FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

For the transition period from ___________ to ______________

Commission file number 814-01253

VENTURE LENDING & LEASING IX, INC.

INDEX

 

Venture Lending & Leasing IX, Inc. (the “Fund”) was incorporated in Maryland on June 28, 2017 as a non-diversified closed-end management investment company electing status as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (“1940 Act”) and is managed by Westech Investment Advisors, LLC, (“Manager” or “Management”). The Fund will be dissolved on December 31, 2028 unless an election is made to dissolve earlier by the Board of Directors of the Fund (the “Board”). One hundred percent of the stock of the Fund is held by Venture Lending & Leasing IX, LLC (the “Company”). Prior to commencing its operations on May 2, 2018, the Fund had no operations other than accruing organizational expenses, the sale to the Company of 100,000 shares of common stock, $0.001 par value (“Shares”) in June 2017 and the receipt of $25,000 from the Company as consideration for the purchase of the Shares. This issuance of stock was a requirement to apply for a finance lender’s license from the California Commissioner of Corporations, which was obtained on September 22, 2017.

In the Manager’s opinion, the accompanying condensed interim financial statements (hereafter referred to as “financial statements”) include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of financial position and results of operations for interim periods. Certain information and note disclosures normally included in audited annual financial statements prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) have been omitted; however, the Fund believes that the disclosures made are adequate to make the information presented not misleading. The interim results for the sixnine months ended JuneSeptember 30, 2018 are not necessarily indicative of what the results would be for a full year. These financial statements should be read in conjunction with the financial statements and the notes included in the Fund’s Annual Report on Form 10-K for the year ended December 31, 2017.

Basis of Accounting

The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents consist of cash on hand and cash equivalents with maturities of 90 days or less. Included in this are money market mutual funds that are valued at their most recently traded price prior to the valuation date. Within cash and cash equivalents, as of JuneSeptember 30, 2018, the Fund held 33,016,7046,939,066 units in the Blackrock Treasury Trust Institutional Fund at $1 per unit at a yield of 1.66%,1.86%. Cash and cash equivalents were $6,189,987, which represents 64.4%represented 10.9% of the net assets of the Fund.

Interest income on loans is recognized on an accrual basis using the effective interest method including amounts from the amortization of discounts attributable to equity securities received as part of a loan transaction. Additionally, fees received as part of the transaction are added to the loan discount and amortized over the life of the loan.

The Fund accounts for loans at fair value in accordance with the valuation methods below. All valuations are determined under the direction of the Manager, in accordance with those valuation methods.

As of JuneSeptember 30, 2018, the financial statements include nonmarketable investments of $19.5$51.8 million (or 37.0%88.3% of total assets), and as of December 31, 2017, the Fund had not yet commenced investment operations and accordingly had no nonmarketable investments. The fair value of each investment is determined by the Manager in the absence of readily determinable market values. Because of the inherent uncertainty of these valuations, estimated fair values of such investments may differ significantly from the values that would have been used had a readily available market for the securities existed, and the differences could be material. Below is the information used by the Manager in making these estimates.

Unearned income and commitment fees on loans are recognized using the effective interest method over the term of the loan. Commitment fees are carried as liabilities when received for commitments upon which no draws have been made. When the first draw is made, the fee is treated as unearned income and is recognized as described above. If a draw is never made, the forfeited commitment fee less any applicable legal costs becomes recognized as other income after the commitment expires.

    

In August 2018, the Securities and Exchange Commission (“SEC”) issued Release No. 33-10532 Disclosure Update and Simplification, which amended Regulation S-X and certain other securities laws (the “Amendments”) effective November 2016,5, 2018. The SEC adopted the Amendments with the intention of simplifying reporting through the elimination of redundant, duplicative, overlapping, outdated, or superseded disclosure requirements. The Fund has reviewed and adopted the applicable Amendments, including with respect to Regulation S-X. The Amendments did not have a material impact on the Fund's financial statements or disclosures.

In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-18, “Statement of Cash Flows (topic 230): Restricted Cash, a consensus of the FASB Emerging Issues Task Force,2018-13, “Fair Value Measurement (Topic 820),” which requires that a statementmade changes to the fair value measurement disclosure requirements in ASC 820, “Fair Value Measurements and Disclosures.” The changes included new disclosure requirements, elimination of cash flows explainsome requirements and the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-the-period and end-of-the-period total amounts shown on the statementmodification of cash flows.others. ASU 2016-182018-13 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. We do2019. The Fund does not believe that ASU 2016-182018-13 will have a material impact on ourits financial statements and disclosures.or disclosures, but continue to evaluate the ASU requirements.

