PROSPECTUS SUPPLEMENT
(To Prospectus dated December 19, 2001)

Filed Pursuant to Rule 497 Registration
Statement No. 333-67336

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      All of the 409,837 shares of the common stock, par value $.0001 per share, of Allied Capital Corporation are being issued and sold by us to an institutional investor at negotiated purchase prices for total offering proceeds to the Company of $10 million.

      These negotiated purchase prices, per share, are equal to the Volume Weighted Average Price on the New York Stock Exchange, as reported by Bloomberg L.P. using the AQR function for the shares (the “Average Trading Price”), less a discount of 3% (the “Purchase Price”), for each of the thirteen trading days during the period from December 3, 2001 to December 19, 2001 (the “Investment Period”).

      The total number of shares offered hereby equals the aggregate number of shares resulting from:

	(i)	the allocation of the purchaser’s proposed aggregate investment of $10 million on a pro rata basis over the Investment Period; and

	(ii)	the purchase, on each day during the Investment Period on which the Average Trading Price exceeds $22.00 (the “Threshold Price”) or on which the Average Trading Price is below the Threshold Price and the purchaser chooses to purchase shares at the Threshold Price, of the maximum number of whole shares at the Purchase Price. Since no dividend was paid on the shares issued as part of this transaction, the price paid was reduced by $0.15 for each of the seven business days prior to the ex-dividend date within the Investment Period to adjust the prices, which assumed receipt of the dividend, for these days.

This results in the purchase of a total of 409,837 shares at an average purchase price per share of $24.40.

      Our common stock is traded on the New York Stock Exchange under the symbol “ALD.” On December 19, 2001, the last reported sales price for the common stock was $25.24.

      We are an internally managed closed-end management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended. Our investment objective is to achieve current income and capital gains.

      Please read this prospectus supplement, and the accompanying prospectus, before investing, and keep it for future reference. It contains important information about the Company. To learn more about the Company, you may want to look at the Statement of Additional Information dated December 19, 2001 (known as the “SAI”). For a free copy of the SAI, contact us at Allied Capital Corporation, 1919 Pennsylvania Avenue, N.W., Washington, DC 20006, 1-888-253-0512. We have filed the SAI with the U.S. Securities and Exchange Commission and have incorporated it by reference into the prospectus. The SAI’s table of contents appears on page B-1 of the prospectus. The Commission maintains an Internet website (http://www.sec.gov) that contains the SAI, material incorporated by reference and other information about the Company.

      You should review the information including the risk of leverage, set forth under “Risk Factors” on page 8 of the prospectus, before investing in common stock of the Company.

      Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus supplement or the prospectus. Any representation to the contrary is a criminal offense.

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December 19, 2001

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      We have not authorized any dealer, salesperson or other person to give any information or to make any representation other than those contained or incorporated by reference in this prospectus supplement or the prospectus. You must not rely upon any information or representation not contained or incorporated by reference in this prospectus supplement or the prospectus as if we had authorized it. This prospectus supplement and the prospectus do not constitute an offer to sell or a solicitation of any offer to buy any security other than the registered securities to which they relate, nor do they constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such an offer or solicitation in such jurisdiction. The information contained in this prospectus supplement and the prospectus is accurate as of the dates on their covers.

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TABLE OF CONTENTS

		Page
Prospectus Supplement
Fees and Expenses			S-1
Use of Proceeds			S-2
Plan of Distribution			S-2
Prospectus
Prospectus Summary			1
Selected Consolidated Financial Data			5
Risk Factors			8
The Company			14
Use of Proceeds			14
Price Range of Common Stock and Distributions			15
Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Senior Securities			37
Business			41
Portfolio Companies			53
Determination of Net Asset Value			59
Management			60
Tax Status			67
Certain Government Regulations			72
Dividend Reinvestment Plan			74
Description of Securities			76
Plan of Distribution			80
Legal Matters			81
Safekeeping, Transfer and Dividend Paying Agent and Registrar			81
Independent Public Accountants			81
Table of Contents of Statement of Additional Information			82
Index to Financial Statements			83

      Information contained or incorporated by reference in this prospectus supplement, and the prospectus, may contain “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology. The matters described in “Risk Factors” in the prospectus and certain other factors noted throughout this prospectus supplement and the prospectus, and in any exhibits to the registration statement of which this prospectus supplement and the prospectus are a part, constitute cautionary statements identifying important factors with respect to any such forward-looking statements, including certain risks and uncertainties, that could cause actual results to differ materially from those in such forward-looking statements. In this prospectus supplement and the prospectus, unless otherwise indicated, the “Company”, “we”, “us” or “our” refer to Allied Capital Corporation and its subsidiaries.

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FEES AND EXPENSES

      This table describes the various costs and expenses that an investor in the Company will bear directly or indirectly.

Shareholder Transaction Expenses
	Privately negotiated transaction (as a percentage of offering price)(1)				3.0%
	Dividend reinvestment plan fees(2)				None
Annual Expenses (as a percentage of consolidated net assets attributable to common shares)(3)
	Operating expenses(4)				3.4%
	Interest payments on borrowed funds(5)				5.1%
		Total annual expenses(6)			8.5%

Example

      The following example, required by the Commission, demonstrates the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in the Company. In calculating the following expense amounts, we assumed we would have no additional leverage and that our operating expenses would remain at the levels set forth in the table above.

		1 Year				3 Years				5 Years				10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return		$	113			$	280			$	447			$	868

      Although the example assumes (as required by the Commission) a 5.0% annual return, our performance will vary and may result in a return of greater or less than 5.0%. In addition, while the example assumes reinvestment of all dividends and distributions at net asset value, participants in the DRIP plan may receive shares that we issue at or above net asset value or purchased by the administrator of the DRIP plan, at the market price in effect at the time, which may be higher than, at, or below net asset value. See “Dividend Reinvestment Plan” in the accompanying prospectus.

The example should not be considered a representation of future expenses, and the actual expenses may be greater or less than those shown.

S-1

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USE OF PROCEEDS

      The net proceeds from the sale of the shares, after deducting estimated expenses of this offering, are approximately $9.95 million. We intend to use the net proceeds from selling shares to finance our Company’s growth and for general corporate purposes, which may include investment in private growth companies, purchase of commercial mortgage-backed securities and acquisitions. We may also repay a portion of our revolving line of credit.

      We raise new equity from time to time using a shelf registration statement. We raise new equity when we have a clear use of proceeds for attractive investment opportunities. Historically, this process has enabled us to raise equity on an accretive basis for existing shareholders.

PLAN OF DISTRIBUTION

      All of the 409,837 shares of common stock, par value $0.0001 per share, that we are offering by this prospectus supplement and the accompanying prospectus are being issued and sold to an institutional investor at negotiated purchase prices for total offering proceeds to the Company of $10 million.

      These negotiated purchase prices, per share, are equal to the Volume Weighted Average Price on the New York Stock Exchange, as reported by Bloomberg L.P. using the AQR function for the shares (the “Average Trading Price”), less a discount of 3.0% (the “Purchase Price”), for each of the thirteen trading days during the period from December 3, 2001 to December 19, 2001 (the “Investment Period”). The total number of shares offered hereby equals the aggregate number of shares resulting from:

	(i)	the allocation of the purchaser’s proposed aggregate investment of $10 million on a pro rata basis over the Investment Period, and
	(ii)	the purchase, on each day during the Investment Period on which the Average Trading Price exceeds $22.00 (the “Threshold Price”) or on which the Average Trading Price is below the Threshold Price and the purchaser chooses to purchase shares at the Threshold Price, of the maximum number of whole shares at the Purchase Price. Since no dividend was paid on the shares issued as part of this transaction, the price paid was reduced by $0.15 for each of the seven business days prior to the ex-dividend date within the Investment Period to adjust the prices, which assumed receipt of the dividend, for these days. This results in the purchase of a total of 409,837 shares at an average purchase price per share of $24.40.

      The net offering proceeds to us, after deduction of estimated offering expenses of approximately $50,000, will be approximately $9.95 million.

S-2

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$300,000,000

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Please read this prospectus, and the accompanying prospectus supplement, if any, before investing, and keep it for future reference. It contains important information about the Company.

To learn more about the Company, you may want to look at the Statement of Additional Information dated December 19, 2001 (known as the “SAI”). For a free copy of the SAI, contact us at:

	Allied Capital Corporation 1919 Pennsylvania Avenue, N.W. Washington, DC 20006 1-888-253-0512

The Company has filed the SAI with the U.S. Securities and Exchange Commission and has incorporated it by reference into this prospectus. The SAI’s table of contents appears on page 82 of this prospectus.

The Commission maintains an Internet website (http://www.sec.gov) that contains the SAI, material incorporated by reference and other information about the Company.

Our common stock is traded on the New York Stock Exchange under the symbol “ALD.” As of December 19, 2001, the last reported sales price on the New York Stock Exchange for the common stock was $25.24.

We may offer, from time to time, up to $300,000,000 of our common stock, par value $0.0001 per share, preferred stock, or debt securities in one or more offerings. All shares of common stock, preferred stock, and debt securities that are offered under this prospectus are collectively referred to herein as the “Securities.”

The Securities may be offered at prices and on terms to be described in one or more supplements to this prospectus. In the case of our common stock, the offering price per share less any underwriting commissions or discounts will not be less than the net asset value per share of our common stock at the time we make the offering.

We are an internally managed closed-end management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended.

Our investment objective is to achieve current income and capital gains. We seek to achieve our investment objective by investing primarily in private businesses in a variety of industries throughout the United States. No assurances can be given that we will continue to achieve our objective.

	You should review the information including the risk of leverage, set forth under “Risk Factors” on page 8 of this prospectus before investing in Securities of the Company.

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	Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representations to the contrary is a criminal offense.

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	This prospectus may not be used to consummate sales of Securities unless accompanied by a prospectus supplement.

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      We have not authorized any dealer, salesman or other person to give any information or to make any representation other than those contained or incorporated by reference in this prospectus or any accompanying supplement to this prospectus. You must not rely upon any information or representation not contained or incorporated by reference in this prospectus or the accompanying prospectus supplement as if we had authorized it. This prospectus and any prospectus supplement do not constitute an offer to sell or a solicitation of any offer to buy any security other than the registered securities to which they relate, nor do they constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such an offer or solicitation in such jurisdiction. The information contained in this prospectus and any prospectus supplement is accurate as of the dates on their covers.

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TABLE OF CONTENTS

		Page
Prospectus Summary			1
Selected Consolidated Financial Data			5
Risk Factors			8
The Company			14
Use of Proceeds			14
Price Range of Common Stock and Distributions			15
Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Senior Securities			37
Business			41
Portfolio Companies			53
Determination of Net Asset Value			59
Management			60
Tax Status			67
Certain Government Regulations			72
Dividend Reinvestment Plan			74
Description of Securities			76
Plan of Distribution			80
Legal Matters			81
Safekeeping, Transfer and Dividend Paying Agent and Registrar			81
Independent Public Accountants			81
Table of Contents of Statement of Additional Information			82
Index to Financial Statements			83

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(i)

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PROSPECTUS SUMMARY

      The following summary contains basic information about this offering. It may not contain all the information that is important to an investor. For a more complete understanding of this offering, we encourage you to read this entire document and the documents to which we have referred.

      In this prospectus or any accompanying prospectus supplement, unless otherwise indicated, the “Company”, “ACC”, “we”, “us” or “our” refer to Allied Capital Corporation and its subsidiaries.

THE COMPANY (Page 14)

      We are a business development company and provide private investment capital to private and undervalued public companies in a variety of different industries throughout the United States. We have been investing in growing businesses for over 40 years and have financed thousands of companies nationwide. Our investment activity is focused in two areas:

	•	private finance, and
	•	commercial real estate finance, primarily the purchase of commercial mortgage-backed securities (“CMBS”).

Our investment portfolio includes:

	•	long-term unsecured loans with equity features,
	•	equity investments in middle-market companies, which may or may not constitute a controlling equity interest,
	•	commercial mortgage-backed securities, and

	•	commercial mortgage loans.

      We identify loans and investments through our numerous relationships with:

	•	mezzanine and private equity investors,
	•	investment banks, and
	•	other intermediaries, including professional services firms.

In order to increase our sourcing and origination activities, we have two regional offices in New York and Chicago. We centralize our credit approval function and service our loans through an experienced staff of professionals at our headquarters in Washington, DC.

      We have an advantageous tax structure, as compared to operating companies, that allows for the “pass-through” of income to our shareholders through dividends without the imposition of a corporate level of taxation. See “Tax Status.”

      We are an internally managed diversified closed-end management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (“1940 Act”). Our investment objective is to achieve current income and capital gains. We seek to achieve our investment objective by investing in growing businesses in a variety of industries throughout the United States. As a BDC, we are required to meet regulatory tests, the most significant relating to its investments and borrowings. A BDC is required to invest at least 70% of its assets in private or thinly traded public, U.S.-based companies. A BDC must maintain a coverage ratio of assets to senior securities of at least 200%. See “Business — Certain Government Regulations.”

      We are quoted on the New York Stock Exchange and trade under the symbol “ALD.”

1

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THE OFFERING (Page 80)

      We may offer, from time to time, up to $300,000,000 of our Securities, on terms to be determined at the time of offering.

      Securities may be offered at prices and on terms described in one or more supplements to this prospectus. In the case of the offering of our common stock, the offering price per share less any underwriting commission or discount will not be less than the net asset value per share of our common stock at the time we make the offering.

      Our Securities may be offered directly to one or more purchasers, through agents designated from time to time by us, or to or through underwriters or dealers. The supplement to this prospectus relating to the offering will identify any agents or underwriters involved in the sale of our Securities, and will set forth any applicable purchase price, fee and commission or discount arrangement between our agents and us or among our underwriters or the basis upon which such amount may be calculated.

      We may not sell Securities without delivering a prospectus supplement describing the method and terms of the offering of our Securities.

USE OF PROCEEDS (Page 14)

      Unless otherwise specified in the prospectus supplement accompanying this prospectus, we intend to use the net proceeds from selling Securities for general corporate purposes, which may include investments in private and undervalued public companies, purchase of CMBS, repayment of indebtedness, acquisitions and other general corporate purposes.

DISTRIBUTIONS (Page 15)

      We pay quarterly dividends to holders of our common stock. The amount of our quarterly dividends is determined by the board of directors. Other types of Securities will likely pay distributions in accordance with their terms.

DIVIDEND REINVESTMENT PLAN (Page 74)

      We have adopted an “opt out” dividend reinvestment plan (“DRIP plan”) for our common stockholders. Under the DRIP plan, if your shares of common stock are registered in your name, your dividends will be automatically reinvested in additional shares of our common stock unless you “opt out” of the DRIP plan.

PRINCIPAL RISK FACTORS (Page 8)

      Investment in Securities involves certain risks relating to our structure and our investment objective that you should consider before purchasing Securities.

      As a BDC, our consolidated portfolio includes securities primarily issued by privately held companies. These investments may involve a high degree of business and financial risk, and they are generally illiquid. A large number of entities and individuals compete for the same kind of investment opportunities as we do.

      We borrow funds to make investments in private businesses. As a result, we are exposed to the risks of leverage, which may be considered a speculative investment technique. Borrowings, also known as leverage, magnify the potential for gain and loss on amounts invested and, therefore increase the risks associated with investing in our securities.

      Also, we are subject to certain risks associated with investing in non-investment grade CMBS, valuing our portfolio, changing interest rates, accessing addi-

2

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CERTAIN ANTI-TAKEOVER

      Our charter and bylaws, as well as certain statutory and regulatory requirements, contain certain provisions that may have the effect of discouraging a third party from making an acquisition proposal for the Company. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price for our common stock.

3

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FEES AND EXPENSES

     This table describes the various costs and expenses that an investor in our Securities will bear directly or indirectly.

Shareholder Transaction Expenses
	Sales load (as a percentage of offering price)(1)				—%
	Dividend reinvestment plan fees(2)				None
Annual Expenses (as a percentage of consolidated net assets attributable to common stock)(3)
	Operating expenses(4)				3.4%
	Interest payments on borrowed funds(5)				5.1%
		Total annual expenses(6)			8.5%

(2) The expenses of the Company’s DRIP plan are included in “Operating expenses.” The Company has no cash purchase plan. The participants in the DRIP plan will bear a pro rata share of brokerage commissions incurred with respect to open market purchases, if any. See “Dividend Reinvestment Plan.”

(3) “Consolidated net assets attributable to common stock” equals net assets (i.e., total assets less total liabilities and preferred stock) at September 30, 2001.

(4) “Operating expenses” represent the estimated operating expenses of the Company for the year ending December 31, 2001 excluding interest on indebtedness. This percentage for the year ended December 31, 2000 was 3.4%.

(5) The “Interest payments on borrowed funds” represents the estimated interest payments of the Company for the year ending December 31, 2001. The Company had outstanding borrowings of $924.5 million at September 30, 2001. This percentage for the year ended December 31, 2000 was 5.6%. See “Risk Factors.”

(6) “Total annual expenses” as a percentage of consolidated net assets attributable to common stock are higher than the total annual expenses percentage would be for a company that is not leveraged. The Company borrows money to leverage its net assets and increase its total assets. The Securities and Exchange Commission requires that “Total annual expenses” percentage be calculated as a percentage of net assets, rather than the total assets, including assets that have been funded with borrowed monies. If the “Total annual expenses” percentage were calculated instead as a percentage of consolidated total assets, “Total annual expenses” for the Company would be 4.9% of consolidated total assets.

Example

     The following example, required by the Commission, demonstrates the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in the Company. In calculating the following expense amounts, we assumed we would have no additional leverage and that our operating expenses would remain at the levels set forth in the table above. In the event that shares to which this prospectus relates are sold to or through underwriters, a corresponding prospectus supplement will restate this example to reflect the applicable sales load.

		1 Year				3 Years				5 Years				10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5.0% annual return		$	85			$	254			$	425			$	852

     Although the example assumes (as required by the Commission) a 5.0% annual return, our performance will vary and may result in a return of greater or less than 5.0%. In addition, while the example assumes reinvestment of all dividends and distributions at net asset value, participants in the DRIP plan may receive shares of common stock that we issue at or above net asset value or are purchased by the administrator of the DRIP plan, at the market price in effect at the time, which may be higher than, at, or below net asset value. See “Dividend Reinvestment Plan.”

The example should not be considered a representation of future expenses, and the actual expenses may be greater or less than those shown.

4

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SELECTED CONSOLIDATED FINANCIAL DATA

      You should read the consolidated financial information below with the Consolidated Financial Statements and Notes thereto included in this prospectus. Financial information for the years ended December 31, 2000, 1999, 1998, 1997 and 1996 has been derived from audited financial statements. On December 31, 1997, the Company consummated a merger of five predecessor companies. The selected financial data and all other information in this prospectus, unless otherwise indicated, reflects the operations of the Company with all periods restated as if the predecessor companies had merged as of the beginning of the earliest period presented. Quarterly financial information is derived from unaudited financial data, but in the opinion of management, reflects all adjustments (consisting only of normal recurring adjustments) which are necessary to present fairly the results for such interim periods. Interim results at and for the nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 16 for more information.

				Nine Months
				Ended
				September 30,								Year Ended December 31,
(In thousands,				2001				2000				2000				1999				1998				1997(7)				1996(7)
except per share data)
				(Unaudited)
Operating Data:
Interest and related portfolio income:
	Interest and dividends			$	173,722			$	129,768			$	182,307			$	121,112			$	80,281			$	86,882			$	77,541
	Premiums from loan dispositions				2,070				10,752				16,138				14,284				5,949				7,277				4,241
	Post-merger gain on securitization of commercial mortgage loans				—				—				—				—				14,812				—				—
	Fees and other income				30,652				9,334				13,144				5,744				5,696				3,246				3,155
		Total interest and related portfolio income			206,444				149,854				211,589				141,140				106,738				97,405				84,937
Expenses:
	Interest				47,974				41,645				57,412				34,860				20,694				26,952				20,298
	Employee(1)				22,269				19,506				26,025				22,889				18,878				10,258				8,774
	Administrative				10,166				10,711				15,435				12,350				11,921				8,970				8,289
	Merger				—				—				—				—				—				5,159				—
		Total operating expenses			80,409				71,862				98,872				70,099				51,493				51,339				37,361
	Net operating income before net realized and unrealized gains				126,035				77,992				112,717				71,041				55,245				46,066				47,576
Net realized and unrealized gains:
	Net realized gains				8,339				23,095				15,523				25,391				22,541				10,704				19,155
	Net unrealized gains (losses)				23,463				(267	)			14,861				2,138				1,079				7,209				(7,412	)
		Total net realized and unrealized gains			31,802				22,828				30,384				27,529				23,620				17,913				11,743
Income before minority interests and income taxes					157,837				100,820				143,101				98,570				78,865				63,979				59,319
Minority interests					—				—				—				—				—				1,231				2,427
Income tax expense					—				—				—				—				787				1,444				1,945
Net increase in net assets resulting from operations				$	157,837			$	100,820			$	143,101			$	98,570			$	78,078			$	61,304			$	54,947
Per Share:
Diluted net operating income per common share(2)				$	1.39			$	1.10			$	1.53			$	1.18			$	1.06			$	1.04			$	1.01
Diluted earnings per common share				$	1.74			$	1.42			$	1.94			$	1.64			$	1.50			$	1.24			$	1.17
Dividends per common share(3)				$	1.50			$	1.36			$	1.82			$	1.60			$	1.43			$	1.71			$	1.23
Weighted average common shares outstanding – diluted(4)					90,864				70,777				73,472				60,044				51,974				49,251				46,733

5

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		At September 30,				At December 31,
(in thousands,		2001				2000				1999				1998				1997(7)				1996(7)
except per share data)
		(Unaudited)
Balance Sheet Data:
Portfolio at value		$	2,174,373			$	1,788,001			$	1,228,497			$	807,119			$	703,331			$	612,411
Portfolio at cost			2,128,726				1,765,895				1,222,901				803,479				697,030				618,319
Total assets			2,266,833				1,853,817				1,290,038				856,079				807,775				713,360
Total debt outstanding(5)			924,484				786,648				592,850				334,350				347,663				274,997
Preferred stock issued to SBA(5)			7,000				7,000				7,000				7,000				7,000				7,000
Shareholders’ equity			1,300,237				1,029,692				667,513				491,358				420,060				402,134
Shareholders’ equity per common share (NAV)		$	13.42			$	12.11			$	10.20			$	8.79			$	8.07			$	8.34
Common shares outstanding at period end(4)			96,921				85,057				65,414				55,919				52,047				48,238

		Nine Months
		Ended
		September 30,								Year Ended December 31,
		2001				2000				2000				1999				1998				1997(7)				1996(7)
		(Unaudited)
Other Data:
Portfolio investments funded		$	509,578			$	640,196			$	901,545			$	751,871			$	524,530			$	364,942			$	283,295
Loan repayments			52,016				117,940				154,112				145,706				138,081				233,005				179,292
Loan sales(6)			129,980				151,834				280,244				198,368				81,013				53,912				27,715
Realized gains			9,942				24,664				28,604				31,536				25,757				15,804				30,417
Realized losses			(1,603	)			(1,569	)			(13,081	)			(6,145	)			(3,216	)			(5,100	)			(11,262	)

(1)	Employee expenses include formula and cut-off awards of $91,000 and $4,797,000 for the nine months ended September 30, 2001 and 2000, respectively, and $6,183,000, $6,753,000 and $7,049,000 for the years ended December 31, 2000, 1999 and 1998, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Comparison of Nine Months Ended September 30, 2001 and 2000 and Fiscal Years Ended December 31, 2000, 1999 and 1998.”
(2)	Diluted net operating income per common share for the year ended December 31, 1997 excludes merger expenses.
(3)	Distributions are based on taxable income, which differs from income for financial reporting purposes. In 1997, Allied Capital Corporation (old) distributed $0.34 per common share representing the 844,914 shares of Allied Capital Lending Corporation distributed in conjunction with the merger. The distribution resulted in a partial return of capital. Also in conjunction with the merger, the Company distributed $0.17 per common share representing the undistributed earnings of the predecessor companies at December 31, 1997.
(4)	Excludes 259,983 common shares held in the deferred compensation trust at or for the nine months ended September 30, 2000, and 234,977, 516,779 and 810,456 common shares held in the deferred compensation trust at or for the years ended December 31, 2000, 1999, and 1998, respectively. There were no shares held in the deferred compensation trust at or during the nine months ended September 30, 2001.
(5)	See “Senior Securities” on page 37 for more information regarding the Company’s level of indebtedness.
(6)	Excludes loans sold through securitization in January 1998. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Comparison of the Years Ended December 31, 2000, 1999 and 1998.”
(7)	Our current business and investment portfolio resulted from the merger of five affiliated companies on December 31, 1997. The companies that merged were Allied Capital Corporation (old), Allied Capital Corporation II, Allied Capital Advisers, Inc. (“Advisers”), Allied Capital Commercial Corporation and Allied Capital Lending Corporation. The five companies are referred to as the predecessor companies. The selected consolidated financial data reflects the operations of the company as if the predecessor companies were merged for these periods.

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		2001												2000
(in thousands,		Qtr 3				Qtr 2				Qtr 1				Qtr 4				Qtr 3				Qtr 2				Qtr 1
except per share data)
		(unaudited)												(unaudited)
Quarterly Data:
Total interest and related portfolio income		$	72,634			$	68,739			$	65,071			$	61,735			$	55,992			$	49,965			$	43,897
Net operating income before net realized and unrealized gains			44,189				42,118				39,728				34,725				30,719				24,700				22,573
Net increase in net assets resulting from operations			59,703				46,106				52,028				42,281				36,449				34,790				29,581
Diluted net operating income per share		$	0.47			$	0.46			$	0.46			$	0.43			$	0.40			$	0.35			$	0.34
Diluted earnings per common share			0.63				0.51				0.60				0.52				0.48				0.50				0.45
Dividends declared per common share			0.51				0.50				0.49				0.46				0.46				0.45				0.45
Net asset value per common share(1)			13.42				12.79				12.26				12.11				11.56				10.96				10.44

[Additional columns below]

[Continued from above table, first column(s) repeated]

		1999
(in thousands,		Qtr 4				Qtr 3				Qtr 2				Qtr 1
except per share data)
		(unaudited)
Quarterly Data:
Total interest and related portfolio income		$	42,278			$	37,998			$	33,186			$	27,678
Net operating income before net realized and unrealized gains			21,319				19,273				16,619				13,830
Net increase in net assets resulting from operations			30,925				26,944				22,121				18,580
Diluted net operating income per share		$	0.34			$	0.31			$	0.28			$	0.24
Diluted earnings per common share			0.49				0.44				0.38				0.33
Dividends declared per common share			0.40				0.40				0.40				0.40
Net asset value per common share(1)			10.20				9.66				9.17				9.00

(1)	We determine net asset value per common share as of the last day of the quarter. The net asset values shown are based on outstanding shares at the end of each period, excluding common shares held in the Company’s deferred compensation trust.

WHERE YOU CAN FIND

      We have filed with the Commission a registration statement on Form N-2 together with all amendments and related exhibits under the Securities Act of 1933, as amended (the “Securities Act”). The registration statement contains additional information about us and the registered securities being offered by this prospectus. You may inspect the registration statement and the exhibits without charge at the Securities and Exchange Commission at 450 Fifth Street, NW, Washington, DC 20549. You may obtain copies from the Commission at prescribed rates.

      We file annual, quarterly and special reports, proxy statements and other information with the Commission. You can inspect, without charge, at the public reference facilities of the Commission at 450 Fifth Street, NW, Washington, DC 20549. The Commission also maintains a web site at http://www.sec.gov that contains reports, proxy statements and other information regarding public companies, including our Company. You can also obtain copies of these materials from the public reference section of the Commission at 450 Fifth Street, NW, Washington, DC 20549, at prescribed rates. Please call the Commission at 1-800-SEC-0330 for further information on the public reference room. Copies may also be obtained, after paying a duplicating fee, by electronic request to publicinfo@sec.gov or by written request to Public Reference Section, Washington, DC 20549-0102. You can also inspect reports and other information we file at the offices of the New York Stock Exchange, and you are able to inspect those at 20 Broad Street, New York, NY 10005.

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RISK FACTORS

      Investing in the Company involves a number of significant risks and other factors relating to the structure and investment objective of the Company. As a result, there can be no assurance that the Company will achieve its investment objective. In addition to the information contained in this prospectus, you should consider carefully the following information before making investments in the Securities.

      Investing in Private Companies Involves a High Degree of Risk. Our portfolio consists primarily of long-term loans to and investments in private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative. There is generally no publicly available information about the companies in which we invest, and we rely significantly on the diligence of our employees and agents to obtain information in connection with our investment decisions. In addition, some smaller businesses have narrower product lines and market shares than their competition, and may be more vulnerable to customer preferences, market conditions or economic downturns, which may adversely affect the return on, or the recovery of, our investment in such businesses.

      Economic Recessions or Downturns Could Impair Our Portfolio Companies and Harm Our Operating Results. Although our investment strategy focuses on investment in companies in less cyclical industries, some of the companies in which we have made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may impact the ability of a company to engage in a liquidity event or repay our loans. These conditions could lead to financial losses in our portfolio and a decrease in our revenues, net income and assets. See “Business — Private Finance.”

      On September 11, 2001, a terrorist attack occurred at the World Trade Center in New York City and the Pentagon in Washington, D.C. This incident has had pervasive negative impacts on several U.S. industries and on the U.S. economy in general. While we were not directly impacted by the event, we believe that we could be impacted indirectly. The indirect impacts may include our need to provide a deferral of interest payments to certain portfolio companies that may be affected by the resulting economic slow down and a decrease in the pace of our investment activity.

      Our business of making private equity investments and positioning them for liquidity events also may be impacted by current and future market conditions. The absence of a robust bank lending environment may slow the amount of private equity investment activity generally. As a result, the pace of our investment activity may slow. In addition, significant changes in the capital markets could have an effect on the valuations of private companies and on the potential for liquidity events involving such companies. This could affect the amount and timing of gains realized on our investments. We cannot assure you that the events of September 11, 2001 and the reaction to them may not have other material and adverse implications for us and for the market in general.

      Our Financial Results Could Be Negatively Affected if BLX Fails to Perform as Expected. Business Loan Express, Inc. (“BLX”) is our largest portfolio investment. Our financial results could be negatively affected if BLX, as a portfolio company, fails to perform as expected. At September 30, 2001, the investment totaled $225.5 million, or 10% of total assets. In addition, as controlling shareholder of BLX, we have provided an unconditional guaranty to BLX’s credit facility lenders in an amount equal to 50% of BLX’s total obligations on its $117.5 million unsecured revolving credit facility. The

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      Our Borrowers May Default on Their Payments. We make unsecured, subordinated loans and invest in equity securities, which may involve a higher degree of repayment risk. We primarily invest in and lend to companies that may have limited financial resources and that may be unable to obtain financing from traditional sources. Numerous factors may affect a borrower’s ability to repay its loan, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in any collateral for the loan.

      Our Portfolio of Investments is Illiquid. We acquire most of our investments directly from private companies. The majority of the investments in our portfolio will be subject to restrictions on resale or otherwise have no established trading market. The illiquidity of most of our portfolio may adversely affect our ability to dispose of loans and securities at times when it may be advantageous for us to liquidate such investments.

      Our Private Finance Investments May Not Produce Capital Gains. Private finance investments are typically structured as debt securities with a relatively high fixed rate of interest and with an equity feature such as conversion rights, warrants or options. As a result, private finance investments generate interest income from the time they are made, and may also produce a realized gain from an accompanying equity feature. We cannot be sure that our portfolio will generate a current return or capital gains.

      Investments in Non-Investment Grade Commercial Mortgage-Backed Securities May Be Illiquid and May Have a Higher Risk of Default. The commercial mortgage-backed securities (“CMBS”) in which we invest are non-investment grade, which means that nationally recognized statistical rating organizations rate them below the top four investment-grade rating categories (i.e., “AAA” through “BBB”), and are sometimes referred to as “junk bonds.” The non-investment grade CMBS tend to be less liquid, may have a higher risk of default and may be more difficult to value. Non-investment grade securities usually provide a higher yield than do investment-grade bonds, but with the higher return comes greater risk. Non-investment grade securities are considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not ensured.

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      Our Portfolio Investments are Recorded at Fair Value as Determined by the Board of Directors in Absence of Readily Ascertainable Public Market Values. Pursuant to the requirements of the Investment Company Act of 1940 (“1940 Act”), the Board of Directors is required to value each asset quarterly, and we are required to carry our portfolio at fair value as determined by the Board of Directors. Since there is typically no public market for the loans and equity securities of the companies in which we make investments or the CMBS that we purchase, our Board of Directors estimates the fair value of these investments pursuant to a written valuation policy and a consistently applied valuation process. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses; we are instead required by the 1940 Act to specifically value each individual investment and record an unrealized loss for an asset that we believe has become impaired. Without a readily ascertainable market value, the estimated value of our portfolio of investments may differ significantly from the values that would be placed on the portfolio if there existed a ready market for the investments. We adjust quarterly the valuation of our portfolio to reflect the Board of Directors’ estimate of the current fair value of each investment in our portfolio. Any changes in estimated value are recorded in the Company’s statement of operations as “Net unrealized gains (losses).”

      We Borrow Money Which Magnifies the Potential for Gain or Loss on Amounts Invested and May Increase the Risk of Investing in Our Company. We borrow from, and issue senior debt securities to, banks, insurance companies and other lenders. Lenders of these senior securities have fixed dollar claims on our consolidated assets that are superior to the claims of our common shareholders. Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. If the value of our consolidated assets increases, then leveraging would cause the net asset value attributable to the Company’s common stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our consolidated assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any increase in our consolidated income in excess of consolidated 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 consolidated 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 stock dividend payments. Leverage is generally considered a speculative investment technique.

      At September 30, 2001, the Company had $924.5 million of outstanding indebtedness, bearing a weighted annual interest cost of 7.1%. In order for us to cover these annual interest payments on indebtedness, we must achieve annual returns on our assets of at least 2.9%.

      Illustration. The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns, net of expenses. The

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Assumed Return on the Company’s Portfolio

		-20%				-10%				-5%				0%				5%				10%				20%
Corresponding return to shareholder(1)			-40.0%				-22.5%				-13.8%				-5.1%				3.6%				12.3%				29.8%

(1)	The calculation assumes (i) $2,266.8 million in total assets, (ii) an average cost of funds of 7.1%, (iii) $924.5 million in debt outstanding and (iv) $1,300.2 million of shareholders’ equity.

      We May Not Borrow Money Unless We Maintain Asset Coverage for Indebtedness of at Least 200% Which May Affect Returns to Shareholders. We must maintain asset coverage for a class of senior security representing indebtedness of at least 200%. Our ability to achieve our investment objective may depend in part on our continued ability to maintain a leveraged capital structure by borrowing from banks or other lenders on favorable terms. There can be no assurance that we will be able to maintain such leverage. If asset coverage declines to less than 200%, we may be required to sell a portion of our investments when it is disadvantageous to do so. As of September 30, 2001, our asset coverage for senior indebtedness was 255%.

      Changes in Interest Rates May Affect Our Cost of Capital and Net Operating Income. Because we borrow money to make investments, our net operating income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our portfolio income. In periods of sharply rising interest rates, our cost of funds would increase, which would reduce our net operating income before net realized and unrealized gains. However, there would be no effect on the return, if any, that could be generated from our equity interests. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. The Company utilizes its short-term credit facilities only as a means to bridge to long-term financing. Our long-term fixed-rate investments are financed primarily with long-term fixed-rate debt and equity. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.

      Because We Must Distribute Income, We Will Continue to Need Additional Capital to Grow. We will continue to need capital to fund incremental growth in our investments. Historically, we have borrowed from financial institutions and have issued equity securities. A reduction in the availability of new capital could limit our ability to grow. We must distribute at least 90% of our taxable net operating income excluding net realized long-term capital gains to our stockholders to maintain our regulated investment company (“RIC”) status. As a result such earnings will not be available to fund investment originations. We expect to continue to borrow from financial institutions and sell additional equity securities. If we fail to obtain funds from such sources or from other sources to fund our investments, it could limit our ability to grow, which could have a material adverse

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      Loss of Pass-Through Tax Treatment Would Substantially Reduce Net Assets and Income Available for Dividends. We have operated the Company so as to qualify to be taxed as a RIC under Subchapter M of the Internal Revenue Code of 1986, as amended (“Code”). If we meet source of income, diversification and distribution requirements, the Company qualifies for effective pass-through tax treatment. The Company would cease to qualify for such pass-through tax treatment if it were unable to comply with these requirements, or if it ceased to qualify as a BDC under the 1940 Act. We also could be subject to a 4% excise tax and/or corporate level income tax if we fail to make required distributions as a RIC. If the Company ceased to qualify as a RIC, the Company would become subject to federal income tax as if it were an ordinary corporation, which would substantially reduce our net assets and the amount of income available for distribution to our shareholders.

      We Operate in a Competitive Market for Investment Opportunities. We compete for investments with many other companies and individuals, some of whom have greater resources than we do. Increased competition would make it more difficult for us to purchase or originate investments at attractive prices. As a result of this competition, sometimes we may be precluded from making otherwise attractive investments.

      Changes in the Law or Regulations that Govern the Company Could Have a Material Impact on the Company or Our Operations. We are regulated by the Securities and Exchange Commission and the SBA. In addition, changes in the laws or regulations that govern BDCs, RICs, real estate investment trusts (“REITs”) and SBICs may significantly affect our business. Any change in the law or regulations that govern our business could have a material impact on the Company or its operations. Laws and regulations may be changed from time to time, and the interpretations of the relevant laws and regulations also are subject to change.

      Quarterly Results May Fluctuate and May Not Be Indicative of Future Quarterly Performance. The Company’s quarterly operating results could fluctuate and therefore, you should not rely on quarterly results to be indicative of the Company’s performance in future quarters. Factors that could cause quarterly operating results to fluctuate include, among others, variations in the investment origination volume and fee income earned, variation in timing of prepayments, 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.

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Disclosure Regarding Forward-Looking Statements

      Information contained or incorporated by reference in this prospectus, and the accompanying prospectus supplement, if any, may contain “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate” or “continue” or the negative thereof or other variations or similar words or phrases. The matters described in “Risk Factors” and certain other factors noted throughout this prospectus, and the accompanying prospectus supplement, if any, and in any exhibits to the registration statement of which this prospectus, and the accompanying prospectus supplement, if any, is a part, constitute cautionary statements identifying important factors with respect to any such forward-looking statements, including certain risks and uncertainties, that could cause actual results to differ materially from those in such forward-looking statements.

