Runway Growth Finance (RWAY) - 2021 Q4 - Annual Report

PART I Business Runway Growth Finance Corp. (RWAY) is an externally managed BDC and RIC providing senior secured loans to high-growth companies, aiming for total return through income and capital appreciation - The company is a specialty finance firm providing senior secured loans to late and growth-stage companies in high-growth industries[12] - As of December 31, 2021, the debt investment portfolio consisted of 39 debt investments in 25 portfolio companies with a fair value of $635.9 million; 98.0% of the debt portfolio at fair value consisted of senior term loans[18][19] - The company closed its Initial Public Offering (IPO) on October 25, 2021, issuing 6,850,000 shares at $14.60 per share and receiving net proceeds of approximately $93 million; the stock trades on the Nasdaq Global Select Market under the symbol "RWAY"[16] Portfolio Yield Overview (Year Ended Dec 31) | Metric | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Debt Investments Yield (Fair Value) | 13.77% | 14.91% | 20.47% | | Equity Interest Yield (Fair Value) | 2.68% | 3.59% | —% | | All Investments Yield (Fair Value) | 12.74% | 13.88% | 19.31% | External Management and Strategic Relationships The company is externally managed by Runway Growth Capital LLC, which provides investment advisory and administrative services, and maintains a strategic relationship with Oaktree Capital Management - RGC manages day-to-day operations and provides investment advisory services for a base management fee and an incentive fee[25][28] - As of December 31, 2021, OCM, an affiliate of Oaktree, owned 48% of the company's total issued and outstanding shares; OCM has the right to nominate a member to the Board of Directors and appoint a member to RGC's Investment Committee[41][42][43] Investment Strategy and Market Opportunity The company maximizes total return by providing senior secured term loans to late and growth-stage companies in high-growth industries, leveraging a favorable and underserved venture debt market - The primary investment focus is on senior secured term loans, with occasional investments in second lien loans and equity securities (like warrants) acquired in connection with loans[45] - Investment origination is pursued through two main strategies: Sponsored Growth Lending (targeting companies with at least $15 million annual revenue) and Non-Sponsored Growth Lending (targeting companies with at least $20 million annual revenue)[47][49][50] - The venture debt lending market was estimated at $29.9 billion in 2021, representing about 9.1% of total U.S. venture capital deal value, indicating a large and growing market for the company's services[60] Competitive Advantages and Competition The company leverages an experienced team, disciplined process, and Oaktree partnership for competitive advantage, while facing intense competition from larger, less regulated financial entities - Key competitive strengths include an experienced management team, a disciplined credit-first investment process, proprietary risk analytics, and deep relationships within the venture community[63][69][73][75] - The company's debt portfolio is 98.0% first lien senior secured; since inception, the cumulative gross loss rate has been 0.98% of total commitments, with a net loss rate of 0.04%[71] - Primary competitors include public and private funds, other BDCs, commercial and investment banks, and venture-oriented commercial banks; many competitors are larger and not subject to the same regulatory restrictions as a BDC[79] Regulatory and Tax Structure The company operates as a BDC and RIC, subject to regulations on asset composition, leverage, and income distribution, while benefiting from reduced reporting as an emerging growth company - As a BDC, the company is required to maintain an asset coverage ratio of at least 200% after each issuance of senior securities, though the Board approved a proposal to reduce this to 150% effective October 28, 2022, or earlier with stockholder approval[117][137] - To qualify as a RIC, the company must derive at least 90% of its gross income from specified sources and meet certain asset diversification tests at the end of each quarter[91][97] - The company must distribute at least 90% of its investment company taxable income to maintain its RIC status and generally avoid corporate-level U.S. federal income tax[95] - The company is classified as an "emerging growth company," exempting it from certain reporting requirements, such as the auditor attestation report on internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act[83] Risk Factors The company faces significant risks including economic uncertainties, business and structural challenges, investment-specific risks, potential conflicts of interest, and