| ARES CAPITAL CORP Item 1A Risk Factors RISK FACTORS THAT MAY AFFECT FUTURE RESULTS We are a new company with a limited operating history |
| We were incorporated in April 2004, completed our initial public offering in October 2004 and have a limited operating history |
| We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objectives and that the value of our common stock could decline substantially |
| 18 ______________________________________________________________________ Our investment adviser and the members of its investment committee have limited experience managing a BDC The 1940 Act imposes numerous constraints on the operations of business development companies |
| For example, business development companies are required to invest at least 70prca of their total assets primarily in securities of private or thinly traded US public companies, cash, cash equivalents, US government securities and other high quality debt investments that mature in one year or less |
| Our investment adviser and the majority of the members of our senior management only have limited experience managing or providing management consultant services to an operating company, such as may be required of a BDC Our investment adviser’s and the members of its investment committee’s lack of experience in managing a portfolio of assets under such constraints may hinder their ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objectives |
| A failure on our part to maintain our status as a BDC would significantly reduce our operating flexibility |
| If we do not continue to qualify as a BDC, we might be regulated as a closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility |
| The Company may not replicate Ares’ historical success |
| Our primary focus in making investments differs from those of other private funds that are or have been managed by Ares’ investment professionals |
| Further, our stockholders do not have an interest in other Ares funds |
| While Ares Capital may consider potential co-investment participation in portfolio investments with other Ares funds (other than ACOF), no investment opportunities are currently under consideration and any such investment activity could be subject to, among other things, regulatory and independent board member approvals, the receipt of which, if sought, cannot be assured |
| Accordingly, we cannot assure you that Ares Capital will replicate Ares’ historical success, and we caution you that our investment returns could be substantially lower than the returns achieved by those private funds |
| We are dependent upon Ares Capital Management’s key personnel for our future success and upon their access to Ares investment professionals |
| We depend on the diligence, skill and network of business contacts of the members of Ares Capital Management’s investment committee |
| We also depend, to a significant extent, on Ares Capital Management’s access to the investment professionals of Ares and the information and deal flow generated by Ares’ investment professionals in the course of their investment and portfolio management activities |
| Our future success will depend on the continued service of Ares Capital Management’s investment committee |
| The departure of any of the members of Ares Capital Management’s investment committee, or of a significant number of the investment professionals or partners of Ares, could have a material adverse effect on our ability to achieve our investment objectives |
| In addition, we cannot assure you that Ares Capital Management will remain our investment adviser or that we will continue to have access to Ares’ investment professionals or its information and deal flow |
| Our financial condition and results of operation will depend on our ability to manage future growth effectively |
| Our ability to achieve our investment objectives depends on our ability to acquire suitable investments and monitor and administer those investments, which depends, in turn, on Ares Capital Management’s ability to identify, invest in and monitor companies that meet our investment criteria |
| Accomplishing this result on a cost-effective basis is largely a function of Ares Capital Management’s structuring of the investment process and its ability to provide competent, attentive and efficient services to us |
| Our executive officers and the members of Ares Capital Management have substantial responsibilities in connection with their roles at Ares and with the other Ares funds as well as responsibilities under the investment advisory 19 ______________________________________________________________________ and management agreement |
| They may also be called upon to provide managerial assistance to our portfolio companies on behalf of our administrator |
| These demands on their time, which will increase as the number of investments grow, may distract them or slow the rate of investment |
| In order to grow, Ares Capital Management will need to hire, train, supervise and manage new employees |
| However, we cannot assure you that any such employees will be retained |
| Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations |
| Our ability to grow will depend on our ability to raise capital |
| We will need to periodically access the capital markets to raise cash to fund new investments |
| Unfavorable economic conditions could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us |
| An inability to successfully access the capital markets could limit our ability to grow our business and fully execute our business strategy and could decrease our earnings, if any |
| With certain limited exceptions, we are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200prca after such borrowing |
| The amount of leverage that we employ will depend on our investment adviser’s and our board of directors’ assessment of market and other factors at the time of any proposed borrowing |
