| HARRIS & HARRIS GROUP INC /NY/ Item 1A Risk Factors |
| 14 Item 1A Risk Factors Investing in our shares of common stock involves significant risks relating to our business and investment objective |
| You should carefully consider the risks and uncertainties described below before you purchase any of our shares of common stock |
| These risks and uncertainties are not the only ones we face |
| Unknown additional risks and uncertainties, or ones that we currently consider immaterial, may also impair our business |
| If any of these risks or uncertainties materialize, our business, financial condition or results of operations could be materially adversely affected |
| In this event, the trading price of our shares of common stock could decline, and you could lose all or part of your investment |
| Investing in small, private companies involves a high degree of risk and is highly speculative |
| We have invested a substantial portion of our assets in privately held development stage or start-up companies, the securities of which are inherently illiquid |
| These businesses tend to lack management depth, to have limited or no history of operations and to have not attained profitability |
| Tiny technology companies are especially risky, involving scientific, technological and commercialization risks |
| Because of the speculative nature of these investments, these securities have a significantly greater risk of loss than traditional investment securities |
| Some of our venture capital investments are likely to be complete losses or unprofitable, and some will never realize their potential |
| We have been, and will continue to be, risk seeking rather than risk averse in our approach to venture capital and other investments |
| Neither our investments nor an investment in our shares of common stock are intended to constitute a balanced investment program |
| We may invest in companies working with technologies or intellectual property that currently have few or no proven commercial applications |
| Nanotechnology, in particular, is a developing area of technology, of which much of the future commercial value is unknown, difficult to estimate and subject to widely varying interpretations |
| There are as of yet relatively few nanotechnology products commercially available |
| The timing of additional future commercially available nanotechnology products is highly uncertain |
| Our portfolio companies may not successfully develop their products |
| The technology of our portfolio companies is new and in many cases unproven |
| Their potential products require significant and lengthy product development, manufacturing and marketing efforts |
| To date, many of our portfolio companies have not developed any commercially available products |
| In addition, our portfolio companies may not be able to manufacture successfully or to market their products in order to achieve commercial success |
| Further, the products may never gain commercial acceptance |
| If our portfolio companies are not able to develop, manufacture or market successful tiny technology-enabled products, they will be unable to generate product revenue or build sustainable or profitable businesses |
| 14 Our portfolio companies working with tiny technology may be particularly susceptible to intellectual property litigation |
| Research and commercialization efforts in tiny technology are being undertaken by a wide variety of government, academic and private corporate entities |
| As additional commercially viable applications of tiny technology begin to emerge, ownership of intellectual property on which these products are based may be contested |
| Any litigation over the ownership of, or rights to, any of our portfolio companies &apos technologies or products would have a material adverse effect on those companies &apos values |
| Unfavorable economic conditions could result in the inability of our portfolio companies to access additional capital, leading to financial losses in our portfolio |
| Most of the companies in which we have made, or will make, investments are susceptible to economic slowdowns or recessions |
| An economic slowdown or adverse capital or credit market conditions may affect the ability of a company in our portfolio to raise additional capital from venture capital or other sources or to engage in a liquidity event such as an initial public offering or merger |
| Adverse economic, capital or credit market conditions may lead to financial losses in our portfolio |
| The value of our portfolio could be adversely affected if the technologies utilized by our portfolio companies are found to cause health or environmental risks |
| Our portfolio companies work with new technologies, which could have potential environmental and health impacts |
| Tiny technology in general and nanotechnology in particular are currently the subject of health and environmental impact research |
| If health or environmental concerns about tiny technology or nanotechnology were to arise, whether or not they had any basis in fact, our portfolio companies might incur additional research, legal and regulatory expenses, and might have difficulty raising capital or marketing their products |
| Public perception of ethical and social issues regarding nanotechnology may limit or discourage the use of nanotechnology-enabled products, which could reduce our portfolio companies &apos revenues and harm our business |
