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FSEN FS Energy & Power Fund

Filed: 9 Apr 20, 8:00pm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2019
OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                 TO
COMMISSION FILE NUMBER: 814-00841
FS Energy and Power Fund
(Exact name of registrant as specified in its charter)
Delaware27-6822130
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
201 Rouse Boulevard
Philadelphia, Pennsylvania
(Address of principal executive offices)
19112
(Zip Code)
Registrant’s telephone number, including area code: (215) 495-1150
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Shares of Beneficial Interest, par value
$0.001 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐ No ☒.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐ No ☒.
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒ No ☐.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).  Yes ☐ No ☐.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of  “accelerated filer,” “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☐Accelerated filer ☐Non-accelerated filer ☒
(Do not check if a smaller
reporting company)
Smaller reporting company ☐Emerging Growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected to not use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ☐ No ☒.
There is no established market for the Registrant’s common shares of beneficial interest. The Registrant closed the public offering of its common shares in November 2016. Since the registrant closed its public offering, it has continued to issue shares pursuant to its distribution reinvestment plan. The most recent price at which the registrant has issued shares pursuant to the distribution reinvestment plan was $3.70 per share.
There were 436,755,981 shares of the Registrant’s common shares of beneficial interest outstanding as of April 9, 2020.
Documents Incorporated by Reference
None.

 
FS ENERGY AND POWER FUND
FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2019
TABLE OF CONTENTS
Page
PART I
1
19
49
49
49
50
PART II
51
53
54
71
72
140
140
141
PART III
142
147
148
149
153
PART IV
155
161
162
 
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PART I
Many of the amounts and percentages presented in Part I have been rounded for convenience of presentation and all dollar amounts, excluding per share amounts, are presented in thousands unless otherwise noted.
Item 1.
Business.
FS Energy and Power Fund, or the Company, which may also be referred to as “we,” “us” or “our,” was organized in September 2010 and commenced investment operations in July 2011. We are an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. In addition, we have elected to be treated for U.S. federal income tax purposes, and intend to qualify annually, as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. As of December 31, 2019, we had total assets of approximately $3.7 billion.
We are managed by FS/EIG Advisor, LLC, or FS/EIG Advisor, a registered investment adviser under the Investment Advisers Act of 1940, as amended, or the Advisers Act, pursuant to an investment advisory and administrative services agreement dated as of April 9, 2018, or the FS/EIG investment advisory agreement. FS/EIG Advisor oversees the management of our operations and is responsible for making investment decisions with respect to our portfolio.
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of energy and power, or Energy, companies. This investment policy may not be changed without at least 60 days’ prior notice to holders of our common shares of any such change. We consider Energy companies to be those companies that engage in the exploration, development, production, gathering, transportation, processing, storage, refining, distribution, mining, generation or marketing of natural gas, natural gas liquids, crude oil, refined products, coal or power, including those companies that provide equipment or services to companies engaged in any of the foregoing. We concentrate our investments on debt securities in Energy companies that we believe have, or are connected to, a strong infrastructure and/or underlying asset base so as to enhance collateral coverage and downside protection for our investments. We may also make select equity investments in certain Energy companies meeting our investment objectives of current income generation and long-term capital appreciation. Our primary areas of focus will be the upstream, midstream, power and service and equipment sub-sectors of the Energy industry; however, we broadly define our “Energy Investment Universe” as follows:

Upstream—businesses that find, develop and extract energy resources, including natural gas, crude oil and coal, from onshore and offshore reservoirs;

Midstream—businesses that gather, process, store and transmit energy resources and their by-products, including businesses that own pipelines, gathering systems, gas processing plants, liquefied natural gas facilities and other energy infrastructure;

Downstream—businesses that refine, market and distribute refined energy resources, such as customer-ready natural gas, propane and gasoline, to end-user customers;

Power—businesses engaged in the generation, transmission and distribution of power and electricity or in the production of alternative energy; and

Service and Equipment—businesses that provide services and/or equipment to aid in the exploration and production of oil and natural gas, including seismic, drilling, completion and production activities, as well as those companies that support the operations and development of power assets.
Our investment objectives are to generate current income and long-term capital appreciation. We seek to meet our investment objectives by:

utilizing the experience and expertise of FS/EIG Advisor in sourcing, evaluating and structuring transactions;
 
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employing a conservative investment approach focused on current income and long-term investment performance;

focusing primarily on debt or debt-like investments, such as structured preferred equity investments, in a broad array of private Energy companies within the United States;

making select equity investments in certain Energy companies that have strong growth potential;

investing primarily in established, stable enterprises with positive cash flow and strong asset and collateral coverage so as to limit the risk of potential principal loss; and

maintaining rigorous portfolio monitoring in an attempt to anticipate and pre-empt negative events within our portfolio.
Our portfolio is comprised primarily of income-oriented securities, which principally refers to debt securities and income-oriented preferred and common equity interests, of privately-held Energy companies within the United States. We expect to invest primarily in directly originated investments and primary market transactions, as this will provide us with the ability to tailor investments to best match a project’s or company’s needs with our investment objectives. We intend to weight our portfolio towards senior secured debt and directly originated preferred equity investments, which we believe offer opportunities for superior risk-adjusted returns and income generation. Our debt investments may take the form of corporate or project loans or bonds, may be secured or unsecured and may, in some cases, be accompanied by yield enhancements. These yield enhancements are typically expected to include royalty interests in mineral, oil and gas properties, warrants, options, net profits interests, cash flow participations or other forms of equity participation that can provide additional consideration or “upside” in a transaction. Our preferred equity investments are mostly directly originated and may take the form of perpetual or redeemable securities, typically with a current income component and minimum base returns. In addition, certain income-oriented preferred or common equity interests may include interests in master limited partnerships, or MLPs. MLPs are entities that (i) are structured as limited partnerships or limited liability companies, (ii) are publicly traded, (iii) satisfy certain requirements to be treated as partnerships for U.S. federal income tax purposes and (iv) primarily own and operate midstream and upstream Energy companies. In connection with certain of our debt investments or any restructurings of these debt investments, we may on occasion receive equity interests, including warrants or options, as additional consideration or otherwise in connection with a restructuring. In addition, a portion of our portfolio may be comprised of derivatives, including total return swaps and credit default swaps. FS/EIG Advisor will seek to tailor our investment focus as market conditions evolve. Depending on market conditions, we may increase or decrease our exposure to less senior portions of the capital structure or other more opportunistic investments. We expect that the size of our individual investments will generally range between $10 million and $250 million each, although investments may vary proportionately as amounts available for investment change and the size of our capital base changes and will ultimately be at the discretion of FS/EIG Advisor, subject to oversight by our board of trustees.
To seek to enhance our returns, we intend to employ leverage as market conditions permit and at the discretion of FS/EIG Advisor, but in no event will leverage employed exceed the maximum amount permitted by the 1940 Act. With certain limited exceptions, we are only allowed to borrow amounts or issue debt securities if our asset coverage, as calculated pursuant to the 1940 Act, equals at least 200% immediately after such borrowing. The minimum asset coverage requirement applicable to BDCs under the 1940 Act, however, is currently 150% provided that certain disclosure and approval requirements are met.
As a BDC, we are subject to certain regulatory restrictions in making our investments. For example, BDCs generally are not permitted to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence of an exemptive order from the U.S. Securities and Exchange Commission, or SEC. However, BDCs are permitted to, and may, simultaneously co-invest in transactions where price is the only negotiated term. In an order dated June 4, 2013, or the Order, the SEC granted exemptive relief permitting us, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with certain affiliates of FS Investment Advisor, LLC, or FS Advisor, including FS KKR Capital Corp., FS KKR Capital Corp. II and any future BDCs that are advised by FS Advisor or its affiliated investment advisers, or collectively our co-investment affiliates. Effective April 9, 2018, or the JV Effective Date, and in connection with the transition of advisory services to a joint
 
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advisory relationship with EIG, our board of trustees authorized and directed that we (i) withdraw from the Order, except with respect to any transaction in which we participated in reliance on the Order prior to the JV Effective Date, and (ii) rely on an exemptive relief order dated April 10, 2018, granted to EIG and its affiliates which permits us to participate in co-investment transactions with certain other EIG advised funds, or the EIG Order.
While a BDC may list its shares for trading in the public markets, we have currently elected not to do so. Prior to any liquidity event, a non-traded structure allows us to operate with a long-term view, instead of managing to quarterly market expectations. We and FS/EIG Advisor will continue to evaluate the appropriate form and timing of any liquidity event, taking into account, among other things, the composition of our portfolio and market conditions.
For information regarding our share repurchase program, distributions and our distribution reinvestment plan, including certain related tax considerations, see “Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities—Share Repurchase Program and Distributions” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—RIC Status and Distributions.”
About FS/EIG Advisor
FS/EIG Advisor is a Delaware limited liability company, located at 201 Rouse Boulevard, Philadelphia, PA 19112, registered as an investment adviser with the SEC under the Advisers Act. FS/EIG Advisor is jointly operated by an affiliate of Franklin Square Holdings, L.P. (which does business as FS Investments), or FS Investments, and EIG Asset Management, LLC, or EIG. Our chairman and chief executive officer, Michael C. Forman, serves as FS/EIG Advisor’s chairman and chief executive officer, and Eric Long, our president, also serves as FS/EIG Advisor’s president.
FS/EIG Advisor’s management team has significant experience investing in the energy markets, including private lending and private equity investing, and has developed an expertise in using all levels of a firm’s capital structure to produce income-generating investments, while focusing on risk management. The team also has extensive knowledge of the managerial, operational and regulatory requirements of publicly registered alternative asset entities, such as BDCs. We believe that the active and ongoing participation by personnel of FS Investments, EIG and their respective affiliates in the credit markets, and the depth of experience and disciplined investment approach of FS/EIG Advisor’s management team, will allow FS/EIG Advisor to successfully execute our investment strategies.
Our board of trustees, including a majority of independent trustees, oversees and monitors our investment performance, and beginning with the second anniversary of the effective date of the FS/EIG investment advisory agreement, will review such agreement to determine, among other things, whether the fees payable under such agreement are reasonable in light of the services provided.
About FS Investments
FS Investments is a leading asset manager dedicated to helping individuals, financial professionals and institutions design better portfolios. The firm provides access to alternative sources of income and growth and focuses on setting the industry standards for investor protection, education and transparency.
FS Investments is headquartered in Philadelphia, PA with offices in New York, NY, Orlando, FL and Washington, D.C. The firm had approximately $24 billion in assets under management as of December 31, 2019.
About EIG
EIG Global Energy Partners specializes in private investments in energy and energy-related infrastructure on a global basis and had $23.6 billion under management as of December 31, 2019. During its 38-year history, EIG has been one of the leading providers of institutional capital to the global energy industry, providing financing solutions across the balance sheet for companies and projects in the oil and gas, midstream, infrastructure, power and renewables sectors globally. EIG has committed over $33.0 billion in 355 portfolio investments in 36 countries on six continents. EIG is headquartered in Washington, D.C.,
 
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with offices in Houston, London, Sydney, Rio de Janeiro, Hong Kong and Seoul. For more information, please visit www.eigpartners.com.
Potential Market Opportunity
FS/EIG Advisor believes that global energy and energy-related infrastructure markets are in a period of dynamic change and that fundamental shifts in global supply and demand have created, and will continue to create, investment opportunities across the entire Energy value chain.
Characteristics of and Risks Related to Investments in Private Companies
We invest primarily in income-oriented securities of privately-held Energy companies within the United States. Investments in private companies pose significantly greater risks than investments in public companies. First, private companies have reduced access to the capital markets, resulting in diminished capital resources and ability to withstand financial distress. As a result, these companies, which may present greater credit risk than public companies, may be unable to meet the obligations under their debt and equity securities that we hold. Second, the investments themselves may often be illiquid. The securities of many of the companies in which we invest are not publicly traded or actively traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors. In addition, our directly originated investments generally will not be traded on any secondary market, and a trading market for such investments may not develop. These securities may also be subject to legal and other restrictions on resale. As such, we may have difficulty exiting an investment promptly or at a desired price prior to maturity or outside of a normal amortization schedule. These investments may also be difficult to value because little public information generally exists about private companies, requiring an experienced due diligence team to analyze and value the potential portfolio company. Finally, these companies may not have third-party debt ratings or audited financial statements. We must therefore rely on the ability of FS/EIG Advisor or EIG to obtain adequate information through their due diligence efforts to evaluate the creditworthiness of, and risks involved in investing in, these companies, and to determine the optimal time to exit an investment. These companies and their financial information will also generally not be subject to the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and other rules and regulations that govern public companies that are designed to protect investors.
Investment Strategy
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may not be changed without at least 60 days’ prior notice to holders of our common shares of any such change. In accordance with the best interests of our shareholders, FS/EIG Advisor monitors our targeted investment mix as economic conditions evolve.
When identifying prospective portfolio companies, we focus primarily on the attributes set forth below, which we believe help us generate higher total returns with an acceptable level of risk. While these criteria provide general guidelines for our investment decisions, we caution investors that, if we believe the benefits of investing are sufficiently strong, not all of these criteria necessarily will be met by each prospective portfolio company in which we choose to invest. These attributes are:

Deeply-rooted asset value.    We seek to invest in companies that have significant asset value rather than speculative investments that rely solely on rising energy commodity prices, exploratory drilling success or factors beyond the control of a portfolio company. We focus on companies that have strong potential for enhancing asset value through factors within their control, such as operating cost reductions and revenue increases driven by improved operations of previously under-performing or under-exploited assets. We expect such investments to have significant collateral coverage and downside protection irrespective of the broader economy.

Defensible market positions.    We seek to invest in companies that have developed strong positions within their sector and exhibit the potential to maintain sufficient cash flows and profitability to service our investments in a range of economic environments. We seek companies that can protect their competitive advantages through scale, scope, customer loyalty, product pricing or product quality versus their competitors, thereby minimizing business risk and protecting profitability.
 
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Proven management teams.    We focus on companies that have experienced management teams with an established track record of success. We typically require our portfolio companies to have proper incentives in place, which may include non-cash and performance-based compensation, to align management’s goals with ours.

Commodity price management.    We seek to invest in companies that appropriately manage their commodity price exposure through the use of hedging arrangements and other contracts and instruments that seek to minimize the company’s exposure to significant commodity price volatility.

Allocation among various issuers and sub-sectors.    We seek to allocate our portfolio broadly among issuers and certain sectors within the Energy industry, thereby attempting to reduce the risk of a downturn in any one company or sector having a disproportionate adverse impact on the value of our portfolio.
In addition, since the JV Effective Date, the EIG Order has permitted us to participate in co-investment transactions with certain other EIG advised funds. We believe that the ability to participate in co-investment transactions with other funds managed by EIG permits us to participate in a broader range of, and allocate a higher percentage of our portfolio to, secured, directly negotiated investments that span the upstream, midstream, power/renewables, and infrastructure sectors.
Potential Competitive Strengths
We believe that we offer investors the following potential competitive strengths:
Global Platform with Seasoned Investment Professionals.
We believe that the breadth and depth of the experience of FS/EIG Advisor’s management team, which is dedicated to sourcing, structuring, executing, monitoring and harvesting a broad range of private investments, provides us with a significant competitive advantage in sourcing and analyzing what we believe to be attractive investment opportunities.
Long-term Investment Horizon.
Our long-term investment horizon gives us great flexibility for pursuing transactions, which we believe allows us to maximize returns on our investments. Unlike private equity and venture capital funds, we are not required to return capital to our shareholders once we exit a portfolio investment. Such funds typically can only be invested once and capital must be returned to investors after a specific time period. These provisions often force private equity and venture capital funds to seek liquidity events, including initial public offerings, mergers or recapitalizations, more quickly than they otherwise might, potentially resulting in a lower return to investors. We believe that freedom from such capital return requirements, which allows us to invest using a longer term focus, provides us with the opportunity to increase total returns on invested capital, compared to other private company investment vehicles.
Disciplined, Income-Oriented Investment Philosophy.
FS/EIG Advisor employs an investment approach focused on current income and long-term investment performance. This investment approach involves a multi-stage selection process for each investment opportunity, as well as ongoing monitoring of each investment made, with particular emphasis on early detection of deteriorating credit conditions at portfolio companies which would result in adverse portfolio developments. This strategy is designed to maximize current income and minimize the risk of capital loss while maintaining the potential for long-term capital appreciation.
Investment Expertise Across All Levels of the Corporate Capital Structure.
FS/EIG Advisor believes that its broad expertise and experience investing at all levels of a company’s capital structure enable us to manage risk while affording us the opportunity for positive returns on our investments. We attempt to capitalize on this expertise in an effort to produce and maintain an investment portfolio that will perform in a broad range of economic conditions. In addition, we seek to leverage this broad-ranging capability to enable us to provide Energy companies with financing that most closely aligns
 
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with their particular capital needs. We believe that such flexibility is valuable to Energy companies and provides us with an advantage over other capital providers that are more limited in the securities in which they invest.
Energy Specialists with In-House Technical Expertise
The energy industry expertise and experience of the investment personnel of FS/EIG Advisor continue to represent a competitive advantage for us relative to other Energy company capital providers. We believe it is important to have experience investing throughout multiple business and commodity cycles and maintain extensive technical capabilities due to the complexities in the underlying businesses. Focusing on providing capital to Energy projects and companies since 1982, EIG has employed investment professionals and engineers with significant industry experience and maintains one of the longest continuous track records of any institutional investor in the industry. FS/EIG Advisor leverages this experience as it makes investment decisions. We further believe that we are a desirable partner for Energy companies because we have specialized knowledge of the economic, regulatory, and stakeholder considerations faced by them.
Investment Sourcing Capabilities
We believe that the experience, technical expertise, depth and continuity of the FS/EIG Advisor’s team are key differentiators for us relative to our competitors. We believe that FS/EIG Advisor’s substantial in-house technical expertise and recognized brand name in the Energy industry provide a competitive advantage in sourcing, analyzing and executing Energy, resource and related infrastructure projects, as FS/EIG Advisor is typically able to make independent evaluations of investment opportunities without significant reliance on third-party consultants.
Operating and Regulatory Structure
Our investment activities are managed by FS/EIG Advisor and supervised by our board of trustees, a majority of whom are independent. Under the FS/EIG investment advisory agreement, we have agreed to pay FS/EIG Advisor an annual base management fee based on the average weekly value of our gross assets during the most recently completed calendar quarter as well as an incentive fee based on our performance. See “See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations” for a description of the fees we pay to FS/EIG Advisor.
FS/EIG Advisor oversees our day-to-day operations, including the provision of general ledger accounting, fund accounting, legal services, investor relations, certain government and regulatory affairs activities and other administrative services. FS/EIG Advisor also performs, or oversees the performance of, our corporate operations and required administrative services, which includes being responsible for the financial records that we are required to maintain and preparing reports for our shareholders and reports filed with the SEC. In addition, FS/EIG Advisor assists us in calculating our net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to our shareholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others.
Pursuant to the FS/EIG investment advisory agreement, we reimburse FS/EIG Advisor for expenses necessary to perform services related to our administration and operations, including FS/EIG Advisor’s allocable portion of the compensation and/or related expenses of certain personnel of FS Investments and EIG providing administrative services to us on behalf of FS/EIG Advisor, and for transactional expenses for prospective investments, such as fees and expenses associated with performing due diligence reviews of investments that do not close, often referred to as “broken deal” costs. We reimburse FS/EIG Advisor no less than quarterly for all costs and expenses incurred by FS/EIG Advisor in performing its obligations and providing personnel under the FS/EIG investment advisory agreement. The amount of this reimbursement is set at the lesser of  (1) FS/EIG Advisor’s actual costs incurred in providing such services and (2) the amount that we estimate would be required to pay alternative service providers for comparable services in the same geographic location. FS/EIG Advisor allocates the cost of such services to us based on factors such as time allocations and other reasonable metrics. Our board of trustees reviews the methodology employed in determining how the expenses are allocated to us and assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services as compared to the
 
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estimated cost to us of obtaining similar services from third-party service providers known to be available. In addition, our board of trustees considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, our board of trustees compares the total amount paid to FS/EIG Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs. We do not reimburse FS/EIG Advisor for any services for which it receives a separate fee, or for rent, depreciation, utilities, capital equipment or other administrative items allocated to a controlling person of FS/EIG Advisor.
In addition, we have contracted with State Street Bank and Trust Company, or State Street, to provide various accounting and administrative services including, but not limited to, preparing preliminary financial information for review by FS/EIG Advisor, preparing and monitoring expense budgets, maintaining accounting and corporate books and records, processing trade information provided by us and performing testing with respect to RIC compliance.
As a BDC, we are required to comply with certain regulatory requirements. Also, while we are permitted to finance investments using debt, our ability to use debt will be limited in certain significant respects pursuant to the 1940 Act. Within the limits of existing regulation, we will adjust our use of debt, according to market conditions, to the level we believe will allow us to generate maximum risk-adjusted returns. See “—Regulation.” We have elected to be treated for U.S. federal income tax purposes, and intend to qualify annually, as a RIC under Subchapter M of the Code.
Investment Types
Our portfolio is comprised primarily of income-oriented securities, which principally refers to debt securities and income-oriented preferred and common equity interests, of privately-held Energy companies within the United States. We expect to invest primarily in directly originated investments and primary market transactions, as this will provide us with the ability to tailor investments to best match a project’s or company’s needs with our investment objectives. We intend to weight our portfolio towards senior secured debt and directly originated preferred equity investments, which we believe offer opportunities for superior risk-adjusted returns and income generation. Our debt investments may take the form of corporate or project loans or bonds, may be secured or unsecured and may, in some cases, be accompanied by yield enhancements. These yield enhancements are typically expected to include royalty interests in mineral, oil and gas properties, warrants, options, net profits interests, cash flow participations or other forms of equity participation that can provide additional consideration or “upside” in a transaction. Our preferred equity investments are mostly directly originated and may take the form of perpetual or redeemable securities, typically with a current income component and minimum base returns. FS/EIG Advisor will seek to tailor our investment focus as market conditions evolve.
Historically, we have focused on the following investment categories: (i) direct originations and (ii) broadly syndicated investments. Going forward, FS/EIG Advisor intends to continue to rebalance our portfolio from syndicated investments into mostly directly originated investments.
Senior secured debt
Senior secured debt is situated at the top of the capital structure. Because this debt has priority in payment, it typically carries the lowest risk among all investments in a company. Generally, senior secured debt in which we invest is expected to have a maturity period of three to seven years, offer some form of amortization, and have first priority security interests in the assets of the borrower. Senior secured debt may also include second lien debt, which is granted a second priority security interest in the assets of the borrower, meaning that any realization of collateral will generally be applied to pay first lien debt in full before second lien debt positions are paid, and the value of the collateral may not be enough to repay in full both first lien secured debt and second lien secured debt. Generally, we expect that the variable interest rate on our first lien debt will typically range between 4.0% and 9.0% over a standard benchmark, such as the prime rate or LIBOR. We expect that the variable interest rate on second lien debt will range between 6.0% and 12.0% over a standard benchmark. In addition, we may receive additional returns from any yield enhancements we receive in connection with these investments.
 
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Unsecured debt
In addition to senior secured debt, we may invest a portion of our assets in unsecured debt. Unsecured debt is effectively subordinated to first lien and second lien secured debt to the extent of the collateral securing such debt, but is senior to preferred equity and common equity in the capital structure. In return for its junior status compared to first lien and second lien secured debt, unsecured debt typically offers higher returns through both higher interest rates and possible equity ownership in the form of warrants or other yield enhancements, enabling the investor to participate in the capital appreciation of the borrower. Where warrants are received, they typically require only a nominal cost to exercise. We intend to generally target unsecured debt with interest-only payments throughout the life of the security, with the principal due at maturity. Typically, unsecured debt investments have maturities of five to ten years. In normalized markets, we expect these securities to carry a fixed rate or a floating current yield of 8.0% to 12.0% over a standard benchmark. In addition, we may receive additional returns from any warrants or other yield enhancements we receive in connection with these investments. In some cases, a portion of the total interest may accrue or be paid-in-kind, or PIK.
Preferred equity
Preferred equity typically includes a stated value or liquidation preference that is contractually senior to common equity, and may include a dividend or yield feature. Holders of preferred equity can be entitled to a wide range of voting and other rights, depending on the structure of each security. Preferred equity can also include a conversion feature whereby the securities convert into common stock based on established parameters according to set ratios. We seek to invest in primarily income-oriented equity securities of Energy companies in a manner consistent with our status as a BDC. Going forward, FS/EIG Advisor intends to focus on preferred equity securities that are directly originated.
Other equity securities
We may also invest in other equity securities which are typically subordinated to all other securities within the capital structure and do not have a stated maturity. As compared to more senior securities, equity interests have greater risk exposure, but also have the potential to provide a higher return.
Net profits interests, royalty interests, volumetric production payments, or VPPs
We may invest in energy-specific non-operating investments including net profits interests, royalty interests or VPPs. Such non-operating interests do not include the rights and obligations of operating a mineral property (costs of exploration, development and operation) and do not bear any part of the net losses. Net profits interests and royalty interests are contractual agreements whereby the holders of such interests are entitled to a portion of the mineral production or proceeds therefrom. A VPP is a type of structured investment whereby the owner sells a specific volume of production in a field or property to an investor and the investor receives a specific quota of production on a monthly basis in either raw output or proceeds therefrom. A VPP is typically set to expire after a certain length of time or after a specified aggregate total volume of the commodity has been delivered. If the producer cannot meet the supply quota for a given period, the supply obligation rolls forward to future cycles until the buyer is made financially whole.
Non-U.S. securities
We may invest in non-U.S. securities, including securities of companies in emerging markets, which may include securities denominated in U.S. dollars or in non-U.S. currencies, to the extent permitted by the 1940 Act. In addition, investing in securities of companies in emerging markets involves many risks, including potential inflationary economic environments, regulation by foreign governments, different accounting standards, political uncertainties and economic, social, political, financial, tax and security conditions in the applicable emerging market, any of which could negatively affect the value of companies in emerging markets or investments in their securities.
Investments with Third-Parties
We may co-invest with third parties through partnerships, joint ventures or other entities, thereby acquiring jointly-controlled or non-controlling interests in certain investments in conjunction with participation by one or more third parties in such investment.
 
