[March 15, 2013] HARRIS & HARRIS GROUP INC /NY/ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations. Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The information contained in this section should be read in conjunction with the Company's 2012 Consolidated Financial Statements and notes thereto. Cautionary Statement Regarding Forward-Looking Statements This Annual Report on Form 10-K contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about the Company, our current and prospective portfolio investments, our industry, our beliefs, and our assumptions. Words such as "anticipates," "expects," "intends," "plans," "will," "may," "continue," "believes," "seeks," "estimates," "would," "could," "should," "targets," "projects," and variations of these words and similar expressions are intended to identify forward-looking statements. The forward-looking statements contained in this Annual Report involve risks and uncertainties, including statementsas to: • our future operating results; • our business prospects and the prospects of our portfolio companies; • the impact of investments that we expect to make; • our contractual arrangements and relationships with third parties; • the dependence of our future success on the general economy and its impact on the industries in which we invest; • the ability of our portfolio companies to achieve their objectives; • our expected financings and investments; • the adequacy of our cash resources and working capital; and • the timing of cash flows, if any, from the operations and/or monetization of our positions in our portfolio companies. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements, including without limitation: 40 • an economic downturn could impair our portfolio companies' ability to continue to operate, which could lead to the loss of some or all of our investments in such portfolio companies; • a contraction of available credit and/or an inability to access the equity markets could impair our investment activities; • interest rate volatility could adversely affect our results, particularly if we elect to use leverage as a material part of our investment strategy; • currency fluctuations could adversely affect the results of our investments in foreign companies, particularly to the extent that we receive payments denominated in foreign currency rather than U.S. dollars; and • the risks, uncertainties and other factors we identify in "Risk Factors" and elsewhere in this Annual Report on Form 10-K and in our other filings with the SEC. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. Important assumptions include our ability to originate new investments, certain margins and levels of profitability and the availability of additional capital. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Annual Report on Form 10-K should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described or identified in "Risk Factors" and elsewhere in this Annual Report on Form 10-K. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this AnnualReport on Form 10-K. Background and Overview We incorporated under the laws of the state of New York in August 1981. In 1983, we completed an IPO. In 1984, we divested all of our assets except Otisville BioTech, Inc., and became a financial services company with the investment in Otisville as the initial focus of our business activity. In 1992, we registered as an investment company under the 1940 Act, commencing operations as a closed-end, non-diversified investment company. In 1995, we elected to become a BDC subject to the provisions of Sections 55 through 65of the 1940 Act. We believe we provide five core benefits to our shareholders. First, we are an established firm with a positive track record of investing in venture capital-backed companies. Second, we provide shareholders with access to disruptive science-enabled companies, particularly ones that are enabled by nanotechnology that would otherwise be difficult to access or inaccessible for most current and potential shareholders. Third, we have an existing portfolio of companies at varying stages of maturity that provide for a potential pipeline of investment returns over time. Fourth, we are able to invest opportunistically in a range of types of securities to take advantage of market inefficiencies. Fifth, we provide access to venture capital investments in a vehicle that, unlike private venture capital firms, is both transparent and liquid. 41 We are an early-stage, active investor in transformative companies. We make venture capital investments in companies enabled by multi-disciplinary, scientific innovations, particularly those enabled by nanotechnology and microsystems. We define venture capital investments as the money and resources made available to privately held and publicly traded small businesses with exceptional growth potential. Nanotechnology and microsystems are technologies that allow for the characterization, design, manipulation and manufacture of materials and systems on the molecular and micro levels, respectively. We believe companies that leverage scientific innovations, particularly those at the nanoscale, are emerging as leaders in their respective industry sectors. These industry sectors include life sciences, energy and electronics. Innovations within each sector often have very different, sometimes unexpected, origins. The knowledge of core domains within each of these industry sectors can be augmented by exposure to the adjacent or even entirely "white-field" multi-disciplinary technology domains including: nanoscale materials, novel analytical instrumentation and manufacturing tools, ultrafast computational and modeling capabilities, high-function mobile devices, high-speed wireless data transfer and high-density, long-lasting and renewable sources of energy. Our investment team has the ability to identify and invest in such domains. [[Image Removed]] [[Image Removed]] We believe that as the impact of scientific innovation, and particularly nanotechnology, occurs, our portfolio companies are well positioned to profit and that we will see investment returns as a result. We consider a company to fit our investment thesis if the company employs, or intends to employ, science-enabled technologies, particularly those that we consider to be at the microscale or smaller, and if the employment of that technology is material to its business plan. By making these investments, we seek to provide our shareholders with a portfolio of venture capital investments that address a variety of industries, markets and products leveraging science-related innovations, particularly in nanotechnology and microsystems. 42 Industry Sector Overview Life Sciences We classify companies in our life sciences portfolio as those that address problems in life sciences-related industries, including biotechnology, agriculture, advanced materials and chemicals, diagnostics, healthcare, bioprocessing, water, industrial biotechnology, food, nutrition and energy. We historically referred to our life sciences portfolio using the term "healthcare." We believe "life sciences" is a more appropriate term to describe this portion of our portfolio owing to the scope of applications for life sciences-related companies and technologies outside of traditional healthcare markets, including agriculture, food and industrial biotechnology. We are living through an unprecedented rate of change in our understanding of biological systems and the ability to manipulate the fundamental building blocks of nature. Novel, rapidly maturing discovery, characterization, analysis, control and manufacturing techniques can have profound impact on life sciences and related industries that can be addressed through the understanding of biological systems and the ability to manipulate the fundamental building blocks of nature. Trends generating disruptive investment opportunities include: · Healthcare budgets are out of balance globally, with the aging population jeopardizing the financial viability of the leading economies of the world. Life sciences innovations in diagnostics, treatment and monitoring of disease must simultaneously reduce cost and improve the quality of life; · Continuing global growth in population and in improvements in quality of life substantially increase demand for raw materials, water, food and energy. This demand cannot be adequately met with conventional methods of manufacturing, generation, mining or harvesting. Biological pathways are becoming economically viable and ecologically preferable for production, utilization, and disposal/remediation; and · The ubiquity of data and internet access, while stationary and increasingly mobile, enable handheld devices to become a natural access point for communication and data sharing between healthcare service providers and their patients. Soon, they could be acting as diagnostic and treatment companions too. We continue to believe we are positioned well to take advantage of today's growth markets within life sciences having been early investors in many of these markets. We believe our initial investments in single-cell analysis (Enumeral), three-dimensional biology (Champions Oncology), metabolomics (Metabolon), synthetic carbohydrates (Ancora), oncolytic viruses (BioVex, which was acquired by Amgen in 2011), solid state pH sensors (Senova), positioned us well to capture the growth of commercial interest in personalized medicine, industrial biotechnology, vaccines and molecular diagnostics. We also believe we have an emerging pipeline of companies that are developing solutions for growth markets that exist today or may develop in future years such as long-read genomic analysis (OpGen) and agricultural products from the microbiome (AgBiome, formerly AgInnovation). We discuss these companies in more detail in the section below titled, "New Investments in 2012." 43 We also have a number of portfolio companies that address life sciences-related sectors as a secondary industry focus of their businesses. These related industries and portfolio companies include environmental remediation (ABSMaterials), chemical and fuel production (Cobalt and Solazyme), nanofabrication for life sciences-related tools (Molecular Imprints) and non-destructive, soft-tissue analysis (Xradia). Our interest in life sciences will continue to be multi-disciplinary. For example, analytical, modeling and data acquisition techniques accelerated drastically in the first decade of the century, rapidly increasing the development of new diagnostic testing. We believe that this trend will continue owing to successful migration of well-developed semiconductor manufacturing and computational technologies into life sciences applications. There have been numerous examples, such as gene sequencing, metabolomics or bioinformatics, where transition from matter to data resulted in positive shifts in performance of the underlying machinery. Furthermore, as Moore's law scaling in the semiconductor manufacturing industry is expected to continue for at least another two decades, we expect to see continuing migration of the novel techniques and computational capabilities into life-sciences applications. The rapid development of internet and mobile computing represents another vector of developing innovation for the life sciences market. The move from central lab to hand-held devices changes how diagnostic information is used in decision making for patient care. Real-time information can be shared and analyzed by one or more physicians immediately at the point of care in a single visit rather than requiring multiple, sometimes lengthy delays and follow-up visits. The next step in this direction will be sensing networks and life sciences functionality embedded into always-on devices. These devices will generate substantial amounts of data that will require significant computing capability and new software algorithms for analyzing and using the data to derive suggestions for clinical diagnosis and, potentially, treatment options for consideration by healthcare providers. The data generated by these devices will need to be transferred at high speed, often wirelessly, to data centers where such analysis could take place. While a number of technologies exist today that can address some of these needs, substantial improvements in speed, cost and capability are required for the realization of all of the capabilities desired by healthcare providers. Such needs present significant opportunity for innovations such as those targeted by us. Manufacturing techniques are also undergoing rapid changes, and the cross-pollination is bi-directional. Biological- and life-sciences-inspired techniques are penetrating natural resources and mining industries. Water treatment, usage and utilization and fermentation technologies are influencing other unrelated verticals. Synthetic biology promises to impact the oil-derived chemical industry. Membrane science is impacting food production, ore enrichment and waste remediation. As such, our portfolio companies will often produce products and/or services that are applicable to multiple industry sectors. We sometimes address this cross-sector nature by indicating a primary and secondary industry sector focus for some of our portfolio companies, as applicable. 44 The table below lists the equity-focused companies in our portfolio as of December 31, 2012, and the equity-focused companies that were formerly in our portfolio that target life sciences-related needs as either the primary or secondary focus of those businesses and the year in which we initially invested in each company: Current Life Sciences Portfolio Companies Past Life Sciences Portfolio Companies ABS Materials, Inc. Alliance Pharmaceutical Corporation AgBiome, LLC BioVex Group, Inc. (formerly AgInnovation, LLC) Ancora Pharmaceuticals Inc. Chlorogen, Inc. Champions Oncology, Inc. (OTC:CSBR) Crystal IS, Inc. Cobalt Technologies, Inc. ENDOcare, Inc. D-Wave Systems, Inc. Evolved Nanomaterial Sciences,Inc. Ensemble Therapeutics Corporation Gel Sciences, Inc. Enumeral Biomedical Corp. Genomica Corporation HzO, Inc. Guilford Pharmaceuticals, Inc. Mersana Therapeutics, Inc. Heartware, Inc. Metabolon, Inc. Kereos, Inc. Molecular Imprints, Inc. Kriton Medical, Inc. OpGen, Inc. Magellan Health Services Senova Systems, Inc. MedLogic Global Corporation Solazyme, Inc. (NASDAQ:SZYM) MultiTarget, Inc. Xradia, Inc. NanoGram Devices Corporation Nanomix, Inc. NeuroMetrix, Inc. Pharmaceutical Peptides, Inc. Phoenix Molecular, Inc. PolyRemedy Inc. SciQuest, Inc. TetraVitae Bioscience, Inc. The percent of life sciences investments in our portfolio has been increasing over the past ten years. Approximately 70 percent of our initial investments since 2007, and all of our investments in 2012, were in companies addressing needs in the life sciences. Our life sciences companies demonstrate progress and growth through different mechanisms depending on their respective businesses. Businesses that provide services, such as Metabolon, generate revenues from the commercial sale of these services. Businesses that develop and sell products, such as Senova, generate revenues from the sale of those products. Businesses that enter into partnerships for discovery and development of therapeutics, vaccines and diagnostics, such as Ensemble, Enumeral, Mersana and Champions Oncology, may generate revenue from upfront fees, milestone payments and royalties on sales of approved products. Businesses that endeavor to advance a therapeutic, diagnostic or vaccine product through clinical trials may not generate revenue until an approved product is on the market, if ever. Progress for these types of companies can be measured by progress through clinical trials. 45 Energy We classify companies in our energy portfolio as those that seek to improve performance, productivity or efficiency, and to reduce environmental impact, waste, cost, energy consumption or raw materials. Energy is a term used commonly to describe products and processes that solve global problems related to resource constraints. The term, "cleantech," is also used commonly in a similar manner. We are experiencing record levels of demand for energy, chemicals and resources that are crucial components of the global economy. This demand coupled with energy security concerns and volatility of commodity prices, leads to trends that yield disruptive investment opportunities. These trends include: · Identification and extraction of natural resources is becoming more of a science and less of an art. Such a shift in approach is driven, in part, by the need to manage the significant costs associated with energy-related projects, particularly in remote areas, and the availability of new methods of generating, analyzing and using data that was heretofore not available. o Recovery of resources is occurring in exceedingly remote areas and from increasingly more difficult sources to access as the traditional easy-to-access sources of these resources are being drained of supply. This trend is leading to the need for new extraction technologies. o New techniques for extraction of natural gas are increasing the supply and lowering the cost of this resource. Natural gas-powered devices can be more efficient and less polluting than petroleum-powered devices. Advances in distribution could enable natural gas to replace petroleum in certain applications. · Governments and industry worldwide are looking for new and cleaner forms of energy. This has increased interest in the ability to produce chemicals and fuels from renewable resources. · Governments, corporations and individuals worldwide seek ways to translate significant amounts of data generated by today's monitoring capabilities into ways to optimize use of energy and resources. We expect that the foundation of products and services that address the trends above and other energy-related trends will be interdisciplinary. Tools that are commonly used for inspection and certification of electronic devices could find use in analyzing soil and rock samples in oil and gas exploration. Organisms that are used to manufacture therapeutics could find use in the producing of renewable chemicals and fuels. These multidisciplinary products and services will seek to improve performance, productivity and efficiency and to reduce environmental impact, waste, cost, energy consumption or raw materials. 