| Nanotechnology has received both positive and negative publicity and is the subject increasingly of public discussion and debate |
| Government authorities could, for social or other purposes, prohibit or regulate the use of nanotechnology |
| Ethical and emotional concerns about nanotechnology could adversely affect acceptance of the potential products of our portfolio companies or lead to new government regulation of nanotechnology-enabled products |
| For example, debate regarding the production of materials that could cause harm to the environment or the health of individuals could raise concerns in the publicapstas perception of nanotechnology, not all of which may be rational or scientifically based |
| 15 Risks related to the illiquidity of our investments |
| We invest in illiquid securities and may not be able to dispose of them when it is advantageous to do so, or ever |
| Most of our investments are or will be equity or equity-linked securities acquired directly from small companies |
| These equity securities are generally subject to restrictions on resale or otherwise have no established trading market |
| The illiquidity of most of our portfolio of equity securities may adversely affect our ability to dispose of these securities at times when it may be advantageous for us to liquidate these investments |
| Unfavorable economic conditions and regulatory changes could impair our ability to engage in liquidity events |
| Our business of making private equity investments and positioning our portfolio companies for liquidity events may be adversely affected by current and future capital markets and economic conditions |
| The public equity markets currently provide less opportunity for liquidity events than at times in the past when there was more robust demand for initial public offerings, even for more mature technology companies than those in which we typically invest |
| The potential for public market liquidity could further decrease and could lead to an inability to realize potential gains or could lead to financial losses in our portfolio and a decrease in our revenues, net income and assets |
| Recent government reforms affecting publicly traded companies, stock markets, investment banks and securities research practices have made it more difficult for privately held companies to complete successful initial public offerings of their equity securities, and such reforms have increased the expense and legal exposure of being a public company |
| Slowdowns in initial public offerings may also have an adverse effect on the frequency and prices of acquisitions of privately held companies |
| A lack of merger and/or acquisition opportunities for privately held companies may also have an adverse effect on the ability of these companies to raise capital from private sources |
| Public equity market response to company offerings of nanotechnology-enabled products is uncertain |
| An inability to engage in liquidity events could negatively affect our liquidity, our reinvestment rate in new and follow-on investments and the value of our portfolio |
| Even if our portfolio companies complete initial public offerings, the returns on our investments may be uncertain |
| When companies in which we have invested as private entities complete initial public offerings of their securities, these newly issued securities are by definition unseasoned issues |
| Unseasoned issues tend to be highly volatile and have uncertain liquidity, which may negatively affect their price |
| In addition, we are typically subject to lock-up provisions that prohibit us from selling our investments into the public market for specified periods of time after initial public offerings |
| The market price of securities that we hold may decline substantially before we are able to sell these securities |
| Most initial public offerings of technology companies are listed on the Nasdaq National Market |
| Recent government reforms of the Nasdaq National Market have made market making by broker-dealers less profitable, which has caused broker-dealers to reduce their market making activities, thereby making the market for unseasoned stocks less liquid |
| Because there is generally no established market in which to value our investments, our Valuation Committeeapstas value determinations may differ materially from the values that a ready market or third party would attribute to these investments |
| There is generally no public market for the equity securities in which we invest |
| Pursuant to the requirements of the 1940 Act, we value all of the private equity securities in our portfolio at fair value as determined in good faith by a committee of independent members of our Board of Directors, which we call the Valuation Committee, pursuant to Valuation Procedures established by the Board of Directors |
| As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment pursuant to specified valuation principles and processes |
| We are required by the 1940 Act to value specifically each individual investment on a quarterly basis and record unrealized depreciation for an investment that we believe has become impaired |
| Conversely, we must record unrealized appreciation if we believe that our securities have appreciated in value |
| Without a readily ascertainable market value and because of the inherent uncertainty of valuation, the fair value that we assign to our investments may differ from the values that would have been used had an efficient market existed for the investments, and the difference could be material |