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Other securities
We may also invest from time to time in derivatives, such as total return swaps and credit default swaps. We anticipate that any use of derivatives would primarily be as a substitute for investing in conventional securities. Any use of derivatives may subject us to additional risks. See “Risk Factors—Risks Related to Our Investments—We may from time to time enter into total return swaps, credit default swaps or other derivative transactions which expose us to certain risks, including credit risk, market risk, liquidity risk and other risks similar to those associated with the use of leverage.”
Cash and cash equivalents
We may maintain a certain level of cash or cash equivalent instruments to make follow-on investments, if necessary, in existing portfolio companies or to take advantage of new opportunities.
Sources of Income
The primary means through which our shareholders may receive a return of value is through interest income, dividends and capital gains generated by our investments. In addition to these sources of income, we may receive fees paid by our portfolio companies, including one-time closing fees paid at the time each investment is made. Closing fees typically range from 1.0% to 3.0% of the purchase price of an investment. In addition, we may generate revenues in the form of non-recurring commitment, origination, structuring or diligence fees, fees for providing managerial assistance, consulting fees, prepayment fees and performance-based fees.
Risk Management
We seek to limit the downside potential of our investment portfolio by:

applying our investment strategy guidelines for portfolio investments;

requiring a total return on investments (including both interest and potential appreciation) that adequately compensates us for credit risk;

allocating our portfolio among various issuers and sub-sectors, and size permitting, with an adequate number of companies, across different sub-sectors of the Energy industry, with different types of collateral; and

negotiating or seeking debt and other securities with covenants or features that protect us while affording portfolio companies flexibility in managing their businesses consistent with preservation of capital.
Such restrictions may include affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights. We may also enter into interest rate hedging transactions. Such transactions will enable us to selectively modify interest rate exposure as market conditions dictate.
Affirmative Covenants
Affirmative covenants require borrowers to take actions that are meant to ensure the solvency of the company, facilitate the lender’s monitoring of the borrower and ensure payment of interest and loan principal due to lenders. Examples of affirmative covenants include covenants requiring the borrower to maintain adequate insurance, accounting and tax records, and to produce frequent financial reports for the benefit of the lender.
Negative Covenants
Negative covenants impose restrictions on the borrower and are meant to protect lenders from actions that the borrower may take that could harm the credit quality of the lender’s investments. Examples of negative covenants include restrictions on the payment of dividends and restrictions on the issuance of additional debt without the lender’s approval. In addition, certain covenants restrict a borrower’s activities
 
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by requiring it to meet certain earnings interest coverage ratio and leverage ratio requirements. These covenants are also referred to as financial or maintenance covenants.
Investment Process
The investment professionals supporting FS/EIG Advisor have spent their careers developing the experience necessary to invest in private companies. Our current transaction process is highlighted below.
Our Transaction Process
Screening
The relationships of FS/EIG Advisor and its affiliates provide us with access to a robust and established pipeline of investment opportunities from a variety of different investment channels, including private equity sponsors, non-sponsored corporates, financial advisors, banks, brokers and family offices. In addition, personnel of FS/EIG Advisor have long-standing personal contacts within the Energy industry who provide us with additional opportunities for directly originated investments. Similarly, substantial in-house technical expertise and recognized brand name in the Energy industry of FS/EIG Advisor and its affiliates provide a competitive advantage in sourcing, analyzing and executing energy, resource and related infrastructure projects, as FS/EIG Advisor is typically able to make independent evaluations of investment opportunities without significant reliance on third-party consultants. Once a potential investment has been identified, FS/EIG Advisor screens the opportunity and makes a preliminary determination concerning whether to proceed with a more comprehensive deal-level due diligence review.
Due diligence
Our due diligence process will typically involve: (i) evaluation of the proposed investment consistent with our investment criteria; (ii) meetings with project sponsors and management; (iii) a review of technical feasibility; (iv) a preliminary review of key project contracts; and (v) an analysis of fundamental project economics.
Structure iterations and feedback
If a potential investment passes the initial review process, the investment team then negotiates preliminary terms with the potential portfolio company. We seek to maintain flexibility in structuring the form of investments and utilize this flexibility to provide tailor-made financing solutions.
Recommendation and approval process
At an advanced stage of the due diligence process, the deal team will prepare a draft investment recommendation, which is circulated internally for peer review, a process that allows select investment professionals of FS/EIG Advisor and its affiliates who are not directly involved in the transaction to review independently the merits of the investment. A final investment recommendation is submitted to the FS/EIG Advisor investment committee for review and approval. Each investment must be approved by the FS/EIG Advisor investment committee.
Execution
Once the FS/EIG Advisor investment committee has determined that the portfolio company is suitable for investment, FS/EIG Advisor works with the management team of the prospective company to finalize the structure and terms of the investment. We believe that structuring transactions appropriately is a key factor to producing strong investment results. Accordingly, we will actively consider transaction structures and seek to process and negotiate terms that provide the best opportunities for superior risk-adjusted returns.
Post-investment monitoring
Portfolio monitoring.    FS/EIG Advisor monitors our portfolio with a focus toward anticipating negative credit events. To maintain portfolio company performance and help to ensure a successful exit,
 
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FS/EIG Advisor works closely with the lead equity sponsor, loan syndicator, portfolio company management, consultants, advisers and other security holders to discuss financial position, compliance with covenants, financial requirements and execution of the company’s business plan. In addition, depending on the size, nature and performance of the transaction, we may occupy a seat or serve as an observer on a portfolio company’s board of directors or similar governing body. We believe that close contact with management, efficient flow of information and ongoing analysis form the basis of the monitoring process.
Typically, FS/EIG Advisor receives financial reports that may detail information such as operating performance, sales volumes, margins, cash flows, financial position and other key operating metrics on a quarterly basis from our portfolio companies. FS/EIG Advisor uses this data, combined with due diligence gained through contact with the company’s customers, suppliers, competitors, market research and other methods, to conduct an ongoing, rigorous assessment of the company’s operating performance and prospects.
In addition to various risk management and monitoring tools, FS/EIG Advisor uses an investment rating system to characterize and monitor the expected level of returns on each investment in our portfolio. FS/EIG Advisor uses an investment rating scale of 1 to 5. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Portfolio Asset Quality” for a description of the conditions associated with each investment rating.
Valuation Process.    Each quarter, we value investments in our portfolio, and such values are disclosed each quarter in reports filed with the SEC. Investments for which market quotations are readily available are recorded at such market quotations. With respect to investments for which market quotations are not readily available, our board of trustees determines the fair value of such investments in good faith, utilizing the input of our valuation committee, FS/EIG Advisor and any other professionals or materials that our board of trustees deems relevant, including independent third-party pricing services and independent third-party valuation services, if applicable. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Valuation of Portfolio Investments.”
Managerial Assistance.    As a BDC, we must offer, and provide upon request, managerial assistance to certain of our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. Depending on the nature of the assistance required, FS/EIG Advisor will provide such managerial assistance on our behalf to portfolio companies that request this assistance. To the extent fees are paid for these services, we, rather than FS/EIG Advisor, will retain any fees paid for such assistance.
Financing Arrangements
To seek to enhance our returns, we employ leverage as market conditions permit and at the discretion of FS/EIG Advisor, but in no event may leverage employed exceed the maximum amount permitted by the 1940 Act. See Note 9 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our financing arrangements.
Regulation
We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates, principal underwriters and affiliates of those affiliates or underwriters. The 1940 Act requires that a majority of our trustees be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by “a majority of our outstanding voting securities,” which the 1940 Act defines as the lesser of (i) 67% or more of the voting securities present at a meeting if the holders of more than 50% of our outstanding voting securities are present or represented by proxy or (ii) 50% of our voting securities.
We will generally not be able to issue and sell our common shares at a price per share, after deducting underwriting commissions and discounts, that is below our net asset value per share. See “Item 1A. Risk Factors—Risks Related to Business Development Companies—Regulations governing our operation as a
 
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BDC and a RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.” We may seek the approval of our shareholders to issue shares of our common shares at a price below the then current net asset value per share for a twelve month period following shareholder approval. In addition, we may generally issue new shares of our common share at a price below net asset value per share in rights offerings to existing shareholders, in payment of dividends and in certain other limited circumstances.
As a BDC, we are subject to certain regulatory restrictions in making our investments. For example, BDCs generally are not permitted to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence of an exemptive order from the U.S. Securities and Exchange Commission, or SEC. However, BDCs are permitted to, and may, simultaneously co-invest in transactions where price is the only negotiated term. The EIG Order permits us to co-invest in privately negotiated investment transactions with private funds managed by EIG or its affiliates.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are any of the following:
1.
Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:
a.
is organized under the laws of, and has its principal place of business in, the United States;
b.
is not an investment company (other than a small business investment company wholly owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and
c.
satisfies any of the following:
i.
does not have any class of securities that is traded on a national securities exchange;
ii.
has a class of securities listed on a national securities exchange, but has an aggregate market value of outstanding voting and non-voting common equity of less than $250 million;
iii.
is controlled by a BDC or a group of companies including a BDC and the BDC has an affiliated person who is a director of the eligible portfolio company; or
iv.
is a small and solvent company having total assets of not more than $4.0 million and capital and surplus of not less than $2.0 million.
2.
Securities of any eligible portfolio company that we control.
3.
Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.
4.
Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.
5.
Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.
 
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6.
Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.
In addition, a BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described in (1), (2) or (3) above.
Managerial Assistance to Portfolio Companies
In order to count portfolio securities as qualifying assets for the purpose of the 70% test, we must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where we purchase such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the BDC, through its trustees, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.
Temporary Investments
Pending investment in other types of  “qualifying assets,” as described above, our investments may consist of cash, cash equivalents, including money market funds, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the Diversification Tests (as defined below) in order to maintain our qualification as a RIC for U.S. federal income tax purposes as described below under “—Taxation as a RIC.” Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. FS/EIG Advisor will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Senior Securities
We are permitted, under specified conditions, to issue multiple classes of debt and one class of shares senior to our common shares if our asset coverage, as applicable to us under the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we must make provisions to prohibit any distribution to our shareholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see “Item 1A. Risk Factors—Risks Related to Debt Financing” and “Item 1A. Risk Factors—Risks Related to Business Development Companies.”
Code of Ethics
We and FS/EIG Advisor have each adopted a code of ethics pursuant to Rule 17j-1 promulgated under the 1940 Act that, among other things, establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with each code’s requirements. Shareholders may read and copy these codes of ethics at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549. Shareholders may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090.
 
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In addition, each code of ethics is available on our website at www.fsinvestments.com and on the EDGAR Database on the SEC’s Internet site at www.sec.gov. Shareholders may also obtain a copy of each code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, at 100 F Street, N.E, Washington, D.C. 20549.
Compliance Policies and Procedures
We and FS/EIG Advisor have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws and are required to review these compliance policies and procedures annually for their adequacy and the effectiveness of their implementation. Our chief compliance officer and the chief compliance officer of FS/EIG Advisor are responsible for administering these policies and procedures.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to FS/EIG Advisor. The proxy voting policies and procedures of FS/EIG Advisor are set forth below. The guidelines are reviewed periodically by FS/EIG Advisor and our non-interested trustees, and, accordingly, are subject to change.
As an investment adviser registered under the Advisers Act, FS/EIG Advisor has a fiduciary duty to act solely in the best interests of its clients. As part of this duty, it recognizes that it must vote client securities in a timely manner free of conflicts of interest and in the best interests of its clients.
These policies and procedures for voting proxies for the investment advisory clients of FS/EIG Advisor are intended to comply with Section 206 of, and Rule 206(4)-6 promulgated under, the Advisers Act.
Personnel of FS/EIG Advisor and its affiliates will vote proxies relating to our securities in the best interest of its clients. Such personnel will review on a case-by-case basis each proposal submitted for a shareholder vote to determine its impact on the portfolio securities held by its clients. Although FS/EIG Advisor will generally vote against proposals that may have a negative impact on its clients’ portfolio securities, it may vote for such a proposal if there exist compelling long-term reasons to do so.
The proxy voting decisions are made by the senior personnel of FS/EIG Advisor and its affiliates who are responsible for monitoring each of its clients’ investments. To ensure that its vote is not the product of a conflict of interest, it will require that: (a) anyone involved in the decision-making process disclose to its chief compliance officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (b) employees involved in the decision making process or vote administration are prohibited from revealing how FS/EIG Advisor intends to vote on a proposal in order to reduce any attempted influence from interested parties.
Shareholders may obtain information, without charge, regarding how FS/EIG Advisor voted proxies with respect to our portfolio securities by making a written request for proxy voting information to: Chief Compliance Officer, FS Energy and Power Fund, 201 Rouse Boulevard, Philadelphia, Pennsylvania 19112 or by calling us collect at (215) 495-1150.
Other
We will be periodically examined by the SEC for compliance with the 1940 Act.
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any trustee or officer against any liability to us or our shareholders arising from willful misconduct, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
Exchange Act and Sarbanes-Oxley Act Compliance
We are subject to the reporting and disclosure requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, including the filing of quarterly, annual and current reports, proxy statements
 
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and other required items. In addition, we are subject to the Sarbanes-Oxley Act, which imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us. For example:

pursuant to Rule 13a-14 promulgated under the Exchange Act, our chief executive officer and chief financial officer are required to certify the accuracy of the financial statements contained in our periodic reports;

pursuant to Item 307 of Regulation S-K, our periodic reports are required to disclose our conclusions about the effectiveness of our disclosure controls and procedures; and

pursuant to Rule 13a-15 promulgated under the Exchange Act, our management will be required to prepare a report regarding its assessment of our internal control over financial reporting.
The Sarbanes-Oxley Act requires us to review our current policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and take actions necessary to ensure that we are in compliance therewith. In addition, we voluntarily comply with Section 404(b) of the Sarbanes-Oxley Act, and have engaged our independent registered public accounting firm to audit our internal control over financial reporting.
Taxation as a RIC
We have elected to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we distribute as dividends to our shareholders. To qualify for and maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, in order to maintain RIC tax treatment, we must distribute to our shareholders, for each tax year, dividends of an amount at least equal to 90% of our “investment company taxable income,” which is generally the sum of our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses, determined without regard to any deduction for distributions paid, or the Annual Distribution Requirement.
If we:

qualify as a RIC; and

satisfy the Annual Distribution Requirement,
then we will not be subject to U.S. federal income tax on the portion of our income or capital gains we distribute (or are deemed to distribute) as dividends to our shareholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) as dividends to our shareholders.
As a RIC, we will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute dividends in a timely manner to our shareholders generally of an amount at least equal to the sum of  (1) 98% of our net ordinary income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains over capital losses (as adjusted for certain ordinary losses) for the one-year period ending October 31 of that calendar year and (3) any net ordinary income and capital gain net income for the preceding years that were not distributed during such years and on which we paid no U.S. federal income tax, or the Excise Tax Avoidance Requirement. Any distribution declared by us during October, November or December of any calendar year, payable to shareholders of record on a specified date in such a month and actually paid during January of the following calendar year, will be treated as if it had been paid by us, as well as received by our U.S. shareholders on December 31 of the calendar year in which the distribution was declared. We generally will endeavor in each tax year to avoid any material U.S. federal excise tax on our earnings.
We have previously incurred, and may incur in the future, such excise tax on a portion of our income and capital gains. While we intend to distribute income and capital gains to minimize exposure to the 4% excise tax, we may not be able to, or may choose not to, distribute amounts sufficient to avoid the imposition
 
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of the tax entirely. In that event, we generally will be liable for the excise tax only on the amount by which we do not meet the excise tax avoidance requirement.
In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:

continue to qualify as a BDC under the 1940 Act at all times during each tax year;

derive in each tax year at least 90% of our gross income from dividends, interest, payments with respect to certain securities, loans, gains from the sale of stock or other securities, net income from certain “qualified publicly-traded partnerships,” or other income derived with respect to our business of investing in such stock or other securities, or the 90% Income Test; and

diversify our holdings so that at the end of each quarter of the tax year:

at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and

no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly-traded partnerships,” or the Diversification Tests.
A RIC is limited in its ability to deduct expenses in excess of its investment company taxable income. If our expenses in a given tax year exceed our investment company taxable income, we may experience a net operating loss for that tax year. However, a RIC is not permitted to carry forward net operating losses to subsequent tax years and such net operating losses do not pass through to its stockholders. In addition, deductible expenses can be used only to offset investment company taxable income, not net capital gain. A RIC may not use any net capital losses (that is, the excess of realized capital losses over realized capital gains) to offset its investment company taxable income, but may carry forward such net capital losses, and use them to offset future capital gains, indefinitely. Due to these limits on deductibility of expenses and net capital losses, we may for tax purposes have aggregate taxable income for several years that we are required to distribute and that is taxable to our stockholders even if such taxable income is greater than the net income we actually earn during those years.
For U.S. federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a corresponding payment in cash. For example, if we hold debt instruments that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or debt instruments that were issued with warrants), we must include in income each tax year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same tax year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. We anticipate that a portion of our income may constitute original issue discount or other income required to be included in taxable income prior to receipt of cash.
We invest a portion of our net assets in below investment grade instruments. Investments in these types of instruments may present special tax issues for us. U.S. federal income tax rules are not entirely clear about issues such as when we may cease to accrue interest, original issue discount or market discount, when and to what extent deductions may be taken for bad debts or worthless instruments, how payments received on instruments in default should be allocated between principal and income and whether exchanges of debt obligations in a bankruptcy or workout context are taxable. We will address these and other issues to the extent necessary in order to seek to ensure that we distribute sufficient income to avoid any material U.S. federal income or excise tax.
Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of the accrual, we may be required to make a distribution to our shareholders in order to satisfy the Annual Distribution Requirement, even though we will not have received
 
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any corresponding cash amount. As a result, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under Subchapter M of the Code. We may have to sell or otherwise dispose of some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level U.S. federal income tax.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell or otherwise dispose of assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our shareholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. See “—Regulation—Senior Securities.” Moreover, our ability to sell or otherwise dispose of assets to meet the Annual Distribution Requirement may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we sell or otherwise dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
To satisfy the Diversification Tests at the close of each quarter of our tax year, we will generally have invested no more than 25% of the value of our total assets in MLPs and certain other “qualified publicly traded partnerships”. As a limited partner in the MLPs in which we seek to invest, we will be deemed to have received our share of income, gains, losses, deductions, and credits from those MLPs. Historically, a significant portion of income from MLPs has been offset by tax deductions. As a result, this income has been significantly lower than cash distributions paid by MLPs. The percentage of an MLP’s income and gains which is offset by tax deductions, losses and credits will fluctuate over time for various reasons. A significant slowdown in acquisition activity or capital spending by MLPs held in our portfolio could result in a reduction of accelerated depreciation generated by new acquisitions, which may result in an increase in our investment company taxable income that we are required to distribute to shareholders to satisfy the Annual Distribution Requirement or the Excise Tax Avoidance Requirement or to eliminate our liability for U.S. federal income tax. If our income from our investments in MLPs exceeds the cash distributions received from such investments, we may need to obtain cash from other sources in order to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we may fail to qualify for RIC tax treatment and become subject to corporate-level U.S. federal income tax. We may also recognize for U.S. federal income tax purposes gain in excess of cash proceeds upon the sale of an interest in an MLP. Any such gain may need to be distributed (or deemed distributed) in order to avoid liability for corporate-level U.S. federal income taxes on such gain.
A portfolio company in which we invest may face financial difficulties that require us to work-out, modify or otherwise restructure our investment in the portfolio company. Any such transaction could, depending upon the specific terms of the transaction, result in unusable capital losses and future non-cash income. Any such transaction could also result in our receiving assets that give rise to non-qualifying income for purposes of the 90% Income Test or otherwise would not count toward satisfying the Diversification Tests.
Some of the income that we might otherwise earn, such as fees for providing managerial assistance, certain fees earned with respect to our investments, income recognized in a work-out or restructuring of a portfolio investment, or income recognized from an equity investment in an operating partnership, may not satisfy the 90% Income Test. To manage the risk that such income might disqualify us as a RIC for failure to satisfy the 90% Income Test, one or more subsidiary entities treated as U.S. corporations for entity-level tax purposes may be employed to earn such income and (if applicable) hold the related asset. Such subsidiary entities will be required to pay U.S. federal income tax on their earnings, which ultimately will reduce the yield to our shareholders on such fees and income.
Competition
Our primary competitors for investments include other BDCs and investment funds (including private equity funds, mezzanine funds and CLO funds). In addition, alternative investment vehicles, such as hedge funds, have begun to invest in areas in which they have not traditionally invested, including making investments in middle market private U.S. companies. We also compete with traditional financial services companies
 
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such as commercial banks. We believe we will be able to compete with these entities for financing opportunities on the basis of, among other things, the experience of FS/EIG Advisor’s senior management team. Furthermore, while we believe that regulatory changes and other factors have diminished the role of traditional financial institutions and certain other capital providers in providing financing to middle market private U.S. companies, we are not certain whether this trend will continue as a result of the potentially changing regulatory landscape due to the presidential administration. For additional information, see “—Potential Market Opportunity” and “—Potential Competitive Strengths.”
Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we have. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than us. Furthermore, many of our competitors have greater experience operating under, or are not subject to, the regulatory restrictions that the 1940 Act imposes on us as a BDC. For additional information concerning the competitive risks we face, see “Item 1A. Risk Factors—Risks Related to Our Business and Structure—We may face increasing competition for investment opportunities, which could delay deployment of our capital, reduce returns and result in losses.”
Employees
We do not currently have any employees. Each of our executive officers is a principal, officer or employee of FS/EIG Advisor (or its affiliates), which manages and oversees our investment operations. In the future, FS/EIG Advisor may retain additional investment personnel based upon its needs.
Available Information
For so long as our bylaws require, we will distribute to all shareholders of record our quarterly report on Form 10-Q within 60 days after the end of each fiscal quarter and our annual report on Form 10-K within 120 days after the end of each fiscal year. We also file with or submit to the SEC annual, quarterly and current periodic reports, proxy statements and other information meeting the informational requirements of the Exchange Act. This information is available free of charge by calling us collect at (215) 495-1150 or on our website at www.fsinvestments.com. Information contained on our website is not incorporated into this annual report on Form 10-K and such information should not be considered to be part of this annual report on Form 10-K.
Shareholders also may inspect and copy these reports, proxy statements and other information, as well as this annual report on Form 10-K and related exhibits and schedules, at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549. Such information is also available from the EDGAR database on the SEC’s web site at www.sec.gov. Shareholders also can obtain copies of such information, after paying a duplicating fee, by sending a request by e-mail to publicinfo@sec.gov or by writing the SEC’s Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, Washington, D.C. 20549. Shareholders may obtain information on the operation of the SEC’s Public Reference Room by calling the SEC at (202) 551-8090.
 
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Item 1A.
Risk Factors.
Investing in our common shares involves a number of significant risks. In addition to the other information contained in this annual report on Form 10-K, investors should consider carefully the following information before making an investment in our common shares. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely affected. In such case, the net asset value of our common shares could decline or the value of our debt or equity investments may decline, and investors may lose all or part of their investment.
Future disruptions or instability in capital markets could negatively impact the valuation of our investments and our ability to raise capital.
From time to time, the global capital markets may experience periods of disruption and instability, which could be prolonged and which could materially and adversely impact the broader financial and credit markets, have a negative impact on the valuations of our investments and reduce the availability to us of debt and equity capital. The recent global outbreak of COVID-19 (more commonly known as the Coronavirus) has disrupted economic markets and the prolonged economic impact is uncertain. Some economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a world-wide economic downturn. Many manufacturers of goods in China and other countries in Asia have seen a downturn in production due to the suspension of business and temporary closure of factories in an attempt to curb the spread of the illness. As the impact of the Coronavirus spreads to other parts of the world, similar impacts may occur with respect to affected countries. Similarly, between 2008 and 2009, instability in the global capital markets resulted in disruptions in liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of credit risk in the broadly syndicated credit market and the failure of major domestic and international financial institutions. In particular, the financial services sector was negatively impacted by significant write-offs as the value of the assets held by financial firms declined, impairing their capital positions and abilities to lend and invest. While market conditions have largely recovered from the events of 2008 and 2009, there have been continuing periods of volatility (e.g., in the fourth quarter of 2018). For example, continued uncertainty surrounding the negotiation of trade deals between Britain and the European Union following the United Kingdom’s exit from the European Union and uncertainty between the United States and other countries with respect to trade policies, treaties, and tariffs, among other factors, have caused disruption in the global markets. There can be no assurance that market conditions will not worsen in the future.
While most of our investments are not publicly traded, applicable accounting standards require us to assume as part of our valuation process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity) and impairments of the market values or fair market values of our investments, even if unrealized, must be reflected in our financial statements for the applicable period, which could result in significant reductions to our net asset value for the period. With certain limited exceptions, we are only allowed to borrow amounts or issue debt securities if our asset coverage, as calculated pursuant to the 1940 Act, equals at least 200% immediately after such borrowing. Equity capital may also be difficult to raise during periods of adverse or volatile market conditions because, subject to some limited exceptions, as a BDC, we are generally not able to issue additional shares of our common stock at a price less than net asset value without first obtaining approval for such issuance from our shareholders and our independent trustees. If we are unable to raise capital or refinance existing debt on acceptable terms, then we may be limited in our ability to make new commitments or to fund existing commitments to our portfolio companies. Significant changes in the capital markets may also affect the pace of our investment activity and the potential for liquidity events involving our investments. Thus, the illiquidity of our investments may make it difficult for us to sell such investments to access capital if required, and as a result, we could realize significantly less than the value at which we have recorded our investments if we were required to sell them for liquidity purposes.
Uncertainty with respect to the financial stability of the United States, several countries in Europe and China could have a significant adverse effect on our business, financial condition and results of operations.
In August 2011, S&P lowered its long-term sovereign credit rating on the U.S. from “AAA” to “AA+,” which was last affirmed by S&P in June 2018. Moody’s and Fitch Ratings, Inc. have also warned that they
 
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may downgrade the U.S. federal government’s credit rating under certain circumstances. Further downgrades or warnings by S&P or other rating agencies, and the U.S. government’s credit and deficit concerns in general, could cause interest rates and borrowing costs to rise, which may negatively impact both the perception of credit risk associated with our debt portfolio and our ability to access the debt markets on favorable terms. In addition, a decreased U.S. government credit rating could create broader financial turmoil and uncertainty, which could have material adverse effects on our business, financial condition and results of operation.
Deterioration in the economic conditions in the Eurozone and globally, including instability in financial markets, may pose a risk to our business. Financial markets have been affected at times by a number of global macroeconomic and political events, including large sovereign debts and fiscal deficits of several countries in Europe and in emerging markets jurisdictions, levels of non performing loans on the balance sheets of European banks, the potential effect of any European country leaving the Eurozone, including the effect of the United Kingdom leaving the European Union, the potential effect of Scotland leaving the United Kingdom, and market volatility and loss of investor confidence driven by political events and the results of elections. Market and economic disruptions have affected, and may in the future affect, among other factors, consumer confidence levels and spending, personal and corporate bankruptcy rates, levels of debt incurrence and default on consumer debt and home prices. Market disruptions in Europe or in other major global economies, including the increased cost of funding for certain governments and financial institutions, could negatively impact the global economy, and there can be no assurance that assistance packages will be available, or if available, will be sufficient to stabilize countries and markets. To the extent uncertainty regarding any economic recovery negatively impacts consumer confidence levels and spending, personal bankruptcy rates, levels of incurrence and default on consumer debt and home prices, or other credit factors, our business, financial condition and results of operations could be materially adversely affected, including with respect to the value of our investments in European or other foreign companies and companies that have operations that may be affected by the Eurozone or other foreign economies.
In the second quarter of 2015, stock prices in China experienced a significant decline, resulting primarily from continued sell-off of shares trading in Chinese markets. In addition, in August 2015, Chinese authorities sharply devalued China’s currency. Since then, the Chinese capital markets have continued to experience periods of instability. The recent outbreak of the novel coronavirus which originated in Wuhan, China and has spread to other areas of China and recently other countries, may potentially cause widespread economic disruption globally and in the United States which may adversely impact the operations of our borrowers and their sponsors. These market and economic disruptions have affected, and may in the future affect, the U.S. capital markets, which could have material adverse effects on our business, financial condition and results of operations.
Federal Reserve policy can have a significant impact on market conditions. The Federal Reserve raised the Federal funds rate throughout the course of 2015 through 2018 and then pivoted in the fourth quarter of 2018 towards easier monetary policy and cut rates several times in 2019. This development, along with the United States government’s credit and deficit concerns, concerns about financial stability in Europe and an economic slowdown in China, could cause interest rates to be volatile, which may negatively impact our ability to access the debt and equity markets on favorable terms.
We invest in European companies and companies that have operations that may be affected by the United Kingdom’s exit from the European Union.
We invest in European companies and companies that have operations that may be affected by the United Kingdom’s exit from the European Union on January 31, 2020. While the United Kingdom will remain under the European Union’s rules of trade until December 31, 2020, it is unclear if or when new rules of trade between the United Kingdom and the European Union will be adopted, and therefore the United Kingdom and the European Union are and may continue to be in a period of legal, regulatory and political uncertainty. We may invest in portfolio companies and other issuers with significant operations and/or assets in the United Kingdom, any of which could be adversely impacted by any new legal, tax and regulatory environment, whether by increased costs or impediments to the implementation of their business plan, which could have a material adverse effect on our business, financial condition and results of operations, including with respect to the value of our investment in European companies and companies that have operations that may be affected by the Eurozone economy.
 
