Hercules Capital, Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Fair Value of Financial Instruments

Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2024

Fair value estimates are made at discrete points in time based on relevant information. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Investments measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations as of March 31, 2024 and December 31, 2023.


(in thousands)	Balance as of March 31, 2024		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description
Other assets
Escrow and Other Investment Receivables	$	5,020	$	—	$	—	$	5,020

Investments
Senior Secured Debt	$	3,312,225	$	—	$	—	$	3,312,225
Unsecured Debt	70,745		—		—		70,745
Preferred Stock	52,309		—		—		52,309
Common Stock (2)	97,890		57,852		—		40,038
Warrants	32,693		—		13,411		19,282
	$	3,565,862	$	57,852	$	13,411	$	3,494,599
Investment Funds & Vehicles measured at Net Asset Value (3)	5,779
Total Investments, at fair value	$	3,571,641
Derivative Instruments (4)	(537)
Total Investments, at fair value including derivative instruments	$	3,571,104


(in thousands)	Balance as of December 31, 2023		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description
Cash and cash equivalents
Money Market Fund (1)	$	56,000	$	56,000	$	—	$	—

Other assets
Escrow and Other Investment Receivables	$	10,888	$	—	$	—	$	10,888

Investments
Senior Secured Debt	$	2,987,577	$	—	$	—	$	2,987,577
Unsecured Debt	69,722		—		—		69,722
Preferred Stock	53,038		—		—		53,038
Common Stock (2)	99,132		57,342		—		41,790
Warrants	33,969		—		11,881		22,088
	$	3,243,438	$	57,342	$	11,881	$	3,174,215
Investment Funds & Vehicles measured at Net Asset Value(3)	4,608
Total Investments, at fair value	$	3,248,046
Derivative Instruments (4)	(766)
Total Investments including cash and cash equivalents and derivative instruments	$	3,303,280

(1)This investment is included in Cash and cash equivalents in the accompanying Consolidated Statements of Assets and Liabilities.

(2)Common Stock includes non-voting security in the form of a promissory note with a lien on shares of issuer's Common Stock.

(3)In accordance with U.S. GAAP, certain investments are measured at fair value using the net asset value per share (or its equivalent) as a practical expedient and are not categorized within the fair value hierarchy as per ASC 820. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the accompanying Consolidated Statements of Assets and Liabilities.

(4)Derivative Instruments are carried at fair value and a level 2 security within the Company's fair value hierarchy.

The table below presents a reconciliation of changes for all financial assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the three months ended March 31, 2024 and 2023.


(in thousands)	Balance as of January 1, 2024		Net Realized Gains (Losses) (1)		Net Change in Unrealized Appreciation (Depreciation) (2)		Purchases (4)		Sales		Repayments(5)		Gross Transfers into Level 3		Gross Transfers out of Level 3		Balance as of March 31, 2024

Investments
Senior Secured Debt	$	2,987,577	$	—	$	(104)	$	498,787	$	—	$	(174,035)	$	—	$	—	$	3,312,225
Unsecured Debt	69,722		—		481		542		—		—		—		—		70,745
Preferred Stock	53,038		—		(2,326)		1,597		—		—		—		—		52,309
Common Stock	41,790		—		(1,752)		—		—		—		—		—		40,038
Warrants	22,088		904		(2,113)		1,232		(2,829)		—		—		—		19,282
Other Assets
Escrow and Other Investment Receivables	10,888		13		7,353		—		(13,234)		—		—		—		5,020
Total	$	3,185,103	$	917	$	1,539	$	502,158	$	(16,063)	$	(174,035)	$	—	$	—	$	3,499,619


(in thousands)	Balance as of January 1, 2023		Net Realized Gains (Losses) (1)		Net Change in Unrealized Appreciation (Depreciation) (2)		Purchases (4)		Sales		Repayments(5)		Gross Transfers into Level 3 (3)		Gross Transfers out of Level 3 (3)		Balance as of March 31, 2023
Investments
Senior Secured Debt	$	2,741,388	$	—	$	16,023	$	362,781	$	—	$	(209,666)	$	—	$	—	$	2,910,526
Unsecured Debt	54,056		—		3,746		323		—		—		—		—		58,125
Preferred Stock	41,488		—		(1,143)		—		—		—		—		—		40,345
Common Stock	25,059		—		5,632		—		(207)		—		—		—		30,484
Warrants	19,419		(858)		1,508		948		(7)		—		—		—		21,010
Other Assets
Escrow Receivable	875		26		—		—		(98)		—		—		—		803
Total	$	2,882,285	$	(832)	$	25,766	$	364,052	$	(312)	$	(209,666)	$	—	$	—	$	3,061,293

(1)Included in net realized gains (losses) in the accompanying Consolidated Statements of Operations.