| Any changes in fair value are recorded in our consolidated statements of operations as a change in the "e Net (decrease) increase in unrealized appreciation on investments "e |
| In the venture capital industry, even when a portfolio of early stage, high-technology venture capital investments proves to be profitable over the portfolioapstas lifetime, it is common for the portfolioapstas value to undergo a so-called "e J-curve "e valuation pattern |
| This J-curve valuation pattern results from write-downs and write-offs of portfolio investments that appear to be unsuccessful, prior to write-ups for portfolio investments that prove to be successful |
| Because early stage companies typically have negative cash flow and are by their nature inherently fragile, it is easier in a valuation process to substantiate a loss of value than an increase in value, absent a substantial investment at a higher valuation by a third party, knowledgeable, non-strategic investor |
| Even if our venture capital investments prove to be profitable in the long run, such J-curve valuation patterns could have a significant adverse effect on the value of our shares of common stock in the interim |
| As we continue to make additional tiny technology investments, this J-curve pattern may not be relevant for the portfolio as a whole because the individual J-curves for each investment, or series of investments, may overlap with previous investments at different stages of their J-curves |
| 17 Because we are a non-diversified company with a relatively concentrated portfolio, the value of our business is subject to greater volatility than the value of companies with more broadly diversified investments |
| As a result of our assets being invested in the securities of a small number of issuers, we are classified as a non-diversified company |
| We may be more vulnerable to events affecting a single issuer or industry and therefore subject to greater volatility than a company whose investments are more broadly diversified |
| Accordingly, an investment in our shares of common stock may present greater risk to you than an investment in a diversified company |
| We may be obligated to pay substantial amounts under our profit-sharing plan |
| Our employee profit-sharing plan requires us to distribute to our officers and employees 20 percent of any net after-tax realized income as reflected on our consolidated statements of operations for that year, less any non-qualifying gain |
| Payments may be made under our profit-sharing plan in a particular year, even if we have incurred losses in previous years |
| These distributions reduce funds available for investment and may have a significant effect on the amount of direct distributions in the form of cash dividends, or indirect distributions in the form of tax credits, if any, made to our shareholders |
| We are dependent upon key management personnel for future success and may not be able to retain them |
| We are dependent upon the diligence and skill of our senior management and other key advisers for the selection, structuring, closing and monitoring of our investments |
| We utilize lawyers and outside consultants, including two of our directors, Dr |
| Kelly S Kirkpatrick and Lori D Pressman, to assist us in conducting due diligence when evaluating potential investments |
| There is generally no publicly available information about the companies in which we invest, and we rely significantly on the diligence of our employees and advisers to obtain information in connection with our investment decisions |
| Our future success to a significant extent depends on the continued service and coordination of our senior management team, and particularly on our Chairman and Chief Executive Officer, Charles E Harris |
| The departure of any of our executive officers, key employees or advisers could materially adversely affect our ability to implement our business strategy |
| We do not maintain for our benefit any key man life insurance on any of our officers or employees |
| We will need to hire additional employees as the size of our portfolio increases |
| We anticipate that it will be necessary for us to add investment professionals with expertise in venture capital and/or tiny technology and administrative and support staff to accommodate the increasing size of our portfolio |
| We may need to provide additional scientific, business, accounting, legal or investment training for our hires |
| There is competition for highly qualified personnel, and we may not be successful in our efforts to recruit and retain highly qualified personnel |
| 18 The market for venture capital investments, including tiny technology investments, is highly competitive |
| We face substantial competition in our investing activities from many competitors, including but not limited to: private venture capital funds; investment affiliates of large industrial, technology, service and financial companies; small business investment companies; wealthy individuals; and foreign investors |
| Our most significant competitors typically have significantly greater financial resources than we do |
| Greater financial resources are particularly advantageous in securing lead investor roles in venture capital syndicates |
| Lead investors negotiate the terms and conditions of such financings |
| Many sources of funding compete for a small number of attractive investment opportunities |
