CORRESP: A correspondence can be sent as a document with another submission type or can be sent as a separate submission.
Published on January 29, 2007
STEVEN B. BOEHM
DIRECT LINE: 202-383-0176
Internet: steven.boehm@sablaw.com
DIRECT LINE: 202-383-0176
Internet: steven.boehm@sablaw.com
January 29, 2007
VIA EDGAR AND HAND DELIVERY
Richard Pfordte, Esq.
Mr. Kevin Rupert
Vincent Di Stefano, Esq.
Division of Investment Management
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-0504
Mr. Kevin Rupert
Vincent Di Stefano, Esq.
Division of Investment Management
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-0504
Re: | Triangle Capital Corporation Registration Statement on Form N-2 File No. 333-138418 |
Dear Messrs. Pfordte, Rupert and Di Stefano:
On January 26, 2006, we received additional comments from you by telephone on the Registration
Statement on Form N-2, File No. 333-138418 (Registration Statement) for Triangle Capital
Corporation (the Company or the BDC). Set forth below are the Companys responses to your
comments.
COMMENT 1: It appears that the Company is issuing the members of the general partner
(GP) of Triangle Mezzanine Fund, LLLP (the SBIC) $7.5M of the Companys common stock as
compensation for their services. Explain why the issuance of the $7.5M of stock to the
members of the GP is not in violation of Section 23(a) of the Investment Company Act of 1940
(the 1940 Act), as well as Section 23(b), as interpreted in the 1961 Release and the Big
Apple no action letter. Explain how the $7.5M valuation of the GP Interests was calculated.
RESPONSE: The proposed transaction does not violate Section 23(a) or (b), or any other
provision of the 1940 Act. In relevant part, Section 23(a) prohibits a closed-end investment
company (and, by reason of Section 63, a BDC) from issuing its securities for services, or for
property other than cash or securities, except in connection with a reorganization. In the
proposed transaction (the Reorganization), the Company will issue its securities to the
Limited Partners of the SBIC (the LPs) and the members of the GP to acquire 100% of the
outstanding equity interests in the ongoing business of the SBIC.
Letter to SEC
January 29, 2007
Page 2 of 10
January 29, 2007
Page 2 of 10
The Company is purchasing more than merely assets in the form of the SBIC and its investment
portfolio. It is acquiring an established and ongoing specialty finance business, which
includes an established and successful management team. That management team built the
SBICs infrastructure more than three years ago, identified and structured the SBICs
investments, will monitor those investments and work with the portfolio companies to
maximize the value of those investments, will determine when and under what circumstances to
dispose of those investments, and will make, manage and dispose of other investments in the
future. The GP also procured the valuable SBIC license, which enables access to the SBAs
highly favorable leverage program, which license the Company will effectively acquire in the
Reorganization.
The terms of the Reorganization reflect an arms length transaction between sophisticated
parties the GP on the one hand and the LPs (approximately 97.5% of the SBICs committed
capital comes from commercial banks) on the other. As with the sale of most businesses, the
sale of the SBIC will not occur at book value (or net asset value). Successful businesses
regularly sell at multiples, often significant multiples, of book value. These multiples
reflect the fact that the book value, which is approximately the liquidation value of the
SBICs assets, fails to adequately capture the value of a successful operating company as an
ongoing business. In this case, both immediately prior to and immediately after the
Companys IPO, the value of the assets that the Company will hold (through its SBIC
subsidiary) will be approximately $22.744 million (per the 9/30/2006 audited balance sheet).
The proposed $15 per share IPO price will, however, value the Company at approximately
$28.75 million. This will reflect approximately a 1.26x multiple to book value, which is
somewhat lower than the multiples to book value that the market currently assigns to other
BDCs.
Investors in the Company might be willing to pay a 1.26x multiple to the net asset value for
any number of reasons. They are free to decide that is a reasonable amount to pay for the
anticipated periodic distributions from the Company, especially when combined with the
potential for gain embedded in the equity and equity-related securities held by the Company.
