Edgar Filing: ALLIED CAPITAL CORP

nv2

As filed with the Securities and Exchange Commission on April 3, 2007

Registration No. 333-

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM N-2

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

o Pre-Effective Amendment No.

o Post-Effective Amendment No.

ALLIED CAPITAL CORPORATION

(Exact Name of Registrant as Specified in Charter)

1919 Pennsylvania Avenue, N.W.

Washington, D.C. 20006-3434

(202) 721-6100

(Address and Telephone Number, including Area Code, of Principal Executive Offices)

William L. Walton, Chairman and Chief Executive Officer

Allied Capital Corporation

1919 Pennsylvania Avenue, N.W.

Washington, D.C. 20006-3434

(Name and Address of Agent for Service)

Copies of information to:


Cynthia M. Krus, Esq.
Steven B. Boehm, Esq.
Sutherland Asbill & Brennan LLP
1275 Pennsylvania Avenue, N.W.
Washington, D.C. 20004-2415

Approximate Date of Proposed Public Offering:

From time to time after the effective date of the Registration Statement.

If any securities being registered on this form will be offered on a delayed or continuous basis in reliance on Rule 415 under the Securities Act of 1933, other than securities offered in connection with a dividend reinvestment plan, check the following box. x

CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933




		Proposed Maximum	Amount of
Title of Securities	Amount Being	Aggregate	Registration
Being Registered	Registered⁽¹⁾	Principal Amount⁽²⁾	Fee⁽³⁾

Debt Securities	$1,380,000,000	$1,500,000,000	$42,366


(1)	In reliance upon Rule 429 under the Securities Act of 1933, this amount is in addition to the amount previously registered by the Registrant under a registration statement on Form N-2 (File No. 333-133755). All amounts unsold under the prospectus contained in such prior Registration Statement (a total of $120,000,000) are carried forward into this Registration Statement, and the prospectus contained as a part of this Registration Statement shall be deemed to be combined with the prospectus contained in the above- referenced registration statement, which has previously been filed.

(2)	Estimated solely for the purpose of computing the registration fee pursuant to Rule 457(o) of the Securities Act of 1933, as amended.

(3)	In reliance upon Rule 429 under the Securities Act of 1933, all amounts unsold under a registration statement on Form N-2 (File No. 333-133755) (a total of $120,000,000) are carried forward into this Registration Statement. A registration fee of $12,840 has been paid previously with respect to such securities. The registration fee of $42,366 relates solely to the registration of the aggregate principal amount of $1,380,000,000 of one or more series of debt securities not previously registered.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this registration statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

PROSPECTUS (SUBJECT TO COMPLETION)

ISSUED , 2007

$1,500,000,000

Debt Securities

We may offer, from time to time, up to an aggregate principal amount of $1,500,000,000 of one or more classes or series of debt securities, including notes, debentures, medium-term notes, commercial paper, retail notes or similar obligations evidencing indebtedness in one or more offerings.

The debt securities may be offered at prices and on terms to be described in one or more supplements to this prospectus.

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

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

Please read this prospectus, the accompanying prospectus supplement, if any, and the pricing supplement, if any, before investing in our debt securities and keep it for future reference. The prospectus and the accompanying prospectus supplement, if any, and the pricing supplement, if any, will contain important information about us that a prospective investor should know before investing in our debt securities. We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. This information is available free of charge by contacting us at 1919 Pennsylvania Avenue, N.W., Washington, DC, 20006 or by telephone at (202) 721-6100 or on our website at www.alliedcapital.com. The SEC also maintains a website at www.sec.gov that contains such information.

You should review the information set forth under “Risk Factors” on page 9 of this prospectus before investing in our debt securities.

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 representation to the contrary is a criminal offense.

This prospectus may not be used to consummate sales of our debt securities unless accompanied by a prospectus supplement and, if applicable, a pricing supplement.

April , 2007

We have not authorized any dealer, salesman or other person to give any information or to make any representation other than those contained in this prospectus or any prospectus supplement, if any, or any pricing supplement, if any, to this prospectus. You must not rely upon any information or representation not contained in this prospectus or any such supplements as if we had authorized it. This prospectus and any such supplements 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 such supplements is accurate as of the dates on their covers; however, the prospectus and any supplements will be updated to reflect any material changes.

TABLE OF CONTENTS


	Page

Prospectus Summary		1
Selected Condensed Consolidated Financial Data		6
Where You Can Find Additional Information		8
Risk Factors		9
Ratios of Earnings to Fixed Charges		17
Use of Proceeds		19
Price Range of Common Stock and Distributions		20
Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Recent Developments		63
Senior Securities		64
Business		67
Portfolio Companies		84
Determination of Net Asset Value		92
Management		96
Portfolio Management		103
Compensation of Directors and Executive Officers		106
Control Persons and Principal Holders of Securities		126
Certain Relationships and Related Party Transactions		128
Tax Status		129
Certain Government Regulations		132
Stock Trading Plans and Ownership Guidelines		136
Dividend Reinvestment Plan		136
Description of Capital Stock		138
Description of Public Notes		145
Plan of Distribution		157
Legal Matters		158
Custodians, Transfer and Dividend Paying Agent and Registrar		158
Brokerage Allocation and Other Practices		159
Independent Registered Public Accounting Firm		159
Index to Consolidated Financial Statements		F-1

ABOUT THIS PROSPECTUS

This prospectus is part of a registration statement that we have filed with the Securities and Exchange Commission using the “shelf” registration process. Under the shelf registration process, which constitutes a delayed offering in reliance on Rule 415 under the Securities Act of 1933, as amended, we may offer, from time to time, up to $1,500,000,000 in aggregate principal amount of debt securities on the terms to be determined at the time of the offering. The debt securities may be offered at prices and on terms described in one or more supplements to this prospectus. This prospectus provides you with a general description of the debt securities we may offer. Each time we use this prospectus to offer debt securities, we will provide a prospectus supplement and, if applicable, a pricing supplement that will contain specific information about the terms of that offering. Please carefully read this prospectus and any such supplements together with the additional information described under “Where You Can Find Additional Information” in the “Prospectus Summary” and “Risk Factors” sections before you make an investment decision.

A prospectus supplement and, if applicable, a pricing supplement may also add to, update or change information contained in this prospectus.

(i)

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 prospectus and the documents that are referred to in this prospectus, together with any accompanying supplements.

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

BUSINESS (Page 67)

We are a business development company in the private equity business and we are internally managed. We provide long-term debt and equity capital to primarily private middle market companies in a variety of industries. We have participated in the private equity business since we were founded in 1958 and have financed thousands of companies nationwide. Our investment objective is to achieve current income and capital gains.

We believe the private equity capital markets are important to the growth of small and middle market companies because such companies often have difficulty accessing the public debt and equity capital markets. We use the term middle market to include companies with annual revenues typically between $50 million and $500 million. We believe that we are well positioned to be a source of capital for such companies.

We primarily invest in the American entrepreneurial economy. At December 31, 2006, our private finance portfolio included investments in 145 companies that generate aggregate annual revenues of over $13 billion and employ more than 90,000 people.

We generally target companies in less cyclical industries with, among other things, high returns on invested capital, management teams with meaningful equity ownership, well-constructed balance sheets, and the ability to generate free cash flow. As a private equity investor, we spend significant time and effort identifying, structuring, performing due diligence, monitoring, developing, valuing, and ultimately exiting our investments.

Our investment activity is primarily focused on making long-term investments in the debt and equity of primarily private middle market companies. Debt investments may include senior loans, unitranche debt (a single debt investment that is a blend of senior and subordinated debt terms), or subordinated debt (with or without equity features). Equity investments may include a minority equity stake in connection with a debt investment or a substantial equity stake in connection with a buyout transaction. In a buyout transaction, we generally invest in senior debt, subordinated debt and equity (preferred and/or voting or non-voting common) where our equity ownership represents a significant portion of the equity, but may or may not represent a controlling interest.

Our investments in the debt and equity of primarily private middle market companies are generally long-term in nature and are privately negotiated, and no readily available market exists for them. This makes our investments highly illiquid and, as result, we cannot readily trade them. When we make an investment, we enter into a long-term arrangement where our ultimate exit from that investment may be three to ten years in the future.

The capital we provide is used by portfolio companies to fund buyouts, acquisitions, growth, recapitalizations, note purchases, or other types of financings.

Our investments are typically structured to provide recurring cash flow in the form of interest income to us as the investor. In addition to earning interest income, we may structure our investments to generate income from management, consulting, diligence, structuring, or other fees. We may also enhance our total return from capital gains through equity features, such as nominal cost warrants, or by investing in equity investments.

We provide managerial assistance to our portfolio companies, including, but not limited to, management and consulting services related to corporate finance, marketing, human resources, personnel and board member recruiting, business operations, corporate governance, risk management and other general business matters.

We have elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, otherwise referred to as the Code. As such, we are not subject to corporate level income taxation on income we timely distribute to our stockholders as dividends. See “Tax Status.” We pay regular quarterly dividends based upon an estimate of annual taxable income available for distribution to shareholders and the amount of taxable income carried over from the prior year for distribution in the current year. Since 1963, our portfolio has provided sufficient ordinary taxable income and realized net capital gains to sustain or grow our dividends over time.

We are a Maryland corporation and a closed-end, non-diversified management investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, which we refer to as the “1940 Act.”

As a business development company, we are required to meet certain regulatory tests, the most significant relating to our investments and borrowings. A business development company is required to invest at least 70% of its assets in eligible portfolio companies. A business development company must also maintain a coverage ratio of assets to senior securities of at least 200%. See “Certain Government Regulations” and “Risk Factors.”

Our executive offices are located at 1919 Pennsylvania Avenue, N.W., Washington, DC, 20006-3434 and our telephone number is (202) 721-6100. In addition, we have regional offices in New York, Chicago, and Los Angeles.

