benefit of $0 and $8,593, respectively, related to the Taxable Subsidiaries. In addition, as of March 31, 2018 and December 31, 2017, the Company had a deferred tax liability of $0 and $0, respectively.

Earnings per Share

Basic per share calculations are computed utilizing the weighted average number of shares of common stock outstanding for the period. The Company has no common stock equivalents. As a result, there is no difference between diluted earnings per share and basic per share amounts.

Paid In Capital

The Company records the proceeds from the sale of its common stock on a net basis to (i) capital stock and (ii) paid in capital in excess of par value, excluding all commissions and marketing support fees.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU supersedes the revenue recognition requirements in Revenue Recognition (Topic 605). Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Note, the guidance exempts interest income from the above guidance, indicating recognition will remain the same. We have completed our analysis on the above guidance and have concluded on the recognition treatment of other income streams such as repayment penalty fees, origination fees, miscellaneous fees etc. Stellus will continue to recognize origination fees over the life of the loan. Repayment penalty fees will be recognized immediately if a repayment is made and miscellaneous fees such as administration fees will be recognized on the contract renewal date or other discrete point in time per the credit agreement. Per the Topic 606 update, Stellus’ timing of its revenue recognition will remain the same for the identified revenue streams as previously reported.

In November 2015, the FASB issued ASU 2015-17 — Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. It simplifies the current guidance, which requires entities to separately present deferred tax assets and liabilities as current or noncurrent in a classified balance sheet. The guidance was effective for the Company as of January 1, 2017 and there is no material impact on its consolidated financial statement.

In January 2016, the FASB issued ASU No. 2016-01 — Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods therein. The Company adopted this standard effective January 1, 2018, which did not have a material impact on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15 — Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The new guidance addresses the classification of various transactions including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, distributions received

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES  – (continued)

from equity method investments, beneficial interests in securitization transactions, and others. The update is effective for annual periods beginning after December 31, 2018, and interim periods within those annual periods. While the Company is currently assessing the impact of the guidance we do not expect the impact of this new standard on our consolidated financial statements to be material.

From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. We believe the impact of the recently issued standards and any that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.

NOTE 2 — RELATED PARTY ARRANGEMENTS

Investment Advisory Agreement

The Company has entered into an investment advisory agreement with Stellus Capital. Pursuant to this agreement, the Company has agreed to pay to Stellus Capital an annual base management fee of 1.75% of gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents, and an annual incentive fee.

For the three months ended March 31, 2018 and 2017, the Company recorded an expense for base management fees of $1,748,896 and $1,564,528, respectively. As of March 31, 2018 and December 31, 2017, $1,575,366 and $1,621,592, respectively, were payable to Stellus Capital.

The incentive fee has two components, investment income and capital gains, as follows:

Investment Income Incentive Fee

The investment income component (“Investment Income Incentive Fee”) is calculated, and payable to the Advisor, quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The pre-incentive fee net investment income, which is expressed as a rate of return on the value of the Company’s net assets attributable to the Company’s common stock, for the immediately preceding calendar quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as the “Hurdle”). Pre-incentive fee net investment income means interest income, dividend income and any other income accrued during the calendar quarter, minus the Company’s operating expenses for the quarter excluding the incentive fee. Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which the Company’s pre-incentive fee net investment income does not exceed the Hurdle. Subject to the cumulative total return requirement described below, the Advisor receives 100% of the Company’s pre-incentive fee net investment income for any calendar quarter with respect to that portion of the pre-incentive net investment income for such quarter, if any, that exceeds the Hurdle but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the “Catch-up”) and 20.0% of the Company’s pre-incentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets.

The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any Investment Income Incentive Fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which the Company’s pre-incentive fee net investment income for such calendar

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

quarter exceeds the 2.0% hurdle, subject to the Catch-up, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such incentive fee that is attributable to deferred interest until the Company actually receives such interest in cash.

For the three months ended March 31, 2018 and March 31, 2017, the Company incurred $968,826 and $1,021,136, respectively, of Investment Income Incentive Fees. As of March 31, 2018 and December 31, 2017, $1,164,735 and $371,648, respectively, of such incentive fees were payable to the Advisor, of which $951,729 and $175,739, respectively, are currently payable (as explained below). As of March 31, 2018 and December 31, 2017, $213,006 and $195,909, respectively, of incentive fees incurred but not paid by the Company were generated from deferred interest (i.e. PIK, certain discount accretion and deferred interest) and are not payable until such amounts are received in cash.

Capital Gains Incentive Fee

The Company also pays the Advisor an incentive fee based on capital gains (the “Capital Gains Incentive Fee”). The Capital Gains Incentive Fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). The Capital Gains Incentive Fee is equal to 20.0% of the Company’s cumulative aggregate realized capital gains from Inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid Capital Gain Incentive Fees is subtracted from such Capital Gain Incentive Fees calculated.

U.S. GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation or depreciation of investments or other financial instruments in the calculation, as an incentive fee would be payable if such realized gains and losses and unrealized capital appreciation or depreciation were realized, even though such realized gains and losses and unrealized capital appreciation or depreciation is not permitted to be considered in calculating the fee actually payable under the investment advisory agreement (the “Capital Gains Incentive Fee”). There can be no assurance that unrealized appreciation or depreciation will be realized in the future. Accordingly, such fees, as calculated and accrued, would not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of incentive fees in subsequent periods. For the three months ended March 31, 2018 and 2017, the Company incurred no incentive fees related to the Capital Gains Incentive Fee. As of March 31, 2018 and December 31, 2017, no Capital Gains Incentive Fees were payable to the Advisor.