46 We believe innovations in energy markets include: · New Approaches to Production: The term "production," is defined here to indicate the process of combining one or more individual components into a final product. A final product made using a process can be quite diverse and include a physical device (e.g., a solar panel, battery or solid-state coolers), a chemical (e.g., butanol, ethanol or biodiesel), or even a component that produces light. Although many existing processes are capable of producing these types of products in large quantities and of high quality, they each suffer from various inefficiencies that could be overcome using new approaches and solutions. · New Materials: The physical properties of a product are defined primarily by the materials that comprise it. In some cases, these properties limit the ability of a product to meet the needs of the industry. The semiconductor industry is a classic example of this phenomenon with its efforts to reduce the dimensions of the transistors to allow them to pack more transistors into a device to increase its speed while decreasing the size of the die itself to reduce manufacturing costs. As this reduction in size occurs, the silicon dioxide insulating layer in the transistors begins to leak electrons, which results in a reduction in performance and an increase in energy use. At dimensions of less than approximately 10 nm, the insulating behavior of silicon dioxide degrades in performance, and the transistor cannot function properly. This example of reduced performance as a layer of a traditional material is reduced in thickness is a common problem of traditional materials that limits product development and advancement in a number of industries. This and other inherent limitations in the properties of traditional materials often force companies to use underperforming devices that present difficulties such as environmental hazards, low energy efficiency or incompatible form factors because alternative technology is not available. New advanced materials permit the development of new products that overcome inherent limitations of existing technology and approaches. We continue to believe we are positioned well to take advantage of today's growth markets within energy. We have been early investors in many of these markets. Our initial investments in renewable chemicals and biofuels (Solazyme), produced water remediation (Produced Water Absorbents), light-emitting diodes (Bridgelux) and alternative sources for high-intensity light (Laser Light Engines) positioned us well to participate in the growth of these respective industries. Additionally, a number of our energy portfolio companies completed recent liquidity events. Solazyme completed a successful IPO in the second quarter of 2011, raising over $200 million. DuPont acquired Innovalight in the third quarter of 2011. Asahi Kasei acquired Crystal IS in the fourth quarter of 2011. We also have a number of portfolio companies that address energy-related needs as a secondary focus of their respective businesses. These companies are targeting needs such as low-power memory (Nantero and Adesto) and low-power, uncooled infrared image sensors (SiOnyx). 47 The table below lists the equity-focused companies in our portfolio as of December 31, 2012, and the equity-focused companies that were formerly in our portfolio that target energy-related needs as either the primary or secondary focus of those businesses and the year in which we initially invested in each company: Current Energy Portfolio Companies Past Energy Portfolio Companies ABSMaterials, Inc. CORDEX Petroleums, Inc. Adesto Technologies Corporation Crystal IS, Inc. Bridgelux, Inc. Dynecology Incorporated Cobalt Technologies, Inc. Innovalight, Inc. Contour Energy Systems, Inc. Molten Metal Technology, Inc. Laser Light Engines, Inc. NanoGram Corporation Nanosys, Inc. NanoGram Devices Corporation Nantero, Inc. Siluria Technologies, Inc. Nextreme Thermal Solutions, Inc. Starfire Systems, Inc. Produced Water Absorbents, Inc. TetraVitae Bioscience, Inc. SiOnyx, Inc. Solazyme, Inc. (NASDAQ:SZYM) Ultora, Inc. Many of our Energy portfolio companies are generating commercial revenues and/or have entered into partnerships and joint development agreements with large corporations. Electronics We classify companies in our electronics portfolio as those that address problems in electronics-related industries, including semiconductors, telecommunications and data communications, metrology and test and measurement. We believe macroeconomic and microeconomic trends, including global connectivity, demand for increasing bandwidth owing to pervasiveness of electronics in daily life, the desire to see not just hear, the need for real-time availability of data and demand for more functionality driven by increasing global prosperity, create attractive investment opportunities in electronics. We believe innovations in electronics include: · New Methods of Production: Continuation of Moore's Law allows for exponential increases of the number of integrated circuits in semiconductor devices. · New Materials: New materials enable unique capabilities, performance and form-factors in electronic devices. · New Forms of Computation: New methods of solving equations and other problems that would be difficult or impossible with standard digital computing techniques. 48 We continue to believe we are positioned well to take advantage of today's growth markets within electronics having been early investors in many of these markets. We believe our initial investments in non-volatile memory (Nantero and Adesto), transparent conductors (Cambrios), image sensors (SiOnyx), integrated photonics (NeoPhotonics), waterproofing (HzO) and metrology (Xradia), positioned us well to capture the growth of commercial interest in smartphones and tablet computers with touchscreens, the exponential increase in demand for bandwidth for data and telecommunications, and the demand for non-destructive imaging capabilities in a variety of industries. We also believe we have an emerging pipeline of companies that are developing solutions for growth markets that exist today or may develop in future years such as high-performance computing enabled by quantum mechanics (D-Wave Systems) and radio-frequency identification and near-field communication devices enabled by printed electronics (Kovio). We also have a number of portfolio companies that address electronics-related needs as a secondary focus of their respective businesses. These companies are targeting needs such as high-efficiency, high-color-gamut LED displays (Nanosys), high-energy density storage devices (Contour and Ultora) and novel, electrically driven, solid-state sensors (Senova). The table below lists the equity-focused companies in our portfolio as of December 31, 2012, and the equity-focused companies that were formerly in our portfolio that target electronics-related needs as either the primary or secondary focus of those businesses and the year in which we initially invested in each company: Current Electronics Portfolio Companies Past Electronics Portfolio Companies Adesto Technologies Corporation Agile Materials and Technologies, Inc. Bridgelux, Inc. CMA Group, Inc. Cambrios, Inc. Continuum Photonics, Inc. Contour Energy Systems, Inc. Cswitch Corporation D-Wave Systems, Inc. Informio, Inc HzO, Inc. Micracor, Inc. Kovio, Inc. NanoGram Corporation Laser Light Engines, Inc. Nanomix, Inc. Molecular Imprints, Inc. NanoOpto Corporation Nanosys, Inc. Nanophase TechnologiesCorporation Nantero, Inc. Nanotechnologies, Inc. NeoPhotonics Corporation (NYSE:NPTN)* NBX Corporation Nextreme Thermal Solutions, Inc. nFX Corporation Senova Systems, Inc. Optiva, Inc. SiOnyx, Inc. Princeton Video Image, Inc. Ultora, Inc. Schwoo, Inc. Xradia, Inc. Starfire Systems, Inc. Voice Control Systems, Inc. Zia Laser, Inc. * As of February 16, 2013, we no longer hold any shares of NeoPhotonics Corporation. Many of our electronics portfolio companies are generating commercial revenues and/or have entered into partnerships and joint development agreements with large corporations. 49 Maturity of Current Equity-Focused Venture Capital Portfolio Our equity-focused venture capital portfolio is composed of companies at varying maturities facing different types of risks. We have defined these levels of maturity and sources of risk as: 1) Early Stage/Technology Risk, 2) Mid Stage/Market Risk and 3) Late Stage/Execution Risk. Early-stage companies have a high degree of technical, market and execution risk, which is typical of initial investments by venture capital firms, including us. These companies often require substantial development of their technologies before they begin introducing products to market. Mid-stage companies are those that have overcome most of the technical risk associated with their products and are now focused on addressing the market acceptance for their products. For those companies developing therapeutics or medical devices, the focus is on bringing their products through the first phases of clinical trials. Late-stage companies are those that have determined there is a market for their products, and they are now focused on sales execution and scale. Late-stage, life-sciences companies are typically generating revenue from the commercial sale of one or more products or, in the case of therapeutic or medical devise-focused life-sciences companies, are in Phase III Clinical Trials, which are the pivotal trials before a possible FDA approval and commercial launch of a product. We seek to create a portfolio of companies that enables consistent flows of potential liquidity events in multiple industries in three sectors, life sciences, energy, and electronics, which can be monetized as these companies mature. We believe a portfolio of companies focused on a diverse set of industries reduces the potential impact of cyclicality of any one industry. Our current portfolio is comprised of companies at varying stages of maturity in a diverse set of industries within three sectors. As our portfolio companies mature, we seek to invest in new early- and mid-stage companies that may mature into mid- and late-stage companies. This continuous progression creates a pipeline of investment maturities that may lead to future sources of positive contributions to net asset value per share as these companies mature and potentially experience liquidity and exit events. This diversity of industries and our pipeline of investment maturities are demonstrated by the distribution of our current early- and mid-stage portfolio companies that primarily address needs in the sectors shown in the table below. [[Image Removed]] 50 The interdisciplinary nature of science-based inventions enables our portfolio companies to address needs in multiple sectors rather than being confined to addressing needs in one sector. As such, many of our companies can adjust their business foci to address needs in a secondary sector should opportunities in the company's primary sector decrease in number or magnitude. We discuss this attribute in more detail in the section above titled, "Industry Sector Overview." We expect some of our portfolio companies to transition between stages of maturity over time. This transition may be forward if the company is maturing and is successfully executing its business plan or may be backward if the company is not successfully executing its business plan or decides to change its business plan substantially from its original plan. Transitions backward are commonly accompanied by an increase in non-performance risk, which reduces valuation. We discuss non-performance risk and its implications on value below in the section titled "Valuation of Investments." During the fourth quarter of 2012, we transitioned ABSMaterials from a mid-stage company to an early-stage company owing to a change in its primary target market during the quarter. Portfolio Company Revenue We currently have 24 companies in our equity-focused venture capital portfolio that generate revenues ranging from nominal to significant from commercial sales of products and/or services, from commercial partnerships and/or from government grants. In aggregate, our portfolio companies had approximately $532 million in revenue in 2012, a 25.5 percent increase from aggregate 2011 revenue of approximately $424 million, a 39.9 percent increase from aggregate 2010 revenue of approximately $380 million and a 99.1 percent increase from aggregate 2009 revenue of $267 million. New Investments in 2012 In 2012, we made two new investments. In both cases, we invested more dollars and took ownership positions that are more meaningful than we had done historically. This is a strategy we implemented over the past few years. During 2012, we invested $3.26 million in OpGen, Inc. OpGen is an innovator in providing rapid, accurate, DNA analysis products and services. The company's proprietary Whole Genome Mapping technology provides high-resolution, whole genome maps for sequence assembly and validation, strain typing and comparative genomics. The company is dedicated to positively influencing individual healthcare outcomes, advancing scientific research and enhancing public health by delivering precise, actionable information and results to customers in the life sciences and healthcare communities. OpGen's customers include genomic research centers, public health agencies, bio-defense organizations, academic institutions, clinical research organizations and biotechnology companies. 51 In December 2012, we made a $2 million investment in AgBiome, LLC. We are a founding investor in AgBiome. AgBiome is a provider of early-stage research and discovery for agriculture and is utilizing the crop microbiome to identify products that reduce risk and improve yield. Early-Stage, Active Investing Despite rapidly expanding research and development budgets, publications and patents covering life sciences, the number of early-stage venture capitalists investing in science-enabled companies has decreased substantially. This has resulted in decreased competition for attractive investment opportunities and increased attractive pricing available to investors in those opportunities. [[Image Removed]] * Includes data through September 1, 2011. Source: Lux Research, Inc. According to data from Lux Research, between 2006 and 2011, seed/Series A venture capital investments, as a percentage of all financings in the type of investments made by us, fell from a high of 33 percent to approximately 11 percent. Owing to financial conditions, many venture capital firms have substantially reduced or ceased completely participation in the financing of early-stage, companies, particularly in the industry sectors in which we invest. Many of these firms are now focused on financing later stage, and/or, in the case of life sciences-related companies, therapeutics-focused, clinical-stage companies. Despite this shift to later stage investing, over the previous decade, research by Palo Alto Venture Science, a venture capital firm that employs analytical models for investing in early-stage companies, showed that the risk of later stage investing is not significantly less than early stage investing. Over the previous decade, there was a 49 percent failure rate in early rounds yielding a 2.8 times money multiple versus a 45 percent failure rate in later rounds yielding a 1.3 times multiple. We believe the money multiple will increase as more funds have exited early-stage investing. 