Our Internet website address is www.alliedcapital.com. Information contained on our website is not incorporated by reference into this prospectus and you should not consider information contained on our website to be part of this prospectus.

DETERMINATION OF

NET ASSET VALUE (Page 92)

Our portfolio investments are generally recorded at fair value as determined in good faith by our Board of Directors in the absence of readily available public market values.

Pursuant to the requirements of the 1940 Act, we value substantially all of our portfolio investments at fair value as determined in good faith by the Board of Directors on a quarterly basis. Since there is typically no readily available market value for the investments in our portfolio, our Board of Directors determines in good faith the fair value of these portfolio investments pursuant to our valuation policy and consistently applied valuation process.

There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we are required to specifically value each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has appreciated in value. Without a readily available market value and because of the inherent uncertainty of valuation, the fair value of our investments determined in good faith by the Board of Directors 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.

We adjust the valuation of our portfolio quarterly to reflect the change in the value of each investment in our portfolio. Any changes in value are recorded in our statement of operations as “net change in unrealized appreciation or depreciation.”

PLAN OF DISTRIBUTION (Page 157)

We may offer, from time to time, up to $1,500,000,000 aggregate principal amount of debt securities, including notes, debentures, medium-term notes, commercial paper, retail notes or similar obligations evidencing indebtedness, on terms to be determined at the time of the offering.

Our debt securities may be offered at prices and on terms described in one or more supplements to this prospectus. Our debt 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 supplements to this prospectus relating to any offering of debt securities will identify any agents or underwriters involved in the sale of our debt securities, and will set forth any applicable purchase price, fee and commission or discount arrangement or the basis upon which such amount may be calculated.

We may not offer our debt securities if our BDC asset coverage ratio would be less than 200% after giving effect to such offering. We may not sell debt securities pursuant to this prospectus without delivering a prospectus supplement and, if applicable, a pricing supplement describing the method and terms of the offering of such debt securities.

USE OF PROCEEDS (Page 19)

We intend to use the net proceeds from selling debt securities for general corporate purposes, which includes investing in debt or equity securities in primarily privately negotiated transactions, repayment of indebtedness, acquisitions and other general corporate purposes.

The supplements to this prospectus relating to any offering of debt securities will more fully identify the use of proceeds from such offering.

RISK FACTORS (Page 9)

Investment in our debt securities involves a number of significant risks relating to our business and our investment objective that you should consider before investing in our debt securities.

Our portfolio of investments is generally illiquid. Our portfolio includes securities primarily issued by private companies. These investments may involve a high degree of business and financial risk; they are illiquid, and may not produce current returns or capital gains. If we were forced to immediately liquidate some or all of the investments in the portfolio, the proceeds of such liquidation could be significantly less than the current value of such investments. We may be required to liquidate some or all of our portfolio investments to meet our debt service obligations or in the event we are required to fulfill our obligations under agreements pursuant to which we guarantee the repayment of indebtedness by third parties.

An economic slowdown may affect the ability of a portfolio company to engage in a liquidity event, which is a transaction that involves the sale or recapitalization of all or part of a portfolio company. These conditions could lead to financial losses in our portfolio and a decrease in our revenues, net income and assets. Numerous other 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.

Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies.

We may not borrow money unless we maintain asset coverage for indebtedness of at least 200%, which may affect returns to shareholders. We borrow funds to make investments. 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.

A large number of entities and individuals compete for the same kind of investment opportunities as 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.

Our business of making private equity investments and positioning them for liquidity events also may be affected by current and future market conditions.

To maintain our status as a business development company, we must not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets.

We may not be able to pay dividends and failure to qualify as a regulated investment company for tax purposes could have a material adverse effect on the income available for debt service or distributions to our shareholders, which may have a material adverse effect on our total return to common shareholders, if any.

Also, we are subject to certain risks associated with valuing our portfolio, changing interest rates, accessing additional capital, fluctuating financial results, and operating in a regulated environment.

The market value of our debt securities may be volatile due to market factors that may be beyond our control.

CERTAIN ANTI-TAKEOVER PROVISIONS (Page 140)

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 Allied Capital. 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.

RATIOS OF EARNINGS TO FIXED CHARGES (Page 17)

Our ratio of earnings to fixed charges for the five years ended December 31, 2006, was 3.6, 12.3, 4.3, 3.4, and 4.2, respectively. For more information, see the section entitled “Ratios of Earnings to Fixed Charges” in this prospectus.

SENIOR SECURITIES (Page 64)

At December 31, 2006, we had $1.9 billion of outstanding indebtedness bearing a weighted average annual interest cost of 6.5%. If our portfolio fails to produce adequate returns, we may be unable to make interest or principal payments on our indebtedness when they are due, which could give rise to a default on and acceleration of our indebtedness. In order for us to cover annual interest payments on indebtedness, we had to achieve annual returns on our assets of at least 2.5% as of December 31, 2006, which returns were achieved.

SELECTED CONDENSED CONSOLIDATED FINANCIAL DATA

You should read the condensed consolidated financial information below with the Consolidated Financial Statements and Notes thereto included herein. Financial information at and for the years ended December 31, 2006, 2005, 2004, and 2003, has been derived from our financial statements that were audited by KPMG LLP. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below for more information.


			Year Ended December 31,

(in thousands,			2006			2005		2004			2003			2002
except per share data)
Operating Data:
Interest and related portfolio income:
	Interest and dividends		$	386,427		$	317,153	$	319,642		$	290,719		$	264,042
	Fees and other income			66,131			56,999		47,448			38,510			45,886

		Total interest and related portfolio income		452,558			374,152		367,090			329,229			309,928

Expenses:
	Interest			100,600			77,352		75,650			77,233			70,443
	Employee			92,902			78,300		53,739			36,945			33,126
	Employee stock options⁽¹⁾			15,599			—		—			—			—
	Administrative			39,005			69,713		34,686			22,387			21,504

		Total operating expenses		248,106			225,365		164,075			136,565			125,073

Net investment income before income taxes				204,452			148,787		203,015			192,664			184,855
	Income tax expense (benefit), including excise tax			15,221			11,561		2,057			(2,466	)		930

Net investment income				189,231			137,226		200,958			195,130			183,925

Net realized and unrealized gains (losses):
	Net realized gains			533,301			273,496		117,240			75,347			44,937
	Net change in unrealized appreciation or depreciation			(477,409	)		462,092		(68,712	)		(78,466	)		(571	)

		Total net gains (losses)		55,892			735,588		48,528			(3,119	)		44,366

Net increase in net assets resulting from operations			$	245,123		$	872,814	$	249,486		$	192,011		$	228,291

Per Share:
Diluted earnings per common share			$	1.68		$	6.36	$	1.88		$	1.62		$	2.20
Net investment income plus net realized gains per share⁽²⁾			$	4.96		$	2.99	$	2.40		$	2.28		$	2.21
Dividends per common share⁽²⁾			$	2.47		$	2.33	$	2.30		$	2.28		$	2.23
Weighted average common shares outstanding – diluted				145,599			137,274		132,458			118,351			103,574


	At December 31,

(in thousands,	2006		2005		2004		2003		2002
except per share data)
Balance Sheet Data:
Portfolio at value	$	4,496,084	$	3,606,355	$	3,013,411	$	2,584,599	$	2,488,167
Total assets		4,887,505		4,025,880		3,260,998		3,019,870		2,794,319
Total debt outstanding⁽³⁾		1,899,144		1,284,790		1,176,568		954,200		998,450
Shareholders’ equity		2,841,244		2,620,546		1,979,778		1,914,577		1,546,071
Shareholders’ equity per common share (net asset value)⁽⁴⁾	$	19.12	$	19.17	$	14.87	$	14.94	$	14.22
Common shares outstanding at end of year		148,575		136,697		133,099		128,118		108,698
Asset Coverage ratio⁽⁵⁾		250%		309%		280%		322%		270%
Debt to equity ratio		0.67		0.49		0.59		0.50		0.65


	Year Ended December 31,

	2006			2005			2004			2003			2002

Other Data:
Investments funded	$	2,437,828		$	1,675,773		$	1,524,523		$	931,450		$	506,376
Principal collections related to investment repayments or sales		1,055,347			1,503,388			909,189			788,328			356,641
Realized gains		557,470			343,061			267,702			94,305			95,562
Realized losses		(24,169	)		(69,565	)		(150,462	)		(18,958	)		(50,625	)


	2006								2005

(in thousands,	Qtr 4		Qtr 3		Qtr 2		Qtr 1		Qtr 4		Qtr 3		Qtr 2		Qtr 1
except per share data)
Quarterly Data (unaudited):
Total interest and related portfolio income	$	117,708	$	113,383	$	110,456	$	111,011	$	98,169	$	94,857	$	86,207	$	94,919
Net investment income		49,078		48,658		50,195		41,300		37,073		46,134		15,267		38,752
Net increase in net assets resulting from operations		33,921		77,886		33,729		99,587		328,140		113,168		311,885		119,621
Diluted earnings per common share		0.23		0.53		0.24		0.70		2.36		0.82		2.29		0.88
Dividends declared per common share ⁽⁶⁾		0.67		0.61		0.60		0.59		0.61		0.58		0.57		0.57
Net asset value per common share⁽⁴⁾		19.12		19.38		19.17		19.50		19.17		17.37		17.01		15.22


⁽¹⁾	Effective January 1, 2006, we adopted the provisions of Statement No. 123 (Revised 2004), Share-Based Payment. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.
⁽²⁾	Dividends are based on taxable income, which differs from income for financial reporting purposes. Net investment income and net realized gains are the most significant components of our annual taxable income from which dividends are paid. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.
⁽³⁾	See “Senior Securities” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding our level of indebtedness.
⁽⁴⁾	We determine net asset value per common share as of the last day of the period presented. The net asset values shown are based on outstanding shares at the end of each period presented.
⁽⁵⁾	As a business development company, we are generally required to maintain a minimum ratio of 200% of total assets to total borrowings.
⁽⁶⁾	Dividends declared per common share for the fourth quarter of 2006 included the regular quarterly dividend of $0.62 per common share and an extra dividend of $0.05 per common share. Dividends declared per common share for the fourth quarter of 2005 included the regular quarterly dividend of $0.58 per common share and an extra dividend of $0.03 per common share.