| We cannot assure you that we will be able to maintain our current Facilities or obtain another line of credit at all or on terms acceptable to us |
| We operate in a highly competitive market for investment opportunities |
| A number of entities compete with us to make the types of investments that we make in middle market companies |
| We compete with other business development companies, public and private funds, commercial and investment banks, commercial financing companies, insurance companies, high yield investors, hedge funds, and, to the extent they provide an alternative form of financing, private equity funds |
| Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do |
| Some competitors may have a lower cost of funds and access to funding sources that are not available to us |
| In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us |
| Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act will impose on us as a BDC We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations |
| Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we cannot assure you that we will be able to identify and make investments that meet our investment objectives |
| We do not seek to compete primarily based on the interest rates we offer and we believe that some of our competitors may make loans with interest rates that will be comparable to or lower than the rates we offer |
| We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure |
| If we match our competitors’ pricing, terms and structure, we may experience decreased net interest income and increased risk of credit loss |
| As a result of operating in such a competitive environment, we may make investments that are on better terms to our portfolio companies than what we may have originally anticipated, which may impact our return on these investments |
| We will be subject to corporate-level income tax if we are unable to qualify as a RIC To qualify as a RIC under the Code, we must meet certain income source, asset diversification and annual distribution requirements |
| The annual distribution requirement for a RIC is satisfied if we distribute to our stockholders on a timely basis an amount equal to at least 90prca of our ordinary income and realized net short-term capital 20 ______________________________________________________________________ gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses, for each year |
| Because we may use debt financing in the future, we may be subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan agreements that could, under certain circumstances, restrict us from making distributions necessary to qualify as a RIC If we are unable to obtain cash from other sources, we may fail to qualify as a RIC and, thus, may be subject to corporate-level income tax |
| To qualify as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter |
| Failure to meet these tests may result in our having to (i) dispose of certain investments quickly or (ii) raise additional capital to prevent the loss of RIC status |
| If we fail to qualify as a RIC for any reason and become or remain subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions |
| Such a failure would have a material adverse effect on us and our stockholders |
| We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income |
| For federal income tax purposes, we include in income certain amounts that we have not yet received in cash, such as original issue discount, which may arise if we receive warrants in connection with the making of a loan or possibly in other circumstances, or contracted payment-in-kind interest, which represents contractual interest added to the loan balance and due at the end of the loan term |
| Such original issue discount or increases in loan balances are included in income before we receive any corresponding cash payments |
| We also may be required to include in income certain other amounts that we will not receive in cash, including, for example, non-cash income from pay-in-kind securities and deferred payment securities |
| Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the tax requirement to distribute an amount equal to at least 90prca of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses, to maintain our status as a RIC Accordingly, we may have to sell some of our investments at times we would not consider advantageous, raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements |
| If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously used in the calculation of the incentive fee will become uncollectible |
| The investment adviser is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never receive as a result of a default by an entity on the obligation that resulted in the accrual of such income |
| Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital |
| We may issue debt securities or preferred stock, which we refer to collectively as ‘‘senior securities,’’ and borrow money from banks or other financial institutions up to the maximum amount permitted by the 1940 Act |
| Under the provisions of the 1940 Act, we will be permitted, as a BDC, to incur indebtedness or issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200prca after such incurrence or issuance |
| If the value of our assets declines, we may be unable to satisfy this test, which would prohibit us from paying dividends and could prevent us from maintaining our status as a RIC If we cannot satisfy this test, we may be required to sell a portion of our investments and, 21 ______________________________________________________________________ depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous |
| As of December 31, 2005, our asset coverage for senior securities was 3cmam265prca |
| We are not generally able to issue and sell our common stock at a price below net asset value per share |
| We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current net asset value of the common stock if our board of directors determines that such sale is in our best interests and the best interests of our stockholders, and our stockholders approve such sale |
