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Executives

Ben Burnham - Vice President of Investor Relations Counsel

Vincent D. Foster - Chairman, Chief Executive Officer, President, Member of Credit Committee and Member of Investment Committee; General Partner, Main Street Capital II GP, LLC

Todd A. Reppert - Executive Vice Chairman, Member of Credit Committee and Member of Investment Committee

Dwayne Louis Hyzak - Chief Financial Officer, Senior Managing Director and Treasurer

Analysts

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

John T. G. Rogers - Janney Montgomery Scott LLC, Research Division

Main Street Capital (MAIN) Q4 2012 Earnings Call March 8, 2013 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Main Street Capital's Fourth Quarter Earnings Conference Call. [Operator Instructions] Today's conference is being recorded, March 8, 2013. I would now like to turn the conference over to Ben Burnham with Dennard-Lascar Associates. Please go ahead.

Ben Burnham

Thank you, Alicia, and good morning, everyone. Thanks for joining us for the Main Street Capital Corporation Fourth Quarter and Year-End 2012 Earnings Conference Call. Joining me today on the call are Chairman, President and CEO, Vince Foster; Vice Chairman, Todd Reppert; and Chief Financial Officer, Dwayne Hyzak.

Main Street issued a press release yesterday afternoon that details the company's quarterly and year-end financial and operating results. This document is available on the Investor Relations section of the company's website at www.mainstcapital.com. If you would like to be added to the company's e-mail list to receive press releases, please call Dennard-Lascar Associates at (713) 529-6600. A replay of today's call will be available beginning about an hour after the completion of the call and will remain available until March 15. Information on how to access the replay is included in yesterday's press release. We also advise you that this conference call is being broadcast live through an Internet webcast that can be accessed through the company's web page. Please note that information reported on this call speaks only as of today, March 8, 2013. And therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening.

Our conference call today will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions. These statements are based on management's estimates, assumptions and projections as of the date of this call, and they are not guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties and other factors, including, but not limited to, the factors set forth in the company's filings with the Securities and Exchange Commission, which can be found on the company's website or at www.sec.gov. Main Street assumes no obligation to update any of these statements unless required by law.

During today's call, management will discuss non-GAAP financial measures, including distributable net investment income and distributable net realized income. Please refer to yesterday's press release, which can be found on the company's website for a reconciliation of these measures to the most directly comparable GAAP financial measures. Certain information discussed in this call including information relating to portfolio companies was derived from third-party sources and has not been independently verified.

And now with that, I'd like to turn the call over to Vince.

Vincent D. Foster

Thanks, Ben, and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent special dividend and our dividend outlook, highlight our origination activity and conclude by commenting on the current investing environment in our markets. Following my comments, Todd will cover our fourth quarter portfolio activity in more detail. Then, Dwayne will comment on our fourth quarter financial results, our current liquidity position and certain key portfolio statistics. After which, we will take your questions.

Our investment portfolio continued to deliver strong performance during the fourth quarter. Our lower middle market investments appreciated during the quarter by $12.1 million on a net basis, with 27 of our investments appreciating during the quarter and 9 depreciating, and our middle market investments appreciated by $900,000 during the quarter. We finished the quarter with a net asset value per share of $18.59, a sequential increase of $1.10 per share over the last quarter. Our lower middle market portfolio companies ended the quarter with $118 million -- over $118 million in cash on their balance sheets and averaged a very conservative net debt-to-EBITDA ratio of 2x through our debt position and 2.2:1 including all debt.

Earlier this week, we announced that our Board declared our regular monthly dividends for the second quarter of $0.155 a share payable in April, May and June, respectively. The second quarter dividends represent an increase of $0.015 or 3.3% over the first quarter and a 10.7% increase over the second quarter of last year. In setting our dividends and determining dividend increases, our Board targeted a payout percentage of recurring or core net investment income in the 90% to 95% range. In other words, while we generally expect to receive some level of extraordinary dividends, prepayment fees and similar special items each quarter and to a degree, we have, in fact experienced, some amount of this type of income in the past and expect this to continue, we are not forecasting it as part of our dividend-setting policy.