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THE COMPANY

      Allied Capital is principally engaged in lending to and investing in private and undervalued public companies. The Company is organized in the state of Maryland and is an internally managed closed-end management investment company that has elected to be regulated as a business development company (as defined above, a “BDC”) under the 1940 Act.

      Our executive offices are located at 1919 Pennsylvania Avenue, NW, Washington, DC 20006 and our telephone number is (202) 331-1112. In addition, we have two regional offices in New York and Chicago. We also have an office in Frankfurt, Germany.

USE OF PROCEEDS

      Unless otherwise specified in the prospectus supplement accompanying this prospectus, we intend to use the net proceeds from selling Securities for general corporate purposes, which may include investment in private and undervalued public companies, purchase of commercial mortgage-backed securities, repayment of indebtedness, acquisitions and other general corporate purposes.

      We raise equity from time to time using a shelf registration statement. We raise new equity when we have a clear use of proceeds for attractive investment opportunities. Historically, this process has enabled us to raise equity on an accretive basis for existing shareholders of our common stock.

      We anticipate that substantially all of the net proceeds of any offering of Securities will be used, as described above, within six months, but in no event longer than two years. Pending investment, we intend to invest the net proceeds of any offering of Securities in time deposits, income-producing securities with maturities of three months or less that are issued or guaranteed by the federal government or an agency of the federal government, and high quality debt securities maturing in one year or less from the time of investment. Our ability to achieve our investment objective may be limited to the extent that the net proceeds of any offering, pending full investment, are held in time deposits and other short-term instruments.

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PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

      Our common stock is traded on the New York Stock Exchange under the symbol “ALD.” The following table lists the high and low closing sales prices for the Company’s common stock. On December 19, 2001, the last reported closing sale price of the common stock was $25.24 per share.

			Closing Sale Price(1)
			High				Low
Year ended December 31, 1999
	First Quarter		$	20.250			$	16.500
	Second Quarter			24.000				17.000
	Third Quarter			23.813				20.250
	Fourth Quarter			23.125				16.750
Year ended December 31, 2000
	First Quarter		$	19.688			$	16.063
	Second Quarter			18.688				16.563
	Third Quarter			21.125				17.438
	Fourth Quarter			21.375				18.500
Year ending December 31, 2001
	First Quarter		$	24.436			$	20.125
	Second Quarter			25.400				19.570
	Third Quarter			24.830				21.500
	Fourth Quarter (through December 19, 2001)			26.00				21.57

(1)	Prior to June 6, 2001, the Company’s common stock was traded on the Nasdaq National Market under the symbol “ALLC.” The closing sale prices listed are as reflected on the respective exchanges for the periods presented.

      Our common stock continues to trade in excess of net asset value. There can be no assurance, however, that we will maintain a premium to net asset value.

      We pay quarterly dividends to stockholders of our common stock. The amount of our quarterly dividends is determined by the Board of Directors. The Company’s Board has established a dividend policy to review the dividend rate quarterly and to adjust the quarterly dividend rate as the Company’s earnings momentum builds. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Equity Capital and Dividends” and “Tax Status.” We cannot assure that we will achieve investment results or maintain a tax status that will permit any particular level of dividend payment.

      Our credit facilities limit our ability to declare dividends if we default under certain provisions.

      We have adopted an “opt out” dividend reinvestment plan (“DRIP plan”) for our common stockholders. Under the DRIP plan, if your shares of our common stock are registered in your name, your dividends will be automatically reinvested in additional shares of common stock unless you “opt out” of the DRIP plan.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

      The information contained in this section should be read in conjunction with the Selected Consolidated Financial Data and the Company’s Consolidated Financial Statements and Notes thereto.

OVERVIEW

      The Company provides private investment capital to private and undervalued public companies in a variety of different industries and in diverse geographic locations. Our lending and investment activity is focused in private finance and commercial real estate finance, primarily the purchase of commercial mortgage-backed securities.

      The Company’s portfolio composition at September 30, 2001, and December 31, 2000, 1999 and 1998 was as follows:

						At
		At				December 31,
		September 30,
		2001				2000				1999				1998
Private Finance			71	%			72	%			53	%			48	%
Commercial Real Estate Finance			29	%			28	%			42	%			44	%
Small Business Finance			—	%			—	%			5	%			8	%

      The Company’s earnings depend primarily on the level of interest and related portfolio income and net realized and unrealized gains earned on the Company’s investment portfolio after deducting interest paid on borrowed capital and operating expenses. Interest income results from the stated interest rate earned on a loan and the amortization of loan origination points and discounts. The level of interest income is directly related to the balance of the interest-bearing investment portfolio multiplied by the weighted average yield on the interest-bearing portfolio. The Company’s ability to generate interest income is dependent on economic, regulatory and competitive factors that influence interest rates and loan originations, and the Company’s ability to secure financing for its investment activities.

PORTFOLIO AND INVESTMENT ACTIVITY

      Total portfolio investment activity and yields as of and for the three and nine months ended September 30, 2001 and 2000 and as of and for the years ended December 31, 2000, 1999 and 1998 were as follows:

		At and for the Three								At and for the Nine
		Months Ended								Months Ended								At and for the
		September 30,								September 30,								Years Ended December 31,
		2001				2000				2001				2000				2000				1999				1998
($ in millions)
Portfolio at Value		$	2,174.4			$	1,638.2			$	2,174.4			$	1,638.2			$	1,788.0			$	1,228.5			$	807.1
Investments Funded		$	209.5			$	237.8			$	509.6			$	640.2			$	901.5			$	751.9			$	524.5
Repayments		$	7.9			$	59.1			$	52.0			$	117.9			$	154.1			$	145.7			$	138.0
Sales		$	57.5			$	34.7			$	130.0			$	151.8			$	280.2			$	198.4			$	304.4
Yield			14.1	%			13.9	%			14.1	%			13.9	%			14.1	%			13.0	%			12.5	%

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Private Finance

      Private finance investment activity and yields as of and for the three and nine months ended September 30, 2001 and 2000 and as of and for the years ended December 31, 2000, 1999 and 1998 were as follows:

		At and for the								At and for the
		Three Months								Nine Months								At and for the Years Ended
		Ended Sept. 30,								Ended Sept. 30,								December 31,
		2001				2000				2001				2000				2000				1999				1998
($ in millions)
Portfolio at Value		$	1,539.3			$	967.5			$	1,539.3			$	967.5			$	1,282.5			$	647.0			$	388.6
Investments Funded		$	112.7			$	148.5			$	226.8			$	387.6			$	600.9			$	346.7			$	236.0
Repayments		$	5.8			$	49.6			$	29.8			$	88.8			$	117.7			$	87.5			$	41.3
Yield			14.5	%			14.6	%			14.5	%			14.6	%			14.6	%			14.2	%			14.6	%

      The private finance portfolio increased 20% from December 31, 2000 to September 30, 2001, and increased 98% and 67% during the years ended December 31, 2000 and 1999, respectively. In addition to the $226.8 million of funded investments for the nine months ended September 30, 2001, the Company invested an additional $31.7 million in portfolio companies through receipt of payment in-kind securities. Buyout and private finance activity across the industry has been slow during the first nine months of 2001 largely due to credit tightening among senior lenders. Since equity-focused buyout firms generally need both senior and subordinated debt to leverage private equity investments, buyout activity has been reduced due to a lower level of activity in the senior bank market, and in particular the senior syndicated loan market. As a result, the Company’s investment activity for the nine months ended September 30, 2001 has been at a slower pace than the comparable period for the prior year.

      During the third quarter, the Company closed the controlled buyout of SunSource Inc. on September 26, 2001. Pursuant to the merger agreement signed on June 18, 2001, the Company paid $10.375 per SunSource common share, or $71.5 million, in cash for the outstanding common equity of SunSource. On September 28, 2001, SunSource announced that it completed the sale of its STS business unit. Pursuant to this sale, SunSource returned $15.0 million in cash to the Company, reducing the Company’s cost basis. The Company’s cost basis in the common stock of SunSource after the return of capital from the STS sale and the capitalization of deal costs was $58.6 million at September 30, 2001. The SunSource investment has been structured to provide for a current return to be earned through interest on debt and management/ consulting fees for services provided by the Company. In addition, during the third quarter of 2001, the Company earned investment banking fees of $2.8 million for the acquisition of SunSource and the sale of STS, earned a syndication fee of $1.6 million for the syndication of SunSource’s senior credit facilities and realized a gain of $2.5 million from the sale of warrants in SunSource prior to the controlled buyout transaction. As part of the STS sale, the Company invested $3.2 million in the new STS.

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      The Company’s increasing capital base has enabled it to make larger private finance investments, supporting the increase in originations in 2000, 1999 and 1998. Key investment characteristics for new private finance mezzanine investments were as follows:

			For the Years
			Ended
			December 31,
			2000				1999				1998
New investment characteristics:
	Number of investments			34				27				19
	Average investment size (millions)		$	14.0			$	12.4			$	10.6
	Average current yield			14.7	%			13.6	%			13.3	%
	Average portfolio company revenue (millions)		$	153.5			$	86.9			$	81.3
	Average portfolio company years in business			36				29				22

      The average investment characteristics above are computed using simple averages based upon underwriting data for investment activity for that year. As a result, any one investment may have had individual investment characteristics that may vary significantly from the stated simple average. In addition, average investment characteristics may vary from year to year.

      The current yield on the private finance portfolio will fluctuate over time depending on the equity “kicker” or warrants received with each debt financing. Private finance investments are generally structured such that equity kickers may provide an additional future investment return of up to 10%.

      During 2000, the Company acquired BLC Financial Services, Inc. in a going private transaction, which thereafter changed its name to Business Loan Express, Inc. (“BLX”). The Company’s investment in BLX is included in the private finance portfolio. See “Small Business Finance” discussion for more details below.

      During the second quarter of 2000, the Company began an initiative to invest in and strategically partner with select private equity funds focused on venture capital investments. The strategy for these fund investments is to provide solid investment returns and build strategic relationships with the fund managers and their portfolio companies. The Company believes that it will have opportunities to co-invest with the funds as well as finance their portfolio companies as they mature.

      The Company believes that the fund investment strategy is an effective means of participating in private equity investing through a diverse pooled investment portfolio. The fund concept allows the Company to participate in a pooled investment return without exposure to the risk of any single investment. Since the beginning of 2000, the Company has committed a total of $44.5 million to eight private equity funds. The committed amount is expected to be invested over the next three years. The Company funded $0.4 million, $3.5 million and $7.0 million of this commitment for the three and nine months ended September 30, 2001 and for the year ended December 31, 2000, respectively.

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Commercial Real Estate Finance

      Commercial real estate finance investment activity and yields as of and for the three and nine months ended September 30, 2001 and 2000 and as of and for the years ended December 31, 2000, 1999 and 1998 were as follows:

		At and for the								At and for the								At and for the
		Three Months Ended								Nine Months Ended								Years Ended
		September 30,								September 30,								December 31,
		2001				2000				2001				2000				2000				1999				1998
($ in millions)
Portfolio at Value		$	635.1			$	600.0			$	635.1			$	600.0			$	505.5			$	520.0			$	355.0
Investments Funded		$	96.8			$	52.6			$	282.8			$	143.7			$	149.0			$	288.7			$	214.6
Repayments		$	2.1			$	6.5			$	22.2			$	20.8			$	24.8			$	51.5			$	92.5
Sales		$	57.5			$	1.6			$	130.0			$	53.1			$	151.7			$	86.1			$	256.9
Yield			13.5	%			13.2	%			13.5	%			13.2	%			13.1	%			12.3	%			10.4	%

      The commercial real estate finance portfolio increased 26% from December 31, 2000 to September 30, 2001, and decreased 3% and increased 46% for the years ended December 31, 2000 and 1999, respectively. During 1998, the Company reduced its commercial mortgage loan origination activity for its own portfolio due to declining interest rates and began to sell its loans to other lenders. Then, beginning in the fourth quarter of 1998, the Company began to take advantage of a unique market opportunity to acquire non-investment grade commercial mortgage-backed securities (“CMBS”) at significant discounts from the face amount of the bonds. Turmoil in the capital markets at that time created a lack of liquidity for the traditional buyers of non-investment grade bonds. As a result, yields on these collateralized bonds increased, thus providing an attractive investment opportunity. The Company believes that CMBS is an attractive asset class because of the yields that can be earned on a security that is secured by commercial mortgage loans. The Company has opportunistically purchased CMBS since the fourth quarter of 1998. The Company plans to continue its CMBS investment activity, however, in order to maintain a balanced portfolio the Company expects that purchased CMBS will continue to represent approximately 20% to 25% of total assets during 2001. The Company’s CMBS investment activity level will be dependent upon its ability to purchase CMBS at attractive yields.

      The Company purchases CMBS at an approximate discount of 50% from the face amount of the bonds. During the third quarter of 2001, the Company purchased $96.8 million in CMBS with a face value of $171.1 million and a weighted average yield to maturity of 15.0% after assuming a 1% loss rate on the underlying collateral mortgage pool. During the nine months ended September 30, 2001 the Company purchased $256.1 million in CMBS with a face value of $449.0 million. During the first quarter of 2001, the Company also purchased $24.6 million in non-investment grade securities related to a collateralized debt issuance secured by CMBS and investment grade real estate investment trust bonds. The weighted average yield to maturity on purchases made during the first nine months of 2001 is 15.0% after assuming a 1% loss rate on the underlying collateral mortgage pool. During 2000 and 1999, the Company purchased $124.3 million and $245.9 million in CMBS with a face amount of $244.6 million and $507.9 million and a weighted average yield to maturity of 14.7% and 14.6% after assuming a 1% loss rate on the underlying collateral mortgage pool, respectively.

      As a part of the Company’s strategy to maximize its return on equity capital, the Company sold CMBS bonds rated BB+, BB and BB- during the third quarter of 2001,

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      The original principal balance of the underlying pool of the approximately 3,300 loans that are collateral for the Company’s CMBS had underwritten loan to value (“LTV”) and underwritten debt service coverage ratios (“DSCR”) as follows:

Loan to Value Ranges		$				%
		($ in
		millions)
Less than 60%		$	2,060.4				11	%
60-65%			1,663.9				9	%
65-70%			2,834.0				16	%
70-75%			5,838.7				33	%
75-80%			5,332.0				30	%
Greater than 80%			214.3				1	%
		$	17,943.3				100	%
Weighted average LTV			69.7	%

Debt Service Coverage
Ratio Ranges		$				%
		($ in
		millions)
Greater than 2.00		$	556.6				3	%
1.76-2.00			551.8				3	%
1.51-1.75			2,046.3				11	%
1.26-1.50			10,393.0				58	%
1.00-1.25			4,395.6				25	%
		$	17,943.3				100	%
Weighted average DSCR			1.40

      The Company has been liquidating much of its whole commercial mortgage loan portfolio so that it can redeploy the proceeds into higher yielding assets and for the three and nine months ended September 30, 2001, the Company sold $1.9 million and $7.6 million, respectively of commercial mortgage loans. For the years ended December 31, 2000 and 1999, the Company sold $53.1 million and $86.1 million of commercial mortgage loans, respectively. At September 30, 2001, the Company’s whole commercial real estate loan portfolio had been reduced to $86.2 million from $106.4 million at December 31, 2000.

      During 1998, the Company sold through securitization approximately $295 million in lower yielding commercial mortgage loans and sold whole loans to third parties aggregating approximately $33.5 million.

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Small Business Finance

      On December 31, 2000, the Company acquired 95% of BLC Financial Services, Inc. in a “going private” buyout transaction for $95.2 million. The Company issued approximately 4.1 million shares, or $86.1 million of new equity, and paid $9.1 million in cash to acquire BLC, which is now BLX.

      As part of the transaction, the Company recapitalized its Allied Capital Express operations as an independently managed private portfolio company and merged it into BLX. As part of the recapitalization, the Company contributed certain assets, including the online rules-based underwriting technology and fixed assets, and transferred 37 employees into the private portfolio company. Upon completion of the transaction, the Company’s investment in BLX totaled $204.1 million and consisted of $74.5 million of 25% subordinated debt, $25.1 million of preferred stock, and $104.5 million of common stock. BLX is included in the private finance portfolio.

      At September 30, 2001, BLX had a 3-year $117.5 million revolving credit facility (“BLX Credit Facility”), which was increased to $124.0 million in October 2001. As the controlling shareholder of BLX, the Company has provided an unconditional guaranty to the BLX Credit Facility lenders in an amount of up to 50% of the total obligations (consisting of principal, accrued interest and other fees) of BLX on the line of credit. The amount guaranteed by the Company at September 30, 2001 was $50.3 million. This guaranty can be called by the lenders only in the event of a default by BLX. BLX was in compliance with the terms of the BLX Credit Facility at September 30, 2001.

      Prior to its contribution to BLX, Allied Capital Express loan activity and yields as of and for the years ended December 31, 2000, 1999 and 1998 were as follows:

($ in millions)		2000				1999				1998
Portfolio at Value		$	—			$	61.4			$	63.6
New Investments		$	151.6			$	116.5			$	73.9
Repayments		$	11.6			$	6.7			$	4.2
Sales		$	128.5			$	112.3			$	47.5
Yield			—				11.5	%			11.2	%

      Allied Capital Express loan origination activity for 2000 and 1999 increased due to the opening of new regional office locations and from opportunities created by the Company’s Internet site launched in the fall of 1999. Loans in the Allied Capital Express program were originated for sale; therefore, the increase in loan sales was the result of the increase in originations. In addition, beginning in 1999, the Company began to sell 90% of the unguaranteed portion of SBA 7(a) loans through a structured finance agreement with a commercial paper conduit. Allied Capital Express targeted small commercial real estate loans that were, in many cases, originated in conjunction with SBA 7(a) loans. SBA 7(a) loans were originated with variable interest rates priced at spreads ranging from 1.75% to 2.75% over the prime lending rate.

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RESULTS OF OPERATIONS

Comparison of Nine Months Ended September 30, 2001 and 2000

      The following table summarizes Allied Capital’s operating results for the nine months ended September 30, 2001 and 2000.

				For the Nine
				Months Ended
				September 30,
																Percent
				2001				2000				Change				Change
($ in thousands, except per share amounts)
Interest and Related Portfolio Income
	Interest and dividends			$	173,722			$	129,768			$	43,954				34	%
	Premiums from loan dispositions				2,070				10,752				(8,682	)			(81	%)
	Fees and other income				30,652				9,334				21,318				228	%
		Total interest and related portfolio income			206,444				149,854				56,590				38	%
Expenses
	Interest				47,974				41,645				6,329				15	%
	Employee				22,269				19,506				2,763				14	%
	Administrative				10,166				10,711				(545	)			(5	%)
		Total operating expenses			80,409				71,862				8,547				12	%
		Net operating income before net realized and unrealized gains			126,035				77,992				48,043				62	%
Net Realized and Unrealized Gains
	Net realized gains				8,339				23,095				(14,756	)			(64	%)
	Net unrealized gains				23,463				(267	)			23,730				8,888	%
		Total net realized and unrealized gains			31,802				22,828				8,974				39	%
Net increase in net assets resulting from operations				$	157,837			$	100,820			$	57,017				57	%
Diluted net operating income per share				$	1.39			$	1.10			$	0.29				26	%
Diluted earnings per share				$	1.74			$	1.42			$	0.32				23	%
Weighted average shares outstanding — diluted					90,864				70,777				20,087				28	%

      Net increase in net assets resulting from operations (NIA) results from total interest and related portfolio income earned, less total expenses incurred in the operations of the Company, plus net realized and unrealized gains or losses.

      Total interest and related portfolio income is primarily a function of the level of interest income earned and the balance of portfolio assets. In addition, total interest and

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		For the Nine
		Months Ended
		September 30,
		2001				2000
($ in millions, except per share amounts)
Total Interest and Related Portfolio Income		$	206.4			$	149.9
Per share		$	2.27			$	2.11

      The increase in interest income earned results primarily from continued growth of the Company’s investment portfolio and the Company’s focus on increasing its overall portfolio yield. The Company’s investment portfolio, excluding non-interest bearing equity interests in portfolio companies, increased by 17% to $1,732.0 million at September 30, 2001 from $1,485.0 million at September 30, 2000. The weighted average yield on the interest bearing investments in the portfolio at September 30, 2001 and 2000 was as follows:

		September 30,
		2001				2000
Private Finance			14.5%				14.6%
Commercial Real Estate Finance			13.5%				13.2%
Small Business Finance			—%				12.3%
Total Portfolio			14.1%				13.9%

      Included in premiums from loan dispositions are premiums from loan sales and premiums received on the early repayment of loans. Premiums from loan sales were $0.5 million and $8.7 million for the nine months ended September 30, 2001 and 2000, respectively. Premium income results from the premium paid by purchasers on loans sold less the origination commissions associated with the loans sold. For the nine months ended September 30, 2000, premiums from loan sales resulted primarily from the sale of loans originated through Allied Capital Express. Upon the merger of the Allied Capital Express operations into BLX, the premium from loan sales earned historically is intended to be replaced with interest income earned by the Company from its subordinated debt investment in BLX as well as fees earned from its guaranty of the BLX Credit Facility and its management contract with BLX.

      Prepayment premiums were $1.6 million and $2.1 million for the nine months ended September 30, 2001 and 2000, respectively. While the scheduled maturities of private finance and commercial real estate loans range from five to ten years, it is not unusual for the Company’s borrowers to refinance or pay off their debts to the Company ahead of schedule. Because the Company seeks to finance primarily seasoned, performing companies, such companies at times can secure lower cost financing as their balance sheets strengthen, or as more favorable interest rates become available. Therefore, the Company generally structures its loans to require a prepayment premium for the first three to five years of the loan.

      Fees and other income include diligence, financial structuring, management and guaranty fees of $29.7 million and $5.4 million for the nine months ended September 30, 2001 and 2000, respectively. Fees and other income for the nine months ended September 30, 2001 include fees earned from the SunSource buyout transaction totaling

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      Operating expenses include interest, employee and administrative expenses. The Company’s single largest expense is interest on indebtedness. The fluctuations in interest expense during the nine months ended September 30, 2001 and 2000 are attributable to changes in the level of borrowings by the Company and its subsidiaries under various notes payable and debentures and revolving credit facilities. The Company’s borrowing activity and weighted average interest cost, including fees and closing costs, were as follows:

		At and for the
		Nine Months
		Ended
		September 30,
		2001				2000
($ in millions)
Total Outstanding Debt		$	924.5			$	762.2
Average Outstanding Debt		$	821.9			$	684.3
Weighted Average Cost			7.1	%			8.1	%
BDC Asset Coverage*			255	%			236	%

*	As a BDC, the Company is generally required to maintain a ratio of 200% of total assets to total borrowings.

      Employee expenses include salaries, employee benefits and formula and cut-off awards. The increase in salaries and employee benefits for the periods presented reflects wage increases and the experience level of employees hired. Total employees were 95 and 136 at September 30, 2001 and 2000, respectively. As part of the recapitalization of Allied Capital Express discussed above, employees of the Company were transferred to the portfolio company at the end of 2000. Expenses related to employees dedicated to Allied Capital Express are reflected in employee expense for the nine months ended September 30, 2000. The formula and cut-off awards totaled $4.8 million for the nine months ended September 30, 2000. The formula award vested over a three-year period which ended on December 31, 2000.

      Administrative expenses include the leases for the Company’s headquarters in Washington, DC, and its regional offices, travel costs, stock record expenses, directors’ fees, legal and accounting fees and various other expenses. Administrative expenses for the nine months ended September 30, 2000 included expenses related to Allied Capital Express regional offices. The cost of these regional offices was transferred to BLX at the beginning of 2001. For the nine months ended September 30, 2001 and 2000, employee and administrative costs as a percentage of total interest and related portfolio income less interest expense plus net realized and unrealized gains was 17% and 19%, respectively.

      Net realized gains resulted from the sale of equity securities associated with certain private finance investments and the realization of unamortized discount resulting from the sale and early repayment of private finance loans, commercial mortgage loans and

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		For the Nine
		Months Ended
		September 30,
		2001				2000
($ in millions)
Realized Gains		$	9.9			$	24.7
Realized Losses			(1.6	)			(1.6	)
Net Realized Gains		$	8.3			$	23.1
Net Unrealized Gains		$	23.5			$	(0.3	)

      Realized gains for the nine months ended September 30, 2001 primarily resulted from transactions involving three private finance portfolio companies, FTI Consulting, Inc. ($4.6 million), SunSource Inc. ($2.5 million) as discussed above, and Southwest PCS, LLC ($0.8 million), and the sale of Purchased CMBS BB bonds ($1.7 million). Realized gains for the nine months ended September 30, 2000 resulted primarily from transactions involving seven portfolio companies. The Company reversed previously recorded unrealized appreciation totaling $3.8 million and $6.2 million when gains were realized for the nine months ended September 30, 2001 and 2000, respectively.

      Realized losses for the nine months ended September 30, 2001 and 2000 resulted from the continued liquidation of the Company’s whole loan commercial real estate portfolio, as well as other small losses in the private finance portfolio. The Company reversed previously recorded unrealized depreciation totaling $1.5 million and $1.3 million when the related losses were realized in the nine months ended September 30, 2001 and 2000, respectively.

      Net unrealized gains for the nine months ended September 30, 2001 and 2000 consisted of valuation changes resulting from the Board of Directors’ valuation of the Company’s assets and the effect of reversals of unrealized appreciation or depreciation resulting from realized gains or losses.

      The Company increased the value of its equity investment in BLX by $15.5 million at March 31, 2001. During the first quarter, BLX secured a 3-year $117.5 million revolving credit facility and completed a $65 million securitization of unguaranteed SBA 7(a) loans. As a result of the elimination of the refinancing risk that existed at the time of the merger, and BLX’s progress in merger integration, the Company increased the value of its equity investment. The Company also increased the value of its investment in Wyo-Tech Acquisition Corporation by $8.8 million and $28.3 million at March 31, 2001 and September 30, 2001, due to its continued growth and positive performance. In addition to BLX and Wyo-Tech, the Company increased the value of other portfolio companies by $11.3 million in total for the nine months ended September 30, 2001. These companies increased in value because of continued positive performance, and valuation data that would indicate that a valuation increase was necessary.

      During the nine months ended September 30, 2001, the Company reversed previously recorded unrealized appreciation totaling $8.9 million on investments that the Company believed required adjustment based upon the portfolio company’s performance in a weaker economy or a lower valuation multiple at which these companies would be expected to be sold in today’s economy.

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      During the nine months ended September 30, 2001, the Company decreased the value of its common equity investments in Startec Global Communications Corporation by $3.0 million at March 31, 2001, and decreased the value of its debt investment in NETtel Communications, Inc. by $5.0 million at March 31, 2001 and $2.0 million at September 30, 2001. In addition, the Company decreased the value of other portfolio companies by a total of $19.2 million for the nine months ended September 30, 2001.

      At September 30, 2001, net unrealized appreciation in the portfolio totaled $42.8 million and was composed of unrealized appreciation of $99.1 million, resulting primarily from appreciated equity interests in portfolio companies, and unrealized depreciation of $56.3 million, resulting primarily from underperforming loan and equity interests in the portfolio. Net realized and unrealized gains can vary substantially on a quarterly basis.

      The Company employs a standard grading system for the entire portfolio. Grade 1 is used for those investments from which a capital gain is expected. Grade 2 is used for investments performing in accordance with plan. Grade 3 is used for investments that require closer monitoring; however, no loss of interest or principal is expected. Grade 4 is used for investments for which some loss of contractually due interest is expected, but no loss of principal is expected. Grade 5 is used for investments for which some loss of principal is expected and the investment is written down to net realizable value.

      At September 30, 2001, the Company’s portfolio was graded as follows:

		Portfolio				Percentage of
Grade		at Value				Total Portfolio
		(in millions)
1		$	479.4				22.1	%
2			1,561.7				71.8	%
3			57.3				2.6	%
4			48.0				2.2	%
5			28.0				1.3	%
		$	2,174.4				100.0	%

      Grade 5 private finance investments at September 30, 2001, totaled $26.0 million, at value, or 1.2%, of the Company’s total portfolio. Total Grade 4 and 5 assets as a percentage of the total portfolio at value at September 30, 2001 and December 31, 2000 and 1999 were 3.5%, 5.7% and 3.8%, respectively. The Company expects that a certain number of portfolio companies will be in the Grade 4 or 5 category from time to time. Part of the business of private finance is working with troubled portfolio companies to improve their businesses and protect the Company’s investment. The number of portfolio companies and related investment amount included in Grade 4 and 5 may fluctuate significantly from quarter to quarter as the Company helps these companies work through their problems. The Company continues to follow its historical practices of working with a troubled portfolio company in order to recover the maximum amount of the Company’s investment, but records unrealized depreciation for the expected full amount of the potential loss when such exposure is identified.

      At September 30, 2001, delinquencies in the underlying collateral pool for the Company’s CMBS portfolio were 0.30%. The yield used to accrue interest on this portfolio assumes a 1% loss rate on the entire underlying collateral mortgage pool, and as of

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      For the total investment portfolio, loans greater than 120 days delinquent were $61.6 million at value at September 30, 2001, or 2.8% of the total portfolio. Included in this category are loans valued at $10.4 million that are fully secured by real estate. Loans greater than 120 days delinquent generally do not accrue interest. Loans greater than 120 days delinquent at December 31, 2000 were $56.4 million at value, or 3.2% of the total portfolio, which included $13.3 million that were fully secured by real estate. As a provider of long-term privately negotiated investment capital, it is not atypical to defer payment of principal or interest from time to time. As a result, the amount of the portfolio that is greater than 120 days delinquent may vary from quarter to quarter. The terms of the private finance agreements frequently provide an opportunity for portfolio companies to restructure their debt and equity capital. During such restructuring, the Company may not receive or accrue interest or dividend payments. The investment portfolio is priced to provide current returns for our shareholders assuming that a portion of the portfolio at any time may not be accruing interest currently. The Company also prices its investments for a total return including current interest or dividends plus capital gains from the sale of equity securities. Therefore, the amount of loans greater than 120 days delinquent is not necessarily an indication of future principal loss or loss of anticipated investment return. The Company’s portfolio grading system is used as a means to assess loss of investment return (Grade 4 assets) or loss of investment principal (Grade 5 assets).

      The Company has elected to be taxed as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (“Code”). As long as the Company qualifies as a RIC, the Company is not taxed on its investment company taxable income or realized capital gains, to the extent that such income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis. Annual tax distributions may differ from NIA for the fiscal year due to timing differences in the recognition of income and expenses, returns of capital and net unrealized appreciation or depreciation, which are not included in taxable income.

      In order to maintain its RIC status, the Company must, in general, (1) continue to qualify as a BDC; (2) derive at least 90% of its gross income from dividends, interest, gains from the sale of securities and other specified types of income; (3) meet investment diversification requirements as defined in the Code; and (4) distribute annually to shareholders at least 90% of its investment company taxable income as defined in the Code. The Company intends to take all steps necessary to continue to meet the RIC qualifications. However, there can be no assurance that the Company will continue to qualify for such treatment in future years.

      The weighted average common shares outstanding used to compute basic earnings per share were 89.3 million and 70.6 million for the nine months ended September 30, 2001

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      All per share amounts included in management’s discussion and analysis have been computed using the weighted average shares used to compute diluted earnings per share, which were 90.9 million and 70.8 million for the nine months ended September 30, 2001 and 2000, respectively.

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RESULTS OF OPERATIONS

Comparison of the Years Ended December 31, 2000, 1999 and 1998

      The following table summarizes the Company’s operating results for the years ended December 31, 2000, 1999 and 1998:

																Percent																Percent
				2000				1999				Change				Change				1999				1998				Change				Change
				(in thousands, except per share amounts)
Interest and Related Portfolio Income
	Interest and dividends			$	182,307			$	121,112			$	61,195				51%			$	121,112			$	80,281			$	40,831				51%
	Premiums from loan dispositions				16,138				14,284				1,854				13%				14,284				5,949				8,335				140%
	Post-Merger gain on securitization of commercial mortgage loans				—				—				—				0%				—				14,812				(14,812	)			(100%	)
	Fees and other income				13,144				5,744				7,400				129%				5,744				5,696				48				1%
		Total interest and related portfolio income			211,589				141,140				70,449				50%				141,140				106,738				34,402				32%
Expenses
	Interest				57,412				34,860				22,552				65%				34,860				20,694				14,166				68%
	Employee				19,842				16,136				3,706				23%				16,136				11,829				4,307				36%
	Administrative				15,435				12,350				3,085				25%				12,350				11,921				429				4%
		Total operating expenses			92,689				63,346				29,343				46%				63,346				44,444				18,902				43%
	Formula and cut-off awards				6,183				6,753				(570	)			(8%	)			6,753				7,049				(296	)			(4%	)
		Net operating income before net realized and unrealized gains			112,717				71,041				41,676				59%				71,041				55,245				15,796				29%
Net Realized and Unrealized Gains
	Net realized gains				15,523				25,391				(9,868	)			(39%	)			25,391				22,541				2,850				13%
	Net unrealized gains				14,861				2,138				12,723				595%				2,138				1,079				1,059				98%
		Total net realized and unrealized gains			30,384				27,529				2,855				10%				27,529				23,620				3,909				17%
Income before income taxes					143,101				98,570				44,531				45%				98,570				78,865				19,705				25%
Income tax expense					—				—				—				0%				—				787				(787	)			(100%	)
Net increase in net assets resulting from operations				$	143,101			$	98,570			$	44,531				45%			$	98,570			$	78,078			$	20,492				26%
Diluted net operating income per share				$	1.53			$	1.18			$	0.35				30%			$	1.18			$	1.06			$	0.12				11%
Diluted earnings per share				$	1.94			$	1.64			$	0.30				18%			$	1.64			$	1.50			$	0.14				9%
Weighted average shares outstanding – diluted					73,472				60,044				13,428				22%				60,044				51,974				8,070				16%

      Net increase in net assets resulting from operations (NIA) results from total interest and related portfolio income earned, less total expenses incurred in the operations of the Company, plus net realized and unrealized gains or losses.

      Total interest and related portfolio income is primarily a function of the level of interest income earned and the balance of portfolio assets. In addition, total interest and

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		2000				1999				1998
		(in millions, except per
		share amounts)
Total Interest and Related Portfolio Income		$	211.6			$	141.1			$	106.7
Per share		$	2.88			$	2.35			$	2.05

      The increase in interest income earned results primarily from continued growth of the Company’s investment portfolio and the Company’s focus on increasing its overall portfolio yield. The Company’s investment portfolio, excluding non-interest bearing equity interests in portfolio companies, increased by 29% to $1,471.8 million at December 31, 2000 from $1,141.2 million at December 31, 1999, and increased by 51% during 1999 from $757.7 million at December 31, 1998. The weighted average yield on the interest bearing investments in the portfolio at December 31, 2000, 1999 and 1998 was as follows:

		2000				1999				1998
Private Finance			14.6%				14.2%				14.6%
Commercial Real Estate Finance			13.1%				12.3%				10.4%
Small Business Finance			—				11.5%				11.2%
Total Portfolio			14.1%				13.0%				12.5%

      Included in net premiums from loan dispositions are premiums from loan sales and premiums received on the early repayment of loans. Premiums from loan sales were $13.3 million, $10.5 million and $3.8 million for the years ended December 31, 2000, 1999 and 1998, respectively. This premium income results primarily from the premium paid by purchasers of loans originated through Allied Capital Express, less the origination commissions associated with the loans sold. In addition to selling the guaranteed portion of the SBA 7(a) loans, in 1999 the Company began to sell 90% of the unguaranteed portion of SBA 7(a) loans through a structured finance agreement with a commercial paper conduit. The 176% increase in premiums from loan sales in 1999 is primarily the result of a significant increase in the sale of the guaranteed SBA 7(a) loans and unguaranteed portions of SBA 7(a) loans. SBA 7(a) loan sales were $101.0 million, $93.7 million and $37.0 million for the years ended December 31, 2000, 1999 and 1998, respectively. Upon the merger of the Allied Capital Express operations into BLX, the premium from loan sales earned historically is intended to be replaced with interest income earned by the Company from its subordinated debt investment in BLX as well as fees earned from its management contract with BLX.

      Prepayment premiums were $2.8 million, $3.8 million and $2.2 million for the years ended December 31, 2000, 1999 and 1998, respectively. While the scheduled maturities of private finance and commercial real estate loans range from five to ten years, it is not unusual for the Company’s borrowers to refinance or pay off their debts to the Company ahead of schedule. Because the Company seeks to finance primarily seasoned, performing companies, such companies at times can secure lower cost financing as their balance sheets strengthen, or as more favorable interest rates become available. Therefore, the Company generally structures its loans to require a prepayment premium for the first three to five years of the loan.

      Total interest and related portfolio income for 1998 includes a one-time gain on sale of $14.8 million resulting from a commercial mortgage loan securitization transaction that

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      Operating expenses include interest, employee and administrative expenses. The Company’s single largest expense is interest on indebtedness. The fluctuations in interest expense during 2000, 1999 and 1998 are attributable to changes in the level of borrowings by the Company and its subsidiaries under various notes payable and debentures and revolving credit facilities. The Company’s borrowing activity and weighted average interest cost, including fees and closing costs, were as follows:

		2000				1999				1998
		($ in millions)
Total Outstanding Debt		$	786.6			$	592.9			$	334.4
Average Outstanding Debt		$	707.4			$	461.5			$	261.3
Weighted Average Cost			8.3	%			7.9	%			7.5	%
BDC Asset Coverage*			245	%			228	%			273	%

*	As a BDC, the Company is generally required to maintain a ratio of 200% of total assets to total borrowings.

      Employee expenses include salaries, employee benefits and formula and cut-off awards. The increase in salaries and employee benefits for the periods presented reflects the increase in total employees, combined with wage increases and the experience level of employees hired. Total employees were 97, 129 and 106 at December 31, 2000, 1999 and 1998, respectively. As part of the recapitalization of Allied Capital Express discussed above, 37 employees of the Company were transferred to the portfolio company at the end of 2000. Expenses related to these employees are reflected in employee expense for the year. The formula and cut-off awards totaled $6.2 million, $6.8 million and $7.0 million for the years ended December 31, 2000, 1999 and 1998, respectively.

      The formula award expense totaled $5.7 million, $6.2 million and $6.2 million for the years ended December 31, 2000, 1999 and 1998, respectively. The formula award was designed as an incentive compensation program that would replace canceled stock options that were canceled as a result of the Company’s 1997 Merger and would balance share ownership among key officers. The formula award vested over a three-year period, on the anniversary date of the Merger, beginning on December 31, 1998.

