Edgar Filing: ALLIED CAPITAL CORP

PROSPECTUS SUPPLEMENT
(To Prospectus dated March 30, 2001)

1,030,928 SHARES

[ALLIED CAPITAL LOGO]
COMMON STOCK

------------------------

All of the 1,030,928 shares (the "Shares") of the Company's common stock
offered hereby are being issued and sold by the Company to an institutional
investor in a directly negotiated transaction at a purchase price of $20.00 per
share, less a 3% discount, or $19.40 per share, for an aggregate purchase price
of $20 million.

Our common stock is traded on the Nasdaq National Market under the symbol
"ALLC." On April 23, 2001, the last reported sales price for the common stock
was $20.49.

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 March 30, 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,
1-888-818-5298. 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 70 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.

------------------------

April 24, 2001
2

You should rely on the information contained in this prospectus supplement
and the prospectus. We have not authorized anyone to provide you with
information different from that which is set forth in this prospectus supplement
or the prospectus. We are offering to sell shares of common stock and seeking
offers to buy shares of common stock only in jurisdictions where offers and
sales are permitted. The information contained in this prospectus supplement and
the prospectus is accurate only as of the date on their respective covers,
regardless of the time of delivery of this prospectus supplement and the
prospectus or of any sale of common stock.

TABLE OF CONTENTS

PAGE
----

PROSPECTUS SUPPLEMENT
Fees and Expenses........................................... S-1
Recent Developments......................................... S-2
Use of Proceeds............................................. S-6
Plan of Distribution........................................ S-6
PROSPECTUS
Prospectus Summary.......................................... 1
Selected Consolidated Financial Data........................ 5
Risk Factors................................................ 8
The Company................................................. 13
Use of Proceeds............................................. 13
Price Range of Common Stock and Distributions............... 14
Management's Discussion and Analysis of Financial Condition
and Results of
Operations................................................ 15
Senior Securities........................................... 28
Business.................................................... 32
Portfolio Companies......................................... 42
Determination of Net Asset Value............................ 48
Management.................................................. 49
Tax Status.................................................. 56
Certain Government Regulations.............................. 61
Dividend Reinvestment Plan.................................. 63
Description of Securities................................... 64
Plan of Distribution........................................ 68
Legal Matters............................................... 69
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. 69
Independent Public Accountants.............................. 69
Table of Contents of Statement of Additional Information.... 70
Index to Financial Statements............................... 71

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.

(i)
3

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)....... 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).................. 5.6%
-----
Total annual expenses(6)........................... 9.0%
=====

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(1) The discounts with respect to the shares sold by the Company in this
offering are the only sales load paid in connection with this offering.

(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"
in the prospectus.

(3) "Consolidated net assets attributable to common shares" equals net assets
(i.e., total assets less total liabilities and preferred stock) at December
31, 2000.

(4) "Operating expenses" represent all operating expenses of the Company for the
year ending December 31, 2000 excluding interest on indebtedness. Operating
expenses exclude the formula and cut-off awards. See
"Management -- Compensation Plans" in the prospectus.

(5) The "Interest payments on borrowed funds" percentage is based on interest
payments for the year ending December 31, 2000 divided by consolidated net
assets attributable to common shares at December 31, 2000. The Company had
outstanding borrowings of $786.6 million at December 31, 2000. See "Risk
Factors" in the prospectus.

(6) "Total annual expenses" as a percentage of consolidated net assets
attributable to common shares 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 5.0% of consolidated total assets.

EXAMPLE

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........... $119 $296 $474 $ 917

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" in the 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
4

RECENT DEVELOPMENTS

OPERATING RESULTS

Net operating income before net realized and unrealized gains was $39.7
million, or $0.46 per share for the first quarter of 2001, a 35% increase over
net operating income of $22.6 million, or $0.34 per share, for the first quarter
of 2000. The increase in net operating income stemmed from growth in the
investment portfolio, and increased structuring and management fee income.

For the three months ended March 31, 2001, the Company reported net income
of $52.0 million, or $0.60 per share, a 33% increase over net income of $29.6
million, or $0.45 per share, for the three months ended March 31, 2000. The
significant increase in net income resulted from strong operating income and
realized and unrealized net gains in the portfolio.

Total net realized and unrealized gains totaled $12.3 million, or $0.14 per
share, for the first quarter of 2001 as compared to $7.0 million, or $0.11 per
share, for the first quarter of 2000. Net realized gains totaled $1.2 million;
net unrealized gains totaled $11.1 million. Net realized and unrealized gains
can vary substantially from quarter to quarter.

During the three months ended March 31, 2001, the Company invested a total
of $150.8 million. After total repayments of $26.6 million, sales of $35.2
million, and valuation changes during the quarter, the Company's investment
portfolio increased to $1.9 billion at March 31, 2001.

At March 31, 2001, total assets were $2.0 billion, a 6% increase over total
assets of $1.9 billion at December 31, 2000. Shareholders' equity was $1.1
billion at March 31, 2001, and net asset value was $12.26 per share.

The Company invested a total of $150.8 million for the three months ended
March 31, 2001. At March 31, 2001, the overall weighted average yield on the
Company's portfolio was 14.3%.

PRIVATE FINANCE

The private finance portfolio totaled $1.3 billion at March 31, 2001. The
debt portion of this portfolio, which totaled $959.5 million at March 31, 2001,
had a weighted average yield of 14.7%. The equity securities in the private
finance portfolio totaled $343.8 million at March 31, 2001. Included in the
equity portfolio is the Company's equity investment in Business Loan Express,
Inc. ("BLX"), which was valued at $145 million.

During the first quarter of 2001, the Company committed a total of $31.5
million and invested a total of $20.6 million in its core private finance
business. Buyout and private finance activity across the industry was slow
during the first quarter of 2001 largely due to credit tightening among senior
lenders. Equity-focused buyout firms need both senior and subordinated debt to
leverage private equity investments, and during the first quarter of 2001, the
senior bank market, and in particular the senior syndicated loan market, was
effectively closed. The Company completed the financing for only one buyout
transaction during the quarter. The Company provided $10 million of senior
subordinated debt financing with warrants to finance the management buyout of
Redox Brands, Inc., which is a marketer of leading consumer branded products in
the cleaning and detergent market,

S-2
5

including Biz and Oxydol. The Company also funded financing commitments for
existing portfolio companies.

CMBS INVESTING

During the first quarter of 2001, the Company's commercial real estate
finance group invested $104.4 million in non-investment grade commercial
mortgage-backed securities (CMBS) in two transactions. In addition, the Company
purchased $24.6 million in non-investment grade securities related to a
collateralized debt offering secured by CMBS and investment grade REIT bonds.
The effective yield on these new commercial real estate securities is estimated
to be 15.9%, after assuming a 1% loss on the entire underlying collateral pool.
The Company also sold $35.2 million in CMBS BB bonds during the quarter, and
recognized short-term capital gains of $0.8 million.

The Company's entire purchased CMBS portfolio of $406.6 million at March
31, 2001 had a weighted average yield to maturity of 15.6%, after assuming a 1%
loss on the entire underlying collateral pool. The credit characteristics of the
underlying loan portfolios remain strong with less than 0.5% in delinquencies.
At March 31, 2001, the unamortized discount on the purchased CMBS portfolio was
$431.7 million.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2001, the Company had a weighted average cost of debt of 7.8%.
The Company has significant current availability on its unsecured short-term
line of credit, and the Company has no significant maturities of long-term debt
until 2003. At March 31, 2001, the Company had regulatory asset coverage ratio
of 232%. The Company is required to maintain regulatory asset coverage of at
least 200%.

PORTFOLIO QUALITY AND VALUATION

As a business development company, the Company is required quarterly to
value its portfolio at fair value as determined by the Board of Directors.
During the first quarter of 2001, the Company recognized $11.1 million in net
unrealized gains.

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
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, 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 $6.1 million in total. These companies increased in
value because of continued positive performance, and valuation data that would
indicate that a valuation increase was necessary.

The Company decreased the value of its common equity investment in Startec
Global Communications Corporation by $3 million. The Company also decreased the
value of its debt investment in NETtel Communications, Inc. by $5 million. In
addition, the Company decreased the value of other private finance investments
by a total of $11.3 million.

S-3
6

The Company employs a grading system to monitor the quality of its
portfolio. Grade 1 is for those investments from which a capital gain is
expected. Grade 2 is for investments performing in accordance with plan. Grade 3
is for investments that require closer monitoring, but no loss of interest or
principal is expected. Grade 4 is for investments for which some loss of
contractually due interest is expected, but no loss of principal is expected.
Grade 5 is for investments for which full loss of interest and some loss of
principal is expected, and the loan is marked down to net realizable value.

At March 31, 2001, the portfolio of Grade 1 investments totaled $430.2
million, or 23% of the total portfolio at value; Grade 2 investments totaled
$1.3 billion, or 70% of the total portfolio; Grade 3 investments totaled $35.3
million, or 2% of the total portfolio; Grade 4 investments totaled $61.1
million, or 3% of the total portfolio; and Grade 5 investments totaled $36.6
million, or 2% of the total portfolio. Included in Grade 4 and 5 investments are
assets totaling $14.4 million that are secured by commercial real estate.

For the total investment portfolio, loans greater than 120 days delinquent
were $55.3 million at value at March 31, 2001, or 2.9% of the total portfolio.
Included in this category are loans valued at $9.8 million that are fully
secured by commercial real estate. Loans greater than 120 days delinquent
generally do not accrue interest. At December 31, 2000, delinquencies in the
CMBS portfolio related to the underlying collateral pool were negligible.

ALLIED CAPITAL TO LIST ON THE NYSE

The Company has been cleared to list its common stock on the New York Stock
Exchange, and will begin trading on June 6, 2001 under the symbol "ALD".
Beginning on June 6, 2001, the Company will trade under the stock symbol "ALD".
Until that day, the Company will continue to trade on the Nasdaq National Market
under ticker symbol "ALLC." The Company's CUSIP number, 01903-Q10-8, and
transfer agent, American Stock Transfer & Trust Company, will remain the same.

QUARTERLY DIVIDEND

The Company increased its regular quarterly dividend to $0.50 per share for
the second quarter of 2001. The regular quarterly dividend had previously been
$0.49 per share. The dividend will be payable on June 29, 2001 to shareholders
of record on June 15, 2001.

The Company's dividend is paid from taxable income. The Board of Directors
determines the dividend based on annual estimates of taxable income, which
differs from book income because of both timing and absolute differences in
income and expense recognition. Changes in unrealized appreciation and
depreciation have no impact on the Company's taxable income.