During the course of our last 2 conference calls, I referenced our spillover taxable income of $30 million. To reduce this amount and stay in compliance with the regulated investment company tax rules, we also announced in reference to our Board-approved special dividend, which was subsequently distributed in January this year, equal to $0.35 a share. We now estimate that at the end of the first quarter '13, we will have spillover taxable income of roughly $40 million, and this is after giving effective special dividend paid in January. We therefore expect that we will ask our Board to declare another special dividend at or around the end of this year of at least $0.40 a share. In addition, this will posture us to request our Board to declare similar special dividends at the end of 2014 and 2015 assuming our regular dividends continue to be covered by our net investment income.

We reported to our shareholders via Form 1099 that over 46% of our 2012 dividends will be taxed at the highly favorable 2012 tax rates on long-term capital gains. In calendar 2011, 26% of our dividends qualified for the long-term capital gain rates. We are extremely pleased to once again deliver this level of tax efficiency to our taxpaying shareholders.

I would like to now turn to originations. Net originations for the quarter totaled $79 million with lower middle market producing $41.5 million and middle market producing about $37.5 million. Impacting the lower middle market net production were repayments of $16.5 million. Our lower middle market transaction pipeline is consistent with the levels we have experienced over the last few quarters with the earlier part of this quarter being impacted by tax rate change-related fourth quarter 2012 accelerated activity. We continue to seek significant equity participation in our lower middle market investments and as of quarter end, continue to average 32% fully diluted equity ownership positions in the 90% of these investments where we currently have equity exposure.

Our middle market investing activity continues to be focused on upgrading, via rotation, the overall quality of our positions. We continue to seek attractive risk adjusted yields and acceptable structures but have flattened our growth as yields continue to drop and structures become more aggressive. Our office or director group has continued to increase their ownership of our shares via our dividend reinvestment plan and open market purchases, investing over $440,000 in cash in our shares during the fourth quarter and over $1.9 million during calendar 2012.

With that, I'd like to turn the call over to Todd Reppert to cover our portfolio activity in more detail.

Todd A. Reppert

Okay. Thanks, Vince, and good morning, everyone. We are very pleased to report another strong quarter and full year, which reflect our key long-term goals for sustainable growth and dividends per share, while also generating meaningful growth and book value per share. We think the combination of steady long-term growth in our regular dividend payout and meaningful book value per share growth are a two-pronged value proposition that differentiates Main Street and has a generated a premium total return realized by our investors. In the 5 years since our IPO, Main Street's performance has supported this value proposition in that Main Street has been able to cumulatively grow its announced quarterly dividends per share by 41% while also growing NAV per share from approximately $12.85 to $18.59 at December 31.

These increases are even more notable given that 2 of the first 5 years as a public company involved a recessionary economic environment, and substantially all of the BDC sector experienced reductions in book value per share over this time frame. The cumulative dividend growth includes 11% growth and run rate regular dividends per share during calendar 2012, which followed 8% growth during 2011.

In addition, as Vince discussed, Main Street has excess undistributed taxable income or spillover of approximately $1.28 per share at December 31, 2012, which allowed us to pay a $0.35 per share special dividend in January 2013. This is in addition to almost $3 per share of net unrealized appreciation within our investment portfolio at year end.

Large spillover amount means that in addition to growing our regular dividends since the IPO, we have significantly outearned those dividends on a realized basis, which provides flexibility for additional future special dividends or other corporate uses. The cumulative NAV per share growth, since our IPO, includes 22% growth during calendar 2012, which followed 16% growth in NAV per share during 2011. As Vince noted, during the fourth quarter of 2012, our investment activity included approximately $58 million of gross investments in the lower middle market component of the portfolio including investments in 4 new portfolio companies and several follow-on investments. Net of repayments and redemptions, our lower middle market portfolio increased $41.5 million during the quarter.