      The cut-off award expense totaled $0.5 million, $0.6 million and $0.8 million for the years ended December 31, 2000, 1999 and 1998, respectively. The cut-off award was designed to cap the appreciated value in unvested options at the Merger announcement date in order to set the foundation to balance option awards upon the Merger. The cut-off award will only be payable if the award recipient is employed by the Company on a future vesting date.

      Administrative expenses include the leases for the Company’s headquarters in Washington, DC and its regional offices, travel costs, stock record expenses, directors’ fees, legal and accounting fees and various other expenses. For the years ended December 31, 2000, 1999 and 1998, employee and administrative costs as a percentage of total interest and related portfolio income less interest expense plus net realized and unrealized gains was 19%, 21% and 22%, respectively.

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      Net realized gains resulted from the sale of equity securities associated with certain private finance investments and the realization of unamortized discount resulting from the sale and early repayment of private finance loans, commercial mortgage loans and Purchased CMBS bonds, offset by losses on investments. Realized gains and losses and net unrealized gains for the years ended December 31, 2000, 1999 and 1998 were as follows:

		2000				1999				1998
		(in millions)
Realized Gains		$	28.6			$	31.5			$	25.8
Realized Losses			(13.1	)			(6.1	)			(3.3	)
Net Realized Gains		$	15.5			$	25.4			$	22.5
Net Unrealized Gains		$	14.9			$	2.1			$	1.1

      Realized gains during 2000 resulted primarily from transactions involving eight investments — Southwest PCS, L.P. ($11.5 million), Grant Television, Inc. ($5.4 million), CMBS bonds sold ($3.9 million), Julius Koch USA, Inc. ($1.7 million), Wilmar Industries, Inc. ($1.2 million), Hotelevision ($1.0 million), FTI Consulting, Inc. ($0.7 million) and Panera Bread Co. ($0.7 million). The Company reversed previously recorded unrealized appreciation of $7.5 million when these gains were realized in 2000. Realized gains in 1999 and 1998 resulted primarily from transactions involving 6 and 10 portfolio companies, and the Company reversed previously recorded unrealized appreciation of $14.6 million and $8.1 million, respectively, when these gains were realized.

      Realized losses in 2000, 1999 and 1998 represented 0.7%, 0.5% and 0.4% of the Company’s total assets, respectively. Realized losses of $13.1 million during 2000 resulted primarily from two portfolio investments — NETtel Communications, Inc. ($8.5 million) and Total Foam, Inc. ($1.3 million). The remaining losses consisted of several losses of less than $0.5 million each. Losses realized in 2000 had been recognized in NIA over time as unrealized depreciation when the Company determined that the respective portfolio security’s value had become impaired. Thus, the Company reversed previously recorded unrealized depreciation totaling $12.0 million, $5.4 million and $3.6 million when the related losses were realized in 2000, 1999 and 1998, respectively.

      Net unrealized gains for 2000, 1999 and 1998 consisted of valuation changes resulting from the Board of Directors’ valuation of the Company’s assets and the effect of reversals of unrealized appreciation or depreciation resulting from realized gains or losses. At December 31, 2000, net unrealized appreciation in the portfolio totaled $19.4 million and was composed of unrealized appreciation of $49.1 million, resulting primarily from appreciated equity interests in portfolio investments, and unrealized depreciation of $29.7 million resulting primarily from underperforming loan and equity interests in the portfolio. At December 31, 1999 and 1998, net unrealized appreciation in the portfolio totaled $4.5 million and $2.4 million, respectively, and was composed of unrealized appreciation of $32.1 million and $27.3 million, and unrealized depreciation of $27.6 million and $24.9 million, respectively.

      The Company employs a standard grading system for the entire portfolio. Grade 1 is used for those investments from which a capital gain is expected. Grade 2 is used for investments performing in accordance with plan. Grade 3 is used for investments that require closer monitoring; however, no loss of interest or principal is expected. Grade 4 is used for investments for which some loss of contractually due interest is expected, but no

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      At December 31, 2000, the Company’s portfolio was graded as follows:

		Portfolio				Percentage of
Grade		at Value				Total Portfolio
		($ in millions)
1		$	208.3				11.7%
2			1,461.7				81.7%
3			15.4				0.9%
4			76.0				4.2%
5			26.6				1.5%
		$	1,788.0				100.0%

      Included in Grade 4 and 5 investments are assets totaling $20.5 million and $10.6 million that are secured by commercial real estate at December 31, 2000 and 1999, respectively. Grade 5 private finance investments at December 31, 2000 and 1999 totaled $18.7 million and $12.6 million at value, or 1.0% and 1.0% of the Company’s total portfolio, respectively. The Company continues to follow its historical practices of working with a troubled portfolio company in order to recover the maximum amount of the Company’s investment, but records unrealized depreciation for the expected full amount of the potential loss when such exposure is identified.

      At December 31, 2000, delinquencies in the underlying collateral pool for the Company’s CMBS portfolio were 0.38%. The yield used to accrue interest on this portfolio assumes a 1% loss rate on the entire underlying collateral mortgage pool.

      For the total investment portfolio, loans greater than 120 days delinquent were $56.4 million at value at December 31, 2000, or 3.2% of the total portfolio. Included in this category are loans valued at $13.3 million that are fully secured by commercial real estate. Loans greater than 120 days delinquent at December 31, 1999 were $18.6 million at value, or 1.5% of the total portfolio, which included $11.7 million that were fully secured by real estate. As a provider of long-term privately negotiated investment capital, it is not atypical to defer payment of principal or interest from time to time. As a result, the amount of the portfolio that is greater than 120 days delinquent may vary from quarter to quarter. The terms of the private finance agreements frequently provide an opportunity for portfolio companies to restructure their debt and equity capital. During such restructuring, the Company may not receive or accrue interest or dividend payments. The investment portfolio is priced to provide current returns for our shareholders assuming that a portion of the portfolio at any time may not be accruing interest currently. The Company also prices its investments for a total return including current interest or dividends plus capital gains from the sale of equity securities. Therefore, the amount of loans greater than 120 days delinquent is not necessarily an indication of future principal loss or loss of anticipated investment return. The Company’s portfolio grading system is used as a means to assess loss of investment return (Grade 4 assets) or loss of investment principal (Grade 5 assets).

      The weighted average common shares outstanding used to compute basic earnings per share were 73.2 million, 59.9 million and 51.9 million for the years ended December 31, 2000, 1999 and 1998, respectively. The increases in the weighted average shares reflect the

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      All per share amounts included in management’s discussion and analysis have been computed using the weighted average shares used to compute diluted earnings per share, which were 73.5 million, 60.0 million and 52.0 million for the years ended December 31, 2000, 1999 and 1998, respectively.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents

      At September 30, 2001, the Company had $3.1 million in cash and cash equivalents. The Company invests otherwise uninvested cash in U.S. government-or agency-issued or guaranteed securities that are backed by the full faith and credit of the United States, or in high quality, short-term repurchase agreements fully collateralized by such securities. The Company’s objective is to manage to a low cash balance and fund new originations with its credit facilities.

Debt

      The Company had outstanding debt at September 30, 2001 as follows:

																	Annual
																	Portfolio
																	Return
													Annual				to Cover
					Facility				Amount				Interest				Interest
					Amount				Outstanding				Cost(1)				Payments(2)
($ in millions)
Notes payable and debentures:
	Unsecured long-term notes				$	544.0			$	544.0				7.9%				1.9%
	SBA debentures					101.8				87.0				8.0%				0.3%
	Auction rate reset note					80.8				80.8				5.4%				0.2%
	OPIC loan					5.7				5.7				6.6%				0.0%
			Total notes payable and debentures		$	732.3			$	717.5				7.6%				2.4%
Revolving credit facilities:
		Revolving line of credit				467.5				207.0				5.5%				0.5%
			Total debt		$	1,199.8			$	924.5				7.1%				2.9%

(1)	The annual interest cost includes the cost of commitment fees and other facility fees.
(2)	The annual portfolio return to cover interest payments is calculated as the September 30, 2001 annualized cost of debt per class of financing divided by total assets at September 30, 2001.

     Unsecured Long-term Notes. The Company has issued long-term debt to institutional lenders, primarily insurance companies. The notes have five- or seven-year maturities, with maturity dates beginning in 2003. The notes require payment of interest only semi-annually, and all principal is due upon maturity.

      On October 30, 2001, the Company issued $150 million of five-year unsecured long-term debt, financed primarily by insurance companies. The five-year notes were priced at 7.16% and have substantially the same terms as the Company’s existing unsecured long-term notes.

      SBA Debentures. The Company, through its SBIC subsidiary, has debentures payable to the SBA with terms of ten years. The notes require payment of interest only semi-annually, and all principal is due upon maturity. The Company may currently borrow up to $101.8 million from the SBA under the SBIC program. At September 30, 2001, the

34

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      Auction Rate Reset Note. The Company has a $80.8 million Auction Rate Reset Senior Note Series A that matures on December 2, 2002 and bears interest at the three-month London Inter-Bank Offer Rate (“LIBOR”) plus 1.75% which adjusts quarterly. Interest is due quarterly and the Company, at its option, may pay or defer and capitalize such interest payments. The amount outstanding on the note will increase as interest due is deferred and capitalized. As a means to repay the note, the Company has entered into an agreement to issue $80.8 million of debt, equity or other securities in one or more public or private transactions, or prepay the Auction Rate Reset Note, on or before August 31, 2002. If the note is prepaid, the Company will pay a fee equal to 0.5% of the aggregate amount of the note outstanding.

      Revolving Line of Credit. As of September 30, 2001, the Company has a $467.5 million unsecured revolving line of credit that expires in August 2003 with the right to extend maturity for one additional year at the Company’s sole option, under substantially similar terms. This facility may be expanded up to $600 million. At the Company’s option, the credit facility bears interest at a rate equal to (i) the one-month LIBOR plus 1.25% or (ii) the higher of (a) the Bank of America, N.A. prime rate or (b) the Federal Funds rate plus 0.50%. The credit facility requires monthly payments of interest, and all principal is due upon maturity.

Equity Capital and Dividends

      The Company raises debt and equity capital for continued investment in its portfolio. Because the Company is a RIC, it distributes its income and requires external capital for growth. Because the Company is a BDC, it is limited in the amount of debt capital it may use to fund its growth, since it is generally required to maintain a ratio of 200% of total assets to total borrowings, or approximately 1 to 1 debt to equity capital ratio.

      To support its growth during the nine months ended September 30, 2001, the Company raised $237.0 million in new equity capital primarily through the sale of shares from its shelf registration statement. The Company issues equity from time to time when it has a clear use of proceeds for attractive investment opportunities. Historically, this process has enabled the Company to raise equity on an accretive basis for existing shareholders. At September 30, 2001, total shareholders’ equity had increased to $1.3 billion.

      The Company’s Board reviews the dividend rate quarterly, and adjusts the quarterly dividend rate throughout the year as the Company’s earnings momentum builds. For the first, second and third quarter of 2001, the Board declared a $0.49, $0.50 and $0.51 per common share dividend, respectively. For the fourth quarter of 2001, the Board has declared a dividend of $0.51 per common share. Dividends are paid from the Company’s taxable income.

      As a result of growth in ordinary taxable income combined with the increased size and diversity of the Company’s portfolio and its projected future capital gains, the Company’s Board of Directors will continue to evaluate whether to retain or distribute capital gains as they occur. The Company’s dividend policy allows the Company to continue to distribute some capital gains, but will also allow the Company to retain gains that exceed a normal capital gains distribution level, and therefore avoid any unusual spike

35

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      The Company plans to maintain a strategy of financing its operations, dividend requirements and future investments with cash from operations, through borrowings under short- or long-term credit facilities or other debt securities, through asset sales, or through the sale or issuance of new equity capital. The Company maintains a matched-funding philosophy that focuses on matching the estimated maturities of its loan and investment portfolio to the estimated maturities of its borrowings. The Company will utilize its short-term credit facilities only as a means to bridge to long-term financing, which may result in temporary differences in the matching of estimated maturities. The Company evaluates its interest rate exposure on an ongoing basis. To the extent deemed necessary, the Company may hedge variable and short-term interest rate exposure through interest rate swaps or other techniques. At September 30, 2001, the Company’s debt to equity ratio was 0.71 to 1 and weighted average cost of funds was 7.1%. There are no significant maturities of long-term debt until 2003. The Company believes that it has access to capital sufficient to fund its ongoing investment and operating activities, and from which to pay dividends.

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SENIOR SECURITIES

      Information about our senior securities is shown in the following tables as of the fiscal year ended December 31, unless otherwise noted. The “—” indicates information which the Commission expressly does not require to be disclosed for certain types of senior securities.

		Total Amount
		Outstanding								Involuntary
		Exclusive of				Asset				Liquidating				Average
		Treasury				Coverage				Preference				Market Value
Class and Year		Securities(1)				Per Unit(2)				Per Unit(3)				Per Unit(4)
Unsecured Long-term Notes Payable
1991		$	0			$	0			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			0				0				—				N/A
1995			0				0				—				N/A
1996			0				0				—				N/A
1997			0				0				—				N/A
1998			180,000,000				2,734				—				N/A
1999			419,000,000				2,283				—				N/A
2000			544,000,000				2,445				—				N/A
2001 (as of September 30, unaudited)			544,000,000				2,545				—				N/A
SBA Debentures(5)
1991		$	49,800,000			$	3,834			$	—				N/A
1992			49,800,000				5,789				—				N/A
1993			49,800,000				6,013				—				N/A
1994			54,800,000				3,695				—				N/A
1995			61,300,000				2,868				—				N/A
1996			61,300,000				2,485				—				N/A
1997			54,300,000				2,215				—				N/A
1998			47,650,000				2,734				—				N/A
1999			62,650,000				2,283				—				N/A
2000			78,350,000				2,445				—				N/A
2001 (as of September 30, unaudited)			87,000,000				2,545				—				N/A
Auction Rate Reset Note
1991		$	0			$	0			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			0				0				—				N/A
1995			0				0				—				N/A
1996			0				0				—				N/A
1997			0				0				—				N/A
1998			0				0				—				N/A
1999			0				0				—				N/A
2000			76,598,000				2,445				—				N/A
2001 (as of September 30, unaudited)			80,784,000				2,545				—				N/A

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		Total Amount
		Outstanding								Involuntary
		Exclusive of				Asset				Liquidating				Average
		Treasury				Coverage				Preference				Market Value
Class and Year		Securities(1)				Per Unit(2)				Per Unit(3)				Per Unit(4)
Overseas Private Investment Corporation Loan
1991		$	0			$	0			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			0				0				—				N/A
1995			0				0				—				N/A
1996			8,700,000				2,485				—				N/A
1997			8,700,000				2,215				—				N/A
1998			5,700,000				2,734				—				N/A
1999			5,700,000				2,283				—				N/A
2000			5,700,000				2,445				—				N/A
2001 (as of September 30, unaudited)			5,700,000				2,545				—				N/A
Revolving Lines of Credit
1991		$	0			$	0			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			32,226,000				3,695				—				N/A
1995			20,414,000				2,868				—				N/A
1996			45,099,000				2,485				—				N/A
1997			38,842,000				2,215				—				N/A
1998			95,000,000				2,734				—				N/A
1999			82,000,000				2,283				—				N/A
2000			82,000,000				2,445				—				N/A
2001 (as of September 30, unaudited)			207,000,000				2,545				—				N/A
Master Repurchase Agreement and Master Loan and Security Agreement
1991		$	0			$	0			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			23,210,000				3,695				—				N/A
1995			0				0				—				N/A
1996			85,775,000				2,485				—				N/A
1997			225,821,000				2,215				—				N/A
1998			6,000,000				2,734				—				N/A
1999			23,500,000				2,283				—				N/A
2000			0				0				—				N/A
2001 (as of September 30, unaudited)			0				0				—				N/A

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		Total Amount
		Outstanding								Involuntary
		Exclusive of				Asset				Liquidating				Average
		Treasury				Coverage				Preference				Market Value
Class and Year		Securities(1)				Per Unit(2)				Per Unit(3)				Per Unit(4)
Senior Note Payable(6)
1991		$	0			$	0			$	—				N/A
1992			20,000,000				5,789				—				N/A
1993			20,000,000				6,013				—				N/A
1994			20,000,000				3,695				—				N/A
1995			20,000,000				2,868				—				N/A
1996			20,000,000				2,485				—				N/A
1997			20,000,000				2,215				—				N/A
1998			0				0				—				N/A
1999			0				0				—				N/A
2000			0				0				—				N/A
2001 (as of September 30, unaudited)			0				0				—				N/A
Bonds Payable
1991		$	0			$	0			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			0				0				—				N/A
1995			98,625,000				2,868				—				N/A
1996			54,123,000				2,485				—				N/A
1997			0				0				—				N/A
1998			0				0				—				N/A
1999			0				0				—				N/A
2000			0				0				—				N/A
2001 (as of September 30, unaudited)			0				0				—				N/A
Reverse Repurchase Agreements(7)
1991		$	2,761,000			$	3,834			$	—				N/A
1992			0				0				—				N/A
1993			0				0				—				N/A
1994			0				0				—				N/A
1995			0				0				—				N/A
1996			0				0				—				N/A
1997			0				0				—				N/A
1998			0				0				—				N/A
1999			0				0				—				N/A
2000			0				0				—				N/A
2001 (as of September 30, unaudited)			0				0				—				N/A

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		Total Amount
		Outstanding								Involuntary
		Exclusive of				Asset				Liquidating				Average
		Treasury				Coverage				Preference				Market Value
Class and Year		Securities(1)				Per Unit(2)				Per Unit(3)				Per Unit(4)
Redeemable Cumulative Preferred Stock(5)
1991		$	1,000,000			$	338			$	100				N/A
1992			1,000,000				526				100				N/A
1993			1,000,000				546				100				N/A
1994			1,000,000				351				100				N/A
1995			1,000,000				277				100				N/A
1996			1,000,000				242				100				N/A
1997			1,000,000				217				100				N/A
1998			1,000,000				267				100				N/A
1999			1,000,000				225				100				N/A
2000			1,000,000				242				100				N/A
2001 (as of September 30, unaudited)			1,000,000				252				100				N/A
Non-Redeemable Cumulative Preferred Stock(5)
1991		$	6,000,000			$	338			$	100				N/A
1992			6,000,000				526				100				N/A
1993			6,000,000				546				100				N/A
1994			6,000,000				351				100				N/A
1995			6,000,000				277				100				N/A
1996			6,000,000				242				100				N/A
1997			6,000,000				217				100				N/A
1998			6,000,000				267				100				N/A
1999			6,000,000				225				100				N/A
2000			6,000,000				242				100				N/A
2001 (as of September 30, unaudited)			6,000,000				252				100				N/A

(1)	Total amount of each class of senior securities outstanding at the end of the period presented.
(2)	The asset coverage ratio for a class of senior securities representing indebtedness is calculated as the Company’s consolidated total assets, less all liabilities and indebtedness not represented by senior securities, divided by senior securities representing indebtedness. This asset coverage ratio is multiplied by $1,000 to determine the Asset Coverage Per Unit. The asset coverage ratio for a class of senior securities that is preferred stock is calculated as the Company’s consolidated total assets, less all liabilities and indebtedness not represented by senior securities, divided by senior securities representing indebtedness, plus the involuntary liquidation preference of the preferred stock (see footnote 3). The Asset Coverage Per Unit for preferred stock is expressed in terms of dollar amounts per share.
(3)	The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it.
(4)	Not applicable, as senior securities are not registered for public trading.
(5)	Issued by the Company’s SBIC subsidiary to the SBA. These categories of senior securities are not subject to the asset coverage requirements of the 1940 Act. See “Certain Government Regulations — SBA Regulations.”
(6)	The Company was the obligor on $15 million of the senior notes. The Company’s SBIC subsidiary was the obligor on the remaining $5 million, which is not subject to the asset coverage requirements of the 1940 Act.
(7)	U.S. government agency guaranteed loans sold under agreements to repurchase. The Company was advised by the Staff of the Commission that these reverse repurchase agreements were not considered a class of senior security representing indebtedness and thus were not subject to the asset coverage requirements of the 1940 Act.

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BUSINESS

      As a business development company, we provide private investment capital to private companies and undervalued public companies in a variety of different industries and in diverse geographic locations throughout the United States. We have been investing in growing businesses for over 40 years and have financed thousands of private companies nationwide. Today, our investment activity is focused in two areas:

	•	Private finance and
	•	Commercial real estate finance, primarily the purchase of CMBS.

      Our investment portfolio consists primarily of long-term unsecured loans with equity features, equity investments in middle-market companies, which may or may not constitute a controlling equity interest, commercial mortgage-backed securities, and commercial mortgage loans. At September 30, 2001, our investment portfolio totaled $2.2 billion. Our investment objective is to achieve current income and capital gains.

Private Finance

      We provide long-term debt and equity financing to private companies nationwide. Our core private finance activities target a market niche between the senior debt financing provided by traditional lenders, such as banks, commercial finance companies and insurance companies, and the equity capital provided by private equity investors. These types of investments are commonly referred to as mezzanine investments.

      Our private financing is generally used to fund growth, buyouts, acquisitions, recapitalizations, note purchases, and bridge financings. We generally invest in private companies though, from time to time, we may invest in undervalued public companies that lack access to public capital and whose securities may not be marginable. We target two types of companies when seeking new investments. The first type of company we seek is a market leader in a stable industry that has demonstrated over many years of operations that it can successfully achieve its business plan and thereby achieve our investment objective. The second type of company we seek is an emerging company in a growing industry that is positioned for significant growth. We have spent over 40 years refining our highly selective investment discipline, which is founded on seeking portfolio companies having key characteristics and targeting specific industries.

      We primarily originate mezzanine investments generally ranging in size from $5 million to $35 million. Our private finance mezzanine investments are generally structured as an unsecured, subordinated loan that carries a relatively high fixed interest rate (generally 12% to 18%), with interest-only payments in the early years and payments of both principal and interest in the later years, with maturities of five to ten years. Approximately 97% of the loans and debt securities in the private finance portfolio have fixed rates of interest. Our private finance mezzanine investments typically include equity features, such as warrants or options to buy a minority interest in the portfolio company. We also make preferred and common equity investments, particularly when we see unique opportunities to profit from the growth of an emerging company. At September 30, 2001, 71% of the private finance portfolio consisted of loans and debt securities, and 29% consisted of equity securities. Our nationwide private finance portfolio includes investments in a wide variety of industries, including non-durable consumer products, business services, financial services, light industrial products, broadcasting and cable, and education.

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      Capital providers for the finance of private companies can be generally categorized as shown in the diagram below:

Capital Provider

Banks

Commercial Finance Companies

Private Placement/ High Yield

Allied Capital

Private Mezzanine Funds

Private Equity Funds

Primary Business Focus

Senior, short- term debt

Asset-based lending

Large credits (private > $50 mm) (public > $150 mm)

Unsecured long- term debt with warrants Preferred and common equity

Unsecured long- term debt with warrants Preferred and common equity

Equity

Typical Pricing Spectrum*

LIBOR+

[graphic of arrow stretching between “LIBOR+” and “30%+”]

30%+

---

*	Based on market experience of our marketing and investment professionals.

     Banks are primarily focused on providing senior secured and unsecured short-term debt. They typically do not provide meaningful long-term unsecured loans. Commercial finance companies are primarily focused on providing senior secured long-term debt. The private placement and high-yield debt markets are focused primarily on very large financing transactions, typically in excess of the financings we do. We generally do not compete with banks, commercial finance companies, or the private placement/high yield market. Instead, we compete directly with the private mezzanine sector of the private equity market. Private mezzanine funds are also focused on providing unsecured long-term debt to private companies for the types of transactions discussed above. We believe that we have key structural and operational advantages when compared to private mezzanine funds.

      Our scale of operations, equity capital base, and successful track record as a private finance investor has enabled us to borrow long-term capital to leverage our returns on our common equity. Therefore, our access to debt capital reduces our total cost of capital. In many cases, a private mezzanine fund is unable to access the debt capital markets, and therefore must achieve an unleveraged equity return for their investors. Our lower cost of capital gives us a pricing advantage when competing for new investments. In addition, the perpetual nature of our corporate structure enables us to be a better long-term partner for our portfolio companies than a traditional mezzanine fund, which typically has a finite life.

      We estimate that we fund approximately 2% of all the private finance investments that we review. When assessing a prospective investment, we look for a company that has achieved, or has the potential to achieve, market leadership in a niche, critical mass and longevity, and a sustainable cash flow. We also look for companies that, because of their industry and business plan, can demonstrate minimal vulnerability to changes in economic cycles. Since our debt securities are primarily unsecured in nature, we look for companies in industries that are less cyclical, cash flow intensive, and can demonstrate a high return on their invested capital. We generally do not target companies in industries where businesses tend to be vulnerable to changes in economic cycles, are capital intensive, and have low returns on their invested capital. We generally target and do not target the following industries, though we will consider investments in any industry if the prospective

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Industries Targeted

Industries Not Targeted

      Another critical element of our investment discipline is to invest in companies with a significant equity capital base, and a strong private equity sponsor. For example, in 2000, 75% of our core private mezzanine financings were completed in conjunction with private equity firms, which provided capital that is junior to ours. We believe strong equity sponsorship significantly strengthens our position as a long-term lender. A strong equity sponsor provides not only strong equity capital beneath our investment, but also provides a reliable source of additional equity capital if the portfolio company requires additional financing. Private equity sponsors also help us confirm our own due diligence findings when assessing a new investment opportunity, and they provide assistance and leadership to the portfolio company’s management team throughout our investment period.

      We target a total return of 18% to 25% for our private finance mezzanine investments. The typical private finance mezzanine structure focuses, first and foremost, on the protection of our investment principal. Our debt instruments generally provide for a contractual interest rate ranging from 12% to 18%, which provides current interest income. The debt instruments also have restrictive covenants that protect our interests in the transaction. The warrants we receive with our debt securities generally require only a minimal cost to exercise, and thus as the portfolio company appreciates in value, we achieve additional investment return from this equity interest. We seek to achieve additional investment returns of up to 10% from the appreciation and sale of our warrants.

      Generally, our warrants expire five years after the related debt is repaid. The warrants typically include registration rights, which allow us to sell the securities if the portfolio company completes a public offering. In most cases, the warrants also have a put option that requires that the borrower repurchase our equity position after a specified period of time at a formula price or at its fair market value. Most of the gains we realize from our warrant portfolio arise as a result of the sale of the portfolio company to another business, or through a recapitalization. Historically, we have not been dependent on the public equity markets for the sale of our warrant positions. From time to time, we may also acquire preferred or common equity in a company as a part of our core private finance investing activities. Preferred equity investments may be structured with a dividend yield of up to 8% which would provide us with a current return. With respect to preferred or common equity investments, we target an investment return of 25% to 40%.

      In addition to our primary core private finance mezzanine investment activities, from time-to-time we may acquire more than 50% of the common stock of a company in a control buyout transaction. In addition to our common equity investment, we may also provide additional capital to the controlled portfolio company in the form of senior loans,

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      We generally structure our control investments such that we receive a current return through a combination of interest income on our senior loans and subordinated debt, dividends on our preferred and/or common stock, and/or a management/consulting fee to compensate us for the managerial assistance that we provide to a controlled portfolio company. For these types of investments, we target a current return of 12% to 17% on the total investment. In addition to the current return, we target an overall investment return on control investments of 25% to 40%.

      When we acquire a controlling interest in a company, we may have the opportunity to acquire the company’s equity with Allied Capital’s common stock. The issuance of our stock as consideration provides us with the benefit of raising equity without having to access the public markets in an underwritten offering, including the added benefit of the elimination of any underwriter commissions.

      As a BDC, we make managerial assistance available to the portfolio companies in which we invest. Therefore, in addition to the interest, dividend and management fee income received from our private finance investments, we may charge consulting, structuring or syndication fees to our portfolio companies in return for the financial and managerial services that we provide related to our borrowers’ debt and equity capital needs.

      We hold a portion of our private finance investments in a wholly owned subsidiary, Allied Investment Corporation. Allied Investment is a BDC and is licensed and regulated by the Small Business Administration to operate as a small business investment company (“SBIC”). See “Certain Government Regulations” below for further information about SBIC regulation.

      In addition to funding private finance investments as described above, since the second quarter of 2000 we have made commitments to invest in select private equity funds. In addition to the return we expect to achieve from these investments, we believe we can achieve strategic benefits from these funds, including technology expertise for private finance portfolio companies, co-investment opportunities and increased deal flow. We may make additional commitments to other such funds, but expect our total investment in this area to remain a small percentage of our total portfolio.

Commercial Real Estate Finance

      Commercial Mortgage Loans. We have been a commercial real estate lender for many years, and maintain a small whole commercial mortgage loan portfolio. During 1998, we significantly reduced our middle-market commercial real estate lending activities because we believed that the market was under-pricing commercial real estate loans, and that the returns on senior commercial real estate loans were below a level that would result in a fair return on equity for our shareholders.

      Since 1999, we have been liquidating a significant portion of our whole commercial mortgage loan portfolio. We believe that we can redeploy the proceeds into higher yielding

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      Commercial Mortgage-Backed Securities. The same pricing pressures that caused us to reduce our origination of commercial mortgage loans in 1998 created significant liquidity problems for many other real estate lenders who had remained active lenders as pricing declined throughout 1998. In the fourth quarter of 1998, many of these lenders experienced severe liquidity constraints that caused them to exit the commercial mortgage-backed securities market. This liquidity turmoil in the real estate capital markets created a unique opportunity for us to acquire newly issued, non-investment grade commercial mortgage-backed securities (“Purchased CMBS”) at significant discounts from the face amount of the bonds and at attractive yields.

      As an investor, we believe that Purchased CMBS has attractive risk/return characteristics. The Purchased CMBS in which we invest are non-investment grade, which means that nationally recognized statistical rating organizations rate them below the top four investment-grade rating categories (i.e., “AAA” through “BBB”), and are sometimes referred to as “junk bonds.” Unlike most “junk bonds,” which are typically unsecured debt instruments, the non-investment grade Purchased CMBS in which we invest are secured by mortgage loans with real estate collateral. Our Purchased CMBS are fully collateralized by senior mortgage loans on commercial real estate properties where the loans are, on average, supported by a 30% equity investment. We acquire our Purchased CMBS on the initial issuance of the CMBS bond offering, and are able to underwrite and negotiate to purchase the securities at a significant discount from their face amount, generally resulting in an estimated yield to maturity ranging from 13% to 16%. Our negotiated discount and estimated yield to maturity assumes a 1% loss rate on the entire underlying commercial mortgage loan collateral pool, which takes into consideration certain business and economic uncertainties and contingencies. We find the yields for Purchased CMBS very attractive given their collateral protection.

      We believe this risk/return dynamic exists in this market today because there are significant barriers to entry for a non-investment grade CMBS investor. First, non-investment grade CMBS are long-term investments and require long-term investment capital. Our capital structure, which is in excess of 50% equity capital, is well suited for this asset class. Second, when we purchase CMBS in an initial issuance, we re-underwrite every mortgage loan in the underlying collateral pool, and we meet with the issuer to discuss the nature and type of loans we will accept into the pool. We have significant commercial mortgage loan underwriting expertise, both in terms of the number of professionals we employ and the depth of their commercial real estate experience. Access to this type of expertise is another barrier to entry into this market.

      As a non-investment grade CMBS investor, we recognize that non-investment grade securities have a higher degree of risk than do investment grade bonds. Non-investment grade securities are considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not ensured. They tend to be less liquid, may have a higher risk of default, and may be more difficult to value. We invest in non-investment grade CMBS represented by the “BB” to non-rated tranches of a CMBS issuance. Due to the underlying structure of the CMBS issuances, our CMBS tranches receive principal payments only after the securities that are senior to our securities are repaid. Thus, if losses are incurred in the underlying mortgage loan collateral pool, we would experience these losses.

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      To mitigate this risk, we perform extensive due diligence prior to an investment in Purchased CMBS. When we evaluate a CMBS investment, we use the same underwriting procedures and criteria for the mortgage loans in the collateral pool as we do for all of the loans we originate. These underwriting procedures and criteria are described in detail below. We will only invest in CMBS when we believe, as a result of our underwriting procedures, that the underlying mortgage pool adequately secures our position. Our portfolio of CMBS is secured by approximately 3,300 commercial real estate properties located in diverse geographic locations across the United States in a wide variety of property types, including retail, multi-family housing, office, and hospitality. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a summary of the loan to value ratios and debt service coverage ratios of the mortgage loans securing our Purchased CMBS investments.

      Our Purchased CMBS activity complements our private finance activity because it provides a steady stream of recurring interest income. In addition, given our depth of our commercial real estate experience and the extensive due diligence that we perform prior to an investment in Purchased CMBS, we may receive structuring and diligence fees upon the purchase of CMBS bonds. These fees are separately negotiated for each transaction. In order to maintain a balanced investment portfolio, we expect to limit our Purchased CMBS activity to approximately 20% to 25% of total assets.

Small Business Finance

      On December 31, 2000, Allied Capital and BLC Financial Services, Inc. (“BLC”) completed a merger whereby Allied Capital acquired BLC. The effect of the merger was to create an independently managed, private portfolio company of Allied Capital to focus exclusively on small business lending, including the origination of SBA 7(a) loans. BLC changed its name to Business Loan Express, Inc. (“BLX”).

      As part of this transaction, on December 28, 2000, we recapitalized our wholly owned small business lending subsidiary, Allied Capital SBLC Corporation, as an independently managed private portfolio company. Allied SBLC established a separate board of directors, and the employees and operations attributed to Allied Capital Express, including the online loan origination technology, were transferred to Allied SBLC. We restructured previous intercompany debt owed to us by Allied SBLC at the time of the recapitalization as $74.5 million in subordinated debt now owed by the new portfolio company. Allied SBLC was subsequently merged into BLX and we received $25.1 million in BLX preferred stock in exchange for our equity in Allied SBLC.

      BLX is currently financed with a combination of senior and subordinated debt, and preferred and common equity. Allied Capital owns 94.9% of BLX. Allied Capital’s investment in BLX is expected to generate interest income, dividends and fee income. In addition, we believe there is opportunity to add value to the new portfolio company and to position the investment for a future capital gain. The Company has entered into a management contract with BLX to provide management services, including certain technology and transition services. Our investment in BLX is included in our private finance portfolio.

      BLX is a non-bank small business lender licensed as a participant in the SBA 7(a) Guaranteed Loan Program. BLX has a total of 31 offices nationwide, and SBA Preferred Lender status in 66 markets. BLX believes it will be a technology leader in online small business loan origination, and will have significant online loan origination relationships as

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Investment Advisory Services

      We are a registered investment adviser, pursuant to the Investment Advisers Act of 1940, and have an investment advisory agreement to manage a private investment fund. The revenue generated from this agreement is not material to the Company’s operations.

Loan Sourcing

      We have established a business development group within Allied Capital that actively sources new investment opportunities. We maintain a network of hundreds of relationships with investors, lenders and intermediaries including:

	•	private mezzanine and equity investors;
	•	investment banks;
	•	business and mortgage brokers;
	•	national retail financial services companies; and
	•	banks, law firms and accountants.

      We believe that our experience and reputation provide a competitive advantage in originating new investments. We have established an extensive network of investment referral relationships over our history. We are recognized as a pioneer in the private finance industry, and have developed a reputation in the commercial real estate finance market for our ability to finance complex transactions.

Investment Approval and Underwriting Procedures

      In assessing new investment opportunities, we maintain conservative credit standards based on our underwriting guidelines, a thorough due diligence process, and a centralized credit approval process requiring committee review, all of which are described below. The combination of conservative underwriting standards and our credit-oriented culture has resulted in a record of minimal realized losses.

      Private Finance. We generally require that the companies in which we invest demonstrate strong market position, sales growth, positive cash flow, and profitability, as discussed above. We emphasize the quality of management, and seek experienced entrepreneurs with a management track record, relevant industry experience and a significant equity stake in the business. In a typical private financing, we thoroughly review, analyze and substantiate, through due diligence, the business plan and operations of the potential portfolio company. We perform financial due diligence, often with assistance of an accounting firm; perform operational due diligence, often with the assistance of an industry consultant; study the industry and competitive landscape; and conduct numerous reference checks with current and former employees, customers, suppliers and competitors. The typical private finance transaction requires two to three months of diligence and structuring before funding occurs.

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      Private finance transactions are approved by an investment committee consisting of our most senior private finance professionals and chaired by our Chairman and Chief Executive Officer. The private finance approval process benefits from the experience of the investment committee members and from the experience of our other investment professionals who together with the committee members, on average, have over twelve years of professional experience. For every transaction of $10 million or greater, we also require approval from the Executive Committee of the Board of Directors in addition to the investment committee approval. Even after all such approvals are received, due diligence must be successfully completed with final investment committee approval before funds are disbursed to a portfolio company.

      Purchased CMBS. We receive extensive packages of information regarding the mortgage loans comprising a CMBS pool. We work with the issuer, the investment bank, and the rating agencies in performing our diligence on a CMBS purchase. The typical CMBS purchase takes between two to three months to complete because of the breadth and depth of our diligence procedures. We re-underwrite all of the underlying commercial mortgage loans securing the CMBS. We challenge the estimate of underwriteable cash flow and challenge necessary carve-outs, such as replacement reserves. We study the trends of the industry and geographic location of each property, and independently assess our own estimate of the anticipated cash flow over the period of the loan. Our loan officers physically inspect most of the collateral properties, and assess appraised values based on our own opinion of comparable market values.

      Based on the findings of our diligence procedures, we may reject certain mortgage loans from inclusion in the pool. We then formulate our negotiated purchase price and discount to achieve an effective yield on our investment over a ten-year period to approximate 13% to 16%. In computing this estimated yield, we assume a 1% loss rate on the entire underlying mortgage pool.

      CMBS transactions are approved by an investment committee and, because of their size, every CMBS transaction is reviewed and approved by the Executive Committee of the Board of Directors. The investment committee for CMBS transactions consists of our most senior commercial real estate professionals and is chaired by our Chairman and Chief Executive Officer.

Portfolio Management

      Portfolio Diversity.  We monitor the portfolio to maintain both industry and geographic diversity. We currently do not have a policy with respect to “concentrating” (i.e., investing 25% or more of our total assets) in any industry or group of industries and currently our portfolio is not concentrated. We may or may not concentrate in any industry or group of industries in the future.

      Loan Servicing.  Our loan servicing staff is responsible for routine loan servicing, which includes:

	•	delinquency monitoring;
	•	payment processing;
	•	borrower inquiries;
	•	escrow analysis and processing;
	•	third-party reporting; and
	•	insurance and tax administration.