As of JuneSeptember 30, 2018, all loans were valued using significant unobservable inputs and were made to non-affiliates as follows (unaudited):

* Indicates assets that the Fund deems “non-qualifying assets” under Section 55(a) of the 1940 Act. Qualifying assets must represent at least 70% of the Fund’s total assets at the time of acquisition of any additional non-qualifying assets. As of JuneSeptember 30, 2018, 0.9%2.8% of the Fund’s assets represented non-qualifying assets. As part of this calculation, the numerator consists of all eligible portfolio companies as defined in Section 2(a)(46); of the 1940 Act; and the denominator consists of total assets less the assets described in Section 55(a)(7).

As of December 31, 2017, the Fund had not yet commenced investment operations and accordingly had no loans or other investments to report.

The risk profile of a loan changes when events occur that impact the credit analysis of the borrower and loan as described in our loan accounting policy. Such changes result in the fair value adjustments made to the individual loans, which in accordance with GAAP, would be based on the price that would be received to sell an asset or paid to settle a liability in an orderly transaction between market participants at the measurement date. Where the risk profile is consistent with the original underwriting, which is primarily the case for this loan portfolio, the par value of the loan will approximate fair value.

As of JuneSeptember 30, 2018 and December 31, 2017, the Fund has unexpired commitments to borrowers of $11.3$24.3 million and $0.0 million,$0, respectively.

Transfers of investments between levels of the fair value hierarchy are recorded on the actual date of the event or change in circumstances that caused the transfer. There were no transfers in and out of Level 1, 2, and 3 during the period ended JuneSeptember 30, 2018.

The Fund’s loan transactions are individually negotiated and unique, and because there is no market in which these assets trade, the inputs for these assets, which are valued using estimated exit values, are classified as Level 3.  

The following table provides quantitative information about the Fund’s Level 3 fair value measurements of its investments as of JuneSeptember 30, 2018. In addition to the techniques and inputs noted in the tables below, the Fund may also use other valuation techniques and methodologies when determining its fair value measurements.

The following tables present the balances of assets and liabilities as of JuneSeptember 30, 2018 and December 31, 2017 measured at fair value on a recurring basis:

† For a detailed listing of borrowers comprising this amount, please refer to Note 3, Schedule of Investments.

    

The following tables provide a summary of changes in Level 3 assets measured at fair value on a recurring basis:

As of JuneSeptember 30, 2018 and December 31, 2017, the Fund had 10,000,000 shares authorized, and 100,000 Shares issued and outstanding. Total committed capital of the Company, as of JuneSeptember 30, 2018 and December 31, 2017, was $460.0 million and $450.0 million, respectively. Total contributed capital to the Company through JuneSeptember 30, 2018 and December 31, 2017 was $69.0$96.6 million and $25,000, respectively, and of which $54.5$63.5 million and $25,000 were contributed to the Fund.

As compensation for its services to the Fund, from the date of the first capital call, May 1, 2018 to June 30, 2018, the Manager received a management fee (“Management Fee”) computed and paid at the end of the quarter at an annual rate of 1.575% of the Company's committed equity capital (regardless of when or if the capital was called). The

For bothManagement fees of $1.8 million and $3.0 million were recognized as expenses for the three months ended September 30, 2018 and for the period from May 1, 2018 to JuneSeptember 30, 2018, and the six months ended June 30, 2018, management fees were $1.2 million.respectively.

GAAP requires disclosure of financial highlights of the Fund for the three and sixnine months ended JuneSeptember 30, 2018.

The total rate of return is defined as the return based on the change in value during the period of a theoretical investment made at the beginning of the period. The total rate of return assumes a constant rate of return for the Fund during the period reported and weights each cash flow by the amount of time held in the Fund. This required methodology differs from an internal rate of return.

The ratios of expenses and net investment income (loss) to average net assets, calculated below, are annualized and are computed based upon the aggregate weighted average net assets of the Fund for the periods presented. Net income (loss) is inclusive of all income net of expenses, and excludes realized or unrealized gains and losses.

Beginning and ending net asset values per share are based on the beginning and ending number of shares outstanding. Other per share information is calculated based upon the aggregate weighted average net assets of the Fund for the period presented.

The following per share data and ratios have been derived from the information provided in the financial statements:

* Total return for the three and sixnine months ended JuneSeptember 30, 2018 reflect the start upstartup of the investment operations and were not driven by the performance of the investment portfolio. The nine month total return figure is a reflection of the Fund's negative capital at the start of the its life.