52 The shift of many venture capital firms away from early-stage investing has created opportunity for us. Innovation continues to accelerate, and with a dearth of funding available, high-quality investment opportunities at attractive valuations are prevalent. Additionally, the turmoil in the venture capital industry has made start-up companies more interested in engaging with strategic corporations as partners and investors. Our ability to bring early-stage financing and strong corporate partnering early in the development process could be perceived as valuable by potential portfolio companies and may be of particular benefit in investment opportunities that become competitive. Corporate Partnerships are Increasingly Important to Us We have historically built our portfolio companies through a combination of investment from other venture capital firms, high-net-worth individuals and other sources of equity capital, partnerships and investments from corporations and federal funding. The venture capital industry is undergoing contraction that is reducing the amount of capital available for investment, particularly in the types of companies that we invest in. The U.S. government is reducing spending, and the partisan gridlock creates substantial uncertainty around the availability of federal funding. Corporations, on the other hand, have substantial amounts of cash, know-how and a need to harness innovation to drive future growth. [[Image Removed]] As such, we believe that corporate involvement is evolving to become more critical for the success of early-stage companies in the years ahead. In addition to the points discussed above, two other factors are driving this evolution. First, corporations and the public markets have become less willing to take technology, scale and manufacturing risk. Corporations and the public markets often are requiring more mature companies with proven scale and customers prior to an IPO or acquisition. Second, the time period between investment and exit over the past decade has lengthened considerably. This extension of time results in the need for start-up companies to secure larger amounts of capital from dilutive and non-dilutive sources than was historically required before being acquired or seeking capital in IPOs. 53 [[Image Removed]] At the same time, facing a depleting pool of acquisition targets and the necessity to supplement downsized internal research and development operations, large corporations are investing actively in venture capital-backed companies. Early-stage entrepreneurs and investors have proven effective at company formation, early intellectual property strategy, building management teams, and characterizing, reproducing and establishing base-line processes. The challenges for early-stage companies have been in scale and manufacturing and end-market access. Thus, active corporate involvement is becoming increasingly valuable, especially as technology becomes more complex, to overcome these challenges. The combination of 1) rapid development capabilities of small companies, and 2) manufacturing expertise and channel access of large corporations has become exceedingly powerful for all entities involved in such efforts. We are actively working to increase our engagement with corporate partners as we believe that working closely with corporations will permit us to 1) identify and to diligence technologies more efficiently and effectively, 2) gather market intelligence that these corporations have from their involvement in the industry, 3) gain a better perspective on the dynamic competitive landscape, 4) better understand integration challenges of bringing a new technology to this industry, and 5) provide insights into the requirements of scale and manufacturing while we work actively with our portfolio companies to ready the technology for launch. We also believe it will help these young companies identify and pursue markets for products where there is a proven demand. 54 Investment Objective and Strategy Our principal investment objective is to achieve long-term capital appreciation by making equity-focused venture capital investments in companies that we believe have exceptional growth potential. Therefore, a significant portion of our current venture capital investment portfolio provides little or no income in the form of dividends or interest. Current income is a secondary investment objective. We seek to reach the point where future growth is financed through reinvestment of our capital gains from our venture capital investments and where current income offsets significant portions of our annual expenses during periods of time between realizations of capital gains on our investments. We also plan to implement a strategy to grow assets under management and generate current income by raising one or more third-party funds to manage. It is possible that we will invest our capital alongside or through these funds in portfolio companies. These funds may be focused on specific sectors such as life sciences, energy and electronics that are enabled by scientific breakthroughs, including nanotechnology. It is also possible these funds will also invest in companies in each of these sectors that are not directly enabled by nanotechnology. There is no assurance when and if we will be able to raise such fund(s) or, if raised, whether they will be successful. We have discretion in the investment of our capital to achieve our objectives. Our venture capital investments are made primarily in equity-related securities of companies that can range in stage from pre-revenue to generating positive cash flow. These businesses tend to be thinly capitalized, unproven, small companies that lack management depth, have little or no history of operations and are developing unproven technologies. These businesses may be privately held or publicly traded. We historically have invested in equity securities of these companies that are generally illiquid due to restrictions on resale and to the lack of an established trading market. We refer to our portfolio of investments in equity and equity-related securities in later sections of the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") as our "equity-focused" portfolio of investments. We have historically, from time to time, taken advantage of opportunities to generate near-term cash flow by investing in non-convertible debt securities of small businesses. These businesses tend to be generating cash or have near-term visibility to reaching positive cash flow. We refer to our portfolio of investments in non-convertible debt in later sections of the MD&A as our "venture debt" portfolio of investments. While we have historically made venture debt investments, we currently plan to focus our efforts on equity-focused investments and on raising and managing one or more third-party funds. We are both early-stage and long-term investors. We seek to identify investment opportunities in industries and markets that will be growth opportunities three to seven years from the date of our initial investment. We expect to invest capital in these companies at multiple points in time subsequent to our initial investment. We refer to such investments as "follow-on" investments. Our efforts to identify and predict future growth industries and markets rely on patient and deep due diligence in nanotechnology-enabled innovations developed at universities and corporate and government research laboratories, and the examination of macroeconomic and microeconomic trends and industry dynamics. We believe it is the early identification of and investments in these growth opportunities that will lead to investment returns for our shareholders, growth of our net assets, and capital for us to invest in tomorrow's growth opportunities. Involvement with Portfolio Companies The 1940 Act requires that BDCs offer to "make available significant managerial assistance" to portfolio companies. We are actively involved with our portfolio companies through membership on boards of directors, as observers to the boards of directors and/or through frequent communication with management. As of December 31, 2012, we held at least one board seat or observer rights on 24 of our 29 equity-focused portfolio companies (83 percent). 55 We may hold two or more board seats in early-stage portfolio companies or those in which we have significant ownership. We may transition off of the board of directors to an observer role as our portfolio companies raise additional capital from new investors, as they mature or as they are able to attract independent members who have relevant industry experience and contacts. We also typically step off the board of directors upon the completion of an IPO. Our observer rights at board of directors meetings commonly cease when companies complete an IPO. We have not held a board seat or observer rights at either Solazyme, Inc., or NeoPhotonics Corporation since each company completed an IPO in May 2011 and February 2011, respectively. We may be involved actively in the formation and development of business strategies of our earliest stage portfolio companies. This involvement may include hiring management, licensing intellectual property, securing space and raising additional capital. We also provide managerial assistance to late-stage companies looking for potential exit opportunities by leveraging our relationships with the banking and investment community and our knowledge and experience in running a micro-capitalization publicly traded business. Investments and Current Investment Pace Since our investment in Otisville in 1983 through December 31, 2012, we have made a total of 95 equity-focused venture capital investments. We have completely exited 66 of these 95 investments and partially exited through the sale of shares and/or the sale of call options covered by shares of two of these 95 investments, recognizing aggregate net realized gains of $69,347,255 on invested capital of $99,559,771. For the securities of the 29 companies in our equity-focused portfolio held at December 31, 2012, we have net unrealized depreciation of $3,964,152 on invested capital of $106,568,131. We have aggregate net realized gains and unrealized depreciation for our 95 equity-focused investments of $65,383,103 on invested capital of $206,127,902. The amount of net realized gains includes: · $13,992,952 in upfront payments received in 2011 from the sale of BioVex Group, Inc., to Amgen, Inc., the sale of Innovalight, Inc., to DuPont and the sale of Crystal IS, Inc., to Asahi Kasei Group. We had invested a total of $11,383,299 in these three portfolio companies; · $953,480 from the portion of our upfront payment held in escrow from the sale of BioVex Group, Inc., to Amgen, Inc., which was released on March 16, 2012; · $11,140 from the portion of our upfront payment held in escrow from the sale of Crystal IS, Inc., to Asahi Kasei Group, which was released on April 30, 2012; 56 · $5,199,223 from the sale of shares of Solazyme, Inc., on invested capital of $1,195,693. $2,911,500 of the total proceeds was generated from the call of shares of Solazyme under option contracts. $2,287,723 in total proceeds was generated from the sale of 182,359 shares of Solazyme through open market transactions; · $2,000,500 from the call of shares under option contracts of NeoPhotonics Corporation on invested capital of $6,477,619; and · $1,605,907 in realized gains on our sale of call option contracts covered by our shares of NeoPhotonics Corporation and Solazyme, Inc. The aggregate net realized gains and the cumulative invested capital also do not reflect the cost or value of our shares of NeoPhotonics Corporation or Solazyme, Inc., which completed IPOs on February 2, 2011, and May 27, 2011, respectively, that we owned as of December 31, 2012, or the premiums received on open option contracts of $50,000. The aggregate net realized gains also do not include potential escrow payments from the sale of Crystal IS, Inc., or Innovalight, Inc., or potential milestone payments that could occur as part of the acquisition of BioVex Group, Inc., by Amgen, Inc., at points in time in the future as of December 31, 2012. If these amounts were included, our aggregate net realized gains and cumulative invested capital would be $86,022,057 and $107,921,968, respectively. From August 2001 through December 31, 2012, all 53 of our initial equity-focused investments have been in science-enabled companies commercializing or integrating products enabled by nanotechnology or microsystems. From August 2001 through December 31, 2012, we have invested a total (before any subsequent write-ups, write-downs or dispositions) of $159,140,325 in these companies. We currently have 27 equity-focused companies in our portfolio that have yet to complete liquidity events (e.g., IPO or M&A transactions). At December 31, 2012, from first dollar in, the average and median holding periods for these 27 investments were 5.4 years and 5.7 years, respectively. Historically, as measured from first dollar in to last dollar out, the average and median holding periods for the 66 investments we have exited were 4.2 years and 3.3 years, respectively. The following is a summary of our initial and follow-on equity-focused investments in nanotechnology companies from January 1, 2008, to December 31, 2012. We consider a "round led" to be a round where we were the new investor or the leader of a group of investors in an investee company. Typically, but not always, the lead investor negotiates the price and terms of the deal with the investee company. 57 Investments in Our Equity-Focused Portfolio of Investments in Privately Held and Publicly Traded Companies 2008 2009 2010 2011 2012 Total Incremental Investments $ 17,779,462 $ 12,334,051 $ 9,560,721 $ 17,688,903 $ 15,141,941 No. of New Investments 4 2 3 4 2 No. of Follow-On Investment Rounds 25 29 27 31 26 No. of Rounds Led 4 5 5 4 3 Average Dollar Amount - Initial $ 683,625 $ 174,812 $ 117,069 $ 1,339,744 $ 1,407,500 Average Dollar Amount - Follow-On $ 601,799 $ 413,256 $ 341,093 $ 397,740 $ 474,113 Importance of Availability of Liquid Capital Private venture capital funds are structured commonly as limited partnerships with a committed level of capital and finite lifetime. Capital is "called" from limited partners to make investments and pay for expenses of running the firm at various points within the lifetime of the fund. For each initial investment, the fund must reserve additional capital for follow-on investments at later stages of the life of the portfolio companies. These follow-on investments are required because often venture-backed portfolio companies in areas in which we invest, whether privately held or publicly traded, operate with negative cash flow for lengthy periods of time. In general, the cumulative total of initial invested capital and reserves cannot exceed the committed level of capital of the fund. Our strategy for investing capital is similar to this approach in some respects. We make initial investments in privately held and publicly traded companies and project the amount of capital that may be required should the company mature successfully. These projections, equivalent to the reserves of private venture capital funds, are reviewed weekly by management, are updated frequently and are a component of the data that guide our decisions on whether to make new and follow-on investments. As a publicly traded, internally managed venture capital company, our cash used to make investments and pay expenses is held by us and not called from external sources when needed. Accordingly, it is crucial that we operate the company with a substantial balance of liquid capital for this reason and for four additional reasons. 1) We manage the company and our investment criteria and pace such that our projected needs for capital to make new and follow-on investments do not exceed the total of our liquid investments. Although we use best efforts to predict when this capital will be required for use in new and follow-on investments, we cannot predict with certainty the timing for these investments. We would be unable to make new or follow-on investments in our portfolio companies without having substantial liquid resources of capital available to us. 58 2) Venture capital firms traditionally invest beside other venture capital firms in a process called syndication. The size of the fund and the amount of capital reserves available to syndicate partners is often an attribute that potential co-investors consider when deciding on syndicate partners. As we do not have committed capital from limited partners, we believe we must have adequate available liquid capital on our balance sheet to be able to have access to high-quality deal flow. 3) We rarely commit the total amount of cumulative capital intended for investment in any portfolio company at one point in time. Instead, our investments consist of multiple rounds of financing of a given portfolio company, in which we typically participate if we believe that the merits of such an investment outweigh the risks. We also commonly have preemptive rights to invest additional capital in our privately held portfolio companies. These rights are useful to protect and potentially increase the value of our positions in our portfolio companies as they mature. Commonly, the terms of such financings in privately held companies also include penalties for those investors that do not invest in these subsequent rounds of financing. Without available capital at the time of investment, our ownership in the company would be subject to these penalties that can lead to a partial or complete loss of the capital invested prior to that round of financing. 