Incorporated in 1983, Harris & Harris Group is a publicly traded venture capital company that since 1995 has elected to operate as a business development company under the Investment Company Act of 1940. In addition, for tax purposes we have elected to be treated as a regulated investment company, or RIC.
Business development company ("BDC") regulation was created in 1980 by Congress in order to encourage the flow of public equity capital to private businesses in the United States. BDCs are subject to certain provisions of the Investment Company Act of 1940. BDCs are unique because they focus on investing in private companies or public companies with small market capitalizations. BDCs are required to report to shareholders like traditional operating companies by filing regular quarterly and annual reports with the Securities and Exchange Commission. They are also required to make available significant managerial assistance to their portfolio companies. By investing in Harris & Harris Group, shareholders enjoy the liquidity of a publicly traded stock, while participating in the private venture capital industry.
The Company has also elected to be a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code (the "Code") for federal income tax purposes. In general, a RIC is not taxable on its income or gains to the extent it distributes such income or gains to its shareholders. With respect to its net long-term capital gains, Subchapter M provides the Company with three choices: it can retain them and pay tax, it can declare a deemed dividend (or designated undistributed capital gain dividend) or it can pay out the gains as a distribution.
Harris & Harris Group trades on The NASDAQ Global Market under the ticker symbol "TINY." Information about our stock price and other related data can be found by visiting the stock information page (http://www.hhvc.com/stockquote.cfm) on our website.
We make venture capital investments exclusively in companies commercializing or integrating products enabled by nanotechnology or microsystems. We consider a company to fit our investment thesis if the company employs or intends to employ technology that we consider to be at the microscale or smaller and if the employment of that technology is material to its business plan.
Nanotechnology is measured in nanometers, which are units of measurement in billionths of a meter. Nanotechnology manifests itself in tools, materials, systems and devices that address broad markets, including instrumentation, alternative energy, electronics, photonics, computing, medical devices, pharmaceutical manufacturing, drug delivery and drug discovery. The development and commercialization of nanotechnology often require the integration of multiple disciplines, including biology, physics, chemistry, materials science, computer science and the engineering sciences.
Microsystems are measured in micrometers, which are units of measurement in millionths of a meter. In practice, any device, or device enabled by components, in a size range from 100 microns down to 0.1 micron may be considered "micro."
In our view, nanotechnology is neither an industry nor a single technology, but a variety of enabling technologies with critical dimensions below 100 micrometers. Although we do not have a policy of diversification, below is a snapshot of our portfolio as of September 30, 2009:
We identify investment opportunities primarily through five channels: (1) our involvement in the field of nanotechnology and microsystems; (2) research institutions, universities and corporations that seek to transfer their scientific discoveries to the private sector; (3) other venture capital companies seeking co-investors or referring deals to us; (4) referrals from our portfolio companies; and (5) direct calls and business plan submissions by companies, business incubators and individuals seeking venture capital.
No. Investors must go through a broker or to the Company's transfer agent, American Stock Transfer, to purchase shares. Please visit American Stock Transfer's website at www.amstock.com or call 1-888-777-0324 for more information.
We do not release information about our net asset value before the filing of our Forms 10-K or 10-Q. Our Form 10-Ks are filed no later than 75 days after the end of our fiscal year end, which is December 31st . Our Form 10-Qs are filed no later than 45 days after the end of each of our fiscal quarters, which are March 31st, June 30th and September 30th.
As of September 30, 2009, the Company held $66,971,440 in U.S. treasuries. Our investments in privately held, illiquid securities are amongst the most risky of asset classes. We believe it is appropriate to minimize the risk associated with the available cash of the Company. Accordingly, we have historically held the majority of cash in U.S. treasury securities and plan to continue to do so for the foreseeable future.
Our cash is used to fund investments in portfolio companies and to pay for operating expenses. Our investments in portfolio companies begin with an initial investment that may range in amount from hundreds of thousands of dollars to millions of dollars. We may make additional follow on investments in our portfolio companies at varying points in time after our initial investment.
Compensation expense related to the grant of options will increase our total operating expenses and net operating loss. Because the increase to expenses is offset by an increase to our additional paid-in capital, the granting of options itself has no net impact on our net asset value per share. If options are exercised, net asset value per share will decrease if the net asset value per share at the time of exercise is higher than the exercise price; conversely, net asset value per share will increase if the net asset value per share at the time of exercise is lower than the exercise price.