The following tables summarize the components of the incentive fees discussed above:

   
  Three Months Ended
March 31
     2018   2017
Investment Income Incentive Fees Incurred   $ 968,826     $ 1,021,227  
Capital Gains Incentive Fee Incurred            
Incentive Fee Expense   $ 968,826     $ 1,021,227  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

   
  March 31, 2018   December 31, 2017
Investment Income Incentive Fee Currently Payable   $ 951,729     $ 175,738  
Investment Income Incentive Fee Deferred     213,006       195,909  
Incentive Fee Payable   $ 1,164,735     $ 371,647  

Director Fees

For both the three months ended March 31, 2018 and 2017, the Company recorded an expense relating to director fees of $92,000. As of both March 31, 2018 and December 31, 2017, the Company owed its independent directors no director fees.

Co-Investment Pursuant to SEC Order

The Company has received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management where doing so is consistent with its investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of the Company’s independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company or its stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of the Company’s stockholders and is consistent with its investment objectives and strategies. The Company intends to co-invest, subject to the conditions included in the exemptive order the Company received from the SEC, with a private credit fund managed by Stellus Capital Management that has an investment strategy that is identical to the Company’s investment strategy. The Company believes that such co-investments may afford it additional investment opportunities and an ability to achieve greater diversification.

Administrative Agent

The Company serves as the administrative agent on certain investment transactions. As of March 31, 2018 and December 31, 2017, Cash and Cash Equivalents included $109,346 and $0, respectively, of cash due to other investment funds managed by Stellus Capital Management related to interest paid by a borrower to the Company as administrative agent. Any such amount are included in “Other Accrued Expenses and Liabilities” on the Consolidated Statement of Assets and Liabilities.

License Agreement

The Company has entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant the Company a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, the Company has a right to use the “Stellus Capital” name for so long as Stellus Capital Management or one of its affiliates remains its investment advisor. Other than with respect to this limited license, the Company has no legal right to the “Stellus Capital” name. This license agreement will remain in effect for so long as the investment advisory agreement with Stellus Capital Management is in effect.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 2 — RELATED PARTY ARRANGEMENTS  – (continued)

Administration Agreement

The Company has entered into an administration agreement with Stellus Capital pursuant to which Stellus Capital will furnish the Company with office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under this administration agreement, Stellus Capital will perform, or oversee the performance of, the its required administrative services, which includes, among other things, being responsible for the financial records which the Company is required to maintain and preparing reports to its stockholders and reports filed with the SEC.

For the three months ended March 31, 2018 and 2017, the Company recorded expenses of $313,833 and $279,922 respectively, relating to the administration agreement. As of March 31, 2018 and December 31, 2017, $313,833 and $279,141, respectively, remained payable to Stellus Capital under the administration agreement.

Indemnifications

The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the investment advisory agreement, Stellus Capital and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital’s services under the investment advisory agreement or otherwise as our investment adviser.

NOTE 3 — DISTRIBUTIONS

Distributions are generally declared by the Company’s board of directors each calendar quarter, paid monthly and recognized as distribution liabilities on the ex-dividend date. The Company intends to distribute net realized gains (i.e., net capital gains in excess of net capital losses), if any, at least annually. The stockholder distributions, if any, will be determined by the board of directors. Any distribution to stockholders will be declared out of assets legally available for distribution.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 3 — DISTRIBUTIONS  – (continued)

The following table reflects the Company’s distributions declared and paid or to be paid on its common stock since Inception:

     
Date Declared   Record Date   Payment Date   Per Share
Fiscal 2012
                          
December 7, 2012     December 21, 2012       December 27, 2012     $ 0.1812  
Fiscal 2013(1)
                          
various     various       various     $ 1.3600  
Fiscal 2014(2)(3)
                          
various     various       various     $ 1.4246  
Fiscal 2015(2)
                          
various     various       various     $ 1.3596  
Fiscal 2016(2)
                          
various     various       various     $ 1.3596  
Fiscal 2017(2)
                          
January 13, 2017     January 31, 2017       February 15, 2017     $ 0.1133  
January 13, 2017     February 28, 2017       March 15, 2017     $ 0.1133  
January 13, 2017     March 31, 2017       April 14, 2017     $ 0.1133  
April 14, 2017     April 28, 2017       May 15, 2017     $ 0.1133  
April 14, 2017     May 31, 2017       June 15, 2017     $ 0.1133  
April 14, 2017     June 30, 2017       July 14, 2017     $ 0.1133  
July 7, 2017     July 31, 2017       August 15, 2017     $ 0.1133  
July 7, 2017     August 31, 2017       September 15, 2017     $ 0.1133  
July 7, 2017     September 29, 2017       October 13, 2017     $ 0.1133  
October 12, 2017     October 31, 2017       November 15, 2017     $ 0.1133  
October 12, 2017     November 30, 2017       December 15, 2017     $ 0.1133  
October 12, 2017     December 29, 2017       January 12, 2018     $ 0.1133  
Fiscal 2018(2)
                          
January 11, 2018     January 31, 2018       February 15, 2018     $ 0.1133  
January 11, 2018     February 28, 2018       March 15, 2018     $ 0.1133  
January 11, 2018     March 29, 2018       April 13, 2018     $ 0.1133  
Total               $ 7.3845  

(1) Distributions made quarterly
(2) Distributions made monthly
(3) Includes special distribution of $0.065 per share in addition to monthly distributions

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 3 — DISTRIBUTIONS  – (continued)

Unless the stockholder elects to receive its distributions in cash, the Company intends to make such distributions in additional shares of the Company’s common stock under the Company’s dividend reinvestment plan. Although distributions paid in the form of additional shares of the Company’s common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in the Company’s dividend reinvestment plan will not receive any corresponding cash distributions with which to pay any such applicable taxes. Any distributions reinvested through the issuance of shares through the Company’s dividend reinvestment plan will increase the Company’s gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital. The Company issued 7,931 and 0 shares, respectively, in connection with the distributions made during the three months ended March 31, 2018 and 2017.