4) We may have the opportunity to increase ownership in late rounds of financing in some of our most mature companies. Many private venture capital funds that invested in these companies are reaching the end of the term associated with their limited partnerships. This issue may limit the available capital to these funds for follow-on investments, and the ability to take advantage of potentially valuable terms given to those who have investable capital. Having permanent, liquid capital available for investment and access to the capital markets allows us to take advantage of these opportunities as they arise. Our Sources of Liquid Capital The sources of liquidity that we use to make our investments are classified as primary and secondary liquidity. As of December 31, 2012, and December 31, 2011, our total primary and secondary liquidity was $38,231,691 and $65,368,303, respectively. We do not include funds available from our credit facility as primary or secondary liquidity. We believe it is important to examine both our primary and secondary liquidity when assessing the strength of our balance sheet and our future investment capabilities. Primary liquidity is comprised of cash, U.S. Treasury securities and certain receivables. As of December 31, 2012, we held $13,998,880 in U.S. government obligations, and we had an additional $8,379,111 in cash, of which $4,775,143 was held in non-interest-bearing, fully FDIC insured bank accounts. As of December 31, 2011, we held $33,841,394 in cash, of which $25,251,666 was held in non-interest-bearing, fully FDIC insured bank accounts. The temporary unlimited FDIC insurance coverage expired on January 1, 2013. As of December 31, 2011, we held $0 in U.S. government obligations. With the expiration of the full FDIC insurance on non-interest-bearing accounts on December 31, 2012, we expect to resume holding a portion of our cash in U.S. government obligations. 59 On March 16, 2012, the Company received payment of its portion of the proceeds held in escrow since the closing of the transaction on March 4, 2011, from Amgen, Inc.'s acquisition of BioVex Group, Inc., totaling $953,480. On April 30, 2012, the Company received $11,140 from the portion of our upfront payment held in escrow from the sale of Crystal IS, Inc., to Asahi Kasei Group. These payments immediately added to our primary liquidity. Payments upon achieving milestones of the BioVex Group, Inc., sale or expiration of the escrow periods for the Crystal IS, Inc., and Innovalight, Inc., dispositions would also add to our primary liquidity in future quarters if these milestones are achieved successfully and escrowed funds are released in part or in full. The probability-adjusted values of the future milestone payments for the sale of BioVex and of the funds held in escrow from the dispositions of Crystal IS and Innovalight, as determined at the end of each fiscal quarter, are included as an asset on our Consolidated Statements of Assets and Liabilities and will be included in primary liquidity only if and when payment is received for achievement of the milestones and the funds held in escrow are released, respectively. During the year ended December 31, 2012, 324,000 shares of our investment in Solazyme, Inc., were called under option contracts. We received $2,911,500 in gross proceeds from these transactions, which added to our primary liquidity. We also sold an additional 182,359 shares of Solazyme on the open market during this period for gross proceeds of $2,287,723. During the year ended December 31, 2012, 400,100 shares of our investment in NeoPhotonics Corporation were called under option contracts. We received $2,000,500 in gross proceeds from these transactions, which also added to our primary liquidity. Our secondary liquidity is comprised of the stock of publicly traded companies. Although these companies are publicly traded, their stock may not trade at high volumes and prices may be volatile, which may restrict our ability to sell our positions at any given time. As of December 31, 2012, our secondary liquidity was $15,770,488. NeoPhotonics Corporation and Solazyme, Inc., account for $14,422,261 of this amount based on the closing price of each company as of December 31, 2012. As of December 31, 2012, shares of NeoPhotonics and Solazyme were trading below the strike price of the call options that were open and outstanding. The fair value of our shares of Champions Oncology, Inc., accounts for $1,348,227 of the total amount of secondary liquidity. As of December 31, 2011, our secondary liquidity was $31,457,861. NeoPhotonics and Solazyme account for $29,484,527 of this amount based on the closing price of each company as of December 31, 2011. Champions Oncology accounts for $1,973,334 of the total amount of secondary liquidity. As of December 31, 2012, and December 31, 2011, our shares of each of these companies were freely tradable securities. A decision to sell our shares would result in the cash received from the sale of these assets being included in primary liquidity. Until that time, we will continue to include the value of our shares of our publicly traded portfolio companies in secondary liquidity unless the average trading volume of each company reaches sufficient levels for us to monetize our stock in such companies over a short period of time. Potential Pending Liquidity Events from Our Portfolio as of December 31, 2012 During the fourth quarter of 2012, one of our portfolio companies received letters of intent to acquire the company. As of December 31, 2012, discussions between this portfolio company and the potential acquirers are ongoing, and there can be no assurance that this company will be able to consummate a transaction within the next twelve months, if at all. 60 Additionally, our companies often plan for and/or begin the process of pursuing potential sales and/or IPOs of those companies by hiring bankers and/or advisors to attempt to pursue such liquidity events. We consider these efforts to be in the ordinary course of business for those companies until the potential and timing of a transaction become tangible through events such as receipt of letters of intent to acquire a company and/or drafting of registration documents to pursue an IPO. Other than the company mentioned above, as of December 31, 2012, we did not have any additional companies for which the potential and timing of a transaction are tangible. As of December 31, 2012, we valued potential milestone payments from the sale of BioVex Group, Inc., at $3,400,734. If all the remaining milestone payments were to be paid by Amgen, Inc., we would receive $9,526,393. We have not received any milestone payments as of December 31, 2012, and there can be no assurance as to the timing and how much of this amount we will ultimately realize in the future, if any. Strategy for Managing Publicly Traded Positions Our equity-focused portfolio companies may seek to raise capital and provide liquidity to shareholders through IPOs. It is generally rare that pre-IPO investors are afforded the ability to sell a portion of shares owned in the IPO. These pre-IPO shares are often subject to lock-up provisions that prevent the sale of those shares, options against those shares or other transactions associated with those shares until expiration of the lock-up period, which is often 180 days from the date of the IPO. We commonly plan to hold our shares of our publicly traded portfolio companies following the expiration of the lock-up restrictions if we believe that the prospects for future growth of the portfolio company and the underlying value of our shares are as great or greater than other opportunities we are currently encountering. We believe we are able to make such assessments using our extensive knowledge of the companies having actively worked with them and their management teams over multiple years as pre-IPO investors. As such, we may hold our shares of publicly traded portfolio companies for extended periods of time from the date of IPO. Following the expiration of the lock-up restrictions, we may pursue the sale of call options covered by our ownership of shares in our publicly traded portfolio companies. The Company will only "sell" or "write" options on common stocks held in the Company's portfolio. We will not sell "naked" call options, i.e., options representing more shares of the stock than are held in the portfolio. These call options give the buyer the right to purchase our stock at a given price, the "strike price," prior to a specific date, the "expiration date." A call option whose strike price is above the current price of the underlying stock is called "out-of-the-money." A call option whose strike price is below the current price of the underlying stock is called "in-the-money." When stocks in the portfolio rise, call options that were out-of-the-money when written may become in-the-money, thereby increasing the likelihood that they could be exercised, and we would be forced to sell the stock. The opposite would occur for an in-the-money option that would become out-of-the-money if the stock were to fall below the strike price of the option. We have used and currently plan to continue to use both in-the-money and out-of-the-money options as part of our strategy for managing our ownership in publicly traded portfolio companies. 61 We may also purchase put options as a method of limiting the downside risk that the price per share of these companies may decrease substantially from current levels. This type of option is particularly useful for hedging risk for volatile stocks such as NeoPhotonics Corporation and Solazyme, Inc., that are relatively illiquid compared to the number of shares owned by us. A put option gives its holder the right to sell a specified number of shares of a specific security at a specific price (known as the exercise strike price) by a certain date. The buyer of a put option is betting that the price of the security will decrease before the option expires. The risk for us as the option holder is that the option expires unexercised, and we have lost the money spent on buying the option. For conventional listed call options, the options' expiration dates are commonly up to nine months from the date the call options are first listed for trading. Longer-term call options can have expiration dates up to three years from the date of listing. We currently expect the majority of written call options to be ones with expirations of equal to or shorter than one year from the date the call option is first listed for trading. We believe this strategy of selling covered call options on our publicly traded portfolio companies provides at least three benefits: 1) We receive payment of a premium in cash at the time of the sale of the call option. The amount of the premium received is negotiated between the buyer and us and is influenced generally by the market price of the underlying stock, the volatility of the stock and the length of time between the date of sale of the call option and the expiration date. If the option expires out-of-the-money, we retain the premium as a gain on our investment. 2) If the option is exercised, it enables the monetization of the stock held by us in an orderly transaction that yields known returns. Our publicly traded portfolio companies currently trade at small average daily volumes of shares compared with our positions in these companies. As such, a decision by us to sell a portion or all of our shares in these companies in the public markets through brokers could negatively affect the price at which we would be able to sell these shares and, therefore, our ultimate returns. The sale of a call option sets a price at which our shares would sell if the option is exercised, which negates the potential impact of illiquidity or other market dynamics on our returns from the sale of these shares. That said, it also sets an upper limit for the proceeds we would receive in such sale. We plan to enter into such contracts at a price per share and in a timeframe that we would be willing to sell those shares. While we may repurchase call options when advantageous to us, we commonly do not sell call options with the expectation that we will repurchase them at a future date. 3) The sale of options may help generate interest and liquidity in the stock of our publicly traded portfolio companies. Current market dynamics make it difficult for small capitalization stocks to attract interest from institutional and retail investors. This difficulty leads to low average trading volumes and low liquidity options for existing shareholders. We believe the sale of call options may aid in increasing the interest and liquidity in the stock of these companies and may be beneficial to our future potential returns on these investments. 62 During the twelve months ended December 31, 2012, our strategy for managing our publicly traded positions has generated approximately $1,444,840 in net cash proceeds from premiums on call options sold and put options purchased of Solazyme, Inc. We added approximately $2,911,500 in gross cash proceeds to our primary liquidity resulting from options called that were covered by a portion of our shares of Solazyme. During 2012, we sold an additional 182,359 shares of Solazyme for gross cash proceeds of $2,287,723. The net increase in our primary liquidity from these transactions was $6,644,063. The average sale price on assignments under option contracts and open market sales for Solazyme was $10.27 for the year. Our cost basis in Solazyme is $2.36 per share. The proceeds from the premiums received from the sale of call options and the cash from the sale of shares discussed above have yielded cash that is approximately the same as the original amount we invested in Solazyme. This increase in primary liquidity is important for our efforts to continue to fund existing and new portfolio companies that could generate future investment returns. As of December 31, 2012, we had 150,000 of our remaining 1,797,790 shares of Solazyme under the following option contracts: No. of Shares Expiration Date Strike Price 150,000 March 16, 2013 $ 10.00 During the twelve months ended December 31, 2012, our strategy for managing our publicly traded positions has generated approximately $195,717 in net cash proceeds from premiums on call options sold and put options purchased of NeoPhotonics Corporation. We also added approximately $2,000,500 in gross cash proceeds to our primary liquidity resulting from options called that were covered by a portion of our shares of NeoPhotonics. The net increase in our primary liquidity from these transactions was $2,196,217. The average sale price on assignments under option contracts of NeoPhotonics was $5.00 for the year. Our cost basis in NeoPhotonics is $16.19 per share. As of December 31, 2012, we had 50,000 of our remaining 50,807 shares of NeoPhotonics under the following option contracts: No. of Shares Expiration Date Strike Price 50,000 February 16, 2013 $ 7.50 Current Business Environment The fourth quarter of 2012 ended with decreases in value in the public market indices. These decreases coincided with a decrease in the number of IPOs and M&A transactions, though IPO values increased. Compared with 2011, M&A activity was comparable and the number of IPOs decreased by 11 percent. These dynamics continue to lead to a difficult fundraising environment for venture capital firms and for venture-backed companies, particularly those in the middle stages of development. 