S-4
7

SUMMARY FINANCIAL INFORMATION

AT MARCH 31, AT DECEMBER 31,
2001 2000
------------ ---------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT) (UNAUDITED)

ASSETS
Portfolio at Value:
Private finance....................................... $1,303,288 $1,282,467
Commercial real estate finance........................ 583,465 505,534
---------- ----------
Total Portfolio at Value...................... 1,886,753 1,788,001
Cash and cash equivalents............................... 9,392 2,449
Other assets............................................ 77,353 63,367
---------- ----------
Total Assets.................................. $1,973,498 $1,853,817
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debt.................................................... 883,776 786,648
Other liabilities....................................... 28,477 30,477
---------- ----------
912,253 817,125
Preferred stock issued to SBA........................... 7,000 7,000
Common shareholders' equity............................. 1,054,245 1,029,692
---------- ----------
Total Liabilities and Shareholders' Equity.... $1,973,498 $1,853,817
========== ==========
Net asset value per share............................... $12.26 $12.11
Actual shares outstanding at end of period.............. 85,956 85,057

FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------
2001 2000
------------ ---------------
(UNAUDITED)

INTEREST AND RELATED PORTFOLIO INCOME:
Interest and dividends................................ $ 54,875 $ 38,812
Net premiums from loan dispositions................... 821 3,289
Investment advisory fees and other income............. 9,375 1,796
---------- ----------
Total interest and related portfolio income... 65,071 43,897
---------- ----------
EXPENSES:
Interest.............................................. 15,930 12,311
Employee.............................................. 6,418 4,569
Administrative........................................ 2,967 2,753
---------- ----------
Total operating expenses...................... 25,315 19,633
---------- ----------
Formula and cut-off awards............................ 28 1,691
---------- ----------
Net operating income before net realized and unrealized
gains................................................. 39,728 22,573
---------- ----------
Net realized and unrealized gains:
Net realized gains.................................... 1,154 2,176
Net unrealized gains.................................. 11,146 4,832
---------- ----------
Total net realized and unrealized gains....... 12,300 7,008
---------- ----------
Net Income.............................................. $ 52,028 $ 29,581
========== ==========
Diluted earnings per common share....................... $0.60 $0.45
Weighted average common shares outstanding -- diluted... 87,059 66,308

S-5
8

USE OF PROCEEDS

The net proceeds from the sale of the shares, after deducting estimated
expenses of this offering, are approximately $19.9 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

The net offering proceeds to us, after deduction of estimated offering
expenses of approximately $50,000, will be approximately $19.9 million.

S-6
9

PROSPECTUS FILED PURSUANT TO RULE 497
REGISTRATION STATEMENT NO. 333-43534

$310,500,000

[ALLIED CAPITAL LOGO]

COMMON STOCK
PREFERRED STOCK
DEBT SECURITIES
------------------------

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 March 30, 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
1-888-818-5298

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 70 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 Nasdaq National Market under the symbol
"ALLC." As of March 30, 2001, the last reported sales price for the common stock
was $20.13.

We may offer, from time to time, up to $310,500,000 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.
------------------------
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.
------------------------
THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF SECURITIES UNLESS
ACCOMPANIED BY A PROSPECTUS SUPPLEMENT.
------------------------

March 30, 2001
10

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.

------------------------

TABLE OF CONTENTS

PAGE
----

Prospectus Summary.......................................... 1
Selected Consolidated Financial Data........................ 5
Risk Factors................................................ 8
The Company................................................. 13
Use of Proceeds............................................. 13
Price Range of Common Stock and Distributions............... 14
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 15
Senior Securities........................................... 28
Business.................................................... 32
Portfolio Companies......................................... 42
Determination of Net Asset Value............................ 48
Management.................................................. 49
Tax Status.................................................. 56
Certain Government Regulations.............................. 61
Dividend Reinvestment Plan.................................. 63
Description of Securities................................... 64
Plan of Distribution........................................ 68
Legal Matters............................................... 69
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. 69
Independent Public Accountants.............................. 69
Table of Contents of Statement of Additional Information.... 70
Index to Financial Statements............................... 71

------------------------

(i)
11

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.

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.

All information in this prospectus, unless otherwise indicated, has been
presented as if the predecessor companies had merged as of the beginning of the
earliest period presented. In this prospectus or any accompanying prospectus
supplement, unless otherwise indicated, the "Company", "ACC", "we", "us" or
"our" refer to the post-merger Allied Capital Corporation and its subsidiaries.

THE COMPANY (Page 13)

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. As of January 2001, 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,

- 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 three
regional offices in New York, Chicago and San Francisco. 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.

1
12

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 Nasdaq National Market and trade under the symbol
"ALLC."

THE OFFERING (Page 68)

We may offer, from time to time, up to $310,500,000 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 13)

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 14)

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 63)

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.

2
13

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 additional capital, fluctuating quarterly results, and operating in a
regulated environment. In addition, the loss of pass-through tax treatment could
have a material adverse effect on our total return, if any.

CERTAIN ANTI-TAKEOVER
PROVISIONS (Page 65)

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.

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14

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).................. 5.6%
----
Total annual expenses(6)........................... 9.0%
====

-------------------------
(1) In the event that the Securities to which this prospectus relates are sold
to or through underwriters, a corresponding prospectus supplement will
disclose the applicable sales load.

(3) "Consolidated net assets attributable to common stock" equals net assets
(i.e., total assets less total liabilities and preferred stock) at December
31, 2000.

(5) The "Interest payments on borrowed funds" percentage is based on interest
payments for the year ending December 31, 2000 divided by consolidated net
assets attributable to common stock at December 31, 2000. The Company had
outstanding borrowings of $786.6 million at December 31, 2000. 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 5.0% 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........ $90 $271 $451 $902

THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES, AND
THE ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
4
15

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. The selected
financial data 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. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" ON PAGE 15 FOR MORE INFORMATION.

YEAR ENDED DECEMBER 31,
--------------------------------------------------
(IN THOUSANDS, 2000 1999 1998 1997 1996
EXCEPT PER SHARE DATA) -------- -------- -------- ------- -------

OPERATING DATA:
Interest and related portfolio income:
Interest and dividends.................... $182,307 $121,112 $ 80,281 $86,882 $77,541
Premiums from loan dispositions........... 16,138 14,284 5,949 7,277 4,241
Post-merger gain on securitization of
commercial mortgage loans............... -- -- 14,812 -- --
Investment advisory fees and other
income.................................. 13,144 5,744 5,696 3,246 3,155
-------- -------- -------- ------- -------
Total interest and related portfolio
income............................. 211,589 141,140 106,738 97,405 84,937
-------- -------- -------- ------- -------
Expenses:
Interest.................................. 57,412 34,860 20,694 26,952 20,298
Employee.................................. 19,842 16,136 11,829 10,258 8,774
Administrative............................ 15,435 12,350 11,921 8,970 8,289
Merger.................................... -- -- -- 5,159 --
-------- -------- -------- ------- -------
Total operating expenses............. 92,689 63,346 44,444 51,339 37,361
Formula and cut-off awards(1)............. 6,183 6,753 7,049 -- --
-------- -------- -------- ------- -------
Portfolio income before net realized and
unrealized gains........................ 112,717 71,041 55,245 46,066 47,576
-------- -------- -------- ------- -------
Net realized and unrealized gains:
Net realized gains........................ 15,523 25,391 22,541 10,704 19,155
Net unrealized gains (losses)............. 14,861 2,138 1,079 7,209 (7,412)
-------- -------- -------- ------- -------
Total net realized and unrealized
gains.............................. 30,384 27,529 23,620 17,913 11,743
-------- -------- -------- ------- -------
Income before minority interests and income
taxes....................................... 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.................................. $143,101 $ 98,570 $ 78,078 $61,304 $54,947
======== ======== ======== ======= =======

YEAR ENDED DECEMBER 31,
-----------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------

PER SHARE:
Basic earnings per common share....... $ 1.95 $ 1.64 $ 1.50 $ 1.24 $ 1.19
Diluted earnings per common share..... $ 1.94 $ 1.64 $ 1.50 $ 1.24 $ 1.17
Dividends per common share(2)......... $ 1.82 $ 1.60 $ 1.43 $ 1.71 $ 1.23
Weighted average common shares
outstanding - basic(3).............. 73,165 59,877 51,941 49,218 46,172
Weighted average common shares
outstanding - diluted(3)............ 73,472 60,044 51,974 49,251 46,733

5
16

AT DECEMBER 31,
--------------------------------------------------------
(IN THOUSANDS, 2000 1999 1998 1997 1996
EXCEPT PER SHARE DATA) ---------- ---------- -------- -------- --------

BALANCE SHEET DATA:
Portfolio at value............ $1,788,001 $1,228,497 $807,119 $703,331 $612,411
Portfolio at cost............. 1,765,895 1,222,901 803,479 697,030 618,319
Total assets.................. 1,853,817 1,290,038 856,079 807,775 713,360
Total debt outstanding(4)..... 786,648 592,850 334,350 347,663 274,997
Preferred stock issued to
SBA(4)...................... 7,000 7,000 7,000 7,000 7,000
Shareholders' equity.......... 1,029,692 667,513 491,358 420,060 402,134
Shareholders' equity per
common share (NAV).......... $ 12.11 $ 10.20 $ 8.79 $ 8.07 $ 8.34
Common shares outstanding at
period end(3)............... 85,057 65,414 55,919 52,047 48,238

YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- -------- -------- --------

OTHER DATA:
New portfolio investments..... $ 901,545 $ 751,871 $524,530 $364,942 $283,295
Loan repayments............... 154,112 145,706 138,081 233,005 179,292
Loan sales(5)................. 280,244 198,368 81,013 53,912 27,715
Realized gains................ 28,604 31,536 25,757 15,804 30,417
Realized losses............... (13,081) (6,145) (3,216) (5,100) (11,262)

-------------------------
(1) 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."

(2) 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.

(3) Excludes 234,977, 516,779 and 810,456 common shares held in the deferred
compensation trust at or for the year ended December 31, 2000, 1999 and
1998, respectively.

(4) See "Senior Securities" on page 28 for more information regarding the
Company's level of indebtedness.

(5) 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."
6
17

2000 1999
------------------------------------- -------------------------------------
(IN THOUSANDS, QTR 4 QTR 3 QTR 2 QTR 1 QTR 4 QTR 3 QTR 2 QTR 1
EXCEPT PER SHARE DATA) ------- ------- ------- ------- ------- ------- ------- -------

QUARTERLY DATA:
Total interest and related portfolio
income............................ $61,735 $55,992 $49,965 $43,897 $42,278 $37,998 $33,186 $27,678
Portfolio income before net realized
and unrealized gains.............. 34,725 30,719 24,700 22,573 21,319 19,273 16,619 13,830
Net increase in net assets resulting
from operations................... 42,281 36,449 34,790 29,581 30,925 26,944 22,121 18,580
Basic earnings per common share..... $ 0.52 $ 0.48 $ 0.50 $ 0.45 $ 0.49 $ 0.44 $ 0.38 $ 0.33
Diluted earnings per common share... 0.52 0.48 0.50 0.45 0.49 0.44 0.38 0.33
Net asset value per common
share(1).......................... 12.11 11.56 10.96 10.44 10.20 9.66 9.17 9.00
Dividends declared per common
share............................. 0.46 0.46 0.45 0.45 0.40 0.40 0.40 0.40

-------------------------
(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
ADDITIONAL INFORMATION

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
202-942-8090 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 Nasdaq Stock Market, 1735 K Street, NW, Washington,
DC 20006.
7
18

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 the Company's 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.