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Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies.
There have been significant changes to United States trade policies, treaties and tariffs, and in the future there may be additional significant changes. These and any future developments, and continued uncertainty surrounding trade policies, treaties and tariffs, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies’ access to suppliers or customers and could have material adverse effects on our business, financial condition and results of operations.
Economic sanction laws in the United States and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and companies.
Economic sanction laws in the United States and other jurisdictions may prohibit us or our affiliates from transacting with certain countries, individuals and companies. In the United States, the U.S. Department of the Treasury’s Office of Foreign Assets Control administers and enforces laws, executive orders and regulations establishing U.S. economic and trade sanctions, which prohibit, among other things, transactions with, and the provision of services to, certain non-U.S. countries, territories, entities and individuals. These types of sanctions may significantly restrict or completely prohibit investment activities in certain jurisdictions, and if we, our portfolio companies or other issuers in which we invest were to violate any such laws or regulations, we may face significant legal and monetary penalties.
The Foreign Corrupt Practices Act, or FCPA, and other anti-corruption laws and regulations, as well as anti-boycott regulations, may also apply to and restrict our activities, our portfolio companies and other issuers of our investments. If an issuer or we were to violate any such laws or regulations, such issuer or we may face significant legal and monetary penalties. The U.S. government has indicated that it is particularly focused on FCPA enforcement, which may increase the risk that an issuer or us becomes the subject of such actual or threatened enforcement. In addition, certain commentators have suggested that private investment firms and the funds that they manage may face increased scrutiny and/or liability with respect to the activities of their underlying portfolio companies. As such, a violation of the FCPA or other applicable regulations by us or an issuer of our portfolio investments could have a material adverse effect on us. We are committed to complying with the FCPA and other anti-corruption laws and regulations, as well as anti-boycott regulations, to which it is subject. As a result, we may be adversely affected because of its unwillingness to enter into transactions that violate any such laws or regulations.
Future economic recessions or downturns could impair our portfolio companies and harm our operating results.
Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay our debt investments during these periods. Therefore, our non-performing assets are likely to increase, and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions may also decrease the value of any collateral securing our debt investments. A prolonged recession may further decrease the value of such collateral and result in losses of value in our portfolio and a decrease in our revenues, net income and net asset value. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us on terms we deem acceptable. These events could prevent us from increasing investments and harm our operating results. Economic downturns or recessions may also result in a portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders, which could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its assets representing collateral for its obligations, which could trigger cross defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the debt that we hold and the value of any equity securities we own. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company.
 
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Risks Related to Our Business and Structure
Our board of trustees may change our investment policy by providing our shareholders with 60 days’ prior notice, or may modify or waive our current operating policies and strategy without prior notice or shareholder approval, the effects of which may be adverse.
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may be changed by our board of trustees if we provide our shareholders with at least 60 days’ prior notice. In addition, our board of trustees has the authority to modify or waive our current operating policies, investment criteria and strategy without prior notice and without shareholder approval. We cannot predict the effect any changes to our investment policy, current operating policies, investment criteria and strategy would have on our business, net asset value, operating results and the value of our common shares. However, the effects might be adverse, which could negatively impact our ability to pay distributions to shareholders and cause shareholders to lose all or part of their investment. Finally, because our common shares are not expected to be listed on a national securities exchange for the foreseeable future, shareholders will be limited in their ability to sell their common shares in response to any changes in our investment policy, operating policies, investment criteria or strategy.
Our ability to achieve our investment objectives depends on FS/EIG Advisor’s ability to manage and support our investment process. If our agreement with FS/EIG Advisor were to be terminated, or if FS/EIG Advisor were to lose certain members of its investment team, our ability to achieve our investment objectives could be significantly harmed.
Because we have no employees, we depend on the investment expertise, skill and network of business contacts of FS/EIG Advisor. FS/EIG Advisor evaluates, negotiates, structures, executes, monitors and services our investments. Our future success depends to a significant extent on the continued service of FS/EIG Advisor, as well as its investment team. The departure of certain members of FS/EIG Advisor’s investment team could have a material adverse effect on our ability to achieve our investment objectives.
Our ability to achieve our investment objectives depends on FS/EIG Advisor’s ability to identify, analyze, invest in, finance and monitor companies that meet our investment criteria. FS/EIG Advisor’s capabilities in structuring the investment process, providing competent, attentive and efficient services to us, and facilitating access to financing on acceptable terms depend on the employment of investment professionals in an adequate number and of adequate sophistication to match the corresponding flow of transactions. To achieve our investment objectives, FS/EIG Advisor may need to hire, train, supervise and manage new investment professionals to participate in our investment selection and monitoring process. FS/EIG Advisor may not be able to find investment professionals in a timely manner or at all. Failure to support our investment process could have a material adverse effect on our business, financial condition and results of operations.
In addition, the FS/EIG investment advisory agreement has termination provisions that allow the parties to terminate the agreement without penalty. The FS/EIG investment advisory agreement may be terminated at any time, without penalty, by FS/EIG Advisor, upon 60 days’ written notice to us. If the FS/EIG investment advisory agreement is terminated, it may adversely affect the quality of our investment opportunities. In addition, in the event such agreement is terminated, it may be difficult for us to replace FS/EIG Advisor. Furthermore, the termination of the FS/EIG investment advisory agreement may adversely impact the terms of any existing or future financing arrangement, which could have a material adverse effect on our business, financial condition and results of operations.
FS/EIG Advisor is a recently-formed investment adviser with a limited track record of acting as an investment adviser to a BDC, and any failure by FS/EIG Advisor to manage and support our investment process may hinder the achievement of our investment objectives.
FS/EIG Advisor is a recently-formed investment adviser jointly operated by an affiliate of FS and EIG and has limited prior experience acting as an investment adviser to a BDC. The 1940 Act and the Code impose numerous constraints on the operations of BDCs that do not apply to other investment vehicles. FS/EIG Advisor’s limited experience in managing a portfolio of assets under the constraints of the 1940 Act and the Code may hinder FS/EIG Advisor’s ability to take advantage of attractive investment opportunities and,
 
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as a result, may adversely affect our ability to achieve our investment objectives. The track records and achievements of affiliates of, and funds advised or managed by, FS or EIG are not necessarily indicative of the future results FS/EIG Advisor will achieve as a joint investment adviser. Accordingly, we can offer no assurance that we will replicate the historical performance of other investment companies with which FS and EIG have been affiliated, and we caution that our investment returns could be lower than the returns achieved by such other companies.
Because our business model depends to a significant extent upon relationships with issuers, private equity sponsors, investment banks and commercial banks, the inability of FS/EIG Advisor to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
If FS/EIG Advisor fails to maintain its existing relationships with issuers, private equity sponsors, investment banks and commercial banks on which it relies to provide us with potential investment opportunities or develop new relationships with other issuers, sponsors or sources of investment opportunities, we may not be able to grow our investment portfolio. In addition, individuals with whom FS/EIG Advisor has relationships generally are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate investment opportunities for us.
Our financial condition and results of operations depend on our ability to manage future growth effectively.
Our ability to achieve our investment objectives depends on our ability to acquire suitable investments and monitor and administer those investments, which depends, in turn, on our investment adviser’s ability to identify, invest in and monitor companies that meet our investment criteria.
Accomplishing this result on a cost-effective basis is largely a function of the structuring of our investment process and the ability of FS/EIG Advisor to provide competent, attentive and efficient services to us. Our executive officers and the members of FS/EIG Advisor’s investment committee have substantial responsibilities in connection with their roles at FS, EIG and the other entities affiliated with FS and EIG, as well as responsibilities under the FS/EIG investment advisory agreement. They may also be called upon to provide significant managerial assistance to certain of our portfolio companies. These demands on their time, which will increase as the number of investments grows, may distract them or slow the rate of investment. In order to grow, FS/EIG Advisor will need to hire, train, supervise, manage and retain new personnel. However, we cannot assure you that FS/EIG Advisor will be able to do so effectively. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.
We may face increasing competition for investment opportunities, which could delay deployment of our capital, reduce returns and result in losses.
We compete for investments with other BDCs and investment funds (including private equity funds, mezzanine funds, hedge funds and collateralized loan obligation, or CLO, funds), as well as traditional financial services companies such as commercial banks and other sources of funding. Moreover, alternative investment vehicles, such as hedge funds, have begun to invest in areas in which they have not traditionally invested, including making investments in middle market private U.S. companies. As a result of these new entrants, competition for investment opportunities in middle-market private U.S. companies may intensify. Many of our competitors are substantially larger and have considerably greater financial and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we have. These characteristics could allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than we are able to do. We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure. If we are forced to match our competitors’ pricing, terms and structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of capital loss. A significant part of our competitive advantage stems from the market for investments in middle market private U.S. companies currently being underserved by traditional commercial banks and other financial sources. A significant increase in the number and/or the size of our competitors in this target
 
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market could force us to accept less attractive investment terms. Furthermore, many of our competitors have greater experience operating under, or are not subject to, the regulatory restrictions that the 1940 Act imposes on us as a BDC.
A significant portion of our investment portfolio is and will be recorded at fair value as determined in good faith by our board of trustees and, as a result, there is and will be uncertainty as to the value of our portfolio investments.
Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as determined in good faith by or under the direction of our board of trustees. There is not a public market for the securities of certain of the companies in which we invest. Many of our investments are not publicly-traded or actively-traded on a secondary market but are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors or are not traded at all. As a result, we value these securities quarterly at fair value as determined in good faith by our board of trustees. Our board of trustees has delegated day-to-day responsibility for implementing our valuation policy to FS/EIG Advisor’s management team, and has authorized FS/EIG Advisor’s management team to utilize independent third-party valuation and pricing services that have been approved by our board of trustees.
Certain factors that may be considered in determining the fair value of our investments include dealer quotes for securities traded on the secondary market for institutional investors, the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to comparable publicly-traded companies, discounted cash flows and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Due to this uncertainty, our fair value determinations may cause our net asset value on a given date to materially understate or overstate the value that we may ultimately realize upon the sale of one or more of our investments.
Declines in market values or fair market values of our investments could result in significant net unrealized depreciation of our portfolio, which, in turn, would reduce our net asset value.
Under the 1940 Act, we are required to carry our investments at market value or, if there is no readily available market value, at fair value as determined in good faith by our board of trustees. While most of our investments will not be publicly traded, applicable accounting standards require us to assume as part of our valuation process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity) and impairments of the market values or fair market values of our investments, even if unrealized, must be reflected in our financial statements for the applicable period as unrealized depreciation, which could result in significant reductions to our net asset value for a given period.
If we, our affiliates and our and their respective third-party service providers are unable to maintain the availability of electronic data systems and safeguard the security of data, our ability to conduct business may be compromised, which could impair our liquidity, disrupt our business, damage our reputation or otherwise affect our business.
Cybersecurity refers to the combination of technologies, processes, and procedures established to protect information technology systems and data from unauthorized access, attack, or damage. We, our affiliates and our and their respective third-party service providers are subject to cybersecurity risks. Cybersecurity risks have significantly increased in recent years and, while we have not experienced any material losses relating to cyber attacks or other information security breaches, we could suffer such losses in the future. Our, our affiliates and our and their respective third-party service providers’ computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code and other events that could have a security impact. If one or more of such events occur, this could jeopardize confidential and other information, including nonpublic personal information and sensitive business data, processed and stored in, and transmitted through, computer systems and networks, or otherwise
 
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cause interruptions or malfunctions in our operations or the operations of our affiliates and our and their respective third-party service providers. This could result in significant losses, reputational damage, litigation, regulatory fines or penalties, or otherwise adversely affect our business, financial condition or results of operations. Privacy and information security laws and regulation changes, and compliance with those changes, may result in cost increases due to system changes and the development of new administrative processes. In addition, we may be required to expend significant additional resources to modify our protective measures and to investigate and remediate vulnerabilities or other exposures arising from operational and security risks.
There is a risk that investors in our common shares may not receive distributions or that our distributions may not grow over time.
We cannot assure shareholders that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. All distributions will be paid at the discretion of our board of trustees and will depend on our earnings, our net investment income, our financial condition, maintenance of our RIC status, compliance with applicable BDC regulations and such other factors as our board of trustees may deem relevant from time to time. In addition, due to the asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions. See “Item 1. Business—Regulation—Senior Securities.”
Our distribution proceeds have exceeded and in the future may exceed our earnings. Therefore, portions of the distributions that we make may represent a return of capital to shareholders, which will lower their tax basis in their common shares.
We may pay all or a substantial portion of our distributions from the proceeds of our continuous public offering or from borrowings in anticipation of future cash flow, which may constitute a return of shareholders’ capital and will lower such shareholders’ tax basis in their common shares. A return of capital generally is a return of a shareholder’s investment rather than a return of earnings or gains derived from our investment activities and will be made after deducting the fees and expenses payable in connection with the offering, including any fees payable to FS/EIG Advisor. Moreover, a return of capital will generally not be taxable, but will reduce each shareholder’s cost basis in our common shares, and will result in a higher reported capital gain or lower reported capital loss when the common shares on which such return of capital was received are sold.
Changes in laws or regulations governing our operations or the operations of our business partners may adversely affect our business or cause us to alter our business strategy.
We, our portfolio companies and our business partners are subject to regulation at the local, state and federal level. New legislation may be enacted or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make and the deductibility of interest expense by our portfolio companies, potentially with retroactive effect. Changes in laws or regulations governing the operations of those with whom we do business, including selected broker-dealers and other financial representatives selling our common shares, could also have a material adverse effect on our business, financial condition and results of operations. In addition, over the last several years there has been an increase in regulatory attention to the extension of credit outside of the traditional banking sector, raising the possibility that some portion of the non-bank financial sector will be subject to new regulation. New or repealed legislation, interpretations, rulings or regulations could require changes to certain business practices of us or our portfolio companies, negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies or otherwise adversely affect our business or the business of our portfolio companies.
In addition, any changes to the laws and regulations governing our operations, including with respect to permitted investments, may cause us to alter our investment strategy to avail ourselves of new or different opportunities or make other changes to our business. Such changes could result in material differences to our strategies and plans as set forth in this annual report on Form 10-K and may result in our investment focus shifting from the areas of expertise of FS/EIG Advisor to other types of investments in which FS/EIG
 
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Advisor may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of a shareholder’s investment.
As a public company, we are subject to regulations not applicable to private companies, such as provisions of the Sarbanes-Oxley Act. Efforts to comply with such regulations will involve significant expenditures, and non-compliance with such regulations may adversely affect us.
As a public company, we are subject to regulations not applicable to private companies, including provisions of the Sarbanes-Oxley Act and the related rules and regulations promulgated by the SEC. Our management is required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act and rules and regulations of the SEC thereunder. We are required to review on an annual basis our internal control over financial reporting, and on a quarterly and annual basis, to evaluate and disclose changes in our internal control over financial reporting. Section 404 of the Sarbanes-Oxley Act also generally requires an attestation from our independent registered public accounting firm on the effectiveness of our internal control over financial reporting.
We incur significant expenses in connection with our compliance with the Sarbanes-Oxley Act and other regulations applicable to public companies, which may negatively impact our financial performance and our ability to make distributions. Compliance with such regulations also requires a significant amount of our management’s time and attention. For example, we cannot be certain as to the timing of the completion of our Sarbanes-Oxley mandated evaluations, testings and remediation actions, if any, or the impact of the same on our operations, and we may not be able to ensure that the process is effective or that our internal control over financial reporting are or will be deemed effective in the future. In the event that we are unable to maintain an effective system of internal control and maintain compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected.
Changes in laws or regulations governing our operations or the operations of our portfolio companies, changes in the interpretation thereof or newly enacted laws or regulations, such as the Wall Street Reform and Consumer Protection Act and the Tax Cuts and Jobs Act, could require changes to certain business practices of us or our portfolio companies, negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies or otherwise adversely affect our business or the business of our portfolio companies.
We and our portfolio companies are subject to regulation by laws and regulations at the local, state, federal and, in some cases, foreign levels. These laws and regulations, as well as their interpretation, may be changed from time to time, and new laws and regulations may be enacted. Accordingly, any change in these laws or regulations, changes in their interpretation, or newly enacted laws or regulations could require changes to certain business practices of us or our portfolio companies, negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies or otherwise could have a material adverse effect on our or a portfolio company’s business, financial condition and results of operations. At this time it is not possible to determine the potential impact of any new laws and proposals on us.
On July 21, 2010, President Obama signed into law the Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act. Many of the provisions of the Dodd-Frank Act have had extended implementation periods and delayed effective dates and have required extensive rulemaking by regulatory authorities. While many of the rules required to be written have been promulgated, some have not yet been implemented. Although the full impact of the Dodd-Frank Act on us and our portfolio companies may not be known for an extended period of time, the Dodd-Frank Act, including the rules implementing its provisions and the interpretation of those rules relating to capital, margin, trading and clearance and settlement of derivatives, may negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies, intensify the regulatory supervision of us or our portfolio companies or otherwise could have a material adverse effect on our or a portfolio company’s business, financial condition and results of operations.
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, which significantly changed the Code, including a reduction in the corporate income tax rate, a new limitation on the deductibility of interest expense, and significant changes to the taxation of income earned from foreign sources and
 
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foreign subsidiaries. The Tax Cuts and Jobs Act also authorizes the IRS to issue regulations with respect to the new provisions. We cannot predict how the changes in the Tax Cuts and Jobs Act, or regulations or other guidance issued under it, could have a material adverse effect on our or a portfolio company’s business, financial condition and results of operations.
On May 24, 2018, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act, which increased from $50 billion to $250 billion the asset threshold for designation of systemically important financial institutions subject to enhanced prudential standards set by the Federal Reserve, staggering application of this change based on the size and risk of the covered bank holding company. On October 8, 2019, five federal financial agencies finalized revisions to simplify compliance requirements relating to the Volcker rule, which became effective on January 1, 2020. In addition, over the past two years, the House of Representatives and the Senate have considered legislation intended to help small businesses, entrepreneurs and investors by reforming capital markets.
Future legislation or rules could modify how we treat derivatives and other financial arrangements, or place conditions on our use of derivatives and other financial arrangements.
Future legislation or rules may modify how we treat derivatives and other financial arrangements, or place conditions on our use of derivatives and other financial arrangements. For example, the SEC proposed new rules in November 2019 that are designed to modernize the regulation of the use of derivatives by registered investment companies and BDCs. While the adoption of the November 2019 rules is currently uncertain, the proposed rule, if adopted, or any future legislation or rules, may modify how we treat derivatives and other financial arrangements, or place conditions on our use and management of derivatives and other financial arrangements, and, therefore, could affect the nature and extent of our use and management of derivatives, which may be materially adverse to us and our shareholders.
We may experience fluctuations in our quarterly results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be relied upon as being indicative of performance in future periods.
We and FS/EIG Advisor could be the target of litigation.
We and FS/EIG Advisor could become the target of securities class action litigation or other similar claims if our common stock price fluctuates significantly or for other reasons. The proceedings could continue without resolution for long periods of time and the outcome of any such proceedings could materially adversely affect our business, financial condition, and/or operating results. Any litigation or other similar claims could consume substantial amounts of our management’s time and attention, and that time and attention and the devotion of associated resources could, at times, be disproportionate to the amounts at stake. Litigation and other claims are subject to inherent uncertainties, and a material adverse impact on our financial statements could occur for the period in which the effect of an unfavorable final outcome in litigation or other similar claims becomes probable and reasonably estimable. In addition, we could incur expenses associated with defending ourselves against litigation and other similar claims, and these expenses could be material to our earnings in future periods.
Risks Related to FS/EIG Advisor and its Respective Affiliates
There may be conflicts of interest related to obligations FS/EIG Advisor’s senior management and investment teams have to our affiliates and to other clients.
The members of the senior management and investment teams of FS/EIG Advisor serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment vehicles managed by the same personnel. For example, the officers, managers and other personnel of FS/EIG Advisor also serve in similar capacities for the investment advisers to the other
 
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funds managed or advised by FS, and may serve in similar or other capacities for the investment advisers to future investment vehicles affiliated with FS Investments. In serving in these multiple and other capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in our best interests or in the best interest of our shareholders. Our investment objectives may overlap with the investment objectives of such investment funds, accounts or other investment vehicles. For example, we rely on FS/EIG Advisor to manage our day-to-day activities and to implement our investment strategy. FS/EIG Advisor and certain of its affiliates are presently, and plan in the future to continue to be, involved with activities which are unrelated to us. As a result of these activities, FS/EIG Advisor, its employees and certain of its affiliates will have conflicts of interest in allocating their time between us and other activities in which they are or may become involved, including the management of other entities affiliated with FS Investments. FS/EIG Advisor and its employees will devote only as much of its or their time to our business as FS/EIG Advisor and its employees, in their judgment, determine is reasonably required, which may be substantially less than their full time.
FS/EIG Advisor and its affiliates, including our officers and some of our trustees, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in the best interests of our shareholders.
FS/EIG Advisor and its affiliates receive substantial fees from us in return for their services, and these fees could influence the advice provided to us. Among other matters, the compensation arrangements could affect their judgment. In addition, the decision to utilize leverage has increased our assets and, as a result, has increased the amount of base management fees payable to FS/EIG Advisor.
We may be obligated to pay FS/EIG Advisor incentive compensation even if we incur a net loss due to a decline in the value of our portfolio.
The FS/EIG investment advisory agreement entitles FS/EIG Advisor to receive incentive compensation on income regardless of any capital losses. In such case, we may be required to pay FS/EIG Advisor incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or if we incur a net loss for that quarter.
Any incentive fee payable by us that relates to our net investment income may be computed and paid on income that may include interest that has been accrued but not yet received. If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously included in the calculation of the incentive fee will become uncollectible. FS/EIG Advisor is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a default by an entity on the obligation that resulted in the accrual of such income, and such circumstances would result in our paying an incentive fee on income we never received.
For U.S. federal income tax purposes, we are required to recognize taxable income (such as deferred interest that is accrued as original issue discount) in some circumstances in which we do not receive a corresponding payment in cash and to make distributions with respect to such income to maintain our status as a RIC. Under such circumstances, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under the Code. This difficulty in making the required distribution may be amplified to the extent that we are required to pay an incentive fee with respect to such accrued income. As a result, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital, or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
The time and resources that individuals employed by FS/EIG Advisor devote to us may be diverted, and we may face additional competition due to the fact that individuals employed by FS/EIG Advisor are not prohibited from raising money for or managing another entity that makes the same types of investments that we target.
Neither FS/EIG Advisor nor persons providing services to us on behalf of FS/EIG Advisor are prohibited from raising money for and managing another investment entity that makes the same types of investments as those we target. For example, FS Energy Advisor, LLC, an affiliate of FS Advisor, manages FS Energy Total Return Fund, an interval fund with an investment strategy that focuses on investing 80% of
 
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its total assets in natural resource companies. As a result, the time and resources that these individuals may devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities.
Our incentive fee may induce FS/EIG Advisor to make, and EIG to recommend, speculative investments.
The incentive fee payable by us to FS/EIG Advisor may create an incentive for it to enter into investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to FS/EIG Advisor is determined may encourage it to use leverage to increase the return on our investments. In addition, the fact that our base management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may encourage FS/EIG Advisor to use leverage to make additional investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor holders of our common shares. Such a practice could result in our investing in more speculative securities than would otherwise be in our best interests, which could result in higher investment losses, particularly during cyclical economic downturns. In addition, since EIG will receive a portion of the advisory fees paid to FS/EIG Advisor, EIG may have an incentive to recommend investments that are riskier or more speculative.
FS/EIG Advisor’s liability is limited under the FS/EIG investment advisory agreement, and we are required to indemnify FS/EIG Advisor against certain liabilities, which may lead it to act in a riskier manner on our behalf than it would when acting for its own account.
Pursuant to the FS/EIG investment advisory agreement, FS/EIG Advisor and its officers, managers, partners, members (and their members, including the owners of their members), agents, employees, controlling persons and any other person or entity affiliated with FS/EIG Advisor will not be liable to us for their acts under the FS/EIG investment advisory agreement, absent willful misfeasance, bad faith or gross negligence in the performance of their duties. We have agreed to indemnify, defend and protect FS/EIG Advisor and its officers, managers, partners, members (and their members, including the owners of their members), agents, employees, controlling persons and any other person or entity affiliated with FS/EIG Advisor with respect to all damages, liabilities, costs and expenses resulting from acts of FS/EIG Advisor not arising out of willful misfeasance, bad faith or gross negligence in the performance of their duties under the FS/EIG investment advisory agreement. These protections may lead FS/EIG Advisor to act in a riskier manner when acting on our behalf than it would when acting for its own account.
Risks Related to Business Development Companies
The requirement that we invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our current business strategy; conversely, the failure to invest a sufficient portion of our assets in qualifying assets could result in our failure to maintain our status as a BDC.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of such acquisition, at least 70% of our total assets are qualifying assets. Therefore, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets. Similarly, these rules could prevent us from making additional investments in existing portfolio companies, which could result in the dilution of our position, or could require us to dispose of investments at an inopportune time to comply with the 1940 Act. If we were forced to sell non-qualifying investments in the portfolio for compliance purposes, the proceeds from such sale could be significantly less than the current value of such investments. Conversely, if we fail to invest a sufficient portion of our assets in qualifying assets, we could lose our status as a BDC, which would have a material adverse effect on our business, financial condition and results of operations.
Failure to maintain our status as a BDC would reduce our operating flexibility.
If we do not remain a BDC, we might be regulated as a closed-end investment company under the 1940 Act, which would subject us to substantially more regulatory restrictions under the 1940 Act and correspondingly decrease our operating flexibility.
 