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      In addition, our staff is responsible for special servicing activities including delinquency monitoring and collection, workout administration and management of foreclosed assets.

Portfolio Monitoring and Valuation

      We use a grading system in order to help us monitor the credit quality of our portfolio and the potential for capital gains. The grading system assigns grades to investments from 1 to 5, and the portfolio was graded at September 30, 2001 as follows:

										Percentage
						Portfolio at				of Total
Grade				Description		Value				Portfolio
						(in millions)
	1			Probable capital gain		$	479.4				22.1%
	2			Performing security			1,561.7				71.8%
	3			Close monitoring — no loss of principal or interest expected			57.3				2.6%
	4			Workout — Some loss of interest expected			48.0				2.2%
	5			Workout — Some loss of principal expected			28.0				1.3%
						$	2,174.4				100.0%

      The 1940 Act requires that the Board of Directors value each asset in the portfolio on a quarterly basis. As a BDC, we are required to value our portfolio of illiquid private or illiquid public securities at fair value. Fair value reflects what you would expect to receive in a current sale, with current sale generally accepted to mean an orderly disposition over a reasonable period of time. We are not permitted to have a general loan loss reserve, but instead must value each specific investment. We have a written valuation policy that governs the valuation of our assets, and we follow a consistent valuation process quarterly. In valuing each individual investment, we consider the financial performance of each portfolio company, loan payment histories, indications of potential equity realization events, and current collateral values, and then determine whether the value of each asset should be increased through unrealized appreciation or decreased through unrealized depreciation. After each investment professional has made his or her determination of value, members of senior management review the valuations. These valuations are then presented to the board of directors for review and approval.

      As a general rule, we do not value our loans above principal balance, but loans are subject to depreciation events when the asset is considered impaired. Also as a general rule, equity securities may be assigned appreciation if circumstances warrant. With respect to private equity securities, each investment is valued using industry valuation benchmarks, and then the value is assigned a discount reflecting the illiquid nature of the investments as well as our minority, non-control position. When an external event such as a purchase transaction, public offering, or subsequent equity sale occurs, the pricing indicated by the external event is used to corroborate our private equity valuation. Equity securities in public companies that carry certain restrictions on sale are generally valued at a discount from the public market value of the securities. Restricted and unrestricted publicly traded stocks may also be valued at discounts due to the size of our investment, restrictions on trading or market liquidity concerns.

      We monitor loan delinquencies in order to assess the appropriate course of action and overall portfolio quality. With respect to our private finance portfolio, investment professionals closely monitor the status and performance of each individual investment

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      We price our private finance investment portfolio to provide adequate current returns for our shareholders assuming that a portion of the portfolio at any time may not be accruing interest currently. We also price our investments for a total return including current interest or dividends plus capital gains from sale of equity securities. Therefore, the amount of loans that are delinquent is not necessarily an indication of future principal loss or loss of anticipated investment return. Our portfolio grading system is used as a means to assess loss of investment return (Grade 4 assets) or loss of investment principal (Grade 5 assets). We expect that a certain number of portfolio companies will be in the Grade 4 or 5 category from time to time. Part of the business of private finance is working with troubled portfolio companies to improve their businesses and protect our investment. The number of portfolio companies and related investment amount included in Grade 4 and 5 may fluctuate significantly from quarter to quarter as we help these companies work through their problems. We continue to follow our historical practices of working with a troubled portfolio company in order to recover the maximum amount of our investment, but record unrealized depreciation for the expected full amount of the potential loss when such exposure is identified.

     

      With respect to our commercial real estate portfolio, the following outlines the treatment of each delinquency category:

30 Days Past Due		Our loan servicing staff monitors loans and contacts borrowers for collection.
60 Days Past Due		We generally transfer loans to professionals responsible for special servicing activity for monitoring, collection and development of a workout plan, if necessary.
90 Days Past Due		Our accounting department reviews loans in conjunction with the professional responsible for special servicing to determine whether the loans should be placed on a non-accrual status or whether a valuation adjustment is required.
120 Days Past Due		Generally, we place such loans on non-accrual status and the loan is an active workout.

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      With respect to our Purchased CMBS portfolio, we monitor the performance of the individual loans in the underlying collateral pool through market data and discussions with the pool master servicers and special servicers. The master servicers are responsible for the day-to-day loan servicing functions, including billing, payment processing, collections on loans less than 60 days past due, tax and insurance escrow processing, and annual property inspections. The special servicers are responsible for collections on loans greater than 60 days past due, including workout administration and management of foreclosed properties. We discuss the status of past due or underperforming loans with the master servicers on a monthly basis. When a loan moves to a special servicer, a workout plan is formulated by the special servicer and generally reviewed by us as the directing certificate holder. Once reviewed by us, the special servicer carries out the workout plan, updating us on the status at least monthly. We have the ability to replace the named special servicer at any time.

      Since the market for CMBS bonds is relatively illiquid, we do not believe that the fair value of our Purchased CMBS bonds is greater than cost where we intend to hold the investment to maturity, but these CMBS bonds are subject to depreciation events if the fair value is determined to be less than its cost basis. The fair value of these investments considers the current and expected future performance of the underlying loan collateral pool, and the related underlying cash flows that would be generated by the pool as a result of that performance. If we determine that any CMBS bonds will be sold, these bonds will be classified as held for sale and unrealized appreciation or depreciation will be recorded based upon the price at which the CMBS bonds could then be sold.

Investment Gains and Losses

      As an investor focused primarily on debt investments, our investment decisions are based on credit dynamics. Our underwriting focuses on the preservation of principal, and we will pursue our available means to recover our capital investment. As a result of this investment discipline and credit culture, we have a history of low levels of loan losses, and have a demonstrated track record of successfully resolving troubled credit situations with minimal losses. Our realized gains from the sale of our equity interests have historically exceeded losses, as is reflected in the chart below.

		Nine Months Ended
		September 30,								Year Ended December 31,
		2001				2000				2000				1999				1998				1997				1996
Realized gains		$	9,942			$	24,664			$	28,604			$	31,536			$	25,757			$	15,804			$	30,417
Realized losses		$	(1,603	)		$	(1,569	)		$	(13,081	)		$	(6,145	)		$	(3,216	)		$	(5,100	)		$	(11,262	)
Net realized gains		$	8,339			$	23,095			$	15,523			$	25,391			$	22,541			$	10,704			$	19,155
Total assets		$	2,266,833			$	1,731,773			$	1,853,817			$	1,290,038			$	856,079			$	807,775			$	713,360
Realized losses/ Total assets			0.07	%			0.09	%			0.7	%			0.5	%			0.4	%			0.6	%			1.6	%

Employees

      At September 30, 2001, we employed 95 individuals including investment and portfolio management professionals, operations professionals and administrative staff. The majority of these individuals are located in the Washington, DC office. We believe that our relations with our employees are excellent.

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Legal Proceedings

      We are a party to certain lawsuits in the normal course of our business. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.

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PORTFOLIO COMPANIES

      The following is a listing of our portfolio companies in which we had an equity investment at September 30, 2001. We make available significant managerial assistance to our portfolio companies. Other than loans to the portfolio company, our only relationship with each portfolio company is our investment. For information relating to the amount and nature of our investments in portfolio companies, see the Consolidated Statement of Investments at September 30, 2001 at pages F-5 to F-12.

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Acme Paging, L.P.

Paging Services

Limited Partnership

1.8%

1336 Basswood, Suite F

Interests

Schaumburg, IL 60173

Allied Office Products, Inc.

Office Products

Warrants to Purchase

2.0%

75 Route 17 South

Common Stock

Hasbrouck Heights, NJ 07604

American Barbecue & Grill, Inc.

Restaurant Chain

Warrants to Purchase

17.3%

7300 W. 110th Street, Suite 570

Common Stock

Overland Park, KS 66210

American HomeCare Supply, LLC

Home Medical

Warrants to

2.1%

One First Avenue

Equipment

Purchase Class A

Suite 100

Provider

Common Units

Conshohocken, PA 19428

Aspen Pet Products, Inc.

Pet Product

Series B Preferred

40.8%

11701 East 53rd Ave.

Provider

Stock

Denver, CO 80239

Series A Common Stock

4.7%

ASW Holding Corporation

Steel Wool Manufacturer

Warrants to Purchase

5.0%

2825 W. 31st Street

Common Stock

Chicago, IL 60623

Aurora Communications, LLC

Radio Stations

Redeemable Preferred

3.2%

3 Stamford Landing, Suite 210

Equity Interest

46 Southfield Avenue

Stamford, CT 06902

Autania AG

Machine and Tool

Common Stock

6.2%

Industriestrasse 7

Manufacturer

65779 Kelkheim

Germany

Avborne, Inc.

Aviation Services

Warrants to Purchase

3.5%

c/o Trivest, Inc.

Common Stock

2665 S. Bayshore Dr., Suite 800

Miami, FL 33133-5462

Blue Rhino Corporation

Propane Cylinder Exchange

Warrants to Purchase

12.9%

104 Cambridge Plaza Drive

Common Stock

Winston-Salem, NC 27104

Border Foods, Inc.

Mexican Ingredient &

Series A Convertible

9.4%

J Street

Food Product

Preferred Stock

Deming Industrial Park

Manufacturer

Warrants to Purchase

6.2%

Deming, NM 88030

Common Stock

Business Loan Express, Inc.

Small Business Lender

Preferred Stock

100.0%

645 Madison Ave.

Common Stock

94.9%

19th Floor

New York, NY 10022

Camden Partners Strategic Fund II, L.P. (formerly Cahill-Warnock Strategic Partners Fund II, L.P.)

Private Equity Fund

Limited Partnership

4.2%

One South Street

Interest

Suite 2150

Baltimore, MD 21202

CampGroup, LLC

Recreational Camp

Warrants to Purchase

2.6%

4 New King Street

Operator

Common Stock

White Plains, NY 10604

53

---

 

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Candlewood Hotel Company

Extended Stay

Series A Convertible

5.0%

9342 East Central

Facilities

Preferred Stock

Wichita, KS 67206

Celebrities, Inc.

Radio Stations

Warrants to Purchase

25.0%

408-412 W. Oakland Park

Common Stock

Boulevard

Ft. Lauderdale, FL 33311-1712

Colibri Holding Corporation

Outdoor Living Products

Common Stock

3.4%

2201 S. Walbash Street

Warrants to Purchase

2.0%

Denver, CO 80231

Common Stock

The Color Factory Inc.

Cosmetic Manufacturer

Preferred Stock

100.0%

11312 Penrose Street

Common Stock

99.3%

Sun Valley, CA 91352

Component Hardware Group, Inc.

Designer & Developer

Class A Preferred Stock

9.1%

1890 Swarthmore Ave.

of Hardware

Common Stock

8.2%

P.O. Box 2020

Components

Lakewood, NJ 08701

Convenience Corporation of America

Convenience Store Chain

Series A Preferred Stock

10.0%

711 N. 108th Court

Warrants to Purchase

4.0%

Omaha, NE 68154

Senior Preferred Stock

Cooper Natural Resources, Inc.

Sodium Sulfate Producer

Warrants to Purchase

2.5%

P.O. Box 1477

Common Stock

Seagraves, TX 79360

Series A Convertible

100%

Preferred Stock

Warrants to Purchase

36.8%

Series A Convertible Preferred Stock

CorrFlex Graphics, LLC

Packaging Manufacturer

Warrants to Purchase

4.5%

P.O. Box 1337

Common Stock

Monroe, NC 28110

Options to Purchase

7.0%

Common Stock

Coverall North America, Inc.

Commercial Cleaning

Warrants to Purchase

15.0%

500 West Cypress Creek Rd.

Service

Common Stock

Ste. 580

Ft. Lauderdale, FL 33309

Csabai Canning Factory Rt.

Food Processing

Hungarian Quotas

9.2%

5600 Békéscasba

Békís: vt 52-54 Hungary

CyberRep

Operator of Call Service Centers

Warrants to Purchase

24.8%

8300 Greensboro Drive, 6th Floor

Common Stock

McLean, VA 22102

The Debt Exchange, Inc.

Online Sales of

Series B Convertible

49.0%

101 Arch Street, Suite 410

Distressed Assets

Preferred Stock

Boston, MA 02110

Directory Investment Corporation

Telephone Directories

Common Stock

50.0%

1919 Pennsylvania Avenue, N.W.

Washington, DC 20006

Directory Lending Corporation

Telephone Directories

Common Stock

50.0%

1919 Pennsylvania Avenue, N.W.

Washington, DC 20006

Drilltec Patents & Technologies Company, Inc.

Drill Pipe Packager

Warrants to Purchase

15.0%

10875 Kempwood Drive, Suite 2

Common Stock

Houston, TX 77043

eCentury Capital Partners, L.P.

Private Equity Fund

Limited Partnership

25.0%

1101 Connecticut Ave, NW

Interest

7th Floor

Washington, DC 20036

EDM Consulting, LLC

Environmental

Common Stock

25.0%

14 Macopin Avenue

Consulting

Montclair, NJ 07043

54

---

 

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Elexis Beta GmbH

Distance Measurement

Options to Purchase

9.8%

Ulmenstrabe 22

Device

Shares

60325 Frankfurt am Main

Manufacturer

Germany

Esquire Communications Ltd.

Court Reporting

Warrants to Purchase

3.0%

216 E. 45th Street, 8th floor

Services

Common Stock

New York, NY 10017

E-Talk Corporation

Telecommunications

Warrants to Purchase

5.5%

4425 Cambridge Road

Software Provider

Common Stock

Fort Worth, TX 76155-2692

Executive Greetings, Inc.

Personalized Business

Warrants to Purchase

1.1%

120 Industrial Park Access Road

Products

Common Stock

New Hartford, CT 06057

ExTerra Credit Recovery, Inc.

Consumer Finance

Series A Preferred Stock

0.9%

35 Lennon Lane, Suite 200

Receivable Collections

Common Stock

0.7%

Walnut Creek, CA 94598

Warrants to Purchase

0.7%

Common Stock

Fairchild Industrial Products Company

Industrial Controls

Warrants to Purchase

20.0%

3920 Westpoint Boulevard

Manufacturer

Common Stock

Winston-Salem, NC 27013

Galaxy American Communications, Inc.

Cable Television

Option to Purchase

51.0%

1220 N. Main Street

Operator

Common LLC Interest

Sikeston, MO 63801

Garden Ridge Corporation

Home Decor Retailer

Series A Preferred Stock

2.6%

650 Madison Avenue

Common Stock

4.7%

New York, NY 10022

Gibson Guitar Corporation

Guitar Manufacturer

Warrants to Purchase

3.0%

1818 Elm Hill Pike

Common Stock

Nashville, TN 37210

Ginsey Industries, Inc.

Bathroom Accessories

Convertible Debentures

7.0%

281 Benigno Boulevard

Manufacturer

Warrants to Purchase

16.0%

Bellmawr, NJ 08031

Common Stock

Global Communications I, LLC

Muzak Franchisee

Preferred Equity

59.3%

201 East 69th Street

Interest

New York, NY 10021

Options for Common

59.3%

Membership Interest

Grant Broadcasting Systems II

Television Stations

Warrants to Purchase

25.0%

919 Middle River Drive,

Common Stock

Suite 409

Warrants to Purchase

25.0%

Ft. Lauderdale, FL 33304

Common Stock in Affiliate Company

Grant Television, Inc.

Television Stations

Equity Interest

20.0%

(See Grant Broadcasting System II)

Grotech Partners VI, L.P.

Private Equity Fund

Limited Partnership

3.1%

c/o Gntech Capital Group

Interest

9690 Deereco Road

Suite 800

Timonium, MD 21093

The Hartz Mountain Corporation

Pet Supply

Common Stock

2.0%

400 Plaza Drive

Manufacturer

Warrants to Purchase

3.5%

Secaucus, NJ 07094

Common Stock

HealthASPex, Inc.

Third Party

Class A Preferred

26.2%

2812 Trinity Square Drive

Administrator

Stock

Carrollton, TX 75006

Common Stock

26.2%

HMT, Inc.

Storage Tank

Common Stock

27.3%

1422 FM 1960 W.

Maintenance &

Warrants to Purchase

10.0%

Suite 350

Repair

Common Stock

Houston, TX 77068

55

---

 

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Hotelevision, Inc.

Hotel Cable-TV

Series 3

16.2%

599 Lexington Avenue

Network

Preferred Stock

Suite 2300

New York, NY 10022

Icon International, Inc.

Corporate Barter

Class A Common Stock

0.8%

281 Tressor Boulevard

Services

Class C Common Stock

0.2%

8th Floor

Stamford, CT 06901

Impact Innovations Group

Information Technology

Warrants to Purchase

4.0%

5825 Glenridge Drive

Services Provider

Common Stock

Building II, Suite 107

Atlanta, GA 30328

International Fiber Corporation

Cellulose and Fiber

Common Stock

11.0%

50 Bridge Street

Producer

Warrants to Purchase

2.9%

North Tonawanda, NY 14120

Common Stock

iSolve Incorporated

Corporate Barter Services

Series A

2.9%

281 Tresser Boulevard

Preferred Stock

Two Stamford Plaza

Common Stock

1.1%

Stamford, CT 06901

JRI Industries, Inc.

Machinery Manufacturer

Warrants to Purchase

7.5%

2958 East Division

Common Stock

Springfield, MO 65803

Julius Koch USA, Inc.

Mini-Blind Cord

Warrants to Purchase

45.0%

387 Church Street

Manufacturer

Common Stock

New Bedford, MA 02745

Kirker Enterprises, Inc.

Nail Enamel

Warrants to Purchase

22.5%

55 East 6th Street

Manufacturer

Series B Common Stock

Paterson, NJ 07524

Equity Interest in Affiliate Company

22.5%

Kirkland’s, Inc.

Home Furnishing

Series D Preferred Stock

3.3%

P.O. Box 7222

Retailer

Warrants to Purchase

4.2%

Jackson, TN 38308-7222

Common Stock

Kyrus Corporation

Value-Added Reseller,

Warrants to Purchase

8.0%

25 Westridge Market Place

Computer Systems

Common Stock

Chandler, NC 28715

Liberty-Pittsburgh Systems, Inc.

Business Forms Printing

Common Stock

17.2%

265 Executive Drive

Plainview, NY 11803

Logic Bay Corporation

Computer-Based

Series C Redeemable

29.4%

7900 International Drive

Training Developer

Preferred Stock

Suite 750

Minneapolis, MN 55425

Love Funding Corporation

Mortgage Services

Series D Preferred Stock

26.0%

1220 19th Street, NW, Suite 801

Washington, DC 20036

Magna Card, Inc.

Magnet Packager

Preferred Stock

6.3%

10315 South Dolifield Rd.

and Distributor

Common Stock

5.4%

Owings Mills, MD 21117

Master Plan, Inc.

Healthcare Outsourcing

Common Stock

13.6%

21540 Plummer Street

Chatsworth, CA 91311

MedAssets.com, Inc.

Healthcare Outsourcing

Series B Convertible

6.4%

21540 Plummer Street

Preferred Stock

Chatsworth, CA 91311

Warrants to Purchase

2.9%

Preferred Stock

Mid-Atlantic Venture Fund IV, L.P.

Private Equity Fund

Limited Partnership

7.3%

128 Goodman Drive

Interest

Bethlehem, PA 18015

Midview Associates, L.P.

Residential Land

Warrants to purchase

35.0%

2 Eaton Street, Suite 1101

Development

partnership interests

Hampton, VA 23669

56

---

 

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Monitoring Solutions, Inc.

Air Emissions

Common Stock

25.0%

4303 South High School Road

Monitoring

Warrants to Purchase

50.0%

Indianapolis, IN 46241

Common Stock

MortgageRamp.com, Inc.

Internet Based

Class A Common

8.0%

116 Welsh Road

Loan Origination

Stock

Horsham, PA 19044

Service Platform

Morton Grove Pharmaceuticals, Inc.

Generic Drug

Redeemable Convertible

27.8%

6451 West Main Street

Manufacturer

Preferred Stock

Morton Grove, IL 60053

MVL Group, Inc.

Market Research

Warrants to Purchase

8.0%

1061 E. Indiantown Road

Services

Common Stock

Suite 300

Jupiter, FL 33477

Nobel Learning Communities, Inc.

Educational Services

Series D Convertible

100.0%

1400 N. Providence Road,

Preferred Stock

Suite 3055

Warrants to Purchase

13.1%

Media, PA 19063

Common Stock

North American Archery, LLC

Sporting Equipment

Debentures Convertible

26.9%

1733 Gunn Highway

Manufacturer

into LLC Equity

Odessa, FL 33556

Interest

Novak Biddle Venture Partners III, LP

Private Equity Fund

Limited Partnership

2.9%

1750 Tysons Boulevard

Interest

Suite 1190

McLean, VA 22102

Nursefinders, Inc.

Home Healthcare

Warrants to Purchase

3.4%

1200 Copeland Road, Suite 200

Providers

Common Stock

Arlington, TX 76011

Onyx Television GmbH

Cable Television

Preferred Units

12.0%

Immedia Park 6b

50670 Koln

Germany

Opinion Research Corporation

Corporate Marketing

Warrants to Purchase

8.0%

P.O. Box 183

Research Firm

Common Stock

Princeton, NJ 08542

Oriental Trading Company, Inc.

Direct Marketer

Redeemable Preferred

1.7%

108th Street, 4206 South

of Toys

Stock

Omaha, NE 68137

Class A Common Stock

1.7%

Warrants to Purchase

1.4%

Common Stock

Outsource Partners, Inc.

Outsourced Facility

Warrants to Purchase

4.0%

200 Mansell Court East

Services Provider

Preferred Stock

Suite 500

Warrants to Purchase

4.0%

Roswell, GA 30076

Common Stock

Packaging Advantage Corporation

Personal Care,

Common Stock

9.9%

4633 Downey Road

Household and

Warrants to Purchase

5.5%

Los Angeles, CA 90058

Disinfectant Product

Common Stock

Packager

Physicians Specialty Corporation

Physician Practice

Common Stock

80.3%

1150 Lake Hearn Drive

Management Services

Atlanta, GA 30342

Provider

Pico Products, Inc.

Satellite/Television

Common Stock

5.0%

12500 Foothill Boulevard

Component

Warrants to Purchase

15.0%

Lakeview Terr., CA 91342

Manufacturer

Common Stock

Polaris Pool Systems, Inc.

Pool Cleaner

Warrants to Purchase

2.1%

P.O. Box 1149

Manufacturer

Common Stock

San Marcos, CA 92079-1149

Professional Paint, Inc.

Paint Manufacturer

Series A-1 Senior

100.0%

3900 Joliet Street

Exchangeable Preferred

Denver, CO 80239

Stock

Common Stock

11.0%

57

---

 

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Progressive International

Corporation

Retail Kitchenware

Redeemable Preferred

12.5%

6111 S. 228th Street

Stock

P.O. Box 97045

Common Stock

0.02%

Kent, WA 98064

Warrants to Purchase

6.2%

Common Stock

Prosperco Finaz Holding AG

Financial Services

Debt Convertible into

8.5%

Schützengasse 25

Common Stock

CH-8001 Zürich

Common Stock

2.6%

Switzerland

Warrants to Purchase

5.0%

Common Stock

Raytheon Aerospace, LLC

Aviation Maintenance and

Class B LLC Interest

6.7%

555 Industrial Drive South

Logistics

Madison, MS 39110

Redox Brands, Inc.

Cleaning Products

Warrants to Purchase

3.3%

9100 Centre Point Drive

Common Stock

Suite 200

West Chester, OH 45069

Schwinn Holdings Corporation

Bicycle Manufacturer/

Warrants to Purchase

0.7%

1690 38th Street

Distributor

Common Stock

Boulder, CO 80301

Seasonal Expressions, Inc.

Decorative Ribbon

Series A Preferred Stock

50.0%

230 5th Avenue, Suite 1007

Manufacturer

New York, NY 10001

Soff-Cut Holdings, Inc.

Concrete Sawing

Series A Preferred Stock

4.0%

1112 Olympic Drive

Equipment Manufacturer

Common Stock

2.7%

Corona, CA 91719

Warrants to Purchase

6.7%

Common Stock

Southern Communications, LLC

Communications Tower

Equity Interest

85.0%

1919 Pennsylvania Ave., NW

Leasing

Washington, DC 20006

Spa Lending Corporation

Health Spas

Series A Preferred Stock

100.0%

1919 Pennsylvania Avenue, N.W.

Series B Preferred Stock

68.4%

Washington, DC 20006

Series C Preferred Stock

46.3%

Common Stock

62.1%

Staffing Partners Holding Company, Inc.

Temporary Employee

Redeemable Preferred

48.3%

104 Church Lane #100

Services

Stock

Baltimore, MD 21208

Class A-1 Common

50.0%

Stock

Class A-2 Common

24.4%

Stock

Class B Common

24.0%

Stock

Startec Global Communications Corporation

Integrated

Common Stock

1.3%

10411 Motor City Drive

Communications

Warrants to

0.9%

Bethesda, MD 20852

Service Provider

Purchase Common Stock

STS Operating, Inc.

Engineering Design and

Common Stock

42.2%

2301 Windsor Court

Services

Addison, IL 60101

SunSource Inc.

Wholesale Machinery and

Common Stock

93.2%

One Logan Square

Supplies

Philadelphia, PA 19013

Sure-Tel, Inc.

Prepaid Telephone

Series A Convertible

41.7%

5 North McCormick

Services Company

Redeemable Preferred

Oklahoma City, OK 73127

Stock

Warrants to Purchase

9.6%

Common Stock

Options to Purchase

41.7%

Common Stock

Total Foam, Inc.

Packaging Systems

Common Stock

49.0%

P.O. Box 688

Ridgefield, CT 06877

58

---

 

Percentage

Name and Address

Nature of its

Title of Securities

of Class

of Portfolio Company

Principal Business

Held by the Company

Held(1)

Tubbs Snowshoe Company, LLC

Snowshoe Manufacturer

Warrants to Purchase

7.7%

52 River Road

Common Units

Stowe, VT 05672

Equity Interests in

10.9%

Affiliate Company

United Pet Group, Inc.

Manufacturer of Pet

Warrants to Purchase

0.8%

125 High Street

Products

Common Stock

Boston, MA 02110

Updata Venture Partners II, L.P.

Private Equity Fund

Limited Partnership

16.1%

11600 Sunrise Valley Drive

Interest

Reston, VA 20191

Velocita, Inc.

Fiber Optic Network

Warrants to Purchase

0.6%

(formerly PF.Net

Common Stock

Communications, Inc.)

677 Washington Blvd.

Stamford, CT 06912

Venturehouse Group, LLC

Private Equity Fund

Common Equity Interest

2.3%

1780 Tysons Blvd., Suite 400

McLean, VA 22102

Walker Investment Fund II, LLLP

Private Equity Fund

Limited Partnership

5.1%

3060 Washington Road

Interest

Suite 200

Glenwood, MD 21738

Warn Industries, Inc.

Sport Utility Accessories

Warrants to Purchase

4.3%

12900 S.E. Capps Rd.

Manufacturer

Common Stock

Clackamas, OR 97015

Williams Brothers Lumber

Company

Builders’ Supplies

Warrants to Purchase

14.1%

3165 Pleasant Hill Road

Common Stock

Duluth, GA 30136

Wilmar Industries, Inc.

Repair and Maintenance

Warrants to Purchase

3.0%

303 Harper Drive

Product Distributor

Common Stock

Moorestown, NJ 08057

Wilshire Restaurant Group, Inc.

Restaurant Chain

Warrants to Purchase

3.0%

1100 Town & Country Road

Common Stock

Suite 1300

Orange, CA 92868-4654

Woodstream Corporation

Pest Control

Equity Interest in

13.8%

69 North Locust Street

Manufacturer

Affiliate Company

Lititz, PA 17543

Warrants to Purchase

7.2%

Common Stock

Wyo-Tech Acquisition Corporation

Vocational School

Preferred Stock

100.0%

4373 N. 3rd Street

Common Stock

99.0%

Laramie, WY 82072

(1)	Percentages shown for warrants and options held represent the percentage of class of security we may own, on a fully diluted basis, assuming we exercise our warrants or options.

DETERMINATION OF NET ASSET VALUE

      We determine the net asset value per share of our common stock quarterly. The net asset value per share is equal to the value of our total assets minus liabilities and preferred stock divided by the total number of common shares outstanding.

      Portfolio assets are carried at fair value as determined by the board of directors under our valuation policy. As a general rule, we do not value the Company’s loans or CMBS bonds above cost, but loans or CMBS bonds are subject to depreciation events when the asset is considered impaired. Also as a general rule, equity securities may be assigned appreciation if circumstances warrant. With respect to private equity securities, each investment is valued using industry valuation benchmarks, and then the value is assigned a

59

---

 

      Determination of fair value involves subjective judgments that cannot be substantiated by auditing procedures. Accordingly, under current standards, the accountants’ opinion on the Company’s financial statements in our annual report refers to the uncertainty with respect to the possible effect on the financial statements of such valuation.

MANAGEMENT

      The Board of Directors supervises the management of the Company. The responsibilities of each director include, among other things, the oversight of the loan approval process, the quarterly valuation of our assets, and oversight of our financing arrangements. The board of directors maintains an Executive Committee, Audit Committee, Compensation Committee, and Nominating Committee, and may establish additional committees in the future. Some or all of the Company’s directors also serve as directors of its subsidiaries.

      Our investment decisions in each business area are made by investment committees composed of the Company’s most senior investment professionals. No one person is primarily responsible for making recommendations to a committee.

      The Company is internally managed and our investment professionals manage our portfolio and the portfolios of companies for which we serve as investment adviser. These investment professionals have extensive experience in managing investments in private growing businesses in a variety of industries and in diverse geographic locations, and are familiar with our approach of lending and investing. Because the Company is internally managed, we pay no investment advisory fees, but instead we pay the operating costs associated with employing investment management professionals.

Structure of Board of Directors

      The Board of Directors is classified into three approximately equal classes with three-year terms, with only one of the three classes expiring each year. Directors serve until their successors are elected and qualified.

60

---

 

Directors

      Information regarding the Board of Directors is as follows:

								Director				Expiration
Name		Age				Position		Since(1)				of Term
William L. Walton*			52			Chairman, Chief Executive
						Officer and President			1986				2004
George C. Williams, Jr.*			75			Chairman Emeritus			1964				2004
Brooks H. Browne			52			Director			1990				2004
John D. Firestone			57			Director			1993				2002
Anthony T. Garcia			45			Director			1991				2002
Lawrence I. Hebert			55			Director			1989				2002
John I. Leahy			71			Director			1994				2003
Robert E. Long			70			Director			1972				2004
Warren K. Montouri			72			Director			1986				2003
Guy T. Steuart II			70			Director			1984				2003
T. Murray Toomey, Esq			77			Director			1959				2003
Laura W. van Roijen			49			Director			1992				2002

(1) Includes service as a director of any of the predecessor companies.

Executive Officers

      Information regarding the Company’s executive officers is as follows:

Name		Age				Position
William L. Walton			52			Chairman, Chief Executive Officer and President
Joan M. Sweeney			42			Chief Operating Officer
Penni F. Roll			35			Chief Financial Officer
Scott S. Binder			47			Managing Director
Samuel B. Guren			54			Managing Director
Philip A. McNeill			42			Managing Director
John M. Scheurer			49			Managing Director
Thomas H. Westbrook			38			Managing Director
G. Cabell Williams, III			47			Managing Director

Biographical Information

Directors

      William L. Walton has been the Chairman, Chief Executive Officer and President of the Company since 1997. He has served on Allied Capital’s board of directors since 1986, and was named Chairman and CEO in February 1997. Mr. Walton has an extensive background in general management, marketing, strategic planning, mergers and acquisitions and financial analysis. Mr. Walton previously served as Managing Director of New York-based Butler Capital Corporation, a mezzanine buyout firm, (1987-1991) and was the personal venture capital advisor for William S. Paley, founder and Chairman of CBS. In addition, he was a Senior Vice President in Lehman Brother Kuhn Loeb’s Investment Banking Group. Mr. Walton also founded and managed two start-up businesses, Success Lab, Inc. and Language Odyssey, in the emerging education industry

61

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      George C. Williams, Jr. is Chairman Emeritus of the Company. Mr. Williams was an officer of the predecessor companies from the later of 1959 or the inception of the relevant entity and President or Chairman and Chief Executive Officer of the predecessor companies from the later of 1964 or each entity’s inception until 1991. Mr. Williams is the father of G. Cabell Williams III, an executive officer of the Company.

      Brooks H. Browne has been the President of Environmental Enterprises Assistance Fund since 1993. Mr. Browne is a director of SEAF, Corporation Financiera Ambiental (Panama), Empresas Ambientales de Centro America (Costa Rica) Renewable Energy and Energy Efficiency Fund, Terra Capital Investors Limited, the Solar Development Foundation, and Yayasan Bina Usaha Lingkungan (Indonesia) (environmental nonprofit or investment funds).

      John D. Firestone has been a Partner of Secor Group (venture capital) since 1978. Mr. Firestone is a director of Security Storage Company of Washington, DC, Bryn Mawr Bank Corporation and the National Organization on Disability. Mr. Firestone is Senior Advisor to GeoPortals.com, and a Trustee of The Washington Ballet.

      Anthony T. Garcia is currently a private investor. Mr. Garcia was General Manager of Breen Capital Group (investor in tax liens) from 1997 to 2000 and a Senior Vice President of Lehman Brothers Inc. from 1985 to 1996.

      Lawrence I. Hebert is a director and President and Chief Executive Officer of Riggs Bank N.A. (a subsidiary of Riggs National Corporation) since February 2001; Director of Riggs National Corporation since 1988. He also serves as director of Riggs Investment Management Corporation and Riggs Bank Europe Limited (both indirect subsidiaries of Riggs National Corporation). Mr. Hebert is the President and a director Perpetual Corporation (owner of Allbritton Communications Company and ALLSNEWSCO, Inc.) Mr. Hebert is a director of ALLSNEWSCO, Inc. (news programming service), the President of Westfield News Advertiser, Inc. (owner of a television station and newspapers), Trustee of The Allbritton Foundation and Vice Chairman of Allbritton Communications Company. Mr. Hebert previously served as Vice Chairman (1983 to 1998), President (1984 to 1998) and Chairman and Chief Executive Officer (1998 to 2001) of Allbritton Communications Company.

      John I. Leahy has been the President of Management and Marketing Associates (a management consulting firm) since 1986. Mr. Leahy was the President and Group Executive Officer, Western Hemisphere of Black & Decker Corporation from 1982 to 1985. Mr. Leahy is a director of Kar Kraft Systems, Inc., Cavanaugh Capital, Inc., Acorn Products, Inc., The Wills Group, Thulman-Eastern Company and Gallagher Fluid Seals, Inc.

      Robert E. Long is the CEO and Director of Goodwyn, Long & Black Investment Management, Inc. and has been the Chairman and Chief Executive Officer of Emerald City Radio Partners, LLC since 1997. Mr. Long was the President of Business News Network, Inc. from 1995 to 1998, was the Chairman and Chief Executive Officer of Southern Starr Broadcasting Group, Inc. from 1991 to 1995, and a director and the President of Potomac Asset Management, Inc. from 1983 to 1991. Mr. Long is a director of AmBase Corporation, CSC Scientific, Inc., and Advanced Solutions International, Inc.

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      Warren K. Montouri has been a Partner of Montouri & Roberson (real estate investment firm) since 1980. Mr. Montouri was a director of C&S/Sovran Bank from 1970 to 1990, a director of Sovran Financial Corporation from 1989 to 1990, a director of NationsBank, N.A. from 1990 to 1996, a director of BB&T Bank (formerly Franklin National Bank) from 1996 to 2000, a Trustee of Suburban Hospital from 1991 to 1994, and a Trustee of The Audubon Naturalist Society from 1979 to 1985.

      Guy T. Steuart II has been a director and President of Steuart Investment Company (manages, operates, and leases real and personal property and holds stock in operating subsidiaries engaged in various businesses) since 1960. Mr. Steuart is Trustee Emeritus of Washington and Lee University.

      T. Murray Toomey, Esq. has been an attorney at law since 1949. Mr. Toomey is a director of The National Capital Bank of Washington and Federal Center Plaza Corporation. He is also a Trustee of The Catholic University of America.

      Laura W. van Roijen has been a private real estate investor since 1992. Ms. van Roijen was the Chairman of CWV & Associates (RTC qualified contracting firm) from 1991 to 1994, a director and the Treasurer of Black Possum Inc. (retail concern) from 1994 to 1996, the President of Volta Place, Inc. (real estate advisory firm) from 1991 to 1994, and Vice President (from 1986 to 1991) and Market Director (from 1989 to 1991) of Citicorp Real Estate, Inc.

Executive Officers who are not Directors

      Joan M. Sweeney, Chief Operating Officer, has been employed by the Company since 1993. Ms. Sweeney oversees all company operations and is responsible for strategic planning, financial management, information technology, marketing, investor relations, and all regulatory compliance. Prior to joining the Company, Ms. Sweeney spent ten years of her career consulting with private and small public companies at both Ernst & Young and Coopers & Lybrand. Ms. Sweeney was a member of the SEC Division of Enforcement in the late 1980s.

      Penni F. Roll, Chief Financial Officer, has been employed by the Company since 1995. Ms. Roll is responsible for the Company’s financial management and reporting, accounting, loan servicing, special servicing, portfolio monitoring and regulatory compliance activities. Prior to joining the Company, she spent seven years in the financial services practice at KPMG Peat Marwick, including serving as a Manager from 1993 to 1995.

      Scott S. Binder, Managing Director, has worked with the Company since 1991 and is responsible for the Company’s managed fund investment activities. Prior to joining the Company, Mr. Binder formed and was President of Overland Communications Group, which owned and operated cable television systems and radio stations. He also has worked in the specialty finance and leasing industry.

      Samuel B. Guren, Managing Director, joined the Company in 1999. He joined the Company to develop the Company’s private equity investment business. Mr. Guren has more than 26 years of venture capital investing experience. Prior to joining the Company, Mr. Guren was the Senior Managing Partner at Baird Capital. He also served as a Senior Managing Partner at William Blair Venture Partners for 15 years.

      Philip A. McNeill, Managing Director, has been employed by the Company since 1993 and is responsible for co-managing the Company’s private finance group. Before

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      John M. Scheurer, Managing Director, has been employed by the Company since 1991 and manages the Company’s commercial real estate finance group. He has more than 22 years of experience in commercial finance and real estate lending and management. Prior to joining the Company, Mr. Scheurer worked in various capacities with Capital Recovery Advisors, Inc. and First American Bank. He also started his own company, The Scheurer Company, and co-founded Hunter & Associates, a major leasing and consulting real estate firm in the Washington, DC area.