| In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities (less any commission or discount) |
| If our common stock trades at a discount to net asset value, this restriction could adversely affect our ability to raise capital |
| In addition, we may seek to securitize our loans to generate cash for funding new investments |
| To securitize loans, we may create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary |
| This could include the sale of interests in the subsidiary on a non-recourse basis to purchasers who we would expect to be willing to accept a lower interest rate to invest in investment grade loan pools, and we would retain a portion of the equity in the securitized pool of loans |
| An inability to successfully securitize our loan portfolio could limit our ability to grow our business, fully execute our business strategy and decrease our earnings, if any |
| The securitization market is subject to changing market conditions and we may not be able to access this market when we would otherwise deem appropriate |
| Moreover, the successful securitization of our loan portfolio might expose us to losses as the residual loans in which we do not sell interests will tend to be those that are riskier and more apt to generate losses |
| The 1940 Act may also impose restrictions on the structure of any securitization |
| If our primary investments are deemed not to be qualifying assets, we could lose our status as a BDC or be precluded from investing according to our current business plan |
| If we are to maintain our status as a BDC, we must not acquire any assets other than ‘‘qualifying assets’’ unless, at the time of and after giving effect to such acquisition, at least 70prca of our total assets are qualifying assets |
| If we acquire senior loans, mezzanine investments or equity securities from an issuer that has outstanding marginable securities at the time we make an investment, these acquired assets may not be treated as qualifying assets |
| This results from the definition of ‘‘eligible portfolio company’’ under the 1940 Act, which in part looks to whether a company has outstanding marginable securities |
| Amendments promulgated in 1998 by the Board of Governors of the Federal Reserve System to Regulation T under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’), expanded the definition of marginable security to include any non-equity security |
| These amendments have raised questions as to whether a private company that has outstanding debt would qualify as an eligible portfolio company |
| We believe that the senior loans and mezzanine investments that we acquire should constitute qualifying assets because the privately held issuers will not, at the time of our investment, have outstanding marginable securities for the reasons set forth in this paragraph |
| First, we make a large portion of our investments in companies that, to the extent they have any outstanding debt, have issued such debt on terms and in circumstances such that such debt should not, under existing legal precedent, be ‘‘securities’’ under the Exchange Act and therefore should not be deemed marginable securities under Regulation T Second, we believe that, should a different position be taken such that those investments may be securities, they should still not be marginable securities |
| In particular, debt that does not trade in a public secondary market or is not rated investment grade is generally not a margin eligible security under the rules established by the self-regulatory organizations, including the New York Stock Exchange and National Association of Securities Dealers, that govern the terms on which broker-dealers may extend margin credit |
| Unless the questions raised by the amendments to Regulation T have been addressed by legislative, administrative or judicial action that contradicts our interpretation, we intend to treat as 22 ______________________________________________________________________ qualifying assets only those senior loans and mezzanine investments that, at the time of our investment, are issued by an issuer that does not have outstanding a class of margin eligible securities |
| Likewise, we will treat equity securities issued by a portfolio company as qualifying assets only if such securities are issued by a company that has no margin eligible securities outstanding at the time we purchase such securities |
| If there were a court ruling or regulatory decision that conflicts with our interpretations, we could lose our status as a BDC or be precluded from investing in the manner described in this Annual Report, either of which would have a material adverse effect on our business, financial condition and results of operations |
| Such a ruling or decision also may require that we dispose of investments that we made based on our interpretation of Regulation T Such dispositions could have a material adverse effect on us and our stockholders |
| We may need to dispose of such investments quickly, which would make it difficult to dispose of such investments on favorable terms |
| In addition, because these types of investments will generally be illiquid, we may have difficulty in finding a buyer and, even if we do find a buyer, we may have to sell the investments at a substantial loss |
| On November 1, 2004, the Securities and Exchange Commission proposed for comment two new rules under the 1940 Act that are designed to realign the definition of eligible portfolio company set forth under the 1940 Act, and the investment activities of BDCs, with their original purpose by (1) defining eligible portfolio company with reference to whether an issuer has any class of securities listed on a national securities exchange or on an automated interdealer quotation system of a national securities association (‘‘NASDAQ’’) and (2) permitting BDCs to make certain additional (‘‘follow-on’’) investments in those issuers even after they list their securities on a national securities exchange or on NASDAQ The proposed rules are intended to expand the definition of eligible portfolio company in a manner that would promote the flow of capital to small, developing and financially troubled companies |