NOTE 4 — EQUITY OFFERINGS AND RELATED EXPENSES

The table below illustrates the number of common stock shares the Company issued since Inception through various equity offerings.

           
Issuance of Common Stock   Number of
Shares
  Gross
Proceeds(1)(2)
  Underwriting
fees
  Offering
Expenses
  Net Proceeds   Average
Offering
Price
Year ended December 31, 2012     12,035,023     $ 180,522,093     $ 4,959,720     $ 835,500     $ 174,726,873     $ 14.90  
Year ended December 31, 2013     63,998       899,964                   899,964       14.06  
Year ended December 31, 2014     380,936       5,485,780       75,510       29,904       5,380,366       14.47  
Year ended December 31, 2017     3,465,922       48,741,407       1,358,880       307,022       47,075,505       14.06  
Quarter ended March 31, 2018     7,931       94,461                   94,461       11.95  
Total     15,953,810     $ 235,743,705     $ 6,394,110     $ 1,172,426     $ 228,177,169        

(1) Net of partial share redemptions. Such share redemptions reduced gross proceeds by $327, $142, $29 and $31 in 2018, 2017, 2016 and 2015, respectively.
(2) Includes common shares issued under the DRIP of $94,788 during the year ended 2018, $0 for the years ended 2017, 2016 and 2015, and $398,505, $938,385, $113,000 for the years ended 2014, 2013, and 2012, respectively.

The Company issued 7,931 and 0 shares, respectively, of common stock during the three months ended March 31, 2018 and the year ended December 31, 2017 in connection with the stockholder distribution reinvestment plan.

The Company issued 3,162,500 shares in a secondary offering and 303,422 shares in connection with the ATM program during the year ended December 31, 2017. Gross proceeds resulting from the secondary offering totaled $44,591,250 and underwriting and other expenses totaled $1,530,632. The per share offering price for the secondary offering was $14.10. Gross proceeds resulting from the ATM Program in 2017 totaled $4,150,299 and underwriting and other expenses totaled $135,270. The average per share offering price of shares issued in the ATM Program during 2017 was $13.68.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 5 — NET INCREASE IN NET ASSETS PER COMMON SHARE

The following information sets forth the computation of net increase in net assets resulting from operations per common share for the three months ended March 31, 2018 and March 31, 2017.

   
  Three Months Ended
     March 31,
2018
  March 31,
2017
Net increase in net assets resulting from operations   $ 7,343,929     $ 6,024,752  
Weighted average common shares     15,952,841       12,479,957  
Basic and diluted earnings per common share   $ 0.46     $ 0.48  

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE

In accordance with the authoritative guidance on fair value measurements and disclosures under U.S. GAAP, the Company discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 — Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;

Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.

The Company considers whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if the Company determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.

At March 31, 2018, the Company had investments in 52 portfolio companies. The total fair value and cost of the investments were $431,299,720 and $426,379,871, respectively. The composition of our investments as of March 31, 2018 is as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 198,445,230     $ 199,372,307  
Senior Secured – Second Lien     180,292,855       177,644,589  
Unsecured Debt     27,147,168       26,732,823  
Equity     20,494,618       27,550,001  
Total Investments   $ 426,379,871     $ 431,299,720  

(1) Includes unitranche investments, which account for 16.1% of our portfolio at fair value.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

At December 31, 2017, the Company had investments in 48 portfolio companies. The composition of our investments as of December 31, 2017 was as follows:

   
  Cost   Fair Value
Senior Secured – First Lien(1)   $ 140,915,106     $ 141,006,923  
Senior Secured – Second Lien     181,164,730       178,432,850  
Unsecured Debt     27,903,141       27,430,000  
Equity     18,470,229       24,969,999  
Total Investments   $ 368,453,206     $ 371,839,772  

(1) Includes unitranche investments, which account for 13.2% of our portfolio at fair value.

The Company’s investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require the Company to provide funding when requested by portfolio companies in accordance with the terms and conditions of the underlying loan agreements. As of March 31, 2018 and December 31, 2017, the Company had six and four such investments, respectively, with aggregate unfunded commitments of $11,186,667 and $8,686,667, respectively. The Company maintains sufficient liquidity to fund such unfunded commitments should the need arise.

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of March 31, 2018 are as follows:

       
  Quoted Prices in
Active Markets
for Identical
Securities
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
Senior Secured – First Lien   $     $     $ 199,372,307     $ 199,372,307  
Senior Secured – Second Lien                 177,644,589       177,644,589  
Unsecured Debt                 26,732,823       26,732,823  
Equity                 27,550,001       27,550,001  
Total Investments   $     —     $     —     $ 431,299,720     $ 431,299,720  

The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2017 are as follows:

       
  Quoted Prices in
Active Markets
for Identical
Securities
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total
Senior Secured – First Lien   $     $     $ 141,006,923     $ 141,006,923  
Senior Secured – Second Lien                 178,432,850       178,432,850  
Unsecured Debt                 27,430,000       27,430,000  
Equity                 24,969,999       24,969,999  
Total Investments   $     —     $     —     $ 371,839,772     $ 371,839,772  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The aggregate values of Level 3 portfolio investments changed during the three months ended March 31, 2018 are as follows:

         
  Senior Secured
Loans-First
Lien
  Senior Secured
Loans-Second
Lien
  Unsecured
Debt
  Equity   Total
Fair value at beginning of year   $ 141,006,923     $ 178,432,850     $ 27,430,000     $ 24,969,999     $ 371,839,772  
Purchases of investments     58,676,526       9,800,000             3,237,261       71,713,787  
Payment-in-kind interest     28,610       111,314       12,082             152,006  
Sales and redemptions     (1,319,663 )      (10,952,460 )      (797,872 )      (2,548,139 )      (15,618,134 ) 
Realized Loss                       1,335,269       1,335,269  
Change in unrealized appreciation included in earnings     835,261       83,614       58,795       555,611       1,533,281  
Amortization of premium and accretion of discount, net     144,650       169,271       29,818             343,739  
Transfer from Level 2                              
Fair value at end of period   $ 199,372,307     $ 177,644,589     $ 26,732,823     $ 27,550,001     $ 431,299,720  
Change in unrealized appreciation (depreciation) on Level 3 investments still held as of March 31, 2018   $ 835,260     $ 181,527     $ 58,795     $ 555,611     $ 1,631,193  

