7/21/22, 1:41 PM Venture Debt Players (HTGC, HRZN & TPVG) _ Dividend Yield 7-9% _ Seeking Alpha

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Venture Debt Players Yielding 7% To 9% For

Your Portfolio: Hercules, Horizon Tech,
TriplePoint
Oct. 21, 2021 11:51 AM ET | Hercules Capital, Inc. (HTGC), TPVG, HRZN | HCXY, HTFA, TRIN... |
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Summary
This article compares HTGC, HRZN and TPVG, currently paying dividend yields of
7% to 9% supported by debt and equity investments in venture capital (VC)-backed
technology and high-growth companies.

Two of these companies continue to outperform the S&P 500.

There are many considerations when investing in these companies including quality
of management and upcoming dividend coverage.

This article provides insights for each of these companies that will be reporting Q3
results next week.

Please do your own due diligence or at least subscribe to a research service that
provides this information before investing in BDCs.

Looking for a portfolio of ideas like this one? Members of Sustainable Dividends get
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designer491/iStock via Getty Images

This article compares TriplePoint Venture Growth (NYSE:TPVG), Hercules Capital

(NYSE:HTGC), and Horizon Technology Finance (NASDAQ:HRZN) which are business
development companies ("BDCs") that provide capital to venture capital-backed
technology and high growth companies currently yielding between 7.0% (for HRZN) and
9.0% (for HTGC with specials). It should be noted that Trinity Capital (TRIN) is another
BDC with a similar focus which became publicly traded earlier this year and will likely
start coverage after connecting with management.

TPVG is focused on providing customized debt financing with warrants and direct
equity investments to venture growth stage companies in technology and other high
growth industries backed by a select group of venture capital firms.

Source: TPVG Website

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HTGC is the leading and largest specialty finance company focused on providing
senior secured venture growth loans to high-growth, innovative venture capital-
backed companies in a broad variety of technology, life sciences and sustainable and
renewable technology industries.

Source: HTGC Website

HRZN is a leading provider of secured loans to venture capital-backed and private

equity-backed growth stage companies focused on technology, life science,
healthcare technology, and sustainability.

Source: HRZN Website

Source: TPVG Investor Presentation

Why Would Venture-Backed Companies Use Venture Debt?

1. Less dilutive than new VC round

2. Lengthens time before next equity round

3. Provides negotiating leverage for higher valuations

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4. Leverages returns for equity investors

Source: HTGC Website

Dividend Yield, Market Cap and Trading Volumes

I typically cover larger BDCs with adequate trading volumes as the BDC sector can be
volatile with meaningful swings during markets "flight to safety." Larger investors prefer
having liquidity, especially when BDCs report "good" or "bad" results so that they can
take advantage of the timing of trades, etc. In a down market, you do not want to be
holding a smaller BDC. Also, larger companies typically have more institutional investors
that can drive management to do the right thing if needed.

Quality of Management

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This is likely the most important part of BDC analysis, as management is responsible for
building a portfolio to deliver returns to shareholders while protecting the capital
invested. BDC management controls all the levers including the quality of the
origination/credit platform, managing the capital structure with appropriate leverage,
meaningful share repurchases, accretive equity offerings, and dividend policy, creating
an efficient operating cost structure and willingness to “do the right thing” by waiving
management fees or having a best in class fee structure that protects returns to
shareholders. I'm not going to get into all of the details for each BDC here, as it would
be an entire article for each company.

I have been covering HTGC for a while now including almost nine years here on
Seeking Alpha and I firmly believe that larger investors squashed Manuel A. Henriquez's
desire for HTGC to become externally managed for the reasons discussed in "Hercules
Capital: External Management Analysis" in 2017. Please note that Mr. Henriquez
resigned during the Operation Varsity Blues scandal and I have full confidence in the
current management team not to pursue 'externalization' again.

HRZN is an outlier in the BDC sector and is one of the few BDCs that has issued shares
below NAV as well as the previously discussed dividend cuts and the 33% decline in
NAV per share. On March 24, 2015, HRZN completed a follow-on public equity offering
of 2 million shares for net proceeds of $26.7 million, or $13.35 per share, which was 7%
below its NAV per share of $14.36.