| We cannot assure you that these rules, or related rules arising out of the comment process, will be approved by the Securities and Exchange Commission |
| Until the Securities and Exchange Commission or its staff has issued final rules with respect to the issue discussed above, we will continue to monitor this issue closely, and may be required to adjust our investment focus to comply with and/or take advantage of any future administrative position, judicial decision or legislative action |
| We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing with us |
| As of December 31, 2005, we had dlra18 million of outstanding borrowings under our Facilities |
| In order for us to cover our annual interest payments on indebtedness, we must achieve annual returns on our December 31, 2005 total assets of at least 0dtta13prca |
| The interest rate charged on our borrowings as of December 31, 2005 was 5dtta0723prca |
| We intend to continue borrowing under the Facilities in the future and we may increase the size of the Facilities or otherwise issue debt securities or other evidences of indebtedness in the future |
| Our ability to service our debt depends largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures |
| The amount of leverage that we employ at any particular time will depend on our investment adviser’s and our board of directors’ assessment of market and other factors at the time of any proposed borrowing |
| Our Facilities impose financial and operating covenants that restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a regulated investment company under Subchapter M of the Internal Revenue Code |
| A failure to renew our Facilities, or to add new or replacement debt facilities could have a material adverse effect on our business, financial condition and results of operations |
| Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities |
| We currently borrow under our 23 ______________________________________________________________________ Facilities and in the future may borrow from or issue senior debt securities to banks, insurance companies, and other lenders |
| Lenders of senior securities have fixed dollar claims on our consolidated assets that are superior to the claims of our common stockholders |
| If the value of our consolidated assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not leveraged |
| Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged |
| Similarly, any increase in our consolidated income in excess of consolidated interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our consolidated income would cause net income to decline more sharply than it would have had we not borrowed |
| Such a decline could negatively affect our ability to make common stock dividend payments |
| There is no assurance that a leveraging strategy will be successful |
| The following table illustrates the effect on return to a holder of our common stock of the leverage created by our use of borrowing at the interest rate of 5dtta0723prca and assumes (i) our total value of net assets as of December 31cmam2005; (ii)dlra18cmam000cmam000 debt outstanding as of December 31, 2005 and (iii) hypothetical annual returns on our portfolio of minus 15 to plus 15 percent |
| Assumed Return on Portfolio (Net of Expenses)(1) -15dtta0 % -10dtta0 % -5dtta0 % — 5dtta0 % 10dtta0 % 15dtta0 % Corresponding Return to Common Stockholders(2) -16dtta3 % -10dtta9 % -5dtta6 % -0dtta2 % 5dtta2 % 10dtta6 % 16dtta0 % _________________________________________________________________ (1) The assumed portfolio return based on Securities and Exchange Commission regulations and is not a prediction of, and does not represent, our projected or actual performance |
| (2) In order to compute the ‘‘Corresponding Return to Common Stockholders,’’ the ‘‘Assumed Return on Portfolio’’ is multiplied by the total value of our assets at December 31, 2005 to obtain an assumed return to us |
| From this amount, the interest expense calculated by multiplying the interest rate of 5dtta0723prca times the dlra18cmam000cmam000 debt is subtracted to determine the return available to stockholders |
| The return available to stockholders is then divided by the total value of our net assets as of December 31, 2005 to determine the ‘‘Corresponding Return to Common Stockholders |
| ’’ We will be exposed to risks associated with changes in interest rates |
| General interest rate fluctuations may have a substantial negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on investment objectives and our rate of return on invested capital |
| Because we borrow money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds |
| As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income |
| Trading prices for debt that pays a fixed rate of return tend to fall as interest rates rise |
| Trading prices tend to fluctuate more for fixed-rate securities that have longer maturities |
| Although we have no policy governing the maturities of our investments, under current market conditions we expect that we will invest in a portfolio of debt generally having maturities of up to 10 years |
| This means that we will be subject to greater risk (other things being equal) than a fund invested solely in shorter-term securities |
| A decline in the prices of the debt we own could adversely affect the trading price of our shares |
| 24 ______________________________________________________________________ Many of our portfolio investments are not publicly traded and, as a result, there will be uncertainty as to the value of our portfolio investments |