      Thomas H. Westbrook, Managing Director, has been with the Company since 1991 and is responsible for co-managing the Company’s private finance group. Prior to joining the Company, Mr. Westbrook worked with North Carolina Enterprise Fund and was a lending officer in NationsBank’s corporate lending unit. He is the former president of the southern RASBIC and has served on the NASBIC Board of Governors.

      G. Cabell Williams, III, Managing Director, has been employed by the Company since 1981 in the Company’s private finance group. He has over 19 years of private finance experience, and has structured numerous types of private debt and equity finance transactions. Mr. Williams has served in many capacities during his tenure with the Company.

Employment Agreements

      The Company has entered into employment agreements with eight senior executives of the Company, including William L. Walton, the Company’s Chairman and CEO, Joan M. Sweeney, Chief Operating Officer, and John M. Scheurer, Managing Director. Each of the agreements provides for a three-year term, with annual renewals thereafter, and specifies each executive’s compensation during the term of the agreement, in accordance with the achievement of certain performance standards.

      The annual base salary on the effective date of the employment agreements of Mr. Walton, Ms. Sweeney, and Mr. Scheurer was $405,000, $256,500, and $256,500, respectively. The Board of Directors has the right to increase the base salary during the term of the employment agreement. In addition, each employment agreement states that the Board of Directors may provide, at their sole discretion, an annual cash bonus. This bonus is to be determined with reference to each executive’s performance in accordance with performance criteria to be determined by the Board in its sole discretion. Under each agreement, each executive also is entitled to participate in the Company’s Amended Stock Option Plan, and to receive all other awards and benefits previously granted to each executive including life insurance premiums.

      In addition, each employment agreement provides for a long-term cash retention award for the performance period from 2001 through 2003. The long-term cash retention award will vest and be payable in six equal installments on June 30th and December 31st of each year from 2001 through 2003. Mr. Walton will be eligible for a long-term cash retention award of $3,375,000, or $1,125,000 per year, over the performance period; Ms. Sweeney will be eligible for $2,550,000, or $850,000 per year; and Mr. Scheurer will be eligible for $2,115,000, or $705,000 per year.

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      Employment will terminate if the term of the agreement expires without written agreement of both parties. The executive has the right to voluntarily terminate employment at any time with 30 days’ notice, and in such case, the employee will not receive any severance pay. Among other things, the employment agreements prohibit the solicitation of employees from the Company in the event of an executive’s departure for a period of two years.

      If employment is terminated with cause, the employee will not receive any severance pay. If employment is terminated without cause during the term of the agreement, the executive shall be entitled to severance pay for a period not to exceed 36 months for Mr. Walton; 30 months for Ms. Sweeney; and 24 months for Mr. Scheurer. Severance pay shall include the continuation of the employee’s base salary, and the greater of (a) the average of the annual bonuses paid during the preceding three years, or (b) the amount of the last annual bonus paid to the employee. In addition, the executive shall be entitled to receive any payments under the long-term cash retention award that would have vested and been payable during the severance period. However, stock options would cease to vest during the severance period.

      If, within 12 months after a change of control (as defined in the employment agreements) termination of employment occurs either by the executive officer or the Company, the executive officer shall not be entitled to severance pay, but will instead be entitled to lump sum compensation as well as certain other benefits. For Mr. Walton, this lump sum is equal to three years of base salary and bonus (as calculated for severance pay), plus an amount equal to $5,565,000. For Ms. Sweeney, this lump sum is equal to two and a half years of base salary and bonus, plus an amount equal to $2,600,000. For Mr. Scheurer, this lump sum is equal to two years of base salary and bonus, plus an amount equal to $2,350,000. Under the terms of the agreement, the Company would also provide compensation to offset any applicable excise tax penalties imposed on the executive under section 4999 of the Internal Revenue Code.

      The other six employment agreements carry terms substantially similar to those of Mr. Scheurer’s agreement, as described herein.

Compensation Plans

Stock Option Plan

      The Company’s stock option plan (the “Stock Option Plan”) is intended to encourage stock ownership in the Company by officers and directors, thus giving them a proprietary interest in the Company’s performance. The Stock Option Plan was approved by shareholders at the Special Meeting of Shareholders on November 26, 1997. On May 9, 2000, the Company’s stockholders amended the Stock Option Plan to increase the authorized shares under the plan to 12,350,000 shares as well as make certain other administrative changes.

      The Committee’s principal objective in awarding stock options to the eligible officers of the Company is to align each optionee’s interests with the success of the Company and the financial interests of its stockholders by linking a portion of such optionee’s compensation with the performance of the Company’s stock and the value delivered to stockholders.

      Stock options are granted under the Stock Option Plan at a price not less than the prevailing market value and will have value only if the Company’s stock price increases.

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      For the nine months ended September 30, 2001 and for the year ended, December 31, 2000, a total of 2,800,323 and 4,162,112 options, respectively, were granted, including grants made by the Company’s compensation committee to certain officers and automatic grants to non-officer directors of the Company. These options generally vest over a three-year period except that grants to non-officer directors vest immediately. See “Control Persons and Principal Holders of Securities” in the SAI for currently exercisable options granted to certain executive officers and non-officer directors.

      On September 8, 1999, the Company received approval from the Commission to grant options under the Stock Option Plan to non-officer directors. On that date, each incumbent non-officer director received options to purchase 10,000 shares, and pursuant to the Commission order, each will receive options to purchase 5,000 shares each year thereafter on the date of the annual meeting of stockholders. New directors will receive options to purchase 10,000 shares upon election to the board, and options to purchase 5,000 shares each year thereafter on the date of the annual meeting.

      The Stock Option Plan is designed to satisfy the conditions of Section 422 of the Code so that options granted under the Stock Option Plan may qualify as “incentive stock options.” To qualify as “incentive stock options,” options may not become exercisable for the first time in any year if the number of incentive options first exercisable in that year multiplied by the exercise price exceeds $100,000.

Formula Award and Cut-Off Award

      Formula Award. The Formula Award was designed as an incentive compensation program that would replace stock options of the predecessor companies that were cancelled as a result of the Company’s 1997 merger, and would balance share ownership among key officers. The Company accrued the Formula Award over the three-year period on the anniversary of the merger date (December 31) in 1998, 1999 and 2000. The Formula Award expense for 1998, 1999 and 2000 totaled $6.2 million, $6.2 million and $5.7 million, respectively, and is included in employee expenses in the Company’s consolidated statement of operations. The terms of the Formula Award required that the award be contributed to the Company’s deferred compensation plan, and used to purchase shares of the Company in the open market. See “Deferred Compensation Plan.” The amount of the Formula Awards received by certain executive officers in 2000 is provided in the SAI.

      On January 2, 2001, the trust that holds the deferred compensation plan distributed shares of the Company’s common stock with a value of $4,383,165 representing the final portion of the Formula Award that vested on December 31, 2000. These shares are held in restricted accounts at a brokerage firm.

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      Cut-Off Award. The Cut-Off Award was designed to cap the appreciated value in unvested options at the merger announcement date in order to set the foundation to balance option awards upon the merger on December 31, 1997. The Cut-Off Award is payable for each canceled option as the canceled options would have vested and vests automatically in the event of a change of control. The Cut-Off Award is payable if the award recipient is employed by the Company on the future vesting date. The Cut-Off Award expense for the nine months ended September 30, 2001 and for the year ended December 31, 2000 totaled $0.09 million and $0.5 million respectively, and is included in employee expenses in the Company’s consolidated statement of operations. The amount of the Cut-Off Award received by certain executive officers in 2000 is provided in the SAI.

401(k) Plan

      The Company maintains a 401(k) plan (the “401(k) Plan”). All employees who are at least 21 years of age have the opportunity to contribute pre-tax salary deferrals into the 401(k) Plan of up to $10,500, and to direct the investment of these contributions. The 401(k) Plan allows eligible participants to invest in shares of the Company’s common stock, among other investment options. In addition, beginning in 2000, the Company contributed to each eligible participant’s (i.e., employees with 1,000 hours of service) 401(k) account 5% of each participant’s cash compensation as defined by the 401(k) Plan. Employer contributions that exceed $8,500 (5% of $170,000 cash compensation) are directed to the participant’s Deferred Compensation Plan account. All contributions are fully vested at the time of contribution. On September 30, 2001, the 401(k) Plan held less than 1% of the outstanding shares of the Company.

Deferred Compensation Plan

      The Company maintains a deferred compensation plan. The deferred compensation plan is a funded plan that provides for the deferral of compensation by employees and consultants of the Company. Employees and consultants of the Company are eligible to participate in the plan at such time and for such period as designated by the board of directors. The deferred compensation plan is administered through a trust, and the Company funds this plan through cash contributions.

TAX STATUS

      The following discussion is a general summary of the material United States federal income tax considerations applicable to the Company and to an investment in the common stock. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. The discussion is based upon the Code, Treasury Regulations, and administrative and judicial interpretations, each as of the date of this prospectus and all of which are subject to change. You should consult your own tax advisor with respect to tax considerations that pertain to your purchase of the common stock.

      This summary is intended to apply to investments in common stock and assumes that investors hold the common stock as capital assets. This summary does not discuss all aspects of federal income taxation relevant to holders of the common stock in light of particular circumstances, or to certain types of holders subject to special treatment under federal income tax laws, including dealers in securities, pension plans and trusts and

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      This summary does not discuss the consequences of investments in preferred stock or debt securities of the Company. The tax consequences of an offering of preferred stock or debt securities of the Company will be discussed in a prospectus supplement relating to or for such offering.

      Except as specifically indicated herein, this summary is intended to apply to U.S. Stockholders (as defined below) and does not purport to discuss all U.S. federal income tax consequences to persons who are not U.S. Stockholders (“Non-U.S. Stockholders”) from an investment in the common stock. (A “U.S. Stockholder” is a stockholder who is (i) a citizen or resident of the United States, (ii) a corporation, partnership or other entity created in or organized under the laws of the United States or any political subdivision thereof, (iii) an estate, the income of which is subject to United States federal income taxation regardless of its source, or (iv) a trust subject to the supervision of a court within the United States and the control of a United States person.) Non-U.S. Stockholders should consult their own tax advisors to discuss the consequences of an investment in the common stock.

Taxation as a RIC

      The Company intends to be treated for tax purposes as a “regulated investment company” or “RIC” under Subchapter M of the Code. If the Company (i) qualifies as a RIC and (ii) distributes to stockholders in a timely manner at least 90% of its “investment company taxable income,” as defined in the Code (i.e., net investment income, including accrued original issue discount, and net short-term capital gain) (the “90% Distribution Requirement”) each year, it will not be subject to federal income tax on the portion of its investment company taxable income and net capital gain (i.e., net long-term capital gain in excess of net short-term capital loss) it distributes (or treats as “deemed distributed”) to stockholders. In addition, if the Company distributes in a timely manner the sum of (i) 98% of its ordinary income for each calendar year, (ii) 98% of its capital gain net income for the one-year period ending December 31 in that calendar year, and (iii) any income not distributed in prior years, the Company will not be subject to the 4% nondeductible federal excise tax on certain undistributed income of RICs (the “Excise Tax Avoidance Requirements”). The Company generally will endeavor to distribute (or treat as deemed distributed) to stockholders all of its investment company taxable income and its net capital gain, if any, for each taxable year so that it will not incur federal income or excise taxes on its earnings. The Company will be subject to federal income tax at the regular corporate rate for any amounts of investment company taxable income or net capital gain not distributed (or deemed distributed) to the stockholders.

      In order to qualify as a RIC for federal income tax purposes, the Company must, among other things: (a) continue to qualify as a BDC under the 1940 Act, (b) derive in each taxable year at least 90% of its gross income from dividends, interest, payments with respect to securities loans, gains from the sale of stock or other securities, or other income derived with respect to its business of investing in such stock or securities (the “90% Income Test”); and (c) diversify its holdings so that at the end of each quarter of the taxable year (i) at least 50% of the value of the Company’s assets consists of cash, cash

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      If the Company acquires or is deemed to have acquired debt obligations that were issued originally at a discount or that otherwise are treated under applicable tax rules as having original issue discount, it must include in income each 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 it in the same taxable year. Any amount accrued as original issue discount will be included in the Company’s investment company taxable income for the year of accrual and may have to be distributed to the stockholders in order to satisfy the 90% Distribution Requirement or the Excise Tax Avoidance Requirements even though the Company has not received any cash representing such income.

      Although it does not currently intend to do so, if the Company were to invest in certain options, futures, or forward contracts, it may be required to report income from such investments on a mark-to-market basis, which could result in the Company recognizing unrealized gains and losses for federal income tax purposes even though it may not realize such gains and losses when it ultimately disposes of such investments. The Company could also be required to treat such gains and losses as 60% long-term capital gain or loss and 40% short-term capital gain or loss regardless of its holding period for the investments. In addition, if the Company were to engage in certain hedging transactions, including hedging transactions in options, future contracts, and straddles, or other similar transactions, it will be subject to special tax rules (including constructive sale, mark-to-market, straddle, wash sale, and short sale rules), the effect of which may be to accelerate income to the Company, defer losses to the Company, cause adjustments in the holding periods of the Company’s securities, convert long-term capital gains into short-term capital gains or convert short-term capital losses into long-term capital losses. These rules could affect the Company’s investment company taxable income or net capital gain for a taxable year and thus affect the amounts that the Company would be required to distribute to its stockholders pursuant to the 90% Distribution Requirement and the Excise Tax Avoidance Requirements for such year.

      Although it does not presently expect to do so, the Company is authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, the Company is not permitted to make distributions to stockholders while the Company’s debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, the Company’s ability to dispose of assets to meet its distribution requirements may be limited by other requirements relating to its status as a RIC, including the Diversification Test. If the Company disposes of assets in order to meet the 90% Distribution Requirement or the Excise Tax Avoidance Requirements, the Company may make such dispositions at times that, from an investment standpoint, are not advantageous.

      If the Company fails to satisfy the 90% Distribution Requirement or otherwise fails to qualify as a RIC in any taxable year, it will be subject to tax in that year on all of its

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      The remainder of this Summary assumes that the Company qualifies as a RIC and satisfies the 90% Distribution Requirement.

Taxation of Stockholders

      Distributions of the Company generally are taxable to stockholders as ordinary income or capital gains. Distributions of the Company’s investment company taxable income will be taxable as ordinary income to stockholders to the extent of the Company’s current or accumulated earnings and profits, whether paid in cash or reinvested in additional common stock. Distributions of the Company’s net capital gains properly designated by the Company as “capital gain dividends” will be taxable to a stockholder as long-term capital gains regardless of the stockholder’s holding period for his or her common stock and regardless of whether paid in cash or reinvested in additional common stock (including any dividends reinvested through the company’s DRIP plan). Distributions in excess of the Company’s earnings and profits first will reduce a stockholder’s adjusted tax basis in such stockholder’s common stock and, after the adjusted basis is reduced to zero, will constitute capital gains to such stockholder.

      At the Company’s option, the Company may elect to retain some or all of its net capital gains for a tax year, but designate the retained amount as a “deemed distribution.” In that case, among other consequences, the Company will pay tax on the retained amount for the benefit of its stockholders, the stockholders will be required to report their share of the deemed distribution on their tax returns as if it had been distributed to them, and the stockholders will report a credit for the tax paid thereon by the Company. The amount of the deemed distribution net of such tax will be added to the stockholder’s cost basis for his or her common stock. Since the Company expects to pay tax on any retained net capital gains at its regular corporate capital gain tax rate, and since that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual stockholders will be treated as having paid and for which they will receive a credit will exceed the amount of tax that such stockholders would be required to pay on the retained net capital gains. Such excess generally will be available to offset other tax liabilities of the stockholders. A stockholder that is not subject to U.S. federal income tax should be able to file a return on the appropriate form or a claim for refund that allows such stockholder to recover the taxes paid on his or her behalf. In the event the Company chooses this option, it must provide written notice to the stockholders prior to the expiration of 60 days after the close of the relevant tax year.

      Any dividend declared by the Company in October, November, or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following year, will be treated as if it had been received by the stockholders on December 31 of the year in which the dividend was declared.

      You should consider the tax implications of buying common stock just prior to a distribution. Even if the price of the common stock includes the amount of the

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      You may recognize taxable gain or loss if you sell or exchange your common stock. The amount of the gain or loss will be measured by the difference between your adjusted tax basis in your common stock and the amount of the proceeds you receive in exchange for such stock. Any gain or loss arising from (or, in the case of distributions in excess of earnings and profits, treated as arising from) the sale or exchange of common stock generally will be a capital gain or loss. This capital gain or loss normally will be treated as a long-term capital gain or loss if you have held your common stock for more than one year; otherwise, it will be classified as short-term capital gain or loss. However, any capital loss arising from the sale or exchange of common stock held for six months or less generally will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received (or treated as deemed distributed) with respect to such stock and, for this purpose, the special rules of Section 852(b)(4)(C) of the Code generally apply in determining the holding period of such stock. In addition, all or a portion of any loss realized upon a taxable disposition of common stock may be disallowed if other shares of the Company’s common stock are purchased (under the Company’s DRIP or otherwise) within 30 days before or after the disposition.

      In general, non-corporate stockholders currently are subject to a maximum federal income tax rate on their net long-term capital gain (the excess of net long-term capital gain over net short-term capital loss) for a taxable year (including a long-term capital gain derived from an investment in the common stock of the company) that is lower than the maximum rate for other income. Corporate taxpayers currently are subject to federal income tax on net capital gains at a maximum rate equal to the maximum rate applied to ordinary income. Tax rates imposed by states and local jurisdictions on capital gain and ordinary income may differ. Non-corporate stockholders with net capital losses for a year (i.e., capital losses in excess of capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year; any net capital losses of a non-corporate stockholder in excess of $3,000 generally may be carried forward and used in subsequent years as provided in Section 1212(b) of the Code. Corporate stockholders generally may not deduct any net capital losses for a year, but may carryback such losses for three years or carry forward such losses for five years.

      The Company will send to each of its stockholders, as promptly as possible after the end of each calendar year, a notice detailing, on a per share and per distribution basis, the amounts includible in such stockholder’s taxable income for such year as ordinary income and as long-term capital gain. In addition, the federal tax status of each year’s distributions generally will be reported to the IRS. Distributions may also be subject to additional state, local, and foreign taxes depending on a stockholder’s particular situation. The Company’s ordinary income dividends to corporate stockholders may, if certain conditions are met, qualify for the dividends received deduction to the extent that the Company has received qualifying dividend income during the taxable year; capital gain dividends distributed by the Company are not eligible for the dividends received deduction.

      A Non-U.S. Stockholder may be subject to withholding of U.S. federal tax at a 30% rate (or lower applicable treaty rate) on distributions (including certain redemptions of common stock) from the Company. Accordingly, investment in the Company is likely to be appropriate for a Non-U.S. Stockholder only if such person can utilize a foreign tax credit or corresponding tax benefit in respect of such withholding tax. Non-U.S. Stockholders should consult their own tax advisors with respect to the U.S. federal income

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      The Company may be required to withhold U.S. federal income tax (“backup withholding”) from all taxable distributions payable to (i) any stockholder who fails to furnish the Company with its correct taxpayer identification number or a certificate that the stockholder is exempt from backup withholding, and (ii) any stockholder with respect to whom the IRS notifies the Company that the stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. The Company may be required to report annually to the IRS and to each Non-U.S. Stockholder the amount of dividends paid to such stockholder and the amount, if any, of tax withheld pursuant to the backup withholding rules with respect to such dividends. This information may also be made available to the tax authorities in the Non-U.S. Stockholder’s country of residence. Backup withholding is not an additional tax. Any amounts withheld under the backup withholding rules from payments made to a stockholder may be refunded or credited against such stockholder’s United States federal income tax liability, if any, provided that the required information is furnished to the IRS.

      You should consult your own tax advisor with respect to the particular tax consequences to you of an investment in the Company, including the possible effect of any pending legislation or proposed regulation.

CERTAIN GOVERNMENT REGULATIONS

      We operate in a highly regulated environment. The following discussion generally summarizes certain regulations.

      Business Development Company (“BDC”). A business development company is defined and regulated by the Investment Company Act of 1940. It is a unique kind of investment company that primarily focuses on investing in or lending to small private companies and making managerial assistance available to them. A BDC may use capital provided by public shareholders and from other sources to invest in long-term, private investments in growing businesses. A BDC provides shareholders the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits, if any, of investing in privately owned growth companies.

      As a BDC, we may not acquire any asset other than “Qualifying Assets” unless, at the time we make the acquisition, our Qualifying Assets represent at least 70% of the value of our total assets (the “70% test”). The principal categories of Qualifying Assets relevant to our business are:

	(1)	Securities purchased in transactions not involving any public offering, the issuer of which is an eligible portfolio company. An eligible portfolio company is defined to include any issuer that (a) is organized and has its principal place of business in the United States, (b) is not an investment company other than an SBIC wholly owned by a BDC (our investment in Allied Investment and certain other subsidiaries generally are Qualifying Assets), and (c) does not have any class of publicly traded securities with respect to which a broker may extend margin credit;
	(2)	Securities received in exchange for or distributed with respect to securities described in (1) above or pursuant to the exercise of options, warrants, or rights relating to such securities; and

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	(3)	Cash, cash items, government securities, or high quality debt securities (within the meaning of the 1940 Act), maturing in one year or less from the time of investment.

      To include certain securities described above as Qualifying Assets for the purpose of the 70% test, a BDC must make available to the issuer of those securities significant managerial assistance such as providing significant guidance and counsel concerning the management, operations, or business objectives and policies of a portfolio company, or making loans to a portfolio company. We will provide managerial assistance on a continuing basis to any portfolio company that requests it, whether or not difficulties are perceived.

      As a BDC, the Company is entitled to issue senior securities in the form of stock or senior securities representing indebtedness, including debt securities and preferred stock, as long as each class of senior security has an asset coverage of at least 200% immediately after each such issuance. This limitation is not applicable to borrowings by our SBIC subsidiary, and therefore any borrowings by these subsidiaries are not included in this asset coverage test. See “Risk Factors.”

      We have adopted a Code of Ethics that establishes procedures for personal investments and restricts certain transactions by the Company’s personnel. A copy of the Code of Ethics may be reviewed at or obtained from the Commission. See “Where You Can Find More Information.”

      We may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC unless authorized by vote of a “majority of the outstanding voting securities,” as defined in the 1940 Act, of our shares. Since we made our BDC election, we have not made any substantial change in the nature of our business.

      Regulated Investment Company (“RIC”). Our status as a RIC enables us to avoid the cost of federal taxation and generally avoid the cost of state taxation, and as a result achieve pre-tax investment returns. We believe that this tax advantage enables us to achieve strong equity returns without having to aggressively leverage our balance sheet.

      In order to qualify as a RIC, the Company must, among other things:

	(1)	Continue to qualify as a BDC.
	(2)	Derive at least 90% of its gross income from dividends, interest, payments with respect to securities loans, gains from the sale of stock or other securities or other income derived with respect to its business of investing in such stock or securities.

      (3) Diversify its holdings so that

	(a)	at least 50% of the value of the Company’s assets consists of cash, cash items, 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 Company’s assets and 10% of the outstanding voting securities of the issuer, and
	(b)	no more than 25% of the value of the Company’s assets are invested in securities (other than U.S. government securities) of any one issuer, or of two or more issuers that are controlled by the Company and which are engaged in same or similar or related trades or businesses.

	(4)	Distribute at least 90% of its “investment company taxable income” each tax year to its shareholders. In addition, if the Company distributes in a timely

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		manner (or treats as “deemed distributed”) 98% of its capital gain net income for each one year period ending on December 31 and distributes 98% of its ordinary income for each calendar year, it will not be subject to the 4% nondeductible federal excise tax on certain undistributed income of RICs.

      SBA Regulations. Allied Investment, a wholly owned subsidiary of the Company, is licensed by the SBA as an SBIC under Section 301(c) of the Small Business Investment Act of 1958, as amended (the “1958 Act”), and has elected to be regulated as a BDC.

      SBICs are authorized to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a net worth not exceeding $18 million and have average annual fully taxed net income not exceeding $6 million for the most recent two fiscal years. In addition, an SBIC must devote 20% of its investment activity to “smaller” concerns as defined by the SBA. A smaller concern is one that has a net worth not exceeding $6 million and has average annual fully taxed net income not exceeding $2 million for the most recent two fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses, and provide them with consulting and advisory services. Allied Investment provides long-term loans to qualifying small businesses; equity investments and consulting and advisory services are typically provided only in connection with such loans.

      Allied Investment is periodically examined and audited by the SBA staff to determine its compliance with SBIC regulations.

      Allied Investment has the opportunity to sell to the SBA subordinated debentures with a maturity of up to ten years, up to an aggregate principal amount of $111.7 million. This limit generally applies to all financial assistance provided by the SBA to any licensee and its “associates,” as that term is defined in SBA regulations. Historically, an SBIC was also eligible to sell preferred stock to the SBA. Allied Investment had received $87.0 million of subordinated debentures and $7.0 million of preferred stock from the SBA at September 30, 2001; as a result of the $111.7 million limit, the Company is limited on its ability to apply for additional financing from the SBA. Interest rates on the SBA debentures currently outstanding have a weighted average interest cost of 8.0%.

DIVIDEND REINVESTMENT PLAN

      We have adopted an “opt out” dividend reinvestment plan (“DRIP plan”). Under the DRIP plan, if you own shares of common stock registered in your own name, our transfer agent, acting as reinvestment plan agent, will automatically reinvest any dividend in additional shares of common stock. Shareholders may change enrollment status in the DRIP plan at any time by contacting either the plan agent or the Company.

      A shareholder’s ability to participate in a DRIP plan may be limited according to how the shares of common stock are registered. A nominee may preclude beneficial owners holding shares in street name from participating in the DRIP plan. Shareholders who wish to participate in a DRIP plan may need to register their shares of common stock in their own name. Shareholders will be informed of their right to opt out of the DRIP plan in the Company’s annual and quarterly reports to shareholders. Shareholders who hold shares in the name of a nominee should contact the nominee for details.

      All distributions to investors who do not participate (or whose nominee elects not to participate) in the DRIP plan will be paid by check mailed directly, or through the

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      Under the DRIP plan, we may issue new shares unless the market price of the outstanding shares of common stock is less than 110% of the last reported net asset value. Alternatively, the plan agent may buy shares of common stock in the market. We value newly issued shares of common stock for the DRIP plan at the average of the reported last sale prices of the outstanding shares of common stock on the last five trading days prior to the payment date of the distribution, but not less than 95% of the opening bid price on such date. The price in the case of shares bought in the market will be the average actual cost of such shares of common stock, including any brokerage commissions. There are no other fees charged to shareholders in connection with the DRIP plan. Any distributions reinvested under the plan will nevertheless remain taxable to the shareholders.

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DESCRIPTION OF SECURITIES

      The following summary of the Company’s capital stock and other securities does not purport to be complete and is subject to, and qualified in its entirety by, the Company’s Amended and Restated Articles of Incorporation, as amended (the “Charter”). Reference is made to the Charter for a detailed description of the provisions summarized below.

      On September 18, 2000, the Board of Directors voted unanimously to amend the Company’s Charter to increase its authorized capital stock (the “Capital Stock”) from 100,000,000 shares, $0.0001 par value, to 200,000,000 shares, and authorized management to hold a special meeting of shareholders on November 15, 2000 to seek shareholder approval for such amendment. The Charter amendment was approved by shareholders and the Charter amendment was filed with the state of Maryland on November 17, 2000.

      The Board of Directors may classify and reclassify any unissued shares of Capital Stock of the Company by setting or changing in one or more respects the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications, terms or conditions or redemption or other rights of such shares of Capital Stock.

Common Stock

      At December 19, 2001, there were 98,908,464 shares of common stock outstanding and 11,273,787 shares of common stock reserved for issuance under the Amended Stock Option Plan. The following are the outstanding classes of securities of the Company as of December 19, 2001:

(4)

(3)

Amount

Amount Held

Outstanding

(2)

by Company

Exclusive of

(1)

Amount

or for its

Amounts Shown

Title of Class

Authorized

Account

Under(3)

Allied Capital Corporation

Common Stock

200,000,000

—

98,908,464

      All shares of common stock have equal rights as to earnings, assets, dividends and voting privileges and all outstanding shares of common stock are fully paid and non-assessable. Distributions may be paid to the holders of common stock if and when declared by the Board of Directors out of funds legally available therefore. Our common stock has no preemptive, conversion, or redemption rights and is freely transferable. In the event of liquidation, each share of common stock is entitled to share ratably in all assets of the Company that are legally available for distributions after payment of all debts and liabilities and subject to any prior rights of holders of Preferred Stock, if any, then outstanding. Each share of common stock is entitled to one vote and does not have cumulative voting rights, which means that holders of a majority of the shares, if they so choose, could elect all of the directors, and holders of less than a majority of the shares would, in that case, be unable to elect any director. All shares of common stock offered hereby will be, when issued and paid for, fully paid and non-assessable.

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Preferred Stock

      In addition to shares of common stock, the articles of incorporation authorizes the issuance of preferred stock (“Preferred Stock”). The Board of Directors is authorized to provide for the issuance of Preferred Stock with such preferences, powers, rights and privileges as the Board deems appropriate; except that, such an issuance must adhere to the requirements for the 1940 Act. The 1940 Act requires, among other things, that (i) immediately after issuance and before any distribution is made with respect to common stock, the Preferred Stock, together with all other senior securities, must not exceed an amount equal to 50% of the Company’s total assets and (ii) the holders of shares of Preferred Stock, if any are issued, must be entitled as a class to elect two directors at all times and to elect a majority of the directors if dividends on the Preferred Stock are in arrears by two years or more. The Company believes the availability of such stock will provide the Company with increased flexibility in structuring future financings and acquisitions. If we offer Preferred Stock under this prospectus, we will issue an appropriate prospectus supplement. You should read that prospectus supplement for a description of the Preferred Stock, including, but not limited to, whether there will be an arrearage in the payment of dividends or sinking fund installments, if any, restrictions with respect to the declaration of dividends, requirements in connection with the maintenance of any ratio or assets, or creation or maintenance of reserves, or provisions for permitting or restricting the issuance of additional securities.

Debt Securities

      The Company may issue debt securities that may be senior or subordinated in priority of payment. The Company will provide a prospectus supplement that describes the ranking, whether senior or subordinated, the specific designation, the aggregate principal amount, the purchase price, the maturity, the redemption terms, the interest rate or manner of calculating the interest rate, the time of payment of interest, if any, the terms for any conversion or exchange, including the terms relating to the adjustment of any conversion or exchange mechanism, the listing, if any, on a securities exchange, the name and address of the trustee and any other specific terms of the debt securities.

Limitation on Liability of Directors

      The Company has adopted provisions in its charter and bylaws limiting the liability of directors and officers of the Company for monetary damages. The effect of these provisions in the charter and bylaws is to eliminate the rights of the Company and its shareholders (through shareholders’ derivative suits on behalf of the Company) to recover monetary damages against a director or officers for breach of the fiduciary duty of care as a director or officer (including breaches resulting from negligent or grossly negligent behavior) except in certain limited situations. These provisions do not limit or eliminate the rights of the Company or any shareholder to seek non-monetary relief such as an injunction or rescission in the event of a breach of a director’s or officer’s duty of care. These provisions will not alter the liability of directors or officers under federal securities laws.

Certain Anti-Takeover Provisions

      The charter and bylaws of the Company and certain statutory and regulatory requirements contain certain provisions that could make more difficult the acquisition of the Company by means of a tender offer, a proxy contest or otherwise. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of the Company to negotiate first with the board of directors. We believe that the benefits of these provisions

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Classified Board of Directors

      The charter provides for the Board of Directors to be divided into three classes of directors serving staggered three-year terms, with each class to consist as nearly as possible of one-third of the directors then elected to the board. A classified board may render more difficult a change in control of the Company or removal of incumbent management. We believe, however, that the longer time required to elect a majority of a classified board of directors helps to ensure continuity and stability of the Company’s management and policies.

Issuance of Preferred Stock

      The Board of Directors of the Company, without shareholder approval, has the authority to reclassify authorized but unissued common stock as preferred stock and to issue preferred stock. Such stock could be issued with voting, conversion or other rights designed to have an anti-takeover effect.

Maryland Corporate Law

      The Company is subject to the Maryland Business Combination Statute and the Control Share Acquisition Statute, as defined below. The partial summary of the foregoing statutes contained in this prospectus is not intended to be complete and reference is made to the full text of such states for their entire terms.

      Business Combination Statute. Certain provisions of the Maryland Law establish special requirements with respect to “business combinations” between Maryland corporations and “interested shareholders” unless exemptions are applicable (the “Business Combination Statute”). Among other things, the Business Combination Statute prohibits for a period of five years a merger or other specified transactions between a company and an interested shareholder and requires a super majority vote for such transactions after the end of such five-year period.

      “Interested shareholders” are all persons owning beneficially, directly or indirectly, 10% or more of the outstanding voting stock of a Maryland corporation. “Business combinations” include certain mergers or similar transactions subject to a statutory vote and additional transactions involving transfer of assets or securities in specified amounts to interested shareholders or their affiliates.

      Unless an exemption is available, a “business combination” may not be consummated between a Maryland corporation and an interested shareholder or its affiliates for a period of five years after the date on which the shareholder first became an interested shareholder and thereafter may not be consummated unless recommended by the board of directors of the Maryland corporation and approved by the affirmative vote of at least 80% of the votes entitled to be cast by all holders of outstanding shares of voting stock and 66 2/3% of the votes entitled to be cast by all holders of outstanding shares of voting stock other than the interested shareholder or its affiliates or associates, unless, among other things, the corporation’s shareholders receive a minimum price (as defined in the Business Combination Statute) for their shares and the consideration is received in cash or in the same form as previously paid by the interested shareholder for its shares.

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      A business combination with an interested shareholder which is approved by the board of directors of a Maryland corporation at any time before an interested shareholder first becomes an interested shareholder is not subject to the five-year moratorium or special voting requirements. An amendment to a Maryland corporation charter electing not to be subject to the foregoing requirements must be approved by the affirmative vote of at least 80% of the votes entitled to be cast by all holders of outstanding shares of voting stock and 66 2/3% of the votes entitled to be cast by holders of outstanding shares of voting stock who are not interested shareholders. Any such amendment is not effective until 18 months after the vote of shareholders and does not apply to any business combination of a corporation with a shareholder who became an interested shareholder on or prior to the date of such vote.

      Control Share Acquisition Statute. The Maryland Law imposes limitations on the voting rights of shares acquired in a “control share acquisition.” The control share statute defines a “control share acquisition” to mean the acquisition, directly or indirectly, of “control shares” subject to certain exceptions. “Control shares” of a Maryland corporation are defined to be voting shares of stock which, if aggregated with all other shares of stock previously acquired by the acquiror, would entitle the acquiror to exercise voting power in electing directors with one of the following ranges of voting power:

	(1)	one-tenth or more but not less than one-third;
	(2)	one-third or more but less than a majority; or
	(3)	a majority of all voting power.

      Control shares do not include shares which the acquiring person is entitled to vote as a result of having previously obtained shareholder approval. Control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast by shareholders in the election of directors, excluding shares of stock as to which the acquiring person, officers of the corporation and directors of the corporation who are employees of the corporation are entitled to exercise or direct the exercise of the voting power of the shares in the election of the directors.

      The control share statute also requires Maryland corporations to hold a special meeting at the request of an actual or proposed control share acquiror generally within 50 days after a request is made with the submission of an “acquiring person statement,” but only if the acquiring person:

	(1)	gives a written undertaking and, if required by the directors of the issuing corporation, posts a bond for the cost of the meeting; and
	(2)	submits definitive financing agreements for the acquisition of the control shares to the extent that financing is not provided by the acquiring person.

      In addition, unless the issuing corporation’s charter or bylaws provide otherwise, the control share statute provides that the issuing corporation, within certain time limitations, shall have the right to redeem control shares (except those for which voting rights have previously been approved) for “fair value” as determined pursuant to the control share statue in the event:

	(1)	there is a shareholder vote and the grant of voting rights is not approved; or
	(2)	an “acquiring person statement” is not delivered to the target within 10 days following a control share acquisition.

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      Moreover, unless the issuing corporation’s charter or bylaws provide otherwise, the control share statute provides that if, before a control share acquisition occurs, voting rights are accorded to control shares which result in the acquiring person having majority voting power, then all shareholders other than the acquiring person have appraisal rights as provided under the Maryland Law. An acquisition of shares may be exempted from the control share statute provided that a charter or bylaw provision is adopted for such purpose prior to the control share acquisition by any person with respect to the Company. The control share acquisition statute does not apply to shares acquired in a merger, consolidation or share exchange to which the corporation is a party.

Regulatory Restrictions

      Allied Investment, a wholly owned subsidiary, is an SBIC. The SBA prohibits, without prior SBA approval, a “change of control” or transfers which would result in any person (or group of persons acting in concert) owning 10% or more of any class of capital stock of an SBIC. A “change of control” is any event which would result in a transfer of the power, direct or indirect, to direct the management and policies of an SBIC, whether through ownership, contractual arrangements or otherwise.

PLAN OF DISTRIBUTION

      We may offer, from time to time, up to $300,000,000 of our Securities. We may sell the Securities through underwriters or dealers, directly to one or more purchasers, through agents or through a combination of any such methods of sale. Any underwriter or agent involved in the offer and sale of the Securities will be named in the applicable prospectus supplement.

      The distribution of the Securities may be effected from time to time in one or more transactions at a fixed price or prices, which may be changed, at prevailing market prices at the time of sale, at prices related to such prevailing market prices, or at negotiated prices, provided, however, that in the case of common stock, the offering price per share, less any underwriting commissions or discounts, must equal or exceed the net asset value (“NAV”) per share of our common stock at the time of the offering.

      In connection with the sale of the Securities, underwriters or agents may receive compensation from the Company or from purchasers of the Securities, for whom they may act as agents, in the form of discounts, concessions or commissions. Underwriters may sell the Securities to or through dealers and such dealers may receive compensation in the form of discounts, concessions or commissions from the underwriters and/or commissions from the purchasers for whom they may act as agents. Underwriters, dealers and agents that participate in the distribution of the Securities may be deemed to be underwriters under the Securities Act, and any discounts and commissions they receive from the Company and any profit realized by them on the resale of the Securities may be deemed to be underwriting discounts and commissions under the Securities Act. Any such underwriter or agent will be identified and any such compensation received from the Company will be described in the applicable prospectus supplement.