| Hence, we face substantial competition in sourcing good investment opportunities on terms of investment that are commercially attractive |
| In addition to the difficulty of finding attractive investment opportunities, our status as a regulated business development company may hinder our ability to participate in investment opportunities or to protect the value of existing investments |
| We are required to disclose on a quarterly basis the names and business descriptions of our portfolio companies and the value of any portfolio securities |
| Most of our competitors are not subject to these disclosure requirements |
| Our obligation to disclose this information could hinder our ability to invest in some portfolio companies |
| Additionally, other current and future regulations may make us less attractive as a potential investor than a competitor not subject to the same regulations |
| Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio |
| Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as "e follow-on "e investments, in order to: (1) increase or maintain in whole or in part our ownership percentage; (2) exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or (3) attempt to preserve or enhance the value of our investment |
| "e Pay to play "e provisions have become common in venture capital transactions |
| These provisions require proportionate investment in subsequent rounds of financing in order to preserve preferred rights such as anti-dilution protection or even to prevent preferred shares from being converted to common shares |
| We may elect not to make follow-on investments or otherwise lack sufficient funds to make such investments |
| We have the discretion to make any follow-on investments, subject to the availability of capital resources |
| The failure to make a follow-on investment may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation, or may cause us to lose some or all preferred rights or even substantially all of our equity ownership in it pursuant to "e pay to play "e provisions |
| Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to increase our concentration of risk, because we prefer other opportunities or because we are inhibited by compliance with business development company requirements or the desire to maintain our tax status |
| 19 Bank borrowing or the issuance of debt securities or preferred stock by us to fund investments in portfolio companies or to fund our operating expenses would make our total return to common shareholders more volatile |
| The first is the risk of leverage, which is the use of debt to increase the pool of capital available for investment purposes |
| The use of debt leverages our available common equity capital, magnifying the impact on net asset value of changes in the value of our investment portfolio |
| For example, a business development company that uses 33 percent leverage (that is, dlra50 of leverage per dlra100 of common equity) will show a 1dtta5 percent increase or decline in net asset value for each 1 percent increase or decline in the value of its total assets |
| The second risk is that the cost of debt or preferred stock financing may exceed the return on the assets the proceeds are used to acquire, thereby diminishing rather than enhancing the return to common shareholders |
| If we issue preferred shares, the common shareholders would bear the cost of this leverage |
| To the extent that we utilize debt or preferred stock financing for any purpose, these two risks would likely make our total return to common shareholders more volatile |
| In addition, we might be required to sell investments, in order to meet dividend, interest or principal payments, when it may be disadvantageous for us to do so |
| As provided in the 1940 Act and subject to some exceptions, we can issue debt or preferred stock so long as our total assets immediately after the issuance, less some ordinary course liabilities, exceed 200 percent of the sum of the debt and any preferred stock outstanding |
| The debt or preferred stock may be convertible in accordance with SEC guidelines, which may permit us to obtain leverage at more attractive rates |
| The requirement under the 1940 Act to pay, in full, dividends on preferred shares or interest on debt before any dividends may be paid on our shares of common stock means that dividends on our shares of common stock from earnings may be reduced or eliminated |
| An inability to pay dividends on our shares of common stock could conceivably result in our ceasing to qualify as a regulated investment company, or RIC, under the Code, which would in most circumstances be materially adverse to the holders of our shares of common stock |
| As of the date hereof, we do not have any debt or preferred stock outstanding |
| We are authorized to issue preferred stock, which would convey special rights and privileges to its owners senior to those of common stock shareholders |
| We are currently authorized to issue up to 2cmam000cmam000 shares of preferred stock, under terms and conditions determined by our Board of Directors |
| These shares would have a preference over our common stock with respect to dividends and liquidation |
| The statutory class voting rights of any preferred shares we would issue could make it more difficult for us to take some actions that may, in the future, be proposed by the Board and/or holders of common stock, such as a merger, exchange of securities, liquidation or alteration of the rights of a class of our securities if these actions were perceived by the holders of the preferred shares as not in their best interests |