The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2017 are as follows:

         
  Senior Secured
Loans-First
Lien
  Senior Secured
Loans-Second
Lien
  Unsecured
Debt
  Equity   Total
Fair value at beginning of year   $ 113,482,205     $ 144,521,388     $ 70,725,412     $ 18,931,886     $ 347,660,891  
Purchases of investments     85,892,733       73,388,500       6,203,400       6,686,613       172,171,246  
Payment-in-kind interest     113,723       319,629       66,244             499,596  
Sales and redemptions     (57,242,106 )      (47,725,650 )      (49,578,812 )      (9,369,308 )      (163,915,876 ) 
Transfer from term loan to equity     (864,101 )                  864,101        
Net realized gain (loss)     (626,949 )                  5,367,925       4,740,976  
Change in unrealized depreciation (appreciation) included in earnings     (126,190 )      (2,146,961 )      (278,564 )      2,488,782       (62,933 ) 
Amortization of premium and accretion of discount, net     377,608       525,944       292,320             1,195,872  
Transfer from Level 2           9,550,000                   9,550,000  
Fair value at end of year   $ 141,006,923     $ 178,432,850     $ 27,430,000     $ 24,969,999     $ 371,839,772  
Change in unrealized depreciation on Level 3 investments still held as of December 31, 2017   $ (498,183 )    $ (1,679,419 )    $ (278,567 )    $ 3,465,063     $ 1,008,894  

There were no Level 3 transfers during the quarter ended March 31, 2018.

During the year ended December 31, 2017, there was one transfer from a Level 2 to a Level 3 because the observable inputs were not available. Transfers are reflected at the value of the securities at the beginning of the period.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of geographical concentration of our investment portfolio as of March 31, 2018:

     
  Cost   Fair Value   % of Total
Investments
Texas   $ 111,024,052     $ 110,713,387       25.67 % 
California     45,368,765       45,800,000       10.62 % 
New Jersey     34,281,271       34,319,692       7.96 % 
New York     28,581,847       28,913,750       6.70 % 
Canada     26,340,678       26,641,739       6.18 % 
Illinois     24,256,766       25,580,000       5.93 % 
Arizona     21,414,850       22,190,812       5.15 % 
Massachusetts     22,552,094       22,187,850       5.14 % 
Ohio     21,660,379       21,760,000       5.05 % 
South Carolina     21,100,842       21,090,000       4.89 % 
Arkansas     15,364,791       15,678,106       3.64 % 
North Carolina     11,841,982       12,032,500       2.79 % 
Tennessee     9,854,786       10,000,000       2.32 % 
Georgia     5,981,496       8,650,000       2.01 % 
Pennsylvania     7,855,929       8,010,938       1.86 % 
Minnesota     5,130,946       5,130,946       1.19 % 
Puerto Rico     8,842,160       5,080,000       1.18 % 
Alabama     1,206,682       3,300,000       0.77 % 
Washington     2,132,745       2,560,000       0.59 % 
Utah     1,294,505       880,000       0.20 % 
Florida     242,304       380,000       0.09 % 
Missouri           300,000       0.07 % 
Virginia     50,001       100,000       0.02 % 
     $ 426,379,871     $ 431,299,720       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of geographical concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
Texas   $ 109,043,496     $ 108,445,000       29.16 % 
New Jersey     34,531,876       34,595,527       9.30 % 
New York     28,939,268       29,365,000       7.90 % 
Canada     26,315,677       26,440,000       7.11 % 
California     25,519,753       25,930,000       6.97 % 
Illinois     24,250,169       25,700,000       6.91 % 
Massachusetts     22,534,191       22,247,850       5.98 % 
Arizona     13,565,958       13,840,000       3.72 % 
North Carolina     12,248,770       12,499,167       3.36 % 
Ohio     10,112,627       9,990,000       2.69 % 
Tennessee     9,848,614       9,950,000       2.68 % 
Missouri     9,152,087       9,530,000       2.56 % 
Georgia     5,929,223       8,329,998       2.24 % 
Pennsylvania     7,848,470       8,058,746       2.17 % 
Arkansas     7,397,881       7,618,484       2.05 % 
Minnesota     5,421,770       5,420,000       1.46 % 
Puerto Rico     8,827,864       5,080,000       1.37 % 
Washington     4,172,743       4,520,000       1.22 % 
Alabama     1,206,682       2,880,000       0.77 % 
Utah     1,293,782       880,000       0.24 % 
Florida     242,304       420,000       0.11 % 
Virginia     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of industry concentration of our investment portfolio as of March 31, 2018:

     
  Cost   Fair Value   % of Total
Investments
Software   $ 46,552,172     $ 47,127,850       10.93 % 
Healthcare & Pharmaceuticals     48,406,241       45,493,446       10.55 % 
Services: Business     34,916,431       37,560,001       8.71 % 
Finance     36,356,619       37,510,000       8.70 % 
High Tech Industries     36,089,266       35,810,000       8.30 % 
Retail     29,289,480       29,278,638       6.79 % 
Consumer Goods: Durable     24,556,850       24,778,106       5.74 % 
Capital Equipment     24,346,104       24,580,000       5.70 % 
Media: Broadcasting & Subscription     21,616,409       24,053,750       5.58 % 
Services: Consumer     17,681,579       18,010,000       4.18 % 
Construction & Building     17,926,928       17,780,000       4.12 % 
Automotive     17,410,929       17,570,938       4.07 % 
Education     17,043,239       17,171,053       3.98 % 
Consumer goods: non-durable     13,229,563       13,220,000       3.07 % 
Chemicals, Plastics, & Rubber     11,683,058       12,065,000       2.80 % 
Energy: Oil & Gas     9,040,642       9,068,387       2.10 % 
Transportation: Cargo     6,791,312       6,841,739       1.59 % 
Insurance     5,413,835       5,510,000       1.28 % 
Beverage, Food, & Tobacco     3,967,191       3,600,000       0.83 % 
Hotel, Gaming, & Leisure     3,245,580       3,400,812       0.79 % 
Environmental Industries     766,442       770,000       0.18 % 
Services: Government     50,001       100,000       0.02 % 
     $ 426,379,871     $ 431,299,720       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following is a summary of industry concentration of our investment portfolio as of December 31, 2017:

     
  Cost   Fair Value   % of Total
Investments
Software   $ 48,560,675     $ 48,997,850       13.18 % 
Healthcare & Pharmaceuticals     41,192,879       37,829,167       10.17 % 
High Tech Industries     36,058,477       35,460,000       9.54 % 
Finance     26,500,097       28,330,000       7.62 % 
Services: Business     23,386,714       25,749,999       6.93 % 
Capital Equipment     24,300,027       24,170,000       6.50 % 
Media: Broadcasting & Subscription     21,680,239       23,665,000       6.36 % 
Chemicals, Plastics, & Rubber     20,825,458       21,145,000       5.69 % 
Services: Consumer     17,862,616       18,070,000       4.86 % 
Construction & Building     17,913,413       17,980,000       4.84 % 
Education     17,197,396       17,335,526       4.66 % 
Consumer Goods: Durable     16,559,947       16,798,484       4.52 % 
Consumer goods: non-durable     13,250,000       13,250,000       3.56 % 
Retail     8,288,083       8,280,000       2.23 % 
Automotive     7,848,470       8,058,746       2.17 % 
Transportation: Cargo     6,785,894       6,840,000       1.84 % 
Energy: Oil & Gas     6,766,968       6,700,000       1.80 % 
Insurance     5,410,226       5,500,000       1.48 % 
Beverage, Food, & Tobacco     3,964,242       3,580,000       0.96 % 
Hotel, Gaming, & Leisure     3,284,942       3,420,000       0.92 % 
Environmental Industries     766,442       580,000       0.16 % 
Services: Government     50,001       100,000       0.03 % 
     $ 368,453,206     $ 371,839,772       100.00 % 

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following provides quantitative information about Level 3 fair value measurements as of March 31, 2018:

       
Description:   Fair Value   Valuation Technique   Unobservable Inputs   Range (Average)(1)(3)
First lien debt   $ 199,372,307       Income/Market
approach
(2)      HY credit spreads,
Risk free rates
Market multiples
      -3.84% to 5.28% (-0.97%)
0.69% to 1.64% (1.02%)
5x to 17x (12x)(4)
 
Second lien debt   $ 177,644,589       Income/Market
approach
(2)      HY credit spreads,
Risk free rates
Market multiples
      -2.29% to 4.52% (-0.67)
0.19% to 1.46% (0.81%)
7x to 30x (13x)(4)
 
Unsecured debt   $ 26,732,823       Income/Market
approach
(2)      HY credit spreads,
Risk free rates
Market multiples
      -0.82% to 3.68% (0.71%)
0.57% to 1.64% (0.98%)
1x to 14x (5x)(4)
 
Equity investments   $ 27,550,001       Market approach (5)      Underwriting multiple/
EBITDA Multiple
      1x to 12x (9x)  
Total Long Term Level 3 Investments   $ 431,299,720                    

(1) Weighted average based on fair value as of March 31, 2018.
(2) Inclusive of not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3) The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for second lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -2.29% (-229 basis points) to 4.52% (452 basis points). The average of all changes was -0.67% (-67 basis points).
(4) Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5) The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE  – (continued)

The following provides quantitative information about Level 3 fair value measurements as of December 31, 2017:

       
Description:   Fair Value   Valuation Technique   Unobservable Inputs   Range (Average)(1)(3)
First lien debt   $ 141,006,923       Income/Market approach (2)      HY credit spreads,
Risk free rates
Market multiples
      -3.73% to 5.53% (-0.81%)
-0.24% to 1.12% (0.54%)
11x to 13x (10x)(4)
 
Second lien debt   $ 178,432,850       Income/Market approach (2)      HY credit spreads,
Risk free rates
Market multiples
      -2.52% to 4.78% (-0.58%)
-0.28% to 1.01% (0.39%)
8x to 8x (8x)(4)
 
Unsecured debt   $ 27,430,000       Income/Market approach (2)      HY credit spreads,
Risk free rates
Market multiples
      -0.67% to 3.93% (0.89%)
0.12% to 1.18% (0.52%)
1x to 14x (13x)(4)
 
Equity investments   $ 24,969,999       Market approach (5)      Underwriting multiple/
EBITDA Multiple
      1x to 15x (9x)  
Total Long Term Level 3 Investments   $ 371,839,772                    

(1) Weighted average based on fair value as of December 31, 2017.
(2) Inclusive of not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3) The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -3.73% (-373 basis points) to 5.53% (535 basis points). The average of all changes was -.81% (-81 basis points).
(4) Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5) The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 7 — COMMITMENTS AND CONTINGENCIES

The Company is currently not subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition or results of operations.

As of March 31, 2018 and December 31, 2017, the Company had unfunded commitments of $11,186,667 and $8,686,667, respectively, to provide debt financing for six and four portfolio companies, respectively. As of March 31, 2018, the Company had sufficient liquidity to fund such unfunded commitments should the need arise.