common stock volatility Risks Related to the Economy The company's performance is vulnerable to broad economic conditions, including pandemic impacts, market disruptions, recessions, and rising inflation, which could impair loan repayments - The COVID-19 pandemic has caused severe disruptions in the U.S. economy, creating significant business disruption for portfolio companies and adversely impacting the value and performance of certain investments[169][171] - Economic recessions or downturns could increase non-performing assets, decrease the value of collateral securing loans, and lead to financial losses in the portfolio[184] - Rising inflation and interest rates could impair portfolio companies' cash flow and operations, potentially leading to increased defaults[184][191] Risks Related to Our Business and Structure The company faces business and structural risks from subjective private investment valuations, intense competition, reliance on its external adviser, regulatory constraints, and interest rate fluctuations - A significant portion of the investment portfolio is recorded at fair value determined in good faith by the Board of Directors, which is inherently subjective and uncertain[192][193] - The company operates in a highly competitive market, which may limit its ability to find attractive investment opportunities and could lead to decreased yields[200][202] - Regulations governing BDCs affect the ability to raise additional capital, particularly the restriction on selling common stock below net asset value without stockholder approval[220][225] - The potential phase-out of LIBOR and transition to alternative reference rates like SOFR could impact the interest rates on both its loans and its borrowings, creating uncertainty for financial results[249][250] Risks Related to Our Investments Investments in high-growth, private companies are inherently risky, speculative, and illiquid, with potential for concentration risk and significant impact from industry downturns - Investing in high growth-potential, private companies involves a high degree of risk, as these companies may have limited financial resources, shorter operating histories, and be more vulnerable to competition and economic downturns[256][261][262] - The portfolio may be concentrated in a limited number of companies and industries (such as technology and life sciences), subjecting it to significant loss if one or more of these companies default or if a specific industry experiences a downturn[279][280] - The illiquidity of investments in privately held companies may make it difficult to sell them when desired or to realize their recorded value in a quick liquidation[277] - Prepayments of debt investments by portfolio companies could adversely impact results of operations, as proceeds may need to be reinvested at lower yields[306] Risks Related to Our Conflicts of Interest External management, the Oaktree strategic relationship, and asset-based fee structures create potential conflicts of interest, particularly concerning risk-taking and valuation - The strategic relationship with Oaktree creates potential conflicts, as OCM is a major shareholder with representation on the Board and RGC's Investment Committee, and Oaktree may engage in similar investment activities[314][316] - The base management fee is based on gross assets, which may incentivize RGC to use leverage; the incentive fee is based on net capital gains, which could induce more speculative investments[210][211] - The participation of RGC's investment team in the valuation process could result in a conflict of interest, as management and incentive fees are based, in part, on the value of the company's assets[323] Risks Related to Our Common Stock Common stock risks include trading at a discount to NAV, potential price impact from substantial sales, and dilution for non-participating stockholders in dividend reinvestment - Shares of BDCs frequently trade at a discount to their net asset value, and there is no assurance the company's common stock will trade at, above, or below its NAV[326] - Sales of substantial amounts of common stock in the public market, particularly after lock-up periods expire, could adversely affect the market price[329][336] - Stockholders who do not participate in the dividend reinvestment plan may experience dilution in the NAV of their shares if the company's shares are trading at a discount to NAV[344] Risks Related to RIC Tax Treatment Maintaining RIC status is crucial to avoid corporate income tax, with failure to meet distribution or income tests leading to substantial reductions in net assets and distributable income - If the company fails to qualify as a RIC, it will be subject to U.S. federal income tax at corporate rates, which could substantially reduce net assets