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Regulations governing our operation as a BDC and a RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.
As a result of our need to satisfy the Annual Distribution Requirement in order to maintain RIC tax treatment under Subchapter M of the Code, we may need to periodically access the capital markets to raise cash to fund new investments. We may issue “senior securities,” as defined in the 1940 Act, including issuing preferred shares, borrowing money from banks or other financial institutions or issuing debt securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. Our ability to issue certain other types of securities is also limited. Under the 1940 Act, we are also generally prohibited from issuing or selling our shares at a price per share, after deducting underwriting commissions, that is below our net asset value per share, without first obtaining approval for such issuance from our shareholders and our independent trustees. Compliance with these limitations on our ability to raise capital may unfavorably limit our investment opportunities and may reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend.
We expect to continue to borrow for investment purposes. If the value of our assets declines, we may be unable to satisfy the asset coverage test, which would prohibit us from paying distributions and as a result could cause us to be subject to corporate-level tax on our income and capital gains, regardless of the amount of distributions paid. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales may be disadvantageous.
Our ability to enter into transactions with our affiliates is restricted.
We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of a majority of the independent members of our board of trustees and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act and we will generally be prohibited from buying or selling any securities from or to such affiliate, absent the prior approval of our board of trustees. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our board of trustees and, in some cases, the SEC. In an order dated June 4, 2013, the SEC granted exemptive relief permitting us, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions with our co-investment affiliates. Similarly, pursuant to the EIG Order we are permitted to participate in co-investment transactions with certain other EIG advised funds. If a person acquires more than 25% of our voting securities, we will be prohibited from buying or selling any security from or to such person or certain of that person’s affiliates, or entering into prohibited joint transactions with such persons to the extent not covered by our exemptive relief, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or trustees or their affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security from or to any portfolio company of a fund managed by FS Advisor without the prior approval of the SEC, which may limit the scope of investment opportunities that would otherwise be available to us.
We are uncertain of our sources for funding our future capital needs; if we cannot obtain debt or equity financing on acceptable terms, our ability to acquire investments and to expand our operations will be adversely affected.
Any working capital reserves we maintain may not be sufficient for investment purposes, and we may require debt or equity financing to operate. We may also need to access the capital markets to refinance existing debt obligations to the extent maturing obligations are not repaid with cash flows from operations. In order to maintain RIC tax treatment, we must make distributions to our shareholders each tax year on a timely basis generally of an amount at least equal to 90% of our investment company taxable income, determined without regard to any deduction for distributions paid, and the amounts of such distributions will therefore not be available to fund investment originations or to repay maturing debt. In addition, with certain limited exceptions, we are only allowed to borrow amounts or issue debt securities or preferred shares, which we refer to collectively as “senior securities,” such that our asset coverage, as calculated pursuant
 
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to the 1940 Act, equals at least 200% immediately after such borrowing, which, in certain circumstances, may restrict our ability to borrow or issue debt securities or preferred shares. In the event that we develop a need for additional capital in the future for investments or for any other reason, and we cannot obtain debt or equity financing on acceptable terms, or at all, our ability to acquire investments and to expand our operations will be adversely affected. As a result, we would be less able to allocate our portfolio among various issuers and sub-sectors and achieve our investment objectives, which may negatively impact our results of operations and reduce our ability to make distributions to our shareholders.
Risks Related to Our Investments
Our investments in prospective portfolio companies may be risky, and we could lose all or part of our investment.
Our investments in senior secured and unsecured debt, select equity investments and other investments issued by private Energy companies may be risky.
Senior Debt.   There is a risk that any collateral pledged by portfolio companies in which we have taken a security interest may decrease in value over time or lose its entire value, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market conditions, including as a result of the inability of the portfolio company to raise additional capital. To the extent our debt investment is collateralized by the securities of a portfolio company’s subsidiaries, such securities may lose some or all of their value in the event of the bankruptcy or insolvency of the portfolio company. Also, in some circumstances, our security interest may be contractually or structurally subordinated to claims of other creditors. In addition, deterioration in a portfolio company’s financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Loans that are under-collateralized involve a greater risk of loss. In addition, second lien secured loans are granted a second priority security interest in collateral, which means that any realization of collateral will generally be applied to pay first lien secured loans in full before second lien secured loans are paid. Consequently, the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to the senior debt’s terms, or at all, or that we will be able to collect on the loan should we be forced to enforce our remedies.
Unsecured Debt.    Our unsecured debt investments will generally rank junior in priority of payment to senior debt and will generally be unsecured. This may result in a heightened level of risk and volatility or a loss of principal, which could lead to the loss of the entire investment. These investments may involve additional risks that could adversely affect our investment returns. To the extent interest payments associated with such debt are deferred, such debt may be subject to greater fluctuations in valuations, and such debt could subject us and our shareholders to non-cash income. Because we will not receive any principal repayments prior to the maturity of some of our unsecured debt investments, such investments will be of greater risk than amortizing loans.
Equity and Equity-Related Investments.   We expect to make select equity investments in income-oriented preferred or common equity interests, which may include interests in MLPs. In addition, when we invest in senior secured loans and notes or unsecured debt, we may acquire warrants to purchase equity securities. The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.
Net Profits Interests, Royalty Interests or VPPs.   We may invest in energy-specific non-operating investments including net profits interests, royalty interests or VPPs. Net profits interests and royalty interests are contractual agreements whereby the holders of such interests are entitled to a portion of the mineral production, or proceeds therefrom. A VPP is a type of structured investment whereby the owner sells a specific volume of production in a field or property to an investor and the investor receives a specific quota of production on a monthly basis in either raw output or proceeds therefrom. We will not have any operational control over these investments and our receipt of payments is contingent on the producer’s ability to meet its supply obligations, which can make these types of investments highly speculative.
Non-U.S. Securities.   We may invest in non-U.S. securities, which may include securities denominated in U.S. dollars or in non-U.S. currencies and securities of companies in emerging markets, to the extent
 
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permitted by the 1940 Act. Because evidences of ownership of such securities usually are held outside the United States, we would be subject to additional risks if we invested in non-U.S. securities, which include possible adverse political and economic developments, seizure or nationalization of foreign deposits and adoption of governmental restrictions which might adversely affect or restrict the payment of principal and interest on the non-U.S. securities to investors located outside the country of the issuer, whether from currency blockage or otherwise. Because non-U.S. securities may be purchased with and payable in foreign currencies, the value of these assets as measured in U.S. dollars may be affected unfavorably by changes in currency rates and exchange control regulations.
Investments in Asset-Based Opportunities.    We may invest in asset-based opportunities through joint ventures, investment platforms, private investment funds or other business entities that provide one or more of the following services: origination or sourcing of potential investment opportunities, due diligence and negotiation of potential investment opportunities and/or servicing, development and management (including turnaround) and disposition of investments. Such investments may be in or alongside existing or newly formed operators, consultants and/or managers that pursue such opportunities and may or may not include capital and/or assets contributed by third party investors. Such investments may include opportunities to direct-finance physical assets, such as airplanes and ships, and/or operating assets, such as financial service entities, as opposed to investment securities, or to invest in origination and/or servicing platforms directly. In valuing our investments, we rely primarily on information provided by operators, consultants and/or managers. Valuations of illiquid securities involve various judgments and consideration of factors that may be subjective. There is a risk that inaccurate valuations could adversely affect the value of our common stock. We may not be able to promptly withdraw our investment in these asset-based opportunities, which may result in a loss to us and adversely affect our investment returns.
In addition, we invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. They may also be difficult to value and illiquid.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to receive payment of interest or principal on or before the dates on which we are entitled to receive payments with respect to the debt instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any proceeds. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt instruments in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.
If one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. In situations where a bankruptcy carries a high degree of political significance, our legal rights may be subordinated to other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or in instances where we exercise control over the borrower or render significant managerial assistance.
We generally will not control our portfolio companies.
We do not expect to control most of our portfolio companies, even though we may have board representation or board observation rights, and our debt agreements with such portfolio companies may
 
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contain certain restrictive covenants. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as debt investors. Due to the lack of liquidity for our investments in non-traded companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like or at an appropriate valuation. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.
Second priority liens on collateral securing debt investments that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and us.
Certain debt investments that we make in portfolio companies may be secured on a second priority basis by the same collateral securing first priority debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by such company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the debt obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the debt obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against such company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the debt investments we make in our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.
A covenant breach by our portfolio companies may harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize a portfolio company’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
Our portfolio companies may be highly leveraged.
Some of our portfolio companies may be highly leveraged, which may have adverse consequences to these companies and to us as an investor. These companies may be subject to restrictive financial and operating covenants and the leverage may impair these companies’ ability to finance their future operations and capital needs. As a result, these companies’ flexibility to respond to changing business and economic conditions and to take advantage of business opportunities may be limited. Further, a leveraged company’s income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used.
 
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Investing in middle-market companies involves a number of significant risks, any one of which could have a material adverse effect on our operating results.
Investments in middle-market companies involve some of the same risks that apply generally to investments in larger, more established companies. However, such investments have more pronounced risks in that they:

may have limited financial resources and may be unable to meet the obligations under their debt and equity securities that we hold, which may be accompanied by a deterioration in the value of any collateral pledged under such securities and a reduction in the likelihood of us realizing any guarantees we may have obtained in connection with our investment;

have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tends to render them more vulnerable to competitors’ actions and changing market conditions, as well as general economic downturns;

are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;

generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position. In addition, our executive officers, trustees and members of FS Advisor may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies; and

may have difficulty accessing the capital markets to meet future capital needs, which may limit their ability to grow or to repay their outstanding indebtedness upon maturity.
We may not realize gains from our equity investments.
Certain investments that we may make may include equity related securities, such as rights and warrants that may be converted into or exchanged for shares or the cash value of the shares. In addition, we may make direct equity investments in portfolio companies. The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. We may also be unable to realize any value if a portfolio company does not have a liquidity event, such as a sale of the business, recapitalization or public offering, which would allow us to sell the underlying equity interests. We may be unable to exercise any put rights we acquire which grant us the right to sell our equity securities back to the portfolio company for the consideration provided in our investment documents if the issuer is in financial distress.
An investment strategy focused primarily on privately-held companies presents certain challenges, including the lack of available information about these companies.
Our investments are primarily in privately-held companies. Investments in private companies pose significantly greater risks than investments in public companies. First, private companies have reduced access to the capital markets, resulting in diminished capital resources and the ability to withstand financial distress. As a result, these companies, which may present greater credit risk than public companies, may be unable to meet the obligations under their debt and equity securities that we hold. Second, the investments themselves often may be illiquid. The securities of many of the companies in which we invest are not publicly-traded or actively-traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors. In addition, such securities may be subject to legal and other restrictions on resale. As such, we may have difficulty exiting an investment promptly or at a desired price prior to maturity or outside of a normal amortization schedule. In addition, in a restructuring, we may receive substantially different securities than our original investment in a portfolio company, including securities in a different part of the capital structure. These investments may also be difficult to value because little public information generally exists about private companies, requiring an
 
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experienced due diligence team to analyze and value the potential portfolio company. Finally, these companies often may not have third-party debt ratings or audited financial statements. We must therefore rely on the ability of FS/EIG Advisor to obtain adequate information through due diligence to evaluate the creditworthiness and potential returns from investing in these companies. These companies and their financial information will generally not be subject to the Sarbanes-Oxley Act and other rules and regulations that govern public companies. If we are unable to uncover all material information about these companies, or receive timely information, we may not make a fully informed investment decision, and we may lose money on our investments.
A lack of liquidity in certain of our investments may adversely affect our business.
We invest in certain companies whose securities are not publicly-traded or actively-traded on the secondary market and are, instead, traded on a privately-negotiated over-the-counter secondary market for institutional investors, and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly-traded securities. The illiquidity of certain of our investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. The reduced liquidity of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.
We may not have the funds or ability to make additional investments in our portfolio companies.
We may not have the funds or ability to make additional investments in our portfolio companies. After our initial investment in a portfolio company, we may be called upon from time to time to provide additional funds to such company or have the opportunity to increase our investment through the exercise of a warrant to purchase common stock. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decisions not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a portfolio company in need of such an investment, may result in a missed opportunity for us to increase our participation in a successful operation or may reduce the expected return on the investment.
Our investments may include original issue discount and PIK instruments.
To the extent that we invest in original issue discount or PIK instruments and the accretion of original issue discount or PIK interest income constitutes a portion of our income, we will be exposed to risks associated with the requirement to include such non-cash income in taxable and accounting income prior to receipt of cash, including the following:

The higher interest rates on PIK instruments reflect the payment deferral and increased credit risk associated with these instruments, and PIK instruments generally represent a significantly higher credit risk than coupon loans;

Original issue discount and PIK instruments may have unreliable valuations because the accruals require judgments about collectability of the deferred payments and the value of any associated collateral;

An election to defer PIK interest payments by adding them to the principal on such instruments increases our future investment income which increases our gross assets and, as such, increases FS/EIG Advisor’s future base management fees which, thus, increases FS/EIG Advisor’s future income incentive fees at a compounding rate;

Market prices of PIK instruments and other zero coupon instruments are affected to a greater extent by interest rate changes, and may be more volatile than instruments that pay interest periodically in cash. While PIK instruments are usually less volatile than zero coupon debt instruments, PIK instruments are generally more volatile than cash pay securities;

The deferral of PIK interest on an instrument increases the loan-to-value ratio, which is a measure of the riskiness of a loan, with respect to such instrument;
 
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Even if the conditions for income accrual under GAAP are satisfied, a borrower could still default when actual payment is due upon the maturity of such loan;

For accounting purposes, cash distributions to investors representing original issue discount income do not come from paid-in capital, although they may be paid from the offering proceeds. Thus, although a distribution of original issue discount income may come from the cash invested by investors, the 1940 Act does not require that investors be given notice of this fact;

Recent tax legislation requires that income be recognized for tax purposes no later than when recognized for financial reporting purposes;

The required recognition of PIK interest for U.S federal income tax purposes may have a negative impact on liquidity, as it represents a non-cash component of our investment company taxable income, income that may require cash distributions to shareholders in order to maintain our ability to be subject to tax as a RIC; and

Original issue discount may create a risk of non-refundable cash payments to FS/EIG Advisor based on non-cash accruals that may never be realized.
We may from time to time enter into total return swaps, credit default swaps, fixed priced swaps or other derivative transactions which expose us to certain risks, including credit risk, market risk, commodity risk, liquidity risk and other risks similar to those associated with the use of leverage.
We may from time to time enter into total return swaps, credit default swaps or other derivative transactions that seek to modify or replace the investment performance of a particular reference security or other asset. These transactions are typically individually negotiated, non-standardized agreements between two parties to exchange payments, with payments generally calculated by reference to a notional amount or quantity. Swap contracts and similar derivative contracts are not traded on exchanges; rather, banks and dealers act as principals in these markets. These investments may present risks in excess of those resulting from the referenced security or other asset. Because these transactions are not an acquisition of the referenced security or other asset itself, the investor has no right directly to enforce compliance with the terms of the referenced security or other asset and has no voting or other consensual rights of ownership with respect to the referenced security or other asset. In the event of insolvency of a counterparty, we will be treated as a general creditor of the counterparty and will have no claim of title with respect to the referenced security or other asset.
A total return swap is a contract in which one party agrees to make periodic payments to another party based on the change in the market value of the referenced security or other assets underlying the total return swap during a specified period, in return for periodic payments based on a fixed or variable interest rate.
A total return swap is subject to market risk, liquidity risk and risk of imperfect correlation between the value of the total return swap and the debt obligations underlying the total return swap. In addition, we may incur certain costs in connection with a total return swap that could in the aggregate be significant.
A credit default swap is a contract in which one party buys or sells protection against a credit event with respect to an issuer, such as an issuer’s failure to make timely payments of interest or principal on its debt obligations, bankruptcy or restructuring during a specified period. Generally, if we sell credit protection using a credit default swap, we will receive fixed payments from the swap counterparty and if a credit event occurs with respect to the applicable issuer, we will pay the swap counterparty par for the issuer’s defaulted debt securities and the swap counterparty will deliver the defaulted debt securities to us. Generally, if we buy credit protection using a credit default swap, we will make fixed payments to the counterparty and if a credit event occurs with respect to the applicable issuer, we will deliver the issuer’s defaulted securities underlying the swap to the swap counterparty and the counterparty will pay us par for the defaulted securities. Alternatively, a credit default swap may be cash settled and the buyer of protection would receive the difference between the par value and the market value of the issuer’s defaulted debt securities from the seller of protection.
Credit default swaps are subject to the credit risk of the underlying issuer. If we are selling credit protection, there is a risk that we will not properly assess the risk of the underlying issuer, a credit event will
 
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occur and we will have to pay the counterparty. If we are buying credit protection, there is a risk that we will not properly assess the risk of the underlying issuer, no credit event will occur and we will receive no benefit for the premium paid.
A fixed price swap is a contract between two parties in which settlements are made at a specified time based on the difference between the fixed priced specified in the contract and the referenced settlement price. When the referenced settlement price is less than the price specified in the contract, one party receives an amount from the second party based on the price difference multiplied by the volume. Similarly, when the referenced settlement price exceeds the price specified in the contract, one party pays the second party an amount based on the price difference multiplied by the volume.
A fixed price swap is subject to commodity risk of the underlying commodity. If we are purchasing fixed price swaps for oil, there is a risk the fixed price we paid to enter the contract for oil will be more than the price of oil at the specified settlement date, and we will owe the counterparty the difference in price multiplied by the volume of the contracted volume.
A derivative transaction is also subject to the risk that a counterparty will default on its payment obligations thereunder or that we will not be able to meet our obligations to the counterparty. In some cases, we may post collateral to secure our obligations to the counterparty, and we may be required to post additional collateral upon the occurrence of certain events such as a decrease in the value of the reference security or other asset. In some cases, the counterparty may not collateralize any of its obligations to us.
Derivative investments effectively add leverage to a portfolio by providing investment exposure to a security or market without owning or taking physical custody of such security or investing directly in such market. In addition to the risks described above, such arrangements are subject to risks similar to those associated with the use of leverage. See “—Risks Related to Debt Financing.”
Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and reduce our return on equity.
We are subject to the risk that the investments we make in our portfolio companies may be repaid prior to maturity. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments will typically have substantially lower yields than the debt being prepaid and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elect to prepay amounts owed to us. Additionally, prepayments, net of prepayment fees, could negatively impact our return on equity.
We may invest through joint ventures, partnerships or other special purpose vehicles and our investments through these vehicles may entail greater risks, and investments in which we have a non-controlling interest may involve risks specific to third-party management of those investments.
We may co-invest with third parties through partnerships, joint ventures or other entities, thereby acquiring jointly-controlled or non-controlling interests in certain investments in conjunction with participation by one or more third parties in such investment. We may have interests or objectives that are inconsistent with those of the third-party partners or co-venturers. Although we may not have full control over these investments, and therefore may have a limited ability to protect our position therein, we expect that we will negotiate appropriate rights to protect our interests. Nevertheless, such investments may involve risks not present in investments where a third party is not involved, including the possibility that a third-party partner or co-venturer may have financial difficulties, resulting in a negative impact on such investment, may have economic or business interests or goals which are inconsistent with ours, or may be in a position to take (or block) action in a manner contrary to our investment objectives or the increased possibility of default by, diminished liquidity or insolvency of, the third party, due to a sustained or general economic downturn. Third-party partners or co-venturers may opt to liquidate an investment at a time during which such liquidation is not optimal for us. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers. In those circumstances where such third parties involve a
 
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management group, such third parties may receive compensation arrangements relating to such investments, including incentive compensation arrangements.
Energy Company Risks
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may not be changed without at least 60 days’ prior notice to holders of our common shares of any such change. The revenues, income (or losses) and valuations of Energy companies can fluctuate suddenly and dramatically due to a number of factors.
Because our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies, our portfolio will not be well allocated among various industries.
As there can be a correlation in the valuation of the securities in our portfolio, a decline in value of the securities of one company may be accompanied by a decline in the valuations of the securities of other companies within the Energy industry that we may hold in our portfolio. A decline in value of the securities of such issuers or a downturn in the Energy sector might have a more severe impact on us than on an entity that is more broadly allocated among various industries.
An increase or decrease in commodity supply or demand may adversely affect our business.
A decrease in the production of natural gas, natural gas liquids, crude oil, coal or other energy commodities, a decrease in the volume of such commodities available for transportation, mining, processing, storage or distribution, or a sustained decline in demand for such commodities may adversely impact the financial performance or prospects of Energy companies in which we may invest. Energy companies are subject to supply and demand fluctuations in the markets they serve which will be impacted by a wide range of factors, including fluctuating commodity prices, weather, increased conservation or use of alternative fuel sources, increased governmental or environmental regulation, depletion of natural gas, natural gas liquids, crude oil or coal production, rising interest rates, declines in domestic or foreign production of natural gas, natural gas liquids and crude oil, accidents or catastrophic events and economic conditions, among others.
An increase or decrease in commodity pricing may adversely affect our business.
The return on our prospective investments in Energy companies will be dependent on the margins received by those companies for the exploration, development, production, gathering, transportation, processing, storing, refining, distribution, mining, generation or marketing of natural gas, natural gas liquids, crude oil, refined products, coal or power. These margins may fluctuate widely in response to a variety of factors including global and domestic economic conditions, weather conditions, natural disasters, the supply and price of imported energy commodities, the production and storage levels of energy commodities in certain regions or in the world, political instability, terrorist activities, transportation facilities, energy conservation, domestic and foreign governmental regulation and taxation and the availability of local, intrastate and interstate transportation systems. Volatility of commodity prices may also make it more difficult for Energy companies in which we may invest to raise capital to the extent the market perceives that their performance may be directly or indirectly tied to commodity prices.
Cyclicality within the Energy sector may adversely affect our business.
Industries within the Energy sector are cyclical with fluctuations in commodity prices and demand for commodities driven by a variety of factors. The highly cyclical nature of the industries within the Energy sector may lead to volatile changes in commodity prices, which may adversely affect the earnings of Energy companies in which we may invest.
A prolonged continuation of depressed oil and natural gas prices could have a material adverse effect on us.
Prices for oil and natural gas, which historically have been volatile and may continue to be volatile, may be subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas. A prolonged continuation of depressed oil and natural gas prices would adversely
 
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affect the credit quality and performance of certain of our debt and equity investments in Energy companies. A decrease in credit quality and performance would, in turn, negatively affect the fair value of these investments, which would consequently negatively affect our net asset value. Should a prolonged period of depressed oil and natural gas prices occur, it is likely that our portfolio companies’ abilities to satisfy financial or operating covenants imposed by us or other lenders will be adversely affected, thereby negatively impacting their financial condition and their ability to satisfy their debt service and other obligations to us. Likewise, should a prolonged period of depressed oil and natural gas prices occur, it is likely that our portfolio companies’ cash flow and profit generating capacities would also be adversely affected thereby negatively impacting their ability to pay us dividends or distributions on certain of our investments.
Changes in international, foreign, federal, state or local government regulation may adversely affect our business.
Energy companies are subject to significant international, foreign, federal, state and local government regulation, including how facilities are constructed, maintained and operated, environmental and safety controls, and the prices they may charge for the products and services they provide. Various governmental authorities have the power to enforce compliance with these regulations and the permits issued under them, and violators are subject to administrative, civil and criminal penalties, including civil fines, injunctions or both. For example, many state and federal environmental laws provide for civil penalties as well as regulatory remediation, thus adding to the potential liability an Energy company may face. More extensive laws, regulations or enforcement policies could be enacted in the future which would likely increase compliance costs and may adversely affect the financial performance of Energy companies in which we may invest.
In particular, changes to laws and increased regulations or enforcement policies as a result of oil spills may adversely affect the financial performance of Energy companies. Additionally, changes to laws and increased regulation or restrictions on the use of hydraulic fracturing may adversely impact the ability of Energy companies to economically develop oil and natural gas resources and, in turn, reduce production for such commodities. Any such changes or increased regulations or policies may adversely affect the performance of Energy companies in which we may invest.
Energy companies are subject to various operational risks.
Energy companies are subject to various operational risks, such as failed drilling or well development, unscheduled outages, disruption of operations, mining, drilling or installation accidents, inability to timely and effectively integrate newly acquired assets, unanticipated operation and maintenance expenses, lack of proper asset integrity, underestimated cost projections, inability to renew or increased costs of rights of way, failure to obtain the necessary permits to operate and failure of third-party contractors to perform their contractual obligations. Thus, some Energy companies may be subject to construction risk, acquisition risk or other risks arising from their specific business strategies.
Energy companies that focus on exploration and production are subject to numerous reserve and production related risks.
Exploration and production businesses are subject to overstatement of the quantities of their reserves based upon any reserve estimates that prove to be inaccurate, the possibility that no commercially productive oil, natural gas or other energy reservoirs will be discovered as a result of drilling or other exploration activities, the curtailment, delay or cancellation of exploration activities as a result of unexpected conditions or miscalculations, title problems, pressure or irregularities in formations, equipment failures or accidents, adverse weather conditions, compliance with environmental and other governmental requirements and cost of, or shortages or delays in the availability of, drilling rigs and other exploration equipment, and operational risks and hazards associated with the development of the underlying properties, including natural disasters, blowouts, explosions, fires, leakage of crude oil, natural gas or other resources, mechanical failures, cratering and pollution.
Competition between Energy companies may adversely affect our business.
The Energy companies in which we may invest face substantial competition in acquiring assets, expanding or constructing assets and facilities, obtaining and retaining customers and contracts, securing trained personnel and operating their assets. Many of their competitors may have superior financial and other resources.
 