Our valuation process is conducted on a quarterly basis. The investment team prepares a detailed summary of the status of each portfolio company that includes all information relevant to value as of the end of the quarter. The investment team uses these data to calculate proposed valuations for each of our portfolio companies. These proposed valuations and the information used to derive them are reviewed and commented on by multiple parties including:
- Duff & Phelps, a firm with valuation expertise that reviews a rotating set of four to five valuation summaries and proposed values each quarter;
- Our board of directors, always including the chairs of the audit committee and the valuation committee;
- Our independent auditors as part of their review of our quarterly financials and our year-end audit.
The management team then proposes these valuations to our valuation committee that is comprised of all of our independent directors. It is the valuation committee that ultimately sets the valuations of our privately held portfolio companies at the end of each quarter.
Our investments are fair valued according to the methods set forth by ASC 820 (formerly FAS 157.)
Inputs used to determine fair value include:
- The cost of the investment;
- Transactions of securities of a company following our initial investment;
- The financial condition and operating results of a company;
- The progress toward milestones;
- The long-term potential of the business and technology of a company;
- The value of similar securities issued by companies in similar businesses;
- Multiples to revenues, net income or EBITDA of similar businesses;
- The proportion of the company we own and any rights to obtain additional securities of a company; and
- The rights and preferences of the securities owned compared to other classes of securities outstanding.
As of September 30, 2009, we had 30 active tiny technology companies in our portfolio. As of September 30, 2009, from first dollar in, the average and median holding periods for these 30 active tiny technology investments were 4.3 years and 3.7 years, respectively. DowJones VentureSource reports that it took a median of 6.13 years and 13 years for a venture-backed company to reach liquidity by a merger or acquisition or by an initial public offering, respectively. We believe these lengths of time are substantially greater than those during prior years due in part to the recent turmoil in the capital markets. We believe these economic conditions could result in our portfolio companies taking longer to reach a liquidity event than in prior periods of time in our history.
In any year in which we have capital gains, the Board of Directors plans to declare a designated undistributed capital gain dividend (or deemed dividend). The Board of Directors has no current intention to pay cash distributions. When the Company declares a deemed dividend instead of a cash distribution, the Company is taxable on the retained capital gains, the shareholders are deemed to have received the deemed dividend as a capital gain dividend and the shareholders are deemed to have paid the tax actually paid by the Company. Thus, they receive a tax credit that they can use to offset their tax on the deemed dividend or for other purposes. The shareholders also increase their cost basis in their shares in the Company by the amount of the deemed distribution, net of taxes paid by the Company and deemed paid by the shareholders.
Shareholders of record on the record date will be provided with the exact amount of the deemed dividend attributable to their shares by their brokerage firm or bank, if their shares are held in electronic format, or by American Stock Transfer, if their shares are held directly. This information is to be reported by you on IRS Form 2439, along with your tax return.
The following simplified examples illustrate the tax treatment under Subchapter M of the Code for us and our individual shareholders with regard to three possible distribution alternatives, assuming a net capital gain of $1.00 per share, consisting entirely of sales of non-real property assets held for more than 12 months.
Under Alternative A: 100 percent of net capital gain declared as a cash dividend and distributed to shareholders:
1. No federal taxation at the Company level.
2. Taxable shareholders receive a $1.00 per share dividend and pay federal tax at a rate not in excess of 15 percent* or $.15 per share, retaining $.85 per share.
3. Non-taxable shareholders that file a federal tax return receive a $1.00 per share dividend and pay no federal tax, retaining $1.00 per share.
Under Alternative B (Current Tax Structure Employed): 100 percent of net capital gain retained by the Company and designated as "undistributed capital gain" or deemed dividend:
1. The Company pays a corporate-level federal income tax of 35 percent on the undistributed gain or $.35 per share and retains 65 percent of the gain or $.65 per share.
2. Taxable shareholders increase their cost basis in their stock by $.65 per share. They pay federal capital gains tax at a rate not in excess of 15 percent* on 100 percent of the undistributed gain of $1.00 per share or $.15 per share in tax. Offsetting this tax, shareholders receive a tax credit equal to 35 percent of the undistributed gain or $.35 per share.
3. Non-taxable shareholders that file a federal tax return receive a tax refund equal to $.35 per share.
*Assumes all capital gains qualify for long-term rates of 15 percent.
Under Alternative C: 100 percent of net capital gain retained by the Company, with no designated undistributed capital gain or deemed dividend:
1. The Company pays a corporate-level federal income tax of 35 percent on the retained gain or $.35 per share plus an excise tax of four percent of $.98 per share, or about $.04 per share.
2. There is no tax consequence at the shareholder level.
The investor or trustee should still receive a Form 2439 for shares held in these accounts. There is a method for the trustee to apply for a refund of taxes withheld related to these accounts. The trustee needs to file a Form 990-T and the investor should also consult their personal tax advisor. You can get the Form 990-T from a tax advisor or online at www.irs.gov.
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