Our fourth quarter 2012 investment activity also included a little over $37 million in net growth within the middle market portfolio, which reflects new investments net of all repayments and exits. We have generated over $15 million in net realized gains during 2012 from the exit or partial exit of several portfolio investments, including a $9.9 million realized gain on the partial exit of Laurus Healthcare during the fourth quarter. I'm also pleased to report that our overall portfolio performance remains strong, and the portfolio continues to improve its diversification by issuer, industry, end markets, geography and vintage. At December 31, we had investments in 144 portfolio companies that are in approximately 50 different industries across both the lower middle market and middle market components of the portfolio. The largest portfolio company investment is well under 3% of our assets, and the vast majority of our portfolio investments represent less than 1% of our assets. This increasing diversity adds structural protection to our portfolio, our revenue sources and our cash flow, which translates into structural protection for our shareholders.

I would also characterize the bulk of our lower middle market portfolio as seasoned and that we have been in a majority of those investments for at least 2 years and many for significantly longer. The seasoned nature of the lower middle market portfolio is reflected in a deleveraged or lower-risk position for many of these investments and an expanding list of equity investments with growing or accelerating unrealized appreciation. We expect to continue the historical pattern of periodically realizing gains from our appreciated equity investments. However, we are also very pleased to continue collecting dividend income from these investments as generated from their free cash flow. The equity component of our lower middle market investment strategy remains a significant differentiating advantage for Main Street, and we expect we will benefit for years to come from this strategy.

As Vince mentioned, we hold equity positions in substantially all of our lower middle market companies with an average fully diluted ownership of 32%. Importantly, these equity positions have a low-cost basis relative to the ownership involved since they are a combination of nominally priced warrants and lower-basis, lower-multiple direct equity investments. The equity component of the portfolio was the primary contributor to over $60 million of total net portfolio appreciation before reversals for realized gains during calendar 2012, which, in turn, was a major contributor to our growth in NAV per share during the year. At December 31, our equity investment portfolio had a blended fair value that is over 2x its cost basis, reflecting over $100 million or roughly $3 per share of net unrealized appreciation.

In summary, Main Street continues to perform at a high level and deliver upon our long-term goals of sustaining and growing our dividends, as well as generating meaningful growth and book value per share. We believe that executing on this unique 2-pronged value proposition continues to translate into premium total returns for our shareholders. Our investors should also derive great comfort that they are invested in a very capable and deep management team at Main Street and all of our personnel are highly aligned with continuing to generate significant shareholder returns over the long term.

With that, I'll turn the call over to Dwayne to cover our financial results, liquidity and certain key portfolio statistics.

Dwayne Louis Hyzak

Thanks, Todd. As Vince and Todd previously mentioned, we're very happy to report our fourth quarter and full year 2012 results representing significant improvement from the prior year in all of our key financial metrics, including total investment income, net investment income, net asset value, realized gains and unrealized appreciation and the ratio of our operating expenses as a percentage of total assets. Our total investment income increased by 33% for the fourth quarter and 37% for the full year over the same periods in 2011 to a total of $26.2 million for the quarter and $90.5 million for the year. The increases were primarily driven by increased amounts of interest income associated with higher levels of portfolio debt investments, increased dividend activity from portfolio equity investments and increased fee income due to higher levels of transaction activity. The increase in investment income in the fourth quarter included an increase of approximately $1.7 million in investment income associated with higher levels of accelerated prepayment activity for certain middle market debt investments in comparison to prior year and special dividend activity of $1.4 million.

Fourth quarter 2012 operating expenses, excluding noncash share-based compensation expense, increased by $100,000 over the fourth quarter prior year to a total of $7.3 million. The operating expense increase was a result of higher personnel costs and accrued incentive compensation, which were partially offset by decreases in other operating expenses compared to the fourth quarter of the prior year. Our total operating expenses, excluding interest expense as a percentage of our average total assets, which we believe is a key metric in evaluating our operating efficiency, was 1.8% on an annualized basis for the fourth quarter of 2012 compared to 2.3% on an annualized basis for the fourth quarter of 2011 and 1.8% for the full year in 2012 compared to 2.2% for the full year in 2011. We believe that this metric compares very favorably to other BDCs and is approximately half the same metric for the BDC industry as a whole. Our low-cost, internally managed operating structure allows us to deliver a greater portion of our gross portfolio returns to our shareholders, and we estimate that our efficient cost structure generates accretion to our earnings of approximately 20% when compared to the BDC industry average cost structure.