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Inability by companies in which we may invest to make accretive acquisitions may adversely affect our business.
The ability of Energy companies in which we may invest to grow and, where applicable, to increase dividends or distributions to their equity holders can be highly dependent on their ability to make acquisitions of infrastructure assets that result in an increase in free cash flow. In the event that such companies are unable to make such accretive acquisitions because they are unable to identify attractive acquisition candidates or negotiate acceptable purchase contracts, because they are unable to raise financing for such acquisitions on economically acceptable terms, or because they are outbid by competitors, their future growth and ability to make or raise dividends or distributions will be limited and their ability to repay their debt and make payments to preferred equity holders may be weakened. Furthermore, even if these companies do consummate acquisitions that they believe will be accretive, the acquisitions may instead result in a decrease in free cash flow.
A significant accident or event that is not fully insured could adversely affect the operations and financial condition of Energy companies in which we may invest.
The operations of Energy companies in which we may invest are subject to many hazards inherent in the transporting, processing, storing, distributing, mining, generating or marketing of natural gas, natural gas liquids, crude oil, coal, refined products, power or other commodities, or in the exploring, managing or producing of such commodities, including: damage to pipelines, storage tanks, vessels or related equipment and surrounding properties caused by hurricanes, tornadoes, floods, fires and other natural disasters or by acts of terrorism; inadvertent damage from construction or other equipment; leaks of natural gas, natural gas liquids, crude oil, refined products or other commodities; cyber attacks; and fires and explosions. Further, since the September 11th terrorist attacks, the U.S. government has issued warnings that energy assets and facilities, specifically U.S. pipeline infrastructure, may be targeted in future terrorist attacks. These risks could result in substantial losses due to personal injury or loss of life, severe damage to and destruction of property and equipment and pollution or other environmental damage and may result in the curtailment or suspension of their related operations. Not all Energy companies are fully insured against all risks inherent to their businesses. If a significant accident or event occurs that is not fully insured, it could adversely affect the Energy company’s operations and financial condition. In addition, any increased governmental regulation to mitigate such risks (including regulations related to recent oil spills or hydraulic fracturing), could increase insurance premiums and other operating costs for Energy companies in which we may invest.
Energy reserves naturally deplete as they are produced over time and this may adversely affect our business.
Energy reserves naturally deplete as they are produced over time. Many Energy companies are either engaged in the production of natural gas, natural gas liquids, crude oil or coal, or are engaged in transporting, storing, distributing and processing these items or their derivatives on behalf of shippers. To maintain or grow their revenues, these companies or their customers need to maintain or expand their reserves through exploration of new sources of supply, through the development of existing sources or through acquisitions. The financial performance of Energy companies in which we may invest may be adversely affected if they, or the companies to whom they provide services, are unable to cost-effectively acquire additional reserves sufficient to replace the depleted reserves. If an Energy company fails to add reserves by acquiring or developing them, its reserves and production will decline over time as the reserves are produced. If an Energy company is not able to raise capital on favorable terms, it may not be able to add to or maintain its reserves.
Certain Energy companies are dependent on their parents or sponsors for a majority of their revenues and may be subject to affiliate party risk.
Certain Energy companies in which we may invest are dependent on their parents or sponsors for a majority of their revenues. Any failure by an Energy company’s parent or sponsor to satisfy its payments or obligations would impact the Energy company’s revenues and cash flows and ability to make debt service payments and/or distributions.
Changing economic, regulatory and political conditions in some countries, including political and military conflicts, may adversely affect the businesses in which we invest.
Changing economic, regulatory and political conditions in some countries, including political and military conflicts, have from time to time resulted in attacks on vessels, mining of waterways, piracy,
 
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terrorism, labor strikes, boycotts and government inspections or requisitioning of vessels. These types of events could impact the delivery of commodities or impact pricing of commodities.
Risks Related to Our Investments in MLPs
An investment in MLP units involves certain risks which differ from an investment in the common stock of a corporation. Holders of MLP units have limited control and voting rights on matters affecting the partnership. In addition, there are certain tax risks associated with an investment in MLP units. See “—Risks Related to U.S. Federal Income Tax.”
An MLP’s cash flow, and consequently its distributions, are subject to operational and general energy industry risks, which may result in disparate quarterly distributions.
A portion of the cash flow received by us may be derived from investments in the equity securities of MLPs. The amount of cash that an MLP has available for distributions and the tax character of such distributions depend upon the amount of cash generated by the MLP’s operations. Cash available for distribution will vary from quarter to quarter and is largely dependent on factors affecting the MLP’s operations and factors affecting the Energy industry in general. In addition to the risk factors described above, other factors which may reduce the amount of cash an MLP has available for distribution in a given quarter include increased operating costs, maintenance capital expenditures, acquisition costs, expansion, construction or exploration costs and borrowing costs.
Investments in MLPs may have limited liquidity.
Although common units of some MLPs may trade on public exchanges, certain of these securities may trade less frequently, particularly those with smaller capitalizations. Securities with limited trading volumes may display volatile or erratic price movements. As a result, these securities may be difficult to dispose of at a fair price at the times when we believe it is desirable to do so. These securities are also more difficult to value, and our judgment as to value will often be given greater weight than market quotations, if any exist. Investment of our capital in securities that are less actively-traded, or over time experience decreased trading volume, may restrict our ability to take advantage of other market opportunities. In addition, many MLP units are privately held.
Investments in MLPs are susceptible to interest rate fluctuation risks.
Interest rate risk is the risk that securities will decline in value because of changes in market interest rates. The yields of equity and debt securities of MLPs are susceptible in the short-term to fluctuations in interest rates and, like treasury bonds, the prices of these securities typically decline when interest rates rise. Accordingly, our net asset value may be impacted by an increase in interest rates. Further, rising interest rates could adversely impact the financial performance of MLPs in which we invest by increasing their costs of capital. This may reduce their ability to execute acquisitions or expansion projects in a cost-effective manner.
Investments in MLPs are subject to certain tax risks.
MLPs are not subject to tax at the partnership level. Rather, each partner is allocated a share of the MLP’s income, gains, losses, deductions, and expenses. A change in current tax law, or a change in the underlying business of a given MLP could result in the MLP being treated as a corporation for U.S. federal tax purposes, which would result in such MLP being required to pay U.S. federal income tax on its taxable income. Such treatment also would have the effect of reducing the amount of cash available for distribution by the affected MLP.
Our investments in MLPs may be subject to additional fees and expenses, including management and incentive fees, and, as a result, our investments in MLPs may achieve a lower rate of return than our other investments.
MLPs are subject to additional fees, some of which are paid regardless of the performance of its assets. We will pay certain management fees to the adviser entity of any MLP in which we invest. FS/EIG Advisor will also earn its base management fee from us based on our gross assets, including our investment in any
 
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such MLP; therefore, we will be paying both FS/EIG Advisor’s base management fee and any management fees charged by an MLP. As a result, our investment returns attributable to MLPs in which we invest may be lower than other investments we select. In addition, because the fees received by an MLP adviser are typically based on the managed assets of the MLP, including the proceeds of any leverage it may incur, the MLP adviser has a financial incentive to utilize leverage, which may create a conflict of interest between the MLP adviser and us as a shareholder in the MLP.
Risks Related to Debt Financing
We currently use borrowed funds to make investments and are exposed to the typical risks associated with leverage.
Borrowings and other types of financing, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increases the risks associated with investing in our securities. Our and our special-purpose financing subsidiaries’ lenders and debt holders have fixed dollar claims on our and their assets that are superior to the claims of our shareholders. If the value of our assets increases, then leverage would cause the net asset value to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leverage would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our income in excess of consolidated interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make distributions to shareholders. Leverage is generally considered a speculative investment technique.
The agreements governing our financing arrangements contain various covenants which, if not complied with, could accelerate repayment under the applicable arrangement, thereby materially and adversely affecting our liquidity, financial condition, results of operations and our ability to pay distributions to our shareholders.
The agreements governing these financing arrangements contain various default provisions and operational covenants which, if triggered, could result in the termination of the respective financing arrangements and the acceleration of any amounts outstanding thereunder, which could require us or our subsidiaries to liquidate positions at a time and/or at a price which is disadvantageous to us. This could result in losses and impact our ability to meet our investment objectives and pay distributions to shareholders. There can be no assurance that we or our subsidiaries will comply with the covenants in our debt arrangements in the future. The failure to negotiate a waiver or amendment with the applicable lenders, pay off in full the applicable facility or otherwise come into compliance with those or other covenants could, subject to applicable notice, grace and cure periods, result in an event of default allowing for the acceleration of the repayment of obligations due under the financing arrangements. Our or our subsidiaries’ failure to comply with the covenants set forth in the financing arrangements could materially and adversely affect our liquidity, financial condition and results of operations.
Our and our subsidiaries’ failure to comply with the covenants set forth in the financing arrangements could also materially and adversely affect our ability to pay distributions to our shareholders. We cannot assure shareholders that we or our subsidiaries will be able to borrow funds under any such financing arrangements at any particular time or at all. See Note 9 to our consolidated financial statements contained in this annual report on Form 10-K for a more detailed discussion of the terms of our financing arrangements.
If we borrow money, the potential for gain or loss on amounts invested in us will be magnified and may increase the risk of investing in us.
The use of borrowings, also known as leverage, increases the volatility of investments by magnifying the potential for gain or loss on invested equity capital. If we use leverage to partially finance our investments, through borrowing from banks and other lenders, shareholders will experience increased risks of investing in our common shares. If the value of our assets increases, leverage would cause the net asset value attributable to our common shares to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leverage would cause net asset value to decline more sharply than it
 
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otherwise would have had we not leveraged. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net income to increase more than it would without the leverage, while any decrease in our income would cause net income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make common share distribution payments. Leverage is generally considered a speculative investment technique. In addition, the decision to utilize leverage will increase our assets and, as a result, will increase the amount of base management fees payable to FS/EIG Advisor.
Illustration.   The following table illustrates the effect of leverage on returns from an investment in our common shares assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing below. The calculation assumes (i) $4,043,791 in total average assets, (ii) a weighted average cost of funds of 5.88%, (iii) $1,670,000 in borrowings outstanding (i.e., assumes that the full $433,333 available to us as of December 31, 2019 under our financing arrangements as of such date is outstanding), and (iv) $2,379,466 in average shareholders’ equity. In order to compute the “Corresponding return to shareholders,” the “Assumed Return on Our Portfolio (net of expenses)” is multiplied by the assumed total average assets to obtain an assumed return to us. From this amount, the interest expense is calculated by multiplying the assumed weighted average cost of funds times the assumed borrowings outstanding, and the product is subtracted from the assumed return to us in order to determine the return available to shareholders. The return available to shareholders is then divided by our shareholders’ equity to determine the “Corresponding return to shareholders.” Actual interest payments may be different.
Assumed Return on Our Portfolio (net of expenses)-10%-5%0%5%10%
Corresponding return to shareholders-21.17%-12.66%-4.14%4.38%12.90%
Similarly, assuming (i) approximately $4,043,791 in total average assets, (ii) a weighted average cost of funds of approximately 5.88% and (iii) $1,670,000 in borrowings outstanding (i.e., assumes that the full $433,333 available to us as of December 31, 2019 under the financing arrangements as of such date is outstanding), our assets would need to yield an annual return (net of expenses) of approximately 2.43% in order to cover the annual interest payments on our outstanding borrowings.
We are exposed to risks associated with changes in interest rates, including with respect to the phase out of LIBOR.
Because we intend to use debt to finance investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates when we have debt outstanding, our cost of funds will increase, which could reduce our net investment income. We expect that our long-term fixed-rate investments will be financed primarily with equity and long-term debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. These activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations. Also, we have limited experience in entering into hedging transactions, and we will initially have to develop such expertise or arrange for such expertise to be provided.
We have and may continue to structure the majority of our debt investments with floating interest rates to position our portfolio for rate increases. However, there can be no assurance that this will successfully mitigate our exposure to interest rate risk. For example, in the event of a rising interest rate environment, payments under floating rate debt instruments generally would rise and there may be a significant number of issuers of such floating rate debt instruments that would be unable or unwilling to pay such increased interest costs and may otherwise be unable to repay their loans. Rising interest rates could also cause portfolio companies to shift cash from other productive uses to the payment of interest, which may have a material adverse effect on their business and operations and could, over time, lead to increased defaults. Investments in floating rate debt instruments may also decline in value in response to rising interest rates if the interest
 
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rates of such investments do not rise as much, or as quickly, as market interest rates in general. Similarly, during periods of rising interest rates, our fixed rate investments may decline in value because the fixed rate of interest paid thereunder may be below market interest rates.
In July 2017, the head of the United Kingdom Financial Conduct Authority announced the desire to phase out the use of LIBOR by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. In addition, in April 2018, the Federal Reserve System, in conjunction with the Alternative Reference Rates Committee, announced a preferred replacement of U.S. dollar LIBOR with a new index, calculated by reference to short-term repurchase agreements collateralized by U.S. Treasury securities, called the Secured Overnight Financing Rate, or SOFR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. Although a SOFR-derived rate appears to be the preferred replacement rate for U.S. dollar LIBOR, at this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or other reforms to LIBOR for U.S. dollars and other major currencies that may be enacted in the United States, the United Kingdom or elsewhere. As such, the potential effect of the phase-out or replacement of LIBOR on our cost of capital and net investment income cannot yet be determined. If LIBOR ceases to exist, we may need to renegotiate any credit or similar agreements extending beyond 2021 with our portfolio companies that utilize LIBOR as a factor in determining the interest rate and certain of our existing credit facilities, in each case to replace LIBOR with the new standard that is established. Moreover, the discontinuation of LIBOR and the transition to an alternative benchmark rate may adversely impact the functioning, liquidity, volatility and value of floating rate income securities and could lead to significant short-term and long-term uncertainty and market instability. These risks will be exacerbated if the work necessary to effect an orderly transition to an alternative reference rate is not completed in a timely manner. These events may also increase the difficulty of borrowing or refinancing and may diminish the effectiveness of hedging strategies. The precise impacts of a transition away from LIBOR on the Company, on floating rate income securities in which we may invest and on the financing market generally remain uncertain. Additionally, because the usefulness of LIBOR as a benchmark could deteriorate during the transition period, these effects could occur prior to the end of 2021.
Alteration of the terms of a debt instrument or a modification of the terms of other types of contracts to replace an interbank offered rate with a new reference rate could result in a taxable exchange and the realization of income and gain/loss for U.S. federal income tax purposes. The IRS has issued proposed regulations regarding the tax consequences of the transition from interbank offered rates to new reference rates in debt instruments and non-debt contracts. Under the proposed regulations, to avoid such alteration or modification of the terms of a debt instrument being treated as a taxable exchange, the fair market value of the modified instrument or contract must be substantially equivalent to its fair market value before the qualifying change was made. The IRS may withdraw, amend or finalize, in whole or part, these proposed regulations and/or provide additional guidance, with potential retroactive effect.
Furthermore, a rise in the general level of interest rates can be expected to lead to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate and may result in a substantial increase of the amount of incentive fees payable to FS/EIG Advisor with respect to pre-incentive fee net investment income.
The Small Business Credit Availability Act, or the SBCA Act, allows us to incur additional leverage.
On March 23, 2018, the SBCA Act became law. The SBCA Act, among other things, amends Section 61(a) of the 1940 Act to add a new Section 61(a)(2) which reduces the asset coverage requirements for senior securities applicable to BDCs from 200% to 150% provided that certain disclosure and approval requirements are met. Before the reduced asset coverage requirements under Section 61(a)(2) are effective with respect to us, the application of that section of the 1940 Act must be approved by either (1) a “required majority,” as defined in Section 57(o) of the 1940 Act, of our board of trustees or (2) a majority of votes cast at a special or annual meeting of our shareholders. If we choose to seek such approval, we may be able to incur substantial additional indebtedness, and, therefore the risk of an investment in us may increase. See “Risks Related to Debt Financing—We currently use borrowed funds to make investments and are exposed to the typical risks associated with leverage.”
 
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Risks Related to U.S. Federal Income Tax
We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code or to satisfy RIC distribution requirements.
To qualify for and maintain RIC tax treatment under Subchapter M of the Code, we must meet the following annual distribution, income source and asset diversification requirements. See “Item 1. Business—Taxation as a RIC.”

The Annual Distribution Requirement for RIC tax treatment will be satisfied if we distribute to our shareholders each tax year, dividends of an amount at least equal to the sum of 90% of our “investment company taxable income,” which is generally the sum of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, determined without regard to any deduction for dividends paid. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and may in the future become subject to certain financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.

The income source requirement will be satisfied if we obtain at least 90% of our gross income for each tax year from dividends, interest, gains from the sale of securities or similar sources.

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our tax year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs and other securities if such securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.
We must satisfy these tests on an ongoing basis in order to maintain RIC tax treatment, and may be required to make distributions to shareholders at times when it would be more advantageous to invest cash in our existing or other investments, or when we do not have funds readily available for distribution. Compliance with the RIC tax requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of our shareholders’ investments. If we fail to qualify for or maintain RIC tax treatment for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions.
Some of our investments may be subject to corporate-level income tax.
We may invest in certain debt and equity investments through taxable subsidiaries and the taxable income of these taxable subsidiaries will be subject to federal and state corporate income taxes. We may invest in certain foreign debt and equity investments which could be subject to foreign taxes (such as income tax, withholding and value added taxes).
We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.
For U.S. federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a corresponding payment in cash. For example, our investments may include debt obligations that are treated under applicable tax rules as having original issue discount (such as debt
 
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instruments with PIK interest or, in certain cases, increasing interest rates or debt obligations that were issued with warrants). To the extent original issue discount or PIK interest constitutes a portion of our income, we must include in taxable income each tax year a portion of the original issue discount or PIK interest that accrues over the life of the instrument, regardless of whether cash representing such income is received by us in the same tax year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. We anticipate that a portion of our income may constitute original issue discounts or other income required to be included in taxable income prior to receipt of cash. Further, we may elect to amortize market discounts and include such amounts in our taxable income in the current tax year, instead of upon disposition, as not making the election would limit our ability to deduct interest expenses for tax purposes.
Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the tax year of the accrual, we may be required to make a distribution to our shareholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under Subchapter M of the Code. We may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for or maintain RIC tax treatment and thus become subject to corporate-level income tax.
We may be adversely affected if an MLP or other non-corporate business structure in which we invest is treated as a corporation, rather than a partnership, for U.S. federal income tax purposes.
Our ability to meet our investment objectives will depend on the level of taxable income and distributions and dividends we receive from the MLPs and other Energy company securities in which we may invest, a factor over which we have no control. The benefit we derive from an investment in MLPs is largely dependent on the MLPs being treated as partnerships for U.S. federal income tax purposes. As a partnership, an MLP has no tax liability at the entity level. If, as a result of a change in current law or a change in an MLP’s business, an MLP is treated as a corporation for U.S. federal income tax purposes, such MLP would be obligated to pay U.S. federal income tax on its income at the corporate tax rate. If an MLP were classified as a corporation for U.S. federal income tax purposes, the amount of cash available for distribution would be reduced and distributions received by us would be taxed under U.S. federal income tax laws applicable to corporate distributions (as dividend income, return of capital or capital gain). Therefore, treatment of an MLP as a corporation for U.S. federal income tax purposes would result in a reduction in the after-tax return to us, likely causing a reduction in the value of our common shares. In addition, if we receive a Schedule K-1 from an MLP after having mailed a Form 1099-DIV to our shareholders, and our estimates with respect to the applicable MLP are determined to have been materially incorrect, we may be required to mail an amended Form 1099-DIV to our shareholders.
We may be adversely affected if an MLP or other non-corporate business structure in which we invest is unable to take advantage of certain tax deductions for U.S. federal income tax purposes and our income from investments in MLPs may exceed the cash received from such investments.
As a limited partner in the MLPs in which we seek to invest, we will receive our share of income, gains, losses, deductions and credits from those MLPs. Historically, a significant portion of income from MLPs has been offset by tax deductions. As a result, this income has been significantly lower than cash distributions paid by MLPs. We will incur a current tax liability on our share of an MLP’s income and gains that is not offset by tax deductions, losses, and credits, or our net operating loss carryforwards, if any. The percentage of an MLP’s income and gains which is offset by tax deductions, losses, and credits will fluctuate over time for various reasons. A significant slowdown in acquisition activity or capital spending by MLPs held in our portfolio could result in a reduction of accelerated depreciation generated by new acquisitions, which may result in an increase in our net ordinary income that we are required to distribute to shareholders to maintain our status as a RIC and to eliminate our liability for U.S. federal income tax. If our income from our investments in MLPs exceeds the cash distributions received from such investments, we may need to obtain cash from other sources in order to satisfy the Annual Distribution Requirement. If we are unable
 
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to obtain cash from other sources, we may fail to qualify for or maintain RIC tax treatment and become subject to corporate-level federal income tax. We may also recognize gain in excess of cash proceeds upon the sale of an interest in an MLP. Any such gain may need to be distributed or deemed distributed in order to avoid liability for corporate-level federal income taxes on such gain.
Our portfolio investments may present special tax issues.
Investments in below-investment grade debt instruments and certain equity securities may present special tax issues for us. U.S. federal income tax rules are not entirely clear about issues such as when we may cease to accrue interest, original issue discount or market discount, when and to what extent deductions may be taken for bad debts or worthless debt in equity securities, how payments received on obligations in default should be allocated between principal and interest income, as well as whether exchanges of debt instruments in a bankruptcy or workout context are taxable. Such matters could cause us to recognize taxable income for U.S. federal income tax purposes, even in the absence of cash or economic gain, and require us to make taxable distributions to our shareholders to maintain our RIC status or preclude the imposition of either U.S. federal corporate income or excise taxation. Additionally, because such taxable income may not be matched by corresponding cash received by us, we may be required to borrow money or dispose of other investments to be able to make distributions to our shareholders. These and other issues will be considered by us, to the extent determined necessary, in order that we minimize the level of any U.S. federal income or excise tax that we would otherwise incur. See “Item 1. Business—Taxation as a RIC.”
Legislative or regulatory tax changes could adversely affect investors.
At any time, the federal income tax laws governing RICs or the administrative interpretations of those laws or regulations may be amended. Any of those new laws, regulations or interpretations may take effect retroactively and could adversely affect the taxation of us or our shareholders. Therefore, changes in tax laws, regulations or administrative interpretations or any amendments thereto could diminish the value of an investment in our shares or the value or the resale potential of our investments. In particular, on December 22, 2017, the Tax Cuts and Jobs Act was signed into law. This tax legislation lowered the general corporate income tax rate from 35 percent to 21 percent, made changes regarding the use of net operating losses, repealed the corporate alternative minimum tax and made significant changes with respect to the U.S. international tax rules. In addition, the legislation generally requires a holder that uses the accrual method of accounting for U.S. tax purposes to include certain amounts in income no later than the time such amounts are reflected on certain financial statements, which therefore if applicable would require us to accrue income earlier than under prior law, although the precise application of this rule is un-clear at this time. The legislation also limited the amount or value of interest deductions of borrowers and in that way may potentially affect the loan market and our and our portfolio companies’ use of leverage. For individual taxpayers, the legislation reduces the maximum individual income tax rate and eliminates the deductibility of miscellaneous itemized deductions for taxable years 2018 through 2025.
Risks Related to an Investment in Our Common Shares
Our common shares are not listed on an exchange or quoted through a quotation system, and will not be for the foreseeable future, if ever. Therefore, shareholders will have limited liquidity and may not receive a full return of invested capital upon selling common shares.
Our common shares are illiquid assets for which there is not a secondary market and it is not expected that any will develop in the foreseeable future. There can be no assurance that we will complete a liquidity event. A liquidity event could include (1) a listing of our common shares on a national securities exchange, (2) the sale of all or substantially all of our assets either on a complete portfolio basis or individually followed by a liquidation or (3) a merger or another transaction approved by our board of trustees in which our shareholders likely will receive cash or shares of a publicly-traded company, including potentially a company that is an affiliate of us.
In addition, any shares repurchased pursuant to our share repurchase program may be purchased at a price which may reflect a discount from the purchase price a shareholder paid for the common shares being repurchased. If our common shares are listed, we cannot assure shareholders that a public trading market
 
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will develop. In addition, a liquidity event involving a listing of our common shares on a national securities exchange may include certain restrictions on the ability of shareholders to sell their common shares. Further, even if we do complete a liquidity event, shareholders may not receive a return of all of their invested capital.
See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Share Repurchase Program and Distributions” for a detailed description of our share repurchase program.
We are not obligated to complete a liquidity event by a specified date; therefore, it will be difficult for an investor to sell his or her common shares.
A liquidity event could include (1) a listing of our common shares on a national securities exchange, (2) the sale of all or substantially all of our assets either on a complete portfolio basis or individually followed by a liquidation, or (3) a merger or another transaction approved by our board of trustees in which our shareholders likely will receive cash or shares of a publicly-traded company, including potentially a company that is an affiliate of us. However, there can be no assurance that we will complete a liquidity event by a specified date or at all. If we do not successfully complete a liquidity event, liquidity for an investor’s common shares will be limited to our share repurchase program, which we have no obligation to maintain.
Only a limited number of common shares may be repurchased pursuant to our share repurchase program and, to the extent shareholders are able to sell their common shares under our share repurchase program, shareholders may not be able to recover the amount of their investment in those shares.
Our share repurchase program includes numerous restrictions that limit shareholders’ ability to sell their common shares. We intend to limit the number of common shares repurchased pursuant to our share repurchase program as follows: (1) we currently intend to limit the number of common shares to be repurchased during any calendar year to the number of common shares we can repurchase with the proceeds we receive from the issuance of our common shares under our distribution reinvestment plan, although at the discretion of our board of trustees, we may also use cash on hand, cash available from borrowings and cash from the liquidation of securities investments as of the end of the applicable period to repurchase common shares; (2) we intend to limit the number of common shares to be repurchased in any calendar year to 10% of the weighted average number of common shares outstanding in the prior calendar year, or 2.5% in each calendar quarter (though the actual number of common shares that we offer to repurchase may be less in light of the limitations noted above); (3) unless shareholders tender all of their common shares, shareholders must tender at least 25% of the number of common shares they have purchased and generally must maintain a minimum balance of  $5,000 subsequent to submitting a portion of their common shares for repurchase by us; and (4) to the extent that the number of common shares tendered for repurchase exceeds the number of common shares that we are able to repurchase, we will repurchase common shares on a pro rata basis, not on a first-come, first-served basis. Further, we will have no obligation to repurchase common shares if the repurchase would violate the restrictions on distributions under federal law or Delaware law, which prohibits distributions that would cause a trust to fail to meet statutory tests of solvency. Any of the foregoing limitations may prevent us from accommodating all repurchase requests made in any year.
In addition, our board of trustees may amend, suspend or terminate the share repurchase program upon 30 days’ notice. We will notify shareholders of such developments (1) in our quarterly reports or (2) by means of a separate mailing to shareholders, accompanied by disclosure in a current or periodic report under the Exchange Act. In addition, although we have adopted a share repurchase program, we have discretion to not repurchase common shares, to suspend the share repurchase program and to cease repurchases. Further, the share repurchase program has many limitations and should not be relied upon as a method to sell common shares promptly or at a desired price.
We may pay distributions from borrowings or the sale of assets to the extent our cash flows from operations, net investment income or earnings are not sufficient to fund declared distributions.
We may fund distributions from the uninvested proceeds of our continuous public offering and borrowings, and we have not established limits on the amount of funds we may use from such sources to
 
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make any such distributions. We have paid and may continue to pay distributions from the sale of assets to the extent distributions exceed our earnings or cash flows from operations.
The timing of our repurchase offers pursuant to our share repurchase program may be at a time that is disadvantageous to our shareholders.
When we make quarterly repurchase offers pursuant to our share repurchase program, we may offer to repurchase common shares at a price that is lower than the price that investors paid for common shares in our offering. As a result, to the extent investors have the ability to sell their common shares to us as part of our share repurchase program, the price at which an investor may sell common shares may be lower than what an investor paid in connection with the purchase of common shares in our offering.
In addition, in the event an investor chooses to participate in our share repurchase program, the investor will be required to provide us with notice of intent to participate prior to knowing what the repurchase price will be on the repurchase date. Although an investor will have the ability to withdraw a repurchase request prior to the expiration date of such tender offer, to the extent an investor seeks to sell common shares to us as part of our share repurchase program, the investor will be required to do so without knowledge of what the repurchase price of our common shares will be on the repurchase date.
A shareholder’s interest in us will be diluted if we issue additional common shares, which could reduce the overall value of an investment in us.
Our investors do not have preemptive rights to any common shares we issue in the future. Our declaration of trust authorizes us to issue 700,000,000 common shares. Pursuant to our declaration of trust, a majority of our entire board of trustees may amend our declaration of trust to increase the number of authorized common shares without shareholder approval. After an investor purchases common shares, our board of trustees may elect to sell additional common shares in the future, issue equity interests in private offerings or issue share-based awards to our independent trustees or employees of FS/EIG Advisor. To the extent we issue additional equity interests after an investor purchases our common shares, an investor’s percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, an investor may also experience dilution in the book value and fair value of their common shares.
Certain provisions of our declaration of trust and bylaws could deter takeover attempts and have an adverse impact on the value of our common shares.
Our declaration of trust and bylaws, as well as certain statutory and regulatory requirements, contain certain provisions that may have the effect of discouraging a third party from attempting to acquire us. Our board of trustees may, without shareholder action, authorize the issuance of shares in one or more classes or series, including preferred shares; and our board of trustees may, without shareholder action, amend our declaration of trust to increase the number of our common shares, of any class or series, that we have authority to issue. In addition, a trustee may be removed only by vote of at least two-thirds of the votes entitled to be cast. These anti-takeover provisions may inhibit a change of control in circumstances that could give the holders of our common shares the opportunity to realize a premium over the value of our common shares.
Item 1B.
Unresolved Staff Comments.
Not applicable.
Item 2.
Properties.
We do not own any real estate or other physical properties materially important to our operation. Our headquarters are located at 201 Rouse Boulevard, Philadelphia, Pennsylvania, 19112. We believe that our office facilities are suitable and adequate for our business as it is presently conducted.
Item 3.
Legal Proceedings.
We are not currently subject to any material legal proceedings, and, to our knowledge, no material legal proceedings are threatened against us. From time to time, we may be party to certain legal proceedings in
 
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the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of any legal proceedings cannot be predicted with certainty, we do not expect that any such proceedings will have a material effect upon our financial condition or results of operations.
Item 4.
Mine Safety Disclosures.
Not applicable.
 