They may believe the Companys strong management team will use the proceeds of the public
offering, as well as the SBA leverage available to the Company (through the SBIC), to make
other investments that also will provide debt and equity returns justifying a 1.26x multiple
to net asset value. And they may believe, based on trading patterns of comparable BDCs and
similar entities that trade at multiples in excess of 1.26x to net asset value, that
purchasing the Companys shares at a 1.26x multiple to
Letter to SEC
January 29, 2007
Page 3 of 10
January 29, 2007
Page 3 of 10
net asset value in the IPO will provide the opportunity for trading gains if in the future
the Companys shares trade at a multiple of net asset value that is greater than
1.26x.1
There is no authority that prohibits the GP from receiving the shares proposed to be issued
to them in the Reorganization. The Commission first addressed the question of the sale of
common stock to the public at a price substantially in excess of a stocks net asset value
in Investment Company Act of 1940 Release. No. 3187 (Feb. 8, 1961) (the Release). There,
the Commission was concerned that the higher offering price was principally to benefit the
promoters by the resultant increase in the net asset value of their shares from the IPO.
The Commission then added that unless some other and more legitimate purpose . . . can be
shown . . . public offerings at such prices may not lawfully be made under the [1940 Act].
In Big Apple Capital Corp.,2 the Staff applied the Release to a newly organized
BDC selling its shares to its organizers in contemplation of a public offering at a higher
price per share. Specifically, the promoters subscribed for 4,250,000 shares of the BDCs
common stock at $0.05 per share. The purported purpose of their investment was to raise
funds to finance the Companys organization and the SEC registration of the IPO. The sale
to the promoters was to be followed by a public offering of 4,000,000 shares at a price of
$1.00 per share, a 2000% multiple to the price paid by the promoters. In that case, where
the only efforts of the promoters was to finance the organization of the BDC immediately
prior to its IPO, the Staff considered the private sales to violate various provisions of
the 1940 Act.
We believe that Big Apple exemplifies the precise type of factual scenario anticipated, and
sought to be prohibited, by the Release. That scenario is clearly not analogous to the
present one. Rather, the circumstances of the Reorganization here are nearly directly
on-point with those of Enervest Capital, Incorporated.3 There, the Staff took a
no-action position where an SBIC was to be taken public approximately three years after its
organization, at a time when its common stock was held by 36 shareholders. During the
period of its operation, the company made a number of investments as well as commitments to
provide additional capital. The shares of common stock of Enervest to
1 | From an accounting standpoint in the N-2 filing, the Company made the decision to provide prospective investors with audited financial statements for the SBIC as of and for the period ended September 30, 2006. Within the scope of this audit was third party valuation assistance provided by Duff & Phelps of 100% of our portfolio (17 companies as of September 30, 2006). The Companys effort to present the highest quality financial and valuation information possible compares favorably to the fact that a number of publicly held BDCs use no third-party valuation assistance whatsoever. As a result, the Reorganization is different from other transactions that the Staff might see on a more routine basis in that potential investors have already been provided audited results in the N-2 filing for every period since the funds inception. | |
2 | Pub. avail. May 6, 1982. | |
3 | Pub. avail. Feb. 18, 1981. |
Letter to SEC
January 29, 2007
Page 4 of 10
January 29, 2007
Page 4 of 10
be offered to the public were to be priced at between 150 and 300% of its then current net
asset value per share.
The facts surrounding our Reorganization are strikingly similar to those at issue in
Enervest. The Company has more than three years of operating history and, as of December
31, 2006, it has made 26 investments with a total cost basis of over $70 million, it has
already returned $5 million to its existing investors (representing 23.5% of their committed
capital), and it has a substantial pipeline of potential new investment opportunities. The
Reorganization has been approved by approximately 90% of the SBICs existing LP interests,
substantially all of which are sophisticated commercial banks, and have a wealth of
financial and other quantitative and qualitative information on which to judge the merits of
the proposed offering price for the ongoing business currently being conducted by the SBIC
and to be acquired by the Company.