and the amount of income available for distribution[356][359] - The company may recognize taxable income from sources like PIK interest before receiving the corresponding cash; this could create difficulty in meeting the 90% distribution requirement to maintain RIC status[360][361] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - None[394] Properties The company does not own real estate; its corporate headquarters and facilities are provided by its Administrator - The company's corporate headquarters are located at 205 N. Michigan Ave., Suite 4200, Chicago, IL 60601, and are provided by the Administrator; the company does not own any real estate[395] Legal Proceedings The company and its investment adviser are not currently subject to any material legal proceedings - The company is not currently subject to any material legal proceedings[396] Mine Safety Disclosures This item is not applicable to the company's business operations - Not applicable[398] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock began trading on Nasdaq in October 2021, with quarterly distributions and an opt-out dividend reinvestment plan - Common stock began trading on Nasdaq Global Select Market on October 21, 2021, under the symbol "RWAY"[401] Quarterly Distributions Declared per Share | Quarter | Record Date | Payment Date | Per Share | | :--- | :--- | :--- | :--- | | 2022 Q1 | Mar 8, 2022 | Mar 22, 2022 | $0.27 | | 2021 Q4 | Nov 8, 2021 | Nov 22, 2021 | $0.25 | | 2021 Q3 | Jul 20, 2021 | Aug 12, 2021 | $0.34 | | 2021 Q2 | Apr 30, 2021 | May 13, 2021 | $0.37 | | 2021 Q1 | Mar 5, 2021 | Mar 19, 2021 | $0.37 | - The company has an "opt-out" dividend reinvestment plan where cash distributions are automatically reinvested in additional shares unless a stockholder elects to receive cash[409] - On March 2, 2022, the closing stock price was $13.34 per share, representing an 8.9% discount to the NAV per share of $14.65 as of December 31, 2021[417] Management's Discussion and Analysis of Financial Condition and Results of Operations This section details the company's financial condition and operational results, including portfolio composition, investment activity, asset quality, and liquidity Portfolio Composition and Investment Activity As of December 31, 2021, the company's $729.5 million portfolio, primarily senior secured term loans, saw significant funding and repayments, with a 13.77% debt portfolio yield Portfolio Composition by Fair Value (as of Dec 31, 2021) | Investment Type | Fair Value | % of Total Portfolio | | :--- | :--- | :--- | | Senior Secured Term Loans | $623,053,646 | 85.4% | | Warrants | $20,087,550 | 2.7% | | Preferred Stock | $17,037,125 | 2.3% | | Second Lien Term Loans | $12,872,588 | 1.8% | | Common Stock | $11,463,865 | 1.6% | | U.S. Treasury Bill | $45,001,500 | 6.2% | | Total Investments | $729,516,274 | 100.0% | - In 2021, the company funded $267.7 million in 12 new portfolio companies and $116.7 million in 10 existing portfolio companies, while receiving $293.3 million in loan repayments from 17 portfolio companies[448] Asset Quality The company monitors debt portfolio quality using a five-level rating system, with most assets performing at or above plan, though some are on non-accrual status Debt Investment Ratings by Fair Value | Rating | Definition | % of Total Portfolio (Dec 31, 2021) | % of Total Portfolio (Dec 31, 2020) | | :--- | :--- | :--- | :--- | | 1 | Performing above plan | 12.5% | —% | | 2 | Performing at or near plan | 65.7% | 61.2% | | 3 | Performing below plan | 6.5% | 14.5% | | 4 | Materially below plan | 0.4% | 4.9% | | 5 | Going concern in question | 2.0% | —% | - As of December 31, 2021, loans to two companies, Mojix, Inc. and Pivot3 Holdings, Inc., were on non-accrual status, representing 4.66% of the company's net assets[454] Results of Operations In 2021, total investment income increased to $71.4 million, while operating expenses also rose, resulting in net investment income of $44.5 million and a net asset increase of $45.6 million Comparison of Results of Operations (Years Ended Dec 31) | Metric | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Total Investment Income | $71,358,455 | $57,626,303 | $55,139,136 | | Total Operating Expenses | $26,866,767 | $19,556,586 | $18,685,305 | | Net Investment Income | $44,491,688 | $38,069,717 | $36,453,831 | | Net Realized (Loss)/Gain | $4,172,366 | ($5,347,409) | $609,031 | | Net Change in Unrealized (Depreciation)/Appreciation | ($3,045,344) | $14,257,592 | ($9,416,462) | | Net Increase in Net Assets from Operations | $45,618,710 | $46,979,900 | $27,646,400 | - The increase in investment income in 2021 was driven by capital deployment, increased invested balance, prepayments, and end-of-term payments[461] - The increase in operating expenses in 2021 