Due to our increased total investment income and the leverage of our low-cost operating structure, distributable net investment income for the fourth quarter of 2012 increased by 51% to $18.8 million or $0.58 per share. Our distributable net investment income for the fourth quarter exceeded our dividends paid by $0.13 per share or approximately 30%, and we estimate that our cumulative spillover taxable income was approximately $44.4 million or $1.28 per share as of year end.

While the dollar amount of distributable net investment income increased by 51% over the prior year, the per share percentage increase was approximately 21% due to the higher average number of shares outstanding compared to the corresponding period in the prior year, primarily due to the impact of the 3 follow-on stock offerings we have completed since the beginning of the fourth quarter of 2011. All other fourth quarter 2012 per share measures were similarly impacted by the higher weighted average shares outstanding.

As a result of the 2 partial exits of our equity investments in Laurus Healthcare and irth Solutions in the fourth quarter 2012 and the increased level of net investment income, our distributable net realized income for the fourth quarter of 2012 increased by 123% to $30 million compared to $13.4 million in the corresponding period of 2011, primarily as a result of these realized gains, which resulted in the corresponding reversals of unrealized appreciation reported in prior periods, our net change in unrealized appreciation in the fourth quarter was a decrease of approximately $1 million.

As Vince previously mentioned, during the fourth quarter of 2012, in addition to the 2 realized gains in the fourth quarter, we also recognized $13 million of net unrealized appreciation on our portfolio investments. This increase included net unrealized appreciation totaling $12.1 million in our lower middle market portfolio, resulting from appreciation on 27 portfolio companies and depreciation on 9 portfolio companies. In addition to the appreciation in our lower middle market portfolio, our middle market portfolio appreciated by $900,000. These increases in unrealized appreciation were offset by approximately $12.5 million of accounting reversals of net unrealized appreciation related to the exits and repayments of portfolio, debt and equity investment during the fourth quarter and approximately $1.4 million of unrealized appreciation related to the SBIC debentures held by our wholly owned subsidiary, Main Street Capital II.

The operating results for the fourth quarter of 2012 resulted in a net increase and net assets from operations of $24.5 million or $0.76 per share. This was after a reduction for a tax provision of $3.8 million. $2.4 million of which was related to noncash deferred taxes on the net unrealized appreciation on equity investments held in our taxable subsidiaries. As a result of the increase in net assets from operations for the fourth quarter and for the full year, and the impact of our accretive follow-on stock offerings, our net asset value per share at year end increased by approximately 6% from the end of the third quarter and by approximately 22% from prior year end to $18.59 per share. As we look forward to the first quarter of 2013 and consider the impact of the accelerated prepayment activity in the middle market portfolio and the special dividend activity in the fourth quarter of 2012 and the impact of our December 2012 follow-on stock offering, which will increase our weighted average shares outstanding in the first quarter of 2013 by approximately 7%, we expect that our first quarter of 2013 distributable net investment income per share will be lower than the per share amount for the fourth quarter of 2012. Based upon our current estimates, we expect that these factors will result in first quarter 2013 distributable net investment income per share, which is approximately $0.03 to $0.05 above our previously announced dividends for the first quarter of $0.45 per share.

On the capital resources front, our liquidity and overall capitalization remains strong. At December 31, 2012, we had $63.5 million of cash and $28.5 million of marketable securities. And today, we have over $14 million of cash, most of which is held at our SBIC subsidiaries. During the fourth quarter, we issued $16 million of new SBIC debentures after repaying $16 million of debentures in the third quarter of 2012 to extend the scheduled maturities of such debentures. As a result of these activities, we lowered the weighted average interest rate for SBIC debentures to 4.7% and extended the first repayment date for such debentures to September 2014.

During the fourth quarter, we amended our credit facility to extend the final maturity to September 2017. And at December 31, 2012, we maintained total commitments under the credit facility of $287.5 million and had approximately $155.5 million of unused capacity. Today, we have approximately $140 million outstanding under the credit facility and unused capacity of approximately $147.5 million. While we will continue to explore various financing sources to support our future operational and investment activities, we remain focused on maintaining significant liquidity and matching the expected duration of our investment assets with our borrowing arrangements.