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Source: HRZN SEC Filing

The following table ranks each company by the amount or regular dividends paid
annually divided by the current book value or net asset value ("NAV"):

HTGC is obviously the winner with an internally managed structure driving increased
dividends and NAV per share with continued accretive equity offerings. TPVG is
externally managed with a stable dividend and pays specials when they can as well as
equity offerings that are less accretive, but the company has historically used the
proceeds quickly to improve returns.

Historical Changes in Book Values

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As discussed in previous articles, changes in book value or NAV per share are not
always a clear indicator of historical credit issues because there are many items that
impact NAV including over or underpaying the dividend, equity issuances, and general
changes in values for assets and liabilities (borrowings). It's also important to recognize
the difference between “realized” and “unrealized” gains and losses. BDCs that have
recently cut dividends due to credit issues likely had larger amounts of realized losses
from investments sold or written off. Many higher-quality BDCs have had previous NAV
per share declines mostly related to unrealized losses and conservatively marking
assets down to reflect general market pricing rather than changes to credit quality.
However, if you use a longer-term when measuring changes it becomes a more
meaningful measure. Clearly, HTGC is the winner in this category and I firmly believe
that BDCs with historical NAV growth should trade at a premium.

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Historical Changes in Dividends

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HTGC and TPVG have never cut their dividends and continue to pay out supplementals
dividends when appropriate especially HTGC as discussed next. HRZN has cut its
dividend twice and has only paid one special dividend.

I have provided quite a few articles predicting dividend increases for HTGC including
"This 10.0% Yielding Tech-Focused BDC Will Likely Increase Its Dividend."

HTGC maintains a “variable distribution policy” with the objective of distributing four
quarterly distributions in an amount that approximates 90% to 100% of the company’s
taxable quarterly income or potential annual income. In addition, the company pays
additional supplemental distributions to distribute approximately all its annual taxable
income in the year it was earned, or it can elect to maintain the option to spill over the
excess taxable income into the coming year for future distribution payments.

We have a variable dividend policy, so it's something that the Board evaluates on a
quarterly basis, and we don't just look short-term, we look long-term when we're
making those decisions. We've been very clear in terms of our public guidance on the
last several calls that we see absolutely no risk to that $0.32 base distribution.“

Source: HTGC Earnings Call

HTGC previously announced that its Board has declared additional supplemental cash
distributions during 2021 due to the “record level of spillover” and “the trajectory of the
business for the course of 2021.” HTGC has been distributing $0.28 per share evenly
over the next four quarters starting with $0.07 per share starting with Q2 2021:

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As of Q2 2021, we have generated record undistributed earnings spillover of

approximately $160.2 million or $1.38 per share subject to final tax filings. This
provides us with additional flexibility with respect to our variable base distribution
going forward and the ability to continue to invest in our team and platform.”

Source: HTGC Earnings Call

Source: Fidelity

On the recent HTGC earnings call, management was asked about the dividend policy as
it relates to the tax requirements of a being registered investment company (“RIC”). My
takeaway is that the $0.28 per share paid over four quarters was required for the
previous amounts of undistributed/spillover income and the company will announce
additional amounts later this year:

Q. “So you have a record $160 million or $1.38 per share there, so can you talk bit
about what your plans are with that and can you remind me if you have any
restrictions there with how much spillover you can have is that 90% of NII or net
assets. And then when would you need to do something if there are restrictions?”

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A. “Our quarterly base distribution is variable, the board evaluates on a quarterly

basis will be what we think makes sense based on the facts and circumstances as of
the time. And then at the beginning of this year in Q1, we announced the $0.28
supplemental distribution for 2021, which will be distributed $0.07 per quarter in each
of the four quarters of 2021. Our plan would be to evaluate at the end of this year, a
further potential supplemental distribution program for 2022 and we will of
course on a quarterly basis reevaluate what base distribution level we think is most
appropriate. As a registered investment company, we're required to distribute 90% of
our earnings basically over a year. So if we accumulate on the ordinary income
earnings that are greater than 90% of annual earnings, then we're reaching that
ceiling that you're talking about. So we would have to distribute it. And then on the
capital gain side we have to distribute about 98% of it, but that measurement period
is really from November to October, and so we need to see what that position
would be after October.”