In addition to the historical information contained herein, the information in this Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the securities laws. These forward-looking statements reflect the current view of the Fund with respect to future events and financial performance and are subject to several risks and uncertainties, many of which are beyond the Fund’s control. All statements, other than statements of historical facts included in this report, regarding the strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans and objectives of the Fund are forward-looking statements. When used in this report, the words “will,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. All forward-looking statements speak only as of the date of this report. The Fund does not undertake any obligation to update or revise publicly any forward-looking statements, whether resulting from new information, future events or otherwise.

The reader of this Quarterly Report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome. The Fund’s actual results could differ materially from those suggested by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, variances in the actual versus projected growth in assets, return on assets, loan losses, expenses, rates charged on loans and earned on securities investments, competition and macro-economic changes including inflation, interest rate expectations, among other factors. This entire Quarterly Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Fund’s business.

The Fund is 100% owned by the Company. The Fund’s shares of Common Stock, at $0.001 par value, were sold to its sole shareholder, the Company, under a stock purchase agreement. The Fund has issued 100,000 of the Fund’s 10,000,000 authorized shares. The Company may make additional capital contributions to the Fund.

The Fund is a financial services company providing financing and advisory services to a variety of carefully selected venture-backed companies that have received equity funding from traditional sources of venture capital equity funding (e.g., a professionally managed venture capital firm) as well as non-traditional sources of venture capital equity funding (e.g., angel investors, strategic investors, family offices, crowdfunding investment platforms, etc.) ("Venture-Backed Companies") primarily throughout the United States with a focus on growth orientedgrowth-oriented companies. It is anticipated that the Fund’s portfolio will be well diversified and consist of companies in the communications, information services, media, and technology, including software and technology-enabled business services, bio-technology, and medical devices industry sectors, among others. The Fund’s capital is generally used by its portfolio companies to finance acquisitions of fixed assets and working capital. On May 1, 2018, the Company called and received its first capital and the Fund started it investment activities.from investors. On May 2, 2018, the Fund completed its first closing of its capital contributions, made its first investment, and became a non-diversified, closed-end investment company under the Investment Company1940 Act. While the Fund intends to operate as a non-diversified investment company within the meaning of Section 5(b)(2) of the 1940 Act, from time to time, the Fund may act as a diversified investment company within the meaning of 1940.Section 5(b)(1) of the 1940 Act.

The Fund expects to eventually elect to be treated a Regulated Investment Company (“RIC”) under the Internal Revenue Code (the "Code") for federal income tax purposes. Pursuant to this election, the Fund generally will not have to pay corporate-level taxes on any income it distributes to the Company as dividends, allowing the Company to substantially reduce or eliminate its corporate-level tax liability.

To qualify as a RIC under the Code, the Fund is required to meet various ongoing requirements, including those for asset diversification. If the Fund fails to meet these requirements, it will be taxed as an ordinary corporation on its taxable income for that year (even if that income is distributed to the Company) and all distributions out of its earnings and profits will be taxable to the Members of the Company as ordinary income; thus, such income will be

subject to a double layer of tax. There is no assurance that the Fund will meet the ongoing requirements to qualify as a RIC for tax purposes.

The Fund’s investment objective is to achieve superior risk adjusted investment returns by primarily providing debt financing to portfolio companies. The Fund generally receives warrants to acquire equity securities in connection with its portfolio investments and either upon receipt, or soon thereafter, it will generally distribute these warrants to its shareholder. The Fund also maintains limits for the percentages of total assets which will be invested in different types of assets.

The portfolio investments of the Fund primarily consist of debt financing to Venture-Backed Companies in the technology sector. The borrower’s ability to repay its loans may be adversely impacted by several factors, and as a result, the loan may not be fully repaid. Furthermore, the Fund’s security interest in any collateral over the borrower’s assets may be insufficient to make up any shortfall in payments.

The Manager also serves as manager for Fund VIII.  The Fund's Board of Directors determined that so long as Fund VIII has capital available to invest in loan transactions with final maturities earlier than December 31, 2025 (the date on which Fund VIII will be dissolved), the Fund may invest in each portfolio company in which Fund VIII invests (“Investments”).  Generally, the amount of each Investment will be allocated 50% to the Fund and 50% to Fund VIII, or such other allocations as may be determined by the respective fund boards.  The ability of the Fund to co-invest with Fund VIII is subject to the conditions (“Conditions”) set forth in certain exemptive relief currently being sought by the Fund from the SEC from the provisions of Sections 17(d) and 57 of the 1940 Act and Rule 17d-1 thereunder.   After June 30, 2022, the Fund will no longer be permitted to enter into new commitments to borrowers; however, the Fund will be permitted to fund existing commitments.  The Manager is permitted to extend the Fund's investment period by up to two (2) additional calendar quarters in its sole and absolute discretion.