      Any common stock sold pursuant to a prospectus supplement will be quoted on the New York Stock Exchange, or another exchange on which the common stock is traded.

      Under agreements into which the Company may enter, underwriters, dealers and agents who participate in the distribution of the Securities may be entitled to indemnification by the Company against certain liabilities, including liabilities under the Securities Act. Underwriters, dealers and agents may engage in transactions with, or perform services for, the Company in the ordinary course of business.

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      If so indicated in the applicable prospectus supplement, the Company will authorize underwriters or other persons acting as the Company’s agents to solicit offers by certain institutions to purchase the Securities from the Company pursuant to contracts providing for payment and delivery on a future date. Institutions with which such contracts may be made include commercial and savings banks, insurance companies, pension funds, investment companies, educational and charitable institutions and others, but in all cases such institutions must be approved by the Company. The obligations of any purchaser under any such contract will be subject to the condition that the purchase of the Securities shall not at the time of delivery be prohibited under the laws of the jurisdiction to which such purchaser is subject. The underwriters and such other agents will not have any responsibility in respect of the validity or performance of such contracts. Such contracts will be subject only to those conditions set forth in the prospectus supplement, and the prospectus supplement will set forth the commission payable for solicitation of such contracts.

      In order to comply with the securities laws of certain states, if applicable, the Securities offered hereby will be sold in such jurisdictions only through registered or licensed brokers or dealers. In addition, in certain states, the Securities may not be sold unless they have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and is complied with.

LEGAL MATTERS

      The legality of the Securities offered hereby will be passed upon for the Company by Sutherland Asbill & Brennan LLP, Washington, D.C. Certain legal matters will be passed upon for underwriters, if any, by the counsel named in the prospectus supplement.

SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT

      The Company’s and its subsidiaries’ investments are held in safekeeping by Riggs Bank, N.A. at 808 17th Street, N.W., Washington, D.C. 20006, as well as by LaSalle National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk Grove Village, Illinois 60007. American Stock Transfer and Trust Company, 59 Maiden Lane, New York, New York 10038 acts as the Company’s transfer, dividend paying and reinvestment plan agent and registrar.

INDEPENDENT PUBLIC ACCOUNTANTS

      The audited financial statements and schedules included in this prospectus and elsewhere in the registration statement to the extent and for the periods indicated in their reports have been audited by Arthur Andersen LLP, independent public accountants, and are included herein in reliance upon the authority of said firm as experts in giving said reports.

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TABLE OF CONTENTS OF

General Information and History			B-2
Investment Objective and Policies			B-2
Management			B-2
	Compensation of Executive Officers and Directors		B-2
	Compensation of Directors		B-3
	Stock Option Awards		B-3
	Formula Award and Cut-off Award		B-5
	Committees of the Board of Directors		B-5
Control Persons and Principal Holders of Securities			B-6
Investment Advisory Services			B-7
Safekeeping, Transfer and Dividend Paying Agent and Registrar			B-7
Brokerage Allocation and Other Practices			B-7

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS

		Page
Consolidated Balance Sheet — September 30, 2001 (unaudited) and December 31, 2000 and 1999			F-1
Consolidated Statement of Operations — For the Nine Months Ended September 30, 2001 and 2000 (unaudited) and for the Years Ended December 31, 2000, 1999 and 1998			F-2
Consolidated Statement of Changes in Net Assets — For the Nine Months Ended September 30, 2001 and 2000 (unaudited) and for the Years Ended December 31, 2000, 1999 and 1998			F-3
Consolidated Statement of Cash Flows — For the Nine Months Ended September 30, 2001 and 2000 (unaudited) and for the Years Ended December 31, 2000, 1999 and 1998			F-4
Consolidated Statement of Investments — September 30, 2001 (unaudited) and December 31, 2000			F-5
Notes to Consolidated Financial Statements			F-20
Report of Independent Public Accountants			F-43

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

								December 31,
				September 30,
				2001				2000				1999
(in thousands, except number of share amounts)				(unaudited)
ASSETS
Portfolio at value:
	Private finance (cost: 2001-$1,495,587; 2000-$1,262,529; 1999-$639,171)			$	1,539,253			$	1,282,467			$	647,040
	Commercial real estate finance (cost: 2001-$633,139; 2000-$503,366; 1999-$522,022)				635,120				505,534				520,029
	Small business finance (cost: 2001-$0; 2000-$0; 1999-$61,708)				—				—				61,428
		Total portfolio at value			2,174,373				1,788,001				1,228,497
Cash and cash equivalents					3,140				2,449				18,155
Other assets					89,320				63,367				43,386
		Total assets		$	2,266,833			$	1,853,817			$	1,290,038
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Notes payable and debentures			$	717,484			$	704,648			$	487,350
	Revolving credit facilities				207,000				82,000				105,500
	Accounts payable and other liabilities				35,112				30,477				22,675
		Total liabilities			959,596				817,125				615,525
Commitments and Contingencies
Preferred stock					7,000				7,000				7,000
Shareholders’ equity:
	Common stock, $0.0001 par value, 200,000,000 shares authorized; 96,920,973, 85,291,696 and 65,930,360 shares issued and outstanding at September 30, 2001, December 31, 2000 and 1999, respectively				10				9				7
	Additional paid-in capital				1,293,396				1,043,653				699,148
	Common stock held in deferred compensation trust (0 shares, 234,977 shares and 516,779 shares at September 30, 2001, December 31, 2000 and 1999, respectively)				—				—				(6,218	)
	Notes receivable from sale of common stock				(26,250	)			(25,083	)			(29,461	)
	Net unrealized appreciation on portfolio				42,842				19,378				4,517
	Distributions in excess of earnings				(9,761	)			(8,265	)			(480	)
		Total shareholders’ equity			1,300,237				1,029,692				667,513
		Total liabilities and shareholders’ equity		$	2,266,833			$	1,853,817			$	1,290,038

The accompanying notes are an integral part of these consolidated financial statements.

F-1

---

 

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

				For the Nine Months								For the Years Ended
				Ended September 30,								December 31,
				2001				2000				2000				1999				1998
(in thousands, except per share amounts)
				(unaudited)
Interest and related portfolio income:
	Interest and dividends			$	173,722			$	129,768			$	182,307			$	121,112			$	80,281
	Premiums from loan dispositions				2,070				10,752				16,138				14,284				5,949
	Post-Merger gain on securitization of commercial mortgage loans				—				—				—				—				14,812
	Fees and other income				30,652				9,334				13,144				5,744				5,696
		Total interest and related portfolio income			206,444				149,854				211,589				141,140				106,738
Expenses:
	Interest				47,974				41,645				57,412				34,860				20,694
	Employee				22,269				19,506				26,025				22,889				18,878
	Administrative				10,166				10,711				15,435				12,350				11,921
		Total operating expenses			80,409				71,862				98,872				70,099				51,493
Net operating income before net realized and unrealized gains					126,035				77,992				112,717				71,041				55,245
Net realized and unrealized gains:
	Net realized gains				8,339				23,095				15,523				25,391				22,541
	Net unrealized gains (losses)				23,463				(267	)			14,861				2,138				1,079
		Total net realized and unrealized gains			31,802				22,828				30,384				27,529				23,620
Net income before income taxes					157,837				100,820				143,101				98,570				78,865
Income tax expense					—				—				—				—				787
Net increase in net assets resulting from operations				$	157,837			$	100,820			$	143,101			$	98,570			$	78,078
Basic earnings per common share				$	1.77			$	1.43			$	1.95			$	1.64			$	1.50
Diluted earnings per common share				$	1.74			$	1.42			$	1.94			$	1.64			$	1.50
Weighted average common shares outstanding — basic					89,282				70,604				73,165				59,877				51,941
Weighted average common shares outstanding — diluted					90,864				70,777				73,472				60,044				51,974

The accompanying notes are an integral part of these consolidated financial statements.

F-2

---

 

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

				For the Nine Months
				Ended September 30,								For the Years Ended December 31,
				2001				2000				2000				1999				1998
(in thousands, except per share amounts)
				(unaudited)
Operations:
	Net operating income before net realized and unrealized gains			$	126,035			$	77,992			$	112,717			$	71,041			$	55,245
	Net realized gains				8,339				23,095				15,523				25,391				22,541
	Net unrealized gains (losses)				23,463				(267	)			14,861				2,138				1,079
	Income tax expense				—				—				—				—				(787	)
		Net increase in net assets resulting from operations			157,837				100,820				143,101				98,570				78,078
Shareholder distributions:
	Common stock dividends				(135,702	)			(98,617	)			(135,795	)			(97,941	)			(75,087	)
	Preferred stock dividends				(165	)			(165	)			(230	)			(230	)			(230	)
		Net decrease in net assets resulting from shareholder distributions			(135,867	)			(98,782	)			(136,025	)			(98,171	)			(75,317	)
Capital share transactions:
	Sale of common stock				237,037				250,912				250,912				164,269				69,675
	Issuance of common stock for portfolio investments				—				—				86,076				—				—
	Issuance of common stock upon the exercise of stock options				7,826				1,467				3,309				5,920				221
	Issuance of common stock in lieu of cash distributions				4,879				3,613				4,773				4,610				6,184
	Net decrease (increase) in notes receivable from sale of common stock				(1,167	)			3,535				4,378				(5,725	)			5,576
	Net decrease (increase) in common stock held in deferred compensation trust				—				4,814				6,218				6,972				(13,190	)
	Other				—				(563	)			(563	)			(290	)			71
		Net increase in net assets resulting from capital share transactions			248,575				263,778				355,103				175,756				68,537
		Total increase in net assets		$	270,545			$	265,816			$	362,179			$	176,155			$	71,298
Net assets at beginning of period				$	1,029,692			$	667,513			$	667,513			$	491,358			$	420,060
Net assets at end of period				$	1,300,237			$	933,329			$	1,029,692			$	667,513			$	491,358
Net asset value per common share				$	13.42			$	11.56			$	12.11			$	10.20			$	8.79
Common shares outstanding at end of period					96,921				80,754				85,057				65,414				55,919

The accompanying notes are an integral part of these consolidated financial statements.

F-3

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

					For the Nine Months
					Ended September 30,								For the Years Ended December 31,
					2001				2000				2000				1999				1998
(in thousands)
					(unaudited)
Cash flows from operating activities:
	Net increase in net assets resulting from operations				$	157,837			$	100,820			$	143,101			$	98,570			$	78,078
	Adjustments
		Net unrealized (gains) losses				(23,463	)			267				(14,861	)			(2,138	)			(1,079	)
		Post-Merger gain on securitization of commercial mortgages				—				—				—				—				(14,812	)
		Depreciation and amortization				724				659				925				788				702
		Amortization of loan discounts and fees				(11,793	)			(9,767	)			(10,101	)			(10,674	)			(6,032	)
		Changes in other assets and liabilities				(8,191	)			(8,712	)			2,036				(8,712	)			11,998
			Net cash provided by operating activities			115,114				83,267				121,100				77,834				68,855
Cash flows from investing activities:
	Portfolio investments					(544,024	)			(675,379	)			(889,251	)			(751,871	)			(524,530	)
	Repayments of investment principal					52,016				117,940				154,112				145,706				138,081
	Proceeds from loan sales					129,980				151,834				280,244				198,368				81,013
	Proceeds from securitization of commercial mortgages					—				—				—				—				223,401
	Net redemption of U.S. government securities					—				—				—				—				11,091
	Other investing activities					(125	)			3,657				1,417				(1,754	)			(2,539	)
			Net cash used in investing activities			(362,153	)			(401,948	)			(453,478	)			(409,551	)			(73,483	)
Cash flows from financing activities:
	Sale of common stock					237,037				250,912				250,912				164,269				69,896
	Purchase of common stock by deferred compensation trust					—				—				—				—				(19,431	)
	Collections of notes receivable from sale of common stock					3,293				4,617				6,363				195				5,591
	Common dividends and distributions paid					(130,823	)			(95,004	)			(131,022	)			(95,031	)			(69,536	)
	Special undistributed earnings distribution paid					—				—				—				—				(8,848	)
	Preferred stock dividends paid					(165	)			(165	)			(230	)			(230	)			(450	)
	Net borrowings under (payments on) notes payable and debentures					12,836				89,800				217,298				254,000				(69,471	)
	Net borrowings under (payments on) revolving lines of credit					125,000				79,500				(23,500	)			4,500				56,158
	Other financing activities					552				(2,940	)			(3,149	)			(2,906	)			(4,643	)
			Net cash provided by (used in) financing activities			247,730				326,720				316,672				324,797				(40,734	)
Net increase (decrease) in cash and cash equivalents					$	691			$	8,039			$	(15,706	)		$	(6,920	)		$	(45,362	)
Cash and cash equivalents at beginning of period					$	2,449			$	18,155			$	18,155			$	25,075			$	70,437
Cash and cash equivalents at end of period					$	3,140			$	26,194			$	2,449			$	18,155			$	25,075

The accompanying notes are an integral part of these consolidated financial statements.

F-4

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

					September 30, 2001
Private Finance					(unaudited)
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Ability One Corporation			Loans		$	10,481			$	10,481
ACE Products, Inc.			Loans			16,000				16,000
Acme Paging, L.P.			Debt Securities			6,989				6,989
			Limited Partnership Interest			1,456				—
Allied Office Products, Inc.			Debt Securities			9,413				8,042
			Warrants			629				—
American Barbecue & Grill, Inc.			Warrants			125				—
American HomeCare Supply,			Debt Securities			6,892				6,892
	LLC		Warrants			579				579
Aspen Pet Products, Inc.			Loans			14,354				14,354
			Preferred Stock (1,860 shares)			1,944				1,944
			Common Stock (1,400 shares)			140				140
ASW Holding Corporation			Warrants			25				25
Aurora Communications, LLC			Loans			15,543				15,543
			Equity Interest			2,461				3,108
Autania AG(1)			Debt Securities			4,340				4,340
			Common Stock (250,000 shares)			2,159				2,159
Avborne, Inc.			Debt Securities			12,787				12,787
			Warrants			1,180				1,180
Bakery Chef, Inc.			Loans			16,733				16,733
Blue Rhino Corporation(1)			Debt Securities			13,796				13,796
			Warrants			1,200				1,200
Border Foods, Inc.			Debt Securities			9,301				9,301
			Preferred Stock (50,919 shares)			2,000				2,000
			Warrants			665				665
Business Loan Express, Inc.			Loan			20,000				20,000
			Debt Securities			60,388				60,388
			Preferred Stock (25,111 shares)			25,111				25,111
			Common Stock (25,503,043 shares)			104,515				120,015
			Guaranty ($50,300 — See Note 3)			—				—
Camden Partners Strategic Fund II, L.P.			Limited Partnership Interest			1,068				1,068
CampGroup, LLC			Debt Securities			2,641				2,641
			Warrants			220				220
Candlewood Hotel Company(1)			Preferred Stock (3,250 shares)			3,189				3,189
Celebrities, Inc.			Loan			248				248
			Warrants			12				662
Classic Vacation Group, Inc.(1)			Loan			6,211				6,211

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-5

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					September 30, 2001
Private Finance					(unaudited)
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Colibri Holding Corporation			Loans		$	3,458			$	3,458
			Common Stock (3,362 shares)			1,250				1,250
			Warrants			290				290
The Color Factory Inc.			Loan			4,833				4,833
			Preferred Stock (600 shares)			600				600
			Common Stock (980 shares)			6,535				6,535
Component Hardware Group, Inc.			Debt Securities			10,655				10,655
			Preferred Stock (18,000 shares)			1,800				1,800
			Common Stock (2,000 shares)			200				200
Convenience Corporation of			Debt Securities			8,355				2,738
	America		Preferred Stock (31,521 shares)			334				—
			Warrants			—				—
Cooper Natural Resources, Inc.			Debt Securities			1,686				1,686
			Preferred Stock (6,316 shares)			1,427				1,427
			Warrants			832				832
CorrFlex Graphics, LLC			Loan			6,970				6,970
			Debt Securities			5,217				5,217
			Warrants			—				1,250
			Options			—				—
Coverall North America, Inc.			Loan			10,312				10,312
			Debt Securities			5,248				5,248
			Warrants			—				—
CPM Acquisition Corp.			Loan			9,454				9,454
Csabai Canning Factory Rt.			Hungarian Quotas (9.2%)			700				—
CTT Holdings			Loan			1,345				1,345
CyberRep			Loan			1,076				1,076
			Debt Securities			14,093				14,093
			Warrants			660				3,310
The Debt Exchange Inc.			Preferred Stock (921,829 shares)			1,250				1,250
Directory Investment Corporation			Common Stock (470 shares)			112				32
Directory Lending Corporation			Common Stock (50 shares)			30				—
Drilltec Patents & Technologies			Loan			10,918				9,262
	Company, Inc.		Debt Securities			1,500				1,500
			Warrants			—				—
eCentury Capital Partners, L.P.			Limited Partnership Interest			1,875				1,875
EDM Consulting, LLC			Debt Securities			1,875				443
			Common Stock (100 shares)			250				—
El Dorado Communications, Inc.			Loans			306				306
Elexis Beta GmbH			Options			426				526
Eparfin S.A.			Loan			29				29
Esquire Communications Ltd.(1)			Warrants			6				—
E-Talk Corporation			Debt Securities			8,852				6,509
			Warrants			1,157				—

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-6

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					September 30, 2001
Private Finance					(unaudited)
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Executive Greetings, Inc.			Debt Securities		$	15,923			$	15,923
			Warrants			360				360
ExTerra Credit Recovery, Inc.			Preferred Stock (500 shares)			568				318
			Common Stock (2,500 shares)			—				—
			Warrants			—				—
Fairchild Industrial Products			Debt Securities			5,856				5,856
	Company		Warrants			280				2,628
Galaxy American			Debt Securities			44,967				45,717
	Communications, Inc.		Options			—				—
Garden Ridge Corporation			Debt Securities			26,890				26,890
			Preferred Stock (1,130 shares)			1,130				1,130
			Common Stock (471 shares)			613				613
Genesis Worldwide, Inc.(1)			Loan			1,067				—
Gibson Guitar Corporation			Debt Securities			16,987				16,987
			Warrants			525				2,325
Ginsey Industries, Inc.			Loans			5,000				5,000
			Debentures			500				500
			Warrants			—				504
Global Communications, LLC			Debt Securities			13,625				13,625
			Equity Interest			11,067				11,067
			Options			1,639				1,639
Grant Broadcasting Systems II			Warrants			87				5,976
Grant Television, Inc.			Equity Interest			660				660
Grotech Partners, VI, L.P.			Limited Partnership Interest			1,179				735
The Hartz Mountain Corporation			Debt Securities			27,363				27,363
			Common Stock (200,000 shares)			2,000				2,000
			Warrants			2,613				2,613
HealthASPex, Inc.			Preferred Stock (1,036,700 shares)			4,140				4,140
			Preferred Stock (414,680 shares)			760				760
			Common Stock (1,451,380 shares)			4				4
HMT, Inc.			Debt Securities			9,961				9,961
			Common Stock (300,000 shares)			3,000				3,000
			Warrants			—				—
Hotelevision, Inc.			Preferred Stock (315,100 shares)			315				315
Icon International, Inc.			Common Stock (37,821 shares)			1,219				1,518
Impact Innovations Group			Debt Securities			6,537				6,537
			Warrants			1,674				1,674
Intellirisk Management Corporation			Loans			22,090				22,090
International Fiber Corporation			Debt Securities			22,115				22,115
			Common Stock (1,029,068 shares)			5,483				5,483
			Warrants			550				550
iSolve Incorporated			Preferred Stock (14,853 shares)			874				—
			Common Stock (13,306 shares)			14				—
Jakel, Inc.			Loan			19,928				19,928

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-7

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					September 30, 2001
Private Finance					(unaudited)
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
JRI Industries, Inc.			Debt Securities		$	1,967			$	1,967
			Warrants			74				74
Julius Koch USA, Inc.			Debt Securities			1,375				1,375
			Warrants			259				6,500
Kirker Enterprises, Inc.			Warrants			348				3,494
			Equity Interest			4				11
Kirkland’s, Inc.			Debt Securities			7,111				7,111
			Preferred Stock (917 shares)			412				412
			Warrants			96				96
Kyrus Corporation			Debt Securities			7,791				7,791
			Warrants			348				348
Liberty-Pittsburgh Systems, Inc.			Debt Securities			3,485				3,485
			Common Stock (64,535 shares)			142				142
The Loewen Group, Inc.(1)			High-Yield Senior Secured Debt			15,150				13,650
Logic Bay Corporation			Preferred Stock (1,131,222 shares)			5,000				5,000
Love Funding Corporation			Preferred Stock (26,000 shares)			359				213
Magna Card, Inc.			Debt Securities			153				153
			Preferred Stock (1,875 shares)			94				94
			Common Stock (4,687 shares)			—				—
Master Plan, Inc.			Loan			1,204				1,204
			Common Stock (156 shares)			42				2,042
MedAssets.com, Inc.			Preferred Stock (260,417 shares)			2,049				2,049
			Warrants			136				136
Mid-Atlantic Venture Fund IV, L.P.			Limited Partnership Interest			2,475				1,989
Midview Associates, L.P.			Warrants			—				—
Monitoring Solutions, Inc.			Debt Securities			1,823				153
			Common Stock (33,333 shares)			—				—
			Warrants			—				—
MortgageRamp.com, Inc.			Common Stock (800,000 shares)			4,000				4,000
Morton Grove			Loan			15,946				15,946
	Pharmaceuticals, Inc.		Preferred Stock (106,947 shares)			5,000				9,000
Most Confiserie GmbH & Co KG			Loan			965				965
MVL Group, Inc.			Debt Securities			16,213				16,213
			Warrants			643				643
NETtel Communications, Inc.			Debt Securities			13,483				6,483
Nobel Learning Communities,			Debt Securities			9,637				9,637
	Inc.(1)		Preferred Stock (265,957 shares)			2,000				2,000
			Warrants			575				575
North American			Loans			3,612				2,848
	Archery, LLC		Debentures			26				0
Northeast Broadcasting Group, L.P.			Debt Securities			321				321

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-8

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					September 30, 2001
Private Finance					(unaudited)
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Novak Biddle Venture Partners III, LP			Limited Partnership Interest		$	330			$	330
Nursefinders, Inc.			Debt Securities			11,075				11,075
			Warrants			900				900
Onyx Television GmbH			Preferred Units (600,000 shares)			201				201
Opinion Research Corporation(1)			Debt Securities			14,146				14,146
			Warrants			996				996
Oriental Trading Company, Inc.			Loan			128				128
			Debt Securities			12,650				12,650
			Preferred Equity Interest			1,500				1,822
			Common Equity Interest			—				—
			Warrants			13				266
Outsource Partners, Inc.			Debt Securities			23,890				23,890
			Warrants			826				826
Packaging Advantage Corporation			Debt Securities			11,563				11,563
			Common Stock (200,000 shares)			2,000				2,000
			Warrants			963				963
Physicians Specialty Corporation			Debt Securities			39,580				39,580
			Common Stock (79,567,042 shares)			1,000				100
Pico Products, Inc.(1)			Loan			1,300				1,300
			Debt Securities			4,591				1,591
			Common Stock (208,000 shares)			59				—
			Warrants			—				—
Polaris Pool Systems, Inc.			Debt Securities			6,556				6,556
			Warrants			1,050				1,050
Powell Plant Farms, Inc.			Loan			16,809				16,809
Proeducation GmbH			Loan			136				136
Professional Paint, Inc.			Debt Securities			21,409				21,409
			Preferred Stock (15,000 shares)			15,000				15,000
			Common Stock (110,000 shares)			69				69
Progressive International			Debt Securities			3,956				3,956
	Corporation		Preferred Stock (500 shares)			500				500
			Common Stock (197 shares)			13				13
			Warrants			—				—
Prosperco Finaz Holding AG			Debt Securities			5,262				5,262
			Common Stock (1,528 shares)			1,059				1,059
			Warrants			—				—
Raytheon Aerospace, LLC			Debt Securities			5,013				5,013
			Common LLC Interest			—				—
Redox Brands, Inc.			Debt Securities			9,368				9,368
			Warrants			584				584
Schwinn Holdings Corporation			Debt Securities			10,206				1,835
			Warrants			395				—
Seasonal Expressions, Inc.			Preferred Stock (1,000 shares)			500				—
Simula, Inc.			Loan			24,875				24,875

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-9

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					September 30, 2001
Private Finance					(unaudited)
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Soff-Cut Holdings, Inc.			Debt Securities		$	8,623			$	8,623
			Preferred Stock (300 shares)			300				300
			Common Stock (2,000 shares)			200				200
			Warrants			446				446
Southern Communications, LLC			Equity Interest			9,778				9,778
Southwest PCS, LLC			Loan			8,088				8,088
Spa Lending Corporation			Preferred Stock (28,625 shares)			470				368
			Common Stock (6,208 shares)			25				15
Staffing Partners Holding			Debt Securities			4,991				4,991
	Company, Inc.		Preferred Stock (414,600 shares)			2,073				2,073
			Common Stock (50,200 shares)			50				50
			Warrants			10				10
Startec Global Communications			Debt Securities			20,742				20,742
	Corporation(1)		Loan			15,156				15,156
			Common Stock (258,064 shares)			3,000				—
			Warrants			—				—
STS Operating, Inc.			Common Stock (3,000,000 shares)			3,177				3,177
SunSource Inc.			Debt Securities			39,819				39,819
			Common Stock (6,890,937 shares)			58,647				58,647
SunStates Refrigerated Services,			Loans			6,062				4,573
	Inc.		Debt Securities			2,445				877
Sure-Tel, Inc.			Loan			207				207
			Preferred Stock (1,116,902 shares)			4,624				4,624
			Warrants			662				662
			Options			—				—
Sydran Food Services II, L.P.			Debt Securities			12,973				12,973
Total Foam, Inc.			Debt Securities			264				127
			Common Stock (910 shares)			10				—
Tubbs Snowshoe Company, LLC			Debt Securities			3,910				3,910
			Warrants			54				54
			Equity Interests			500				500
United Pet Group, Inc.			Debt Securities			4,964				4,964
			Warrants			15				15
Updata Venture Partners, II, L.P.			Limited Partnership Interest			1,900				1,900
Velocita, Inc.			Debt Securities			11,638				11,638
			Warrants			3,540				3,540
Venturehouse Group, LLC			Common Equity Interest			667				459
Walker Investment Fund II, LLLP			Limited Partnership Interest			1,000				638
Warn Industries, Inc.			Debt Securities			18,663				18,663
			Warrants			1,429				3,129
Williams Brothers Lumber Company			Warrants			24				322
Wilmar Industries, Inc.			Debt Securities			32,596				32,596
			Warrants			3,169				3,169

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-10

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				September 30, 2001
Private Finance				(unaudited)
Portfolio Company
(in thousands, except number of shares)		Investment(2)		Cost				Value
Wilshire Restaurant Group, Inc.		Debt Securities		$	15,464			$	15,464
		Warrants			—				—
Wilton Industries, Inc.		Loan			12,000				12,000
Woodstream Corporation		Debt Securities			7,620				7,620
		Equity Interests			1,700				2,372
		Warrants			450				628
Wyo-Tech Acquisition Corporation		Debt Securities			12,579				12,579
		Preferred Stock (100 shares)			3,700				3,700
		Common Stock (99 shares)			100				44,100
Total private finance (132 investments)				$	1,495,587			$	1,539,253

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-11

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											September 30, 2001
											(unaudited)
			Interest				Number of
(in thousands, except number of loans)			Rate Ranges				Loans				Cost				Value
Commercial Real Estate Finance
Commercial Mortgage Loans				Up to  6.99%				4			$	942			$	2,642
				7.00%– 8.99%				21				40,057				42,158
				9.00%–10.99%				21				17,334				17,240
				11.00%–12.99%				12				11,641				11,641
				13.00%–14.99%				8				12,727				12,453
			15.00% and above					2				88				64
	Total commercial mortgage loans							68			$	82,789			$	86,198

				Stated
				Interest				Face
Purchased CMBS
	Mortgage Capital Funding, Series 1998-MC3				5.5%			$	54,491			$	26,640			$	26,640
	Morgan Stanley Capital I, Series 1999-RM1				6.4%				51,046				21,468				21,468
	COMM 1999-1				5.6%				74,879				35,402				35,402
	Morgan Stanley Capital I, Series 1999-FNV1				6.1%				45,527				22,231				22,231
	DLJ Commercial Mortgage Trust 1999-CG2				6.1%				96,432				44,732				44,732
	Commercial Mortgage Acceptance Corp., Series 1999-C1				6.8%				34,856				16,344				16,344
	LB Commercial Mortgage Trust, Series 1999-C2				6.7%				29,005				11,236				11,236
	Chase Commercial Mortgage Securities Corp., Series 1999-2				6.5%				43,046				20,742				20,742
	FUNB CMT, Series 1999-C4				6.5%				49,287				22,502				22,502
	Heller Financial, HFCMC Series 2000 PH-1				6.6%				45,456				18,769				18,769
	SBMS VII, Inc., Series 2000-NL1				7.2%				24,230				13,293				13,293
	DLJ Commercial Mortgage Trust, Series 2000-CF1				7.0%				40,502				19,427				19,427
	Deutsche Bank Alex. Brown, Series Comm 2000-C1				6.9%				41,084				19,383				19,383
	LB-UBS Commercial Mortgage Trust, Series 2000-C4				6.9%				31,471				11,497				11,497
	Credit Suisse First Boston Mortgage Securities Corp., Series 2001-CK1				5.9%				58,786				28,936				28,936
	Crest 2001-1, Ltd. (collateralized debt obligation)				0.0%				24,475				24,625				24,625
	JP Morgan-CIBC-Deutsche 2001				5.8%				60,889				29,479				29,479
	Lehman Brothers-UBS Warburg 2001-C4				6.4%				65,130				32,213				32,213
	SBMS VII, Inc., Series 2001-C1				6.1%				54,780				25,203				25,203
	GE Capital Commercial Mortgage Securities Corp., Series 2001-2				6.1%				57,039				27,991				27,991
		Total purchased CMBS						$	982,411			$	472,113			$	472,113
Residual CMBS												$	72,850			$	72,850
Residual Interest Spread													1,825				1,525
Real Estate Owned													3,562				2,434
		Total commercial real estate finance										$	633,139			$	635,120
Total portfolio												$	2,128,726			$	2,174,373

(1) Public company.

(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-12

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

Private Finance					December 31, 2000
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Ability One Corporation			Loans		$	9,974			$	9,974
ACE Products, Inc.			Loans			14,276				14,276
Acme Paging, L.P.			Debt Securities			6,984				6,984
			Limited Partnership Interest			1,456				—
Allied Office Products, Inc.			Debt Securities			9,360				9,360
			Warrants			629				629
American Barbecue & Grill, Inc.			Warrants			125				—
American Home Care Supply,			Debt Securities			6,853				6,853
	LLC		Warrants			579				579
Aspen Pet Products, Inc.			Loans			13,862				13,862
			Preferred Stock (1,860 shares)			1,860				1,860
			Common Stock (1,400 shares)			140				140
ASW Holding Corporation			Warrants			25				25
Aurora Communications, LLC			Loans			14,410				14,410
			Equity Interest			1,500				3,347
Avborne, Inc.			Debt Securities			12,255				12,255
			Warrants			1,180				1,180
Bakery Chef, Inc.			Loans			15,899				15,899
Border Foods, Inc.			Debt Securities			9,904				9,904
			Preferred Stock (50,919 shares)			2,000				2,000
			Warrants			—				—
Business Loan Express, Inc.			Debt Securities			74,465				74,465
			Preferred Stock (25,111 shares)			25,111				25,111
			Common Stock (25,503,043 shares)			104,504				104,504
Camden Partners Strategic Fund II, L.P.			Limited Partnership Interest			613				613
CampGroup, LLC			Debt Securities			2,579				2,579
			Warrants			220				220
Candlewood Hotel Company(1)			Preferred Stock (3,250 shares)			3,250				3,250
Celebrities, Inc.			Loan			277				277
			Warrants			12				312
Classic Vacation Group, Inc.(1)			Debt Securities			5,688				5,688
Colibri Holding Corporation			Loans			3,438				3,438
			Common Stock (3,362 shares)			1,250				1,250
			Warrants			290				290
Component Hardware Group			Debt Securities			10,302				10,302
			Preferred Stock (18,000 shares)			1,800				1,800
			Common Stock (2,000 shares)			200				200

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-13

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Private Finance					December 31, 2000
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Convenience Corporation of			Debt Securities		$	8,355			$	2,738
	America		Preferred Stock (31,521 shares)			334				—
			Warrants			—				—
Cooper Natural Resources, Inc.			Debt Securities			3,424				3,424
			Warrants			—				—
CorrFlex Graphics, LLC			Loan			6,952				6,952
			Debt Securities			4,954				4,954
			Warrants			—				500
			Options			—				—
Cosmetic Manufacturing			Loan			120				120
	Resources, LLC		Debt Securities			5,848				5,848
			Options			87				87
Coverall North America, Inc.			Loan			9,692				9,692
			Debt Securities			4,965				4,965
			Warrants			—				—
Csabai Canning Factory Rt.			Hungarian Quotas (9.2%)			700				—
CTT Holdings			Loan			1,224				1,224
CyberRep			Loan			949				949
			Debt Securities			10,295				10,295
			Warrants			660				1,310
Directory Investment Corporation			Common Stock (470 shares)			100				20
Directory Lending Corporation			Common Stock (50 shares)			30				—
Drilltec Patents & Technologies			Loan			10,918				8,762
	Company, Inc.		Debt Securities			1,500				1,500
			Warrants			—				—
eCentury Capital Partners, L.P.			Limited Partnership Interest			1,875				1,875
EDM Consulting, LLC			Debt Securities			1,875				343
			Common Stock (100 shares)			250				—
El Dorado Communications, Inc.			Loans			306				306
Elexis Beta GmbH			Options			424				424
Eparfin S.A.			Loan			29				29
Esquire Communications Ltd.(1)			Warrants			6				—
E-Talk Corporation			Debt Securities			8,804				8,804
			Warrants			1,157				1,157
Ex Terra Credit Recovery, Inc.			Preferred Stock (500 shares)			594				344
			Common Stock (2,500 shares)			—				—
			Warrants			—				—
Executive Greetings, Inc.			Debt Securities			15,880				15,880
			Warrants			360				360
Fairchild Industrial Products			Debt Securities			5,810				5,810
	Company		Warrants			280				3,628
FTI Consulting, Inc.(1)			Warrants			970				2,554

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-14

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Private Finance					December 31, 2000
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Galaxy American			Debt Securities		$	33,399			$	33,399
	Communications, Inc.		Warrants			500				1,250
Garden Ridge Corporation			Debt Securities			26,537				26,537
			Preferred Stock (1,130 shares)			1,130				1,130
			Common Stock (471 shares)			613				613
Genesis Worldwide, Inc.(1)			Loan			1,067				1,067
Gibson Guitar Corporation			Debt Securities			16,441				16,441
			Warrants			525				1,525
Ginsey Industries, Inc.			Loans			5,000				5,000
			Debentures			500				500
			Warrants			—				154
Global Communications, LLC			Debt Securities			12,732				12,732
			Equity Interest			10,467				10,467
			Options			1,639				1,639
Grant Broadcasting Systems II			Warrants			87				5,976
Grant Television, Inc.			Equity Interest			660				660
Grotech Partners, VI, L.P.			Limited Partnership Interest			869				869
The Hartz Mountain Corporation			Debt Securities			27,162				27,162
			Common Stock (200,000 shares)			2,000				2,000
			Warrants			2,613				2,613
HealthASPex, Inc.			Preferred Stock (396,908 shares)			1,340				1,340
			Preferred Stock (225,112 shares)			760				760
			Common Stock (1,036,700 shares)			—				—
HMT, Inc.			Debt Securities			9,956				9,956
			Common Stock (300,000 shares)			3,000				3,000
			Warrants			—				—
Hotelevision, Inc.			Preferred Stock (315,100 shares)			315				315
Icon International, Inc.			Common Stock (37,821 shares)			1,218				1,518
Impact Innovations Group			Debt Securities			6,367				6,367
			Warrants			1,674				1,674
Intellirisk Management Corporation			Loans			21,449				21,449
International Fiber Corporation			Debt Securities			21,626				21,626
			Common Stock (1,029,068 shares)			5,483				5,483
			Warrants			550				550
iSolve Incorporated			Preferred Stock (14,853 shares)			874				874
			Common Stock (13,306 shares)			14				14
Jakel, Inc.			Loan			19,236				19,236
JRI Industries, Inc.			Debt Securities			1,953				1,953
			Warrants			74				74
Julius Koch USA, Inc.			Debt Securities			2,294				2,294
			Warrants			259				6,500

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-15

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Private Finance					December 31, 2000
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Kirker Enterprises, Inc.			Warrants		$	348			$	4,493
			Equity Interest			4				11
Kirkland’s, Inc.			Debt Securities			6,347				6,347
			Preferred Stock (917 shares)			412				412
			Warrants			96				96
Kyrus Corporation			Debt Securities			7,734				7,734
			Warrants			348				348
Liberty-Pittsburgh Systems, Inc.			Debt Securities			3,475				3,475
			Common Stock (64,535 shares)			142				142
The Loewen Group, Inc.(1)			High-Yield Senior Secured Debt			15,150				14,150
Logic Bay Corporation			Preferred Stock (1,131,222 shares)			5,000				5,000
Love Funding Corporation			Preferred Stock (26,000 shares)			359				213
Master Plan, Inc.			Loan			2,000				2,000
			Common Stock (156 shares)			42				3,042
MedAssets.com, Inc.			Preferred Stock (227,665 shares)			2,049				2,049
			Warrants			136				136
Mid-Atlantic Venture Fund IV, L.P.			Limited Partnership Interest			2,475				2,475
Midview Associates, L.P.			Warrants			—				—
Monitoring Solutions, Inc.			Debt Securities			1,823				243
			Common Stock (33,333 shares)			—				—
			Warrants			—				—
MortgageRamp.com, Inc.			Common Stock (800,000 shares)			4,000				4,000
Morton Grove			Loan			15,356				15,356
	Pharmaceuticals, Inc.		Preferred Stock (106,947 shares)			5,000				8,500
MVL Group			Debt Securities			14,124				14,124
			Warrants			643				1,912
NETtel Communications, Inc.			Debt Securities			13,472				13,472
Nobel Learning Communities,			Debt Securities			9,571				9,571
	Inc.(1)		Preferred Stock (265,957 shares)			2,000				2,000
			Warrants			575				500
North American			Loans			1,390				811
	Archery, LLC		Debentures			2,248				1,996
Northeast Broadcasting Group, L.P.			Debt Securities			349				349
Nursefinders, Inc.			Debt Securities			11,006				11,006
			Warrants			900				900
Old Mill Holdings, Inc.			Debt Securities			140				—
Onyx Television GmbH			Common Stock (600,000 shares)			200				200
Opinion Research Corporation(1)			Debt Securities			14,033				14,033
			Warrants			996				996