WHERE YOU CAN FIND

ADDITIONAL INFORMATION

We have filed with the SEC a registration statement on Form N-2 together with all amendments and related exhibits under the Securities Act of 1933. The registration statement contains additional information about us and the debt securities being offered by this prospectus.

We file annual, quarterly and current reports, proxy statements and other information with the SEC under the Securities Exchange Act of 1934. You can inspect any materials we file with the SEC, without charge, at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. The information we file with the SEC is available free of charge by contacting us at 1919 Pennsylvania Avenue, N.W., Washington, DC, 20006-3434, or by telephone at (202) 721-6100 or on our website at www.alliedcapital.com. The SEC also maintains a web site that contains reports, proxy statements and other information regarding registrants, including us, that file such information electronically with the SEC. The address of the SEC’s web site is www.sec.gov. Information contained on our website or on the SEC’s web site about us is not incorporated into this prospectus and you should not consider information contained on our website or on the SEC’s web site to be part of this prospectus.

RISK FACTORS

Investing in Allied Capital involves a number of significant risks relating to our business and investment objective. As a result, there can be no assurance that we will achieve our investment objective.

Our portfolio of investments is illiquid. We generally acquire our investments directly from the issuer in privately negotiated transactions. The majority of the investments in our portfolio are subject to certain restrictions on resale or otherwise have no established trading market. We typically exit our investments when the portfolio company has a liquidity event such as a sale, recapitalization, or initial public offering of the company. The illiquidity of our investments may adversely affect our ability to dispose of debt and equity securities at times when we may need to or when it may be otherwise advantageous for us to liquidate such investments. In addition, if we were forced to immediately liquidate some or all of the investments in the portfolio, the proceeds of such liquidation could be significantly less than the current value of such investments.

Investing in private companies involves a high degree of risk. Our portfolio primarily consists of long-term loans to and investments in middle market private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses for us in those investments and accordingly should be considered speculative. There is generally no publicly available information about the companies in which we invest, and we rely significantly on the diligence of our employees and agents to obtain information in connection with our investment decisions. If we are unable to identify all material information about these companies, among other factors, we may fail to receive the expected return on our investment or lose some or all of the money invested in these companies. In addition, these businesses may have shorter operating histories, narrower product lines, smaller market shares and less experienced management than their competition and may be more vulnerable to customer preferences, market conditions, loss of key personnel, or economic downturns, which may adversely affect the return on, or the recovery of, our investment in such businesses. As an investor, we are subject to the risk that a portfolio company may make a business decision that does not serve our interest, which could decrease the value of our investment. Deterioration in a portfolio company’s financial condition and prospects may be accompanied by deterioration in any collateral for the loan.

Substantially all of our portfolio investments are recorded at fair value as determined in good faith by our Board of Directors and, as a result, there is uncertainty regarding the value of our portfolio investments. At December 31, 2006, portfolio investments recorded at fair value were 92% of our total assets. Pursuant to the requirements of the 1940 Act, we value substantially all of our investments at fair value as determined in good faith by our Board of Directors on a quarterly basis. Since there is typically no readily available market value for the investments in our portfolio, our Board of Directors determines in good faith the fair value of these investments pursuant to a valuation policy and a consistently applied valuation process.

permitted to provide a general reserve for anticipated loan losses; we are instead required by the 1940 Act to specifically value each individual investment on a quarterly basis and record unrealized depreciation for an investment that we believe has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has appreciated in value. Without a readily available market value and because of the inherent uncertainty of valuation, the fair value of our investments determined in good faith by the Board of Directors 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. Our net asset value could be affected if our determination of the fair value of our investments is materially different than the value that we ultimately realize.

We adjust quarterly the valuation of our portfolio to reflect the Board of Directors’ determination of the fair value of each investment in our portfolio. Any changes in fair value are recorded in our statement of operations as net change in unrealized appreciation or depreciation.

Economic recessions or downturns could impair our portfolio companies and harm our operating results. Many of the companies in which we have made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may affect the ability of a company to repay our loans or engage in a liquidity event such as a sale, recapitalization, or initial public offering. Our nonperforming assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions also may decrease the value of any collateral securing some of our loans. These conditions could lead to financial losses in our portfolio and a decrease in our revenues, net income, and assets.

Our business of making private equity investments and positioning them for liquidity events also may be affected by current and future market conditions. The absence of an active senior lending environment or a slowdown in middle market merger and acquisition activity may slow the amount of private equity investment activity generally. As a result, the pace of our investment activity may slow. In addition, significant changes in the capital markets could have an effect on the valuations of private companies and on the potential for liquidity events involving such companies. This could affect the timing of exit events in our portfolio and could negatively affect the amount of gains or losses upon exit.

Our borrowers may default on their payments, which may have a negative effect on our financial performance. We make long-term unsecured, subordinated loans and invest in equity securities, which may involve a higher degree of repayment risk. We primarily invest in companies that may have limited financial resources, may be highly leveraged and 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. A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans or foreclosure on its secured assets, which could trigger cross defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the loans or debt securities that we hold. In addition, our portfolio companies may have, or may be permitted to incur, other debt that ranks

senior to or equally with our securities. This means that payments on such senior-ranking securities may have to be made before we receive any payments on our subordinated loans or debt securities. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in any related collateral and may have a negative effect on our financial results.

Our private finance investments may not produce current returns or capital gains. Our private finance investments are typically structured as unsecured debt securities with a relatively high fixed rate of interest and with equity features such as conversion rights, warrants, or options, or as buyouts of companies where we invest in debt and equity securities. As a result, our private finance investments are generally structured to 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.

Our financial results could be negatively affected if a significant portfolio investment fails to perform as expected. Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. At December 31, 2006, our largest investments at value were in Mercury Air Centers, Inc. and Business Loan Express, LLC (BLX), which represented 5.0% and 4.3% of our total assets, respectively, and 2.2% and 4.4% of our total interest and related portfolio income, respectively, for the year ended December 31, 2006.

BLX is a non-bank lender that participates in the Small Business Administration (SBA) 7(a) Guaranteed Loan Program and, as a result, is subject to certain risks associated with changes in government funding, ongoing audits, inspections and investigations, and changes in SBA laws or regulations. The Office of the Inspector General of the SBA and the United States Secret Service have announced an ongoing investigation of allegedly fraudulently obtained SBA-guaranteed loans issued by BLX. We understand that BLX is working cooperatively with the SBA with respect to this matter so that it may remain a preferred lender in the SBA 7(a) program and retain the ability to sell loans into the secondary market. The ultimate resolution of these matters could have a material adverse impact on BLX’s financial condition and, as a result, our financial results could be negatively affected. There may be other investigations initiated by the Office of the Inspector General of the SBA or the U.S. Department of Justice in the future. See “Management’s Discussion and Analysis — Private Finance, Business Loan Express, LLC” and “Recent Developments” for further information and discussion on these matters.

We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us. 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. The debt securities we may issue pursuant to this prospectus, the prospectus supplement, and the applicable pricing supplement, if any, are a form of such borrowings. We borrow from and issue senior debt securities to banks, insurance companies, and other lenders or investors. Holders of these senior securities have fixed dollar claims on our consolidated assets that are superior to the claims of our common shareholders. If the value of our consolidated assets increases, then leveraging would cause the net asset value attributable to our 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. We and, indirectly, our stockholders will bear the cost associated with our leverage activity. Our revolving line of credit and notes payable contain financial and operating covenants that could restrict our business activities, including our ability to declare dividends if we default under certain provisions.

At December 31, 2006, we had $1.9 billion of outstanding indebtedness bearing a weighted average annual interest cost of 6.5% and a debt to equity ratio of 0.67 to 1.00. If our portfolio of investments fails to produce adequate returns, we may be unable to make interest or principal payments on our indebtedness when they are due. In order for us to cover annual interest payments on indebtedness, we must achieve annual returns on our assets of at least 2.5% as of December 31, 2006, which returns were achieved.

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 calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing below. The calculation assumes (i) $4,887.5 million in total assets, (ii) an average cost of funds of 6.5%, (iii) $1,899.1 million in debt outstanding and (iv) $2,841.2 million of shareholders’ equity.

Assumed Return on Our Portfolio

(net of expenses)


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

Corresponding return to shareholder		-38.75%		-21.55%		-12.95%		-4.35%		4.26%		12.86%		30.06%

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 total borrowings 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, insurance companies or other lenders or investors 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, 2006, our asset coverage for senior indebtedness was 250%.

Changes in interest rates may affect our cost of capital and net investment income. Because we borrow money to make investments, our net investment 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 net investment income. In periods of rising interest rates, our cost of funds would increase, which would reduce our net investment income. We use a combination of long-term and short-term borrowings and equity capital to finance our investing activities. We utilize our revolving line of credit 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. We have analyzed the potential impact of changes in interest rates on interest income net of interest expense.

Assuming that the balance sheet as of December 31, 2006, were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical immediate 1% change in interest rates would have affected net income by approximately 1% over a one year horizon. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate.