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.

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.

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.

8
19

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, our Board of
Directors estimates the fair value of these loans and equity securities 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 loans and equity securities may differ significantly
from the values that would be placed on the portfolio if there existed a ready
market for the loans and equity securities. We adjust quarterly the valuation of
our portfolio to reflect the Board of Directors' estimate of the current
realizable 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 December 31, 2000, the Company had $786.6 million of outstanding
indebtedness, bearing a weighted annual interest cost of 8.3%. In order for us
to cover these annual interest payments on indebtedness, we must achieve annual
returns on our December 31, 2000 portfolio of at least 3.4%.

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

9
20

calculations in the table below are hypothetical and actual returns may be
higher or lower than those appearing below.

ASSUMED RETURN ON THE COMPANY'S PORTFOLIO
(NET OF EXPENSES)

-20% -10% -5% 0% 5% 10% 20%
------ ------ ------ ----- ---- ----- -----

Corresponding return to
shareholder(1)............. -42.4% -24.4% -15.4% -6.4% 2.6% 11.6% 29.6%

-------------------------
(1) The calculation assumes (i) $1,853.8 million in total assets, (ii) an
average cost of funds of 8.3%, (iii) $786.6 million in debt outstanding and
(iv) $1,029.7 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 December 31, 2000, our asset coverage for
indebtedness was 245%.

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

10
21

effect on the value of the Company's common stock. In addition, as a business
development company ("BDC"), we are generally required to maintain a ratio of at
least 200% of total assets to total borrowings, which may restrict our ability
to borrow in certain circumstances.

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.

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 pass-through tax treatment.
If the Company fails 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. The Company would cease to qualify for
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.

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, 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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22

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

Our Company 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 three regional offices in New York, Chicago and San Francisco. 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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24

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

Our common stock is traded on the Nasdaq National Market under the symbol
"ALLC." The following table lists the high and low closing sales prices for the
Company's common stock. The stock quotations are interdealer quotations and do
not include markups, markdowns or commissions. On March 30, 2001, the last
reported closing sale price of the common stock was $20.13 per share.

CLOSING SALE PRICE
------------------
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.................................. $24.938 $20.125

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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25

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information contained in this section should be read in conjunction
with the Selected Consolidated Financial Data and the Company's 2000
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 December 31, 2000, 1999 and 1998 was
as follows:

2000 1999 1998
---- ---- ----

Private Finance............................................. 72% 53% 48%
Commercial Real Estate Finance.............................. 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
investment portfolio multiplied by the weighted average yield on the 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 years
ended December 31, 2000, 1999 and 1998 were as follows:

($ IN MILLIONS) 2000 1999 1998
--------------- -------- -------- ------

Portfolio at Value.......................... $1,788.0 $1,228.5 $807.1
New Investments............................. $ 901.5 $ 751.9 $524.5
Repayments.................................. $ 154.1 $ 145.7 $138.0
Sales....................................... $ 280.2 $ 198.4 $304.4
Yield....................................... 14.1% 13.0% 12.5%

PRIVATE FINANCE

Private finance investment 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........................... $1,282.5 $647.0 $388.6
New Investments.............................. $ 600.9 $346.7 $236.0
Repayments................................... $ 117.7 $ 87.5 $ 41.3
Yield........................................ 14.6% 14.2% 14.6%

15
26

The private finance portfolio increased 98% and 67% during the years ended
December 31, 2000 and 1999, respectively. 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:

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%.

In addition to the Company's core private finance investment activity, the
Company acquired 95% of BLC Financial Services, Inc. in a "going private" buyout
transaction for $95.2 million on December 31, 2000. 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. The new portfolio company has changed its name
to Business Loan Express, Inc. ("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
million and consisted of $75 million of 25% subordinated debt, $25 million of
preferred stock, and $104 million of common stock. In addition, the Company has
entered into a management contract with BLX to provide management services,
including certain technology and transition services. The Company's investment
in BLX is included in the private finance portfolio.

BLX is a non-bank small business lender licensed as a participant in the
SBA 7(a) Guaranteed Loan Program. BLX is headquartered in New York City, has 22
offices throughout the country and is an SBA-designated Preferred Lender in 64
markets.

During the second quarter of 2000, the Company began an initiative to
invest in and strategically partner with select private equity funds focused on
investments in technology and the new economy. 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 technology investing through a diverse pooled
investment portfolio. The

16
27

fund concept allows the Company to participate in a pooled investment return
without exposure to the risk of any single technology investment. During 2000,
the Company committed a total of $41.5 million to seven private equity funds.
The committed amount is expected to be invested over the next three years. The
Company funded $7.0 million of this commitment during 2000.

COMMERCIAL REAL ESTATE FINANCE

Commercial real estate finance investment 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............................. $505.5 $520.0 $355.0
New Investments................................ $149.0 $288.7 $214.6
Repayments..................................... $ 24.8 $ 51.5 $ 92.5
Sales.......................................... $151.7 $ 86.1 $256.9
Yield.......................................... 13.1% 12.3% 10.4%

The commercial real estate finance portfolio 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 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 fully
secured by commercial mortgage loans. The Company opportunistically purchased
CMBS throughout 1999 and 2000. 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 average discount of 50% from the face
amount of the bonds. During 2000, the Company purchased $124.3 million in CMBS
with a face amount of $244.6 million and a weighted average yield to maturity of
14.7% after assuming a 1% loss rate on the underlying collateral mortgage pool.
In 1999, the Company purchased $245.9 million in CMBS with a face amount of
$507.9 million and a weighted average yield to maturity of 14.6% after assuming
a 1% loss rate on the underlying collateral mortgage pool.

As part of the Company's strategy to maximize its return on equity capital,
during the fourth quarter of 2000 the Company sold $98.7 million of CMBS bonds
rated BB+, BB and BB-. These bonds had an effective yield of 11.5%, and were
sold for $102.5 million, resulting in a realized gain on the sale. The sale of
these bonds increased the Company's overall liquidity and raised the yield on
the Company's remaining purchased CMBS portfolio to 15.4%, after assuming a 1%
loss on the entire underlying mortgage loan pool. At December 31, 2000, the
value of the purchased CMBS portfolio was $311.3 million and the unamortized
discount was $364.9 million.

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28

The original principal balance of the underlying pool of the approximately
2,600 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%.......................................... $ 1,535.0 12%
60-65%................................................. 961.8 8%
65-70%................................................. 2,050.9 16%
70-75%................................................. 4,247.0 33%
75-80%................................................. 3,727.4 29%
Greater than 80%....................................... 212.4 2%
--------- ---
$12,734.5 100%
========= ===
Weighted average LTV................................... 71.0%

DEBT SERVICE COVERAGE
RATIO RANGES $ %
--------------------- --------- ---
($ IN
MILLIONS)

Greater than 2.00...................................... $ 465.5 4%
1.76-2.00.............................................. 433.0 3%
1.51-1.75.............................................. 1,487.6 12%
1.26-1.50.............................................. 7,172.2 56%
1.00-1.25.............................................. 3,176.2 25%
--------- ---
$12,734.5 100%
========= ===
Weighted average DSCR.................................. 1.31

The Company has been liquidating much of its whole commercial mortgage loan
portfolio so that it can redeploy the proceeds into higher yielding assets. For
the year ended December 31, 2000, the Company sold $53.1 million of commercial
mortgage loans.

At December 31, 2000, the Company's whole commercial loan portfolio had
been reduced to $106.4 million from $154.1 million at December 31, 1999. During
1999, the Company sold $86.1 million of commercial mortgage loans.

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.

SMALL BUSINESS FINANCE

As discussed above in the Private Finance section, the Company established
its Allied Capital Express operations as an independently managed private
portfolio company at the end of 2000 and these operations are now included in
the private finance portfolio.

During the second quarter of 1999, the Company combined its whole
commercial real estate loan origination activity with its SBA 7(a) lending
activity in order to increase its loans originated for sale business under the
Allied Capital Express brand name. Through Allied Capital Express, the Company
provided small business and commercial real estate loans up to $3 million. The
majority of the loans originated in this area were originated for sale,
generally at premiums of up to 10% of the loan amount.

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29

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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30

RESULTS OF OPERATIONS

COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

The following table summarizes Allied Capital'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%)
Investment advisory 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 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 related portfolio income includes premiums from
loan dispositions, prepayment premiums, and investment advisory fees and other
income.

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

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31

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 was completed in January 1998. Excluding the
1998 gain on sale, total interest and related portfolio income increased for the
year ended December 31, 1999 by 53% as compared to the year ended December 31,
1998. The proceeds of $238.4 million from this transaction were used to repay
outstanding debt.

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

21
32

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 and employee benefits. 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.

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.

The formula and cut-off awards totaled $6.2 million, $6.8 million and $7.0
million, or $0.08 per share, $0.11 per share and $0.14 per share, 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.

Net realized gains resulted from the sale of equity securities associated
with certain private finance investments, commercial mortgage loans and CMBS
bonds, and the realization of unamortized discount resulting from the sale and
early repayment of private finance and commercial mortgage loans, offset by
losses on investments. Realized gains

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33

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 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.

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34

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 negligible at 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 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.

24
35

In order to maintain its RIC status, the Company must, in general, (1)
derive at least 90% of its gross income from dividends, interest, gains from the
sale of securities and other specified types of income; (2) meet investment
diversification requirements as defined in the Code; and (3) distribute annually
to shareholders at least 90% of its investment company taxable ordinary income.
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 elect or qualify for such treatment in future years.

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 issuance of new shares and the issuance of
shares pursuant to a dividend reinvestment plan.

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 December 31, 2000, the Company had $2.4 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 December 31, 2000 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
payable........................ $ 544.0 $544.0 8.1% 2.3%
SBA debentures................... 87.3 78.3 8.3% 0.4%
Auction rate reset note.......... 76.6 76.6 8.6% 0.4%
OPIC loan........................ 5.7 5.7 6.6% 0.0%
-------- ------ ---- ----
Total notes payable and
debentures.............. $ 713.6 $704.6 8.2% 3.1%
-------- ------ ---- ----
Revolving credit facilities:
Revolving line of credit....... $ 417.5 $ 82.0 8.4% 3.7%
-------- ------ ---- ----
Total debt................ $1,131.1 $786.6 8.3% 3.4%
======== ====== ==== ====

-------------------------
(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
December 31, 2000 annualized cost of debt per class of financing divided by
total assets at December 31, 2000.

UNSECURED LONG-TERM NOTES PAYABLE. The Company has issued long-term debt
to institutional lenders, primarily insurance companies. The notes have five- or
seven-year maturities. The notes require payment of interest only semi-annually,
and all principal is due upon maturity.