| A large percentage of our portfolio investments are not publicly traded |
| The fair value of investments that are not publicly traded may not be readily determinable |
| We value these investments quarterly at fair value as determined in good faith by our board of directors |
| However, we may be required to value our investments more frequently as determined in good faith by our board of directors to the extent necessary to reflect significant events affecting their value |
| Where appropriate, our board of directors may utilize the services of an independent valuation firm to aid it in determining fair value |
| The types of factors that may be considered in valuing our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow and other relevant factors |
| Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these investments existed |
| Our net asset value could be adversely affected if our determinations regarding the fair value of our investments are materially higher than the values that we ultimately realize |
| The lack of liquidity in our investments may adversely affect our business |
| We generally make investments in private companies |
| Substantially all of these investments will be subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities |
| The illiquidity of our investments may make it difficult for us to sell such investments if the need arises |
| In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments |
| In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we or an affiliated manager of Ares has material non-public information regarding such portfolio company |
| We may experience fluctuations in our quarterly results |
| We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on the debt investments we make, the default rate on such investments, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses and the degree to which we encounter competition in our markets and general economic conditions |
| As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods |
| There are significant potential conflicts of interest that could impact our investment returns |
| Certain of our executive officers and directors, and members of the investment committee of our investment adviser serve or may serve as officers, directors or principals of other entities and affiliates of our adviser and investment funds managed by our affiliates |
| Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders or that may require them to devote time to services for other entities, which could interfere with the time available to provide services to us |
| Ressler, Rosenthal, Kissick and Sachs each are and, will continue to be, founding members of Ares with significant responsibilities for other Ares funds |
| Ressler and Mr |
| Ressler, Rosenthal and Kissick relative to Ares Capital and ACOF are synergistic with and beneficial to the affairs of each of Ares Capital and ACOF 25 ______________________________________________________________________ Although other Ares funds generally have different primary investment objectives than Ares Capital, they may from time to time invest in asset classes similar to those targeted by Ares Capital |
| Ares Capital Management endeavors to allocate investment opportunities in a fair and equitable manner, and in any event consistent with any fiduciary duties owed to Ares Capital |
| Nevertheless, it is possible that we may not be given the opportunity to participate in certain investments made by investment funds managed by investment managers affiliated with Ares Capital Management |
| We pay management and incentive fees to Ares Capital Management, and reimburse Ares Capital Management for certain expenses it incurs |
| As a result, investors in our common stock will invest on a ‘‘gross’’ basis and receive distributions on a ‘‘net’’ basis after expenses, resulting in, among other things, a lower rate of return than one might achieve through direct investments |
| Ares Capital Management’s management fee is based on a percentage of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds) and Ares Capital Management may have conflicts of interest in connection with decisions that could affect the Company’s total assets, such as decisions as to whether to incur debt |
| The incentive fees payable to our investment adviser are subject to certain hurdles |
| To the extent we or Ares Capital Management are able to exert influence over our portfolio companies, these hurdles may provide Ares Capital Management (subject to its fiduciary duty to us) with an incentive to induce our portfolio companies to accelerate or defer interest or other obligations owed to us from one calendar quarter to another under circumstances where accrual would not otherwise occur, such as acceleration or deferral of the declaration of a dividend or the timing of a voluntary redemption |
| Acceleration of obligations may result in stockholders recognizing taxable gains earlier than anticipated, while deferral of obligations creates incremental risk of an obligation becoming uncollectible in whole or in part if the issuer of the security suffers subsequent deterioration in its financial condition |
| Any such inducement by the investment adviser solely for the purpose of adjusting the incentive fees would be a breach of the investment adviser’s fiduciary duty to us |
| The part of the incentive fee payable by us that relates to our pre-incentive fee net investment income is computed and paid on income that may include interest that is accrued but not yet received in cash |
| If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously used in the calculation of the incentive fee will become uncollectible |
| Pursuant to a separate administration agreement, Ares Administration, an affiliate of Ares Capital Management, and furnishes us with office space and we pay Ares Administration our allocable portion of overhead and other expenses incurred by Ares Administration in performing its obligations under the administration agreement, including rent and our allocable portion of the cost of our officers and their respective staffs |