(2)Included in net change in unrealized appreciation (depreciation) in the accompanying Consolidated Statements of Operations.

(3)There were no transfers into or out of Level 3 during the three months ended March 31, 2024 and 2023.

(4)Amounts listed above are inclusive of loan origination fees received at the inception of the loan which are deferred and amortized into fee income as well as the accretion of existing loan discounts and fees during the period. Escrow receivable purchases may include additions due to proceeds held in escrow from the liquidation of level 3 investments. Amounts are net of purchases assigned to the Adviser Funds.

(5)Amounts listed above include the acceleration and payment of loan discounts and loan fees due to early payoffs or restructures along with regularly scheduled amortization.

The following table presents the net unrealized appreciation (depreciation) recorded for debt, preferred stock, common stock, and warrant Level 3 investments relating to assets still held at the reporting date.


(in millions)	Three Months Ended March 31,
	2024		2023
Debt Investments	$	0.4	$	(22.6)
Preferred Stock	(2.3)		(1.1)
Common Stock	(1.8)		5.6
Warrant Investments	0.7		(0.6)

The following tables provide quantitative information about the Company’s Level 3 fair value measurements as of March 31, 2024 and December 31, 2023. In addition to the techniques and inputs noted in the tables below, according to the Company’s valuation policy, the Company may also use other valuation techniques and methodologies when determining the Company’s fair value measurements. The tables below are not intended to be all-inclusive, but rather provide information on the significant Level 3 inputs as they relate to the Company’s fair value measurements. See the accompanying Consolidated Schedule of Investments for the fair value of the Company’s investments. The methodology

for the determination of the fair value of the Company’s investments is discussed in “Note 2 – Summary of Significant Accounting Policies”. The significant unobservable input used in the fair value measurement of the Company’s escrow receivables is the amount recoverable at the contractual maturity date of the escrow receivable.


Investment Type - Level 3 Debt Investments	Fair Value as of March 31, 2024 (in thousands)		Valuation Techniques/ Methodologies	Unobservable Input(1)	Range	Weighted Average(2)
Pharmaceuticals	$	973,558	Market Comparable Companies	Hypothetical Market Yield	10.69% - 21.21%	13.34%
				Premium/(Discount)	(2.00)% - 4.00%	0.03%
	5,215		Liquidation (3)	Probability weighting of alternative outcomes	20.00% - 60.00%	51.20%

Technology	1,078,024		Market Comparable Companies	Hypothetical Market Yield	10.26% - 19.04%	13.96%
				Premium/(Discount)	(1.50)% - 3.50%	0.19%
	24,227		Convertible Note Analysis	Probability weighting of alternative outcomes	1.00% - 60.00%	39.55%
	54,837		Liquidation (3)	Probability weighting of alternative outcomes	30.00% - 100.00%	52.01%

Sustainable and Renewable Technology	1,566		Market Comparable Companies	Hypothetical Market Yield	11.27% - 11.27%	11.27%
				Premium/(Discount)	1.50% - 1.50%	1.50%

Medical Devices	30,480		Market Comparable Companies	Hypothetical Market Yield	12.79% - 12.79%	12.79%
				Premium/(Discount)	0.50% - 0.50%	0.50%

Lower Middle Market	399,205		Market Comparable Companies	Hypothetical Market Yield	10.92% - 18.83%	13.85%
				Premium/(Discount)	0.00% - 3.00%	0.92%