63 Eight U.S. venture-backed companies raised $1.4 billion through IPOs in the fourth quarter of 2012, which is a slight decline in number from the third quarter of 2012 (10 companies) and from the fourth quarter of 2011 (11 companies), according to Dow Jones VentureSource, Thomson Reuters and the National Venture Capital Association ("NVCA"). However, the capital raised increased from the third quarter of 2012 by $300 million. The capital raised in the fourth quarter of 2012 was approximately half of the capital raised in the same period of 2011. M&A transactions of venture-backed companies remained steady from the third to the fourth quarter, with 95 deals in the fourth quarter. There was a 23 percent decrease in the number of transactions as compared with the fourth quarter of 2011. The number of M&A transactions of venture-backed companies decreased from 488 in 2011 to 435 in 2012 (11 percent decline), according to Thomson Reuters and the NVCA. The average disclosed deal value for venture-backed M&A transactions (26 disclosed of 95 deals) in the fourth quarter of 2012 was $134 million, which is comparable with the fourth quarter of 2011, but $100 million less than the third quarter of 2012. The information technology sector dominated these deals, with 65 of the 95 deals. Life sciences companies had 18 deals, with an average disclosed price (12 disclosing of 18) of $130 million. Forty-two U.S. venture capital funds raised $3.3 billion in the fourth quarter of 2012, according to Thomson Reuters and the NVCA. Compared with the third quarter of 2012, this is a 25 percent decrease in the number of funds (down from fifty-three) and a 35 percent decrease in the amount of capital raised (down from $5.0 billion). The top five venture capital funds accounted for 55 percent of the total fundraising in the fourth quarter, which is comparable with the third quarter. Venture capital fundraising for 2012 totaled $20.6 billion, a 10 percent increase in commitments as compared with 2011 ($18.7 billion). This increase in monetary commitments comes despite a three percent decline in the number of funds with closings (182 funds). Of the 182 funds that raised capital, 55 were new funds. The current business environment is also complicated by global economic uncertainty and regional unrest. It remains unclear if and how the debt crisis in Europe will develop and whether it will result in a slowing of worldwide economic growth or even trigger a further global financial crisis. It is unclear if the rising budget deficits and partisan politics in the United States will result in further downgrades in its credit rating. Any outcome could be heightened potentially should an alternative to U.S. Treasury securities emerge as the global safe-haven for invested capital or should large holders of these securities, such as China, decide to divest of them in large quantities or in full. Further, many of our portfolio companies receive non-dilutive funding through government contracts and grants. Sequestration could have a direct and significant reduction in our portfolio companies' contract or grant awards. Sequestration will also likely result in reduced budgets at research facilities, which will reduce the volume of products they could potentially purchase from our portfolio companies. All of this uncertainty could lead to a further broad reduction in risk taken by investors and corporations, which could reduce further the capital available to our portfolio companies, could affect the ability of our portfolio companies to build and grow their respective businesses, and could decrease the liquidity options available to our portfolio companies. Historically, difficult venture environments have resulted in a higher than normal number of companies not receiving financing and being subsequently closed down with a loss to venture investors, and other companies receiving financing but at significantly lower valuations than the preceding financing rounds. This issue is compounded by the fact that many existing venture capital firms have few remaining years of investment and available capital owing to the finite lifetime of the funds managed by these firms. Additionally, even if a firm was able to raise a new fund, commonly venture capital firms are not permitted to invest new funds in existing investments. This limitation of available capital can lead to fractured syndicates of investors. A fractured syndicate can result in a portfolio company being unable to raise additional capital to fund operations; this issue is especially acute in capital-intensive sectors that are enabled by science-related innovations, such as life sciences, energy and electronics, which are generally not in favor among venture capital firms. The result of these difficulties is that the portfolio company may be forced to sell before reaching its full potential or be shut down entirely if the remaining investors cannot financially support the company. As such, improvements in the exit environment for venture-backed companies through IPOs and M&A transactions may not translate to an increase in the available capital to venture-backed companies, particularly those that have investments from funds that are in the latter stage of life unless the markets improve for some time into the future. 64 Our overall goal remains unchanged. We want to maintain our leadership position in investing in science-enabled companies, particularly those enabled by nanotechnology and microsystems and to increase our net asset value. The current environment for venture capital financings continues to favor those firms that have capital to invest regardless of the stage of the investee company. We continue to finance our new and follow-on equity and convertible debt investments from our cash reserves held in bank accounts. We may in the future invest borrowed capital to take advantage of opportunities that we believe will return greater than the cost of such borrowed capital. We have historically held, and may in the future again hold, our cash in U.S. Treasury securities. We believe the current status of the venture capital industry and the current economic climate provide opportunities to invest this capital at historically low valuations and under favorable terms in equity and convertible and non-convertible debt of new and existing privately held and publicly tradedcompanies. Valuation of Investments We value our privately held venture capital investments each quarter as determined in good faith by our Valuation Committee, a committee of all the independent directors, within guidelines established by our Board of Directors in accordance with the 1940 Act. (See "Footnote to Consolidated Schedule of Investments" contained in "Consolidated Financial Statements.") The values of privately held, venture capital-backed companies are inherently more difficult than publicly traded companies to assess at any single point in time because securities of these types of companies are not actively traded. We believe, perhaps even more than in the past, that illiquidity, and the perception of illiquidity, can affect value. Management believes further that the long-term effects of the difficult venture capital market and difficult exit environments will continue to affect negatively the fundraising ability of weak companies regardless of near-term improvements in the overall global economy and public markets, and that these factors can also affect value. In each of the years in the period 2008 through 2012, the Company recorded the following gross write-ups in privately held securities as a percentage of net assets at the beginning of the year ("BOY"), gross write-downs in privately held securities as a percentage of net assets at the beginning of the year, and change in value of private portfolio securities as a percentage of net assets at the beginning of the year. 65 Gross Write-Ups and Write-Downs of the Privately Held Portfolio 2008 2009 2010 2011 2012 Net Asset Value, BOY $ 138,363,344 $ 109,531,113 $134,158,258 $ 146,853,912 $ 145,698,407 Gross Write-Downs During Year $ (39,671,588 ) $ (12,845,574 ) $ (11,391,367 ) $ (11,375,661 ) $ (19,604,046 ) Gross Write-Ups During Year $ 820,559 $ 21,631,864 $ 30,051,847 $ 11,997,991 $ 14,099,904 Gross Write-Downs as a Percentage of Net Asset Value, BOY (28.67 )% (11.7 )% (8.5 )% (7.8 )% (13.5 )% Gross Write-Ups as a Percentage of Net Asset Value, BOY 0.59 % 19.7 % 22.4 % 8.2 % 9.7 % Net Change as a Percentage of Net Asset Value, BOY (28.08 )% 8.0 % 13.9 % 0.4 % (3.8 )% From December 31, 2011, to December 31, 2012, the value of our equity-focused venture capital portfolio, including our rights to potential future milestone payments from the sale of BioVex Group, Inc., to Amgen, Inc., decreased by $5,794,638, from $111,799,351 to $106,004,713. Not including our rights to potential future milestone payments from the sale of BioVex Group, Inc., to Amgen, Inc., our equity-focused portfolio companies decreased in value by $5,832,581. This decrease was primarily owing to 1) a net decrease in the valuations of two of our publicly traded portfolio companies and sales of a portion of our shares of these companies of $15,062,266. These sales yielded gross cash proceeds to us of $7,199,723 that are not included in the valuation of these portfolio companies as of December 31, 2012; 2) a net decrease in the values of comparables of $5,914,918 and 3) a net decrease in value owing to a net increase in discounts for non-performance risk of $4,458,011. These changes were offset by 1) new and follow-on investments of $15,141,941 and 2) a net increase in value owing to the terms and pricing of new rounds of financing and indications of value from potential acquirers of $4,291,036. The remaining component of the change of the value of our equity-focused portfolio companies of $169,637 was owing to changes in the value of warrants, currency fluctuations and interest on convertible bridge notes. We note that our Valuation Committee and ultimately our Board of Directors take into account multiple sources of quantitative and qualitative inputs to determine the value of our privately held portfolio companies and our publicly traded portfolio companies whose values are not derived solely from the closing price on the last day of the quarter. We also note that our Valuation Committee does not set the value of our freely tradable publicly traded portfolio companies, Solazyme, Inc., and NeoPhotonics Corporation. Even though our position in Champions Oncology, Inc., is freely tradable as of December 31, 2012, subjective inputs are also included in the determination of value. Therefore, our Valuation Committee sets the value of this position. 66 We define non-performance as the risk that the price per share (or implied valuation of a portfolio company) or the effective yield of a debt security of a portfolio company, as applicable, does not appropriately represent the risk that a portfolio company that requires or seeks to raise additional capital will be (a) unable to raise capital, will need to be shut down and will not return our invested capital; or (b) able to raise capital, but at a valuation significantly lower than the implied post-money valuation. Our best estimates of non-performance risk of our portfolio companies during the fourth quarter of 2012 are included in the valuation of the companies as of December 31, 2012. Changes in non-performance risk led to a net decrease in value of $7,130,210. In the future, as these companies receive terms for additional financings or if they are unable to receive additional financing and, therefore, proceed with sales or shutdowns of the business, we expect the contribution of the discount for non-performance risk to vary in importance in determining the fair values of our securities of these companies. Changes in discounts for non-performance risk could positively or negatively affect the value of our portfolio companies in future quarters. As of December 31, 2012, non-performance risk was a significant factor in determining the values of nine of our 27 equity-focused portfolio companies that are fair valued by our Board of Directors. These nine companies accounted for approximately $34.6 million, or 33.7 percent,of the total value of our equity-focused venture capital portfolio, not including our rights to milestone payments from the sale of BioVex Group, Inc., to Amgen, Inc. As of December 31, 2011, non-performance risk was a significant factor in determining the values of 10 of our 25 equity-focused portfolio companies that are fair valued by our Board of Directors. These 10 companies accounted for approximately $30.3 million, or 28 percent, of the total value of our equity-focused venture capital portfolio, not including our rights to milestone payments from the sale of BioVex Group, Inc., to Amgen, Inc. We also note that our valuation of our securities of Molecular Imprints, Inc., includes $3,033,338 that is ascribed to a non-convertible bridge note. The principal plus interest of this note was repaid in full in the third quarter of 2011. The remaining value results from a liquidation preference that survived the repayment of the note and, as currently written, would pay the Company $4,044,450 should the company be sold for more than its outstanding debt and a contractual payment to management of Molecular Imprints. This amount assumes that the total non-convertible bridge note preferences of $10.5 million are paid in full. Our value of this portion of our securities of Molecular Imprints as of December 31, 2012, reflects a probability-weighted discount applied to thetotal amount of the preference. As of December 31, 2012, our top ten investments by value accounted for approximately 73 percent of the value of our equity-focused venture capital portfolio. 67 [[Image Removed]] Results of Operations We present the financial results of our operations utilizing accounting principles generally accepted in the United States of America ("GAAP") for investment companies. On this basis, the principal measure of our financial performance during any period is the net increase (decrease) in our net assets resulting from our operating activities, which is the sum of the followingthree elements: Net Operating Income (Loss) - the difference between our income from interest, dividends, and fees and our operating expenses. Net Realized Gain (Loss) on Investments - the difference between the net proceeds of sales of portfolio securities and their stated cost, plus income from interests in limited liability companies. Net Increase (Decrease) in Unrealized Appreciation or Depreciation on Investments - the net unrealized change in the value of our investment portfolio. Owing to the structure and objectives of our business, we generally expect to experience net operating losses and seek to generate increases in our net assets from operations through the long-term appreciation and monetization of our venture capital investments. We have relied, and continue to rely, primarily on proceeds from sales of investments, rather than on investment income, to defray a significant portion of our operating expenses. Because such sales are unpredictable, we attempt to maintain adequate working capital to provide for fiscal periods when there are no such sales. During 2012 and 2011, we made two and three venture debt investments, respectively. The potential for, or occurrence of, inflation could result in rising interest rates for government-backed debt. This trend would have two effects on our business. First, the spread between the interest rates we can obtain from investing in low-risk government debt versus high-risk venture debt will compress, which would result in a reduction of the risk premium associated with investments in venture debt. We may reduce the number and amount invested in venture debt should this risk premium decrease substantially as to not compensate us adequately for the risk associated with such investments. Second, funds drawn from our line of credit will accrue interest at a rate that fluctuates with either the London Interbank Offered Rate (LIBOR) or the prime rate. LIBOR and the prime rate are expected to increase in times of inflation. Our venture debt investmentsmay include both fixed and floating interest rates. Our net interest income would decrease if the spread between the interest rate on funds from our line of credit and our venture debt investments decrease. 68 Comparison of Years Ended December 31, 2012, 2011, and 2010 During the years ended December 31, 2012, and December 31, 2011, we had net decreases in net assets resulting from operations of $19,986,900 and $3,541,363, respectively. During the year ended December 31, 2010, we had a net increase in net assets resulting from operations of $10,586,850. Investment Income and Expenses: During the years ended December 31, 2012, 2011, and 2010, we had net operating losses of $8,803,343, $8,338,365, and $7,555,807, respectively. The variation in these results is primarily owing to the changes in investment income and operating expenses, including non-cash, stock-based compensation expense of $2,928,943 in 2012, $1,894,800 in 2011, and $2,088,091 in 2010. The increase in non-cash, stock-based compensation expense in 2012 is primarily associated with the compensation cost for restricted stock and the compensation cost for the voluntary cancellation of stock options during the second quarter of 2012. The employees who cancelled stock options realized no value from those options. During the years ended December 31, 2012, 2011, and 2010, total investment income was $722,227, $702,765, and $446,038, respectively. During the years ended December 31, 2012, 2011, and 2010, total operating expenses were $9,525,570, $9,041,130, and $8,001,845, respectively. During 2012, as compared with 2011, investment income increased from $702,765 to $722,227, reflecting an increase in interest income from non-convertible promissory notes, subordinated and senior secured debt, and senior secured debt through a participation agreement, offset by a decrease in interest income from convertible bridge notes and a decrease in our average holdings of U.S. government securities. During the twelve months ended December 31, 2012, we accrued net bridge note interest of $235,806, as compared with $368,479 during the twelve months ended December 31, 2011. During the twelve months ended December 31, 2012, our average holdings of U.S. government securities were $3,884,228, as compared with $24,295,971 during the twelve months ended December 312, 2011, primarily owing to the decrease in yield available over the durations of maturities in which we were willing to invest and the availability of fully FDIC insured demand deposit bank accounts. The average yield on our U.S. government securities for the twelve months ended December 31, 2012, and 2011, was 0.10 percent and 0.08 percent, respectively. 