Now let me finish with a few portfolio statistics, all as of September -- all as of December 31. In our lower middle market portfolio, we had 59 investments representing approximately $510 million of fair value as of December 31, or approximately 25% above the cost basis of approximately $408 million. Consistent with our investment strategy, approximately 76% of our lower middle market portfolio investments at cost were in the form of secured debt investments, and approximately 94% of those debt investments held a first lien security position. The weighted average expected yield on our lower middle market portfolio debt investment as of year end was 14.2%. We hold equity positions in 90% of our lower middle market portfolio companies with an average fully diluted ownership of approximately 32%. The fair value of our lower middle market portfolio equity investments as of December 31, 2012, was approximately 205% above the cost of such equity investments. As Vince previously noted, at the lower middle market portfolio level, the weighted average net senior debt-to-EBITDA ratio was 2.0:1 or 2.2:1 including portfolio company debt, which is junior in priority to Main Street's debt position. We expect that these lower middle market portfolio level statistics on a same-store basis should generally improve over time as our company is naturally deleveraged. This deleveraging has the additional positive impact of increasing the fair value of our equity investments in these companies.

Based upon our internal investment rating system with a rating of 1 being the highest and 5 being the lowest, the weighted average investment rating for our lower middle market investment portfolio was 2.1 on December 31, 2012, which is consistent with the weighted average investment ranking at the end of the third quarter. And during the fourth quarter, we had 4 portfolio companies improve their rating, and no portfolio companies decreased their rating.

In our middle market portfolio, we had investments at 85 companies representing approximately $390 million of fair value as of year end that would generate a weighted average yield of approximately 8.8%. Main Street's middle market portfolio investments are primarily in the form of debt investments, and approximately 92% of our middle market portfolio debt investments at cost held the first lien security position. The weighted average revenues for the 85 companies in the middle market portfolio was approximately $514 million. The total investment portfolio fair value at December 31, 2012, was approximately 113% of the related cost basis, and we had no portfolio investments on nonaccrual status and 1 fully impaired portfolio investment representing approximately 0.2% of the total investment portfolio at cost.

With that, I will now turn the call back to the operator so that we may take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Robert Dodd with Raymond James Financial.

Unknown Analyst

This is Bill. I appreciate you all taking my questions here. One, on the HMS income fund, could you give us an idea of how marketing efforts are going and capital raising activity is going for that fund, particularly compared to what you'd expected?

Vincent D. Foster

Yes. I'd have to say, it's definitely slower than what we expected. I think there's probably a number of reasons for it, and I think that it's not -- probably not unique to their efforts. And I think that historically, these types of fundraising activities always start out slow. So that's really about all we can say. We're really not all that close to the marketing. We're just kind of observing from afar. But it's definitely slow, and that's why we don't expect any meaningful activity at all in terms of fee income in calendar 2013. I believe that's correct in our model, right?

Dwayne Louis Hyzak

That's correct.

Vincent D. Foster

Yes. Because I think the story there is more 2014, Bill.

Unknown Analyst

2014, okay. Good deal. And then as a follow-up, you said you had a portfolio of, I thought you said $118 million in cash on the balance sheet. I think that's up about $25 million from Q3. Could you walk us through the owners' psychology, if you could, about keeping more cash on hand versus paying down debt versus investing in their business?

Vincent D. Foster

Yes. As I think I've covered before, it's really something they don't have much choice about when you consider the lower middle market. We typically are the bank. Our credit facilities are typically unitranche, first lien, and we don't -- we're not really in the business of providing them revolvers where they can -- we can sweep their cash every day to pay down our lines. We typically have a provision that says if you want to pay down the credit line, we need you to do it in $250,000 chunks just because we don't really want or have that kind of back-office activity. So as a result, if you don't have a revolver, you really have to use a pile of cash and use that as a revolver. Would you guys describe it any differently?

Todd A. Reppert

No, I think -- Bill, this is Todd. I mean, to put it in perspective, $118 million over 59 companies on average is about $2 million per company. And so some are more, and some are less. But the $118 million is a bigger number probably than it is on any 1 balance sheet just for a little perspective. So it's...