It is instructive that the Enervest no-action letter request specifically discusses that the
Staff refused to permit that company to conduct an IPO at a multiple to net asset value soon
after it was formed, for precisely the reasons identified in Big Apple and the Release.
But, three years later after Enervest had invested $918,000 in 11 companies and made
commitments of $710,000 to 4 additional companies the Staff permitted Enervest to conduct
an IPO at a multiple to net asset value.
Moreover, several recently completed BDC IPOs reflected public offering prices in excess of
NAV and which, in fact, reflected multiples higher than those reflected in the Companys
proposed offering. The offerings by Patriot Capital Funding, Inc. (PCAP) and Hercules
Technology Growth Capital, Inc. (HTGC), for example, are shown in the table
below.4
PCAP | HTGC | TCAP | ||||||||||||||||||||||
Pre- | Post | Pre- | Post | Pre- | Post | |||||||||||||||||||
Deal | Deal | Deal | Deal | Deal | Deal | |||||||||||||||||||
NAV (Book equity) |
$ | 28,433 | $ | 117,753 | $ | 41,440 | $ | 112,650 | $ | 22,744 | $ | 70,099 | ||||||||||||
Shares outstanding |
3,848 | 11,038 | 3,802 | 9,802 | 1,917 | 5,447 | ||||||||||||||||||
NAV per share |
$ | 7.39 | $ | 10.67 | $ | 10.90 | $ | 11.49 | $ | 11.87 | $ | 12.87 | ||||||||||||
IPO Price per share |
$ | 14.00 | $ | 14.00 | $ | 13.00 | $ | 13.00 | $ | 15.00 | $ | 15.00 | ||||||||||||
Share price / NAV |
1.89x | 1.31x | 1.19x | 1.13x | 1.26x | 1.17x |
4 | In PCAP and HTGC offerings, the mid-point price on the front cover of the preliminary prospectus was $15.00 per share, which would imply a larger Share Price / NAV multiple on a pre-deal basis. |
Letter to SEC
January 29, 2007
Page 5 of 10
January 29, 2007
Page 5 of 10
There is no basis for distinguishing the PCAP and HTGC offerings from the Companys
proposed IPO for purposes of the issues raised here by the Staff.
Returning, then, to the Staffs concern under Section 23(a), the BDC is issuing shares to
the GP not for services, but instead as part of its acquisition of all outstanding equity
interests in the SBIC, including the GPs interest in the SBIC. Under the current structure
of the SBIC, the LPs are, in effect, entitled to all of the SBICs distributions (after
payment of expenses and repayment of loans to the SBA) until they have received a return of
their invested capital, plus an amount equal to 7% per year on their invested capital (the
Preferred Return). Then, 100% of distributions are paid to the GP until it receives 25%
of amounts distributed pursuant to the Preferred Return. Thereafter, distributions from the
SBIC are split so that 80% is paid to the LPs, and 20% is paid to the GP. The GPs right to
these payments is referred to as its carried interest.
Economically and practically, in order for the Company to acquire the entire interest in the
SBIC, it must acquire the economic interest of both the LPs and of the GPs. Valuing these
interests is, of course, not an exact science. The GP valued these interests by first
determining a going concern value for the SBIC as a whole, and then allocating an
appropriate portion of that total value to the LPs and the GP in accordance with their
respective economic interests in the SBIC. A summary of the GPs allocations in this regard
are included in Appendix A, and these allocations were approved by approximately 90% of the
LP interests in the SBIC.
Accordingly, the amount being paid to the GP ($7.5M) represents the value of the GP
interests in the SBIC based on the present value of the future profits, cash flows and other
distributions that the GP are contractually entitled to and are giving up in agreeing to the
transaction (taking into account the increasing value of the interests over time, decreasing
discount rates over time, value added by the GP, and the fair market value of the GP
carried interest).