We will continue to need additional capital to grow because we must distribute our income. We will continue to need capital to fund growth in our investments. Historically, we have borrowed from financial institutions or other investors and have issued equity securities to grow our portfolio. A reduction in the availability of new debt or equity capital could limit our ability to grow. We must distribute at least 90% of our taxable ordinary income, which excludes realized net long-term capital gains, to our shareholders to maintain our eligibility for the tax benefits available to regulated investment companies. As a result, such earnings will not be available to fund investment originations. In addition, as a business development company, 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. We intend to continue to borrow from financial institutions or other investors and issue additional debt and 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 effect on the value of our debt securities or common stock.

Loss of regulated investment company tax treatment would substantially reduce net assets and income available for debt service and dividends. We have operated so as to qualify as a regulated investment company under Subchapter M of the Code. If we meet source of income, asset diversification, and distribution requirements, we will not be subject to corporate-level income taxation on income we timely distribute to our stockholders as dividends. We would cease to qualify for such tax treatment if we were unable to comply with these requirements. In addition, we may have difficulty meeting the requirement to make distributions to our stockholders because in certain cases we may recognize income before or without receiving cash representing such income. If we fail to qualify as a regulated investment company, we will have to pay corporate-level taxes on all of our income whether or not we distribute it, which would substantially reduce the amount of income available for debt service and distributions to our stockholders. Even if we qualify as a regulated investment company, we generally will be subject to a corporate-level income tax on the income we do not distribute. If we do not distribute at least 98% of our annual taxable income in the year earned, we generally will be required to pay an excise tax on amounts carried over and distributed to shareholders in the next year equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such income for the current year.

There is a risk that our common stockholders may not receive dividends or distributions. We intend to make distributions on a quarterly basis to our stockholders. We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, due to the asset coverage test applicable to us as a business development company, we may be limited in our ability to make distributions. Also, certain of our credit facilities limit our ability to declare dividends if we default under certain provisions. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of the tax benefits available to us as a regulated investment company. In addition, in accordance with U.S. generally accepted accounting principles and tax regulations, we include in income certain amounts that we have not yet received in cash, such as contractual payment-in-kind interest, which represents contractual interest added to the loan balance that becomes due at the end of the loan term, or the accrual of original issue discount. The increases in loan balances as a result of contractual payment-in-kind arrangements are included in income in advance of receiving cash payment and are separately included in the change in accrued or reinvested interest and dividends in our consolidated statement of cash flows. Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our investment company taxable income to obtain tax benefits as a regulated investment company.

We operate in a competitive market for investment opportunities. We compete for investments with a large number of private equity funds and mezzanine funds, other business development companies, investment banks, other equity and non-equity based investment funds, and other sources of financing, including specialty finance companies and traditional financial services companies such as commercial banks. Some of our competitors may 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.

Our business depends on our key personnel. We depend on the continued services of our executive officers and other key management personnel. If we were to lose any of these officers or other management personnel, such a loss could result in inefficiencies in our operations and lost business opportunities, which could have a negative effect on our business.

Changes in the law or regulations that govern us could have a material impact on us or our operations. We are regulated by the SEC. In addition, changes in the laws or regulations that govern business development companies, regulated investment companies, and real estate investment trusts may significantly affect our business. Any change in the law or regulations that govern our business could have a material impact on us or our 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, which may have a material effect on our operations.

Failure to invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our current business strategy. As a business development company, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. See “Certain Government Regulations.” Therefore, we may be precluded from investing in what we believe are attractive investments if such investments

are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could lose our status as a business development company, which would have a material adverse effect on our business, financial condition and results of operations. Similarly, these rules could prevent us from making additional investments in existing portfolio companies, which could result in the dilution of our position, or could require us to dispose of investments at inopportune times in order to comply with the 1940 Act. If we were forced to sell nonqualifying investments in the portfolio for compliance purposes, the proceeds from such sale could be significantly less than the current value of such investments.

Results may fluctuate and may not be indicative of future performance. Our operating results may fluctuate and, therefore, you should not rely on current or historical period results to be indicative of our performance in future reporting periods. Factors that could cause operating results to fluctuate include, but are not limited to, variations in the investment origination volume and fee income earned, changes in the accrual status of our loans and debt securities, variations in timing of prepayments, variations in and the timing of the recognition of net realized gains or losses and changes in unrealized appreciation or depreciation, the level of our expenses, the degree to which we encounter competition in our markets, and general economic conditions.

Our common stock price may be volatile. The trading price of our common stock may fluctuate substantially. The price of the common stock may be higher or lower than the price paid by stockholders, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include, but are not limited to, the following:


	•	price and volume fluctuations in the overall stock market from time to time;

	•	significant volatility in the market price and trading volume of securities of business development companies or other financial services companies;

	•	volatility resulting from trading in derivative securities related to our common stock including puts, calls, long-term equity anticipation securities, or LEAPs, or short trading positions;

	•	changes in laws or regulatory policies or tax guidelines with respect to business development companies or regulated investment companies;

	•	actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts;

	•	general economic conditions and trends;

	•	loss of a major funding source; or

	•	departures of key personnel.

The trading market or market value of our publicly issued debt securities may be volatile. Upon issuance, our publicly issued debt securities will not have an established trading market. We cannot assure you that a trading market for our publicly issued debt securities will ever develop or be maintained if developed. In addition to our creditworthiness, many factors may materially adversely affect the trading market for, and

market value of, our publicly issued debt securities. These factors include, but are not limited to, the following:


	•	the time remaining to the maturity of these debt securities;

	•	the outstanding principal amount of debt securities with terms identical to these debt securities;

	•	the supply of debt securities trading in the secondary market, if any;

	•	the redemption or repayment features, if any, of these debt securities;

	•	the level, direction and volatility of market interest rates generally; and

	•	market rates of interest higher or lower than rates borne by the debt securities.

You should also be aware that there may be a limited number of buyers when you decide to sell your debt securities. This too may materially adversely affect the market value of the debt securities or the trading market for the debt securities.

Our credit ratings may not reflect all risks of an investment in the debt securities. Our credit ratings are an assessment of our ability to pay our obligations. Consequently, real or anticipated changes in our credit ratings will generally affect the market value of the publicly issued debt securities. Our credit ratings, however, may not reflect the potential impact of risks related to market conditions generally or other factors discussed above on the market value of or trading market for the publicly issued debt securities.

Terms relating to redemption may materially adversely affect your return on the debt securities. If your debt securities are redeemable at our option, we may choose to redeem your debt securities at times when prevailing interest rates are lower than the interest rate paid on your debt securities. In addition, if your debt securities are subject to mandatory redemption, we may be required to redeem your debt securities also at times when prevailing interest rates are lower than the interest rate paid on your debt securities. In this circumstance, you may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as your debt securities being redeemed.

RATIOS OF EARNINGS TO FIXED CHARGES

For the five years ended December 31, 2006, the ratios of earnings to fixed charges of the Company, computed as set forth below, were as follows:


	Year Ended December 31,

	2006		2005		2004		2003		2002

Earnings to Fixed Charges*		3.6		12.3		4.3		3.4		4.2

For purposes of computing the ratios of earnings to fixed charges, earnings represent net increase in net assets resulting from operations plus (or minus) income tax expense (benefit), including excise tax expense plus fixed charges. Fixed charges include interest expense, a portion of rent expense and preferred stock dividend expense. We have assumed that one-third of the annual rent expense represents fixed charges.


	*	Earnings include the net change in unrealized appreciation or depreciation. Net change in unrealized appreciation or depreciation can vary substantially from year to year. Excluding the net change in unrealized appreciation or depreciation, the earnings to fixed charges ratio would be 8.2, 6.4, 5.2, 4.4, and 4.2 for the five years ended December 31, 2006, respectively.

Disclosure Regarding Forward-Looking Statements

Information contained or incorporated by reference in this prospectus, and any prospectus supplement and pricing supplement, if any, accompanying this prospectus contains “forward-looking statements.” These statements include the plans and objectives of management for future operations and financial objectives and 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. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth above in the “Risk Factors” section. Other factors that could cause actual results to differ materially include:


	•	changes in the economy and general economic conditions;

	•	risks associated with possible disruption in our operations due to terrorism;

	•	future changes in laws or regulations and conditions in our operating areas; and

	•	other risks and uncertainties as may be detailed from time to time in our public announcements and SEC filings.

The matters described in “Risk Factors” and certain other factors noted throughout this prospectus and any prospectus supplement and pricing supplement, if any, accompanying this prospectus and in any exhibits to the registration statement of which this prospectus 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.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. Important assumptions include our ability to originate new investments, maintain certain margins and levels of profitability, access the capital markets for debt and equity capital, the ability to meet regulatory requirements and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this prospectus and any prospectus supplement and pricing supplement, if any, accompanying this prospectus should not be regarded as a representation by us that our plans and objectives will be achieved. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this prospectus and the date on the cover of any such supplements with respect to such supplements.

USE OF PROCEEDS

We intend to use the net proceeds from selling debt securities for general corporate purposes, which may include investing in debt or equity securities in primarily privately negotiated transactions, repayment of indebtedness, acquisitions and other general corporate purposes. Because our primary business is to provide long-term debt and equity capital to primarily middle-market companies, we are continuously identifying, reviewing and, to the extent consistent with our investment objective, funding new investments. As a result, we typically raise capital as we deem appropriate to fund such new investments. The supplement to this prospectus relating to an offering will more fully identify the use of the proceeds from such offering.

We anticipate that substantially all of the net proceeds of any offering of debt securities will be used as described above or in any prospectus supplement and pricing supplement, if any, accompanying this prospectus. Pending investment, we intend to invest the net proceeds of any offering of debt 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, high quality debt securities maturing in one year or less from the time of investment or other qualifying investments. Our ability to achieve our investment objective may be limited to the extent that the net proceeds of any offering of debt securities, pending full investment, are held in lower-yielding time deposits and other short-term instruments.