NOTE 8 — FINANCIAL HIGHLIGHTS

   
  For the
three months
ended
March 31,
2018
(unaudited)
  For the
three months
ended
March 31,
2017
(unaudited)
Per Share Data:(1)
                 
Net asset value at beginning of period   $ 13.81     $ 13.69  
Net investment income     0.28       0.33  
Change in unrealized appreciation     0.10       0.22  
Net realized gain (loss)     0.08       (0.06 ) 
Total from investment operations   $ 0.46     $ 0.48  
Stockholder distributions from:
                 
Net investment income     (0.34 )      (0.34 ) 
Net asset value at end of period   $ 13.93     $ 13.83  
Per share market value at end of period   $ 11.51     $ 14.55  
Total return based on market value(2)     (10.6 )%      23.7 % 
Weighted average shares outstanding     15,952,841       12,479,957  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 8 — FINANCIAL HIGHLIGHTS  – (continued)

   
  For the
three months
ended
March 31,
2018
(unaudited)
  For the
three months
ended
March 31,
2017
(unaudited)
Ratio/Supplemental Data:
                 
Net assets at end of period   $ 222,263,132     $ 172,664,634  
Weighted Average net assets   $ 220,269,641     $ 170,901,594  
Annualized ratio of gross operating expenses to net assets(3)(6)     11.85 %      13.58 % 
Annualized ratio of interest expense and other fees to net assets(3)     4.54 %      4.91 % 
Annualized ratio of net investment income to net assets(3)(6)     8.24 %      9.84 % 
Portfolio Turnover(4)     3.89 %      6.45 % 
Notes payable   $ 48,875,000     $ 25,000,000  
Credit Facility payable   $ 118,300,000     $ 102,500,000  
SBA Debentures   $ 90,000,000     $ 65,000,000  
Asset coverage ratio(5)     2.33x       2.35x  

(1) Financial highlights are based on weighted average shares outstanding as of period end.
(2) Total return on market value is based on the change in market price per share since the end of the prior year and assumes enrollment in the Company’s dividend reinvestment plan. The total returns are not annualized.
(3) Financial highlights for periods of less than one year are annualized, with exception of the provision for taxes on the unrealized gain on investments.
(4) Calculated as the lesser of purchases or sales divided by average portfolio balance and is not annualized.
(5) Asset coverage ratio is equal to (i) the sum of (a) net assets at the end of the period and (b) total debt outstanding at the end of the period, divided by (ii) total debt outstanding at the end of the period. SBA debentures are excluded from the numerator and denominator.
(6) These ratios include the impact of the benefit for income taxes related to unrealized loss on investments of $0 for the three months ended March 31, 2018 and a benefit for income taxes related to unrealized gain on investments of $8,593 for the three months ended March 31, 2017, which are not reflected in net investment income, gross operating expenses or net operating expenses. The provision for income taxes related to unrealized gain or loss on investments to net assets for the three months ended March 31, 2018 and 2017 is 0.00% and .01%, respectively.

NOTE 9 — CREDIT FACILITY

On November 7, 2012, the Company entered into a revolving credit facility (the “Original Facility”) with various lenders. SunTrust Bank, one of the lenders, served as administrative agent under the Original Facility. The Original Facility, as amended on November 21, 2014 and August 31, 2016, provided for borrowings in an aggregate amount of $120,000,000 on a committed basis with an accordion feature that allowed the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions. The Company terminated the Original Facility on October 11, 2017, in conjunction with securing and entering into a new senior secured revolving credit agreement, dated as of October 10, 2017 and amended on March 28, 2018, with ZB, N.A., dba Amegy Bank and various other leaders (the “Credit Facility”).

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 9 — CREDIT FACILITY  – (continued)

The Credit Facility provides for borrowings up to a maximum of $140,000,000 on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $195,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.

Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR plus 2.50% with no LIBOR floor or (ii) 1.50% plus an alternate base rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on October 10, 2021.

The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiary, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10,000,000, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 2.0 to 1.0, and (iii) maintaining a minimum shareholder’s equity. As of March 31, 2018, the Company was in compliance with these covenants.

As of March 31, 2018 and December 31, 2017, $118,300,000 and $40,750,000, respectively, was outstanding under the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The fair values of the Credit Facility is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Credit Facility is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. The Company has incurred total costs of $3,067,715 in connection with obtaining, amending, and maintaining the Original Facility. The Company incurred costs of $1,198,616 in connection with the Credit Facility, which are being amortized over the life of the facility. Additionally, $341,979 of costs from the Original Facility will continue to be amortized over the remaining life of the Credit Facility. As of March 31, 2018 and December 31, 2017, $1,351,297 and $1,417,521 of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

The following is a summary of the Credit Facility, net of prepaid loan structure fees:

   
  March 31,
2018
  December 31,
2017
Credit Facility payable   $ 118,300,000     $ 40,750,000  
Prepaid loan structure fees     1,351,297       1,417,521  
Credit facility payable, net of prepaid loan structure fees   $ 116,948,703     $ 39,332,479  

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 9 — CREDIT FACILITY  – (continued)

Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the three months ended March 31, 2018 and 2017:

   
  For the three
months ended
     March 31,
2018
  March 31,
2017
Interest expense   $ 746,998     $ 895,668  
Loan fee amortization     91,667       110,613  
Commitment fees on unused portion     89,747       19,066  
Administration fees     14,557       12,295  
Total interest and financing expenses   $ 942,969     $ 1,037,642  
Weighted average interest rate     4.4 %      3.5 % 
Effective interest rate     5.6 %      4.0 % 
Average debt outstanding   $ 68,202,778     $ 104,747,222  
Cash paid for interest and unused fees   $ 648,017     $ 961,681  

NOTE 10 — SBA-GUARANTEED DEBENTURES

Due to the SBIC subsidiary’s status as a licensed SBIC, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, a single licensee can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of regulatory capital. As of March 31, 2018 and December 31, 2017, the SBIC subsidiary had $75,000,000 and $67,500,000 in regulatory capital, as such term is defined by the SBA.