was primarily due to higher management and incentive fees paid to RGC, increased interest expense, and debt financing fees[463] Financial Condition, Liquidity and Capital Resources The company maintains strong liquidity and capital resources, with a 582% asset coverage ratio, utilizing credit facilities and senior notes to fund operations and commitments - As of December 31, 2021, the company's asset coverage ratio was 582%, well above the regulatory requirement[471] - In December 2021, the company issued $20 million of 4.25% Senior Notes due 2026 in a private placement, with an additional $50 million closing in February 2022[479] - As of December 31, 2021, the company had $61.0 million outstanding under its credit facility and $187.0 million in unfunded loan commitments to 13 portfolio companies[476][487] Quantitative and Qualitative Disclosures About Market Risk The company faces significant market risks, primarily valuation risk for illiquid investments and interest rate risk, while managing the transition from LIBOR - The company's primary market risks are valuation risk for its illiquid portfolio investments and interest rate risk[532][533][536] - As of December 31, 2021, 94.5% of the debt portfolio bore interest at variable rates, primarily based on LIBOR and subject to floors; a hypothetical 200 basis point increase in rates could increase annual investment income by a maximum of $9.6 million, while a decrease would have no impact due to interest rate floors[537] - The company is actively managing the transition away from LIBOR, which is expected to be discontinued after June 30, 2023, and may need to renegotiate credit agreements with portfolio companies and its own borrowing facilities[539] Financial Statements and Supplementary Data This section presents the company's audited financial statements for the fiscal year ended December 31, 2021, including key statements and notes Key Financial Data (as of Dec 31, 2021) | Metric | Amount | | :--- | :--- | | Total Investments at Fair Value | $729,516,274 | | Total Assets | $738,347,480 | | Total Liabilities | $132,152,989 | | Total Net Assets | $606,194,491 | | Net Asset Value per Share | $14.65 | Key Operational Data (Year Ended Dec 31, 2021) | Metric | Amount | | :--- | :--- | | Total Investment Income | $71,358,455 | | Net Investment Income | $44,491,688 | | Net Increase in Net Assets from Operations | $45,618,710 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants regarding accounting and financial disclosure - None[758] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2021 - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2021[759] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2021[763] Other Information This section provides estimated stockholder transaction and annual expenses, with total annual expenses at 3.42% of net assets Estimated Annual Expenses | Expense Category | % of Net Assets | | :--- | :--- | | Management Fee | 1.48% | | Incentive Fee | 1.52% | | Interest payments on borrowed funds | 0.42% | | Other expenses | -% | | Total annual expenses | 3.42% | Disclosure Regarding Foreign Jurisdictions that Prevent Inspection This item is not applicable to the company - None[774] PART III Directors, Executive Officers and Corporate Governance Information for this item is incorporated by reference from the company's definitive 2022 proxy statement - Information is incorporated by reference from the 2022 Proxy Statement[776] Executive Compensation Information for this item is incorporated by reference from the company's definitive 2022 proxy statement - Information is incorporated by reference from the 2022 Proxy Statement[778] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information for this item is incorporated by reference from the company's definitive 2022 proxy statement - Information is incorporated by reference from the 2022 Proxy Statement[779] Certain Relationships and Related Transactions, and Director Independence Information for this item is incorporated by reference from the company's definitive 2022 proxy statement - Information is incorporated by reference from the 2022 Proxy Statement[780] Principal Accounting Fees and Services Information for this item is incorporated by reference from the company's definitive 2022 proxy statement - Information is incorporated by reference from the 2022 Proxy Statement[781] PART IV Exhibits and Financial Statement Schedules This section lists all financial statements and exhibits filed as part of the Annual Report on Form 10-K, including key corporate and contractual documents - This section lists all financial statements and exhibits filed with the Form 10-K, including key agreements like the Second Amended and Restated Investment Advisory Agreement and the Master Note Purchase Agreement[782][783]