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

Our common stock is traded on the New York Stock Exchange under the symbol “ALD.” The following table lists the high and low closing sales prices for our common stock, the closing sales price as a percentage of net asset value (NAV) and quarterly dividends per share. On April 2, 2007, the last reported closing sale price of our common stock was $28.90 per share.


				Closing Sales				Premium			Premium
				Price				of High			of Low
								Sales Price			Sales Price			Declared
		NAV⁽¹⁾		High		Low		to NAV⁽²⁾			to NAV⁽²⁾			Dividends

*Year ended December 31, 2005*
	First Quarter	$	15.22	$	27.84	$	24.89		183	%		164	%	$	0.57
	Second Quarter	$	17.01	$	29.29	$	25.83		172	%		152	%	$	0.57
	Third Quarter	$	17.37	$	29.17	$	26.92		168	%		155	%	$	0.58
	Fourth Quarter	$	19.17	$	30.80	$	26.11		161	%		136	%	$	0.58
	Extra Dividend													$	0.03
*Year ended December 31, 2006*
	First Quarter	$	19.50	$	30.68	$	28.51		157	%		146	%	$	0.59
	Second Quarter	$	19.17	$	31.32	$	28.77		163	%		150	%	$	0.60
	Third Quarter	$	19.38	$	30.88	$	27.30		159	%		141	%	$	0.61
	Fourth Quarter	$	19.12	$	32.70	$	29.99		171	%		157	%	$	0.62
	Extra Dividend													$	0.05
*Year ended December 31, 2007*
	First Quarter		*	$	32.98	$	28.05		*			*		$	0.63
	Second Quarter (through April 2, 2007)		*	$	28.90	$	28.90		*			*			*


⁽¹⁾	Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low sales prices. The net asset values shown are based on outstanding shares at the end of each period.

⁽²⁾	Calculated as the respective high or low closing sales price divided by NAV.


^*	Not determinable at the time of filing.

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

We intend to pay quarterly dividends to shareholders of our common stock. The amount of our quarterly dividends is determined by our Board of Directors. Our Board of Directors has established a dividend policy to review the dividend rate quarterly, and may adjust the quarterly dividend rate throughout the year. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Dividends and Distributions” and “Tax Status.” There can be no assurance that we will achieve investment results or maintain a tax status that will permit any particular level of dividend payment. Certain of our credit facilities limit our ability to declare dividends if we default under certain provisions.

We maintain an “opt in” dividend reinvestment plan for our common shareholders. As a result, if our Board of Directors declares a dividend, then our shareholders will receive cash dividends, unless they specifically “opt in” to the dividend reinvestment plan to reinvest their dividends and receive additional shares of common stock. See “Dividend Reinvestment Plan.”

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information contained in this section should be read in conjunction with our Consolidated Financial Statements and the Notes thereto. In addition, this prospectus contains certain forward-looking statements. These statements include the plans and objectives of management for future operations and financial objectives and 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. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors that could cause actual results and conditions to differ materially from those projected in these forward-looking statements are set forth in “Risk Factors” above. Other factors that could cause actual results to differ materially include:


	•	changes in the economy;

	•	risks associated with possible disruption in our operations due to terrorism;

	•	future changes in laws or regulations and conditions in our operating areas; and

	•	other risks and uncertainties as may be detailed from time to time in our public announcements and SEC filings.

Financial or other information presented for private finance portfolio companies has been obtained from the portfolio companies, and this financial information presented may represent unaudited, projected or pro forma financial information, and therefore may not be indicative of actual results. In addition, the private equity industry uses financial measures such as EBITDA or EBITDAM (Earnings Before Interest, Taxes, Depreciation, Amortization and, in some instances, Management fees) in order to assess a portfolio company’s financial performance and to value a portfolio company. EBITDA and EBITDAM are not intended to represent cash flow from operations as defined by U.S. generally accepted accounting principles and such information should not be considered as an alternative to net income, cash flow from operations or any other measure of performance prescribed by U.S. generally accepted accounting principles.

OVERVIEW

As a business development company, we are in the private equity business. Specifically, we provide long-term debt and equity investment capital to companies in a variety of industries. Our private finance activity principally involves providing financing to middle market U.S. companies through privately negotiated long-term debt and equity investment capital. Our financing is generally used to fund buyouts, acquisitions, growth, recapitalizations, note purchases, and other types of financings. We generally invest in private companies though, from time to time, we may invest in companies that are public but lack access to additional public capital. Our investment objective is to achieve current income and capital gains.

Our portfolio composition at December 31, 2006, 2005, and 2004, was as follows:


	2006			2005			2004

Private finance		97	%		96	%		76	%
Commercial real estate finance⁽¹⁾		3	%		4	%		24	%


⁽¹⁾	On May 3, 2005, we completed the sale of our portfolio of non-investment grade commercial mortgage-backed securities and real estate related collateralized debt obligation bonds and preferred shares investments. Upon the completion of this transaction, our lending and investment activity has been focused primarily on private finance investments.

Our earnings depend primarily on the level of interest and dividend income, fee and other income, and net realized and unrealized gains or losses on our investment portfolio after deducting interest expense on borrowed capital, operating expenses and income taxes, including excise tax. Interest income results from the stated interest rate earned on a loan or debt security and the amortization of loan origination fees and discounts. The level of interest income is directly related to the balance of the interest-bearing investment portfolio outstanding during the year multiplied by the weighted average yield. Our ability to generate interest income is dependent on economic, regulatory, and competitive factors that influence new investment activity, interest rates on the types of loans we make, the level of repayments in the portfolio, the amount of loans and debt securities for which interest is not accruing and our ability to secure debt and equity capital for our investment activities.

Because we are a regulated investment company for tax purposes, we intend to distribute substantially all of our annual taxable income available for distribution to shareholders as dividends to our shareholders. See “Other Matters” below.

PORTFOLIO AND INVESTMENT ACTIVITY

The total portfolio at value, investment activity, and the yield on interest-bearing investments at and for the years ended December 31, 2006, 2005, and 2004, were as follows:


	At and for the
	Years Ended December 31,

	2006			2005			2004
($ in millions)
Portfolio at value	$	4,496.1		$	3,606.4		$	3,013.4
Investments funded⁽¹⁾	$	2,437.8		$	1,675.8		$	1,524.5
Change in accrued or reinvested interest and dividends⁽²⁾	$	11.3		$	6.6		$	52.2
Principal collections related to investment repayments or sales	$	1,055.3		$	1,503.4		$	909.2
Yield on interest-bearing investments⁽³⁾		11.8	%		12.8	%		14.0	%


⁽¹⁾	Investments funded included investments acquired through the issuance of our common stock as consideration totaling $7.2 million and $3.2 million, respectively, for the years ended December 31, 2005 and 2004. See also “— Private Finance” below.

⁽²⁾	Includes changes in accrued or reinvested interest of $3.1 million for the year ended December 31, 2006, related to our investments in money market securities.

⁽³⁾	The weighted average yield on interest-bearing investments is computed as the (a) annual stated interest on accruing loans and debt securities plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans and debt securities less the annual amortization of loan origination costs, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date.

Private Finance

The private finance portfolio at value, investment activity, and the yield on loans and debt securities at and for the years ended December 31, 2006, 2005, and 2004, were as follows:


				At and for the
				Years Ended December 31,

				2006					2005					2004

				Value		Yield⁽²⁾			Value		Yield⁽²⁾			Value		Yield⁽²⁾
($ in millions)
Portfolio at value:
	Loans and debt securities:
		Senior loans		$	405.2		8.4	%	$	239.8		9.5	%	$	234.6		8.5	%
		Unitranche debt			799.2		11.2	%		294.2		11.4	%		43.9		14.8	%
		Subordinated debt			1,980.8		12.9	%		1,560.9		13.8	%		1,324.4		14.9	%

			Total loans and debt securities		3,185.2		11.9	%		2,094.9		13.0	%		1,602.9		13.9	%
	Equity securities				1,192.7					1,384.4					699.2

Total portfolio				$	4,377.9				$	3,479.3				$	2,302.1

Investments funded⁽¹⁾				$	2,423.4				$	1,462.3				$	1,140.8
Change in accrued or reinvested interest and dividends				$	7.2				$	24.6				$	45.6
Principal collections related to investment repayments or sales⁽³⁾				$	1,015.4				$	703.9				$	551.9


⁽¹⁾	Investments funded for the years ended December 31, 2006 and 2004, included debt investments in certain portfolio companies received in conjunction with the sale of such companies. See “— Private Finance, Investments Funded” below.

⁽²⁾	The weighted average yield on loans and debt securities is computed as the (a) annual stated interest on accruing loans and debt securities plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans and debt securities less the annual amortization of loan origination costs, divided by (b) total loans and debt securities at value. The weighted average yield is computed as of the balance sheet date.

⁽³⁾	Includes collections from the sale or repayment of senior loans totaling $322.7 million, $301.8 million, and $35.6 million for the years ended December 31, 2006, 2005, and 2004, respectively.

Our investment activity is focused on making long-term investments in the debt and equity of primarily private middle market companies. Debt investments may include senior loans, unitranche debt (a single debt investment that is a blend of senior and subordinated debt terms), or subordinated debt (with or without equity features). The junior debt that we invest in that is lower in repayment priority than senior debt is also known as mezzanine debt. Equity investments may include a minority equity stake in connection with a debt investment or a substantial equity stake in connection with a buyout transaction. In a buyout transaction, we generally invest in senior and/or subordinated debt and equity (preferred and/or voting or non-voting common) where our equity ownership represents a significant portion of the equity, but may or may not represent a controlling interest.

and terms of our debt and equity investments and where we can potentially realize more attractive total returns from both current interest and fee income and future capital gains. We are also focusing our debt investing on smaller middle market companies where we can provide both senior and subordinated debt or unitranche debt, where our combined current yield may be lower than traditional subordinated debt only. We believe that providing both senior and subordinated debt or unitranche debt provides us with greater protection in the capital structures of our portfolio companies. The yield on loans and debt securities will vary from period to period depending on the level of lower-yielding senior debt in the portfolio.