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PART II
Many of the amounts and percentages presented in Part II have been rounded for convenience of presentation and all dollar amounts, excluding per share amounts, are presented in thousands unless otherwise noted.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
There is currently no market for our common shares, and we do not expect that a market for our common shares will develop in the foreseeable future. In November 2016, we closed our continuous public offering of common shares to new investors. Following the closing of our continuous public offering, we have continued to issue shares pursuant to our distribution reinvestment plan.
Set forth below is a chart describing the classes of our securities outstanding as of April 9, 2020:
(1)(2)(3)(4)
Title of ClassAmount
Authorized
Amount Held by Us or
for Our Account
Amount Outstanding
Exclusive of Amount
Under Column (3)
Common Shares700,000,000436,755,981
As of April 9, 2020, we had 85,468 record holders of our common shares.
Share Repurchase Program, De Minimis Account Liquidation and Distributions
We intend to continue to conduct quarterly tender offers pursuant to our share repurchase program.
The following table provides information concerning our repurchases of common shares pursuant to our share repurchase program and de minimis account liquidation during the quarter ended December 31, 2019:
PeriodTotal
Number of
Shares
Purchased
Average
Price Paid
per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
Maximum Number of
Shares that May Yet
Be Purchased
Under the
Plans or Programs
October 1 to October 31, 20194,733,773$5.8504,733,773
(1)
November 1 to November 30, 2019
December 1 to December 31, 2019   —
Total4,733,773$5.8504,733,773
   (1)
(1)
The maximum number of common shares available for repurchase pursuant to our share repurchase program on October 1, 2019 was 10,974,088. A description of the maximum number of common shares that may be repurchased under our share repurchase program and a description of the de minimis account liquidation are set forth in Note 3 to our consolidated financial statements contained in this annual report on Form 10-K.
Subject to applicable legal restrictions and the sole discretion of our board of trustees, we intend to declare regular cash distributions on a quarterly basis and pay such distributions on a monthly basis. We will calculate each shareholder’s specific distribution amount for the period using record and declaration dates and each shareholder’s distributions will begin to accrue on the date that common shares are issued to such shareholder. From time to time, we may also pay special interim distributions in the form of cash or common shares at the discretion of our board of trustees. The timing and amount of any future distributions to shareholders are subject to applicable legal restrictions and the sole discretion of our board of trustees.
 
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The following table reflects the cash distributions per share that we have declared and paid on our common shares during the years ended December 31, 2019, 2018 and 2017:
���Distribution
For the Year Ended December 31,Per ShareAmount
2017$0.7085$312,694
2018$0.5000$219,047
2019$0.5000$218,187
See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—RIC Tax Treatment and Distributions and Note 5 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our distributions and our distribution reinvestment plan, including certain related tax considerations as well as a detailed discussion of the expense reimbursement agreement, including amounts reimbursed to us by FS Investments thereunder and the repayment of such amounts to FS Investments.
 
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Item 6.
Selected Financial Data.
The following selected consolidated financial data for the years ended December 31, 2019, 2018, 2017, 2016 and 2015 is derived from our consolidated financial statements which have been audited by RSM US LLP, our independent registered public accounting firm. The data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this annual report on Form 10-K.
Year Ended December 31,
20192018201720162015
Statements of operations data:
Investment income$365,910$333,978$418,756$369,740$379,653
Operating expenses
Total expenses170,118150,031160,584138,093152,058
Less: Management fee offset(5,992)(1,276)
Less: Expense reimbursement from sponsor(31,260)
Add: Expense reimbursement due to sponsor2,858
Net expenses164,126148,755132,182138,093152,058
Net investment income201,784185,223286,574231,647227,595
Total net realized and unrealized gain (loss) on investments, swap contracts and foreign currency(238,907)(245,565)(399,544)520,937(738,894)
Net increase (decrease) in net assets resulting from operations$(37,123)$(60,342)$(112,970)$752,584$(511,299)
Per share data:(1)
Net investment income – basic and diluted$0.46$0.42$0.65$0.57$0.67
Net increase (decrease) in net assets resulting from operations – basic and diluted$(0.08)$(0.14)$(0.26)$1.84$(1.51)
Distributions declared(2)
$0.50$0.50$0.71$0.71$0.71
Balance sheet data:
Total assets$3,674,784$3,893,516$4,316,431$4,268,297$3,498,105
Credit facilities, senior secured notes and repurchase agreement payable$1,236,667$1,131,667$1,220,000$873,665$1,040,494
Total net assets$2,379,605$2,648,186$2,966,042$3,348,894$2,417,861
Other data:
Total return(3)
(1.83)%(2.49)%(3.65)%29.53%(17.34)%
Total return (without assuming reinvestment of distributions)(3)
(1.33)%(2.11)%(3.29)%28.00%(15.87)%
Number of portfolio company investments at year end7779768490
Total portfolio investments for the year$1,240,325$1,915,034$1,861,618$1,488,179$1,195,947
Proceeds from sales and prepayments of investments$1,313,072$1,948,414$1,431,648$1,225,052$800,534
(1)
The per share data was derived by using the weighted average shares outstanding during the applicable year.
(2)
The per share data for distributions reflects the actual amount of distributions paid per share during the applicable year.
(3)
The total return for each year presented was calculated based on the change in net asset value during the applicable year, including the impact of distributions reinvested in accordance with our distribution reinvestment plan. The total return (without assuming reinvestment of distributions) for each year presented was calculated by taking the net asset value per share as of the end of the applicable period, adding the cash distributions per share which were declared during the applicable year and dividing the total by the net asset value per share at the beginning of the applicable year. The total returns do not consider the effect of any sales commissions or charges that may be incurred in connection with the sale of our common shares. The total returns include the effect of the issuance of shares at a net offering price that is greater than net asset value per share, which causes an increase in net asset value per share. The historical calculations of total returns in the table should not be considered representations of our future total returns, which may be greater or less than the returns shown in the table due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rates payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be relied upon as being indicative of performance in future years. The total return calculations set forth above represent the total returns on our investment portfolio during the applicable year and do not represent an actual returns to shareholders.
 
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Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(in thousands, except share and per share amounts)
The following discussion should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this annual report on Form 10-K.
Forward-Looking Statements
Some of the statements in this annual report on Form 10-K constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K may include statements as to:

our future operating results;

our business prospects and the prospects of the companies in which we may invest;

the impact of the investments that we expect to make;

the ability of our portfolio companies to achieve their objectives;

our current and expected financing arrangements and investments;

changes in the general interest rate environment;

the adequacy of our cash resources, financing sources and working capital;

the timing and amount of cash flows, distributions and dividends, if any, from our portfolio companies;

our contractual arrangements and relationships with third parties;

actual and potential conflicts of interest with FS/EIG Advisor, FS Investments, EIG, or any of their respective affiliates;

the dependence of our future success on the general economy and its effect on the industries in which we may invest;

our use of financial leverage;

the ability of FS/EIG Advisor to locate suitable investments for us and to monitor and administer our investments;

the ability of FS/EIG Advisor or its affiliates to attract and retain highly talented professionals;

our ability to maintain our qualification as a RIC and as a BDC;

the impact on our business of the Dodd-Frank Act, as amended, and the rules and regulations issued thereunder;

the effect of changes to tax legislation and our tax position; and

the tax status of the enterprises in which we may invest.
In addition, words such as “anticipate,” “believe,” “expect” and “intend” indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this annual report on Form 10-K involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in “Item 1A. Risk Factors.” Other factors that could cause actual results to differ materially include:

changes in the economy;

risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters; and

future changes in laws or regulations and conditions in our operating areas.
We have based the forward-looking statements included in this annual report on Form 10-K on information available to us on the date of this annual report on Form 10-K. Except as required by the
 
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federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. Shareholders are advised to consult any additional disclosures that we may make directly to shareholders or through reports that we may file in the future with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking statements and projections contained in this annual report on Form 10-K are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act.
Overview
We were formed as a Delaware statutory trust under the Delaware Statutory Trust Act on September 16, 2010 and formally commenced investment operations on July 18, 2011. We are an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a BDC under the 1940 Act and has elected to be treated for U.S. federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code. In November 2016, we closed our continuous public offering of common shares to new investors.
Our investment activities are managed by FS/EIG Advisor and supervised by our board of trustees, a majority of whom are independent. Under the FS/EIG investment advisory agreement, we have agreed to pay FS/EIG Advisor an annual base management fee based on the average weekly value of our gross assets and an incentive fee based on our performance. Our investment activities were managed by FS Advisor until April 9, 2018 and thereafter have been managed by FS/EIG Advisor. FS Advisor previously engaged GSO Capital Partners LP, or GSO, to act as our investment sub-advisor. GSO resigned as our investment sub-advisor and terminated the investment sub-advisory agreement dated April 28, 2011, or the investment sub-advisory agreement, that FS Advisor had entered into with GSO, effective April 9, 2018.
Our investment policy is to invest, under normal circumstances, at least 80% of our total assets in securities of Energy companies. This investment policy may not be changed without at least 60 days’ prior notice to holders of our common shares of any such change.
Our investment objective is to generate current income and long-term capital appreciation. We pursue our investment objective by focusing on the following seven investment themes: (i) basin-on-basin competition in U.S. shale, (ii) globalization of natural gas, (iii) coal retirements and the evolving energy generation mix, (iv) renewables focused on power grid parity, (v) export infrastructure for emerging U.S. producers, (vi) market liberalization opening new markets and (vii) midstream infrastructure connecting new supplies. However, we may pursue other investment opportunities if we believe it is in our best interests and consistent with our investment objectives.
Within the above investment themes, we intend to focus on the following investment categories, which we believe will allow us to generate an attractive total return with an acceptable level of risk.
Direct Originations:   Through FS/EIG Advisor, we intend to directly source investment opportunities across the Energy industry. Such investments are typically originated and structured through a negotiated process in which we directly participate and are not generally available to the broader market. These investments may include both debt and equity components. We believe directly originated investments may offer higher returns and more favorable protections than broadly syndicated transactions.
Broadly Syndicated Loan and Bond Transactions:   Although our primary focus is to invest in directly originated transactions, in certain circumstances we will also invest in the broadly syndicated loan and high yield bond markets. Broadly syndicated loans and bonds are generally more liquid than our directly originated investments and provide a complement to our less liquid strategies.
In the case of broadly syndicated investments, we generally intend to capitalize on market inefficiencies by investing in loans, bonds, and other asset classes where the market price of such investment reflects a lower value than we believe is warranted based on our fundamental analysis, providing us with an opportunity to earn an attractive return on our investment.
Our portfolio is comprised primarily of income-oriented securities, which principally refers to debt securities and income-oriented preferred and common equity interests, of privately-held Energy companies
 
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within the United States. We expect to invest primarily in directly originated investments and primary market transactions, as this will provide us with the ability to tailor investments to best match a project’s or company’s needs with our investment objectives. We intend to weight our portfolio towards senior secured debt and directly originated preferred equity investments, which we believe offer opportunities for superior risk-adjusted returns and income generation. Our debt investments may take the form of corporate or project loans or bonds, may be secured or unsecured and may, in some cases, be accompanied by yield enhancements. These yield enhancements are typically expected to include royalty interests in mineral, oil and gas properties, warrants, options, net profits interests, cash flow participations or other forms of equity participation that can provide additional consideration or “upside” in a transaction. Our preferred equity investments are mostly directly originated and may take the form of perpetual or redeemable securities, typically with a current income component and minimum base returns. In addition, certain income-oriented preferred or common equity interests may include interests in master limited partnerships and a portion of our portfolio may be comprised of derivatives, including the use of total return swaps, credit default swaps and other commodity swap contracts. In connection with certain of our debt investments or any restructuring of these debt investments, we may on occasion receive equity interests, including warrants or options, as additional consideration or otherwise in connection with a restructuring. FS/EIG Advisor will seek to tailor our investment focus as market conditions evolve.
Revenues
The principal measure of our financial performance is net increase or decrease in net assets resulting from operations, which includes net investment income, net realized gain or loss on investments, net realized gain or loss on foreign currency, net realized gain or loss on swap contracts, net change in unrealized appreciation or depreciation on investments, net change in unrealized gain or loss on foreign currency investments and net change in unrealized gain or loss on swap contracts. Net investment income is the difference between our income from interest, dividends, fees and other investment income and our operating and other expenses. Net realized gain or loss on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost, including the respective realized gain or loss on foreign currency for those foreign denominated investment transactions. Net realized gain or loss on foreign currency is the portion of realized gain or loss attributable to foreign currency fluctuations. Net realized gain or loss on swap contracts is the portion of realized gain or loss attributable to the difference between the fixed price specified in the contract and the referenced settlement price. Net change in unrealized appreciation or depreciation on investments is the net change in the fair value of our investment portfolio, including the respective unrealized gain or loss on foreign currency for those foreign denominated investments. Net change in unrealized gain or loss on foreign currency is the net change in the value of receivables or accruals due to the impact of foreign currency fluctuations. Net change in unrealized gain or loss on swap contracts is the net change in the value of receivables or accruals due to the impact of the difference between the fixed price specified in the contract and the referenced settlement price.
We principally generate revenues in the form of interest income on the debt investments we hold. We also generate revenues in the form of dividends and other distributions on the equity or other securities we may hold. In addition, we may generate revenues in the form of non-recurring commitment, closing, origination, structuring or diligence fees, fees for providing managerial assistance, consulting fees, prepayment fees and performance-based fees.
Expenses
Our primary operating expenses include the payment of management and incentive fees and other expenses under the FS/EIG investment advisory agreement, interest expense from financing arrangements and other indebtedness, and other expenses necessary for our operations. The management and incentive fees compensate FS/EIG Advisor for its work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments.
FS/EIG Advisor oversees our day-to-day operations, including the provision of general ledger accounting, fund accounting, legal services, investor relations, certain government and regulatory affairs activities, and other administrative services. FS/EIG Advisor also performs, or oversees the performance of, our corporate operations and required administrative services, which includes being responsible for the
 
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financial records that we are required to maintain and preparing reports for our shareholders and reports filed with the SEC. In addition, FS/EIG Advisor assists us in calculating our net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to our shareholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others.
We reimburse FS/EIG Advisor for expenses necessary to perform services related to our administration and operations, including FS/EIG Advisor’s allocable portion of the compensation and related expenses of certain personnel of FS Investments and EIG providing administrative services to us on behalf of FS/EIG Advisor, and for transactional expenses for prospective investments, such as fees and expenses associated with performing due diligence reviews of investments that do not close, often referred to as “broken deal” costs. We reimburse FS/EIG Advisor no less than quarterly for all costs and expenses incurred by FS/EIG Advisor in performing its obligations and providing personnel under the FS/EIG investment advisory agreement. The amount of this reimbursement is set at the lesser of  (1) FS/EIG Advisor’s actual costs incurred in providing such services and (2) the amount that we estimate would be required to pay alternative service providers for comparable services in the same geographic location. FS/EIG Advisor allocates the cost of such services to us based on factors such as time allocations and other reasonable metrics. Our board of trustees reviews the methodology employed in determining how the expenses are allocated to us and assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services as compared to the estimated cost to us of obtaining similar services from third-party service providers known to be available. In addition, our board of trustees considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, our board of trustees compares the total amount paid to FS/EIG Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs. We do not reimburse FS/EIG Advisor for any services for which it receives a separate fee, or for rent, depreciation, utilities, capital equipment or other administrative items allocated to a controlling person of FS/EIG Advisor.
We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:

corporate and organization expenses related to offerings of our common shares, subject to limitations included in the FS/EIG investment advisory agreement;

the cost of calculating our net asset value, including the cost of any third-party pricing or valuation services;

the cost of effecting sales and repurchases of our common shares and other securities;

investment advisory fees;

fees payable to third parties relating to, or associated with, making investments and valuing investments, including fees and expenses associated with performing due diligence reviews of prospective investments;

interest payments on our debt or related obligations;

transfer agent and custodial fees;

research and market data (including news and quotation equipment and services, and any computer hardware and connectivity hardware (e.g. telephone and fiber optic lines) incorporated into the cost of obtaining such research and market data);

fees and expenses associated with marketing efforts;

federal and state registration fees;

federal, state and local taxes;

annual fees of the Delaware trustee;

fees and expenses of our trustees not also serving in an executive officer capacity for us or FS/EIG Advisor;

costs of proxy statements, shareholders’ reports and notices and other filings;
 
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our fidelity bond, trustees and officers/errors and omissions liability insurance and other insurance premiums;

direct costs such as printing, mailing, long distance telephone and staff;

fees and expenses associated with accounting, corporate governance, government and regulatory affairs activities, independent audits and outside legal costs;

costs associated with our reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws, including compliance with the Sarbanes-Oxley Act;

brokerage commissions for our investments;

costs associated with our chief compliance officer; and

all other expenses incurred by FS/EIG Advisor in connection with administering our business, including expenses incurred by FS/EIG Advisor in performing administrative services for us and administrative personnel paid by FS/EIG Advisor, to the extent they are not controlling persons of FS/EIG Advisor and our affiliates, subject to the limitations included in the FS/EIG investment advisory agreement.
In addition, we have contracted with State Street to provide various accounting and administrative services, including, but not limited to, preparing preliminary financial information for review by FS/EIG Advisor, preparing and monitoring expense budgets, maintaining accounting and corporate books and records, processing trade information provided by us and performing testing with respect to RIC compliance.
For information regarding our fee offset and historical expense reimbursement arrangements with FS Investments and FS/EIG Advisor, see Note 4 to our consolidated financial statements contained in this annual report on Form 10-K.
Portfolio Investment Activity for the Years Ended December 31, 2019 and 2018
Total Portfolio Activity
The following tables present certain selected information regarding our portfolio investment activity for the years ended December 31, 2019 and 2018:
For the Year Ended December 31,
Net Investment Activity20192018
Purchases$1,240,325$1,915,034
Sales and Repayments(1,313,072)(1,948,414)
Net Portfolio Activity$(72,747)$(33,380)
For the Year Ended December 31,
20192018
New Investment Activity by Asset ClassPurchasesPercentagePurchasesPercentage
Senior Secured Loans – First Lien$677,67455%$743,64039%
Senior Secured Loans – Second Lien175,75614%128,2927%
Senior Secured Bonds66,3935%118,5876%
Unsecured Debt63,6685%368,74119%
Preferred Equity242,22720%415,37022%
Equity/Other14,6071%140,4047%
Total$1,240,325100%$1,915,034100%
 
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The following table summarizes the composition of our investment portfolio at cost and fair value as of December 31, 2019 and 2018:
December 31, 2019December 31, 2018
Amortized
Cost(1)
Fair ValuePercentage
of Portfolio
Amortized
Cost(1)
Fair ValuePercentage
of Portfolio
Senior Secured Loans – First
Lien
$1,252,529$1,134,57133%$1,231,279$1,176,88132%
Senior Secured Loans – Second Lien752,528564,81316%673,014580,14416%
Senior Secured Bonds529,773524,22115%497,970491,91613%
Unsecured Debt398,233323,2209%797,146706,09019%
Preferred Equity711,883721,84221%554,652502,59413%
Equity/Other480,760213,9706%494,442264,3277%
Total$4,125,706$3,482,637100%$4,248,503$3,721,952100%
(1)
Amortized cost represents the original cost adjusted for the amortization of premiums and/or accretion of discounts, as applicable, on investments.
The following table presents certain selected information regarding the composition of our investment portfolio as of December 31, 2019 and 2018:
December 31, 2019December 31, 2018
Number of Portfolio Companies7779
% Variable Rate (based on fair value)47.4%39.0%
% Fixed Rate (based on fair value)25.7%40.4%
% Income Producing Preferred Equity and Equity/Other Investments (based on fair value)20.3%12.2%
% Non-Income Producing Preferred Equity and Equity/Other Investments (based on fair value)6.6%8.4%
Weighted Average Annual EBITDA of Portfolio Companies$248,795$202,135
Weighted Average Purchase Price of Debt Investments (as a % of par value)96.1%97.7%
% of Investments on Non-Accrual (based on fair value)2.1%1.9%
Gross Portfolio Yield Prior to Leverage (based on amortized cost)8.1%8.1%
Gross Portfolio Yield Prior to Leverage (based on amortized cost) – Excluding Non-Income Producing Assets10.1%10.1%
Based on our regular monthly cash distribution rate of  $0.041667 per share as of December 31, 2019, and the price at which we issued shares pursuant to our distribution reinvestment plan of  $5.50 per share, the annualized distribution rate to shareholders as of December 31, 2019 was 9.09%. Based on our monthly cash distribution rate of  $0.041667 per share as of December 31, 2018, and the price at which we issued shares pursuant to our distribution reinvestment plan of  $6.10 per share, the annualized distribution rate to shareholders as of December 31, 2018 was 8.20%. For the years ended December 31, 2019 and 2018, our total return was (1.83)% and (2.49)%, respectively, and our total return without assuming reinvestment of distributions was (1.33)% and (2.11)%, respectively. On February 7, 2020, our board of trustees reduced the regular monthly cash distribution amount to $0.020833 per share to be paid to shareholders of record for February 2020 and March 2020. Based on a distribution amount of  $0.020833 per share, and the price at which we last issued shares pursuant to our distribution reinvestment plan of $3.70 per share, the annualized distribution rate to shareholders as of March 31, 2020 was 6.76%.
Our estimated gross portfolio yield and annualized distribution rate to shareholders do not represent actual investment returns to shareholders. Our gross annual portfolio yield and distribution rate to
 
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shareholders are subject to change and in the future may be greater or less than the rates set forth above. See “Item 1A. Risk Factors” for a discussion of the uncertainties, risks and assumptions associated with these statements.
Direct Originations
The following tables present certain selected information regarding our direct originations for the three months and year ended December 31, 2019:
New Direct OriginationsFor the Three Months
Ended
December 31, 2019
For the Year
Ended
December 31, 2019
Total Commitments (including unfunded commitments)$124,487$584,910
Exited Investments (including partial paydowns)(397,284)(520,751)
Net Direct Originations$(272,797)$64,159
For the Three Months
Ended
December 31, 2019
For the Year
Ended
December 31, 2019
New Direct Originations by Asset Class (including unfunded commitments)Commitment
Amount
PercentageCommitment
Amount
Percentage
Senior Secured Loans – First Lien$66,25553%$244,62442%
Senior Secured Loans – Second Lien60,25010%
Senior Secured Bonds
Unsecured Debt3,4093%3,4091%
Preferred Equity52,17042%227,17039%
Equity/Other2,6532%49,4578%
Total$124,487100%$584,910100%
For the Three Months
Ended
December 31, 2019
For the Year
Ended
December 31, 2019
Average New Direct Origination Commitment Amount$24,897$36,557
Weighted Average Maturity for New Direct Originations3/20/244/28/24
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of
New Direct Originations Funded during Period
11.9%10.2%
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of
New Direct Originations Funded during Period – Excluding
Non-Income Producing Assets
12.2%11.2%
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of
Direct Originations Exited during Period
8.3%���7.6%
 
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The following table presents certain selected information regarding our direct originations as of December 31, 2019 and 2018:
Characteristics of All Direct Originations held in PortfolioDecember 31, 2019December 31, 2018
Number of Portfolio Companies4947
Weighted Average Annual EBITDA of Portfolio Companies$267,575$190,915
Weighted Average Leverage Through Tranche of Portfolio Companies – Excluding Equity/Other Securities4.7x4.4x
% of Investments on Non-Accrual (based on fair value)2.8%2.7%
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Funded Direct Originations8.0%8.2%
Gross Portfolio Yield Prior to Leverage (based on amortized cost) of Funded Direct Originations – Excluding Non-Income Producing Assets10.4%10.9%
Portfolio Composition by Strategy
The table below summarizes the composition of our investment portfolio by strategy and enumerates the percentage, by fair value, of the total portfolio assets in such strategies as of December 31, 2019 and 2018:
December 31, 2019December 31, 2018
Portfolio Composition by StrategyFair ValuePercentage of
Portfolio
Fair ValuePercentage of
Portfolio
Direct Originations$2,617,06375%$2,644,59471%
Broadly Syndicated/Other865,57425%1,077,35829%
Total$3,482,637100%$3,721,952100%
See Note 7 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our investment portfolio.
Portfolio Asset Quality
In addition to various risk management and monitoring tools, FS/EIG Advisor uses, and FS Advisor historically used, an investment rating system to characterize and monitor the expected level of returns on each investment in our portfolio. FS/EIG Advisor uses, and FS Advisor historically used, an investment rating scale of 1 to 5. The following is a description of the conditions associated with each investment rating:
Investment
Rating
Summary Description
1Investment exceeding expectations and/or capital gain expected.
2Performing investment generally executing in accordance with the portfolio company’s business plan— full return of principal and interest expected.
3Performing investment requiring closer monitoring.
4Underperforming investment—some loss of interest or dividend possible, but still expecting a positive return on investment.
5Underperforming investment with expected loss of interest and some principal.
 