Section 23(a) permits a BDC to issue shares for other securities or property. We believe
that the BDC purchase of the GPs carried interest i.e., a contractual right to receive
future payments is the purchase of a security for which the Company can issue its
shares within the meaning of Section 23(a). Moreover, that provision permits a BDC to issue
shares for property, even if that property is not cash or a security, if the shares are
issued in connection with a reorganization. In this case, that is precisely what has
happened. Pursuant to the Reorganization, the existing Limited Partners and the GP of the
SBIC will receive shares of the Company, and the SBIC will become wholly owned by the
Company. Regardless of whether the carried interest is a security, the carried interest
certainly is property it is a contractual interest in the SBICs profits and cash flows
fully reflected in the limited partnership agreement of the SBIC. The fact that this right
may not be listed as an asset on the GPs balance sheet for purposes of financial reporting
is irrelevant neither is internally generated intellectual property and goodwill, but
these clearly can represent valuable property interests.
Letter to SEC
January 29, 2007
Page 6 of 10
January 29, 2007
Page 6 of 10
Most significantly, this is in effect the same issue the Staff already considered and
approved in Enervest and which did not seem to raise an issue in PCAP or HTGC. In that
case, management received compensation as part of the public offering proceeds for their
interests in the ongoing business enterprise. In addition, the economic result here is
substantially similar to the impact of the IPO on the respective promoters in the HTGC and
PCAP offerings. Section 23(a) was not in those instances deemed to be a barrier. It should
not be one here either.
With respect to Section 23(b), we do not believe that the issuance of shares to the GP in
connection with the Reorganization is inconsistent with that provision. First, the
Reorganization, including the issuance of the shares to the GP, was approved by
approximately 90% of the LP interests. More generally, there is no economic difference
between the issuance of stock to promoters at the outset of the operation of a private fund
that eventually goes public, and the issuance of stock in an IPO here, since in both cases
the promoter is realizing the value it created through its efforts to operate the private
fund successfully.
Traditional rights offerings by closed-end funds also reflect disparities between the NAV
and offering price. A typical formula in a rights offering is the weighted average of 95%
of the previous 5-day market prices, but not lower than NAV (which is why rights offers
typically occur only during periods when shares are trading at a premium to NAV). There, an
issue of dilution is raised with respect to investors who choose not to make additional
investments being diluted. That is, new money would be coming into the fund at, for
example, $0.50 per share less than current market value, which should depress the NAV per
share of all existing shareholders, including those who do not participate in the rights
offer. The rights offer prospectus always contains disclosure to this effect, and the
funds board must consider this issue (among others) when authorizing the rights offer. We
are not aware of any suggestion that the Staff has concerns about the potential for dilution
in that context.
Finally, from a policy perspective, it is important to consider the impact of applying
Sections 23(a) and 23(b) or any other provisions of the 1940 Act so as to prevent this
offering from proceeding. Potential investors will receive a prospectus that will contain a
substantial amount of financial and other quantitative and qualitative information that will
permit them to make their own evaluation of whether $15 per share is a reasonable amount to
pay to purchase an interest in the ongoing business of the Company and its approximately
$22.744 million of assets. Investors may well conclude that they are willing to pay $15 a
share, because they conclude that an approximately 1.26x multiple to net asset value is an
appropriate valuation for that business, or because the internal management structure
ensures that the interest of management would be squarely aligned with those of investors.
As noted above, the sophisticated LPs of the SBIC concluded that this was a reasonable
valuation. Also, experienced and well-respected investment banking firms are prepared to
act as lead underwriters and syndicate members for this transaction. We believe that no
public policy purpose would be furthered, nor
Letter to SEC
January 29, 2007
Page 7 of 10
January 29, 2007
Page 7 of 10
would
any objective of the 1940 Act be achieved, by applying the provisions of the 1940 Act in such a
way as to prevent potential investors from having the opportunity to make their own judgment
of the merits of this investment opportunity. Indeed, if the Staff were to conclude in this
case that all of the value created by the efforts of the GP in an ongoing private fund
pre-IPO were required to be allocated to public shareholders, then we submit, the exception
in Section 23(a) for securities issued in connection with a reorganization would be rendered
meaningless.