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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 borrow up to $108.8 million from the SBA under the SBIC program. At December
31, 2000, the Company has a commitment to borrow up to an additional $9 million
from the SBA. The commitment expires on September 30, 2004.

AUCTION RATE RESET NOTE. The Company has a $75 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.

REVOLVING LINE OF CREDIT. The Company has a two-year, $417.5 million
unsecured revolving line of credit that expires in May 2002. This facility may
be expanded up to $500 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 2000, the Company raised $250.9 million in new
equity capital primarily through the sale of shares from its shelf registration
statement. The Company issues equity from time to time using a shelf
registration statement 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. In addition, the
Company issued $86.1 million of equity capital to purchase BLC Financial
Services, Inc. on December 31, 2000. At December 31, 2000, total shareholders'
equity had increased to $1.03 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 and second quarter of 2000, the Board declared a $0.45 per
common share dividend. For the third and fourth quarters of 2000, the Board
declared a dividend of $0.46 per common share. The Board declared a dividend of
$0.49 per common share for the first quarter of 2001.

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 in dividends in
any one year. The dividend policy also enables the Board to selectively retain
gains to support future growth.

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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 will utilize its short-term credit facilities only as a means to bridge
to long-term financing. The Company evaluates its interest rate exposure on an
ongoing basis. 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. To the extent deemed necessary, the
Company may hedge variable and short-term interest rate exposure through
interest rate swaps or other techniques. At December 31, 2000, the Company's
debt to equity ratio was less than 1 to 1 and weighted average cost of funds was
8.3%. 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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38

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
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
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

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39

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
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
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
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

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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
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
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
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

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-------------------------
(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, commercial mortgage-backed securities, and commercial
mortgage loans. At December 31, 2000, our investment portfolio totaled $1.8
billion. The Company's 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 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.

Our private financing is generally used to fund growth, buyouts, note
purchases, acquisitions, recapitalizations, 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 originate investments generally ranging in size from $5 million to $30
million, and for the year ended December 31, 2000 our average investment size
was $14.0 million. Our private finance 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 98% of the investments in the private finance
portfolio have fixed rates of interest. Our private finance 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 December 31, 2000, 75% of the private finance
portfolio consisted of debt securities, and 25% consisted of equity securities.
Our nationwide private finance portfolio includes investments in a wide variety
of industries, including business services, consumer products, education, light
industrial products and broadcasting.

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43

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

CAPITAL PROVIDER Banks Commercial Insurance Allied Private Private
Finance Companies/ Capital Mezzanine Equity
Companies High Yield Funds Funds
Market
-----------------------------------------------------------------------------------------------------
PRIMARY Senior, Asset-based Large Unsecured Unsecured Equity
BUSINESS short- term lending >$30 million long-term long-term
FOCUS debt credits debt with debt with
equity equity
upside upside
Preferred Preferred
and common and common
equity equity
-----------------------------------------------------------------------------------------------------
TYPICAL PRICING LIBOR+ [graphic of arrow stretching between 'LIBOR+' and 30%+
SPECTRUM* '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 insurance company 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 insurance company/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 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
non-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,

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44

though we will consider investments in any industry if the prospective company
demonstrates unique characteristics that make it an attractive investment
opportunity:

INDUSTRIES TARGETED
NON-CYCLICAL/CASH FLOW INTENSIVE/
HIGH RETURN ON CAPITAL
---------------------------------------
Business services
Education
Consumer products
Light industrial products
Broadcasting

INDUSTRIES NOT TARGETED
CYCLICAL/CAPITAL INTENSIVE/
LOW RETURN ON CAPITAL
---------------------------------------
Heavy manufacturing
Natural resources
Most retail
Low value-add distribution
Agriculture
Transportation
Construction

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 private 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 investments.
The typical private finance 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. With respect to
preferred or common equity investments, we target an investment return of 25% to
40%.

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,
during the second quarter of 2000 we made commitments to invest in select
technology-oriented private equity funds. In addition to the return we expect to
achieve from these

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45

investments, we believe we can achieve strategic benefits from these funds,
including technology expertise from private finance portfolio companies,
co-investment opportunities and increased dealflow. 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 investments. We continue to derive income from the interest
charged on the whole commercial mortgage loan portfolio through contractual
interest and amortization of discounts.

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

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46

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.

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 2,600 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 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 -- ALLIED CAPITAL EXPRESS

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 has 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 as $74.8 million in subordinated debt now owed by the new
portfolio company. Allied SBLC was subsequently merged into BLX and we received
approximately $25 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, directly and indirectly,
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

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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 22 offices nationwide, and
SBA Preferred Lender status in 64 markets. BLX believes it will be a technology
leader in online small business loan origination, and will have significant
online loan origination relationships as well as solid core broker relationships
in the small business community. BLX is licensed by the SBA as a Small Business
Lending Company ("SBLC"), and therefore, changes in the laws or regulations that
govern SBLCs could have a material impact on BLX or its operations.

INVESTMENT ADVISORY SERVICES

We are a registered investment adviser, pursuant to the Investment Advisers
Act of 1940, and have certain investment advisory agreements to manage private
investment funds. The revenue generated from these agreements is not material to
the Company's operations.

LOAN SOURCING

Over the last two years, we have significantly increased the scope of our
sales and marketing activity by opening new regional offices and increasing our
sales and marketing staff. To source new investment opportunities, we work with
thousands of 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

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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.

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 eleven 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 new 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;

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- borrower inquiries;

- escrow analysis and processing;

- third-party reporting; and

- insurance and tax administration.

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 December 31,
2000 as follows:

PERCENTAGE
PORTFOLIO AT OF TOTAL
GRADE DESCRIPTION VALUE PORTFOLIO
----- ----------- ------------- ----------
(IN MILLIONS)

1 Probable capital gain $ 208.3 11.7%
2 Performing security 1,461.7 81.7%
Close monitoring -- no loss of principal or interest
3 expected 15.4 0.9%
4 Workout -- Some loss of interest expected 76.0 4.2%
5 Workout -- Some loss of principal expected 26.6 1.5%
-------- ------
$1,788.0 100.0%
======== ======

The 1940 Act requires that the Board of Directors value each asset in the
portfolio on a quarterly basis. 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, current
collateral values and determine whether the value of the 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

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professionals closely monitor the status and performance of each individual
investment throughout each quarter. Through the process, investments that may
require closer monitoring are generally detected early, and for each such
investment, an appropriate course of action is determined. For the private
finance portfolio, loan delinquencies or payment default is not necessarily an
indication of credit quality or the need to pursue active workout of a portfolio
investment. Because we are a provider of long-term privately negotiated
investment capital, it is not atypical for us to defer payment of principal or
interest from time to time. As a result, the amount of our private finance
portfolio that is delinquent may vary. The terms of our private finance
agreements frequently provide an opportunity for our portfolio companies to
restructure their debt and equity capital. During such restructuring, we may not
receive or accrue interest or dividend payments. Our senior investment
professionals actively work with the portfolio company in these instances to
negotiate an appropriate course of action.

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. 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).

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.

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

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minimal losses. Our realized gains from the sale of our equity interests have
historically exceeded losses, as is reflected in the chart below.

YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- -------- -------- --------

Realized gains....................... $ 28,604 $ 31,536 $ 25,757 $ 15,804 $ 30,417
Realized losses...................... $ (13,081) $ (6,145) $ (3,216) $ (5,100) $(11,262)
Net realized gains................... $ 15,523 $ 25,391 $ 22,541 $ 10,704 $ 19,155
Total assets......................... $1,853,817 $1,290,038 $856,079 $807,775 $713,360
Realized losses/ Total assets........ 0.7% 0.5% 0.4% 0.6% 1.6%

EMPLOYEES

At December 31, 2000, we employed 97 individuals including investment and
portfolio management professionals, operations professionals and administrative
staff. The majority of these individuals are located in the Washington, DC
office. As part of the BLC merger, 37 Allied Capital employees were transferred
to BLX as full-time employees of the new portfolio company. We believe that our
relations with our employees are excellent.

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 December 31, 2000. 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 general terms of our loans to
portfolio companies, see the Consolidated Statement of Investments at December
31, 2000 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 4.9%
75 Route 17 South Retailer 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 A Preferred 40.8%
11701 East 53rd Ave. Provider Stock
Denver, CO 80239 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
Avborne, Inc. .................. Aviation Services Warrants to Purchase 3.5%
c/o Trivest, Inc. Company Common Stock
2665 S. Bayshore Dr., Suite
800
Miami, FL 33133-5462
Border Foods, Inc. ............. Mexican Ingredient & Series A Convertible 9.4%
J Street Deming Food Product Preferred Stock
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
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

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Colibri Holding Corporation..... Outdoor Living Product Common Stock 3.4%
2201 S. Walbash Street Retailer Warrants to Purchase 2.0%
Denver, CO 80231 Common Stock
Component Hardware Group,
Inc. ......................... Designer & Developer 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 25.2%
P.O. Box 1477 Common Stock
Seagraves, TX 79360
CorrFlex Graphics, LLC.......... Packaging Manufacturer Warrants to Purchase 4.8%
P.O. Box 1337 Common Stock
Monroe, NC 28110 Options to Purchase 1.0%
Common Stock
Cosmetic Manufacturing.......... Cosmetic Manufacturer Options to Purchase 22.5%
Resources, LLC Shares
11312 Penrose Street
Sun Valley, CA 91352
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 Bekescasba
Bekis: vt 52-54 Hungary
CyberRep.coM.................... Operator of Call Service Warrants to Purchase 22.5%
Centers
8300 Greensboro Drive, 6th
Floor Common Stock
McLean, VA 22102
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 44.8%
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
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
ExTerra Credit Recovery,
Inc. ......................... Consumer Finance Preferred Stock 0.9%
35 Lennon Lane, Suite 200 Common Stock 0.7%
Walnut Creek, CA 94598 Warrants to Purchase 0.7%
Common Stock

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Executive Greetings, Inc. ...... Personalized Business Warrants to Purchase 1.5%
120 Industrial Park Access
Road Products Common Stock
New Hartford, CT 06057
Fairchild Industrial Products
Company....................... Industrial Controls Warrants to Purchase 20.0%
3920 Westpoint Boulevard Manufacturer Common Stock
Winston-Salem, NC 27013
FTI Consulting, Inc. ........... Litigation Support Warrants to Purchase 4.4%
2021 Research Drive Services Common Stock
Annapolis, MD 21401
Galaxy American Communications,
LLC........................... Cable Television Warrants to Purchase 6.0%
1220 N. Main Street Operator Common Stock
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.... Communications and Preferred Equity 59.3%
201 East 69th Street Media Businesses 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, LP......... Private Equity Fund Limited Partnership 3.1%
c/o Gntech Capital Group Interest
9690 Deereco Road
Suite 800
Timonium, MD 21093
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 Common Stock 24.0%
2812 Trinity Square Drive Administrator Class A Preferred 70.0%
Carrollton, TX 75006 Stock
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
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 Series A Preferred Stock 3.5%
281 Tressor Boulevard Services Series B Preferred Stock 3.5%
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