Source: HTGC Earnings Call

Again, HTGC is the clear winner when it comes to increasing its dividends.

Conclusion and Recommendations

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If you want to increase your exposure to one of these companies, I would choose HTGC
as the safer higher-quality internally managed option. HTGC's pricing is not ideal, but
adequate for a starter position - additional shares can be purchased during any
pullbacks (which are likely coming).

HRZN has had a nice run and hopefully, management has learned from past mistakes
but is likely overpriced relative to TPVG and HTGC driving a much lower dividend yield.

Since 2018, TPVG and HTGC have outperformed the S&P 500 and HRZN.

As discussed earlier this week in "Conservative Portfolio Safely Paying Investors 7.3%:
Golub Capital," historical dividend coverage is not a good indicator of upcoming
coverage for many reasons. I typically project at least three quarters of financial
results for each BDC and then use the results from earnings season to make sure that
the company is "heading the right direction." Please do your own due diligence or at
least subscribe to a proper research service that provides this information before
investing in BDCs.

TPVG has also had quite a run this month partially due to increased activity on what is
considered a "yield chaser" discussion group that has temporarily driven the stock to
overbought levels with its RSI now around 72 as discussed in the "BDC Sector Weekly
Update." However, I'm expecting temporary dividend coverage issues for TPVG mostly
related to previous prepayments (which is generally a good sign of quality originations)
resulting in an underinvested portfolio as discussed in my new Substack blog:

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TPVG Updated Projections: Likely Q3 Miss

Upcoming articles will discuss access to capital as higher quality BDCs can borrow at
much lower fixed rates. On Sept. 16, 2021, HTGC announced the closing of its $325
million of 2.625% unsecured notes due 2026 with the proceeds being used to redeem all
or a portion of its 4.605% asset-backed notes due 2027 and 4.703% asset-backed notes
due 2028. Included in the SEC filings related to the notes was the following update
regarding portfolio activity:

Since the close of our second fiscal quarter of 2021 and as of August 31, 2021, we
and the Adviser Subsidiary Funds have closed new debt and equity commitments of
$186.9 million and funded $107.1 million. We and the Adviser Subsidiary Funds have
pending debt and equity commitments of $553.8 million in signed non-binding term
sheets outstanding as of August 31, 2021. Excluding the commitments and fundings
assigned and/or directly originated or funded by the Adviser Subsidiary Funds, during
the same period, we have closed net debt and equity commitments of $142.0 million
and funded $83.3 million.

This is basically in line with my previous "HTGC Updated Projections & Pricing" showing
base case projected portfolio growth of $79 million and best case of $179 million. Please
keep in mind that there is still the month of September (which is typically busier) as well
as repayments to take into account.

BDCs will begin reporting calendar Q3 2021 results next week including HTGC and
HRZN which is typically when many investors make changes to their portfolios
(including myself). As mentioned in the blog post linked above, there's a chance that
TPVG could miss earnings expectations and might be an opportunity to purchase
shares at a lower price. Also, there's a chance that HRZN could announce a strong
quarter as the company has provided guidance on October 6, 2021. However, HTGC
will also likely announce or at least provide guidance for higher dividends in 2022 as
mentioned earlier.

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We are currently offering 20% off for subscriptions to Sustainable Dividends which
gives you access to several features not available on the public side including the BDC
Google Sheets and:

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This article was written by

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Disclosure: I/we have a beneficial long position in the shares of HTGC, TPVG either through stock
ownership, options, or other derivatives. I wrote this article myself, and it expresses my own
opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no
business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am currently long 17 BDCs but only 2 of them were discussed in this
article.

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