| The issuance of preferred shares convertible into shares of common stock might also reduce the net income and net asset value per share of our common stock upon conversion |
| 20 Loss of status as a RIC would reduce our net asset value and distributable income |
| We qualify as a RIC for 2004 under the tax Code |
| As a RIC, we do not have to pay federal income taxes on our income (including realized gains) that is distributed to our shareholders |
| Accordingly, we are not permitted under accounting rules to establish reserves for taxes on our unrealized capital gains |
| If we failed to qualify for RIC status in 2005 or beyond, to the extent that we had unrealized gains, we would have to establish reserves for taxes, which would reduce our net asset value, net of a reduction in the reserve for employee profit sharing, accordingly |
| In addition, if we, as a RIC, were to decide to make a deemed distribution of net realized capital gains and retain the net realized capital gains, we would have to establish appropriate reserves for taxes |
| It is possible that establishing reserves for taxes could have a material adverse effect on the value of our common stock |
| We operate in a heavily regulated environment and changes to or non-compliance with regulations and laws could harm our business |
| We are subject to substantive SEC regulations as a business development company |
| Securities and tax laws and regulations governing our activities may change in ways adverse to our and our shareholders &apos interests, and interpretations of these laws and regulations may change with unpredictable consequences |
| Any change in the laws or regulations that govern our business could have an adverse impact on us or on our operations |
| Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules, are creating additional expense and uncertainty for publicly held companies in general, and for business development companies in particular |
| These new or changed laws, regulations and standards are subject to varying interpretations in many cases because of their lack of specificity, and as a result, their application in practice may evolve over time, which may well result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices |
| We are committed to maintaining high standards of corporate governance and public disclosure |
| As a result, our efforts to comply with evolving laws, regulations and standards have and will continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities |
| In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors &apos audit of that assessment has required the commitment of significant financial and managerial resources |
| We will continue to evaluate the effectiveness of internal controls and procedures on an ongoing basis |
| A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met |
| Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all controls issues within the Company have been detected |
| These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake |
| Additionally, controls can be circumvented |
| Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected |
| We may identify material weaknesses or significant deficiencies in our internal controls |
| If so, our ability to report our financial results on a timely and accurate basis may be adversely affected |
| 21 Moreover, even though BDCs are not mutual funds, they must comply with several of the new regulations applicable to mutual funds, such as the requirement for the implementation of a comprehensive compliance program and the appointment of a Chief Compliance Officer |
| Further, our Board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties |
| As a result, we may have difficulty attracting and retaining qualified Board members and executive officers, which could harm our business, and we have significantly increased both our coverage under, and the related expense, for directors &apos and officers &apos liability insurance |
| If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies, our reputation may be harmed |
| Also, as business and financial practices continue to evolve, they may render the regulations under which we operate less appropriate and more burdensome than they were when originally imposed |
| This increased regulatory burden is causing us to incur significant additional expenses and is time consuming for our management, which could have a material adverse effect on our financial performance |
| We expect that the market price of our common stock will be volatile |
| The price of the shares of our common stock may be higher or lower than the price you pay for your shares, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance |
| These factors include the following: o announcements regarding any of our portfolio companies; o announcements regarding developments in the nanotechnology field in general; o environmental concerns regarding nanotechnology, whether real or perceptual; o announcements regarding government funding and initiatives related to the development of nanotechnology; o general economic conditions and trends; and/or o departures of key personnel |
| We will not have control over many of these factors but expect that our stock price may be influenced by them |
| As a result, our stock price may be volatile and you may lose all or part of your investment |