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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. .......... Cord Manufacturer Warrants to Purchase 45.0%
387 Church Street Common Stock
New Bedford, MA 02745
Kirker Enterprises, Inc. ....... Nail Enamel Warrants to Purchase 22.5%
55 East 6th Street Manufacturer Common Stock
Paterson, NJ 07524 Equity Interest in 5.0%
Affiliate Company
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 21.2%
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
Master Plan, Inc. .............. Healthcare Outsourcing Common Stock 13.6%
21540 Plummer Street
Chatsworth, CA 91311
MedAssets.com, Inc. ............ Healthcare Outsourcing Series B Convertible 8.5%
21540 Plummer Street Preferred Stock
Chatsworth, CA 91311 Warrants to Purchase 5.3%
Preferred Stock
Mid-Atlantic Venture Fund IV,
L.P........................... Private Equity Fund Limited Partnership 9.7%
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
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 Originator Stock
Horsham, PA 19044
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 Service Common Stock
Suite 300
Jupiter, FL 33477

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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 Convertible Debentures 26.9%
1733 Gunn Highway Manufacturer
Odessa, FL 33556
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 5.5%
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, Nebraska 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 Common Stock
Suite 500 Warrants to Purchase 4.0%
Roswell, GA 30076 Preferred 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
PF.Net Communications, Inc. .... Fiber Optic Network Warrants to Purchase 0.6%
677 Washington Blvd. Common Stock
Stamford, CT 06912
Physicians Specialty
Corporation................... Physician Management Redeemable Preferred 3.1%
1150 Lake Hearn Drive Services Provider Stock
Atlanta, GA 30342 Convertible Preferred 3.0%
Stock
Warrants to Purchase 1.9%
Common Stock
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 Common Stock 11.0%
3900 Joliet Street Series A-1 Senior 100.0%
Denver, CO 80239 Exchangeable Preferred
Stock
Progressive International
Corporation .................. Retail Kitchenware Common Stock 0.0%
6111 S. 228th Street Redeemable Preferred 12.5%
P.O. Box 97045 Stock
Kent, WA 98064 Warrants to Purchase 6.2%
Common Stock
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

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Soff-Cut Holdings, Inc.......... Concrete Sawing Common Stock 2.7%
1112 Olympic Drive Equipment Manufacturer Series A Preferred Stock 4.0%
Corona, CA 91719 Warrants to Purchase 6.7%
Common Stock
Southern Communications, LLC.... Communications Equity Interest 85.0%
1919 Pennsylvania Ave., NW Towers
Washington, D.C. 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
Sunsource Inc. ................. Wholesale Machinery and Warrants to Purchase 4.0%
One Logan Square Supplies Common Stock
Philadelphia, PA 19013
Sure-Tel, Inc. ................. Telephone Services Series A Convertible 41.7%
5 North McCormick Company Redeemable Preferred
Oklahoma City, OK 73127 Stock
Warrants to Purchase 9.6%
Common Stock
Total Foam, Inc. ............... Packaging Systems Common Stock 49.0%
P.O. Box 688
Ridgefield, CT 06877
Tubbs Snowshoe Company, LLC. ... Snowshoe Manufacturer Warrants to Purchase 7.7%
52 River Road Common Units
Stowe, VT 05672 Common Units of 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
Venturehouse Group, LLC......... Private Equity Fund Common Equity Interest 1.5%
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

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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 13.8%
69 North Locust Street Manufacturer Warrants to Purchase 7.2%
Lititz, PA 17543 Common Stock
Wyo-Tech Acquisition
Corporation................... Vocational School Common Stock 99.0%
4373 N. 3rd Street Preferred Stock 100.0%
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 above cost, 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 investment 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
or market liquidity concerns.

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.

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MANAGEMENT

The Board of Directors supervises the management of our 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. 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 comprised 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 Company's 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.

DIRECTORS

Information regarding the board of directors is as follows:

DIRECTOR EXPIRATION
NAME AGE POSITION SINCE(1) OF TERM
---- --- -------- -------- ----------

William L. Walton*........... 51 Chairman, Chief Executive
Officer and President 1986 2001
George C. Williams, Jr.*..... 74 Chairman Emeritus 1964 2001
Brooks H. Browne............. 51 Director 1990 2001
John D. Firestone............ 57 Director 1993 2002
Anthony T. Garcia............ 44 Director 1991 2002
Lawrence I. Hebert........... 54 Director 1989 2002
John I. Leahy................ 70 Director 1994 2003
Robert E. Long............... 69 Director 1972 2001
Warren K. Montouri........... 71 Director 1986 2003
Guy T. Steuart II............ 69 Director 1984 2003
T. Murray Toomey, Esq........ 77 Director 1959 2003
Laura W. van Roijen.......... 48 Director 1992 2002

---------------
* Interested persons of the Company, as defined in the 1940 Act.

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

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EXECUTIVE OFFICERS

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

NAME AGE POSITION
---- --- --------

William L. Walton............ 51 Chairman, Chief Executive Officer and President
Joan M. Sweeney.............. 41 Managing Director and Chief Operating Officer
Scott S. Binder.............. 46 Managing Director
Samuel B. Guren.............. 54 Managing Director
Philip A. McNeill............ 41 Managing Director
John M. Scheurer............. 48 Managing Director
Thomas H. Westbrook.......... 37 Managing Director
G. Cabell Williams, III ..... 46 Managing Director
Penni F. Roll................ 35 Executive Vice President and Chief Financial
Officer

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
(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 in the emerging education industry (1992-1996).
Mr. Walton is a director of Nobel Learning Communities, Inc. and Riggs National
Corporation. He received both a B.A. and a M.B.A. from Indiana University.

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.

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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); 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. Herbert 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.

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

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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, Managing Director and 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.

Scott S. Binder, Managing Director, has worked with the Company since 1991
and is responsible for the Company's telecommunications and broadcasting/cable
investments within the private finance group. 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 in the Company's private finance group. Before joining the Company,
he served as a vice president of M&T Capital Corporation. Prior to entering the
private finance industry, he was founding director of Western Oklahoma National
Bank, and structured and managed numerous privately negotiated investments.

John M. Scheurer, Managing Director, has been employed by the Company since
1991 and manages the Company's 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 the Company's business services investments within
the 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.

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Penni F. Roll, Executive Vice President and 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.

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, Managing Director and 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.

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.

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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. The Committee determines the amount and features of the stock
options, if any, to be awarded to optionees. The Committee evaluates a number of
criteria, including the past service of each such optionee to the Company, the
present and potential contributions of such optionee to the success of the
Company and such other factors as the Committee shall deem relevant in
connection with accomplishing the purposes of the Stock Option Plan, including
the recipient's current stock holdings, years of service, position with the
Company and other factors. The Committee does not apply a formula assigning
specific weights to any of these factors when making its determination. The
Committee awards stock options on a subjective basis and such awards depend in
each case on the performance of the officer under consideration.

For the year ended, December 31, 2000, a total of 4,162,112 options 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.

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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. 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.

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 years ended December
31, 2000, 1999 and 1998 totaled $0.5 million, $0.6 million and $0.8 million,
respectively. 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 (i.e., employees with one (1) year of service), 5% of each
participant's total cash compensation for the year, up to $170,000, to each
participant's plan account on the participant's behalf, which fully vests at the
time of contribution. The contribution with respect to compensation in excess of
$170,000 is made

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to the Deferred Compensation Plan. On March 16, 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"). The Deferred Compensation Plan is a funded plan that
provides for the deferral of compensation by employees and consultants of the
Company. Any employee or consultant of the Company is 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 financial institutions. This
summary does not discuss any aspects of U.S. estate and gift tax or foreign,
state or local tax. It does not discuss the special treatment under federal
income tax laws that could result if the Company invested in tax-exempt
securities or certain other investment assets.

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" generally 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.

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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
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 or more than 10% of the outstanding voting securities
of the issuer, and (ii) no more than 25% of the value of the Company's assets is
invested in the securities (other than U.S. government securities or securities
of other RICs) of one issuer or of two or more issuers that are controlled (as
determined under applicable Code rules) by the Company and are engaged in the
same or similar or related trades or businesses (the "Diversification Tests").
The failure of one or more of the Company's subsidiaries to continue to qualify
as RICs could adversely affect the Company's ability to satisfy the
Diversification Tests.

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

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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 taxable income, regardless of whether it makes
any distributions to its stockholders. In that case, all of the Company's
distributions to its stockholders will be characterized as ordinary income (to
the extent of the Company's current and accumulated earnings and profits). In
contrast, as is explained below, if the Company qualifies as a RIC, a portion of
its distributions or deemed distributions may be characterized as long-term
capital gain in the hands of stockholders.

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.
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

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zero, will constitute capital gains to such stockholder. For a summary of the
tax rates applicable to capital gains, including capital gain dividends, see the
discussion below.

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 will exceed the amount of tax that such stockholders
would be required to pay on the retained net capital gains. A stockholder that
is not subject to U.S. federal income tax or tax on long-term capital gains
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 forthcoming distribution, you may be taxed upon receipt of the distribution
and will not be entitled to offset the distribution against the tax basis in
your common stock.

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 of 20% (subject to reduction in certain situations) 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

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common stock), while other income may be taxed at rates as high as 39.6%.
Corporate taxpayers currently are subject to federal income tax on net capital
gain at the maximum 35% rate also 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 and withholding tax, and state,
local, and foreign tax, consequences of an investment in the common stock.

The Company may be required to withhold U.S. federal income tax at a rate
of 31% ("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.

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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 investments 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

(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. 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

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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 and 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) 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.

(2) 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 one issuer,
or of two or more issuers that are controlled by the Company.

(3) Distribute at least 90% of its "investment company taxable income" each
tax year to its shareholders. In addition, if a RIC distributes in a
timely 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 $108.8 million.

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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 $78.3 million of subordinated debentures and $7.0
million of preferred stock from the SBA at December 31, 2000; as a result of the
$108.8 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 8.3%.

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 nominee, to the record holder by or under the
discretion of the plan agent. The plan agent is American Stock Transfer and
Trust Company, 59 Maiden Lane, New York, New York 10038. Their telephone number
is 800-937-5449.

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 March 30, 2001, there were 85,877,875 shares of common stock outstanding
and 11,674,084 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 March 30, 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 0 85,877,875

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 of the Company 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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outweigh the potential disadvantages of discouraging such proposals because,
among other things, negotiation of such proposals might result in an improvement
of their terms. The description set forth below is intended as a summary only
and is qualified in its entirety by reference to the charter and the bylaws.

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-fifth 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 $310,500,000 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 Nasdaq National Market, 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.

68
79

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
AND REGISTRAR

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. LaSalle
National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk Grove
Village, Illinois 60007, serves as trustee with respect to assets of the Company
held for securitization purposes. 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 financial statements included in this prospectus and elsewhere in the
registration statement to the extent and for the periods indicated in their
report have been audited by Arthur Andersen LLP, independent public accountants,
and is included herein in reliance upon the authority of said firm as experts in
giving said report.