    

Organization costs were $0 and less than $0.1 million for the three and sixnine months ended JuneSeptember 30, 2018.

Banking and professional fees were less than $0.1$0.2 million and $0.2 million for the three and sixnine months ended JuneSeptember 30, 2018.2018, respectively. Banking and professional fees were primarily from the accrual of the audit review conducted in the second quarter of 2018.

Management fees for the three and sixnine months ended JuneSeptember 30, 2018 were $1.2$1.8 million and $3.0 million. Management fees were calculated as 1.575% of committed capital and remain at this percentage for the periodnext three quarters based on the schedule of annual percentages below. For the nine months, the fees calculated from May 1, 2018, the date of the first capital call, to JuneSeptember 30, 2018. The management fee percentage will remain 1.575% for the next four fiscal quarters based on the following schedule of the annual percentages:

Other operating expenses for the three and sixnine months ended JuneSeptember 30, 2018 were less than $0.1 million.

Net investment loss and net decrease in net assets resulting from operations for the three and sixnine months ended JuneSeptember 30, 2018 were $1.0 million.and $1.1$0.5 million and $1.6 million, respectively. On a per share basis, the net decrease in net assets resulting from operations for the three and sixnine months ended JuneSeptember 30, 2018 were $10.34$5.37 and $10.61,$15.97, respectively.

Total capital contributed to the Fund was $54.5$63.5 million and $25,000 as of JuneSeptember 30, 2018 and December 31, 2017, respectively. Committed capital to the Company as of JuneSeptember 30, 2018 and December 31, 2017 was $460.0 million and $450.0 million, respectively, of which $69.0$96.6 million and $25,000 had been called as of JuneSeptember 30, 2018 and December 31, 2017, respectively, 100% of which was contributed to the Fund as consideration for the Company's purchase of 100,000 Shares in June 2017. This issuance of stock by the Fund was required by the California Commissioner of Corporations to apply for a finance lender's license, which was issued to the Fund on September 22, 2017.respectively. As of JuneSeptember 30, 2018, the remaining available committed capital was $391.0$363.4 million of committed capital, which expires on the Fund’s fifth anniversary of its first investment unless extended. Management is permitted to extend the Fund’s investment period by up to two (2) additional calendar quarters in its sole and absolute discretion.

     As of JuneSeptember 30, 2018 and December 31, 2017, 62.5%10.6% and 100.0% of the Fund's total assets consisted of cash and cash equivalents, respectively. For the sixnine months ended JuneSeptember 30, 2018, the Fund invested $22.0$57.6 million entirely in venture loans. Net loan amounts outstanding were $19.5$51.8 million for the same period. Unexpired, unfunded commitments totaled approximately $11.3$24.3 million as of JuneSeptember 30, 2018.

Because venture loans are privately negotiated transactions, investments in these assets are relatively illiquid. It is the Management’s experience that not all unfunded commitments will be used by borrowers.

The Fund will seek to meet the requirements to qualify for the special pass-through status available to RICs under the Code, and thus to be relieved of federal income tax on that part of its net investment income and realized capital gains that it distributes to its shareholder. To qualify as a RIC, the Fund must distribute to its shareholder for each taxable year at least 90% of its investment company taxable income (consisting generally of net investment income and net short-term capital gain) (“Distribution Requirement”). To the extent that the terms of the Fund’s venture loans provide for the receipt by the Fund of additional interest at the end of the loan term or provide for the receipt by the Fund of a purchase price for the asset at the end of the loan term (“residual income”), the Fund would be required to accrue such residual income over the life of the loan, and to include such accrued undistributed income in its gross income for each taxable year even if it receives no portion of such residual income in that year. Thus, in order to meet the Distribution Requirement and avoid payment of income taxes or an excise tax on undistributed income, the Fund may be required in a particular year to distribute as a dividend an amount in excess of the total amount of income it actually receives. Those distributions will be made from the Fund’s cash assets, from amounts received through amortization of loans or from borrowed funds.

As of JuneSeptember 30, 2018, the Fund has cash reserves of $33.0$6.2 million and approximately $5.9$16.3 million in scheduled receivable payments over the next twelve months. Additionally, the Fund has access to uncalled capital of $391.0$363.4 million as a liquidity source and the unused portion of the revolving credit facility.source. Together, these amounts are sufficient to meet the current commitment backlog and operational expenses of the next year. The Fund regularly evaluates potential future liquidity resources and demands before making additional future commitments.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Fund’s business activities contain various elements of risk of which Management considers interest rate and credit risk to be the principal types of risks. Because the Fund considers the management of risk essential to conducting its business and to maintaining profitability, the Fund’s risk management procedures are designed to identify and analyze the Fund’s risks, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs.  