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The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of December 31, 2019 and 2018:
December 31, 2019December 31, 2018
Investment RatingFair ValuePercentage
of Portfolio
Fair ValuePercentage
of Portfolio
1$$
22,115,87561%3,143,43984%
3805,93423%446,87712%
4206,5356%
5354,29310%131,6364%
$3,482,637100%$3,721,952100%
The amount of the portfolio in each grading category may vary substantially from period to period resulting primarily from changes in the composition of the portfolio as a result of new investment, repayment and exit activities. In addition, changes in the grade of investments may be made to reflect our expectation of performance and changes in investment values.
Results of Operations
Comparison of the Years Ended December 31, 2019, 2018 and 2017
Revenues
Our investment income for the years ended December 31, 2019, 2018 and 2017 was as follows:
Years Ended December 31,
201920182017���
AmountPercentage of
Total Income
AmountPercentage of
Total Income
AmountPercentage of
Total Income
Interest income$322,64188%$305,89192%$344,60082%
Paid-in-kind interest income35,30210%10,1633%32,9818%
Fee income7,6882%17,7365%41,17510%
Dividend income2790%1880%
Total investment income(1)
$365,910100%$333,978100%$418,756100%
(1)
Such revenues represent $301,214, $309,907 and $366,567 of cash income earned as well as $64,696, $24,071 and $52,189 in non-cash portions relating to accretion of discount and PIK interest for the years ended December 31, 2019, 2018 and 2017, respectively. Cash flows related to such non-cash revenues may not occur for a number of reporting periods or years after such revenues are recognized.
The level of interest income we receive is generally related to the balance of income-producing investments multiplied by the weighted average yield of our investments. We expect the dollar amount of interest income that we earn to increase as both the interest rates attributed to the investments within our investment portfolio and the proportion of directly originated investments in our investment portfolio increases. The increase in the amount of interest income and PIK income for the year ended December 31, 2019, compared to the year ended December 31, 2018 was primarily due to a combination of factors including an increase in the size of our directly originated investments and structured preferred equity investments in addition to higher yields in certain of our investments. The decrease in the amount of interest income for the year ended December 31, 2018, compared to the year ended December 31, 2017 was primarily due to a temporary decrease in the size of our investment portfolio primarily as a result of our repayment of certain leverage facilities.
Fee income is transaction based, and typically consists of prepayment fees and structuring fees. As such, future fee income is generally dependent on new direct origination investments and the occurrence of events at existing portfolio companies resulting in such fees. The decrease in the amount of fee income for the
 
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year ended December 31, 2019 compared to the year and ended December 31, 2018, and for the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to the decrease of structuring and prepayment activity during the period.
Expenses
Our operating expenses for the years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
201920182017
Management fees$68,526$70,075$88,938
Subordinated income incentive fees10,499
Administrative services expenses4,7603,7172,829
Share transfer agent fees2,7482,6082,723
Accounting and administrative fees1,1061,3181,608
Interest expense88,36466,68149,286
Trustees’ fees7621,004996
Expenses associated with our independent audit and related fees444411524
Legal fees438599477
Printing fees1,0189541,417
Insurance expense99132186
Other1,8532,5321,101
Total operating Expenses170,118150,031160,584
Less: Management fee offset(5,992)(1,276)
Less: Expense reimbursement from sponsor(31,260)
Add: Expense reimbursement due to sponsor2,858
Net operating expenses$164,126$148,755$132,182
The following table reflects selected expense ratios as a percent of average net assets for the years ended December 31, 2019, 2018 and 2017:
Year Ended December 31,
201920182017
Ratio of operating expenses to average net assets6.54%5.19%4.94%
Ratio of management fee offset and expense reimbursement to (from) sponsor to average net assets(0.23)%(0.05)%(0.87)%
Ratio of net operating expenses to average net assets6.31%5.14%4.07%
Less: Ratio of income incentive fees and interest expense to average net assets(1)
3.40%2.30%1.84%
Ratio of net operating expenses, excluding certain expenses, to average net assets2.91%2.84%2.23%
(1)
Ratio may be rounded in order to recompute the ending ratio of net operating expenses, excluding certain expenses, to average net assets.
Incentive fees and interest expense may increase or decrease our expense ratios relative to comparative periods depending on portfolio performance and changes in benchmark interest rates such as LIBOR, among other factors.
 
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Management Fee Offset
During the years ended December 31, 2019 and 2018, $5,992 and $1,276, respectively, of structuring or other upfront fees received by FS/EIG Advisor were offset against management fees due to FS/EIG Advisor from us. See Note 4 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of the management fee offset for the years ended December 31, 2019 and 2018.
Expense Reimbursement
During the year ended December 31, 2017, we accrued $31,260 for expense reimbursements that FS Investments agreed to pay. Under the expense reimbursement agreement, amounts reimbursed to us by FS Investments may become subject to repayment by us in the future. During the year ended December 31, 2017, we accrued and paid $2,858 of expense recoupments to FS Advisor or its affiliates. See Note 4 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of the expense reimbursement agreement and the FS/EIG expense reimbursement agreement, each of which has been terminated.
Net Investment Income
Our net investment income totaled $201,784 ($0.46 per share), $185,223 ($0.42 per share) and $286,574 ($0.65 per share) for the years ended December 31, 2019, 2018 and 2017, respectively.
Net Realized Gains or Losses
Our net realized gains (losses) on investments, swap contracts and foreign currency for the years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
201920182017
Net realized gain (loss) on investments(1)
$(114,746)$(100,914)$(91,083)
Net realized gain (loss) on swap contracts5,4531,165
Net realized gain (loss) on foreign currency1
Total net realized gain (loss)$(109,293)$(99,749)$(91,082)
(1)
We sold investments and received principal repayments of  $882,557 and $430,515, respectively, during the year ended December 31, 2019, $1,401,163 and $547,251, respectively, during the year ended December 31, 2018 and $710,040 and $721,608, respectively, during the year ended December 31, 2017.
Net Change in Unrealized Appreciation (Depreciation) on Investments and Swap Contracts and Unrealized Gain (Loss) on Foreign Currency
Our net change in unrealized appreciation (depreciation) on investments, swap contracts and foreign currency for the years ended December 31, 2019, 2018 and 2017 were as follows:
Year Ended December 31,
201920182017
Net change in unrealized appreciation (depreciation) on investments$(116,518)$(165,490)$(308,513)
Net change in unrealized appreciation (depreciation) on swap contracts(13,103)19,654
Net change in unrealized appreciation (depreciation) on foreign currency72051
Total net change in unrealized appreciation (depreciation)$(129,614)$(145,816)$(308,462)
During the year ended December 31, 2019, the net change in unrealized appreciation (depreciation) on our investments was primarily driven by the decline in Energy markets and performance of certain upstream
 
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and common equity investments. During the year ended December 31, 2018, the net change in unrealized appreciation (depreciation) on our investments was primarily driven by the decline in Energy markets in the fourth quarter and performance of our directly originated investments. During the year ended December 31, 2017, the net change in unrealized appreciation (depreciation) on our investments was primarily driven by the performance of our directly originated investments.
Net Increase (Decrease) in Net Assets Resulting from Operations
For the years ended December 31, 2019, 2018 and 2017, the net increase (decrease) in net assets resulting from operations was $(37,123) ($(0.08) per share), $(60,342) ($(0.14) per share) and $(112,970) ($(0.26) per share), respectively.
Financial Condition, Liquidity and Capital Resources
Overview
As of December 31, 2019, we had $149,752 in unrestricted cash, which we or our wholly-owned financing subsidiaries held in custodial accounts, and $433,333 in borrowings available under our financing arrangements, subject to borrowing base and other limitations. As of December 31, 2019, we also had broadly syndicated investments that could be sold to create additional liquidity. As of December 31, 2019, we had nine senior secured loan investments with aggregate unfunded commitments of  $75,494 and two preferred equity investments with aggregate unfunded commitments of  $10,927. We maintain sufficient cash on hand, available borrowings and liquid securities to fund such unfunded commitments should the need arise.
We generate cash primarily from the issuance of shares under our distribution reinvestment plan and from cash flows from fees, interest and dividends earned from our investments as well as principal repayments and proceeds from sales of our investments. To seek to enhance our returns, we also employ leverage as market conditions permit and at the discretion of FS/EIG Advisor, but unless and until we elect otherwise, as permitted by the 1940 Act, in no event will leverage employed exceed 50% of the value of our assets, as required by the 1940 Act. See “—Financing Arrangements.”
Prior to investing in securities of portfolio companies, we invest the net proceeds from the issuance of shares under our distribution reinvestment plan as well as from sales and paydowns of existing investments primarily in cash, cash equivalents, including money market funds, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, consistent with our BDC election and our election to be taxed as a RIC.
Financing Arrangements
The following table presents a summary of information with respect to our outstanding financing arrangements as of December 31, 2019:
Arrangement(1)
Type of
Arrangement
RateAmount
Outstanding
Amount
Available
Maturity Date
Goldman FacilityTermL+3.20%$425,000$50,000December 2, 2022
JPMorgan FacilityRevolving/TermL+2.75%311,667383,333February 16, 2023
Senior Secured Notes(2)
Bond7.50%500,000August 15, 2023
Total$1,236,667$433,333
(1)
The carrying amount outstanding under the facility approximates its fair value, unless otherwise noted.
(2)
As of December 31, 2019, the fair value of the Senior Secured Notes was approximately $507,500.
For additional information regarding our financing arrangements, see Note 9 to our consolidated financial statements contained in this annual report on Form 10-K.
 
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RIC Tax Treatment and Distributions
We have elected to be treated for U.S. federal income tax purposes, and intend to qualify annually, as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we distribute as dividends to our shareholders. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. In addition, in order to maintain RIC tax treatment, we must distribute to our shareholders, for each tax year, dividends generally of an amount at least equal to 90% of our “investment company taxable income,” which is generally the sum of our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses, determined without regard to any deduction for dividends paid. In addition, we may, in certain cases, satisfy the Annual Distribution Requirement by distributing dividends relating to a tax year after the close of such tax year under the “spillover dividend” provisions of Subchapter M of the Code. If we distribute a spillover dividend, such dividend will be included in a shareholder’s gross income for the tax year in which the spillover distribution is paid. We intend to make sufficient distributions to our shareholders to maintain our RIC tax treatment each tax year. We will also be subject to nondeductible U.S. federal excise taxes on certain undistributed income unless we distribute in a timely manner to our shareholders of an amount at least equal to the sum of  (1) 98% of our net ordinary taxable income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains over capital losses (adjusted for certain ordinary losses), for the one-year period ending October 31 of that calendar year and (3) any ordinary income and capital gain net income for the preceding years that were not distributed during such years and on which we paid no U.S. federal income tax. Any distribution declared by us during October, November or December of any calendar year, payable to our shareholders of record on a specified date in such a month and actually paid during January of the following calendar year, will be treated as if it had been paid by us, as well as received by our U.S. shareholders, on December 31 of the calendar year in which the distribution was declared.
Prior to the closing of our continuous public offering in November 2016, we declared regular cash distributions on a weekly basis, and paid such distributions on a monthly basis. Effective November 30, 2016, and subject to applicable legal restrictions and the sole discretion of our board of trustees, we intend to declare regular cash distributions on a quarterly basis and pay such distributions on a monthly basis. We will calculate each shareholder’s specific distribution amount for the period using record and declaration dates and each shareholder’s distributions will begin to accrue on the date that common shares are issued to such shareholder. From time to time, we may also pay special interim distributions in the form of cash or common shares at the discretion of our board of trustees. The timing and amount of any future distributions to shareholders are subject to applicable legal restrictions and the sole discretion of our board of trustees.
During certain periods, our distributions may exceed our earnings. As a result, it is possible that a portion of the distributions we make will represent a return of capital. A return of capital generally is a return of an investor’s investment rather than a return of earnings or gains derived from our investment activities and will be made after deducting the fees and expenses payable in connection with our continuous public offering, including any fees payable to FS/EIG Advisor. Moreover, a return of capital will generally not be taxable, but will reduce each shareholder’s cost basis in our common shares, and will result in a higher reported capital gain or lower reported capital loss when the common shares on which such return of capital was received are sold. Each year a statement on Form 1099-DIV identifying the sources of the distributions will be mailed to our shareholders.
We intend to continue to make our regular distributions in the form of cash, out of assets legally available for distribution, unless shareholders elect to receive their cash distributions in additional common shares under our distribution reinvestment plan. Any distributions reinvested under the plan will nevertheless remain taxable to a U.S. shareholder.
 
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The following table reflects the cash distributions per share that we have declared and paid on our common shares during the years ended December 31, 2019, 2018 and 2017:
Distribution
For the Year Ended December 31,Per ShareAmount
2017$0.7085$312,694
2018$0.5000$219,047
2019$0.5000$218,187
See Note 5 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our distributions, including a reconciliation of our GAAP-basis net investment income to our tax-basis net investment income, the components of accumulated earnings on a tax basis and deferred taxes.
Critical Accounting Policies
Our financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing the financial statements, management has utilized available information, including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As we execute our operating plans, we will describe additional critical accounting policies in the notes to our future financial statements in addition to those discussed below.
Valuation of Portfolio Investments
We determine the fair value of our investment portfolio each quarter. Securities are valued at fair value as determined in good faith by our board of trustees. In connection with that determination, FS/EIG Advisor provides our board of trustees with portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party valuation services.
Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosure, or ASC Topic 820, issued by the Financial Accounting Standards Board, or the FASB, clarifies the definition of fair value and requires companies to expand their disclosure about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. ASC Topic 820 defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities where there is little or no activity in the market; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
With respect to investments for which market quotations are not readily available, we undertake a multi-step valuation process each quarter, as described below:

our quarterly fair valuation process begins with FS/EIG Advisor reviewing and documenting preliminary valuations of each portfolio company or investment;
 
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such preliminary valuations for each portfolio company or investment are compared to a valuation range that is obtained from an independent third-party valuation service;

FS/EIG Advisor then provides the valuation committee of our board of trustees, or the valuation committee, its valuation recommendation for each portfolio company or investment, along with supporting materials;

preliminary valuations are then discussed with the valuation committee;

the valuation committee reviews the preliminary valuations and FS/EIG Advisor, together with our independent third-party valuation services, if applicable, supplements the preliminary valuations to reflect any comments provided by the valuation committee;

following its review, the valuation committee will recommend that our board of trustees approve our fair valuations; and

our board of trustees discusses the valuations and determines the fair value of each such investment in our portfolio in good faith based on various statistical and other factors, including the input and recommendation of FS/EIG Advisor, the valuation committee and any independent third-party valuation services, if applicable.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements refer to the uncertainty with respect to the possible effect of such valuations and any change in such valuations on our consolidated financial statements. In making its determination of fair value, our board of trustees may use any approved independent third-party pricing or valuation services. However, our board of trustees is not required to determine fair value in accordance with the valuation provided by any single source, and may use any relevant data, including information obtained from FS/EIG Advisor or any approved independent third-party valuation or pricing service that our board of trustees deems to be reliable in determining fair value under the circumstances. Below is a description of factors that FS/EIG Advisor, any approved independent third-party valuation services and our board of trustees may consider when determining the fair value of our investments.
Valuation of fixed income investments, such as loans and debt securities, depends upon a number of factors, including prevailing interest rates for like securities, expected volatility in future interest rates, call features, put features and other relevant terms of the debt. For investments without readily available market prices, we may incorporate these factors into discounted cash flow models to arrive at fair value. Other factors that may be considered include the borrower’s ability to adequately service its debt, the fair market value of the portfolio company in relation to the face amount of its outstanding debt and the quality of collateral securing our debt investments.
For convertible debt securities, fair value generally approximates the fair value of the debt plus the fair value of an option to purchase the underlying security (i.e., the security into which the debt may convert) at the conversion price. To value such an option, a standard option pricing model may be used.
Our equity interests in portfolio companies for which there is no liquid public market are valued at fair value. Our board of trustees, in its determination of fair value, may consider various factors, such as multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. All of these factors may be subject to adjustments based upon the particular circumstances of a portfolio company or our actual investment position. For example, adjustments to EBITDA may take into account compensation to previous owners or acquisition, recapitalization, restructuring or other related items.
FS/EIG Advisor, any approved independent third-party valuation services and our board of trustees may also consider private merger and acquisition statistics, public trading multiples discounted for illiquidity and other factors, valuations implied by third-party investments in the portfolio companies or industry practices in determining fair value. FS/EIG Advisor, any approved independent third-party valuation services and our board of trustees may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, and may apply discounts or premiums, where and as appropriate, due to the higher (or lower) financial risk and/or the smaller size of portfolio companies relative to comparable firms, as well as such other factors as our board of trustees, in consultation with FS/EIG Advisor and any approved independent third-party valuation services, if applicable, may consider relevant in assessing fair value.
 
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Generally, the value of our equity interests in public companies for which market quotations are readily available is based upon the most recent closing public market price. Portfolio securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.
When we receive warrants or other equity securities at nominal or no additional cost in connection with an investment in a debt security, the cost basis in the investment will be allocated between the debt securities and any such warrants or other equity securities received at the time of origination. Our board of trustees subsequently values these warrants or other equity securities received at their fair value.
Swap contracts typically will be valued at their daily prices obtained from an independent third party. The aggregate settlement values and notional amounts of the swap contracts will not be recorded in the statements of assets and liabilities. Fluctuations in the value of the swap contracts will be recorded in the statements of assets and liabilities as gross assets and gross liabilities and in the statements of operations as unrealized appreciation (depreciation) until closed, when they will be recorded as net realized gain (loss).
The fair values of our investments are determined in good faith by our board of trustees. Our board of trustees is solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and consistently applied valuation process. Our board of trustees has delegated day-to-day responsibility for implementing our valuation policy to FS/EIG Advisor, and has authorized FS/EIG Advisor to utilize independent third-party valuation and pricing services that have been approved by our board of trustees. The valuation committee is responsible for overseeing FS/EIG Advisor’s implementation of the valuation process.
See Note 8 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding the fair value of our financial instruments.
Revenue Recognition
Security transactions are accounted for on the trade date. We record interest income on an accrual basis to the extent that we expect to collect such amounts. We record dividend income on the ex-dividend date. Distributions received from limited liability company, or LLC, and limited partnership, or LP, investments are evaluated to determine if the distribution should be recorded as dividend income or a return of capital. We do not accrue as a receivable interest or dividends on loans and securities if we have reason to doubt our ability to collect such income. Our policy is to place investments on non-accrual status when there is reasonable doubt that interest income will be collected. We consider many factors relevant to an investment when placing it on or removing it from non-accrual status including, but not limited to, the delinquency status of the investment, economic and business conditions, the overall financial condition of the underlying investment, the value of the underlying collateral, bankruptcy status, if any, and any other facts or circumstances relevant to the investment. If there is reasonable doubt that we will receive any previously accrued interest, then the interest income will be written-off. Payments received on non-accrual investments may be recognized as income or applied to principal depending upon the collectability of the remaining principal and interest. Non-accrual investments may be restored to accrual status when principal and interest become current and are likely to remain current based on our judgment.
Loan origination fees, original issue discount and market discount are capitalized and we amortize such amounts as interest income over the respective term of the loan or security. Upon the prepayment of a loan or security, any unamortized loan origination fees and original issue discount are recorded as interest income. Structuring and other non-recurring upfront fees are recorded as fee income when earned. We record prepayment premiums on loans and securities as fee income when we earn such amounts.
Net Realized Gains or Losses, Net Change in Unrealized Appreciation or Depreciation and Net Change in Unrealized Gains or Losses on Foreign Currency
Gains or losses on the sale of investments are calculated by using the specific identification method. We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized fees. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any
 
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reversal of previously recorded unrealized gains or losses when gains or losses are realized and the respective unrealized gain or loss on foreign currency for any foreign denominated investments we may hold. Net change in unrealized gains or losses on foreign currency reflects the change in the value of foreign currency held, receivables or accruals during the reporting period due to the impact of foreign currency fluctuations.
Swap Contracts
We enter into swap contracts to economically hedge against the variability in cash flows associated with the sale of future crude oil and natural gas production. While the use of these derivative instruments limits the downside risk of adverse price movements, their use also limits future revenues from upward price movements. Our fixed price swaps are settled monthly based on differences between the fixed price specified in the contract and the referenced settlement price. When the referenced settlement price is less than the price specified in the contract, we receive an amount from the counterparty based on the price difference multiplied by the volume. Similarly, when the referenced settlement price exceeds the price specified in the contract, we pay the counterparty an amount based on the price difference multiplied by the volume.
Uncertainty in Income Taxes
We evaluate our tax positions to determine if the tax positions taken meet the minimum recognition threshold in connection with accounting for uncertainties in income tax positions taken or expected to be taken for the purposes of measuring and recognizing tax benefits or liabilities in our consolidated financial statements. Recognition of a tax benefit or liability with respect to an uncertain tax position is required only when the position is “more likely than not” to be sustained assuming examination by taxing authorities. We recognize interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in our consolidated statements of operations. During the years ended December 31, 2019, 2018 and 2017, we did not incur any interest or penalties.
See Note 2 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our significant accounting policies.
Contractual Obligations
We have entered into an agreement with FS/EIG Advisor to provide us with investment advisory and administrative services. Payments for investment advisory services under the FS/EIG investment advisory agreement are equal to 1.75% of the average weekly value of our gross assets and an incentive fee based on our performance. Base management fees are paid on a quarterly basis in arrears. FS/EIG Advisor agreed to waive incentive fees on income for the period of twelve months ended December 31, 2018. See Note 4 to our consolidated financial statements contained in this annual report on Form 10-K for a discussion of this agreement and for the amount of fees and expenses accrued under these agreements during the years ended December 31, 2019, 2018 and 2017.
A summary of our significant contractual payment obligations for the repayment of outstanding indebtedness at December 31, 2019 is as follows:
Payments Due By Period
Maturity Date(1)
TotalLess than
1 year
1 – 3 years3 – 5 yearsMore than
5 years
Goldman Facility(2)
December 2, 2022$425,000$425,000
JPMorgan Facility(3)
February 16, 2023$311,667$311,667
Senior Secured Notes(4)
August 15, 2023$500,000$500,000
(1)
Amounts outstanding under the financing arrangements will mature, and all accrued and unpaid interest thereunder will be due and payable, on the maturity date.
(2)
At December 31, 2019, $50,000 remained unused under the financing arrangement.
(3)
At December 31, 2019, $383,333 remained unused under the financing arrangement.
(4)
At December 31, 2019, no amounts remained unused under the financing arrangement.
 
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Off-Balance Sheet Arrangements
We currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk.
We are subject to financial market risks, including changes in interest rates. As of December 31, 2019, 47.4% of our portfolio investments (based on fair value) paid variable interest rates, 25.7% paid fixed interest rates, 20.3% were income producing preferred equity and equity/other investments and the remainder (6.6%) consisted of non-income producing preferred equity and equity/other investments. A rise in the general level of interest rates can be expected to lead to higher interest rates applicable to the variable rate investments we hold and to declines in the value of any fixed rate investments we hold. However, many of our variable rate investments provide for an interest rate floor, which may prevent our interest income from increasing until benchmark interest rates increase beyond a threshold amount. To the extent that a substantial portion of our investments may be in variable rate investments, an increase in interest rates beyond this threshold would make it easier for us to meet or exceed the hurdle rate applicable to the subordinated incentive fee on income and may result in a substantial increase in our net investment income and to the amount of incentive fees payable to FS/EIG Advisor with respect to our increased pre-incentive fee net investment income.
Pursuant to the terms of each credit facility and financing arrangement, all credit facilities and financing arrangements, with the exception of the Senior Secured Notes, borrow at a floating rate based on a benchmark interest rate. Under the indenture governing the Senior Secured Notes, we pay interest to the holders of such notes at a fixed rate. To the extent that any present or future credit facilities or other financing arrangements that we or any of our subsidiaries enter into are based on a floating interest rate, we will be subject to risks relating to changes in market interest rates. In periods of rising interest rates when we or our subsidiaries have such debt outstanding or financing arrangements in effect, our interest expense would increase, which could reduce our net investment income, especially to the extent we hold fixed rate investments.
The following table shows the effect over a twelve-month period of changes in interest rates on our interest income, interest expense and net interest income, assuming no changes in the composition of our investment portfolio, including the accrual status of our investments, and our borrowing arrangements in effect as of December 31, 2019 (dollar amounts are presented in thousands):
Basis Point Change in Interest RatesIncrease
(Decrease)
in Interest
Income
Increase
(Decrease)
in Interest
Expense
Increase
(Decrease) in
Net Interest
Income
Percentage
Change in
Net Interest
Income
Down 100 basis points$(13,726)$(7,857)$(5,869)(2.3)%
No Change
Up 100 basis points$16,535$7,857$8,6783.5%
Up 300 basis points$50,324$23,570$26,75410.7%
Up 500 basis points$84,113$39,283$44,83017.9%
We expect that our long-term investments will be financed primarily with equity and debt. If deemed prudent, we may use interest rate risk management techniques in an effort to minimize our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations. During the years ended December 31, 2019, 2018 and 2017, we did not engage in interest rate hedging activities.
In addition, we may have risks regarding portfolio valuation and the potential inability of counterparties to meet the terms of their contracts. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Valuation of Portfolio Investments.”
 
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. In connection with the preparation of our annual financial statements, management has conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this evaluation, we have concluded that, as of December 31, 2019, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting as of December 31, 2019 has been audited by our independent registered public accounting firm.
 