| 22 Quarterly results fluctuate and are not indicative of future quarterly performance |
| These factors include, among others, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we and our portfolio companies encounter competition in our markets and general economic and capital markets conditions |
| As a result of these factors, results for any one quarter should not be relied upon as being indicative of performance in future quarters |
| To the extent that we do not realize income or retain after-tax realized capital gains, we may have a greater need for additional capital to fund our investments and operating expenses |
| As a RIC, we must annually distribute at least 90 percent of our investment company taxable income as a dividend and may either distribute or retain our realized net capital gains from investments |
| As a result, these earnings may not be available to fund investments |
| If we fail to generate net realized capital gains or to obtain funds from outside sources, it would have a material adverse effect on our financial condition and results of operations as well as our ability to make follow-on and new investments |
| Because of the structure and objectives of our business, we generally expect to experience net operating losses and rely on proceeds from sales of investments, rather than on investment income, to defray a significant portion of our operating expenses |
| In addition, as a business development company, we are generally required to maintain a ratio of at least 200 percent of total assets to total borrowings, which may restrict our ability to borrow to fund these requirements |
| Lack of capital could curtail our investment activities or impair our working capital |
| Investment in foreign securities could result in additional risks |
| The Company may invest in foreign securities, although, as of December 31, 2005, we had no investments in foreign securities |
| If we invest in securities of foreign issuers, we may be subject to risks not usually associated with owning securities of US issuers |
| These risks can include fluctuations in foreign currencies, foreign currency exchange controls, social, political and economic instability, differences in securities regulation and trading, expropriation or nationalization of assets, and foreign taxation issues |
| In addition, changes in government administrations or economic or monetary policies in the United States or abroad could result in appreciation or depreciation of our securities and could favorably or unfavorably affect our operations |
| It may also be more difficult to obtain and enforce a judgment against a foreign issuer |
| Any foreign investments made by us must be made in compliance with US and foreign currency restrictions and tax laws restricting the amounts and types of foreign investments |
| 23 Investing in our stock is highly speculative and an investor could lose some or all of the amount invested |
| Our investment objective and strategies result in a high degree of risk in our investments and may result in losses in the value of our investment portfolio |
| Our investments in portfolio companies are highly speculative and, therefore, an investor in our common stock may lose his or her entire investment |
| The value of the shares of our common stock may decline and may be affected by numerous market conditions, which could result in the loss of some or all of the amount invested in our common stock |
| The securities markets frequently experience extreme price and volume fluctuations which affect market prices for securities of companies generally, and technology and very small capitalization companies in particular |
| Because of our focus on the technology and very small capitalization sectors, and because we are a small capitalization company ourselves, our stock price is especially likely to be affected by these market conditions |
| General economic conditions, and general conditions in the Internet and information technology, life sciences, nanotechnology, tiny technology, materials science and other high technology industries, may also affect the price of the shares of our common stock |
| Our shares might trade at discounts from net asset value, or at premiums that are unsustainable over the long term |
| Shares of business development companies like us may, during some periods, trade at prices higher than their net asset value and during other periods, as frequently occurs with closed-end investment companies, trade at prices lower than their net asset value |
| The possibility that our shares will trade at discounts from net asset value or at premiums that are unsustainable over the long term are risks separate and distinct from the risk that our net asset value will decrease |
| The risk of purchasing shares of a business development company that might trade at a discount or unsustainable premium is more pronounced for investors who wish to sell their shares in a relatively short period of time because, for those investors, realization of a gain or loss on their investments is likely to be more dependent upon the existence of a premium or discount than upon portfolio performance |
| Our shares of common stock may or may not trade at a price higher than or equal to net asset value |
| On December 31, 2005, our stock closed at dlra13dtta90 per share, a premium of dlra8dtta22 over our net asset value per share of dlra5dtta68 as of December 31, 2005 |
| You do not have the right to require us to repurchase your shares of common stock |