69 Operating expenses, including non-cash, stock-based compensation expenses, were $9,525,570 and $9,041,130 for the twelve months ended December 31, 2012, and December 31, 2011, respectively. The increase in operating expenses for the twelve months ended December 31, 2012, as compared with the twelve months ended December 31, 2011, was primarily owing to increases in salaries, benefits and stock-based compensation expense, administration and operations expense and rent expense, offset by decreases in professional fees, directors' fees and expenses and custody fees. Salaries, benefits and stock-based compensation expense increased by $610,527, or 10.2 percent, through December 31, 2012, as compared with December 31, 2011, primarily as a result of an increase in non-cash expense of $1,034,143 associated with the Stock Plan. In May 2012, the executive officers of the Company voluntarily cancelled all of their outstanding stock options for no consideration. This resulted in a one-time charge of $1,365,242 to recognize all of the previously unrecognized compensation cost related to these options. While the non-cash, stock-based compensation expense for the Stock Plan increased our operating expenses by $2,928,943, this increase was offset by a corresponding increase to our additional paid-in capital, resulting in no net impact to our net asset value. We also had increases in salaries of employees owing to cost of living adjustments and costs associated with the hiring of one full-time employee and two part-time employees, offset by a decrease in year-end employee bonus expense of $425,000 and a decrease of $415,854 in the projected benefit obligation expense accrual for medical retirement benefits. Administration and operations expense increased by $33,914, or 3.2 percent, through December 31, 2012, as compared with December 31, 2011, primarily as a result of increases in expenses associated with investor outreach expenses and costs of approximately $37,898 related to Meet the Portfolio Day. We did not hold a Meet the Portfolio Day during the comparable period in 2011. Rent expense increased by $32,172, or 8.5 percent, for the period ended December 31, 2012, as compared with the twelve months ended December 31, 2011. Our rent expense of $408,659 for the twelve months ended December 31, 2012, includes $418,662 of rent paid in cash, net of $10,003 non-cash rent expense, credits and abatements that we recognize on a straight-line basis over the lease term. Our rent paid in cash of $418,662 includes $9,320 of real estate tax escalation charges on our corporate headquarters located at 1450 Broadway in New York City. Professional fees decreased by $154,362, or 13.4 percent, through December 31, 2012, as compared with December 31, 2011, primarily as a result of decreases in certain legal and consulting fees associated with investor outreach and marketing efforts, offset by an increase in accounting fees. Directors' fees and expenses decreased by $43,440, or 12.8 percent, through December 31, 2012, as compared with December 31, 2011, primarily owing to the retirement of two members of our Board of Directors in 2012. Custody fees decreased by $12,989, or 20.8 percent, for the twelve months ended December 31, 2012, as compared with December 31, 2011, owing to the lower fees charged by our new custodian, Union Bank. During 2011, as compared with 2010, investment income increased from $446,038 to $702,765, reflecting an increase in interest income from convertible bridge notes, non-convertible promissory notes, subordinated and senior secured debt, and senior secured debt through a participation agreement, offset by a decrease in interest earned on our U.S. government securities. During the twelve months ended December 31, 2011, our average holdings of U.S. government securities were $24,295,971, as compared with $47,139,264 during the twelve months ended December 31, 2010. The average yield on our U.S. government securities for the twelve months ended December 31, 2011, and 2010, was 0.08 percent and 0.10 percent, respectively. We decreased our average holdings of U.S. government securities and ended 2011 with no holdings of U.S. government securities primarily due to the decrease in yield available over the durations of maturities in which we were willing to invest and the availability of fully FDIC insured demand deposit bank accounts. 70 Operating expenses, including non-cash, stock-based compensation expenses, were $9,041,130 and $8,001,845 for the twelve months ended December 31, 2011, and December 31, 2010, respectively. The increase in operating expenses for the twelve months ended December 31, 2011, as compared with the twelve months ended December 31, 2010, was primarily owing to increases in salaries, benefits and stock-based compensation expense, administration and operations expense and professional fees, offset by decreases in rent expense and custody fees. Salaries, benefits and stock-based compensation expense increased by $684,801, or 13.0 percent, through December 31, 2011, as compared with December 31, 2010, primarily as a result of an increase of $529,179 in the projected benefit obligation expense accrual for medical retirement benefits and an increase in year-end employee bonuses of $400,000, offset by a decrease in non-cash expense of $193,291 associated with the Stock Plan and a decrease in salaries and benefits owing primarily to a decrease in our head count. While the non-cash, stock-based compensation expense for the Stock Plan increased our operating expenses by $1,894,800, this increase was offset by a corresponding increase to our additional paid-in capital, resulting in no net impact to our net asset value. Administration and operations expense increased by $34,977, or 3.5 percent, through December 31, 2011, as compared with December 31, 2010, primarily as a result of an increase in accrued expenses associated with increased investor outreach expenses and a one-time leasing commission expense associated with subletting our office space located 420 Florence Street, Suite 200, Palo Alto, CA, commencing on July 1, 2011, offset by a decrease in our directors' and officers' liability insurance expense, decreases in the cost of non-employee-related insurance and decreases in managing directors' travel-related expenses. Professional fees increased by $403,608, or 53.6 percent, through December 31, 2011, as compared with December 31, 2010, primarily as a result of an increase in legal and accounting fees of $50,058 and $40,000, respectively, associated with exploring alternative means for increasing assets under management by potentially raising one or more third-party funds and increases in consulting fees related to investor outreach and marketing efforts. Rent expense decreased by $25,745, or 6.4 percent, for the period ended December 31, 2011, as compared with the twelve months ended December 31, 2010. Our rent expense of $376,487 for the twelve months ended December 31, 2011, includes $336,265 of rent paid in cash and $40,222 non-cash rent expense, credits and abatements that we recognize on a straight-line basis over the lease term. For the twelve months ended December 31, 2010, we had a loss of $56,540 as a result of abandoning our lease at our former office prior to the end of the lease term that expired in April 2010. Custody fees decreased by $33,662, or 35.1 percent, for the twelve months ended December 31, 2011, as compared with December 31, 2010, owing to the lower fees charged by our new custodian, Union Bank. Realized Income and Losses from Investments: During the years ended December 31, 2012 and 2011, we realized net gains on investments of $2,406,433 and $2,449,705, respectively. During the year ended December 31, 2010, we realized net losses on investments of $3,740,518. The variation in these results is primarily owing to variations in gross realized gains and losses from investments. For the years ended December 31, 2012, and 2011, we realized gains from investments, before taxes, of $2,421,669 and $2,456,627, respectively. For the year ended December 31, 2010, we realized losses from investments, before taxes, of $3,736,057. Income tax expense for the years ended December 31, 2012, 2011, and 2010 was $15,236, $6,922, and $4,461, respectively. 71 During the year ended December 31, 2012, we realized net gains of $2,421,669, consisting primarily of a realized gain of $4,101,673 on the sale of 506,359 shares of Solazyme, Inc., including the sale of 324,000 shares that were called subject to the terms of call option contracts and a realized gain of $1,605,907 on the repurchase and expiration of certain Solazyme and NeoPhotonics Corporation written call option contracts, offset by a realized loss of $4,307,592 on the sale of 400,100 shares of NeoPhotonics that were called subject to the terms of call option contracts. At December 31, 2012, we still owned 1,797,790 shares of Solazyme and 50,807 shares of NeoPhotonics. We had a realized gain of $464,485 on our escrow payment from the sale of Innovalight, Inc., in 2011. We also had realized gains on our escrow payments from the sales of BioVex Group, Inc., and Crystal IS, Inc. During the year ended December 31, 2011, we realized net gains of $2,456,627, consisting primarily of realized gains on our investments in BioVex Group, Inc., of $7,508,365, Crystal IS, Inc., of $120,668, and in Siluria Technologies, Inc., of $25,000, offset by realized losses on our investments in Innovalight, Inc., of $664,880, Molecular Imprints, Inc., of $93,405, Polatis, Inc., of $2,018,278, PolyRemedy, Inc., of $204,206, Questech Corporation of $1,966,591, and in TetraVitae Bioscience, Inc., of $250,000. The realized loss in Molecular Imprints, Inc., was owing to the cashless exercise of the warrant to purchase shares of preferred stock upon its expiration. The cashless exercise resulted in an increase in our ownership of preferred shares as of December 31, 2011. During the year ended December 31, 2010, we realized net losses of $3,736,057, consisting primarily of realized losses on a portion of our investment in Kovio, Inc., of $257,007, on a portion of our investment in Mersana Therapeutics, Inc., of $190,902, in NanoGram Corporation of $3,136,552, in Orthovita, Inc., of $167,300, and realized losses on the disposal of fixed assets, offset by realized gains on our investment in Satcon Technology Corporation of $14,320 and realized gains on the sale of U.S. government securities. The realized losses on our investments in Kovio, Inc., and Mersana Therapeutics, Inc., were owing to the termination and expiration of certain warrants, respectively. The warrant from Kovio, Inc., was terminated pursuant to the terms of the Series A' financing which closed during the second quarter of 2010. The warrant from Mersana Therapeutics, Inc., expired unexercised on October 21, 2010. On July 11, 2010, NanoGram was acquired for an undisclosed amount; holders of common stock did not receive any proceeds from this transaction. During the second quarter of 2010, we received a dividend payment of $13,218 representing our pro rata portion of the residual net proceeds from the liquidation of Optiva, Inc. We had invested in Optiva during 2002, and in 2005, it began liquidation under an assignment for the benefit of creditors. This sum represents the final payment from the liquidation. Net Unrealized Appreciation and Depreciation of Portfolio Securities: During the year ended December 31, 2012, net unrealized appreciation on total investments decreased by $13,589,990. During the year ended December 31, 2011, net unrealized appreciation on total investments increased by $2,347,297. During the year ended December 31, 2010, net unrealized depreciation on total investments decreased by $21,883,175. 72 During the year ended December 31, 2012, net unrealized appreciation on total investments decreased by $13,589,990, or 137.9 percent, from net unrealized appreciation of $9,851,603 at December 31, 2011, to net unrealized depreciation of $3,738,387 at December 31, 2012. During the year ended December 31, 2011, net unrealized appreciation on total investments increased by $2,347,297, or 31.3 percent, from net unrealized appreciation of $7,504,306 at December 31, 2010, to net unrealized appreciation of $9,851,603 at December 31, 2011. During the year ended December 31, 2012, net unrealized appreciation on our venture capital investments decreased by $13,480,234, from net unrealized appreciation of $9,731,603 at December 31, 2011, to net unrealized depreciation of $3,748,631 at December 31, 2012, owing primarily to decreases in the valuations of the following investments held: Investment Amount of Write-Down Solazyme, Inc. 6,524,259 Bridgelux, Inc. 6,121,656 Ancora Pharmaceuticals Inc. 4,330,723 Kovio, Inc. 1,721,913 Mersana Therapeutics, Inc. 1,524,629 ABSMaterials, Inc. 1,434,082 Contour Energy Systems, Inc. 1,279,064 Laser Light Engines, Inc. 1,172,892 HzO, Inc. 732,651 Produced Water Absorbents, Inc. 721,830 Champions Oncology, Inc. 625,107 Senova Systems, Inc. 441,363 Cambrios Technologies Corporation 54,040 SiOnyx, Inc. 50,342 NanoTerra, Inc. 18,861 The write-downs for the year ended December 31, 2012, were offset by write-ups in the valuations of the following investments held: Investment Amount of Write-Up Xradia, Inc. 5,324,907 Nanosys, Inc. 2,453,186 Adesto Technologies Corporation 2,393,372 Nantero, Inc. 1,210,298 Ensemble Therapeutics Corporation 1,077,795 Cobalt Technologies, Inc. 823,029 NeoPhotonics Corporation 563,061 D-Wave Systems, Inc. 450,972 Enumeral Biomedical Corp. 215,342 GEO Semiconductor, Inc. 16,335 OHSO Clean, Inc. 10,742 Metabolon, Inc. 22 73 We had an increase in unrealized appreciation of $37,943 on the rights to milestone payments from Amgen, Inc.'s acquisition of BioVex Group, Inc. We had an increase in unrealized appreciation owing to foreign currency translation of $123,904 on our investment in D-Wave Systems, Inc. We had an increase in unrealized appreciation of $4,141,035 on our investment in NeoPhotonics Corporation owing to realized losses on the sale of its securities. We had a decrease in unrealized appreciation of $5,568,765 on our investment in Solazyme, Inc., owing to realized gains on the sale of its securities. Unrealized appreciation on our U.S. government securities portfolio increased from unrealized appreciation of $0 at December 31, 2011, to $2,744 at December 31, 2012. During the year ended December 31, 2011, net unrealized appreciation on our venture capital investments increased by $2,228,565, from net unrealized appreciation of $7,503,038 at December 31, 2010, to net unrealized appreciation of $9,731,603 at December 31, 2011, owing primarily to increases in the valuations of the following investments held: Investment Amount of Write-Up Solazyme, Inc. $ 4,193,551 Molecular Imprints, Inc. 2,988,447 Bridgelux, Inc. 2,201,705 Metabolon, Inc. 1,979,920 Adesto Technologies Corporation 1,571,117 ABSMaterials, Inc. 1,125,000 Cambrios Technologies Corporation 754,344 Kovio, Inc. 620,397 HzO, Inc. 563,577 GEO Semiconductor, Inc. 86,583 Enumeral Biomedical Corp. 83,333 NanoTerra, Inc. 23,568 74 The write-ups for the year ended December 31, 2011, were offset by write-downs of the following investments held: Investment Amount of Write-Down NeoPhotonics Corporation $ 2,734,461 Xradia, Inc. 2,300,249 Laser Light Engines, Inc. 2,033,591 Mersana Therapeutics, Inc. 1,869,902 Nanosys, Inc. 1,450,495 Ensemble Therapeutics Corporation 1,075,003 Ancora Pharmaceuticals Inc. 952,303 Nantero, Inc. 561,602 Nextreme Thermal Solutions, Inc. 550,657 Cobalt Technologies, Inc. 246,482 Contour Energy Systems, Inc. 206,118 D-Wave Systems, Inc. 67,877 Champions Oncology, Inc. 26,666 SiOnyx, Inc. 8,189 We had an increase in unrealized appreciation for Innovalight, Inc., of $1,489,110, Molecular Imprints, Inc., of $121,527, Polatis, Inc., of $2,018,288, PolyRemedy, Inc., of $312,313, Questech Corporation of $1,632,310, and TetraVitae Bioscience, Inc., of $250,000, owing to realized losses on the sale of these securities. The realized loss on our investment in Molecular Imprints, Inc., was owing to the exercise of certain warrants on December 31, 2011. We had an increase in unrealized appreciation for Crystal IS, Inc., of $1,746,837 owing to a realized gain on the sale of its securities. We had an increase in unrealized appreciation of $71,041 on the rights to milestone payments from Amgen from its acquisition of BioVex in the first quarter of 2011. We had a decrease in unrealized appreciation for BioVex of $7,467,615, which resulted from a realized gain on the sale of its securities. We had a decrease in unrealized appreciation owing to foreign currency translation of $53,193 on our investment in D-Wave Systems, Inc. Unrealized appreciation on our U.S. government securities portfolio decreased from unrealized appreciation of $1,268 at December 31, 2010, to $0 at December 31, 2011. During the year ended December 31, 2010, net unrealized depreciation on our venture capital investments decreased by $21,869,464, or 152.2 percent, from net unrealized depreciation of $14,366,426 at December 31, 2009, to net unrealized appreciation of $7,503,038 at December 31, 2010, owing primarily to increases in the valuations of the following investments held: 75 Investment Amount of Write-Up Solazyme, Inc. $ 10,971,812 BioVex Group, Inc. 9,060,913 Xradia, Inc. 3,555,811 SiOnyx, Inc. 3,076,044 D-Wave Systems, Inc. 1,121,841 Mersana Therapeutics, Inc. 937,882 Ensemble Therapeutics Corporation 500,000 Laser Light Engines, Inc. 118,907 Questech Corporation 72,755 Metabolon, Inc. 58,366 The write-ups for the year ended December 31, 2010, were partially offset by decreases in the valuations of the following investments held: Investment Amount of Write-Down Nextreme Thermal Solutions, Inc. $ 3,854,600 Molecular Imprints, Inc. 2,031,749 Kovio, Inc. 1,750,165 NeoPhotonics Corporation 1,519,991 Innovalight, Inc. 1,241,665 Ancora Pharmaceuticas Inc. 301,573 Nanosys, Inc. 280,649 Bridgelux, Inc. 220,252 TetraVitae Bioscience, Inc. 125,000 PolyRemedy, Inc. 53,893 GEO Semiconductor Inc. 11,830 We had a decrease in unrealized depreciation for Kovio, Inc., of $227,469, and Mersana Therapeutics, Inc., of $171,752, owing to the termination and expiration of certain warrants, respectively. The warrant for Kovio, Inc., was terminated pursuant to the terms of the Series A' financing which closed during the second quarter of 2010. The warrant for Mersana Therapeutics, Inc., expired unexercised on October 21, 2010. We had a decrease in unrealized depreciation for NanoGram Corporation of $3,136,552, which resulted from a realized loss on such investment during the period. On July 11, 2010, NanoGram was acquired for an undisclosed amount. Holders of common stock did not receive any proceeds from this transaction. We had a decrease in unrealized depreciation for Orthovita, Inc., of $72,432 owing to the sale of its securities. 