As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200% (or 150% if certain requirements are met) after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from our asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the asset coverage test by permitting us to borrow up to $150,000,000 more than we would otherwise be able to absent the receipt of this exemptive relief.

On a stand-alone basis, the SBIC subsidiary held $210,260,118 and $161,992,327 in assets at March 31, 2018 and December 31, 2017, respectively, which accounted for approximately 43.7% and 40.4% of our total consolidated assets, respectively.

Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. As of both March 31, 2018 and December 31, 2017, the SBIC subsidiary had $90,000,000 of SBA-guaranteed debentures outstanding. SBA-guaranteed debentures incur upfront fees of 3.425%, which consists of a 1.00% commitment fee and a 2.425% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. Once pooled, which occurs in March and September each year, the SBA-guaranteed debentures bear interest at a fixed rate that is set to the current 10-year treasury rate plus a spread at each pooling date.

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TABLE OF CONTENTS

STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 10 — SBA-GUARANTEED DEBENTURES  – (continued)

The following table summarizes the SBIC subsidiary’s SBA-guaranteed debentures as of March 31, 2018:

       
Issuance Date   Maturity Date   Debenture Amount   Interest
Rate
  SBA Annual
Charge
October 14, 2014     March 1, 2025     $ 6,500,000       2.52 %      0.36 % 
October 17, 2014     March 1, 2025       6,500,000       2.52 %      0.36 % 
December 24, 2014     March 1, 2025       3,250,000       2.52 %      0.36 % 
June 29, 2015     September 1, 2025       9,750,000       2.83 %      0.36 % 
October 22, 2015     March 1, 2026       6,500,000       2.51 %      0.36 % 
October 22, 2015     March 1, 2026       1,500,000       2.51 %      0.74 % 
November 10, 2015     March 1, 2026       8,800,000       2.51 %      0.74 % 
November 18, 2015     March 1, 2026       1,500,000       2.51 %      0.74 % 
November 25, 2015     March 1, 2026       8,800,000       2.51 %      0.74 % 
December 16, 2015     March 1, 2026       2,200,000       2.51 %      0.74 % 
December 29, 2015     March 1, 2026       9,700,000       2.51 %      0.74 % 
November 28, 2017     March 1, 2028       25,000,000       3.19 %      0.22 % 
Total SBA-guaranteed debentures         $ 90,000,000              

As of March 31, 2018 and December 31, 2017, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At March 31, 2018 and December 31, 2017, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.

As of March 31, 2018, the Company has incurred $3,082,500 in financing costs related to the SBA-guaranteed debentures since receiving our license, which were recorded as prepaid loan fees. As of March 31, 2018 and December 31, 2017, $2,080,519 and $2,181,187 of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3. See Note 1 for further discussion.

The following is a summary of the SBA-guaranteed debentures, net of prepaid loan fees:

   
  March 31, 2018   December 31, 2017
SBA debentures payable   $ 90,000,000     $ 90,000,000  
Prepaid loan fees     2,080,519       2,181,187  
SBA Debentures, net of prepaid loan fees   $ 87,919,481     $ 87,818,813  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 10 — SBA-GUARANTEED DEBENTURES  – (continued)

The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the three ended March 31, 2018 and 2017:

   
  For the three
months ended
     March 31,
2018
  March 31,
2017
Interest expense   $ 635,570     $ 497,859  
Debenture fee amortization     100,668       80,211  
Total interest and financing expenses   $ 736,238     $ 578,070  
Weighted average interest rate     2.9 %      3.1 % 
Effective interest rate     3.3 %      3.6 % 
Average debt outstanding   $ 90,000,000     $ 65,000,000  
Cash paid for interest   $ 1,161,490     $ 1,001,250  

NOTE 11 — NOTES

On May 5, 2014, the Company closed a public offering of $25,000,000 in aggregate principal amount of 6.50% notes (the “2019 Notes”), due on April 30, 2019. On August 21, 2017, the Company caused notices to be issued to the holders of its 2019 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2019 Notes, pursuant to Section 1101 of the Base Indenture dated as of May 5, 2014, between the Company and U.S. Bank National Association, as trustee, and Section 1.01(h)(i) of the First Supplemental Indenture dated as of May 5, 2014. The Company redeemed all $25,000,000 in aggregate principal amount of the 2019 Notes on September 20, 2017. The 2019 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date.

The following table summarizes the interest expense and deferred financing costs on the 2019 Notes for the three months ended March 31, 2018 and 2017:

   
  For the three
months ended
     March 31, 2018   March 31, 2017
Interest expense   $     $ 406,250  
Deferred financing costs           44,939  
Administration fees           1,730  
Total interest and financing expenses   $     $ 452,919  
Cash paid for interest   $     —     $ 406,250  

On August 21, 2017, the Company issued $42,500,000 in aggregate principal amount of 5.75% fixed-rate notes due September 15, 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6,375,000 in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly beginning December 15, 2017.

The Company used all of the net proceeds from this offering to fully redeem the 2019 Notes and a portion of the amount outstanding under the Original Facility. As of both March 31, 2018 and December 31, 2017, the aggregate carrying amount of the 2022 Notes was approximately $48,875,000 and the fair value of the Notes was approximately $49,148,700 and $49,520,150, respectively. The 2022 Notes are listed on

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 11 — NOTES  – (continued)

New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.

In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1,688,961 of fees which are being amortized over the term of the 2022 Notes, of which $1,485,316 and $1,568,512 remains to be amortized as of March 31, 2018 and December 31, 2017, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability as required by ASU No. 2015-3.