69
80

TABLE OF CONTENTS OF
STATEMENT OF ADDITIONAL INFORMATION

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

70
81

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO FINANCIAL STATEMENTS

PAGE
----

Consolidated Balance Sheet -- December 31, 2000 and 1999.... F-1
Consolidated Statement of Operations -- For the Years Ended
December 31, 2000, 1999
and 1998.................................................. F-2
Consolidated Statement of Changes in Net Assets -- For the
Years Ended December 31, 2000, 1999 and 1998.............. F-3
Consolidated Statement of Cash Flows -- For the Years Ended
December 31, 2000, 1999 and 1998.......................... F-4
Consolidated Statement of Investments -- December 31,
2000...................................................... F-5
Notes to Consolidated Financial Statements.................. F-13
Report of Independent Public Accountants.................... F-35

71
82

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

DECEMBER 31,
--------------------------
2000 1999
(IN THOUSANDS, EXCEPT NUMBER OF SHARE AMOUNTS) ------------- ----------

ASSETS
Portfolio at value:
Private finance (cost: 2000-$1,262,529;
1999-$639,171)....................................... $1,282,467 $ 647,040
Commercial real estate finance (cost: 2000-$503,366;
1999-$522,022)....................................... 505,534 520,029
Small business finance (cost: 2000-$0;
1999-$61,708)........................................ -- 61,428
---------- ----------
Total portfolio at value.......................... 1,788,001 1,228,497
---------- ----------
Cash and cash equivalents................................... 2,449 18,155
Other assets................................................ 63,367 43,386
---------- ----------
Total assets...................................... $1,853,817 $1,290,038
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable and debentures.......................... $ 704,648 $ 487,350
Revolving credit facilities........................... 82,000 105,500
Accounts payable and other liabilities................ 30,477 22,675
---------- ----------
Total liabilities................................. 817,125 615,525
---------- ----------
Commitments and Contingencies
Preferred stock............................................. 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 200,000,000 shares
authorized; 85,291,696 and 65,930,360 issued and
outstanding at December 31, 2000 and 1999,
respectively......................................... 9 7
Additional paid-in capital............................ 1,043,653 699,148
Common stock held in deferred compensation trust
(234,977 shares and 516,779 shares at December 31,
2000 and 1999, respectively)......................... -- (6,218)
Notes receivable from sale of common stock............ (25,083) (29,461)
Net unrealized appreciation on portfolio.............. 19,378 4,517
Distributions in excess of earnings................... (8,265) (480)
---------- ----------
Total shareholders' equity........................ 1,029,692 667,513
---------- ----------
Total liabilities and shareholders' equity........ $1,853,817 $1,290,038
========== ==========

The accompanying notes are an integral part of these consolidated financial
statements.
F-1
83

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE YEARS ENDED
DECEMBER 31,
------------------------------
2000 1999 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -------- -------- --------

Interest and related portfolio income:
Interest and dividends................................ $182,307 $121,112 $ 80,281
Premiums from loan dispositions....................... 16,138 14,284 5,949
Post-Merger gain on securitization of commercial
mortgage loans...................................... -- -- 14,812
Investment advisory fees and other income............. 13,144 5,744 5,696
-------- -------- --------
Total interest and related portfolio income....... 211,589 141,140 106,738
-------- -------- --------
Expenses:
Interest.............................................. 57,412 34,860 20,694
Employee.............................................. 19,842 16,136 11,829
Administrative........................................ 15,435 12,350 11,921
-------- -------- --------
Total operating expenses.......................... 92,689 63,346 44,444
-------- -------- --------
Formula and cut-off awards............................ 6,183 6,753 7,049
-------- -------- --------
Net operating income before net realized and unrealized
gains..................................................... 112,717 71,041 55,245
-------- -------- --------
Net realized and unrealized gains:
Net realized gains.................................... 15,523 25,391 22,541
Net unrealized gains.................................. 14,861 2,138 1,079
-------- -------- --------
Total net realized and unrealized gains........... 30,384 27,529 23,620
-------- -------- --------
Net income before income taxes.............................. 143,101 98,570 78,865
-------- -------- --------
Income tax expense.......................................... -- -- 787
-------- -------- --------
Net increase in net assets resulting from operations........ $143,101 $ 98,570 $ 78,078
======== ======== ========
Basic earnings per common share............................. $ 1.95 $ 1.64 $ 1.50
======== ======== ========
Diluted earnings per common share........................... $ 1.94 $ 1.64 $ 1.50
======== ======== ========
Weighted average common shares
outstanding -- basic...................................... 73,165 59,877 51,941
======== ======== ========
Weighted average common shares
outstanding -- diluted.................................... 73,472 60,044 51,974
======== ======== ========

The accompanying notes are an integral part of these consolidated financial
statements.
F-2
84

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ---------- -------- --------

Operations:
Net operating income before realized and unrealized
gains.............................................. $ 112,717 $ 71,041 $ 55,245
Net realized gains................................... 15,523 25,391 22,541
Net unrealized gains................................. 14,861 2,138 1,079
Income tax expense................................... -- -- (787)
---------- -------- --------
Net increase in net assets resulting from
operations................................... 143,101 98,570 78,078
---------- -------- --------
Shareholder distributions:
Common stock dividends............................... (135,795) (97,941) (75,087)
Preferred stock dividends............................ (230) (230) (230)
---------- -------- --------
Net decrease in net assets resulting from
shareholder distributions.................... (136,025) (98,171) (75,317)
---------- -------- --------
Capital share transactions:
Sale of common stock................................. 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............................................ 3,309 5,920 221
Issuance of common stock in lieu of cash
distributions...................................... 4,773 4,610 6,184
Net decrease (increase) in notes receivable from sale
of common stock.................................... 4,378 (5,725) 5,576
Net decrease (increase) in common stock held in
deferred compensation trust........................ 6,218 6,972 (13,190)
Other................................................ (563) (290) 71
---------- -------- --------
Net increase in net assets resulting from
capital share transactions................... 355,103 175,756 68,537
---------- -------- --------
Total increase in net assets.................... $ 362,179 $176,155 $ 71,298
========== ======== ========
Net assets at beginning of year........................... $ 667,513 $491,358 $420,060
---------- -------- --------
Net assets at end of year................................. $1,029,692 $667,513 $491,358
---------- -------- --------
Net asset value per common share.......................... $ 12.11 $ 10.20 $ 8.79
---------- -------- --------
Common shares outstanding at end of year.................. 85,057 65,414 55,919
========== ======== ========

The accompanying notes are an integral part of these consolidated financial
statements.
F-3
85

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2000 1999 1998
(IN THOUSANDS) --------- --------- ---------

Cash flows from operating activities:
Net increase in net assets resulting from
operations......................................... $ 143,101 $ 98,570 $ 78,078
Adjustments
Net unrealized gains............................... (14,861) (2,138) (1,079)
Post-Merger gain on securitization of commercial
mortgages........................................ -- -- (14,812)
Depreciation and amortization...................... 925 788 702
Amortization of loan discounts and fees............ (10,101) (10,674) (6,032)
Changes in other assets and liabilities............ 2,036 (8,712) 11,998
--------- --------- ---------
Net cash provided by operating
activities.................................... 121,100 77,834 68,855
--------- --------- ---------
Cash flows from investing activities:
Portfolio investments................................. (889,251) (751,871) (524,530)
Repayments of investment principal.................... 154,112 145,706 138,081
Proceeds from loan sales.............................. 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............................ 1,417 (1,754) (2,539)
--------- --------- ---------
Net cash used in investing activities............ (453,478) (409,551) (73,483)
--------- --------- ---------
Cash flows from financing activities:
Sale of common stock.................................. 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.............................................. 6,363 195 5,591
Common dividends and distributions paid............... (131,022) (95,031) (69,536)
Special undistributed earnings distribution paid...... -- -- (8,848)
Preferred stock dividends paid........................ (230) (230) (450)
Net borrowings under (payments on) notes payable and
debentures......................................... 217,298 254,000 (69,471)
Net borrowings under (payments on) revolving lines of
credit............................................. (23,500) 4,500 56,158
Other financing activities............................ (3,149) (2,906) (4,643)
--------- --------- ---------
Net cash provided by (used in) financing
activities.................................... 316,672 324,797 (40,734)
--------- --------- ---------
Net decrease in cash and cash equivalents............... $ (15,706) $ (6,920) $ (45,362)
--------- --------- ---------
Cash and cash equivalents at beginning of year.......... $ 18,155 $ 25,075 $ 70,437
--------- --------- ---------
Cash and cash equivalents at end of year................ $ 2,449 $ 18,155 $ 25,075
========= ========= =========

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

F-4
86

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
Series A Preferred Stock (1,860 shares) 1,860 1,860
Series A 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
Series A Convertible 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
---------------------------------------------------------------------------------------------------------------
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
Class A 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 Series A Preferred Stock (31,521 shares) 334 --
Warrants -- --
---------------------------------------------------------------------------------------------------------------

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

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

F-5
87

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.coM 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 Series A Common Stock (34 shares) -- --
Series B Common Stock (6 shares) 8 --
Series C Common Stock (10 shares) 22 --
---------------------------------------------------------------------------------------------------------------
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. Series A 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
---------------------------------------------------------------------------------------------------------------
Galaxy American Debt Securities 33,399 33,399
Communications, LLC Warrants 500 1,250
---------------------------------------------------------------------------------------------------------------

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

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

F-6
88

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
Convertible 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
---------------------------------------------------------------------------------------------------------------
Global Vacation Group, Inc. Debt Securities 5,688 5,688
---------------------------------------------------------------------------------------------------------------
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. Series A Convertible Preferred Stock
(396,908 shares) 1,340 1,340
Series A 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. Class A Common Stock (12,114 shares) 1,142 1,423
Class C Common Stock (25,707 shares) 76 95
---------------------------------------------------------------------------------------------------------------
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 Series A 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
---------------------------------------------------------------------------------------------------------------

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

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

F-7
89

Julius Koch USA, Inc. Debt Securities $ 2,294 $ 2,294
Warrants 259 6,500
---------------------------------------------------------------------------------------------------------------
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 Series D 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. Series B Convertible
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. Class A Common Stock (800,000 shares) 4,000 4,000
---------------------------------------------------------------------------------------------------------------
Morton Grove Loan 15,356 15,356
Pharmaceuticals, Inc. Redeemable Convertible 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) Series D Convertible
Preferred Stock (265,957 shares) 2,000 2,000
Warrants 575 500
---------------------------------------------------------------------------------------------------------------
North American Loans 1,390 811
Archery, LLC Convertible 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
---------------------------------------------------------------------------------------------------------------

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

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

F-8
90

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
---------------------------------------------------------------------------------------------------------------
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
---------------------------------------------------------------------------------------------------------------
PF.Net Communications, Inc. Debt Securities 11,532 11,532
Warrants 3,540 3,540
---------------------------------------------------------------------------------------------------------------
Physicians Specialty Corporation Debt Securities 14,809 14,809
Redeemable Preferred
Stock (850 shares) 850 --
Convertible 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. Series A 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
---------------------------------------------------------------------------------------------------------------

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

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

F-9
91

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
---------------------------------------------------------------------------------------------------------------
Staffing Partners Holding Debt Securities 4,990 4,990
Company, Inc. Series A Redeemable Preferred Stock (414,600
shares) 2,073 2,073
Class A1 Common Stock (1,000 shares) 1 1
Class A2 Common Stock (40,000 shares) 40 40
Class B Common Stock (9,200 shares) 9 9
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
---------------------------------------------------------------------------------------------------------------
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
---------------------------------------------------------------------------------------------------------------

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

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

F-10
92

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.