Vincent D. Foster

It's really structural than psychological, I'd say.

Todd A. Reppert

And they can -- to go into my comments, I mean, they do -- it is a seasoned portfolio, so they do continue to deleverage and generate more and more free cash flow as time goes on. And so there will be questions of what they do with their free cash flow, but we think that's a good situation. It'll either increase our dividend income, it'll repay the debt and deleverage and de-risk the situation or they'll have growth opportunities for it, and we just think that's -- those kind of options are a great position for companies to be in.

Operator

[Operator Instructions] And our next question comes from the line of Bryce Rowe with Robert W. Baird.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

Just a couple questions. One, I think a couple of quarters ago, you guys talked about the mix between the middle market portfolio and the lower middle market portfolio being about 50-50 or that was the target. I think on a cost basis, we're roughly there today. Wanted to get any update from you as to what -- if there's any change in targeted mix from an investment portfolio perspective?

Vincent D. Foster

Yes. I mean, I think that we would view 50% as the upper limit for middle market that we would not expect to achieve. Right now, we're probably in the low- to mid-40s, I think.

Dwayne Louis Hyzak

It's in the high-40s.

Vincent D. Foster

High 40s, yes.

Dwayne Louis Hyzak

On a cost basis.

Vincent D. Foster

On a cost basis. On a cost basis?

Dwayne Louis Hyzak

Yes.

Vincent D. Foster

So -- but we're -- we want to be majority lower middle market, period. We think the middle market depending upon the market and that's both on the liability side and the asset side is a profitable place for us to operate in. But we never see it really getting to -- on a sustained basis, getting to half or certainly never seeing it getting over half.

Dwayne Louis Hyzak

Yes. And Bryce, just to put some numbers behind Vince's comments, if you look at the split between lower middle market and middle market at 12/31, on a cost basis, it's 52% lower middle market, 48% middle market, and fair value, it's 57% and 43%.

Vincent D. Foster

Yes. I don't -- to me, cost is not relevant. Yes.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

When you say, Vince, cost is irrelevant [ph] ...

Vincent D. Foster

The way we manage the business is what are the assets worth. Some of them are now 13 years old, so...

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

Right, okay. And the second question was on investment pricing. Just wanted to get a sense for what you're seeing especially in the lower middle market there from an investment pricing perspective.

Vincent D. Foster

Sure. In the lower middle market, the answer is we're really not seeing much different pricing than we have historically. What you do find in the lower middle market, which is we're looking at companies with EBITDA from $3 million to $15 million, the $15 million EBITDA companies, because they start to be senior cash flow eligible from commercial banks, et cetera, the pricing gets more aggressive as you get to the top end of the lower middle market scale. But that's kind of always been the case, so we don't really see much difference there. We don't see much more competition. We continue to not really see the strategics as a meaningful threat because of Sarbanes or the public ones, et cetera, it's just really difficult for them to transact to lower middle market. What competition we do see that might drive valuations up is one of our -- is evidenced by the exits of some of our portfolio companies last year. Our companies, particularly the large ones, make nice add-ons for other sponsors' platform companies that they feel like they need to grow by acquisition in order to exit, and we're happy to oblige there. But we really don't see much difference in terms of the pricing we're -- we'd expect we're able to achieve.

Bryce W. Rowe - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then this is the last question, and I think you guys talked about earnings, 1Q earnings being $0.03 to $0.05 as fair above the dividend for the quarter. Just wondering does that include any kind of expectation of dividend or nonrecurring income? Or is that purely just accrued interest revenue, interest income?

Dwayne Louis Hyzak

I'd say it's our current expectation from what we've seen in the portfolio activity through today with an estimate for the month of March, so it includes our full expectations for the income statement for that quarter.

Operator

Our next question comes from the line of J.T. Rogers with Janney Capital Markets.

John T. G. Rogers - Janney Montgomery Scott LLC, Research Division

A quick question on when you guys are underwriting a new lower middle market investment, how does the pricing -- I guess first off, what kind of rate of return are you guys looking for on your equity investments? And how does the current lower middle market from an equity investment perspective look versus, say, where you where 5 years ago?

