Overview of Great Elm Capital Corp.

Great Elm Capital Corp. (GECC) is a business development company (BDC) that seeks to generate both current income and capital appreciation through debt and income-generating equity investments, including investments in specialty finance businesses. GECC invests in secured and senior secured debt instruments of middle market companies, as well as income-generating equity investments in specialty finance companies.

On September 1, 2023, GECC contributed investments in certain of its operating company subsidiaries and other specialty finance assets to its formerly wholly owned subsidiary, Great Elm Specialty Finance, LLC (GESF). A strategic investor purchased approximately 12.5% of the equity interests and subordinated indebtedness in GESF. GESF provides a variety of financing options to middle-market borrowers, including receivables factoring, asset-based and asset-backed lending, lender finance, and equipment financing.

GECC has elected to be treated as a regulated investment company (RIC) for U.S. federal income tax purposes. As a RIC, GECC will not be taxed on its income as long as it distributes at least 90% of its investment company taxable income annually to its shareholders.

Investments and Revenues

GECC’s level of investment activity can vary substantially from period to period depending on factors such as the amount of debt and equity capital available to middle-market companies, merger and acquisition activity, and the general economic environment. As a BDC, GECC’s investments and portfolio composition must comply with regulatory requirements.

GECC generates revenue primarily from interest on the debt investments it holds. It may also generate revenue from dividends on equity investments, capital gains on the disposition of investments, and other fees and income. GECC’s debt investments generally have an expected maturity of three to five years and pay interest quarterly or semi-annually.

Expenses

GECC’s primary operating expenses include a base management fee and incentive fee paid to its external investment manager, Great Elm Capital Management (GECM), as well as administration fees and interest on outstanding indebtedness. The base management fee and incentive fee compensate GECM for identifying, evaluating, negotiating, closing, and monitoring GECC’s investments.

Critical Accounting Policies

Valuation of Portfolio Investments: GECC values its portfolio investments at fair value based on policies adopted by its Board of Directors. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants. GECC utilizes a market approach, an income approach, or both approaches to determine fair value, considering factors such as market trading and transaction comparables, applicable market yields and multiples, the portfolio company’s ability to make payments, and enterprise values.

Revenue Recognition: GECC records interest and dividend income, including payment-in-kind (PIK) income, on an accrual basis. It also recognizes various fees earned on investments, such as origination, structuring, and end-of-term fees, over the life of the respective investments.

Net Realized Gains (Losses) and Net Change in Unrealized Appreciation (Depreciation): GECC measures realized gains or losses as the difference between the net proceeds from the repayment or sale of an investment and its amortized cost basis. The net change in unrealized appreciation or depreciation reflects the net change in the fair values and cost bases of the investment portfolio during the reporting period.

Portfolio and Investment Activity

During 2023 and the first nine months of 2024, GECC’s investment activity was as follows:

The table shows that GECC was actively investing and divesting throughout the periods, with a weighted average yield on its debt investments ranging from 12.58% to 13.77%.

Results of Operations

Investment Income: GECC’s total investment income increased for the three and nine months ended September 30, 2024 compared to the prior year periods, primarily due to an increased debt investment portfolio size and higher dividend income. Interest income rose as the debt portfolio grew, while dividend income increased due to GECC’s investment in the CLO Formation JV, LLC.

Expenses: GECC’s total expenses increased for the three and nine months ended September 30, 2024 compared to the prior year periods. This was mainly driven by higher management fees, incentive fees, and interest expense. Management fees rose due to an increase in the underlying management fee assets, while incentive fees increased due to higher pre-incentive net investment income. Interest expense grew primarily from the issuance of new notes payable.

Realized Gains (Losses): GECC recognized net realized gains of $226,000 and $2,112,000 for the three and nine months ended September 30, 2024, respectively. This included gains from the realization of investments in Florida Marine, LLC and Blackstone Secured Lending Fund, as well as losses from the realization of investments in PFS Holdings Corp. and Eagle Point Credit Company.

Unrealized Appreciation (Depreciation): GECC recorded net unrealized depreciation of $821,000 and $10,742,000 for the three and nine months ended September 30, 2024, respectively. The depreciation was primarily driven by decreases in the fair value of GECC’s investment in GESF common stock and certain other portfolio company investments.

Liquidity and Capital Resources

As of September 30, 2024, GECC had $0.3 million in cash and cash equivalents and $25.7 million in money market fund investments. GECC had $333.3 million in investments at fair value, consisting of $234.5 million in debt instruments and $98.8 million in equity investments.

GECC has a $25 million senior secured revolving credit facility with City National Bank, which was undrawn as of September 30, 2024. GECC also has $235.3 million in aggregate principal amount of unsecured notes outstanding, including the GECCM Notes, GECCO Notes, GECCZ Notes, GECCI Notes, and GECCH Notes.

GECC believes it has sufficient liquidity to meet its short-term and long-term obligations for at least the next 12 months and the foreseeable future.

Outlook and Risks

GECC’s financial performance and outlook are subject to various risks and uncertainties, including:

• Interest rate risk: As of September 30, 2024, approximately $174.6 million of GECC’s debt investments bore interest at variable rates. A prolonged increase in interest rates could increase GECC’s gross investment income, but may also increase its operating expenses.

• Credit risk: GECC’s investments in middle-market companies and specialty finance businesses are subject to the risk of default or deterioration in the financial condition of its portfolio companies.

• Regulatory risk: As a BDC, GECC’s investments and operations must comply with regulatory requirements, which could limit its investment opportunities or increase its compliance costs.

• Competition: GECC faces competition from other capital providers, which could affect its ability to find suitable investments or the terms on which it can make them.

Overall, GECC’s financial results for the periods presented demonstrate its ability to generate investment income and deploy capital, though it continues to navigate a challenging market environment and interest rate environment. The company’s liquidity position and diversified portfolio provide a foundation for weathering potential future headwinds.