The level of investment activity for investments funded and principal repayments for private finance investments can vary substantially from period to period depending on the number and size of investments that we make or that we exit and many other factors, including the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity for such companies, the general economic environment, and the competitive environment for the types of investments we make. We believe that merger and acquisition activity in the middle market is strong, which has resulted in an increase in private finance investment opportunities, as well as increased repayments.

It has been and we believe it will continue to be a highly competitive market for winning new investments. As a result, we have continued to build our business development team to increase the number of potential investments that we see. We also believe that it is important to be disciplined in our investing activities, carefully considering investment risk and return. For 2006, we reviewed over $65 billion in prospective investments and we closed on approximately 3% of the potential new investments that we reviewed. This compares to over $45 billion reviewed and approximately 3% closed for 2005. We continue to have an active pipeline of new investments under consideration and we believe that merger and acquisition activity for middle market companies will remain strong in 2007.

Investments Funded. Investments funded and the weighted average yield on loans and debt securities funded for the years ended December 31, 2006, 2005, and 2004, consisted of the following:


		2006 Investments Funded

		Debt Investments						Buyout Investments					Total

					Weighted					Weighted					Weighted
					Average					Average					Average
		Amount			Yield⁽¹⁾			Amount		Yield⁽¹⁾			Amount		Yield⁽¹⁾
($ in millions)
Loans and debt securities:
	Senior loans	$	245.4			9.4	%	$	239.8		8.9	%	$	485.2		9.2	%
	Unitranche debt⁽²⁾		471.7			10.7	%		146.5		12.9	%		618.2		11.3	%
	Subordinated debt⁽³⁾		510.7			13.0	%		423.8		14.4	%		934.5		13.6	%

Total loans and debt securities			1,227.8			11.4	%		810.1		12.5	%		2,037.9		11.9	%
Equity			91.4	⁽⁵⁾					294.1					385.5

	Total	$	1,319.2					$	1,104.2				$	2,423.4


		2005 Investments Funded

		Debt Investments						Buyout Investments					Total

					Weighted					Weighted					Weighted
					Average					Average					Average
		Amount			Yield⁽¹⁾			Amount		Yield⁽¹⁾			Amount		Yield⁽¹⁾
($ in millions)
Loans and debt securities:
	Senior loans	$	76.8			10.0	%	$	250.2		6.4	%	$	327.0		7.2	%
	Unitranche debt⁽²⁾		259.5			10.5	%		—		—			259.5		10.5	%
	Subordinated debt		296.9	⁽⁴⁾		12.3	%		330.9		12.5	%		627.8		12.4	%

Total loans and debt securities			633.2			11.3	%		581.1		9.9	%		1,214.3		10.6	%
Equity			82.5	⁽⁵⁾					165.5					248.0

	Total	$	715.7					$	746.6				$	1,462.3


		2004 Investments Funded

		Debt Investments						Buyout Investments					Total

					Weighted					Weighted					Weighted
					Average					Average					Average
		Amount			Yield⁽¹⁾			Amount		Yield⁽¹⁾			Amount		Yield⁽¹⁾
($ in millions)
Loans and debt securities:
	Senior loans	$	25.1			9.1	%	$	140.8		7.2	%	$	165.9		7.5	%
	Unitranche debt⁽²⁾		18.9			13.0	%		—		—			18.9		13.0	%
	Subordinated debt⁽³⁾		396.4			13.4	%		320.1		15.5	%		716.5		14.4	%

Total loans and debt securities			440.4			13.2	%		460.9		13.0	%		901.3		13.1	%
Equity			72.3	⁽⁵⁾					167.2					239.5

	Total	$	512.7					$	628.1				$	1,140.8


⁽¹⁾	The weighted average yield on interest-bearing investments is computed as the (a) annual stated interest on accruing interest-bearing investments, divided by (b) total interest-bearing investments funded.

⁽²⁾	Unitranche debt is a single debt investment that is a blend of senior and subordinated debt terms. The yield on a unitranche investment reflects the blended yield of senior and subordinated debt combined.

⁽³⁾	Debt investments funded for the year ended December 31, 2006, included a $150 million subordinated debt investment in Advantage Sales & Marketing, Inc. received in conjunction with the sale of Advantage and a $30 million subordinated debt investment in STS Operating, Inc. received in conjunction with the sale of STS. Debt investments funded for the year ended December 31, 2004, included a $47.5 million subordinated debt investment in The Hillman Companies, Inc. received in conjunction with the sale of Hillman.

⁽⁴⁾	Subordinated debt investments for the year ended December 31, 2005, included $45.5 million in investments in the bonds of collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs) that are managed by Callidus Capital Corporation (Callidus), a portfolio company controlled by us. These CLOs and CDOs primarily invest in senior debt.

⁽⁵⁾	Equity investments for the years ended December 31, 2006, 2005, and 2004, included $26.1 million, $47.9 million, and $23.6 million, respectively, in investments in the preferred shares/income notes of CLOs and CDOs that are managed by Callidus. These CDOs and CLOs primarily invest in senior debt.

We generally fund new investments using cash. In addition, we may acquire securities in exchange for our common equity. Also, we may acquire new securities through the reinvestment of previously accrued interest and dividends in debt or equity securities, or the current reinvestment of interest and dividend income through the receipt of a debt or equity security (payment-in-kind income). From time to time we may opt to reinvest accrued interest receivable in a new debt or equity security in lieu of receiving such interest in cash.

We may originate, underwrite and arrange senior loans related to our portfolio investments or for other companies that are not in our portfolio. Senior loans originated by us may or may not be funded by us at closing. When these senior loans are closed, we may fund all or a portion of the underwritten commitment pending sale of the loan to other investors, which may include loan sales to Callidus Capital Corporation (Callidus) or funds managed by Callidus, a portfolio company controlled by us. After completion of the sale process, we may or may not retain a position in these senior loans. We generally earn a fee on the senior loans originated and underwritten whether or not we fund the underwritten commitment. In addition, we may fund most or all of the debt and equity capital upon the closing of certain buyout transactions, which may include investments in lower-yielding senior debt. Subsequent to the closing, the portfolio company may refinance all or a portion of the lower-yielding senior debt, which would reduce our investment. Repayments include repayments of senior debt funded by us that was subsequently sold by us or refinanced or repaid by the portfolio companies.

Yield. The weighted average yield on the private finance loans and debt securities was 11.9% at December 31, 2006, as compared to 13.0% and 13.9% at December 31, 2005 and 2004, respectively. The weighted average yield on the private finance loans and debt securities may fluctuate from year to year depending on the yield on new loans and debt securities funded, the yield on loans and debt securities repaid, the amount of loans and debt securities for which interest is not accruing (see “Portfolio Asset Quality — Loans and Debt Securities on Non-Accrual Status” below) and the amount of lower-yielding senior or unitranche debt in the portfolio at the end of the year. Yields on senior and subordinated debt investments are generally lower in the current market as a result of the supply of capital available to middle market companies. We believe that debt yields will remain on the lower end of a historical range as long as merger and acquisition activity remains robust and the supply of capital remains strong.

The yield on the private finance portfolio has declined over the past two years partly due to our strategy to pursue investments where our position in the portfolio company capital structure is more senior, such as senior debt and unitranche investments that typically have lower yields than subordinated debt investments. Our weighted average yield at December 31, 2006, was also reduced by 0.5% as a result of the guaranteed dividend yield on our investment in BLX’s 25% Class A equity interests being placed on non-accrual status in the fourth quarter of 2006. The Class A equity interests are included in our loans and debt securities. See “Business Loan Express, LLC” below.

Outstanding Investment Commitments. At December 31, 2006, we had outstanding private finance investment commitments as follows:


		Companies		Companies		Companies
		More Than		5% to 25%		Less Than
		25% Owned⁽¹⁾		Owned		5% Owned		Total

($ in millions)
Senior loans		$	30.4	$	13.6	$	157.4	$	201.4	⁽²⁾
Subordinated debt			36.5		1.1		54.7		92.3

	Total loans and debt securities		66.9		14.7		212.1		293.7
Equity securities			69.6		16.1		46.6		132.3	⁽³⁾

	Total	$	136.5	$	30.8	$	258.7	$	426.0


⁽¹⁾	Includes various commitments to Callidus Capital Corporation (Callidus), a portfolio company controlled by us, which owns 80% (subject to dilution) of Callidus Capital Management, LLC, an asset management company that structures and manages collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), and other related investments, as follows:


						Amount
		Committed		Amount		Available
		Amount		Drawn		to be Drawn
($ in millions)
Revolving line of credit for working capital		$	4.0	$	—	$	4.0
Subordinated debt to support warehouse facilities & warehousing activities^(*)			36.0		—		36.0
Purchase of preferred equity in future CLO transactions			60.0		—		60.0

	Total	$	100.0	$	—	$	100.0


^(*)	Callidus has a secured warehouse credit facility with a third party for up to $240 million. The facility is used primarily to finance the acquisition of loans pending securitization through a CDO or CLO. In conjunction with this warehouse credit facility, we have agreed to designate our subordinated debt commitment for Callidus to draw upon to provide first loss capital as needed to support the warehouse facility.

⁽²⁾	Includes $158.4 million in the form of revolving senior debt facilities to 33 companies.

⁽³⁾	Includes $62.6 million to 17 private equity and venture capital funds, including $4.3 million in co-investment commitments to one private equity fund.