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-16

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Private Finance					December 31, 2000
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Oriental Trading Company, Inc.			Debt Securities		$	12,456			$	12,456
			Loan			128				128
			Preferred Equity Interest			1,483				1,483
			Common Equity Interest			17				17
			Warrants			—				—
Outsource Partners, Inc.			Debt Securities			23,853				23,853
			Warrants			826				826
Packaging Advantage Corporation			Debt Securities			11,497				11,497
			Common Stock (200,000 shares)			2,000				2,000
			Warrants			963				963
Physicians Specialty Corporation			Debt Securities			14,809				14,809
			Preferred Stock (850 shares)			850				—
			Preferred Stock (97,411 shares)			150				—
			Warrants			476				—
Pico Products, Inc.(1)			Loan			1,300				1,300
			Debt Securities			4,591				1,591
			Common Stock (208,000 shares)			59				—
			Warrants			—				—
Polaris Pool Systems, Inc.			Debt Securities			6,483				6,483
			Warrants			1,050				1,050
Powell Plant Farms, Inc.			Loan			15,707				15,707
Proeducation GmbH			Loan			40				40
Professional Paint, Inc.			Debt Securities			20,000				20,000
			Preferred Stock (15,000 shares)			15,000				15,000
			Common Stock (110,000 shares)			69				69
Progressive International			Debt Securities			3,949				3,949
	Corporation		Preferred Stock (500 shares)			500				500
			Common Stock (197 shares)			13				13
			Warrants			—				—
Schwinn Holdings Corporation			Debt Securities			10,367				10,367
			Warrants			395				395
Seasonal Expressions, Inc.			Preferred Stock (1,000 shares)			500				—
Soff-Cut Holdings, Inc.			Debt Securities			8,454				8,454
			Preferred Stock (300 shares)			300				300
			Common Stock (2,000 shares)			200				200
			Warrants			446				446
Southern Communications, LLC			Equity Interest			9,779				9,779
Southwest PCS, LLC			Loan			7,500				7,500
Southwest PCS, L.P.			Debt Securities			6,518				7,435
Spa Lending Corporation			Preferred Stock (28,625 shares)			547				437
			Common Stock (6,208 shares)			25				18

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-17

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Private Finance					December 31, 2000
Portfolio Company
(in thousands, except number of shares)			Investment(2)		Cost				Value
Staffing Partners Holding			Debt Securities		$	4,990			$	4,990
	Company, Inc.		Preferred Stock (414,600 shares)			2,073				2,073
			Common Stock (50,200 shares)			50				50
			Warrants			10				10
Startec Global Communications,			Debt Securities			20,200				20,200
	Corporation(1)		Common Stock (258,064 shares)			3,000				3,000
			Warrants			—				—
Sunsource Inc.(1)			Debt Securities			29,850				29,850
			Warrants			—				—
SunStates Refrigerated Services,			Loans			6,062				4,573
	Inc.		Debt Securities			2,445				1,384
Sure-Tel, Inc.			Loan			207				207
			Preferred Stock (1,116,902 shares)			4,558				4,558
			Warrants			662				662
			Options			—				900
Sydran Food Services II, L.P.			Debt Securities			12,973				12,973
Total Foam, Inc.			Debt Securities			268				127
			Common Stock (910 shares)			10				—
Tubbs Snowshoe Company, LLC			Debt Securities			3,899				3,899
			Warrants			54				54
			Equity Interests			500				500
United Pet Group			Debt Securities			4,959				4,959
			Warrants			15				15
Velocita, Inc.			Debt Securities			11,532				11,532
			Warrants			3,540				3,540
Venturehouse Group, LLC			Common Equity Interest			333				333
Walker Investment Fund II, LLLP			Limited Partnership Interest			800				800
Warn Industries, Inc.			Debt Securities			19,330				19,330
			Warrants			1,429				1,929
Williams Brothers Lumber Company			Warrants			24				322
Wilmar Industries, Inc.			Debt Securities			31,720				31,720
			Warrants			3,169				3,169
Wilshire Restaurant Group, Inc.			Debt Securities			15,191				15,191
			Warrants			—				—
Wilton Industries, Inc.			Loan			12,836				12,836
Woodstream Corporation			Debt Securities			7,590				7,590
			Equity Interests			1,700				1,700
			Warrants			450				450
Wyo-Tech Acquisition Corporation			Debt Securities			15,677				15,677
			Preferred Stock (100 shares)			3,700				3,700
			Common Stock (99 shares)			100				7,100
Total private finance (122 investments)					$	1,262,529			$	1,282,467

(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-18

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											December 31, 2000
			Interest				Number of
(in thousands, except number of loans)			Rate Ranges				Loans				Cost				Value
Commercial Real Estate Finance
Commercial Mortgage Loans				Up to  6.99%				3			$	882			$	2,582
				7.00%– 8.99%				13				30,032				32,132
				9.00%–10.99%				17				22,302				22,190
				11.00%–12.99%				38				35,250				35,042
				13.00%–14.99%				12				14,391				14,391
			15.00% and above					2				100				76
	Total commercial mortgage loans							85			$	102,957			$	106,413

				Stated
				Interest				Face
Purchased CMBS
	Mortgage Capital Funding, Series 1998-MC3				5.5%			$	54,491			$	25,681			$	25,681
	Morgan Stanley Capital I, Series 1999-RM1				6.4%				59,640				27,429				27,429
	COMM 1999-1				5.6%				74,879				34,352				34,352
	Morgan Stanley Capital I, Series 1999-FNV1				6.1%				45,536				21,972				21,972
	DLJ Commercial Mortgage Trust 1999-CG2				6.1%				96,432				44,332				44,332
	Commercial Mortgage Acceptance Corp., Series 1999-C1				6.8%				34,856				16,397				16,397
	LB Commercial Mortgage Trust, Series 1999-C2				6.7%				29,005				10,910				10,910
	Chase Commercial Mortgage Securities Corp., Series 1999-2				6.5%				43,046				20,552				20,552
	FUNB CMT, Series 1999-C4				6.5%				49,287				22,515				22,761
	Heller Financial, HFCMC Series 2000 PH-1				6.6%				45,456				19,039				19,039
	SBMS VII, Inc., Series 2000-NL1				7.2%				30,079				17,820				18,007
	DLJ Commercial Mortgage Trust, Series 2000-CF1				7.0%				40,502				19,166				19,166
	Deutsche Bank Alex. Brown, Series Comm 2000-C1				6.9%				41,084				19,170				19,170
	LB-UBS Commercial Mortgage Trust, Series 2000-C4				6.9%				31,471				11,552				11,552
		Total purchased CMBS						$	675,764			$	310,887			$	311,320
Residual CMBS												$	78,723			$	78,723
Residual Interest Spread													3,297				2,997
Real Estate Owned													7,502				6,081
		Total commercial real estate finance										$	503,366			$	505,534
Total portfolio												$	1,765,895			$	1,788,001

(1) Public company.

(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted.

F-19

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Organization

      Allied Capital Corporation, a Maryland corporation, is a closed-end management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (“1940 Act”). Allied Capital Corporation (“ACC”) has a wholly owned subsidiary that has also elected to be regulated as a BDC. Allied Investment Corporation (“Allied Investment”) is licensed under the Small Business Investment Act of 1958 as a Small Business Investment Company (“SBIC”). In April 2001, ACC established a consolidated wholly owned subsidiary, A.C. Corporation (“AC Corp.”), which provides consulting, structuring and diligence services on private finance and commercial real estate transactions, as well as consulting, structuring and management services to existing portfolio companies. In addition, the Company has a real estate investment trust subsidiary, Allied Capital REIT, Inc. (“Allied REIT”) and several single-member limited liability companies established primarily to hold real estate properties.

      ACC also owned Allied Capital SBLC Corporation (“Allied SBLC”), a BDC licensed by the Small Business Administration (“SBA”) as a Small Business Lending Company and a participant in the SBA Section 7(a) Guaranteed Loan Program. On December 31, 2000, ACC acquired BLC Financial Services, Inc. as a private portfolio company, which then changed its name to Business Loan Express, Inc. (“BLX”). As a part of the transaction, Allied SBLC was recapitalized as an independently managed, private portfolio company on December 28, 2000 and ceased to be a consolidated subsidiary of the Company at that time. Allied SBLC was then subsequently merged into BLX. The results of the operations of Allied SBLC are included in the consolidated financial results of ACC and its subsidiaries for 1998, 1999 and for 2000 through December 27, 2000.

      Allied Capital Corporation and its subsidiaries, collectively, are hereinafter referred to as the “Company.”

      The investment objective of the Company is to achieve current income and capital gains. In order to achieve this objective, the Company invests in private and undervalued public companies in a variety of different industries and in diverse geographic locations.

      On December 31, 1997, Allied Capital Corporation, Allied Capital Corporation II, Allied Capital Commercial Corporation, and Allied Capital Advisers (“Advisers”) merged with and into Allied Capital Lending Corporation (“Allied Lending”) (each a “Predecessor Company” and collectively the “Predecessor Companies”) in a stock-for-stock exchange (the “Merger”). Immediately following the Merger, Allied Lending changed its name to Allied Capital Corporation.

Note 2. Summary of Significant Accounting Policies

  Basis of Presentation

      The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries that make investments or are operating companies that provide services to the Company. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2000, 1999 and 1998 balances to conform with the 2001 financial statement presentation.

      The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP

F-20

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for complete consolidated financial statements. In the opinion of management, the unaudited consolidated financial results of the Company included herein contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position of the Company as of and for the nine months ended September 30, 2001 and 2000 and the results of operations, changes in net assets, and cash flows for these periods. The results of operations for the nine months ended September 30, 2001 are not necessarily indicative of the operating results to be expected for the full year.

  Valuation of Portfolio Investments

      Portfolio assets are carried at fair value as determined by the Board of Directors under the Company’s valuation policy.

  Loans and Debt Securities

      The values of loans and debt securities are considered to be amounts that could be realized in the normal course of business in an orderly disposition over a reasonable period of time. For loans and debt securities, value normally corresponds to cost unless the borrower’s condition or external factors lead to a determination of value at a lower amount.

      When the Company receives nominal cost warrants or free equity securities (“nominal cost equity”), the Company allocates its cost basis in its investment between its debt securities and its nominal cost equity at the time of origination. At that time, the original issue discount basis of the nominal cost equity is recorded by increasing the cost basis in the equity and decreasing the cost basis in the related debt securities.

      Interest income is recorded on the accrual basis to the extent that such amounts are expected to be collected. Loan origination fees, original issue discount and market discount are amortized into interest income using the effective interest method. The weighted average yield on loans and debt securities is computed as the (a) annual stated interest rate earned plus the annual amortization of loan origination fees, original issue discount and market discount earned on accruing loans and debt securities, divided by (b) total loans and debt securities at value. The weighted average yield is computed as of the balance sheet date. Prepayment premiums are recorded on loans when received.

  Equity Securities

      The value of the Company’s equity interests in private or illiquid public companies is considered to be amounts that could be realized in the normal course of business in an orderly disposition over a reasonable period of time. Equity interests in portfolio companies for which there is no liquid public market are valued based on various factors including a history of positive cash flow from operations, the market value of comparable publicly traded companies, and other pertinent factors such as recent offers to purchase a portfolio company’s securities or other liquidation events. The determined values are generally discounted to account for liquidity issues and minority control positions.

      The value of the Company’s equity interests in public companies for which market prices are readily available are valued based upon the average of the closing public market price for the last three trading days up to and including the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security. Restricted and unrestricted publicly traded stocks may also be valued at a discount due to the investment size or

F-21

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

market liquidity concerns. Dividend income on equity securities is recorded when dividends are declared by the portfolio company.

  Commercial Mortgage-Backed Securities (“CMBS”)

      CMBS consists of purchased commercial mortgage-backed securities (“Purchased CMBS”), residual interest in a mortgage securitization (“Residual CMBS”) and residual interest spread.

  Purchased CMBS

      Purchased CMBS is carried at fair value. Fair value is based upon a discounted cash flow model which utilizes assumptions of prepayment and losses based upon historical experience, economic factors and the characteristics of the underlying cash flow. The Company’s assumption with regard to discount rate is based upon the yield of comparable securities. The Company recognizes income from the amortization of original issue discount using the effective interest method, using the anticipated yield over the projected life of the investment. Yields are revised when there are changes in estimates of future credit losses, actual losses incurred, and actual and estimated prepayment speeds. Changes in estimated yield are currently recognized as an adjustment to the estimated yield over the remaining life of the Purchased CMBS. The Company recognizes unrealized depreciation on its Purchased CMBS whenever it determines that the value of its Purchased CMBS is less than the cost basis. The Company generally purchases CMBS bonds with the intention of holding the bonds to their maturity. However, the Company will classify CMBS bonds as held for sale at the time that the Company determines that the bonds will be sold. The Company then recognizes unrealized appreciation or depreciation on its Purchased CMBS classified as held for sale based upon the price at which the CMBS bonds could be currently sold.

  Residual CMBS

      The Company values its residual interest in securitization and recognizes income using the same accounting policies used for the Purchased CMBS.

  Residual Interest Spread

      Residual interest spread is carried at fair value based on discounted estimated future cash flows. The Company recognizes income from the residual interest spread using the effective interest method. At each reporting date, the effective yield is recalculated and used to recognize income until the next reporting date.

  Net Realized and Unrealized Gains

      Realized gains or losses are measured by the difference between the net proceeds from the sale and the cost basis of the investment without regard to unrealized gains or losses previously recognized, and include investments charged off during the year, net of recoveries. Unrealized gains or losses reflect the change in portfolio investment values during the reporting period.

  Fee Income

      Fee income includes fees for diligence, structuring, loan syndication, consulting, management services and investment advisory services rendered by the Company to portfolio companies and other

F-22

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

third parties. Diligence, structuring and loan syndication fees are generally recognized as income when services are rendered or when the related transactions are completed. Consulting, management and investment advisory services fees are generally recognized as income as the services are rendered.

  Deferred Financing Costs

      Financing costs are based on actual costs incurred in obtaining financing and are deferred and amortized as part of interest expense over the term of the related debt instrument.

  Derivative Financial Instruments

      The Company may or may not use derivative financial instruments to reduce interest rate risk. The Company has established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. The Company does not hold or issue derivative financial instruments for trading purposes. All derivative financial instruments are recorded at fair value with changes in value reflected in net unrealized gains during the reporting period.

  Cash and Cash Equivalents

      Cash and cash equivalents include cash in banks and all highly liquid investments with original maturities of three months or less.

  Dividends to Shareholders

      Dividends to shareholders are recorded on the record date.

  Federal and State Income Taxes

      The Company intends to comply with the requirements of the Internal Revenue Code (“Code”) that are applicable to regulated investment companies (“RIC”) and real estate investment trusts (“REIT”). The Company and its wholly owned subsidiaries that qualify as a RIC or a REIT intend to annually distribute or retain through a deemed distribution all of their taxable income to shareholders; therefore, the Company has made no provision for income taxes for these entities. AC Corp. is a corporation subject to federal and state income taxes and will record a provision for income taxes on taxable income.

      With the exception of Advisers, the Predecessor Companies qualified as a RIC or a REIT; however, Advisers was a corporation subject to federal and state income taxes. Income tax expense reported on the consolidated statement of operations relates to the operations of Advisers for all periods presented.

  Per Share Information

      Basic earnings per share is calculated using the weighted average number of shares outstanding for the period presented. Diluted earnings per share reflects the potential dilution that could occur if options to issue common stock were exercised into common stock. Earnings per share is computed after subtracting dividends on preferred shares.

F-23

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

  Use of Estimates in The Preparation of Financial Statements

      The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Note 3. Portfolio

  Private Finance

      At September 30, 2001, December 31, 2000 and 1999, the private finance portfolio consisted of the following:

			2001												2000												1999
			Cost				Value				Yield				Cost				Value				Yield				Cost				Value				Yield
($ in thousands)
Loans and debt securities			$	1,133,817			$	1,095,555				14.5%			$	983,887			$	966,257				14.6%			$	578,570			$	559,746				14.2%
Equity interests				361,770				443,698								278,642				316,210								60,601				87,294
	Total		$	1,495,587			$	1,539,253							$	1,262,529			$	1,282,467							$	639,171			$	647,040

      Private finance investments are generally structured as loans and debt securities that carry a relatively high fixed rate of interest, which may be combined with equity features, such as conversion privileges, or warrants or options to purchase a portion of the portfolio company’s equity at a nominal price.

      Debt securities typically have a maturity of five to ten years, with interest-only payments in the early years and payments of both principal and interest in the later years, although debt maturities and principal amortization schedules vary.

      Equity interests consist primarily of securities issued by privately owned companies and may be subject to restrictions on their resale or may be otherwise illiquid. Equity securities generally do not produce a current return, but are held for investment appreciation and ultimate gain on sale.

      At September 30, 2001 and December 31, 2000, equity interests include the Company’s common stock and preferred stock investment in Business Loan Express, Inc. (“BLX”) of $120,015,000 and $25,111,000 and $104,504,000 and $25,111,000 at value, respectively. During the first quarter of 2001, BLX secured a 3-year $117.5 million unsecured revolving credit facility, which was increased to $124.0 million in October 2001. As the controlling shareholder of BLX, the Company has provided an unconditional guaranty to the BLX credit facility lenders in an amount up to 50% of the total obligations (consisting of principal, accrued interest and other fees) of BLX on the line of credit. The amount guaranteed by the Company at September 30, 2001 was $50,300,000. This guaranty can be called by the lenders only in the event of a default by BLX. BLX was in compliance with the terms of its credit facility at September 30, 2001. In consideration for providing this guaranty, BLX will pay the Company an annual guaranty fee of $2,938,000, which was increased to $3,100,000 effective October 2001.

F-24

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      At September 30, 2001, December 31, 2000 and 1999, approximately 97%, 98% and 98% of the Company’s private finance loan portfolio was composed of fixed interest rate loans, respectively. At September 30, 2001, December 31, 2000 and 1999, loans and debt securities with a value of $60,092,000, $72,966,000 and $34,560,000, respectively, were not accruing interest. Loans greater than 120 days delinquent generally do not accrue interest.

      The geographic and industry compositions of the private finance portfolio at value at September 30, 2001, December 31, 2000 and 1999 were as follows:

			2001				2000				1999
Geographic Region
Mid-Atlantic				41	%			43	%			23	%
West				18				17				11
Midwest				17				18				26
Southeast				14				12				27
Northeast				8				8				9
International				2				2				4
	Total			100	%			100	%			100	%
Industry
Consumer Products				28	%			26	%			19	%
Business Services				21				24				32
Financial Services				15				16				—
Industrial Products				10				9				12
Broadcasting & Cable				5				5				11
Education				5				3				5
Retail				4				5				8
Telecommunications				4				6				5
Other				8				6				8
	Total			100	%			100	%			100	%

  Commercial Real Estate Finance

      At September 30, 2001, December 31, 2000 and 1999, the commercial real estate finance portfolio consisted of the following:

			2001												2000												1999
			Cost				Value				Yield				Cost				Value				Yield				Cost				Value				Yield
($ in thousands)
Loans			$	82,789			$	86,198				8.0%			$	102,957			$	106,413				9.1%			$	153,767			$	154,109				9.4%
CMBS				546,788				546,488				14.4%				392,907				393,040				14.2%				360,950				359,450				13.5%
REO				3,562				2,434								7,502				6,081								7,305				6,470
	Total		$	633,139			$	635,120							$	503,366			$	505,534							$	522,022			$	520,029

  Loans

      The commercial mortgage loan portfolio contains loans that were originated by the Company or were purchased from third-party sellers.

F-25

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      At September 30, 2001, December 31, 2000 and 1999, approximately 77% and 23%, 69% and 31%, and 81% and 19% of the Company’s commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. As of September 30, 2001, December 31, 2000 and 1999, loans with a value of $12,929,000, $14,433,000 and $8,334,000, respectively, were not accruing interest. Loans greater than 120 days delinquent generally do not accrue interest.

      In December 2000, the Company purchased commercial mortgage loans with a face amount of $6.5 million for $5.5 million from Business Mortgage Investors, Inc., a company managed by ACC.

      The geographic composition and the property types securing the commercial mortgage loan portfolio at value at September 30, 2001, December 31, 2000 and 1999 were as follows:

			2001				2000				1999
Geographic Region
Southeast				42	%			39	%			31	%
Mid-Atlantic				22				22				32
West				16				20				25
Midwest				15				14				9
Northeast				5				5				3
	Total			100	%			100	%			100	%
Property Type
Office				32	%			30	%			24	%
Hospitality				30				28				42
Retail				19				19				11
Recreation				4				9				8
Other				15				14				15
	Total			100	%			100	%			100	%

  CMBS

      At September 30, 2001, December 31, 2000 and 1999, the CMBS portfolio consisted of the following:

			2001								2000								1999
			Cost				Value				Cost				Value				Cost				Value
(in thousands)
Purchased CMBS			$	472,113			$	472,113			$	310,887			$	311,320			$	277,694			$	277,694
Residual CMBS				72,850				72,850				78,723				78,723				76,374				76,374
Residual interest spread				1,825				1,525				3,297				2,997				6,882				5,382
	Total		$	546,788			$	546,488			$	392,907			$	393,040			$	360,950			$	359,450

      Purchased CMBS The Company has Purchased CMBS bonds with a face amount of $982,411,000 and a cost of $472,113,000, with the difference representing original issue discount. As of September 30, 2001, December 31, 2000 and 1999, the estimated yield to maturity on the Purchased CMBS was approximately 15.2%, 15.4% and 14.6%, respectively. The Company’s yield on its Purchased CMBS is based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples include the timing and magnitude of credit

F-26

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

losses on the mortgage loans underlying the Purchased CMBS that are a result of the general condition of the real estate market (including competition for tenants and their related credit quality) and changes in market rental rates. At September 30, 2001, December 31, 2000 and 1999, the yield on the Purchased CMBS portfolio was computed assuming a 1% loss estimate for its entire underlying collateral mortgage pool. As these uncertainties and contingencies are difficult to predict and are subject to future events which may alter these assumptions, no assurance can be given that the anticipated yields to maturity will be achieved.

      The non-investment grade and unrated tranches of the Purchased CMBS bonds are junior in priority for payment of principal to the more senior tranches of the related commercial securitization. Cash flow from the underlying mortgages generally is allocated first to the senior tranches, with the most senior tranches having a priority right to the cash flow. Then, any remaining cash flow is allocated, generally, among the other tranches in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages resulting in reduced cash flows, the subordinate tranche will bear this loss first.

      The underlying rating classes of the Purchased CMBS at September 30, 2001, December 31, 2000 and 1999 were as follows:

			2001								2000								1999
							Percentage								Percentage								Percentage
			Value				of Total				Value				of Total				Value				of Total
($ in thousands)
BB+			$	—				—	%		$	—				—	%		$	—				—	%
BB				38,705				8.2				8,472				2.7				41,091				14.8
BB-				56,519				12.0				37,061				11.9				46,692				16.8
B+				86,889				18.4				59,827				19.3				41,765				15.0
B				119,920				25.4				89,999				28.9				64,830				23.4
B-				67,538				14.3				56,665				18.2				40,995				14.8
CCC				8,863				1.9				7,857				2.5				6,506				2.3
Unrated				93,679				19.8				51,439				16.5				35,815				12.9
	Total		$	472,113				100.0	%		$	311,320				100.0	%		$	277,694				100.0	%

      Residual CMBS and Residual Interest Spread. The Residual CMBS primarily consists of a retained interest from a post-Merger asset securitization whereby bonds were sold in three classes rated “AAA,” “AA” and “A.”

      The Company sold $295 million of loans, and received cash proceeds, net of costs, of approximately $223 million. The Company retained a trust certificate for its residual interest in the loan pool sold, and will receive interest income from this Residual CMBS as well as the Residual Interest Spread from the interest earned on the loans sold less the interest paid on the bonds over the life of the bonds.

      As a result of this securitization, the Company recorded a gain of $14.8 million, which represents the difference between the cost basis of the assets sold and the fair value of the assets received, net of the costs of the securitization and the cost of settlement of interest rate swaps. As of September 30, 2001, December 31, 2000 and 1999, the mortgage loan pool had an approximate weighted average stated interest rate of 9.3%. The three bond classes sold had an aggregate weighted average interest rate of 6.6% as of September 30, 2001, and 6.5% as of December 31, 2000 and 1999.

F-27

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company uses a discounted cash flow methodology for determining the value of its retained Residual CMBS and Residual Interest Spread (“Residual”). In determining the cash flow of the Residual, the Company assumes a prepayment speed of 15% after the applicable prepayment lockout period and credit losses of 1% of the total principal balance of the underlying collateral throughout the life of the collateral. The value of the resulting Residual cash flows is then determined by applying a discount rate of 9% which, in the Company’s view, is commensurate with the market’s perception of risk of comparable assets.

      The geographic composition and the property types of the underlying mortgage loan pools securing the CMBS calculated using the underwritten principal balance at September 30, 2001, December 31, 2000 and 1999 were as follows:

			2001				2000				1999
Geographic Region
West				31	%			31	%			32	%
Mid-Atlantic				24				23				23
Midwest				21				22				21
Southeast				18				19				20
Northeast				6				5				4
	Total			100	%			100	%			100	%
Property Type
Retail				33	%			32	%			33	%
Housing				27				30				29
Office				25				21				20
Hospitality				7				8				9
Other				8				9				9
	Total			100	%			100	%			100	%

     Small Business Finance

      The Company, through its wholly owned subsidiary, Allied SBLC, participated in the SBA’s Section 7(a) Guaranteed Loan Program (“7(a) loans”). As discussed in Note 1, Allied SBLC was no longer a consolidated subsidiary of the Company as of December 31, 2000. As a result, the Company’s small business portfolio had no balance at and after December 31, 2000.

      At December 31, 1999, the small business finance portfolio consisted of the following:

			1999
			Cost				Value
(in thousands)
7(a) loans			$	43,246			$	43,000
Residual interest in loans sold				4,036				4,036
Residual interest spread				14,046				14,046
REO				380				346
	Total		$	61,708			$	61,428

F-28

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Pursuant to Section 7(a) of the Small Business Act of 1958, the 7(a) loans were guaranteed by the SBA for 80% of any qualified loan up to $100,000 regardless of maturity, and 75% of any such loan over $100,000 regardless of maturity, to a maximum guarantee of $750,000 for any one borrower.

      The Company charged interest on the 7(a) loans at a variable rate, typically 1.75% to 2.75% above the prime rate, as published in The Wall Street Journal or other financial newspaper, adjusted monthly.

      As permitted by SBA regulations, the Company sold to investors, without recourse, 100% of the guaranteed portion of its 7(a) loans while retaining the right to service 100% of such loans. Additionally, the Company sold up to a 90% interest in the unguaranteed portion of its 7(a) loans through a structured finance agreement with a commercial paper conduit.

      In 1999, the Company sold $36,387,000 of the unguaranteed portion of 7(a) loans into the facility. The Company received $35,500,000 in proceeds and retained a subordinated interest valued at $4,036,000. The Company recognized a premium from the loan sale of $4,106,000, which includes the value of the retained residual interest spread.

Note 4. Debt

      At September 30, 2001, December 31, 2000 and 1999, the Company had the following debt:

				2001								2000								1999
				Facility				Amount				Facility				Amount				Facility				Amount
				Amount				Drawn				Amount				Drawn				Amount				Drawn
(in thousands)
Notes payable and debentures:
	Unsecured long-term notes			$	544,000			$	544,000			$	544,000			$	544,000			$	419,000			$	419,000
	SBA debentures				101,800				87,000				87,350				78,350				74,650				62,650
	Auction rate reset note				80,784				80,784				76,598				76,598				—				—
	OPIC loan				5,700				5,700				5,700				5,700				5,700				5,700
		Total notes payable and debentures			732,284				717,484				713,648				704,648				499,350				487,350
Revolving credit facilities:
	Revolving line of credit				467,500				207,000				417,500				82,000				340,000				82,000
	Master loan and security agreement				—				—				—				—				100,000				23,500
		Total revolving credit facilities			467,500				207,000				417,500				82,000				440,000				105,500
	Total			$	1,199,784			$	924,484			$	1,131,148			$	786,648			$	939,350			$	592,850

  Notes Payable and Debentures

      Unsecured Long-Term Notes. In June 1998, May 1999, November 1999 and October 2000, the Company issued unsecured long-term notes to private institutional investors. The notes require semi-annual interest payments until maturity and have terms of five or seven years. The weighted average interest rate on the notes was 7.8%, 7.8% and 7.6% at September 30, 2001, December 31, 2000 and

F-29

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

1999, respectively. The notes may be prepaid in whole or in part together with an interest premium, as stipulated in the note agreement.

      On October 30, 2001, the Company issued $150 million of five-year unsecured long-term debt, financed primarily by insurance companies. The five-year notes were priced at 7.16% and have substantially the same terms as the Company’s existing unsecured long-term notes.

      SBA Debentures. At September 30, 2001, December 31, 2000 and 1999, the Company had debentures payable to the SBA with terms of ten years and at fixed interest rates ranging from 5.9% to 8.2%. The weighted average interest rate was 7.1%, 7.6% and 7.8% at September 30, 2001, December 31, 2000 and 1999, respectively. The debentures require semi-annual interest-only payments with all principal due upon maturity. The SBA debentures are subject to prepayment penalties if paid prior to maturity.

      Auction Rate Reset Note. The Company has an $80,784,000 Auction Rate Reset Senior Note Series A that matures on December 2, 2002 and bears interest at the three-month London Interbank Offer Rate (“LIBOR”) plus 1.75%, which adjusts quarterly. Interest is due quarterly and the Company, at its option, may pay or defer and capitalize such interest payments. The amount outstanding on the note will increase as interest due is deferred and capitalized.

      As a means to repay the note, the Company has entered into an agreement to issue $80,784,000 of debt, equity or other securities in one or more public or private transactions, or prepay the Auction Rate Reset Note, on or before August 31, 2002. If the note is prepaid, the Company will pay a fee equal to 0.5% of the aggregate amount of the note outstanding.

      Scheduled future maturities of notes payable and debentures at September 30, 2001 are as follows:

Year			Amount Maturing
			(in thousands)
2001			$	—
2002				80,784
2003				140,000
2004				221,000
2005				179,000
Thereafter				96,700
	Total		$	717,484

  Revolving Credit Facilities

      Revolving Line of Credit. The Company has an unsecured revolving line of credit for $467,500,000. The facility may be expanded up to $600,000,000. At the Company’s option, the facility bears interest at a rate equal to (i) the one-month LIBOR plus 1.25% or (ii) the higher of (a) the Bank of America, N.A. prime rate or (b) the Federal Funds rate plus 0.50%. The interest rate adjusts at the beginning of each new interest period, usually every thirty days. The interest rates were 4.5%, 7.9% and 7.7% at September 30, 2001, December 31, 2000 and December 31, 1999, respectively, and the facility requires an annual commitment fee equal to 0.25% of the committed

F-30

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

amount. The line expires in August 2003, and may be extended under substantially similar terms for one additional year at the Company’s sole option. The line of credit requires monthly interest payments and all principal is due upon its expiration.

      Master Loan and Security Agreement.  The Company had a facility to borrow up to $100,000,000, using certain commercial mortgage loans as collateral. The agreement charged interest at the one-month LIBOR plus 1.0%, adjusted daily, or 6.8% at December 31, 1999. The agreement matured on October 27, 2000 and was not renewed.

      The average debt outstanding on the revolving credit facilities was $108,143,000, $154,853,000 and $123,860,000 for the nine months ended September 30, 2001 and for the years ended December 31, 2000 and 1999, respectively. The maximum amount borrowed under these facilities and the weighted average interest rate for the nine months ended September 30, 2001 and for the years ended December 31, 2000 and 1999, were $213,500,000, $257,000,000 and $199,392,000, and 5.9%, 7.6% and 6.5%, respectively.

Note 5. Income Taxes

      For the year ended December 31, 1998, the Company incurred income tax expense of $787,000, which resulted from the realization of a taxable net built-in gain associated with property owned by Advisers prior to the Merger. Therefore, the Company’s effective tax rate was 1.0% for the year ended December 31, 1998.

Note 6. Preferred Stock

      Allied Investment has outstanding a total of 60,000 shares of $100 par value, 3% cumulative preferred stock and 10,000 shares of $100 par value, 4% redeemable cumulative preferred stock issued to the SBA pursuant to Section 303(c) of the Small Business Investment Act of 1958, as amended. The 3% cumulative preferred stock does not have a required redemption date. Allied Investment has the option to redeem in whole or in part the preferred stock by paying the SBA the par value of such securities and any dividends accumulated and unpaid to the date of redemption. The 4% redeemable cumulative preferred stock has a required redemption date in June 2005.

Note 7. Shareholders’ Equity

      Sales of common stock for the nine months ended September 30, 2001, and the years ended December 31, 2000 and 1999 were as follows:

			2001				2000				1999
(in thousands)
Number of common shares				11,010				14,812				8,659
Gross proceeds			$	249,639			$	263,460			$	172,539
Less costs including underwriting fees				(12,602	)			(12,548	)			(8,270	)
	Net proceeds		$	237,037			$	250,912			$	164,269

      In addition, the Company issued 4,123,407 shares of common stock to acquire BLC Financial Services, Inc. in a stock-for-stock exchange on December 31, 2000 for proceeds of $86,076,000.

F-31

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company has a dividend reinvestment plan, whereby the Company may buy shares of its common stock in the open market or issue new shares in order to satisfy dividend reinvestment requests. If the Company issues new shares, the issue price is equal to the average of the closing sale prices reported for the Company’s common stock for the five consecutive days immediately prior to the dividend payment date.

      Dividend reinvestment plan activity for the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999 and 1998 was as follows:

		2001				2000				1999				1998
(in thousands, except per share amounts)
Shares issued			214				254				233				241
Average price per share		$	22.80			$	18.79			$	19.43			$	20.35

Note 8. Earnings Per Common Share

      Earnings per common share for the nine months ended September 30, 2001 and 2000 and for the years ended December 31, 2000, 1999 and 1998 were as follows:

		For the Nine Months
		Ended September 30,
		2001				2000				2000				1999				1998
(in thousands except per share amounts)
Net increase in net assets resulting from operations		$	157,837			$	100,820			$	143,101			$	98,570			$	78,078
Less preferred stock dividends			(165	)			(165	)			(230	)			(230	)			(230	)
Income available to common shareholders		$	157,672			$	100,655			$	142,871			$	98,340			$	77,848
Basic shares outstanding			89,282				70,604				73,165				59,877				51,941
Dilutive options outstanding to officers			1,582				173				307				167				33
Diluted shares outstanding			90,864				70,777				73,472				60,044				51,974
Basic earnings per common share		$	1.77			$	1.43			$	1.95			$	1.64			$	1.50
Diluted earnings per common share		$	1.74			$	1.42			$	1.94			$	1.64			$	1.50

Note 9.	Employee Stock Ownership Plan, 401(k) Plan and Deferred Compensation Plan

      The Company had an employee stock ownership plan (“ESOP”) through 1999. Pursuant to the ESOP, the Company was obligated to contribute 5% of each eligible participant’s total cash compensation for the year to a plan account on the participant’s behalf, which vested over a two-year period. ESOP contributions were used to purchase shares of the Company’s common stock.

      As of December 31, 1999 and 1998, the ESOP held 303,210 shares and 282,500 shares, respectively, of the Company’s common stock, all of which had been allocated to participants’ accounts. The plan was funded annually and the total ESOP contribution expense for the years ended December 31, 1999 and 1998 was $641,000 and $489,000, respectively, net of forfeitures of $4,100 and $4,000, respectively. In 1999, the Company established a 401(k) Plan (see below) and elected to terminate the ESOP Plan. During 2000, the ESOP assets were transferred into the 401(k) Plan.

F-32

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 9.	Employee Stock Ownership Plan, 401(k) Plan and Deferred Compensation Plan, continued

      The Company’s 401(k) Plan is open to all of its employees. The employees may elect voluntary wage deferrals ranging from 0% to 20% of eligible compensation for the year. In 2000, the Company began making contributions to the 401(k) Plan equal to 5% of each eligible participant’s cash compensation as defined by the Plan for the year. Total 401(k) contribution expense for the year ended December 31, 2000 was $590,000.

      The Company also has a deferred compensation plan. Eligible participants in the deferred compensation plan may elect to defer some of their compensation and have such compensation credited to a participant account. All amounts credited to a participant’s account shall be credited solely for purposes of accounting and computation and remain assets of the Company and subject to the claims of the Company’s general creditors. Amounts credited to participants under the deferred compensation plan are at all times 100% vested and non-forfeitable. A participant’s account shall become distributable upon his or her separation from service, retirement, disability, death or at a future determined date. All deferred compensation plan accounts will be distributed in the event of a change of control of the Company or in the event of the Company’s insolvency. Amounts deferred by participants under the deferred compensation plan are funded to a trust which is administered by a Company-appointed trustee.

Note 10. Stock Option Plan

  The Option Plan

      The purpose of the stock option plan (“Option Plan”) is to provide officers and non-officer directors of the Company with additional incentives.

      On May 9, 2000, the Company’s stockholders amended the Option Plan to increase the number of shares that may be granted from 6,250,000 to 12,350,000.

      Options are exercisable at a price equal to the fair market value of the shares on the day the option is granted. Each option states the period or periods of time within which the option may be exercised by the optionee, which may not exceed ten years from the date the option is granted.

      All rights to exercise options terminate 60 days after an optionee ceases to be (i) a non-officer director, (ii) both an officer and a director, if such optionee serves in both capacities, or (iii) an officer (if such officer is not also a director) of the Company for any cause other than death or total and permanent disability. In the event of a change of control of the Company, all outstanding options will become fully vested and exercisable as of the change of control.