The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the three months ended March 31, 2018 and 2017:

   
  For the three
months ended
     March 31, 2018   March 31, 2017
Interest expense   $ 702,578     $  
Deferred financing costs     81,963        
Administration fees     1,233        
Total interest and financing expenses   $ 785,774     $  
Cash paid for interest   $ 702,578     $     —  

The following is a summary of the 2022 Notes Payable, net of deferred financing costs:

   
  March 31, 2018   December 31, 2017
Notes payable   $ 48,875,000     $ 48,875,000  
Deferred financing costs     1,485,316       1,568,512  
Notes payable, net of deferred financing costs   $ 47,389,684     $ 47,306,488  

The indenture and supplements thereto relating to each of the 2019 Notes and 2022 Notes contain certain covenants, including but not limited to (i) a requirement that the Company comply with the asset coverage requirements of the 1940 Act or any successor provisions, and (ii) a requirement to provide financial information to the holders of the notes and the trustee under the indenture if the Company should no longer be subject to the reporting requirements under the Exchange Act.

NOTE 12 — SUBSEQUENT EVENTS

Investment Portfolio

On April 2, 2018, the Company invested $7.9 million in the first lien term loan and $0.9 million in the unfunded revolver of BFC SolmeteX LLC, a leading provider of filtration products in the U.S. and Canada. The Company also invested $1.2 million in a first lien term loan of Bonded Filter Co. LLC, a subsidiary of BFC Solmetex LLC.

On April 13, 2018, the Company invested $16.4 million in the first lien term loan and a $0.75 million in the unfunded revolver of DTE Enterprises, Inc., a provider of industrial powertrain repair and maintenance services for the oil & gas and mining sectors. Additionally, the Company invested $1.5 million in the equity of the company.

On April 13, 2018, the Company made an additional investment of $12.5 million in the 2nd lien term loan of Mobileum, Inc., an existing portfolio company.

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 12 — SUBSEQUENT EVENTS  – (continued)

On April 24, 2018, the Company received full repayment of the first lien term loan of Catapult Learning, LLC for total proceeds of $12.1 million.

On April 30, 2018, the Company received full repayment of the unsecured term loan of Binder & Binder National Social Security Disability Advocates, LLC for total proceeds of $0.1 million.

On May 2, 2018, the Company invested $4.5 million in the second lien term loan of General LED OPCO, LLC, a provider of LED lighting systems and modules.

Credit Facilities

The outstanding balance under the Credit Facility as of May 4, 2018 was $66.1 million.

SBA-guaranteed Debentures

On April 25, 2018, the Company drew $40.0 million of SBA-guaranteed debentures, bringing the total balance of SBA-guaranteed Debentures outstanding to $130.0 million as of May 4, 2018.

Legislative Changes

On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

On April 4, 2018, the board of directors (the “Board”) of Stellus Capital Investment Corporation (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective April 4, 2019 unless approved earlier by a vote of the Company’s stockholders. The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act at the Company’s 2018 annual meeting of stockholders.

Dividend Declared

On April 16, 2018, the Company’s board of directors declared a regular monthly dividend for each of April, May and June 2018 as follows:

       
Declared   Ex-Dividend Date   Record
Date
  Payment
Date
  Amount per
Share
4/16/2018     4/27/2018       4/30/2018       5/15/2018     $ 0.1133  
4/16/2018     5/30/2018       5/31/2018       6/15/2018     $ 0.1133  
4/16/2018     6/28/2018       6/29/2018       7/13/2018     $ 0.1133  

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STELLUS CAPITAL INVESTMENT CORPORATION
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)

NOTE 12 — SUBSEQUENT EVENTS  – (continued)

               
               
Company   Investment(1)   December 31,
2017
Fair Value
  Amount of
Realized
Gain/
(Loss)
  Amount of
Unrealized
Gain/
(Loss)
  Amount of
Interest,
Fees or
Dividends
Credit to
Income(2)
  Gross
Additions(3)
  Gross
Reductions(4)
  March 31,
2018
Fair Value
Non-control Investments
                                                                       
Affiliate investments
                                                                       
Glori Energy Production Inc.     Class A
Common Units
    $ 990           $ 5     $     $ 62     $ (917 )    $ 140  
Amounts related to investments transferred to or from other 1940 Act Classification during the period               $     $ 5     $     $ 62     $ (917 )    $ 140  
Total Non-Control/ Non-Affiliate investments               $ 1,335     $ 4,914     $                    
Total Portfolio               $ 1,335     $ 4,919     $     —                    

This schedule should be read in conjunction with Stellus’s consolidated financial statements, including the consolidated schedule of investments and notes to the consolidated financial statements.

(1) The principal amount, the ownership detail for equity investments accrual status is included in the consolidated schedule of investments.
(2) Represents the total amount of interest, fees and dividends credited to income for the portion of the period for which an investment was included in Control or Affiliate categories, respectively. For investments transferred between Control and Affiliate categories during the period, any income or investment balances related to the time period it was in the category other than the one shown at period end is included in “Amounts from investments transferred from other 1940 Act classifications during the period.”
(3) Gross additions include increases in the cost basis of investments resulting from new portfolio investments, follow-on investments and accrued PIK interest, 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 net unrealized depreciation as well as the movement of an existing portfolio company into this category and out of a different category.
(4) Gross reductions include decreases in the cost basis of investments resulting from principal 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 net unrealized depreciation or net decreases in unrealized appreciation as well as the movement of an existing portfolio company out of this category and into a different category.

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Stellus Capital Investment Corporation
 
 
 
 

2,750,000 Shares
 
  
 
 
 

 
 

PRELIMINARY PROSPECTUS

 
 
 
 
 
 

 
 
 
 

March   , 2019

Joint Bookrunning Managers

   
RAYMOND JAMES   Keefe, Bruyette & Woods
                            A Stifel Company
  Goldman Sachs & Co. LLC