In addition to these outstanding investment commitments at December 31, 2006, we may be required to fund additional amounts under earn-out arrangements primarily related to buyout transactions in the future if those companies meet agreed-upon performance targets. We also had commitments to private finance portfolio companies in the form of standby letters of credit and guarantees totaling $236.2 million. See “Financial Condition, Liquidity and Capital Resources.”

Mercury Air Centers, Inc. At December 31, 2006, our investment in Mercury Air Centers, Inc. (Mercury) totaled $84.3 million at cost and $244.2 million at value, or 5.0% of our total assets, which included unrealized appreciation of $159.9 million. At December 31, 2005, our investment in Mercury totaled $113.3 million at cost and $167.1 million at value, which included unrealized appreciation of $53.8 million. We completed the purchase of a majority ownership in Mercury in April 2004.

Total interest and related portfolio income earned from our investment in Mercury for the years ended December 31, 2006, 2005, and 2004, was as follows:


		2006		2005		2004
($ in millions)
Interest income		$	9.3	$	8.8	$	5.5
Fees and other income			0.6		0.7		1.9

	Total interest and related portfolio income	$	9.9	$	9.5	$	7.4

Interest income from Mercury for the years ended December 31, 2006, 2005, and 2004, included interest income of $2.0 million, $1.6 million, and $1.0 million, respectively, which was paid in kind. The interest paid in kind was paid to us through the issuance of additional debt.

Net change in unrealized appreciation or depreciation included a net increase in unrealized appreciation on our investment in Mercury of $106.1 million, $53.8 million, and zero for the years ended December 31, 2006, 2005, and 2004, respectively.

Mercury owns and operates fixed base operations generally under long-term leases from local airport authorities, which consist of terminal and hangar complexes that service the needs of the general aviation community. Mercury is headquartered in Richmond Heights, OH.

Business Loan Express, LLC. BLX originates, sells, and services primarily real estate secured loans, including real estate secured conventional small business loans, SBA 7(a) loans, and small investment real estate loans. BLX has offices across the United States and is headquartered in New York, NY. We acquired BLX in 2000.

At December 31, 2006, our investment in BLX totaled $295.3 million at cost and $210.7 million at value, or 4.3% of our total assets, which included unrealized depreciation of $84.6 million. At December 31, 2005, our investment in BLX totaled $299.4 million at cost and $357.1 million at value, which included unrealized appreciation of $57.7 million. Subsequent to December 31, 2006, in the first quarter of 2007 we increased our investment in BLX by $12 million by acquiring additional Class A equity interests.

Total interest and related portfolio income earned from our investment in BLX for the years ended December 31, 2006, 2005, and 2004, was as follows:


		2006		2005		2004
($ in millions)
Interest income		$	11.9	$	14.3	$	23.2
Dividend income			—		14.0		14.8
Fees and other income			7.8		9.2		12.0

	Total interest and related portfolio income	$	19.7	$	37.5	$	50.0

Interest and dividend income from BLX for the years ended December 31, 2006, 2005, and 2004, included interest and dividend income of $5.7 million, $8.9 million, and $25.4 million, respectively, which was paid in kind. The interest and dividends paid in kind were paid to us through the issuance of additional debt or equity interests. In the fourth quarter of 2006, we placed our $66.6 million investment in BLX’s 25% Class A equity interests on non-accrual status, which resulted in lower interest income from our investment in BLX for 2006 as compared to 2005.

As a limited liability company, BLX’s taxable income flows through directly to its members. BLX’s annual taxable income generally differs from its book income for the

fiscal year due to temporary and permanent differences in the recognition of income and expenses. We hold all of BLX’s Class A and Class B equity interests, and 94.9% of the Class C equity interests. BLX’s taxable income is first allocated to the Class A equity interests to the extent that guaranteed dividends are paid in cash or in kind on such interests, with the remainder being allocated to the Class B and C equity interests. BLX may declare dividends on its Class B equity interests. If declared, BLX would determine the amount of such dividends considering its estimated annual taxable income allocable to such interests. There were no dividends declared or paid in 2006.

Accrued interest and dividends receivable and other assets at December 31, 2006, included accrued interest and fees due from BLX totaling $1.7 million, which was paid in cash in the first quarter of 2007.

Net change in unrealized appreciation or depreciation included a net decrease on our investment in BLX of $142.3 million and $32.3 million for the years ended December 31, 2006 and 2004, and, a net increase of $2.9 million for the year ended December 31, 2005. See “Results of Operations, Valuation of Business Loan Express, LLC” below.

BLX is a national, non-bank lender that participates in the SBA’s 7(a) Guaranteed Loan Program and is licensed by the SBA as a Small Business Lending Company (SBLC). The Office of the Inspector General of the SBA and the United States Secret Service have announced an ongoing investigation of allegedly fraudulently obtained SBA-guaranteed loans issued by BLX. Specifically, on or about January 9, 2007, BLX became aware of an indictment captioned as the United States v. Harrington, No. 2:06-CR-20662 pending in the United States District Court for the Eastern District of Michigan. The indictment alleges that a former BLX employee in the Detroit office engaged in the fraudulent origination of loans guaranteed, in substantial part, by the SBA. We understand that BLX is working cooperatively with the U.S. Attorney’s Office and the investigating agencies with respect to this matter. We understand that BLX is also working cooperatively with the SBA so that it may remain a preferred lender in the SBA 7(a) program and retain the ability to sell loans into the secondary market. The ultimate resolution of these matters could have a material adverse impact on BLX’s financial condition, and, as a result, our financial results could be negatively affected. We are monitoring the situation and have retained a third party to work with BLX to conduct a review of BLX’s current internal control systems, with a focus on preventing fraud and further strengthening the company’s operations.

Further, on or about January 16, 2007, BLX and Business Loan Center LLC (BLC) became aware of a lawsuit titled, United States, ex rel James R. Brickman and Greenlight Capital, Inc. v. Business Loan Express LLC f/k/a Business Loan Express, Inc.; Business Loan Center LLC f/k/a Business Loan Center, Inc.; Robert Tannenhauser; Matthew McGee; and George Harrigan, 05-CV-3147 (JEC), that is pending in the United States District Court for the Northern District of Georgia. The complaint includes allegations arising under the False Claims Act and relating to alleged fraud in connection with SBA guarantees on shrimp vessel loans made by BLX and BLC. We understand that BLX and BLC plan to vigorously contest the lawsuit. We are monitoring the litigation.

As an SBA lender, BLX is also subject to other SBA and OIG audits, investigations, and reviews. Investigations, changes in the laws or regulations that govern SBLCs or the SBA 7(a) Guaranteed Loan Program, or changes in government funding for this program could have a material adverse impact on BLX and, as a result, could negatively affect our financial results. We have considered these matters in performing the valuation of BLX at

December 31, 2006. See “Results of Operations, Valuation of Business Loan Express, LLC” below.

At December 31, 2006, BLX had a three-year $500.0 million revolving credit facility provided by third party lenders that matures in March 2009. The revolving credit facility may be expanded through new or additional commitments up to $600.0 million at BLX’s option. This facility provides for a sub-facility for the issuance of letters of credit for up to an amount equal to 25% of the committed facility. We have provided an unconditional guaranty to these revolving credit facility lenders in an amount equal to 50% of the total obligations (consisting of principal, letters of credit issued under the facility, accrued interest, and other fees) of BLX under this facility. At December 31, 2006, the principal amount outstanding on the revolving credit facility was $321.9 million and letters of credit issued under the facility were $55.9 million. The total obligation guaranteed by us at December 31, 2006, was $189.7 million.

This guaranty can be called by the lenders in the event of a default under the BLX credit facility, which includes certain defaults under our revolving credit facility. Among other requirements, the BLX facility requires that BLX maintain compliance with certain financial covenants such as interest coverage, maximum debt to net worth, asset coverage, and maintenance of certain asset quality metrics. In addition, BLX would have an event of default if BLX failed to maintain its lending status with the SBA and such failure could reasonably be expected to result in a material adverse effect on BLX, or if BLX failed to maintain certain financing programs for the sale or long-term funding of BLX’s loans. At December 31, 2006, BLX would not have met the required maximum debt to net worth covenant requirement had we not made the additional $12 million investment in the company in the first quarter of 2007 discussed above. Under the terms of the facility, the $12 million investment in the company caused BLX to satisfy the leverage covenant requirement and BLX has determined that it was in compliance with the terms of this facility at December 31, 2006. At December 31, 2006, we had also provided four standby letters of credit totaling $25.0 million in connection with four term securitization transactions completed by BLX.

In consideration for providing the revolving credit facility guaranty and the standby letters of credit, we earned fees of $6.1 million, $6.3 million, and $6.0 million for the years ended December 31, 2006, 2005, and 2004, respectively, which were included in fees and other income above. The remaining fees and other income relate to management fees from BLX. We did not charge a management fee to BLX in the fourth quarter of 2006.

The current market conditions for small business loans remain very competitive, and as a result, BLX continues to experience significant loan prepayments in its securitized loan portfolio. This competitive environment has also had an effect on BLX’s ability to grow its SBA loan origination volume. As a result, BLX has been introducing non-SBA real estate loan products in order to diversify its lending products and develop new market niches. We are discussing various funding alternatives with BLX to more effectively accommodate their non-SBA real estate lending activities. We believe that the changes in BLX’s operations and the effect of the company’s current regulatory issues and ongoing investigations will require a restructure or recapitalization of BLX given the current set of covenants under its revolving credit facility. We intend to work with BLX management to implement its business plan and funding alternatives. In addition, should BLX require additional capital from us, we plan to fund it, if we believe such funding is reasonable and prudent.

See “Recent Developments” for additional discussion of BLX.

Advantage Sales & Marketing, Inc. At December 31, 2005, our investment in Advantage totaled $257.7 million at cost and $660.4 million at value, or 16.4% of our total assets, which included unrealized appreciation of $402.7 million. We completed the purchase of a majority ownership in Advantage in June 2004.