F-33

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Information with respect to options granted, exercised and forfeited under the Option Plan for the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999 and 1998 is as follows:

						Weighted
						Average
						Option
						Price
		Shares				Per Share
(in thousands, except per share amounts)
Options outstanding at January 1, 1998			—			$	—
Granted			5,190				20.16
Exercised			(10	)			21.38
Forfeited			(66	)			21.38
Options outstanding at December 31, 1998			5,114			$	20.14
Granted			1,288				19.75
Exercised			(318	)			19.07
Forfeited			(195	)			20.00
Options outstanding at December 31, 1999			5,889			$	20.12
Granted			4,162				17.02
Exercised			(195	)			17.68
Forfeited			(950	)			19.81
Options outstanding at December 31, 2000			8,906			$	18.76
Granted			2,800				21.82
Exercised			(405	)			19.02
Forfeited			(508	)			17.61
Options outstanding at September 30, 2001			10,793			$	19.60

  Notes Receivable from the Sale of Common Stock

      The Company provides loans to officers for the exercise of options. The loans have varying terms not exceeding ten years, bear interest at the applicable federal interest rate in effect at the date of issue and have been recorded as a reduction to shareholders’ equity. As of September 30, 2001 and December 31, 2000, 1999 and 1998, the Company had outstanding loans to officers of $26,250,000, $25,083,000, $29,461,000, and $23,735,000, respectively. Officers with outstanding loans repaid principal of $3,293,000, $6,363,000, $195,000, and $5,591,000, for the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999 and 1998, respectively. The Company recognized interest income from these loans of $1,144,000, $1,712,000, $1,539,000 and $1,600,000, respectively, during these same periods.

F-34

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table summarizes information about stock options outstanding at September 30, 2001:

						Weighted
						Average				Weighted								Weighted
		Total				Remaining				Average				Total				Average
Range of		Number				Contractual Life				Exercise				Number				Exercise
Exercise Prices		Outstanding				(years)				Price				Exercisable				Price
(in thousands, except per share amounts and years)
$16.81			3,436				8.65			$	16.81				1,113			$	16.81
$17.50-$19.94			1,669				7.91			$	18.33				451			$	18.16
$21.38			2,445				6.27			$	21.38				1,652			$	21.38
$21.59			2,251				9.97			$	21.59				—			$	—
$21.88-$24.06			992				8.77			$	22.46				318			$	22.20
$16.81-$24.06			10,793				8.28			$	19.60				3,534			$	19.60

      The following table summarizes information about stock options outstanding at December 31, 2000:

						Weighted
						Average				Weighted								Weighted
		Total				Remaining				Average				Total				Average
Range of		Number				Contractual Life				Exercise				Number				Exercise
Exercise Prices		Outstanding				(years)				Price				Exercisable				Price
(in thousands, except per share amounts and years)
$15.19			100				7.73			$	15.19				25			$	15.19
$16.81			3,733				9.40			$	16.81				—			$	—
$17.50-$19.88			1,824				8.59			$	18.18				558			$	17.95
$19.94			105				8.84			$	19.34				35			$	19.94
$21.38-$22.13			3,144				7.25			$	21.47				1,609			$	21.47
$15.19-$22.13			8,906				8.45			$	18.76				2,227			$	20.49

      The Company accounts for its stock options as required by the Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” and accordingly no compensation cost has been recognized as the exercise price equals the market price on the date of grant. Had compensation cost for the plan been determined consistent with SFAS No. 123 “Accounting for Stock Based Compensation,” which records options at fair value on the date of issuance and amortizes that amount over the vesting period of the option, the Company’s net increase in net assets

F-35

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

resulting from operations and basic and diluted earnings per common share would have been reduced to the following pro forma amounts:

			2000				1999				1998
(in thousands, except per share amounts)
Net increase in net assets resulting from operations:
	As reported		$	143,101			$	98,570			$	78,078
	Pro forma		$	137,716			$	94,510			$	72,684
Basic earnings per common share:
	As reported			$1.95				$1.64				$1.50
	Pro forma			$1.88				$1.58				$1.39
Diluted earnings per common share:
	As reported			$1.94				$1.64				$1.50
	Pro forma			$1.87				$1.57				$1.39

      Pro forma expenses are based on the underlying value of the options granted by the Company. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model, with the following weighted average assumptions for grants: risk-free interest rate of 6.5%, 5.9% and 5.0% for 2000, 1999 and 1998, respectively; expected life of approximately five years for all options granted; expected volatility of 34%, 37% and 35% for 2000, 1999 and 1998, respectively; and dividend yield of 8.7%, 9.0% and 8.0% for 2000, 1999 and 1998, respectively.

Note 11. Cut-off Award and Formula Award

      The Predecessor Companies’ existing stock option plans were canceled and the Company established a cut-off dollar amount for all existing, but unvested options as of the date of the Merger (the “Cut-off Award”). The Cut-off Award was computed for each unvested option as of the Merger date. The Cut-off Award was equal to the difference between the market price on August 14, 1997 (the Merger announcement date) of the shares of stock underlying the option less the exercise price of the option. The Cut-off Award was payable for each unvested option upon the future vesting date of that option. The Cut-off Award was designed to cap the appreciated value in unvested options at the Merger announcement date, in order to set the foundation to balance option awards upon the Merger. The Cut-off Award approximated $2.9 million in the aggregate and has been expensed as the Cut-off Award vests. For the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999 and 1998, $91,000, $535,000, $532,000, and $807,000, respectively, of the Cut-off Award vested.

      The Formula Award was established to compensate employees from the point when their unvested options would cease to appreciate in value (the Merger announcement date), up until the time at which they would be able to receive option awards in ACC post-merger. In the aggregate, the Formula Award equaled 6% of the difference between an amount equal to the combined aggregated market capitalizations of the Predecessor Companies as of the close of the market on the day before the Merger date (December 30, 1997), less an amount equal to the combined aggregate market capitalizations of Allied Lending and the Predecessor Companies as of the close of the market on the Merger announcement date. Advisers’ compensation committee allocated the Formula Award to individual officers on December 30, 1997. The amount of the Formula Award as computed at December 30, 1997 was $18,994,000. This amount was contributed to the Company’s deferred compensation trust under the deferred compensation plan (see Note 9) and was used to purchase

F-36

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

shares of the Company’s stock (included in common stock held in deferred compensation trust). The Formula Award vested equally in three installments on December 31, 1998, 1999 and 2000. The Formula Award has been expensed in each year in which it vested. For the years ended December 31, 2000, 1999 and 1998, $5,648,000, $6,221,000 and $6,241,000, respectively, was expensed as a result of the Formula Award. At December 31, 2000 and 1999, the liability related to the Formula Award was $5,648,000 and $6,221,000, respectively, and has been included in common stock held in deferred compensation trust. Vested Formula Awards have been distributed to recipients by the Company, however, sale of the Company’s stock by the recipients is restricted. Unvested Formula Awards were forfeited upon a recipient’s separation from service and the related Company stock was retired. During 2000, 1999 and 1998, $563,000, $61,000 and $270,000, respectively, of the Formula Award was forfeited.

      The Cut-off Award and the Formula Award are included in employee expenses in the Company’s consolidated statement of operations.

Note 12. Dividends and Distributions

      The Company’s Board of Directors declared and the Company paid a $1.50 per common share dividend or $135,702,000 for the nine months ended September 30, 2001.

      For the years ended December 31, 2000, 1999 and 1998, the Company declared the following distributions:

		2000								1999								1998
		Total				Total Per				Total				Total Per				Total				Total Per
		Amount				Share				Amount				Share				Amount				Share
(in thousands, except per share amounts)
First quarter		$	30,715			$	0.45			$	23,286			$	0.40			$	18,025			$	0.35
Second quarter			33,150				0.45				23,746				0.40				17,966				0.35
Third quarter			34,751				0.46				24,768				0.40				17,976				0.35
Fourth quarter			37,179				0.46				26,141				0.40				19,444				0.35
Annual extra distribution			—				—				—				—				1,676				0.03
Total distributions to common shareholders		$	135,795			$	1.82			$	97,941			$	1.60			$	75,087			$	1.43

      For income tax purposes, distributions for 2000, 1999 and 1998 were composed of the following:

		2000								1999								1998
						Total								Total								Total
		Total				Per				Total				Per				Total				Per
		Amount				Share				Amount				Share				Amount				Share
(in thousands, except per share amounts)
Ordinary income		$	116,321			$	1.56			$	76,948			$	1.26			$	49,397			$	0.94
Long-term capital gains			19,474				0.26				20,993				0.34				25,690				0.49
Total distributions to common shareholders		$	135,795			$	1.82			$	97,941			$	1.60			$	75,087			$	1.43

F-37

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following table summarizes the differences between financial statement net income and taxable income for the years ended December 31, 2000, 1999 and 1998:

				2000				1999				1998
(in thousands)
Financial statement net income				$	143,101			$	98,570			$	78,078
Adjustments:
	Net unrealized gains				(14,861	)			(2,138	)			(1,079	)
	Amortization of discount				233				129				2,207
	Post-Merger gain on securitization of commercial mortgage loans				—				—				(14,812	)
	Interest income from securitized commercial mortgage loans				3,149				4,640				4,910
	Gains from disposition of portfolio assets				5,202				(4,547	)			1,177
	Expenses not deductible for tax:
		Formula award			1,374				2,158				6,242
		Other			1,197				1,053				1,393
	Other				(1,012	)			(1,492	)			(3,816	)
	Income tax expense				—				—				787
Taxable income				$	138,383			$	98,373			$	75,087

      The Company must distribute at least 90% of its ordinary taxable income to qualify for pass through tax treatment and maintain its RIC status.

Note 13. Concentrations of Credit Risk

      The Company places its cash with financial institutions and, at times, cash held in checking accounts in financial institutions may be in excess of the Federal Deposit Insurance Corporation insured limit. At September 30, 2001, December 31, 2000 and 1999, cash and cash equivalents consisted of the following:

							December 31,
			September 30,
			2001				2000				1999
(in thousands)
Cash and cash equivalents			$	11,363			$	11,337			$	24,419
Less escrows held				(8,223	)			(8,888	)			(6,264	)
	Total cash and cash equivalents		$	3,140			$	2,449			$	18,155

Note 14. Supplemental Disclosure of Cash Flow Information

      For the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999 and 1998, the Company paid $38,867,000, $54,112,000, $21,092,000, and $21,708,000, respectively, for interest and income taxes. For the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999, and 1998, the Company’s non-cash investing activities totaled $4,459,000, $88,062,000, $19,320,000, and $1,265,000, respectively. For the nine months ended September 30, 2001 and for the years ended December 31, 2000, 1999, and 1998, the Company’s

F-38

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

non-cash financing activities totaled $9,338,000, $92,835,000, $10,241,000, and $6,237,000, respectively, and includes common stock issuance resulting from stock option exercises and dividend reinvestment shares issued. The Company’s non-cash investing and financing activities for the year ended December 31, 2000 includes the issuance of $86.1 million of the Company’s common stock to acquire BLC Financial Services, Inc. as discussed in Note 1.

Note 15. Selected Quarterly Data (Unaudited)

		2000
		Qtr 1				Qtr 2				Qtr 3				Qtr 4
(in thousands, except per share amounts)
Total interest and related portfolio income		$	43,897			$	49,965			$	55,992			$	61,735
Net operating income before net realized and unrealized gains		$	22,573			$	24,700			$	30,719			$	34,725
Net increase in net assets resulting from operations		$	29,581			$	34,790			$	36,449			$	42,281
Diluted net operating income per common share		$	0.34			$	0.35			$	0.40			$	0.43
Basic earnings per common share		$	0.45			$	0.50			$	0.48			$	0.52
Diluted earnings per common share		$	0.45			$	0.50			$	0.48			$	0.52

		1999
		Qtr 1				Qtr 2				Qtr 3				Qtr 4
Total interest and related portfolio income		$	27,678			$	33,186			$	37,998			$	42,278
Net operating income before net realized and unrealized gains		$	13,830			$	16,619			$	19,273			$	21,319
Net increase in net assets resulting from operations		$	18,580			$	22,121			$	26,944			$	30,925
Diluted net operating income per common share		$	0.24			$	0.28			$	0.31			$	0.34
Basic earnings per common share		$	0.33			$	0.38			$	0.44			$	0.49
Diluted earnings per common share		$	0.33			$	0.38			$	0.44			$	0.49

F-39

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATING BALANCE SHEET

				December 31, 2000
				Allied				Allied												Consolidated
				Capital				Investment				Others				Eliminations				Total
(in thousands)
ASSETS
Portfolio at value:
	Private finance			$	1,134,409			$	148,058			$	—			$	—			$	1,282,467
	Commercial real estate finance				408,113				4,605				92,816				—				505,534
	Small business finance				—				—				—				—				—
	Investments in subsidiaries				142,169				—				—				(142,169	)			—
		Total portfolio at value			1,684,691				152,663				92,816				(142,169	)			1,788,001
Cash and cash equivalents					41				802				1,606				—				2,449
Intercompany notes and receivables					29,444				225				798				(30,467	)			—
Other assets					57,891				5,285				191				—				63,367
		Total assets		$	1,772,067			$	158,975			$	95,411			$	(172,636	)		$	1,853,817
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Notes payable and debentures			$	626,298			$	78,350			$	—			$	—			$	704,648
	Revolving credit facilities				82,000				—				—				—				82,000
	Accounts payable and other liabilities				28,502				1,800				175				—				30,477
	Dividends and distributions payable				—				2,795				3,700				(6,495	)			—
	Intercompany notes and payables				5,575				1,651				16,746				(23,972	)			—
		Total liabilities			742,375				84,596				20,621				(30,467	)			817,125
Commitments and Contingencies
Preferred stock					—				7,000				—				—				7,000
Shareholders’ Equity:
	Common stock				9				—				1				(1	)			9
	Additional paid-in capital				1,043,653				43,873				72,254				(116,127	)			1,043,653
	Notes receivable from sale of common stock				(25,083	)			—				—				—				(25,083	)
	Net unrealized appreciation (depreciation) on portfolio				19,378				7,233				(1,720	)			(5,513	)			19,378
	Undistributed (distributions in excess of) earnings				(8,265	)			16,273				4,255				(20,528	)			(8,265	)
		Total shareholders’ equity			1,029,692				67,379				74,790				(142,169	)			1,029,692
		Total liabilities and shareholders’ equity		$	1,772,067			$	158,975			$	95,411			$	(172,636	)		$	1,853,817

The accompanying notes are an integral part of these consolidating financial statements.

F-40

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATING STATEMENT OF OPERATIONS

				For the Year Ended December 31, 2000
				Allied				Allied				Allied												Consolidated
				Capital				Investment				SBLC				Others				Eliminations				Total
(in thousands)
Interest and Related Portfolio Income
	Interest and dividends			$	155,790			$	15,248			$	4,958			$	6,311			$	—			$	182,307
	Intercompany interest				5,533				—				—				—				(5,533	)			—
	Premiums from loan dispositions				6,583				117				9,438				—				—				16,138
	Income from investments in wholly owned subsidiaries				26,147				—				—				—				(26,147	)			—
	Investment advisory fees and other income				10,166				103				1,915				960				—				13,144
		Total interest and related portfolio income			204,219				15,468				16,311				7,271				(31,680	)			211,589
Expenses
	Interest				51,043				6,369				—				—				—				57,412
	Intercompany interest				—				170				4,861				502				(5,533	)			—
	Employee				19,375				—				—				467				—				19,842
	Administrative				14,001				72				1,035				327				—				15,435
		Total operating expenses			84,419				6,611				5,896				1,296				(5,533	)			92,689
	Formula and cut-off awards				6,183				—				—				—				—				6,183
Net operating income before net realized and unrealized gains					113,617				8,857				10,415				5,975				(26,147	)			112,717
Net Realized and Unrealized Gains
	Net realized gains (losses)				14,623				1,585				(558	)			(127	)			—				15,523
	Net unrealized gains (losses)				14,861				5,178				(940	)			615				(4,853	)			14,861
		Total net realized and unrealized gains (losses)			29,484				6,763				(1,498	)			488				(4,853	)			30,384
Net increase in net assets resulting from operations				$	143,101			$	15,620			$	8,917			$	6,463			$	(31,000	)		$	143,101

The accompanying notes are an integral part of these consolidating financial statements.

F-41

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATING STATEMENT OF CASH FLOWS

					For the Year Ended December 31, 2000
					Allied				Allied				Allied												Consolidated
					Capital				Investment				SBLC				Others				Eliminations				Total
(in thousands)
Cash Flows from Operating Activities
	Net increase in net assets resulting from operations				$	143,101			$	15,620			$	8,917			$	6,463			$	(31,000	)		$	143,101
	Adjustments
		Net unrealized (gains) losses				(14,861	)			(5,178	)			940				(615	)			4,853				(14,861	)
		Depreciation and amortization				925				—				—				—				—				925
		Amortization of loan discounts and fees				(8,995	)			(737	)			(369	)			—				—				(10,101	)
		Changes in other assets and liabilities				442				(1,487	)			2,097				984				—				2,036
			Net cash provided by operating activities			120,612				8,218				11,585				6,832				(26,147	)			121,100
Cash Flows from Investing Activities
	Portfolio investments					(723,825	)			(32,384	)			(133,042	)			—				—				(889,251	)
	Repayments of investment principal					125,840				21,156				7,116				—				—				154,112
	Proceeds from loan sales					179,293				—				100,951				—				—				280,244
	Net change in intercompany investments					(10,791	)			(17,223	)			10,207				(8,340	)			26,147				—
	Other investing activities					(2,488	)			2,194				927				784				—				1,417
			Net cash used in investing activities			(431,971	)			(26,257	)			(13,841	)			(7,556	)			26,147				(453,478	)
Cash Flows from Financing Activities
	Sale of common stock					250,912				—				—				—				—				250,912
	Collections of notes receivable from sale of common stock					6,363				—				—				—				—				6,363
	Common dividends and distributions paid					(131,022	)			—				—				—				—				(131,022	)
	Preferred stock dividends paid					—				(220	)			—				(10	)			—				(230	)
	Net borrowings under notes payable and debentures					201,598				15,700				—				—				—				217,298
	Net repayments under revolving lines of credit					(23,500	)			—				—				—				—				(23,500	)
	Other financing activities					(3,149	)			—				—				—				—				(3,149	)
			Net cash provided by (used in) financing activities			301,202				15,480				—				(10	)			—				316,672
Net decrease in cash and cash equivalents					$	(10,157	)		$	(2,559	)		$	(2,256	)		$	(734	)		$	—			$	(15,706	)
Cash and cash equivalents at beginning of year					$	10,198			$	3,361			$	2,256			$	2,340			$	—			$	18,155
Cash and cash equivalents at end of year					$	41			$	802			$	—			$	1,606			$	—			$	2,449

The accompanying notes are an integral part of these consolidating financial statements.

F-42

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders and Board of Directors of Allied Capital Corporation and Subsidiaries:

      We have audited the accompanying consolidated balance sheets of Allied Capital Corporation and subsidiaries as of December 31, 2000 and 1999, including the consolidated statement of investments as of December 31, 2000, and the related consolidated statements of operations, changes in net assets and cash flows for each of the three years in the period then ended. These consolidated financial statements and supplementary consolidating financial information referred to below are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and supplementary consolidating financial information referred to below based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. These procedures included physical counts of investments. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      As discussed in Note 2, the consolidated financial statements include investments valued at $1,788,001,000 as of December 31, 2000 and $1,228,497,000 as of December 31, 1999 (96 percent and 95 percent, respectively, of total assets) whose values have been estimated by the board of directors in the absence of readily ascertainable market values. We have reviewed the procedures used by the board of directors in arriving at its estimate of value of such investments and have inspected the underlying documentation, and in the circumstances we believe the procedures are reasonable and the documentation appropriate. However, because of the inherent uncertainty of valuation, the board of directors’ estimate of values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Allied Capital Corporation and subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations, changes in net assets and cash flows for each of the three years in the period then ended in conformity with accounting principles generally accepted in the United States.

      Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The supplementary consolidating balance sheet and related consolidating statements of operations and cash flows are presented for purposes of additional analysis and are not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic consolidated financial statements and in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

Vienna, Virginia
February 13, 2001

F-43

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Allied Capital Corporation

Statement of Additional Information

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        This Statement of Additional Information (“SAI”) is not a prospectus, and should be read in conjunction with the prospectus dated December 19, 2001 relating to this offering and the accompanying prospectus supplement, if any. You can obtain a copy of the prospectus by calling Allied Capital Corporation at 1-888-253-0512 and asking for Investor Relations. Terms not defined herein have the same meaning as given to them in the prospectus.

Table of Contents

			Page in the				Location
			Statement				of Related
			of Additional				Disclosure in
			Information				the Prospectus
General Information and History				B-2				1;14;41
Investment Objective and Policies				B-2				1;14;41
Management				B-2				60
	Compensation of Executive Officers and Directors			B-2				64
	Compensation of Directors			B-3				65
	Stock Option Awards			B-3				65
	Formula Award and Cut-Off Award			B-5				66
	Committees of the Board of Directors			B-5				N/A
Control Persons and Principal Holders of Securities				B-6				N/A
Investment Advisory Services				B-7				47;60
Safekeeping, Transfer and Dividend Paying Agent and Registrar				B-7				81
Brokerage Allocation and Other Practices				B-7				N/A

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B-1

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GENERAL INFORMATION AND HISTORY

      This SAI contains information with respect to Allied Capital Corporation (the “Company”). The Company changed its name from “Allied Capital Lending Corporation” to “Allied Capital Corporation,” effective upon the merger, which was consummated on December 31, 1997. The Company is a registered investment adviser. The Company was initially organized as a corporation in the District of Columbia in 1976 and was reincorporated in the state of Maryland in 1990.

INVESTMENT OBJECTIVE AND POLICIES

      The investment objective of the Company is to achieve current income and capital gains. The Company seeks to achieve its investment objective by providing investment capital to private companies and undervalued public companies in a variety of different industries and diverse geographic locations throughout the United States. We focus on investments in two areas: private finance and commercial real estate finance, primarily the purchase of commercial mortgage-backed securities (“CMBS”). Our investment portfolio consists primarily of long-term unsecured loans with equity features, commercial mortgage-backed securities, and commercial mortgage loans. At September 30, 2001, our investment portfolio totaled $2.2 billion. A discussion of the selected financial data, supplementary financial information and management’s discussion and analysis of financial condition and results of operations is included in the prospectus. In addition to its core lending business, the Company also provides advisory services to private investment funds.

MANAGEMENT

Compensation of Executive Officers and Directors

      Under Commission rules applicable to BDCs, we are required to set forth certain information regarding the compensation of certain executive officers and directors. The following table sets forth compensation paid by the Company in all capacities during the year ended December 31, 2000 to the directors and the three highest paid executive officers of the Company, collectively, the “Compensated Persons”.

Compensation Table

		Aggregate				Securities								Directors
		Compensation				Underlying				Pension or				Fees Paid
		from the				Options/				Retirement				by the
Name and Position		Company(1)				SARs(4)				Benefits				Company(5)
William L. Walton, Chairman and CEO(2)		$	2,582,916				755,500				—			$	0
Joan M. Sweeney, Managing Director(2)			1,438,699				285,000				—				0
John M. Scheurer, Managing Director(2)			1,002,463				125,000				—				0
Brooks H. Browne, Director			14,000				5,000				—				14,000
John D. Firestone, Director			19,500				5,000				—				19,500
Anthony T. Garcia, Director			12,000				5,000				—				12,000
Lawrence I. Hebert, Director			7,000				5,000				—				7,000
John I. Leahy, Director			23,000				5,000				—				23,000
Robert E. Long, Director			22,000				5,000				—				22,000
Warren K. Montouri, Director			16,000				5,000				—				16,000
Guy T. Steuart II, Director			14,000				5,000				—				14,000
T. Murray Toomey, Director			8,000				5,000				—				8,000

B-2

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Aggregate

Securities

Directors

Compensation

Underlying

Pension or

Fees Paid

from the

Options/

Retirement

by the

Name and Position

Company(1)

SARs(4)

Benefits

Company(5)

Laura W. van Roijen, Director

8,000

5,000

—

8,000

George C. Williams, Jr., Director and Chairman Emeritus(3)

735,352

—

—

17,000

(1)	There were no perquisites paid by the Company in excess of the lesser of $50,000 or 10% of the Compensated Person’s total salary and bonus for the year.
(2)	The following table provides detail as to aggregate compensation paid during 2000 as to the three highest paid executive officers of the Company:

										Vested
										Formula				Cut-Off				Other
		Salary				Bonus				Award				Award				Benefits
Mr. Walton		$	430,979			$	650,000			$	1,278,740			$	170,156			$	53,041
Ms. Sweeney			271,612				350,000				749,246				36,603				31,239
Mr. Scheurer			262,727				335,000				347,590				29,248				27,898

	Included for each executive officer in “Other Benefits” is a contribution to the 401(k) Plan, life insurance premiums and a contribution to the Deferred Compensation Plan. See also “—Employment Agreements” and “—Formula Award and Cut-Off Award”.

(3)	In addition to director’s fees, Mr. Williams received $144,000 in consulting fees, $52,373 in Cut-Off Award and $521,979 in vested Formula Award.
(4)	See “Stock Option Awards” for terms of options granted in 2000. The Company does not maintain a restricted stock plan or a long-term incentive plan.
(5)	Consists only of directors’ fees paid by the Company during 2000. Such fees are also included in the column titled “Aggregate Compensation from the Company.”

Compensation of Directors

      During 2000, each director received $1,000 for each Board of Directors or committee meeting attended, except with respect to the members of the Executive Committee, who each received an annual retainer of $10,000 in lieu of fees paid for each Executive Committee meeting attended.

      In May 2001, the Board of Directors voted to modify the directors’ fees to be paid, effective immediately. Each director who does not serve on the Executive Committee will receive a $10,000 annual retainer in lieu of per meeting fees; directors who serve on the Executive Committee will receive a $25,000 annual retainer in lieu of per meeting fees. Members of each committee other than the Executive Committee will receive $1,000 for each committee meeting attended during the year. In addition, the chairmen of the Audit and Compensation Committees each will receive a $3,000 annual retainer for their additional services in these capacities. The Chairman and CEO of the Company does not receive director’s fees.

      Non-officer directors are eligible for stock option awards under the Company’s Stock Option Plan pursuant to an exemptive order from the Commission. The terms of the order, which was granted in September 1999, provided for a one-time grant of 10,000 options to each non-officer director on the date that the order was issued, or on the date that any new director is elected to the Board. Thereafter, each non-officer director will receive 5,000 options each year on the date of the annual meeting of stockholders at the fair market value on the date of grant. See “Stock Option Plan.”

Stock Option Awards

      The following table sets forth the details relating to option grants in 2000 to Compensated Persons under the Company’s Stock Option Plan, and the potential realizable value of each grant, as prescribed to be calculated by the Commission. See “Stock Option Plan” in the Prospectus.

B-3

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Options Grants During 2000

																		Potential Realizable
																		Value at Assumed
		Number of																Annual Rates
		Securities				Percent of												Of Stock Appreciation
		Underlying				Total Options				Exercise								Over 10-Year Term(3)
		Options				Granted				Price Per				Expiration
Name		Granted(1)				In 2000(2)				Share				Date				5%				10%
William L. Walton			755,500				18.15	%		$	16.81				05/26/10			$	7,988,359			$	20,244,070
Joan M. Sweeney			285,000				6.85	%			16.81				05/26/10				3,013,477				7,636,744
John M. Scheurer			125,000				3.00	%			16.81				05/26/10				1,321,701				3,349,449
Brooks H. Browne			5,000				0.12	%			17.50				05/09/10				55,028				139,452
John D. Firestone			5,000				0.12	%			17.50				05/09/10				55,028				139,452
Anthony T. Garcia			5,000				0.12	%			17.50				05/09/10				55,028				139,452
Lawrence I. Hebert			5,000				0.12	%			17.50				05/09/10				55,028				139,452
John I. Leahy			5,000				0.12	%			17.50				05/09/10				55,028				139,452
Robert E. Long			5,000				0.12	%			17.50				05/09/10				55,028				139,452
Warren K. Montouri			5,000				0.12	%			17.50				05/09/10				55,028				139,452
Guy T. Steuart II			5,000				0.12	%			17.50				05/09/10				55,028				139,452
T. Murray Toomey			5,000				0.12	%			17.50				05/09/10				55,028				139,452
Laura W. van Roijen			5,000				0.12	%			17.50				05/09/10				55,028				139,452

(1)	Options granted to officers in 2000 generally vest in three equal installments beginning on the first anniversary date of the grant, with full vesting occurring on the third anniversary of the grant date or change of control of the Company. Options granted to non-officer directors vest immediately.
(2)	In 2000, the Company granted options to purchase a total of 4,162,112 shares.
(3)	Potential realizable value is calculated on 2000 options granted, and is net of the option exercise price but before any tax liabilities that may be incurred. These amounts represent certain assumed rates of appreciation, as mandated by the Commission. Actual gains, if any, or stock option exercises are dependent on the future performance of the shares, overall market conditions, and the continued employment by the Company of the option holder. The potential realizable value will not necessarily be realized.

     The following table sets forth the details of option exercises by Compensated Persons during 2000 and the values of those unexercised options at December 31, 2000.

Option Exercises and Year-End Option Values

										Number of Securities								Value of Unexercised In-the-
										Underlying Unexercised								Money Options
		Shares								Options As of 12/31/00								As of 12/31/00(2)
		Acquired on				Value
Name		Exercise				Realized(1)				Exercisable				Unexercisable				Exercisable				Unexercisable
William L. Walton			0				0				393,448				1,196,961			$	195,582			$	3,412,491
Joan M. Sweeney			0				0				212,310				522,476				161,162				1,397,480
John M. Scheurer			0				0				204,669				348,270				140,641				706,522
George C. Williams, Jr.			0				0				146,396				4,999				15,003				14,997
Brooks H. Browne			0				0				15,000				0				16,875				0
John D. Firestone			0				0				15,000				0				16,875				0
Anthony D. Garcia			0				0				15,000				0				16,875				0
Lawrence I. Hebert			0				0				15,000				0				16,875				0
John I. Leahy			0				0				15,000				0				16,875				0
Robert E. Long			0				0				15,000				0				16,875				0
Warren K. Montouri			0				0				15,000				0				16,875				0
Guy T. Steuart II			0				0				15,000				0				16,875				0
T. Murray Toomey			0				0				15,000				0				16,875				0
Laura W. van Roijen			0				0				15,000				0				16,875				0

(1)	Value realized is calculated as the closing market price on the date of exercise, net of option exercise price, but before any tax liabilities or transaction costs. This is the deemed market value, which may actually be realized only if the shares are sold at that price.
(2)	Value of unexercised options is calculated as the closing market price on December 31, 2000 ($20.88), net of the option exercise price, but before any tax liabilities or transaction costs. “In-the-Money Options” are options with an exercise price that is less than the market price as of December 31, 2000.

B-4

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Formula Award and Cut-Off Award

      Formula Award. The Formula Award was designed as an incentive compensation program that would replace stock options of the predecessor companies that were cancelled as a result of the Company’s 1997 merger, and would balance share ownership among key officers. The Company accrued the Formula Award over the three-year period on the anniversary of the merger date (December 31) in 1998, 1999 and 2000. The Formula Award expense for 2000 totaled $5.7 million. The terms of the Formula Award required that the award be contributed to the Company’s deferred compensation plan, and used to purchase shares of the Company in the open market. See “Deferred Compensation Plan.”

      Cut-Off Award. The Cut-Off Award was designed to cap the appreciated value in unvested options at the merger announcement date in order to set the foundation to balance option awards upon the merger on December 31, 1997. The Cut-Off Award is payable for each canceled option as the canceled options would have vested and vests automatically in the event of a change of control. The Cut-Off Award is payable if the award recipient is employed by the Company on the future vesting date. The Cut-Off Award expense for 2000 totaled $0.5 million.

Committees of the Board of Directors

      The Board of Directors of the Company has established an Executive Committee, an Audit Committee, a Compensation Committee and a Nominating Committee.

      The Executive Committee has and may exercise those rights, powers and authority that the Board of Directors from time to time grants to it, except where action by the full Board is required by statute, an order of the Securities and Exchange Commission (the “Commission”) or the Company’s charter or bylaws. The Executive Committee also reviews and approves all investments of $10 million or more. The Executive Committee met 34 times during 2000. The Executive Committee currently consists of Messrs. Walton, Leahy, Long, Hebert, Steuart, and Williams.

      The Audit Committee operates pursuant to a charter approved by the Board of Directors, a copy of which is incorporated by reference to this registration statement. The charter sets forth the responsibilities of the Audit Committee. Generally, the Audit Committee recommends the selection of independent public accountants for the Company, reviews with such independent public accountants the planning, scope and results of their audit of the Company’s financial statements and the fees for services performed, reviews with the independent public accountants the adequacy of internal control systems, reviews the Company’s annual financial statements and receives the Company’s audit reports and financial statements. The Audit Committee met six times during 2000. The Audit Committee currently consists of Messrs. Browne and Leahy and Ms. van Roijen, all of whom are considered independent under the rules promulgated by the New York Stock Exchange.

      The Compensation Committee determines the compensation for the Company’s executive officers and the amount of salary and bonus to be included in the compensation package for each of the Company’s officers and employees. In addition, the Compensation Committee approves stock option grants for the Company’s officers under the Company’s Stock Option Plan. The Compensation Committee met five times during 2000. The Compensation Committee currently consists of Messrs. Browne, Long, Firestone, and Garcia.

B-5

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      The Nominating Committee recommends candidates for election as directors to the Board of Directors. The Nominating Committee met once during 2000. The Nominating Committee currently consists of Messrs. Walton, Toomey, Browne and Williams.

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

      As of November 6, 2001, there were no persons that owned 25% or more of the Company’s outstanding voting securities, and no person would be deemed to control the Company, as such term is defined in the 1940 Act.

      The following table sets forth, as of November 6, 2001, each current director, the Chief Executive Officer, the Company’s executive officers, and the executive officers and directors as a group. The address for each director and executive officer is 1919 Pennsylvania Avenue, NW, Washington, DC 20006. Unless otherwise indicated, the Company believes that each beneficial owner set forth in the table has sole voting and investment power. The Company is not aware of any shareholder that beneficially owns more than 5% of the Company’s outstanding shares of common stock.

		Number of
		Shares
Name of		Owned				Percentage
Beneficial Owner		Beneficially				of Class(1)
Directors:
William L. Walton			1,456,563	(2,4,9)			1.5	%
Brooks H. Browne			63,561	(3)			*
John D. Firestone			49,713	(3,11)			*
Anthony T. Garcia			78,112	(3)			*
Lawrence I. Hebert			36,800	(3)			*
John I. Leahy			36,818	(3)			*
Robert E. Long			30,796	(3)			*
Warren K. Montouri			246,182	(3)			*
Guy T. Steuart II			338,180	(3,5)			*
T. Murray Toomey, Esq.			52,666	(3,6)			*
Laura W. van Roijen			53,311	(3,12)			*
George C. Williams, Jr.			434,350	(2)			*
Executive Officers:
Scott S. Binder			296,628	(2,10)			*
Samuel B. Guren			222,200	(2)			*
Philip A. McNeill			445,801	(2)			*
Penni F. Roll			151,981	(2)			*
John M. Scheurer			613,067	(2)			*
Joan M. Sweeney			667,654	(2)			*
Thomas H. Westbrook			344,168	(2,8)			*
G. Cabell Williams III			896,968	(2,4)			*
All directors and executive officers as a group (20 in number)			6,211,349	(7)			6.1	%

	(1)	Based on a total of 98,803,522 shares of the Company’s common stock issued and outstanding on November 6, 2001 and shares of the Company’s common stock issuable upon the exercise of immediately exercisable stock options held by each individual executive officer and non-officer director.

B-6

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	(2)	Share ownership for the following directors and executive officers includes:

						Options Exercisable				Allocated
		Owned				Within 60 Days of				to 401(k)
		Directly				November 6, 2001				Plan Account
William L. Walton			414,057				792,109				1,513
Scott S. Binder			68,815				226,417				1,396
Samuel B. Guren			2,500				219,700				0
Philip A. McNeill			191,706				243,529				10,566
Penni F. Roll			53,269				94,221				4,491
John M. Scheurer			277,936				309,125				26,006
Joan M. Sweeney			272,075				384,175				11,404
Thomas H. Westbrook			190,041				154,127				0
George C. Williams, Jr.			286,287				148,063				0
G. Cabell Williams, III			438,284				208,317				89,713

	(3)	Beneficial ownership includes exercisable options to purchase 20,000 shares, except Mr. Toomey who has 15,000 shares and Mr. Montouri who has 15,000 shares.
	(4)	Includes 250,367 shares held by the 401(k) Plan, of which Messrs. Walton and Williams III are co-trustees. Messrs. Walton and Williams III disclaim beneficial ownership of such shares.
	(5)	Includes 276,691 shares held by a corporation for which Mr. Steuart II serves as an executive officer.
	(6)	Includes 37,666 shares held by a trust for the benefit of Mr. Toomey and his wife.
	(7)	Includes a total of 2,969,783 shares underlying stock options exercisable within 60 days of November 6, 2001, which are assumed to be outstanding for the purpose of calculating the group’s percentage ownership, and 250,367 shares held by the 401(k) Plan.
	(8)	Includes 15,865 shares held in an IRA.
	(9)	Includes 10,618 shares held in an IRA.

(10)	Includes 273 shares held in an IRA.
(11)	Includes 704 shares held in an IRA and 1,548 shares held in a Keogh account.
(12)	Includes 4,069 shares held in an IRA.

INVESTMENT ADVISORY SERVICES

      The Company is internally managed and therefore has not entered into any advisory agreement with, nor pays advisory fees to, an outside investment adviser. The Company is a registered investment adviser under the Advisers Act and provides advisory services to one other entity. The Company’s officers provide investment and portfolio management services for the Company, as well as the investments of the other managed entities. See “Management” in the prospectus for additional information about the Company’s executive officers. Our investment decisions in each business area are made by investment committees, composed of the Company’s most senior investment professionals. In addition, in certain instances where risk/return characteristics warrant and for every transaction larger than $10 million, the Executive Committee of the Board of Directors must also approve the transaction. See “Management” in the prospectus.

SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR

      The investments of the Company and its subsidiaries are held in safekeeping by Riggs Bank N.A. (“Riggs”) at 808 17th Street, N.W., Washington, D.C. 20006, as well as by LaSalle National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk Grove Village, Illinois 60007. American Stock Transfer & Trust Company, 59 Maiden Lane, New York, New York 10038 acts as the Company’s transfer, dividend paying and reinvestment plan agent and registrar.

BROKERAGE ALLOCATION AND OTHER PRACTICES

      Since the Company generally acquires and disposes of its investments in privately negotiated transactions, it infrequently uses brokers in the normal course of business.

B-7

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