Vincent D. Foster

Right. So the pricing on the debt pretty much is 12% fixed is kind of what we start off with. And when we look at the investment and we say what kind of overall composite return would we need to take into account our debt equity, that's when we factor in the warrant percentage that we're demanding or the equity coinvestment that we're demanding. We're kind of agnostic as between the 2, and that's kind of how we approach it. And I would say, at the lower end of our lower middle market range, we want to be in the 20% or higher IRR. At the higher end of the range, we might end up in the high teens. Would you say that's accurate, Todd?

Todd A. Reppert

Yes. And it's -- now we do the models, J.T., but it's -- they're almost worthless the quarter after you close the deal. I mean, you...

Vincent D. Foster

You model like you project it.

Todd A. Reppert

Exactly. So I mean, we kind of look at it like what's the right balance of the right ownership percentage given the situation because we do customize versus expected IRRs and in many cases, lower cases, management cases, et cetera and then we kind of negotiate a number that we feel comfortable with. So we're not driven exclusively by a model that, I would say, Vince's numbers are right or, in our minds, trying to target.

Vincent D. Foster

And I would say, we've now hit the century mark in terms of lower middle market investments, and we went back and did some analysis because now we're in our second decade of doing this. Some of them are still in the portfolio, and what we found is maybe 1/4 of the companies underperform our return expectations and maybe 3/4 overperform. But it's -- you don't end up with necessarily a higher yield than you target because the ones that underperform take you down more significantly than the ones that overperform take you up. So we've been reasonably good at it taking into account the 100 deals, but we're not very -- we're not particularly good at hitting a target, taking into account 1 deal. That's just kind of the nature of the beast.

John T. G. Rogers - Janney Montgomery Scott LLC, Research Division

That's great. And then I guess the market right now, have you seen any change in pricing that sellers are demanding in the lower middle market? I think there's talk of -- there's been some multiple expansion in the upper middle market.

Vincent D. Foster

No. I mean, I said we're -- we've been transacting in the 4 to 5, 4 to 6x enterprise value range for a long time. And what determines where we fall within that range is if we're closing companies with $4 million of EBITDA or $12 million. That's kind of what we're seeing. Would you say that's right?

Dwayne Louis Hyzak

Yes, that's correct. I mean, the other thing you'd -- that you would take into consideration is that we offer a very customized financing solution, so it's not a situation where we are out actively competing in auctions for deals. We're providing a very customized solution that is specific to each individual company where valuation is not, just not the key metric that they're looking at.

Vincent D. Foster

So a lot of times, it's -- they're event-driven, time-sensitive transactions. Whoever can get there with the financing solution the fastest will frequently get the deal so...

John T. G. Rogers - Janney Montgomery Scott LLC, Research Division

Okay great. And then just one last question I guess. In the middle market, just wondering what you guys are seeing there from a competitive perspective. It sounds like things have gotten tighter. Credits spreads are falling and leverage levels are up. Just wondering if those trends have continued sort of into March or if they look to be going in the other direction.

Vincent D. Foster

We don't see it going in the other direction. I mean, we monitor it every day. The more liquid CLO-eligible end of that market is very, very competitive. There's several new -- I mean, there are all kinds of new entrants, as you read about the new CLOs being launched almost daily. So we're trying to seek refuge in the less liquid to illiquid smaller companies, smaller facility size end of that market, and we've been pretty successful there. We see less spread compression. We still do -- we still see spread compression on the new issues. You still see a lot of repricings. You see aggressive structures. I don't know when it's going to end. These things always tend to cycle back and forth. But I don't see it -- I don't really see it reversing. You hear some rumors that with some of these megadeals that they all [ph] -- gets [ph] done and some of this other stuff that might alter the supply-demand balance right now, or equation, but I haven't seen any evidence of it.

Operator

[Operator Instructions] And I'm showing no further questions in the queue at this time. I would like to turn the conference back to management for any closing remarks.

Vincent D. Foster

Great. Well, thank you all for joining us and supporting us, and we will see you again or talk to you again in about 60 days.

Operator

Ladies and gentlemen, this concludes our conference for today. Thank you for your participation. You may now disconnect.

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