Debt Investments for which Cost Approximates Fair Value
	615,126		Debt Investments originated within 6 months
	64,479		Imminent Payoffs(4)
	136,253		Debt Investments Maturing in Less than One Year
	$	3,382,970	Total Level 3 Debt Investments
Other Investment Receivables	2,856		Liquidation(3)	Probability weighting of alternative outcomes	10.00% - 50.00%	39.97%
	$	3,385,826	Total Level Three Debt Investments and Other Investment Receivables

(1)The significant unobservable inputs used in the fair value measurement of the Company’s debt securities are hypothetical market yields and premiums/(discounts). The hypothetical market yield is defined as the exit price of an investment in a hypothetical market to hypothetical market participants where buyers and sellers are willing participants. The premiums/(discounts) relate to company specific characteristics such as underlying investment performance, security liens, and other characteristics of the investment. Significant increases (decreases) in the inputs in isolation may result in a significantly lower (higher) fair value measurement, depending on the materiality of the investment.

Debt investments in the industries noted in the Company’s Consolidated Schedule of Investments are included in the industries noted above as follows:

•Pharmaceuticals, above, is comprised of debt investments in the “Drug Discovery & Development” and “Healthcare Services, Other” industries.

•Technology, above, is comprised of debt investments in the “Communications & Networking”, “Information Services”, “Consumer & Business Services”, “Media/Content/Info” and “Software” industries.

•Sustainable and Renewable Technology, above, is comprised of debt investments in the “Sustainable and Renewable Technology” industry.

•Lower Middle Market, above, is comprised of debt investments in the “Healthcare Services – Other”, “Consumer & Business Services”, “Diversified Financial Services”, “Sustainable and Renewable Technology”, and “Software” industries.

(2)The weighted averages are calculated based on the fair market value of each investment.

(3)The significant unobservable input used in the fair value measurement of impaired debt securities and other investment receivables is the probability weighting of alternative outcomes.

(4)Imminent Payoffs represent debt investments that the Company expects to be fully repaid within the next three months, prior to their scheduled maturity date.


Investment Type - Level 3 Debt Investments	Fair Value as of December 31, 2023 (in thousands)		Valuation Techniques/ Methodologies	Unobservable Input(1)	Range	Weighted Average(2)
Pharmaceuticals	$	971,775	Market Comparable Companies	Hypothetical Market Yield	10.91% - 21.43%	13.46%
				Premium/(Discount)	(1.00)% - 3.50%	0.04%
	8,455		Liquidation(3)	Probability weighting of alternative outcomes	10.00% - 50.00%	41.83%

Technology	1,181,823		Market Comparable Companies	Hypothetical Market Yield	11.30% - 20.74%	15.03%
				Premium/(Discount)	(1.00)% - 5.00%	0.47%
	23,244		Convertible Note Analysis	Probability weighting of alternative outcomes	1.00% - 50.00%	39.32%
	—		Liquidation(3)	Probability weighting of alternative outcomes	100.00% - 100.00%	100.00%

Sustainable and Renewable Technology	1,678		Market Comparable Companies	Hypothetical Market Yield	10.75% - 10.75%	10.75%
				Premium/(Discount)	0.75% - 0.75%	0.75%

Lower Middle Market	322,162		Market Comparable Companies	Hypothetical Market Yield	12.54% - 20.15%	14.13%
				Premium/(Discount)	(0.75)% - 2.25%	0.56%

Debt Investments for which Cost Approximates Fair Value
	431,512		Debt Investments originated within 6 months
	54,430		Imminent Payoffs(4)
	62,220		Debt Investments Maturing in Less than One Year
	$	3,057,299	Total Level 3 Debt Investments
Other Investment Receivables	9,648		Liquidation(3)	Probability weighting of alternative outcomes	10.00% - 50.00%	41.83%
	$	3,066,947	Total Level Three Debt Investments and Other Investment Receivables

Debt investments in the industries noted in the Company’s Consolidated Schedule of Investments are included in the industries noted above as follows:

•Pharmaceuticals, above, is comprised of debt investments in the “Drug Discovery & Development” and “Healthcare Services, Other” industries.

•Sustainable and Renewable Technology, above, is comprised of debt investments in the “Sustainable and Renewable Technology” industry.

(2)The weighted averages are calculated based on the fair market value of each investment.