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

F-11
93

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
--------------------------------------------------------------------------------------------------

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

F-12
94

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 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. All intercompany accounts and transactions
have been eliminated in consolidation. Certain reclassifications have been made
to the 1999 and 1998 balances to conform with the 2000 financial statement
presentation.

VALUATION OF PORTFOLIO INVESTMENTS

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

F-13
95
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

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, which generally anticipates
the Company holding the loan to maturity and realizing the face value of the
loan. 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 value of the nominal cost equity is recorded as
original issue discount 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.

EQUITY SECURITIES

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 Company's equity interests in public companies that carry certain
restrictions on sale are typically valued at a discount from the public market
value of the security at the balance sheet date. Restricted and unrestricted
publicly traded stocks may also be valued at a discount due to the investment
size or 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. 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

F-14
96
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

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 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.

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. The Company held no derivative financial
instruments at December 31, 2000 and 1999.

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.

F-15
97
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

DIVIDENDS TO SHAREHOLDERS

Dividends to shareholders are recorded on the record date.

FEDERAL AND STATE INCOME TAXES

The Company and its wholly owned subsidiaries intend 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 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.

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.

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 December 31, 2000 and 1999, the private finance portfolio consisted of
the following:

2000 1999
------------------------------- ---------------------------
COST VALUE YIELD COST VALUE YIELD
($ IN THOUSANDS) ---------- ---------- ----- -------- -------- -----

Loans and debt securities......... $ 983,887 $ 966,257 14.6% $578,570 $559,746 14.2%
Equity interests.................. 278,642 316,210 60,601 87,294
---------- ---------- -------- --------
Total................... $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

F-16
98
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

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 December 31,
2000, equity securities include the Company's common stock and preferred stock
investment in Business Loan Express, Inc. of $104,504,000 and $25,111,000,
respectively.

At December 31, 2000 and 1999, approximately 98% of the Company's private
finance loan portfolio was composed of fixed interest rate loans. At December
31, 2000 and 1999, loans and debt securities with a value of $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 December 31, 2000 and 1999 were as follows:

2000 1999
---- ----

GEOGRAPHIC REGION
Mid-Atlantic................................................ 43% 23%
Midwest..................................................... 18 26
West........................................................ 17 11
Southeast................................................... 12 27
Northeast................................................... 8 9
International............................................... 2 4
--- ---
Total............................................. 100% 100%
=== ===
INDUSTRY
Consumer Products........................................... 26% 19%
Business Services........................................... 24 32
Financial Services.......................................... 16 --
Industrial Products......................................... 9 12
Telecommunications.......................................... 6 5
Retail...................................................... 5 8
Broadcasting & Cable........................................ 5 11
Education................................................... 3 5
Other....................................................... 6 8
--- ---
Total............................................. 100% 100%
=== ===

F-17
99
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

COMMERCIAL REAL ESTATE FINANCE

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

2000 1999
--------------------------- ---------------------------
($ IN THOUSANDS) COST VALUE YIELD COST VALUE YIELD
---------------- -------- -------- ----- -------- -------- -----

Loans................................ $102,957 $106,413 9.1% $153,767 $154,109 9.4%
CMBS................................. 392,907 393,040 14.2% 360,950 359,450 13.5%
REO.................................. 7,502 6,081 7,305 6,470
-------- -------- -------- --------
Total...................... $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.

At December 31, 2000 and 1999, approximately 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 December 31, 2000 and 1999,
loans with a value of $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 December 31, 2000 and 1999 were as follows:

2000 1999
---- ----

GEOGRAPHIC REGION
Southeast................................................... 39% 31%
Mid-Atlantic................................................ 22 32
West........................................................ 20 25
Midwest..................................................... 14 9
Northeast................................................... 5 3
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Office...................................................... 30% 24%
Hospitality................................................. 28 42
Retail...................................................... 19 11
Recreation.................................................. 9 8
Other....................................................... 14 15
--- ---
Total............................................. 100% 100%
=== ===

F-18
100
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED
CMBS

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

2000 1999
------------------- -------------------
COST VALUE COST VALUE
(IN THOUSANDS) -------- -------- -------- --------

Purchased CMBS.............................. $310,887 $311,320 $277,694 $277,694
Residual CMBS............................... 78,723 78,723 76,374 76,374
Residual interest spread.................... 3,297 2,997 6,882 5,382
-------- -------- -------- --------
Total............................. $392,907 $393,040 $360,950 $359,450
======== ======== ======== ========

PURCHASED CMBS The Company has Purchased CMBS bonds with a face amount of
$675,764,000 and a cost of $310,887,000, with the difference representing
original issue discount. As of December 31, 2000 and 1999, the estimated yield
to maturity on the Purchased CMBS was approximately 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 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
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 are as follows:

2000 1999
--------------------- ---------------------
PERCENTAGE PERCENTAGE
VALUE OF TOTAL VALUE OF TOTAL
($ IN THOUSANDS) -------- ---------- -------- ----------

BB.................................................. $ 8,472 2.7% $ 41,091 14.8%
BB-................................................. 37,061 11.9 46,692 16.8
B+.................................................. 59,827 19.3 41,765 15.0
B................................................... 89,999 28.9 64,830 23.4
B-.................................................. 56,665 18.2 40,995 14.8
CCC................................................. 7,857 2.5 6,506 2.3
Unrated............................................. 51,439 16.5 35,815 12.9
-------- ----- -------- -----
Total..................................... $311,320 100.0% $277,694 100.0%
======== ===== ======== =====

F-19
101
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

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 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 6.5% as of December 31, 2000 and 1999.

The Company uses a discounted cash flow methodology for determining the
value of its retained Residual CMBS and Residual Interest Spread ("Residual").
The discounted cash flow methodology includes the use of a cash flow model to
project the gross cash flows from the underlying commercial mortgage pool that
serve as collateral for the Company's Residual. The gross cash flows are based
on the respective loan attributes of each commercial mortgage, such as the
interest rate, original loan amount, prepayment lockout period and term to
maturity, contained within a commercial mortgage pool.

The underlying gross mortgage cash flows from the commercial mortgage pool
may be affected by numerous assumptions and variables including:

(i) the receipt of mortgage payments earlier than projected ("prepayment
risk");

(ii) delays in the receipt of monthly cash flow distributions to CMBS as a
result of mortgage loan defaults;

(iii) increases in the timing and/or amount of credit losses on the
underlying commercial mortgage loans which are a function of:

- the percentage of mortgage loans that experience a default either
during their mortgage term or at maturity;

- the recovery periods represented by the time that elapses between
the default of a commercial mortgage and the subsequent correction,
foreclosure or liquidation of the corresponding real estate by the
Company; and,

- an increase in the percentage of principal loss resulting from the
length of time and/or increased expenses incurred in foreclosing on
the commercial real estate and liquidating the assets in order to
satisfy the Company's lien;

(iv) the discount rate used to derive the value of the Company's Residual.

F-20
102
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

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% or approximately $1.3 million of the total principal balance
of the underlying collateral throughout the life of the collateral. These
assumptions result in an expected weighted average life of the bonds of 1.3
years. 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.

UNDERLYING COLLATERAL. As of December 31, 2000 the underlying collateral
balance of the Residual CMBS was $147.8 million, of which $78.7 million has been
retained by the Company. At December 31, 2000, the underlying collateral loans
include $7.0 million at value that is greater than 120 days delinquent. For the
year ended December 31, 2000, the Company had experienced $0.1 million in credit
losses, which represents 0.1% of the Residual.

ADVERSE CHANGES IN PREPAYMENT SPEED. The Company increased the prepayment
speed of the underlying collateral used in its discounted cash flow methodology
while keeping all other original assumptions constant to demonstrate the impact
of prepayments exceeding those currently anticipated by the Company's management
on the value of its Residual. The Company increased the level of future
anticipated prepayments by 10% and 20%, which resulted in a corresponding
decline in the value of the Residual by approximately $0.02 million (or 0.03%)
and $0.05 million (or 0.06%), respectively.

ADVERSE CHANGES IN CREDIT LOSSES. The Company increased the amount of
credit losses of the underlying collateral used in its discounted cash flow
methodology while keeping all other original assumptions constant to demonstrate
the impact of credit losses exceeding those currently anticipated by the
Company's management on the value of its Residual. The Company increased the
level of future anticipated credit losses by 10% and 20%, which resulted in a
corresponding decline in the value of the Residual by approximately $0.05
million (or 0.06%) and $0.1 million (or 0.13%), respectively.

ADVERSE CHANGES IN THE DISCOUNT RATES. The determination of the discount
rate is dependent on many quantitative and qualitative factors, such as the
market's perception of the issuers and the credit fundamentals of the commercial
real estate underlying each pool of commercial mortgage loans. The Company
assumed that the discount rate used to value its Residual increased by 0.5% and
1.0%. The increase in the discount rate by 0.5% and 1.0%, respectively, resulted
in a corresponding decline in the value of the Company's Residual by
approximately $0.9 million (or 1.1%) and $1.7 million (or 2.2%), respectively.

F-21
103
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

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

2000 1999
---- ----

GEOGRAPHIC REGION
West........................................................ 31% 32%
Mid-Atlantic................................................ 23 23
Midwest..................................................... 22 21
Southeast................................................... 19 20
Northeast................................................... 5 4
--- ---
Total............................................. 100% 100%
=== ===
PROPERTY TYPE
Retail...................................................... 32% 33%
Housing..................................................... 30 29
Office...................................................... 21 20
Hospitality................................................. 8 9
Other....................................................... 9 9
--- ---
Total............................................. 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 is no longer a consolidated subsidiary of the Company at
December 31, 2000. As a result, the Company's small business portfolio had no
balance at 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
======= =======

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.

F-22
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. PORTFOLIO, CONTINUED

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.

As of December 31, 1999, 7(a) loans with a value of $5,562,000 were not
accruing interest. Loans greater than 120 days delinquent generally do not
accrue interest.