COMMENT 2: Why should the Company not be considered engaged in a distribution of the
securities of the SBIC, pursuant to Rule 140 under the Securities Act of 1933, as amended (the
1933 Act)?
RESPONSE: The Company initially intends to act, in effect, as a feeder fund for the SBIC,
with the Company holding only cash and cash-management instruments necessary to pay certain
expenses and to meet certain Subchapter M distribution requirements. For purposes of Rule
140, we believe the SBIC should not be deemed a separate distribution of securities to the
public, but should be, in effect, subsumed into the offering of the Companys common stock, in
accordance with the treatment afforded to similar hub-and-spoke and master-feeder
arrangements.5 As the Companys Form N-2 describes, the two companies are so
integrally interconnected that treating the Company as a distributor of the SBICs
securities under these circumstances would serve no regulatory or investor protection purpose.
The interconnected nature of the two companies is evidenced by their currently pending
application to file consolidated reports under the Securities Exchange Act of 1934, as amended
(the Exchange Act), and the detailed and thorough disclosure regarding the SBIC, its assets,
risks and regulatory considerations, and its contemplated future activities contained in the
Companys Form N-2.
In the context of BDCs specifically, treating a BDC as a distributor of its wholly-owned
SBICs shares would frustrate the intent of the 1940 Act to facilitate ownership of SBICs as
subsidiaries of BDCs.6 In a broader context, if the Company is considered a
distributor of what is, in effect, a master fund, such status would necessarily apply to and
disrupt myriad currently existing and contemplated master-feeder arrangements in both the
registered and unregistered fund context.
COMMENT 3: Why should the transfer of $7.5 million dollars of common stock to the GP, in
connection with the Companys purchase of the SBIC not be considered a sale of an investment
advisory contract under Section 15(f) of the 1940 Act?
5 | See Letter from Richard Breeden, Chairman, U.S. Securities and Exchange Commission, to John Dingell, Chairman, Committee on Energy and Commerce, U.S. House of Representatives (pub. Avail. June 2, 1993). | |
6 | See, e.g., Section 2(a)(46) of the Investment Company Act defining eligible portfolio company so as to exclude from the definition all registered investment companies save for wholly-owned SBICs. |
Letter to SEC
January 29, 2007
Page 8 of 10
January 29, 2007
Page 8 of 10
RESPONSE: The GP has never entered into an investment advisory contract with the SBIC, nor
has it ever provided the SBIC with investment advisory services. The transfer of the $7.5
million in shares to the GP in connection with the Reorganization and purchase transactions,
therefore, cannot represent the sale of an advisory contract, given that the GP is not a party
to such a contract. Triangle Capital Partners, LLC (TCP) serves as the SBICs investment
adviser pursuant to a contract between the SBIC and TCP, made on behalf of the SBIC by the GP.
Concomitantly with the Reorganization and purchase transactions discussed in the Form N-2,
the investment advisory agreement between TCP and the SBIC will terminate and TCP will
dissolve. The management personnel of TCP will now be the internal management of the BDC.
The advisory fee will terminate with the termination of the advisory agreement, and the BDC
will pay the salaries of the internal management staff.
During a January 26, 2007 call, the Staff appeared to imply that the commonality of
ownership between the two entities might affect this conclusion. The GP and TCP, however,
are separate and distinct legal entities; although they share some overlapping ownership,
the membership of the two limited liability companies is not identical, and the relevant
ownership percentages of the overlapping owners differ between the two entities. The GP
possesses members which are unaffiliated with TCP, and who play no part in the provision of
investment advice by TCP under the advisory contract. The legal and economic separation
between these entities is evidenced by the fact that members of the GP who are unaffiliated
with TCP do not share in the stream of management fees TCP earns under its contract with the
SBIC. Thus, it would be inappropriate to conflate TCP and the GP and mingle their
respective assets, liabilities and obligations in assessing the reorganization and purchase
transactions.