(3)The significant unobservable input used in the fair value measurement of impaired debt securities and other investment receivables is the probability weighting of alternative outcomes.

(4)Imminent payoffs represent debt investments that the Company expects to be fully repaid within the next three months, prior to their scheduled maturity date.


Investment Type - Level 3 Equity and Warrant Investments	Fair Value as of March 31, 2024 (in thousands)		Valuation Techniques/ Methodologies	Unobservable Input(1)	Range	Weighted Average(5)
Equity Investments	$	46,154	Market Comparable Companies	Revenue Multiple(2)	0.3x - 19.2x	6.8x

				Tangible Book Value Multiple(2)	1.7x - 1.7x	1.7x
				Discount for Lack of Marketability(3)	9.22% - 92.88%	36.10%
	13,271		Market Adjusted OPM Backsolve	Market Equity Adjustment(4)	(85.55)% - 58.41%	27.06%
	29,884		Discounted Cash Flow	Discount Rate(7)	20.68% - 33.53%	31.62%


	3,038		Other(6)
Warrant Investments	16,912		Market Comparable Companies	Revenue Multiple(2)	1.0x - 12.5x	4.3x

				Discount for Lack of Marketability(3)	7.65% - 34.83%	23.42%
	2,370		Market Adjusted OPM Backsolve	Market Equity Adjustment(4)	(33.06)% - 67.82%	16.48%
	—		Other(6)
Total Level 3 Equity and Warrant Investments	$	111,629

(1)The significant unobservable inputs used in the fair value measurement of the Company’s warrant and equity securities are revenue and/or earnings multiples (e.g. EBITDA, EBT, ARR), market equity adjustment factors, and discounts for lack of marketability. Significant increases/(decreases) in the inputs in isolation would result in a significantly higher/(lower) fair value measurement, depending on the materiality of the investment. For some investments, additional consideration may be given to data from the last round of financing or merger/acquisition events near the measurement date. The significant unobservable input used in the fair value measurement of impaired equity securities is the probability weighting of alternative outcomes.

(2)Represents amounts used when the Company has determined that market participants would use such multiples when pricing the investments.

(3)Represents amounts used when the Company has determined market participants would take into account these discounts when pricing the investments.

(4)Represents the range of changes in industry valuations since the portfolio company's last external valuation event.

(5)Weighted averages are calculated based on the fair market value of each investment.

(6)The fair market value of these investments is derived based on recent private market and merger and acquisition transaction prices.

(7)The discount rate used is based on current portfolio yield adjusted for uncertainty of actual performance and timing in capital deployments.

Investment Type - Level 3 Equity and Warrant Investments

Fair Value as of
December 31, 2023
(in thousands)

Valuation Techniques/
Methodologies

Unobservable Input (1)

Range

Weighted Average (5)

Equity Investments

52,094

Market Comparable Companies

EBITDA Multiple (2)

12.3x - 12.3x

12.3x

Revenue Multiple (2)

0.3x - 20.1x

7.2x

Tangible Book Value Multiple (2)

1.8x - 1.8x

1.8x

Discount for Lack of Marketability (3)

7.11% - 92.72%

31.57%

11,096

Market Adjusted OPM Backsolve

Market Equity Adjustment (4)

(86.14)% - 32.69%

7.47%

28,713

Discounted Cash Flow

Discount Rate (7)

19.88% - 31.97%

30.51%

2,925

Other (6)

Warrant Investments

19,014

Market Comparable Companies

EBITDA Multiple (2)

12.3x -12.3x

12.3x

Revenue Multiple (2)

0.9x - 10.2x

4.2x

Discount for Lack of Marketability (3)

6.21% - 33.12%

21.70%

3,074

Market Adjusted OPM Backsolve

Market Equity Adjustment (4)

(70.67)% - 34.86%

13.17%

—

Other (6)

Total Level 3 Equity and Warrant Investments

116,916

date. The significant unobservable input used in the fair value measurement of impaired equity securities is the probability weighting of alternative outcomes.

(2)Represents amounts used when the Company has determined that market participants would use such multiples when pricing the investments.

(3)Represents amounts used when the Company has determined market participants would take into account these discounts when pricing the investments.