NOTE 4. DEBT

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

2000 1999
--------------------- -------------------
FACILITY AMOUNT FACILITY AMOUNT
AMOUNT DRAWN AMOUNT DRAWN
(IN THOUSANDS) ---------- -------- -------- --------

Notes payable and debentures:
Unsecured long-term notes payable................ $ 544,000 $544,000 $419,000 $419,000
SBA debentures................................... 87,350 78,350 74,650 62,650
Auction rate reset note.......................... 76,598 76,598 -- --
OPIC loan........................................ 5,700 5,700 5,700 5,700
---------- -------- -------- --------
Total notes payable and debentures....... 713,648 704,648 499,350 487,350
---------- -------- -------- --------
Revolving credit facilities:
Revolving line of credit......................... 417,500 82,000 340,000 82,000
Master loan and security agreement............... -- -- 100,000 23,500
---------- -------- -------- --------
Total revolving credit facilities........ 417,500 82,000 440,000 105,500
---------- -------- -------- --------
Total............................................ $1,131,148 $786,648 $939,350 $592,850
========== ======== ======== ========

NOTES PAYABLE AND DEBENTURES

UNSECURED LONG-TERM NOTES PAYABLE. 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% and 7.6% at December 31, 2000 and 1999, respectively.
The notes may be prepaid in whole or in part together with an interest premium,
as stipulated in the note agreement.

SBA DEBENTURES. At 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 6.6% to 9.6%. The weighted average interest rate was 7.6% and 7.8% at
December 31, 2000 and 1999, respectively. The

F-23
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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. DEBT, CONTINUED

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 a $75 million 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 $75 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.

Scheduled future maturities of notes payable and debentures at December 31,
2000 are as follows:

YEAR AMOUNT MATURING
---- ---------------
(IN THOUSANDS)

2001........................................................ $ 9,350
2002........................................................ 76,598
2003........................................................ 140,000
2004........................................................ 221,000
2005........................................................ 179,000
Thereafter.................................................. 78,700
--------
Total............................................. $704,648
========

REVOLVING CREDIT FACILITIES

REVOLVING LINE OF CREDIT. The Company has an unsecured revolving line of
credit for $417,500,000. The facility may be expanded up to $500,000,000. 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 7.9% and 7.7% at December 31, 2000 and December 31, 1999,
respectively, and the facility requires an annual commitment fee equal to 0.25%
of the committed amount. The line expires in March 2002. 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
$154,853,000 and $123,860,000 for the years ended December 31, 2000 and 1999,
respectively. The maximum amount

F-24
106
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. DEBT, CONTINUED

borrowed under these facilities and the weighted average interest rate for the
years ended December 31, 2000 and 1999, were $257,000,000 and $199,392,000, and
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 in 2000 and 1999 were as follows:

2000 1999
(IN THOUSANDS) -------- --------

Number of common shares..................................... 14,812 8,659
Gross proceeds.............................................. $263,460 $172,539
Less costs including underwriting fees...................... (12,548) (8,270)
-------- --------
Net proceeds.............................................. $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.

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 2000, 1999 and 1998 was as follows:

2000 1999 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ------ ------ ------

Shares issued............................................... 254 233 241
Average price per share..................................... $18.79 $19.43 $20.35

F-25
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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 8. EARNINGS PER COMMON SHARE

2000 1999 1998
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) -------- ------- -------

Net increase in net assets resulting from operations.... $143,101 $98,570 $78,078
Less preferred stock dividends.......................... (230) (230) (230)
-------- ------- -------
Income available to common shareholders................. $142,871 $98,340 $77,848
======== ======= =======
Basic shares outstanding................................ 73,165 59,877 51,941
Dilutive options outstanding to officers................ 307 167 33
-------- ------- -------
Diluted shares outstanding.............................. 73,472 60,044 51,974
======== ======= =======
BASIC EARNINGS PER COMMON SHARE......................... $ 1.95 $ 1.64 $ 1.50
======== ======= =======
DILUTED EARNINGS PER COMMON SHARE....................... $ 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 in 2000. During 2000, the ESOP assets were
transferred into the 401(k) plan.

The Company's 401(k) retirement investment 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
total cash compensation 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 (the "DC Plan"). Eligible
participants in the DC 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 DC
Plan are at all times 100% vested and non-forfeitable except for amounts
credited to participants' accounts related to the Formula Award (see Note 11). A
participant's account shall become distributable upon his or her separation from
service, retirement, disability, death or at a future determined date. All DC
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 DC Plan are funded to a trust, the trustee of which
administers the DC Plan on behalf of the Company.

F-26
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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

Information with respect to options granted, exercised and forfeited under
the Option Plan 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
===== ======

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. At December 31, 2000, 1999 and
1998, the Company had outstanding loans to officers of $25,083,000, $29,461,000,
and $23,735,000, respectively. Officers with outstanding loans repaid principal
of $6,363,000, $195,000, and $5,591,000, for the years ended December 31, 2000,
1999 and 1998, respectively. The Company recognized

F-27
109
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 10. STOCK OPTION PLAN, CONTINUED
interest income from these loans of $1,712,000, $1,539,000, and $1,600,000,
respectively, during these same periods.

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 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.

F-28
110
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 years ended December 31, 2000,
1999 and 1998, $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 DC Plan (see Note 9) and was used to
purchase 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.

F-29
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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 12. DIVIDENDS AND DISTRIBUTIONS

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
======== ===== ======= ===== ======= =====

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
======== ======= ========

F-30
112
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 12. DIVIDENDS AND DISTRIBUTIONS, CONTINUED

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 December 31, 2000 and
1999, cash and cash equivalents consisted of the following:

2000 1999
------- -------

(IN THOUSANDS)

Cash and cash equivalents................................... $11,337 $24,419
Less escrows held........................................... (8,888) (6,264)
------- -------
Total cash and cash equivalents................... $ 2,449 $18,155
======= =======

NOTE 14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

During 2000, 1999 and 1998, the Company paid $54,112,000, $21,092,000, and
$21,708,000, respectively, for interest and income taxes. During 2000, 1999, and
1998, the Company's non-cash investing activities totaled $88,062,000,
$19,320,000, and $1,265,000, respectively. During 2000, 1999, and 1998, the
Company's non-cash financing activities totaled $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
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
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-31
113

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-32
114

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-33
115

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-34
116

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.

/s/ Arthur Anderson

Vienna, Virginia
February 13, 2001

F-35
117

ALLIED CAPITAL CORPORATION

STATEMENT OF ADDITIONAL INFORMATION
MARCH 30, 2001

-------------------------

This Statement of Additional Information ("SAI") is not a prospectus, and
should be read in conjunction with the prospectus dated March 30, 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
1-888-818-5298 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;13;32
Investment Objective and Policies.................... B-2 1;13;32
Management........................................... B-2 49
Compensation of Executive Officers and
Directors..................................... B-2 53
Compensation of Directors....................... B-3 54
Stock Option Awards............................. B-3 54
Formula Award and Cut-Off Award................. B-5 55
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 37;49
Safekeeping, Transfer and Dividend Paying Agent and
Registrar.......................................... B-7 69
Brokerage Allocation and Other Practices............. B-7 N/A

-------------------------
B-1
118

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 December 31, 2000, our investment
portfolio totaled $1.8 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
119

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.

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
120

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-
UNDERLYING UNEXERCISED THE-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-

B-4
121

Money Options" are options with an exercise price that is less than the
market price as of December 31, 2000.

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."

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 consists of Messrs. Walton, Leahy,
Long, Montouri, and Williams. The Executive Committee met 34 times during 2000.

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 consists of Messrs. Browne, Leahy
and Steuart, all of whom are considered independent under the rules promulgated
by the Nasdaq Stock Market. The Audit Committee met six times during 2000.

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 consists of Messrs. Browne, Long, Firestone, and Garcia. The
Compensation Committee met five times during 2000.

The Nominating Committee recommends candidates for election as directors to
the Board of Directors. The Nominating Committee consists of Messrs. Walton,
Hebert,

B-5
122

Toomey and Steuart, and Ms. van Roijen. The Nominating Committee met once during
2000.

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of March 16, 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 March 16, 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................................ 1,196,158(2,4,9) 1.4%
Brooks H. Browne................................. 58,412(3) *
John D. Firestone................................ 45,203(3,11) *
Anthony T. Garcia................................ 73,112(3) *
Lawrence I. Hebert............................... 31,800(3) *
John I. Leahy.................................... 31,818(3) *
Robert E. Long................................... 24,796(3) *
Warren K. Montouri............................... 241,182(3) *
Guy T. Steuart II................................ 333,180(3,5) *
T. Murray Toomey, Esq............................ 47,666(3,6) *
Laura W. van Roijen.............................. 47,122(3,12) *
George C. Williams, Jr........................... 432,583(2) *
EXECUTIVE OFFICERS:
Scott S. Binder.................................. 189,564(2,10) *
Samuel B. Guren.................................. 102,500(2) *
Philip A. McNeill................................ 341,683(2) *
Penni F. Roll.................................... 111,461(2) *
John M. Scheurer................................. 550,857(2) *
Joan M. Sweeney.................................. 548,458(2) *
Thomas H. Westbrook.............................. 237,410(2,8) *
G. Cabell Williams III........................... 862,619(2,4) 1.0%
All directors and executive officers as a group
(20 in number)................................. 5,176,553(7) 5.9%

---------------
* Less than 1%

(1) Based on a total of 85,877,875 shares of the Company's common stock issued
and outstanding on March 16, 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
123

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

OPTIONS ALLOCATED
EXERCISABLE TO 401(K)
OWNED WITHIN 60 DAYS PLAN
DIRECTLY OF MARCH 16, 2001 ACCOUNT
-------- ----------------- ---------

William L. Walton.......................... 413,106 503,313 1,441
Scott S. Binder............................ 52,148 136,087 1,329
Samuel B. Guren............................ 2,500 100,000 0
Philip A. McNeill.......................... 191,706 139,915 10,062
Penni F. Roll.............................. 53,269 53,916 4,276
John M. Scheurer........................... 268,568 257,524 24,765
Joan M. Sweeney............................ 272,075 265,523 10,860
Thomas H. Westbrook........................ 190,041 47,369 0
George C. Williams, Jr. ................... 286,187 146,396 0
G. Cabell Williams, III.................... 399,335 183,545 76,864

(3) Beneficial ownership includes exercisable options to purchase 15,000
shares, except Mr. Toomey who has 11,000 shares.
(4) Includes 279,739 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) Shares are held by a trust for the benefit of Mr. Toomey and his wife.
(7) Includes a total of 1,979,588 shares underlying stock options exercisable
within 60 days of March 16, 2001, which are assumed to be outstanding for
the purpose of calculating the group's percentage ownership, and 279,739
shares held by the 401(k) Plan.
(8) Includes certain shares held in IRA or Keogh accounts: Walton -- 9,799
shares; Firestone -- 1,742 shares; van Roijen -- 3,820 shares;
Binder -- 273 shares; Westbrook -- 15,865 shares.

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.
LaSalle National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk
Grove Village, Illinois 60007, serves as the trustee and custodian with respect
to assets of the Company held for securitization purposes. 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