COMMENT 4: Will the SBIC lose its exclusion under the 1940 Act once the IPO for the
Company is effected?
RESPONSE: The SBIC currently relies on Section 3(c)(1) of the 1940 Act for an exclusion
from the definition of investment company. However, it will elect to be regulated as a BDC
upon closing of the IPO. Accordingly, there would be no need for an exclusion from the
investment company definition at that time.
COMMENT 5: Do the SBIC and the post-IPO general partner entity qualify as eligible
portfolio companies of the Company within the meaning of Section 2(a)(46)?
RESPONSE: Yes. The SBIC, as a U.S.-organized and domiciled company that is a Small
Business Investment Company with no publicly traded securities, qualifies as an eligible
portfolio company under Section 2(a)(46)(B) of the 1940 Act.
After the IPO of the Companys securities, a newly formed entity, wholly owned by the
Company, would become the general partner of the SBIC (the New GP). The New GP would also
qualify as an eligible portfolio company. It is a U.S.-organized and domiciled entity which
is neither an investment company nor a company excluded from that
Letter to SEC
January 29, 2007
Page 9 of 10
January 29, 2007
Page 9 of 10
definition pursuant to Section 3(c) of the 1940 Act, and is entirely controlled and
wholly-owned by the Company.
* * *
We hope that the foregoing is fully responsive to your comments. We appreciate your continued
attention and prompt responses to these matters. Unfortunately, the Companys timing has become
urgent. As we mentioned to you in our discussion on Friday, the Company needs to be able to start
its road show by the middle of this week in order for it to have any ability to proceed with its
transaction prior to the financial information becoming stale. If the Company were not able to
proceed this week, it would have to bear the significant additional time and cost of another audit
which would result in a delay of this offering for months, and perhaps permanently. Thus, your
continued responsiveness is very much appreciated.
Please do not hesitate to call the undersigned if you have any comments or questions regarding
the above responses.
Sincerely,
/s/
Steven
B. Boehm
Steven B. Boehm
cc:
|
John Good, Esq. | |
Robert Rosenblum, Esq. |
APPENDIX A
The GP had a reasonable basis for its valuation of the LP interests and GP interests. Duff
and Phelps made its later analysis largely based on the current sale of the assets of the
SBIC, or a liquidation of the SBIC. The GP based its valuation of the SBIC and of the LP
and GP interests on the SBICs value as a going concern. The LPs are receiving their 80%
interests in total fund returns while the GP are receiving their 20% interest in the SBIC,
and the LP interests and GP interests are calculated in the same way. As depicted in the
table below, the GP projected the value of the SBIC and the GP and LP interests over its
anticipated life (9 years) as a going concern (approximately $87M). The capital committed
by the LPs (approximately $21.2M) was then subtracted for the net future value of the SBIC
(approximately $71M). The GPs 20% interest in the net future value (approximately $14.2M)
was reduced to its present value by the weighted average cost of capital (approximately
$7.8M) which amount was further rounded down (to $7.5M). The present value of the LPs
interest was likewise reduced to its present value by the net required internal rate of
return (approximately $20.8M) with was rounded up (to $21.2M).
Output | Projected Fund/LP/GP Value | |||||||||||
Capital | Fund Life | Value | ||||||||||
LP Capital Committed |
$ | 21,250,000 | 9 | $ | 87,303,507 | |||||||
Remaining Return of LP Capital (Net of $5MM distribution) | $ | 16,250,000 | ||||||||||
Net Proceeds Available After Return of Capital | $ | 71,053,507 | ||||||||||
GP Carry 20% of Net Proceeds (Future Value) | $ | 14,210,701 | ||||||||||
GP Carry Present Value (using funds WACC) | $ | 7,874,716 | ||||||||||
LP Present Value (Using Net Required IRR) | $ | 20,896,761 | ||||||||||
LP Guaranteed Minimum Value | $ | 21,250,000 | ||||||||||