| Furthermore, in connection with our initial public offering our investment adviser paid to the underwriters, on our behalf, an additional sales load with respect to the offering of our shares in the aggregate amount of dlra2cmam475cmam000 |
| This amount must be reimbursed under certain circumstances |
| As a result of these arrangements, there may be times when the management team of Ares Capital Management has interests that differ from those of our stockholders, giving rise to a conflict |
| Our stockholders may have conflicting investment, tax and other objectives with respect to their investments in us |
| The conflicting interests of individual stockholders may relate to or arise from, among other things, the nature of our investments, the structure or the acquisition of our investments, and the timing of disposition of our investments |
| As a consequence, conflicts of interest may arise in connection with decisions made by our investment adviser, including with respect to the nature or structuring of our investments, that may be more beneficial for one stockholder than for another stockholder, especially with respect to stockholders’ individual tax situations |
| In selecting and structuring investments appropriate for 26 ______________________________________________________________________ us, our investment adviser will consider the investment and tax objectives of Ares Capital and our stockholders as a whole, not the investment, tax or other objectives of any stockholder individually |
| Our investment adviser’s liability is limited under the investment management agreement, and we will indemnify our investment adviser against certain liabilities, which may lead our investment adviser to act in a riskier manner on our behalf than it would when acting for its own account |
| Our investment adviser has not assumed any responsibility to us other than to render the services described in the investment management agreement, and it will not be responsible for any action of our board of directors in declining to follow our investment adviser’s advice or recommendations |
| Pursuant to the investment management agreement, our investment adviser and its managing members, officers and employees will not be liable to us for their acts, under the investment management agreement, absent willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties |
| We have agreed to indemnify, defend and protect our investment adviser and its managing members, officers and employees with respect to all damages, liabilities, costs and expenses resulting from acts of our investment adviser not arising out of willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties under the investment management agreement |
| These protections may lead our investment adviser to act in a riskier manner when acting on our behalf than it would when acting for its own account |
| We may be obligated to pay our manager incentive compensation even if we incur a loss |
| Our investment adviser is entitled to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our investment income for that quarter (before deducting incentive compensation, net operating losses and certain other items) above a threshold return for that quarter |
| Our pre-incentive fee net investment income for incentive compensation purposes excludes realized and unrealized capital losses that we may incur in the fiscal quarter, even if such capital losses result in a net loss on our statement of operations for that quarter |
| Thus, we may be required to pay our manager incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter |
| Under the investment advisory and management agreement, we will defer cash payment of any incentive fee otherwise earned by our investment adviser if, during the most recent four full calendar quarter period ending on or prior to the date such payment is to be made, the sum of (a) our aggregate distributions to our stockholders and (b) our change in net assets (defined as total assets less indebtedness) is less than 8dtta0prca of our net assets at the beginning of such period |
| These calculations will be adjusted for any share issuances or repurchases |
| Changes in laws or regulations governing our operations, or changes in the interpretation thereof, and any failure by us to comply with laws or regulations governing our operations may adversely affect our business |
| These laws and regulations, as well as their interpretation, may be changed from time to time |
| Accordingly, any change in these laws or regulations, or their interpretation, or any failure by us to comply with these laws or regulations may adversely affect our business |
| As discussed above, there is a risk that certain investments that we intend to treat as qualifying assets will be determined to not be eligible for such treatment |
| Any such determination would have a material adverse effect on our business |
| 27 ______________________________________________________________________ Our ability to enter into transactions with our affiliates is restricted |
| We are prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our independent directors |
| Any person that owns, directly or indirectly, 5prca or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any security from or to such affiliate, absent the prior approval of our independent directors |
| The 1940 Act also prohibits ‘‘joint’’ transactions with an affiliate, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors |
| If a person acquires more than 25prca of our voting securities, we are prohibited from buying or selling any security from or to such person, or entering into joint transactions with such person, absent the prior approval of the SEC |