76 We had a decrease in unrealized depreciation owing to foreign currency translation of $178,295 on our investment in D-Wave Systems, Inc. Unrealized depreciation on our U.S. government securities portfolio decreased from unrealized depreciation of $12,443 at December 31, 2009, to unrealized appreciation of $1,268 at December 31, 2010. Financial Condition December 31, 2012 At December 31, 2012, our total assets and net assets were $131,990,250 and $128,436,774, respectively. At December 31, 2011, they were $150,343,653 and $145,698,407, respectively. At December 31, 2012, our net asset value per share was $4.13 as compared with $4.70 at December 31, 2011. At December 31, 2012, our shares outstanding increased to 31,116,881 from 31,000,601 at December 31, 2011, owing to the vesting of 116,280 shares related to restricted stock awards. Significant developments in the twelve months ended December 31, 2012, included a decrease in the holdings of our venture capital investments of $5,046,059 and a decrease in our cash of $11,463,403. The decrease in the value of our venture capital investments from $113,048,250 at December 31, 2011, to $108,002,191 at December 31, 2012, resulted primarily from a decrease in the net value of our venture capital investments of $13,480,234, offset by an increase owing to three new and 27 follow-on investments of $16,511,941. The decrease in our cash and treasury holdings from $33,841,394 at December 31, 2011, to $22,377,991 at December 31, 2012, is primarily owing to the payment of cash for operating expenses of $6,254,427 and to new and follow-on venture capital investments totaling $16,511,941, offset by net proceeds of $7,167,816 received from the sale of certain of our shares of Solazyme, Inc., and NeoPhotonics Corporation, net premium proceeds of $1,640,557 received from certain Solazyme and NeoPhotonics written call option contracts, $953,480 from the portion of our upfront payment held in escrow from the sale of BioVex Group, Inc., to Amgen, Inc., and $11,140 from the portion of our upfront payment held in escrow from the sale of Crystal IS, Inc., to Asahi Kasei Group. The following table is a summary of additions to our portfolio of venture capital investments made during the twelve months ended December 31, 2012: New Investments Amount of Investment AgBiome, LLC (formerly AgInnovation, LLC) $ 2,000,000 OpGen, Inc. 815,000 OhSo Clean, Inc. 720,000 77 Follow-On Investments Amount of Investment OpGen, Inc. $ 2,445,000 Adesto Technologies Corporation 1,393,147 SiOnyx, Inc. 1,255,523 Ancora Pharmaceuticals Inc. 1,000,000 HzO, Inc. 1,000,000 Enumeral Biomedical Corp. 750,000 Senova Systems, Inc. 657,692 Kovio, Inc. 588,000 Contour Energy Systems, Inc. 480,000 D-Wave Systems, Inc. 440,999 Laser Light Engines, Inc. 434,784 NanoTerra, Inc. 650,000 Mersana Therapeutics, Inc. 316,453 Cambrios Technologies Corporation 216,168 Ultora, Inc. 215,000 ABSMaterials, Inc. 200,000 Laser Light Engines, Inc. 186,955 Nantero, Inc. 139,075 Mersana Therapeutics, Inc. 124,542 Ensemble Therapeutics Corporation 109,433 Ultora, Inc. 107,753 Ultora, Inc. 67,821 Ultora, Inc. 64,652 Cobalt Technologies, Inc. 45,097 Nanosys, Inc. 43,821 Cobalt Technologies, Inc. 29,994 Cobalt Technologies, Inc. 15,032 Total $ 16,511,941 December 31, 2011 At December 31, 2011, our total assets and net assets were $150,343,653 and $145,698,407, respectively. At December 31, 2010, they were $149,289,168 and $146,853,912, respectively. At December 31, 2011, our net asset value per share was $4.70 as compared with $4.76 at December 31, 2010. At December 31, 2011, our shares outstanding increased to 31,000,601 from 30,878,164 at December 31, 2010, owing to the exercise of 122,437 options. These options provided $491,058 of cash to the Company. 78 Significant developments in the twelve months ended December 31, 2011, included an increase in the holdings of our venture capital investments of $6,897,828 and decreases in our holdings of U.S. government obligations and cash of $8,190,142. The increase in the value of our venture capital investments from $106,150,422 at December 31, 2010, to $113,048,250 at December 31, 2011, resulted primarily from an increase in the net value of our venture capital investments of $2,228,565 and by five new and 32 follow-on investments of $19,088,903, offset by the sale of our securities in BioVex Group, Inc., Crystal IS, Inc., Innovalight, Inc., Polatis, Inc., PolyRemedy, Inc., Questech Corporation, Siluria Technologies, Inc., and TetraVitae BioScience, Inc. The decrease in the value of our U.S. government obligations and cash from $42,031,536 at December 31, 2010, to $33,841,394 at December 31, 2011, is primarily owing to the payment of cash for operating expenses of $6,323,055 and to new and follow-on venture capital investments totaling $19,088,903, offset by cash received from the sale of our securities in BioVex Group, Inc., Crystal IS, Inc., Innovalight, Inc., Polatis, Inc., PolyRemedy, Inc., Questech Corporation and Siluria Technologies, Inc. The following table is a summary of additions to our portfolio of venture capital investments made during the twelve months ended December 31, 2011: New Investments Amount of Investment Champions Oncology, Inc. $ 2,000,000 HzO, Inc. 1,666,667 Produced Water Absorbents, Inc. 750,000 Senova Systems, Inc. 692,308 Follow-On Investments Amount of Investment Metabolon, Inc. $ 1,499,999 Ancora Pharmaceuticals Inc. 1,300,000 Adesto Technologies Corporation 1,032,058 Kovio, Inc. 892,315 Molecular Imprints, Inc. 866,668 Bridgelux, Inc. 813,805 Contour Energy Systems, Inc. 720,000 Enumeral Biomedical Corp. 650,000 NeoPhotonics Corporation 550,000 Bridgelux, Inc. 538,945 Ancora Pharmaceuticals Inc. 500,000 Molecular Imprints, Inc. 481,482 Adesto Technologies Corporation 445,659 D-Wave Systems, Inc. 337,579 Mersana Therapeutics, Inc. 298,900 Innovalight, Inc. 272,369 Ancora Pharmaceuticals Inc. 200,000 Ancora Pharmaceuticals Inc. 200,000 Laser Light Engines, Inc. 200,000 Innovalight, Inc. 181,579 Ultora, Inc. 150,500 GEO Semiconductor, Inc. 150,000 Cobalt Technologies, Inc. 121,560 Ancora Pharmaceuticals Inc. 100,000 Enumeral Biomedical Corp. 99,999 Laser Light Engines, Inc. 95,652 Laser Light Engines, Inc. 82,609 Ultora, Inc. 63,250 ABSMaterials, Inc. 60,000 Mersana Therapeutics, Inc. 25,000 Mersana Therapeutics, Inc. 25,000 Mersana Therapeutics, Inc. 25,000 Total $ 19,088,903 79 The following tables summarize the values of our portfolios of venture capital investments and U.S. government obligations, as compared with their cost, at December 31, 2012, and December 31, 2011: December 31, 2012 December 31, 2011 Venture capital investments, at cost $ 111,750,822 $ 103,316,647 Net unrealized (depreciation) appreciation(1) (3,748,631 ) 9,731,603 Venture capital investments, at value $ 108,002,191 $ 113,048,250 December 31, 2012 December 31, 2011 U.S. government obligations, at cost $ 13,996,136 $ 0 Net unrealized appreciation(1) 2,744 0 U.S. government obligations, at value $ 13,998,880 $ 0 (1)At December 31, 2012, and December 31, 2011, the net accumulated unrealized (depreciation) appreciation on investments was $3,738,387 and $9,851,603, respectively. 80 Cash Flow Year Ended December 31, 2012 Net cash used in operating activities for the year ended December 31, 2012, was $(23,741,522), primarily reflecting the net purchase of U.S. government securities of $13,993,650, the purchase of venture capital investments of $16,511,941 and the payment of operating expenses, partially offset by proceeds from the sale of investments of $8,132,435 and net proceeds from call options of $1,640,557. Net cash used in investing activities for the year ended December 31, 2012, was $15,922, primarily reflecting the purchase of fixed assets. Cash used in financing activities for the year ended December 31, 2012, was $1,704,839, resulting from the repayment of our credit facility and the net settlement of restricted stock awards. Year Ended December 31, 2011 Net cash provided by operating activities for the year ended December 31, 2011, was $28,111,456, primarily reflecting net proceeds from the sale of U.S. government securities of $38,248,334 and the sale of venture capital investments of $14,547,826, offset by the purchase of venture capital investments of $19,037,403 and the payment of operating expenses. Net cash used in investing activities for the year ended December 31, 2011, was $18,039, primarily reflecting the purchase of fixed assets. Cash provided by financing activities for the year ended December 31, 2011, was $1,991,058, resulting from the exercise of stock options, and proceeds from the drawdown of our credit facility. Year Ended December 31, 2010 Net cash provided by operating activities for the year ended December 31, 2010, was $2,214,531, primarily reflecting proceeds from the sale of U.S. government securities of $17,700,144 and venture capital investments of $408,899, offset by the purchase of venture capital investments of $10,050,721 and the paymentof operating expenses. Net cash used in investing activities for the year ended December 31, 2010, was $89,790, primarily reflecting the purchase of fixed assets. Cash provided by financing activities for the year ended December 31, 2010, was $20,713, resulting from the exercise of stock options, offset by the payment of certain offering costs relating to the public follow-on offering that closed on October 9, 2009. Liquidity and Capital Resources Our liquidity and capital resources are generated and are generally available through our cash holdings, interest earned on our investments on U.S. government securities, cash flows from the sales of U.S. government securities and payments received on our venture debt investments, proceeds from periodic follow-on equity offerings and realized capital gains retained for reinvestment. We fund our day-to-day operations using interest earned and proceeds from our cash holdings, the sales of our investments in U.S. government securities, when applicable, and interest earned from our venture debt securities. We believe the increase or decrease in the value of our venture capital investments does not materially affect the day-to-day operations of the Company or our daily liquidity. As of December 31, 2012, and December 31, 2011, we had no investments in money market mutual funds. 81 We have a $10 million three-year revolving credit facility with TD Bank, N.A. This credit facility is used to fund our venture debt investments and not for the payment of day-to-day operating expenses. As of December 31, 2012, we had no debt outstanding. We have not issued any debt securities, and, therefore, are not subject to credit agency downgrades. As a venture capital company, it is critical that we have capital available to support our best companies until we have an opportunity for liquidity in our investments. As such, we will continue to maintain a substantial amount of liquid capital on our balance sheet. However, to complement our equity-focused portfolio investing, we seek to invest some of this capital in venture debt where we will have more defined investment return timelines than we currently have in our existing portfolio. In addition, we may, from time to time, opt to borrow money to make investments in debt securities that generate cash flow and have a known timeframe for return on investment. Except for a rights offering, we are also generally not able to issue and sell our common stock at a price below our net asset value per share, exclusive of any distributing commission or discount, without shareholder approval. As of December 31, 2012, our net asset value was $4.13 per share and our closing market price was $3.30 per share. We do not currently have shareholder approval to issue or sell shares below our net asset value per share. December 31, 2012 At December 31, 2012, and December 31, 2011, our total net primary and secondary liquidity was $38,231,691 and $65,368,303, respectively. At December 31, 2012, and December 31, 2011, our total net primary liquidity was $22,461,202 and $33,910,442, respectively. Our primary liquidity is principally comprised of our cash, U.S. government securities, when applicable, and certain receivables. The decrease in our primary liquidity from December 31, 2011, to December 31, 2012, is primarily owing to the use of funds for investments and payment of net operating expenses, offset by the receipt of $953,480 from the portion of our upfront payment held in escrow from the sale of BioVex Group, Inc., to Amgen, Inc., which was released on March 16, 2012, the receipt of $11,140 from the portion of our upfront payment held in escrow from the sale of Crystal IS, Inc., to Asahi Kasei Group, which was released on April 30, 2012, and $7,167,816 received from the net sales of portions of our shares of Solazyme, Inc., and NeoPhotonics Corporation. During the year ended December 31, 2012, we also purchased and sold call option contracts on our publicly traded positions generating net premiums of $1,640,253. 82 At December 31, 2012, and December 31, 2011, our secondary liquidity was $15,770,488 and $31,457,861, respectively. Our secondary liquidity consists of our publicly traded securities. Although these companies are publicly traded, their stock may not trade at high volumes and prices can be volatile, which may restrict our ability to sell our positions at any given time. We may also be restricted for a period of time in selling our positions in these companies due to our shares being unregistered. As of December 31, 2012, none of our publicly traded securities were restricted from sale. We do not include funds held in escrow from the sale of investments in primary or secondary liquidity. These funds will become primary liquidity if and when they are received at the expiration of the escrow period. On January 24, 2013, we received proceeds of $949,468 from the release of the Innovalight escrow. We believe that the current and future venture capital environment may adversely affect the valuation of investment portfolios, lead to tighter lending standards and result in reduced access to capital. These conditions may lead to a decline in net asset value and/or decline in valuations of our portfolio companies in future quarters. Although we cannot predict future market conditions, we continue to believe that our current cash and U.S. government security holdings and our ability to adjust our investment pace will provide us with adequate liquidity to execute our current business strategy. On January 21, 2010, we moved our corporate headquarters from 111 West 57th Street in New York City to 1450 Broadway in New York City. The lease and sublease for our offices at 111 West 57th Street expired on April 17, 2010 and on April 29, 2010, respectively. Total rent expense for the office space at 111 West 57th Street was $57,951 in 2010. Our rent expense in 2010 of $57,951 included $47,094 of real estate tax escalation charges from 2003 to 2010 paid on the office space at 111 West 57th Street. On September 24, 2009, we signed a ten-year lease for approximately 6,900 square feet of office space located at 1450 Broadway, New York, New York. The lease commenced on January 21, 2010, with these offices replacing our corporate headquarters previously located at 111 West 57thStreet in New York City. The base rent is $36 per square foot with a 2.5 percent increase per year over the 10 years of the lease, subject to a full abatement of rent for four months and a rent credit for six months throughout the lease term. The lease expires on December 31, 2019. Total rent expense for this office space in New York City was $238,202 in 2012, $230,302 in 2011 and $215,319 in 2010. Future minimum lease payments in each of the following years are: 2013 - $244,857; 2014 - $250,979; 2015 - $280,673; 2016 - $287,690; 2017 - $294,882; and thereafter for the remaining term - an aggregate of $612,065. On July 1, 2008, we signed a five-year lease for office space at 420 Florence Street, Suite 200, Palo Alto, California, commencing on August 1, 2008, and expiring on August 31, 2013. Total rent expense for this office space in Palo Alto was $136,816 in 2012, $132,831 in 2011, and $128,962 in 2010. Future minimum lease payments in 2013 are $93,135. 