The Fund manages its market risk by maintaining a portfolio that is diverse by industry, size of investment, stage of development, and borrower. The Fund has limited exposure to public market price fluctuations as the Fund primarily invests in private business enterprises and distributes all equity investments upon receipt to the Company.

The Fund’s investments are subject to market risk based on several factors, including, but not limited to, the borrower’s credit history, available cash, support of the borrower’s underlying investors, available liquidity, “burn rate,” revenue income, security interest, secondary markets for collateral, the size of the loan, and term of the loan, and the ability to exit via Initial Public Offering or Merger and Acquisition.

The Fund’s exposure to interest rate sensitivity is regularly monitored and analyzed by measuring the characteristics of assets and liabilities. The Fund utilizes various methods to assess interest rate risk in terms of the potential effect on interest income net of interest expense, the value of net assets and the value at risk in an effort to ensure that the Fund is insulated from any significant adverse effects from changes in interest rates.

Because the Fund’s loans all impose a fixed interest rate upon funding, changes in short-term interest rates will not directly affect interest income associated with the loan portfolio as of JuneSeptember 30, 2018. However, those changes could have the potential to change the Fund’s ability to originate loan commitments, acquire and renew bank facilities, and engage in other investment activities. Further, changes in short-term interest rates also could affect interest rate expense, realized gain from investments and interest on the Fund’s short-term investments.

Based on the Fund’s Condensed Statement of Assets and Liabilities as of JuneSeptember 30, 2018, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in investments and cash balances.

 

Although Management believes that the foregoing analysis is indicative of the Fund’s sensitivity to interest rate changes, it does not take into consideration potential changes in the credit market, credit quality, size and composition of the assets in the portfolio. It also does not assume any new funding to borrowers, repayments from borrowers or defaults on borrowings. Accordingly, no assurances can be given that actual results would not differ materially from the table above.

Item 4.  Controls and Procedures:

As of the end of the period covered by this quarterly report on Form 10-Q, the Fund’s chief executive officer and chief financial officer conducted an evaluation of the Fund’s disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934). Based upon this evaluation, the Fund’s chief executive officer and chief financial officer concluded that the Fund’s disclosure controls and procedures were effective in timely alerting them of any material information relating to the Fund that is required to be disclosed by the Fund in the reports it files or submits under the Securities Exchange Act of 1934.

There were no changes in the Fund’s internal controls over financial reporting or in other factors that could have materially affected, or is reasonably likely to materially affect, the Fund’s internal controls over financial reporting during the period covered by this quarterly report on Form 10-Q.

The Fund may become party to certain lawsuits from time to time in the normal course of business. While the outcome of any legal proceedings cannot now be predicted with certainty, the Fund does not expect any such proceedings will have a material effect upon the Fund’s financial condition or results of operation. Management is not aware of any pending legal proceedings involving the Fund.

Item 1A. Risk Factors

The following discussion point should be read in conjunction with Item 1A - “Risk Factors” in the Fund’s 2017 Annual Report on Form 10-K for a detailed description of the risks attendant to the Fund and its business.

Changes to U.S. trade policy may have a negative effect on the global economy and/or our portfolio companies and, in turn, harm the Fund.

Significant changes to U.S. trade policy, including changes to current legislation and trade agreements and the imposition of tariffs have been discussed by the current U.S. presidential administration and certain members of Congress. Recently, the administration has imposed tariffs on a range of goods imported into the U.S., and a few countries have retaliated with tariffs against the United States. These retaliatory actions could trigger extended “trade wars” between the U.S. and its trading partners, resulting in additional barriers to the international market, inclusive of customers, vendors, and potential investors. Under these circumstances, the cost of goods for some portfolio companies could increase, resulting in lower consumer demand for their goods and reduced cash flows. While it is unknown whether and to what extent new legislation will be enacted into law, the enactment or amendment of trade legislation and/or renegotiation of trade agreements may impose additional compliance costs on portfolio companies, restrict their ability to participate in international markets and otherwise disrupt their current operations.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Prior to the Fund's commencement of operations on May 2, 2018, the Fund sold 100,000 Shares to the Fund’s sole shareholder, the Company, for $25,000 in June 2017. No other shares of the Fund have been sold; however, the Fund received an additional $54.5$63.5 million of paid in capital during the period from May 2, 2018, commencement of operations, through JuneSeptember 30, 2018, which is expected to be used to acquire venture loans and fund operations.

Item 3.  Defaults Upon Senior Securities

Not applicable.