(4)Represents the range of changes in industry valuations since the portfolio company's last external valuation event.

(5)Weighted averages are calculated based on the fair market value of each investment.

(6)The fair market value of these investments is derived based on recent market transactions.

(7)The discount rate used is based on current portfolio yield adjusted for uncertainty of actual performance and timing in capital deployments.

The Company believes that the carrying amounts of its financial instruments, other than investments and debt, which consist of cash and cash equivalents, receivables including escrow receivables, accounts payable and accrued liabilities, approximate the fair values of such items due to the short maturity of such instruments. The debt obligations of the Company are recorded at amortized cost and not at fair value on the Consolidated Statements of Assets and Liabilities. The fair value of the Company’s outstanding debt obligations are based on observable market trading prices or quotations and unobservable market rates as applicable for each instrument.

As of March 31, 2024 and December 31, 2023, the 2033 Notes were trading on the New York Stock Exchange (“NYSE”) at $25.00 and $25.25 per unit at par value. The par value at underwriting for the 2033 Notes was $25.00 per unit. Based on market quotations on or around March 31, 2024 and December 31, 2023, the 2031 Asset-Backed Notes were quoted for 0.958 and 0.950. The fair values of the SBA debentures, July 2024 Notes, February 2025 Notes, June 2025 Notes, June 2025 3-Year Notes, March 2026 A Notes, March 2026 B Notes, September 2026, and January 2027 Notes are calculated based on the net present value of payments over the term of the notes using estimated market rates for similar notes and remaining terms. The fair values of the outstanding debt under the MUFG Bank Facility and the SMBC Facility are equal to their outstanding principal balances as of March 31, 2024 and December 31, 2023.

The following tables provide additional information about the approximate fair value and level in the fair value hierarchy of the Company’s outstanding borrowings as of March 31, 2024 and December 31, 2023:


(in thousands)	March 31, 2024
Description	Carrying Value		Approximate Fair Value		Identical Assets (Level 1)		Observable Inputs (Level 2)		Unobservable Inputs (Level 3)
SBA Debentures	$	170,469	$	147,970	$	—	$	—	$	147,970
July 2024 Notes	104,902		105,145		—		—		105,145
February 2025 Notes	49,895		48,922		—		—		48,922
June 2025 Notes	69,798		68,342		—		—		68,342
June 2025 3-Year Notes	49,810		49,813		—		—		49,813
March 2026 A Notes	49,818		47,335		—		—		47,335
March 2026 B Notes	49,802		47,381		—		—		47,381
September 2026 Notes	322,585		288,832		—		—		288,832
January 2027 Notes	346,266		314,530		—		—		314,530
2031 Asset-Backed Notes	148,691		143,700		—		143,700		—
2033 Notes	38,962		40,000		—		40,000		—
MUFG Bank Facility	136,000		136,000		—		—		136,000
SMBC Facility	215,000		215,000		—		—		215,000
Total	$	1,751,998	$	1,652,970	$	—	$	183,700	$	1,469,270


(in thousands)	December 31, 2023
Description	Carrying Value		Approximate Fair Value		Identical Assets (Level 1)		Observable Inputs (Level 2)		Unobservable Inputs (Level 3)
SBA Debentures	$	170,323	$	142,011	$	—	$	—	$	142,011
July 2024 Notes	104,828		105,755		—		—		105,755
February 2025 Notes	49,866		49,144		—		—		49,144
June 2025 Notes	69,757		67,198		—		—		67,198
June 2025 3-Year Notes	49,771		48,983		—		—		48,983
March 2026 A Notes	49,795		47,702		—		—		47,702
March 2026 B Notes	49,776		47,759		—		—		47,759
September 2026 Notes	322,339		288,711		—		—		288,711
January 2027 Notes	345,935		315,832		—		—		315,832
2031 Asset-Backed Notes	148,544		142,500		—		142,500		—
2033 Notes	38,935		40,400		—		40,400		—
MUFG Bank Facility	61,000		61,000		—		—		61,000
SMBC Facility	94,000		94,000		—		—		94,000
Total	$	1,554,869	$	1,450,995	$	—	$	182,900	$	1,268,095

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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