83 On April 26, 2011, we signed a one-year lease for office space at 530 Lytton Avenue, 2nd Floor, Palo Alto, California, commencing on July 1, 2011, and expiring on June 30, 2012. The lease was renewed commencing on July 1, 2012, and expiring on June 30, 2013. Total rent expense for this office space in Palo Alto was $28,916 in 2012 and $13,354 in 2011. Future minimum lease payments in 2013 are $14,380. On March 22, 2012, we signed a one-year lease for office space at 140 Preston Executive Drive, Space "L," Cary, North Carolina, commencing on April 1, 2012, and expiring on March 31, 2013. The lease was renewed commencing on April 1, 2013, and expiring on March 31, 2014. Total rent expense for this office space in Cary was $4,725 in 2012. Future minimum lease payments in 2013 and 2014 are $6,442 and 1,622, respectively. December 31, 2011 At December 31, 2011, and December 31, 2010, our total net primary and secondary liquidity was $65,368,303 and $42,079,934, respectively. At December 31, 2011, and December 31, 2010, our total net primary liquidity was $33,910,442 and $42,079,934, respectively. Our primary liquidity is principally comprised of our cash, U.S. government securities, when applicable, and certain receivables. The decrease in our primary liquidity from December 31, 2010, to December 31, 2011, is primarily owing to the use of funds for investments and payment of net operating expenses, offset by the proceeds received from thesale of investments. At December 31, 2011, and December 31, 2010, our secondary liquidity was $31,457,861 and $0, respectively. Our secondary liquidity consists of our publicly traded securities. Although these companies are publicly traded, their stock may not trade at high volumes and prices can be volatile, which may restrict our ability to sell our positions at any given time. We may also be restricted for a period of time in selling our positions in these companies due to our shares being unregistered. As of December 31, 2011, none of our publicly traded securities were restricted from sale. We do not include funds held in escrow from the sale of investments in primary or secondary liquidity. These funds will become primary liquidity if and when they are received at the expiration of the escrow period. Borrowings On February 24, 2011, we established a $10 million three-year revolving credit facility with TD Bank, N.A., to be used in conjunction with our venture debt investments. 84 The credit facility, among other things, matures on February 24, 2014, and generally bears interest, at the Company's option, based on (i) LIBOR plus 1.25 percent or (2) the higher of the federal funds rate plus fifty basis points (0.50 percent) or the U.S. prime rate as published in the Wall Street Journal. The credit facility generally requires payment of interest on a monthly basis and requires the payment of a non-use fee of 0.15 percent annually. All outstanding principal is due upon maturity. The credit facility is secured by cash collateral to be held in a non-interest bearing account at TD Bank, N.A. The credit facility contains affirmative and restrictive covenants, including: (a) periodic financial reporting requirements, (b) maintaining our status as a BDC (c) maintaining unencumbered, liquid assets of not less than $7,500,000, (d) limitations on the incurrence of additional indebtedness, (e) limitations on liens, and (f) limitations on mergers and dissolutions. The credit facility is used to supplement our capital to make additional venture debt investments. The Company's outstanding debt balance at December 31, 2012, and December 31, 2011, was $0 and $1,500,000, respectively. The annual weighted average interest cost for the twelve months ended December 31, 2012, was 1.6 percent, exclusive of amortization of closing fees and other expenses related to establishing the credit facility. The remaining capacity under the credit facility was $10,000,000 at December 31, 2012. At December 31, 2012, the Company was in compliance with all financial covenants required by the credit facility. Contractual Obligations A summary of our significant contractual payment obligations is as follows: Payments Due by Period Less than More Than Total 1 Year 1-3 Years 3-5 Years 5 YearsRevolving credit facility(1) $ 0 $ 0 $ 0 $ 0 $ 0 Operating leases $ 2,086,725 $ 358,814 $ 533,274 $ 582,572 $ 612,065 As of December 31, 2012, we had $10,000,000 of unused borrowing capacity under our credit facility. Critical Accounting Policies The Company's significant accounting policies are described in Note 2 to the Consolidated Financial Statements and in the Footnote to the Consolidated Schedule of Investments. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and those that require management's most difficult, complex or subjective judgments. The Company considers the following accounting policies and related estimates to be critical: Valuation of Portfolio Investments The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded. As a BDC, we invest in primarily illiquid securities that generally have no establishedtrading market. 85 Investments are stated at "value" as defined in the 1940 Act and in the applicable regulations of the SEC and U.S. GAAP. ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820 provides a consistent definition of fair value that focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. ASC 820 also establishes the following three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. · Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; · Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs are in those markets for which there are few transactions, the prices are not current, little public information exists or instances where prices vary substantially over time or among brokered market makers; and · Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those inputs that reflect our own assumptions that market participants would use to price the asset or liability based upon the best available information. See "Note 5. Fair Value of Investments" in the accompanying notes to our Consolidated Financial Statements for additional information regarding fair value measurements. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) the fair value as determined in good faith by, or under the direction of, the Board of Directors for all other assets. (See "Valuation Procedures" in the "Footnote to Consolidated Schedule of Investments.") As of December 31, 2012, our financial statements include venture capital investments valued at $93,579,930, the fair values of which were determined in good faith by, or under the direction of, the Board of Directors. As of December 31, 2012, approximately 72.9 percent of our net assets represent investments in portfolio companies at fair value by the Board of Directors. Determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment, although our valuation policy is intended to provide a consistent basis for determining fair value of the portfolio investments. Factors that may be considered include, but are not limited to, the cost of the Company's investment; transactions in the portfolio company's securities or unconditional firm offers by responsible parties; the financial condition and operating results of the company; the long-term potential of the business and technology of the company; the values of similar securities issued by companies in similar businesses; multiples to revenues, net income or EBITDA that similar securities issued by companies in similar businesses receive; the proportion of the company's securities we own and the nature of any rights to require the company to register restricted securities under the applicable securities laws; management's assessment of non-performance risk; the achievement of milestones; discounts for restrictions on transfers of publicly traded securities; and the rights and preferences of the class of securities we own as compared with other classes of securities the portfolio has issued. 86 In addition, with respect to our debt investments for which no readily available market quotations are available, we will generally consider the financial condition and current and expected future cash flows of the portfolio company; the creditworthiness of the portfolio company and its ability to meet its current debt obligations; the relative seniority of our debt investment within the portfolio company's capital structure; the availability and value of any available collateral; and changes in market interest rates and credit spreads for similar debt investments. Historically, difficult venture capital environments have resulted in companies not receiving financing and being subsequently closed down with a loss of investment to venture investors, and other companies receiving financing but at significantly lower valuations than the preceding rounds, leading to very deep dilution for those who do not participate in the new rounds of investment. Our best estimate of this non-performance risk has been quantified and included in the valuation of our portfolio companies as of December 31, 2012. All investments recorded at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels related to the amount of subjectivity associated with the inputs to fair valuation of these assets, are as follows: · Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities. · Level 2: Quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. · Level 3: Unobservable inputs for the asset or liability. As of December 31, 2012, approximately 87 percent of our portfolio company investments were classified as Level 3 in the hierarchy, indicating a high level of judgment required in their valuation. The values assigned to our assets are based on available information and do not necessarily represent amounts that might ultimately be realized, as these amounts depend on future circumstances and cannot be reasonably determined until the individual investments are actually liquidated or become readily marketable. Upon sale of investments, the values that are ultimately realized may be materially different from what is presently estimated. Stock-Based Compensation Determining the appropriate fair-value model and calculating the fair value of share-based awards on the date of grant requires judgment. Historically, we have used the Black-Scholes-Merton option pricing model to estimate the fair value of employee stock options. 87 Management uses the Black-Scholes-Merton option pricing model in instances where we lack historical data necessary for more complex models and when the share award terms can be valued within the model. Other models may yield fair values that are significantly different from those calculated by the Black-Scholes-Merton option pricing model. Management uses a binomial lattice option pricing model in instances where it is necessary to include a broader array of assumptions. We used the binomial lattice model for the 10-year NQSOs granted on March 18, 2009, and for performance-based restricted stock awards. These awards included accelerated vesting provisions or target stock prices that were based on market conditions. Option pricing models require the use of subjective input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. Variations in the expected volatility or expected term assumptions have a significant impact on fair value. As the volatility or expected term assumptions increase, the fair value of the stock option increases. The expected dividend rate and expected risk-free rate of return are not as significant to the calculation of fair value. A higher assumed dividend rate yields a lower fair value, whereas higher assumed interest rates yield higher fair values for stock options. In the Black-Scholes-Merton model, we use the simplified calculation of expected term as described in the SEC's Staff Accounting Bulletin 107 because of the lack of historical information about option exercise patterns. In the binomial lattice model, we use an expected term that assumes the options will be exercised at two-times the strike price because of the lack of option exercise patterns. Future exercise behavior could be materially different than thatwhich is assumed by the model. Expected volatility is based on the historical fluctuations in the Company's stock. The Company's stock has historically been volatile, which increases the fair value of the underlying share-based awards. GAAP requires us to develop an estimate of the number of share-based awards that will be forfeited owing to employee turnover. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported share-based compensation, as the effect of adjusting the rate for all expense amortization after the grant date is recognized in the period the forfeiture estimate is changed. If the actual forfeiture rate proves to be higher than the estimated forfeiture rate, then an adjustment will be made to increase the estimated forfeiture rate, which would result in a decrease to the expense recognized in the financial statements. If the actual forfeiture rate proves to be lower than the estimated forfeiture rate, then an adjustment will be made to decrease the estimated forfeiture rate, which would result in an increase to the expense recognized in the financial statements. Such adjustments would affect our operating expenses and additional paid-in capital, but would have no effecton our net asset value. 88 Pension and Post-Retirement Benefit Plan Assumptions The Company provides a Retiree Medical Benefit Plan for employees who meet certain eligibility requirements. Until it was terminated on May 5, 2011, the Company also provided an Executive Mandatory Retirement Benefit Plan for certain individuals employed by us in a bona fide executive or high policy-making position. Our former President accrued benefits under this plan prior to his retirement, and the termination of the plan has no impact on his accrued benefits. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense and liability values related to our post-retirement benefit plans. These factors include assumptions we make about the discount rate, the rate of increase in healthcare costs, and mortality, among others. The discount rate reflects the current rate at which the post-retirement medical benefit and pension liabilities could be effectively settled considering the timing of expected payments for plan participants. In estimating this rate, we consider the Citigroup Pension Liability Index in the determination of the appropriate discount rate assumptions. The weighted average rate we utilized to measure our post retirement medical benefit obligation as of December 31, 2012, and to calculate our 2013 expense was 4.25 percent. We used a discount rate of 2.75 percent to calculate our pension obligation for the Executive Mandatory Retirement Benefit Plan. Recent Developments - Portfolio Companies In January 2013, we closed our written call option position in NeoPhotonics Corporation, expiring on February 16, 2013, for a payment of $4,747. In January 2013, we also sold 508 written call option contracts on NeoPhotonics expiring in February 2013, with a strike price of $5.00. We received premiums of approximately $28,893 for these contracts. In January 2013 and February 2013, we sold 50,807 shares of NeoPhotonics for net proceeds of approximately $252,042. We no longer hold any shares of NeoPhotonics. In January and February 2013, we sold 1,513 written call option contracts on Solazyme, Inc., expiring in February 2013, with a strike price of $7.50. We received premiums of approximately $55,467 for these contracts. We also purchased put options on Solazyme expiring in February 2013 with a strike price of $7.50. We paid premiums of approximately $53,840. In January 2013, we sold 1,000 written call option contracts on Solazyme, Inc., expiring in March 2013, with a strike price of $7.50. We received premiums of approximately $89,088 for these contracts. In February 2013, we were assigned on a total of 182,800 shares of Solazyme, Inc., relating to the February and March 2013 written call option contracts. We received net proceeds of approximately $1,365,053 related to these sales. In January and February 2013, we sold 1,900 written call option contracts on Solazyme, Inc., expiring in June 2013, with a strike price of $10.00. We received premiums of approximately $68,798 for these contracts. 89 On January 17, 2013, the Company made a $672,000 follow-on investment in a privately held portfolio company. On January 23, 2013, the Company made a $350,000 follow-on investment in Ancora Pharmaceuticals Inc., a privately held portfolio company. On January 24, 2013, we received $949,468 upon the release of funds held in escrow from the acquisition of Innovalight, Inc., by DuPont in 2011. On January 28, 2013, the Company made a $200,000 follow-on investment in Champions Oncology, Inc., a publicly traded portfolio company. On March 11, 2013, the Company made a $28,920 follow-on investment in a privately held portfolio company. On March 12, 2013, the Company made a $350,000 follow-on investment in Nano Terra, Inc., a privately held portfolio company. [ Back To TMCnet.com's Homepage ]