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of
FS Energy and Power Fund
Philadelphia, Pennsylvania
Opinion on the Internal Control Over Financial Reporting
We have audited FS Energy and Power Fund’s (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets, including the consolidated schedules of investments, of FS Energy and Power Fund as of December 31, 2019 and 2018, and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2019 and our report dated April 9, 2020 expressed an unqualified opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ RSM US LLP
Blue Bell, Pennsylvania
April 9, 2020
 
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of
FS Energy and Power Fund
Philadelphia, Pennsylvania
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets, including the consolidated schedules of investments, of FS Energy and Power Fund (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 2019, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of FS Energy and Power Fund as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), FS Energy and Power Fund’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated April 9, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our procedures included confirmation of securities owned as of December 31, 2019 and 2018 by correspondence with the custodians and brokers or by other appropriate auditing procedures where replies from brokers were not received. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the auditor of one or more FS Investments investment companies since 2007.
Blue Bell, Pennsylvania
April 9, 2020
 
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FS Energy and Power Fund
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
December 31,
20192018
Assets
Investments, at fair value
Non-controlled/unaffiliated investments (amortized cost—$3,399,611 and $3,339,313,
respectively)
$3,108,039$3,099,252
Non-controlled/affiliated investments (amortized cost—$698,631 and $881,726, respectively)374,598622,700
Controlled/affiliated investments (amortized cost—$27,464 and $27,464, respectively)
Total investments, at fair value (amortized cost—$4,125,706 and $4,248,503 respectively)3,482,6373,721,952
Cash149,75297,839
Restricted cash667667
Receivable for investments sold and repaid72915,974
Swap income receivable395854
Unrealized appreciation on swap contracts6,83120,521
Interest receivable33,50733,339
Prepaid expenses and other assets2662,370
Total assets$3,674,784$3,893,516
Liabilities
Payable for investments purchased$28,518$91,894
Credit facilities payable (net of deferred financing costs of  $6,370 and $6,465, respectively)(1)
730,297625,202
Secured note payable (net of deferred financing costs of  $7,344 and $9,146, respectively)(1)
485,313481,485
Shareholder distributions payable10,2409,036
Management fees payable15,58216,406
Administrative services expenses payable507498
Interest payable16,56716,228
Swap income payable225
Unrealized depreciation on swap contracts280867
Trustees’ fees payable192183
Other accrued expenses and liabilities7,6833,306
Total Liabilities1,295,1791,245,330
Commitments and contingencies ($28,104 and $28,104, respectively)(2)
Shareholders’ equity
Preferred shares, $0.001 par value, 50,000,000 shares authorized, none issued and outstanding
Common shares, $0.001 par value, 700,000,000 shares authorized, 438,477,007 and 440,451,167 shares issued and outstanding, respectively438440
Capital in excess of par value3,610,5333,746,792
Accumulated earnings (deficit)(1,231,366)(1,099,046)
Total shareholders’ equity2,379,6052,648,186
Total liabilities and shareholders’ equity$3,674,784$3,893,516
Net asset value per common share at year end$5.43$6.01
(1)
See Note 9 for a discussion of the Company’s financing arrangements.
(2)
See Note 10 for a discussion of the Company’s commitments and contingencies.
See notes to consolidated financial statements.
76

 
FS Energy and Power Fund
Consolidated Statements of Operations
(in thousands, except share and per share amounts)
Year Ended December 31,
201920182017
Investment income
From non-controlled/unaffiliated investments:
Interest income$292,728$258,862$272,881
Paid-in-kind interest income34,2287,87821,463
Fee income3,03115,64540,519
Dividend income279188
From non-controlled/affiliated investments:
Interest income29,91347,02971,719
Paid-in-kind interest income1,0742,28511,518
Fee income4,6572,091656
Total investment income365,910333,978418,756
Operating expenses
Management fees68,52670,07588,938
Subordinated income incentive fees(1)
10,499
Administrative services expenses4,7603,7172,829
Share transfer agent fees2,7482,6082,723
Accounting and administrative fees1,1061,3181,608
Interest expense(2)
88,36466,68149,286
Trustees’ fees7621,004996
Other general and administrative expenses3,8524,6283,705
Total operating expenses170,118150,031160,584
Less: Management fee offset(3)
(5,992)(1,276)
Less: Expense reimbursement from sponsor(4)
(31,260)
Add: Expense reimbursement due to sponsor(4)
2,858
Net expenses164,126148,755132,182
Net investment income201,784185,223286,574
Realized and unrealized gain/loss
Net realized gain (loss) on investments:
Non-controlled/unaffiliated(121,361)(94,085)(88,725)
Non-controlled/affiliated6,615(6,829)(2,358)
Net realized gain (loss) on swap contracts5,4531,165
Net realized gain (loss) on foreign currency1
Net change in unrealized appreciation (depreciation) on investments:
Non-controlled/unaffiliated(51,511)(30,914)(88,210)
Non-controlled/affiliated(65,007)(134,576)(218,472)
Controlled/affiliated(1,831)
Net change in unrealized appreciation (depreciation) on swap contracts(13,103)19,654
Net change in unrealized gain (loss) on foreign currency72051
Total net realized and unrealized gain (loss)(238,907)(245,565)(399,544)
Net increase (decrease) in net assets resulting from operations$(37,123)$(60,342)$(112,970)
Per share information—basic and diluted
Net increase (decrease) in net assets resulting from operations (Earnings
per Share)
$(0.08)$(0.14)$(0.26)
Weighted average shares outstanding437,167,745438,963,491442,570,942
(1)
See Note 2 and Note 4 for a discussion of the methodology employed by the Company in calculating the subordinated income incentive fees.
(2)
See Note 9 for a discussion of the Company’s financing arrangements.
(3)
See Note 4 for a discussion of the offset by FS/EIG Advisor, LLC, the Company’s investment adviser, of certain management fees to which it was otherwise entitled during the applicable period.
(4)
See Note 4 for a discussion of expense reimbursements paid to the Company by its former investment adviser and affiliates and recoupment of such amounts paid by the Company to its former investment adviser and affiliates.
See notes to consolidated financial statements.
77

 
FS Energy and Power Fund
Consolidated Statements of Changes in Net Assets
(in thousands)
Year Ended December 31,
201920182017
Operations
Net investment income$201,784$185,223$286,574
Net realized gain (loss) on investments, swap contracts and foreign currency(109,293)(99,749)(91,082)
Net change in unrealized appreciation (depreciation) on investments(116,518)(165,490)(308,513)
Net change in unrealized appreciation (depreciation) on swap contracts(13,103)19,654
Net change in unrealized gain (loss) on foreign currency72051
Net increase (decrease) in net assets resulting from operations(37,123)(60,342)(112,970)
Shareholder distributions(1)
Distributions to shareholders(218,187)(219,047)(311,103)
Distributions representing return of capital(1,591)
Net decrease in net assets resulting from shareholder
distributions
(218,187)(219,047)(312,694)
Capital share transactions(2)
Reinvestment of shareholder distributions101,727118,191186,471
Repurchases of common shares(114,998)(156,658)(143,659)
Net increase (decrease) in net assets resulting from capital share transactions(13,271)(38,467)42,812
Total increase (decrease) in net assets(268,581)(317,856)(382,852)
Net assets at beginning of year2,648,1862,966,0423,348,894
Net assets at end of year$2,379,605$2,648,186$2,966,042
(1)
See Note 5 for a discussion of the sources of distributions paid by the Company.
(2)
See Note 3 for a discussion of the Company’s capital share transactions.
See notes to consolidated financial statements.
78

 
FS Energy and Power Fund
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
201920182017
Cash flows from operating activities
Net increase (decrease) in net assets resulting from operations$(37,123)$(60,342)$(112,970)
Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by (used in) operating activities:
Purchases of investments(1,111,384)(1,768,663)(1,757,630)
Paid-in-kind interest(35,302)(10,163)(32,981)
Proceeds from sales and repayments of investments1,184,1311,802,0431,327,660
Net realized (gain) loss on investments114,746100,91491,083
Net change in unrealized (appreciation) depreciation on investments116,518165,490308,513
Net change in unrealized (appreciation) depreciation on swap contracts13,103(19,654)
Accretion of discount(29,394)(14,868)(22,910)
Amortization of deferred financing costs and discount6,1234,2173,689
(Increase) decrease in receivable for investments sold and repaid15,24550,363(66,315)
(Increase) decrease in interest receivable(168)17,954(13,436)
(Increase) decrease in expense reimbursement due from sponsor(1)
5,945(5,945)
(Increase) decrease in swap income receivable459(854)
(Increase) decrease in prepaid expenses and other assets2,104(2,315)(40)
Increase (decrease) in payable for investments purchased(63,376)3,86181,987
Increase (decrease) in management fees payable(824)(5,428)979
Increase (decrease) in administrative services expense payable9137(1,116)
Increase (decrease) in swap income payable(225)225
Increase (decrease) in interest payable(2)
33910,1951,705
Increase (decrease) in trustees’ fees payable9(69)2
Increase (decrease) in other accrued expenses and liabilities4,377(1,515)377
Net cash provided by (used in) operating activities179,367277,473(197,348)
Cash flows from financing activities
Repurchases of common shares(114,998)(156,658)(143,659)
Shareholder distributions paid(115,256)(102,758)(124,759)
Borrowings under credit facilities(2)
580,000321,667878,263
Borrowings under secured notes(2)
489,865
Repayments of credit facilities(2)
(475,000)(910,000)(206,928)
Repayments of repurchase facility(2)
(325,000)
Deferred financing costs paid(2,200)(16,459)(2,713)
Net cash provided by financing activities(127,454)(374,343)75,204
Total increase (decrease) in cash51,913(96,870)(122,144)
Cash and restricted cash at beginning of year(3)
98,506195,376317,520
Cash and restricted cash at end of year(3)
$150,419$98,506$195,376
Supplemental disclosure
Reinvestment of shareholder distributions$101,727$118,191$186,471
Non-cash purchases of investments$(128,941)$(146,371)$(103,988)
Non-cash sales of investments$128,941$146,371$103,988
(1)
See Note 4 for a discussion of expense reimbursements payable to the Company by its former investment adviser and affiliates.
(2)
See Note 9 for a discussion of the Company’s credit facilities. During the years ended December 31, 2019, 2018 and 2017, the Company paid $81,902, $52,269 and $38,938, respectively, in interest expense on the credit facilities and $0, $0 and $4,954, respectively, in interest expense pursuant to the repurchase agreement.
(3)
Balance includes cash of $149,752 and restricted cash of  $667 for the year ended December 31, 2019 and cash of  $97,839 and restricted cash of  $667 for the for the year ended December 31, 2018. Restricted cash is the cash collateral required to be posted pursuant to the Company’s swap contracts.
See notes to consolidated financial statements.
79

 
FS Energy and Power Fund
Consolidated Schedule of Investments 
As of December 31, 2019
(in thousands, except share amounts)
Portfolio Company(a)
FootnotesIndustry
Rate(b)
FloorMaturity
Principal
Amount(c)
Amortized
Cost
Fair
Value(d)
Senior Secured Loans—First Lien—47.7%
AIRRO (Mauritius) Holdings II(k)(p)(w)PowerL+6951.5%7/24/25$18,186$15,534$15,378
AIRRO (Mauritius) Holdings II(e)(k)(p)(w)PowerL+6951.5%7/24/2517,05517,05514,421
Allied Wireline Services, LLC(w)(x)Service & EquipmentL+9501.5%6/30/20102,718102,65792,960
ARB Midstream Operating Company, LLC(w)(x)MidstreamL+7251.0%11/6/213,1933,1833,186
Bellatrix Exploration Ltd.(k)(w)Upstream10.0%3/31/207,8797,8797,879
Bellatrix Exploration Ltd.(e)(k)(w)Upstream10.0%3/31/203,3773,3773,377
Bioenergy Infrastructure Holdings Limited(k)(w)PowerL+7251.0%12/22/22909904912
Bioenergy Infrastructure Holdings Limited(e)(k)(w)PowerL+7251.0%12/22/22543543545
Bioenergy Infrastructure Holdings Limited(e)(k)(w)PowerL+7251.0%12/22/22544544546
Birch Permian LLC(h)(w)UpstreamL+8001.5%4/12/2341,53141,17641,436
Birch Permian LLC(e)(w)UpstreamL+8001.5%4/12/238,3338,3338,314
BL Sand Hills Unit, L.P.(m)(o)(w)(x)(z)UpstreamPrime+6503.5%12/17/2119,20016,674288
Brazos Delaware II LLC(h)MidstreamL+4005/21/2563,65660,35754,744
Cimarron Energy Inc.(w)(x)Service & Equipment10.0%6/30/217,5007,5007,472
Cox Oil Offshore, LLC, Volumetric Production
Payments
(v)(w)(x)(y)Upstream6.6%12/31/23100,00063,88463,646
CPV Shore Holdings LLCPowerL+37512/29/251,0891,0801,098
Edgewater Generation LLCPowerL+37512/13/252,8852,8792,775
EIF Van Hook Holdings, LLC(h)MidstreamL+5259/5/2434,52133,73932,967
EPIC Crude Services LP(h)MidstreamL+5003/2/269,5009,3279,183
Felix Investments Holdings II, LLC(w)UpstreamL+6501.0%8/9/225,9005,8785,959
FR BR Holdings LLC(h)(w)MidstreamL+65012/14/2389,23384,66986,770
LMBE-MC Holdco II LLCPowerL+4001.0%12/3/251,7121,6931,703
Lower Cadence Holdings LLC(f)(h)MidstreamL+4005/22/2618,95717,82718,803
Lusk Operating LLC(m)(o)(w)(aa)UpstreamPrime+500 PIK (8.8% Max PIK)3.3%1/31/2029,29727,464
Luxe Drillship Operating, LLC(w)Upstream8.0%10/30/2417,14316,11515,819
Luxe Drillship Operating, LLC(e)(w)Upstream8.0%10/30/2432,85732,85730,321
MB Precision Holdings LLC(w)(x)(z)IndustrialsL+725, 2.3% PIK (2.3% Max PIK)1.3%1/23/214,6024,4924,585
MECO IV LLC(h)(w)UpstreamL+7251.5%9/14/2135,00034,84934,405
Navitas Midstream Midland Basin LLC(h)MidstreamL+4501.0%12/13/2477,89576,81573,416
Navitas Midstream Midland Basin LLC (Mirror
Tranche)
MidstreamL+4501.0%12/13/2439,80038,14137,512
NNE Holding LLC(h)(w)UpstreamL+8003/2/2240,00039,93839,492
Panda Hummel Station LLCPowerL+6001.0%10/27/2219,15018,66817,060
Panda Hummel Station LLC(h)PowerL+6001.0%10/27/2224,22723,80221,582
Panda Stonewall LLC(f)(h)PowerL+5501.0%11/13/2153,44753,07049,791
Panda Stonewall LLC(h)PowerL+5501.0%11/13/2121,37220,81319,910
Permian Production Partners LLC(h)(m)(o)(w)(x)UpstreamL+6001.0%5/18/2444,49843,18428,648
Plainfield Renewable Energy Holdings LLC(w)Power10.0%8/22/252,8552,8552,569
Plainfield Renewable Energy Holdings LLC, Letter of
Credit
(e)(w)Power10.0%8/22/232,7092,7092,437
See notes to consolidated financial statements.
80

 
FS Energy and Power Fund
Consolidated Schedule of Investments (Continued)
As of December 31, 2019
(in thousands, except share amounts)
Portfolio Company(a)
FootnotesIndustry
Rate(b)
FloorMaturity
Principal
Amount(c)
Amortized
Cost
Fair
Value(d)
Plainfield Renewable Energy Holdings LLC(w)Power15.5%8/22/25$10,397$10,397$10,441
Power Distribution, Inc.(w)(x)PowerL+7251.3%1/25/2327,89127,89125,982
Prairie ECI Acquiror LP(f)MidstreamL+4753/11/2617,99117,61517,901
Sandy Creek Energy Associates, L.P.(f)PowerL+4001.0%11/9/2072,66666,55362,054
Swift Worldwide Resources US Holdings Corp.(h)(w)(x)Service & Equipment9.5%, L+150 PIK (L+1.5% Max PIK)2.5%7/20/2159,90159,90159,901
Terra-Gen Finance Co LLCPowerL+4251.0%12/9/2125,18523,92224,429
Traverse Midstream Partners LLC(h)MidstreamL+4001.0%9/27/2460,27360,28354,728
Ultra Resources, Inc.UpstreamL+375, 0.25% PIK (0.25% Max PIK)1.0%4/12/2467,40557,06640,542
Warren Resources, Inc.(h)(w)(z)UpstreamL+1000, 0.0% PIK (1.0% Max PIK)1.0%5/22/2027,50727,50727,507
Waterbridge Operating LLC(h)MidstreamL+5751.0%6/22/2624,93824,34824,595
Total Senior Secured Loans—First Lien1,317,9471,199,989
Unfunded Loan Commitments(65,418)(65,418)
Net Senior Secured Loans—First Lien1,252,5291,134,571
Senior Secured Loans—Second Lien—23.7%
Aethon III BR LLC(w)UpstreamL+6751.0%1/10/2510,0009,8689,956
Aethon United BR LP(h)(w)UpstreamL+6751.0%9/8/23148,150146,582146,298
Arena Energy, LP(h)(w)(x)UpstreamL+900, 4.0% PIK (4.0% Max PIK)1.0%1/24/21116,730116,730113,575
Bellatrix Exploration Ltd.(k)(w)Upstream8.5%9/11/2322,51122,51122,511
Bellatrix Exploration Ltd.(k)(m)(o)(w)(x)Upstream8.5%9/11/2354,10849,37917,168
Chisholm Oil and Gas Operating, LLC(w)(x)UpstreamL+550, 3.0% PIK (3.0% Max PIK)1.3%3/21/24197,503196,000149,201
Chisholm Energy Holdings, LLC(w)UpstreamL+6251.5%5/15/2621,42921,23021,090
Chisholm Energy Holdings, LLC(e)(w)UpstreamL+6251.5%5/15/268,5718,5718,436
Encino Acquisition Partners Holdings LLCUpstreamL+6751.0%10/29/2541,82835,33431,579
Peak Exploration & Production, LLC(w)UpstreamL+6751.5%11/16/2313,54513,48413,435
Peak Exploration & Production, LLC(e)(w)UpstreamL+6751.5%11/16/231,5051,5051,493
Penn Virginia Holdings Corp.(h)(k)(w)UpstreamL+7001.0%9/29/2220,00020,00019,726
Rosehill Operating Company, LLC(w)(x)Upstream10.0%1/31/231,6671,6551,619
SilverBow Resources, Inc.(h)(k)(w)UpstreamL+7501.0%12/15/2419,00018,85318,802
Titan Energy Operating, LLC(m)(o)(w)(x)(z)UpstreamL+1300 PIK (L+1300 Max PIK)1.0%2/23/20137,233100,902
Total Senior Secured Loans—Second Lien762,604574,889
Unfunded Loan Commitments(10,076)(10,076)
Net Senior Secured Loans—Second Lien752,528564,813
Senior Secured Bonds—22.0%
Black Swan Energy Ltd.(h)(k)(w)(x)Upstream9.0%1/20/2490,00090,00091,692
Denbury Resources Inc.(k)Upstream7.5%2/15/2412,00011,99510,260
Denbury Resources Inc.(k)Upstream9.3%3/31/2242,34142,13940,024
FourPoint Energy, LLC(h)(w)(x)(z)Upstream9.0%12/31/21235,125231,597223,369
Talen Energy Supply LLC(h)Power7.3%5/15/2734,31934,04236,176
Velvet Energy Ltd.(h)(k)(w)Upstream9.0%10/5/23120,000120,000122,700
Total Senior Secured Bonds529,773524,221
See notes to consolidated financial statements.
81

 
FS Energy and Power Fund
Consolidated Schedule of Investments (Continued)
As of December 31, 2019
(in thousands, except share amounts)
Portfolio Company(a)
FootnotesIndustry
Rate(b)
FloorMaturity
Principal
Amount(c)
Amortized
Cost
Fair
Value(d)
Unsecured Debt—13.6%
Ferrellgas, L.P.Midstream6.5%5/1/21$    24,729$22,296$21,462
Ferrellgas, L.P.Midstream6.8%1/15/2225,02022,13721,337
Global Jet Capital Holdings, LP(w)(x)Industrials15.0% PIK (15.0% Max PIK)1/30/251,1451,0671,145
Global Jet Capital Holdings, LP(w)(x)Industrials15.0% PIK (15.0% Max PIK)4/30/257,2766,7797,276
Global Jet Capital Holdings, LP(w)(x)Industrials15.0% PIK (15.0% Max PIK)9/3/251,5031,4011,503
Global Jet Capital Holdings, LP(w)(x)Industrials15.0% PIK (15.0% Max PIK)9/29/251,4151,3191,415
Global Jet Capital Holdings, LP(w)(x)Industrials15.0% PIK (15.0% Max PIK)12/2/261,2451,1601,245
Great Western Petroleum, LLC(w)(x)Upstream8.5%4/15/2513,63613,10111,966
Great Western Petroleum, LLC(x)Upstream9.0%9/30/2135,83035,76432,129
Hammerhead Resources Inc.(k)(w)(x)Upstream9.0%7/10/22100,00098,29996,750
Lonestar Resources America Inc.(x)Upstream11.3%1/1/2337,50038,31025,781
Martin Midstream Partners L.P.(k)(x)Midstream7.3%2/15/2112,72312,45311,615
Moss Creek Resources, LLC(x)Upstream7.5%1/15/2642,69340,47332,566
Oasis Petroleum Inc.(k)Upstream6.9%3/15/222,0001,9461,930
Oasis Petroleum Inc.(k)Upstream6.9%1/15/2311,85011,08511,613
Talen Energy Supply LLCPower9.5%7/15/2210,36510,44210,371
Tenrgys, LLC(m)(n)(o)(w)(x)UpstreamL+9002.5%12/23/1875,00075,00028,000
Whiting Petroleum Corp.(k)Upstream5.8%3/15/215,3955,2015,116
Total Unsecured Debt398,233323,220
Number of
Shares 
Amortized
Cost 
Fair
Value(d)  
Preferred Equity—30.4%(l)
Abaco Energy Technologies LLC, Preferred Equity(o)(w)(x)Service & Equipment28,942,0031,44711,982
Altus Midstream LP, Series A Preferred Units(j)(w)(x)Midstream11.0%   6/28/2651,05352,18553,095
Global Jet Capital Holdings, LP, Preferred Equity(o)(w)(x)Industrials27,8562,786348
Great Western Petroleum, LLC, Preferred Equity(n)(w)(x)Upstream15.5%12/31/2736,36442,30639,332
Limetree Bay Ventures, LLC, Preferred Equity(w)(x)Midstream13.5%11/27/2383,877,49784,15572,831
Limetree Bay Ventures, LLC, Preferred Equity(w)(x)Midstream13.5%11/27/2342,402,61142,40335,489
MB Precision Investment Holdings LLC, Class A
Preferred Units
(n)(o)(w)(x)(z)Industrials8,952,6231,8801,205
NGL Energy Partners, LP, Preferred Equity(k)(w)(x)Midstream14.2%7/2/27156,250155,770159,198
NuStar, Preferred Equity(h)(k)(w)(x)Midstream12.8%6/29/285,910,165150,836178,842
Rosehill Resources, Inc. Preferred Equity(o)(w)(x)Upstream2,5362,5112,709
Segreto Power Holdings, LLC, Preferred Equity(g)(w)(x)Power13.1%5/8/2570,29783,41882,311
TE Holdings, LLC, Preferred Equity(o)(x)Upstream1,475,53114,734
USA Compression Partners, LP, Preferred Equity(h)(k)(w)(x)Midstream9.8%4/3/2879,33677,45284,500
Total Preferred Equity   711,883   721,842
See notes to consolidated financial statements.
82

 
FS Energy and Power Fund
Consolidated Schedule of Investments (Continued)
As of December 31, 2019
(in thousands, except share amounts)
Portfolio Company(a)
FootnotesIndustryNumber of
Shares
Amortized
Cost
Fair
Value(d)
Equity/Other—9.0%(l)
Abaco Energy Technologies LLC, Common Equity(o)(w)(x)Service & Equipment6,944,444$6,944$2,167
AIRRO (Mauritius) Holdings II, Warrants(k)(o)(p)(w)Power352,6521,129
Allied Downhole Technologies, LLC, Common Equity(n)(o)(w)(x)Service & Equipment7,431,1137,223372
Allied Downhole Technologies, LLC, Warrants(n)(o)(w)(x)Service & Equipment5,344,6801,865267
Ascent Resources Utica Holdings, LLC, Common Equity(o)(q)(w)(x)Upstream148,692,90844,70039,404
Bellatrix Exploration Ltd., Warrants(k)(o)(w)Upstream1,533,197
BL Sand Hills Unit, L.P., Net Profits Interest(o)(s)(w)(x)(z)UpstreamN/A5,180
BL Sand Hills Unit, L.P., Overriding Royalty Interest(o)(s)(w)(x)(z)UpstreamN/A740
BL Sand Hills Unit, L.P., Series A Units(g)(o)(w)(x)(z)Upstream29,11724,019
Chisholm Oil and Gas, LLC, Series A Units(g)(o)(w)(x)Upstream14,700,00014,700
Cimarron Energy Holdco Inc., Common Equity(o)(w)(x)Service & Equipment4,302,2933,950277
Cimarron Energy Holdco Inc., Participation Option(o)(w)(x)Service & Equipment25,000,0001,2891,613
FourPoint Energy, LLC, Common Equity, Class C-II-A Units(n)(o)(w)(x)(z)Upstream66,00066,0006,906
FourPoint Energy, LLC, Common Equity, Class D Units(n)(o)(w)(x)(z)Upstream12,3748,1761,307
FourPoint Energy, LLC, Common Equity, Class E-II Units(g)(o)(w)(x)(z)Upstream150,93737,73415,793
FourPoint Energy, LLC, Common Equity, Class E-III Units(g)(n)(o)(w)(x)(z)Upstream222,75055,68823,306
Harvest Oil & Gas Corp., Common Equity(o)(x)(z)Upstream1,350,62020,2598,644
JSS Holdco, LLC, Net Profits Interest(o)(w)(x)IndustrialsN/A156
Limetree Bay Ventures, LLC, Common Equity(o)(w)(x)Midstream106,3633,406
Lusk Operating LLC, Common Equity(o)(r)(w)(aa)Upstream2,000
Luxe Drillship Operating, LLC, Overriding Royalty Interest(o)(w)UpstreamN/A1,3541,354
MB Precision Investment Holdings LLC, Class A-2 Units(n)(o)(w)(z)Industrials1,426,110490
NGL Energy Partners, LP, Warrants (Par)(k)(o)(w)Midstream2,187,5003,0832,142
NGL Energy Partners, LP, Warrants (Premium)(k)(o)(w)(x)Midstream3,125,0002,6231,924
NGL Energy Partners, LP, Warrants (Premium)(k)(o)(w)Midstream781,250576