On March 29, 2006, we sold our majority equity interest in Advantage. We were repaid our $184 million in subordinated debt outstanding and realized a gain at closing on our equity investment sold of $433.1 million, subject to post-closing adjustments. Subsequent to closing on this sale, we realized additional gains resulting from post-closing adjustments totaling $1.3 million in 2006. In addition, there is potential for us to receive additional consideration through an earn-out payment that would be based on Advantage’s 2006 audited results. Our realized gain of $434.4 million as of December 31, 2006, subject to post-closing adjustments, excludes any earn-out amounts.

As consideration for the common stock sold in the transaction, we received a $150 million subordinated note, with the balance of the consideration paid in cash. In addition, a portion of our cash proceeds from the sale of the common stock were placed in escrow, subject to certain holdback provisions. At December 31, 2006, the amount of the escrow included in other assets on our consolidated balance sheet was approximately $24 million. For tax purposes, the receipt of the $150 million subordinated note as part of our consideration for the common stock sold and the hold back of certain proceeds in escrow will generally allow us, through installment treatment, to defer the recognition of taxable income for a portion of our realized gain until the note or other amounts are collected.

In connection with the sale transaction, we retained an equity investment in the business valued at $15 million at closing as a minority shareholder. During the fourth quarter of 2006, Advantage made a distribution on this minority equity investment, which resulted in a realized gain of $4.8 million.

Total interest and related portfolio income earned from our investment in Advantage while we held a majority equity interest was $14.1 million (which included a prepayment premium of $5.0 million), $37.4 million, and $21.3 million, for the years ended December 31, 2006, 2005, and 2004, respectively. In addition, we earned structuring fees of $2.3 million on our new $150 million subordinated debt investment in Advantage upon the closing of the sale transaction in 2006.

Our investment in Advantage at December 31, 2006, which was composed of subordinated debt and a minority equity interest, totaled $151.6 million at cost and $162.6 million at value, which included unrealized appreciation of $11.0 million. Subsequent to the completion of the sale transaction, our interest income from our subordinated debt investment in Advantage for the year ended December 31, 2006, was $14.1 million.

Advantage is a sales and marketing agency providing outsourced sales, merchandising, and marketing services to the consumer packaged goods industry. Advantage has offices across the United States and is headquartered in Irvine, CA.

Commercial Real Estate Finance

The commercial real estate finance portfolio at value, investment activity, and the yield on interest-bearing investments at and for the years ended December 31, 2006, 2005, and 2004, were as follows:


		At and for the Years Ended December 31,

		2006				2005					2004

		Value		Yield⁽¹⁾		Value			Yield⁽¹⁾		Value		Yield⁽¹⁾
($ in millions)
Portfolio at value:
	CMBS bonds	$	—			$	—				$	373.8		14.6%
	CDO bonds and preferred shares		—				—					212.6		16.8%
	Commercial mortgage loans		71.9		7.5%		102.6			7.6%		95.0		6.8%
	Real estate owned		19.6				13.9					16.9
	Equity interests		26.7				10.6					13.0

Total portfolio		$	118.2			$	127.1				$	711.3

Investments funded		$	14.4			$	213.5				$	383.7
Change in accrued or reinvested interest		$	1.0			$	(18.0	)			$	6.6
Principal collections related to investment repayments or sales⁽²⁾		$	39.9			$	799.5				$	357.3


⁽¹⁾	The weighted average yield on the interest-bearing investments is computed as the (a) annual stated interest on accruing loans plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing interest-bearing investments less the annual amortization of origination costs, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date. Interest-bearing investments for the commercial real estate finance portfolio include all investments except for real estate owned and equity interests.

⁽²⁾	Principal collections related to investment repayments or sales for the year ended December 31, 2005, included $718.1 million related to the sale of our CMBS and CDO portfolio in May 2005.

Our commercial real estate investments funded for the years ended December 31, 2006, 2005, and 2004, were as follows:


		Face					Amount
		Amount		Discount			Funded
($ in millions)
*For the Year Ended December 31, 2006*
Commercial mortgage loans		$	8.0	$	—		$	8.0
Equity interests			6.4		—			6.4

	Total	$	14.4	$	—		$	14.4

*For the Year Ended December 31, 2005*
CMBS bonds⁽¹⁾		$	211.5	$	(90.5	)	$	121.0
Commercial mortgage loans			88.5		(0.8	)		87.7
Equity interests			4.8		—			4.8

	Total	$	304.8	$	(91.3	)	$	213.5

*For the Year Ended December 31, 2004*
CMBS bonds		$	419.1	$	(183.7	)	$	235.4
CDO bonds and preferred shares			40.5		(0.1	)		40.4
Commercial mortgage loans			112.1		(8.2	)		103.9
Equity interests			4.0		—			4.0

	Total	$	575.7	$	(192.0	)	$	383.7


⁽¹⁾	The CMBS bonds invested in during 2005, were sold on May 3, 2005.

At December 31, 2006, we had outstanding funding commitments related to commercial mortgage loans and equity interests of $9.0 million, and commitments in the form of standby letters of credit and guarantees related to equity interests of $6.9 million.

During the fourth quarter of 2006, we sold commercial mortgage loans with a total outstanding principal balance of $21.1 million and realized a gain of $0.7 million. As these loans were purchased at prices that were based in part on comparable Treasury rates, we had a related hedge in place to protect against movements in Treasury rates. Upon the loan sale, we settled the related hedge, which resulted in a realized gain of $0.5 million, which was included in the realized gain on the sale of $0.7 million. At December 31, 2006, we did not have any similar hedges in place.

Sale of CMBS Bonds and Collateralized Debt Obligation Bonds and Preferred Shares. On May 3, 2005, we completed the sale of our portfolio of commercial mortgage-backed securities (CMBS) and real estate related collateralized debt obligation (CDO) bonds and preferred shares to affiliates of Caisse de dépôt et placement du Québec (the Caisse) for cash proceeds of $976.0 million and a net realized gain of $227.7 million, after transaction and other costs of $7.8 million. Transaction costs included investment banking fees, legal and other professional fees, and other transaction costs. The CMBS and CDO assets sold had a cost basis at closing of $739.8 million, including accrued interest of $21.7 million. Upon the closing of the sale, we settled all the hedge positions relating to these assets, which resulted in a net realized loss of $0.7 million, which was included in the net realized gain on the sale.

Simultaneous with the sale of our CMBS and CDO portfolio, we entered into a platform assets purchase agreement with CWCapital Investments LLC, an affiliate of the Caisse (CWCapital), pursuant to which we agreed to sell certain commercial real estate related assets, including servicer advances, intellectual property, software and other platform assets, subject to certain adjustments. Under this agreement, we agreed not to primarily invest in CMBS and real estate-related CDOs and refrain from certain other real estate-related investing or servicing activities for a period of three years, or through May 2008, subject to certain limitations and excluding our existing portfolio and related activities.

The real estate securities purchase agreement, under which we sold the CMBS and CDO portfolio, and the platform asset purchase agreement contain customary representations and warranties, and require us to indemnify the affiliates of the Caisse that are parties to the agreements for certain liabilities arising under the agreements, subject to certain limitations and conditions.

PORTFOLIO ASSET QUALITY

Portfolio by Grade. We employ a grading system for our 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 investment return or principal is expected. Grade 4 is used for investments that are in workout and for which some loss of current investment return is expected, but no loss of principal is expected. Grade 5 is used for investments that are in workout and for which some loss of principal is expected.

At December 31, 2006 and 2005, our portfolio was graded as follows:


	2006					2005

	Portfolio		Percentage of			Portfolio		Percentage of
Grade	at Value		Total Portfolio			at Value		Total Portfolio

($ in millions)
1	$	1,307.3		29.1	%	$	1,643.0		45.6	%
2		2,672.3		59.4			1,730.8		48.0
3		308.1		6.9			149.1		4.1
4		84.2		1.9			26.5		0.7
5		124.2		2.7			57.0		1.6

	$	4,496.1		100.0	%	$	3,606.4		100.0	%

The amount of the portfolio in each grading category may vary substantially from year to year resulting primarily from changes in the composition of the portfolio as a result of new investment, repayment, and exit activity, changes in the grade of investments to reflect our expectation of performance, and changes in investment values.

Total Grade 4 and 5 portfolio assets were $208.4 million and $83.5 million, respectively, or were 4.6% and 2.3%, respectively, of the total portfolio value at December 31, 2006 and 2005. Grade 4 and 5 assets include loans, debt securities, and equity securities. We expect that a number of investments will be in the Grades 4 or 5 categories from time to time. Part of the private equity business is working with troubled portfolio companies to improve their businesses and protect our investment. The number and amount of investments included in Grade 4 and 5 may fluctuate from year to year. We continue to follow our historical practice of working with portfolio companies in order to recover the maximum amount of our investment.

At December 31, 2006, $135.9 million of our investment in BLX at value was classified as Grade 3, which included our Class A equity interests and certain of our Class B equity interests that were not depreciated, and $74.8 million of our investment in BLX at value was classified as Grade 5, which included certain of our Class B equity interests and our Class C equity interests that were depreciated. At December 31, 2005, our investment in BLX of $357.1 million at value was classified as Grade 1. See “— Private Finance, Business Loan Express, LLC” above.

Loans and Debt Securities on Non-Accrual Status. At December 31, 2006 and 2005, loans and debt securities at value not accruing interest for the total investment portfolio were as follows:


			2006			2005
($ in millions)
Loans and debt securities in workout status (classified as Grade 4 or 5)⁽¹⁾
	Private finance
		Companies more than 25% owned	$	51.1		$	15.6
		Companies 5% to 25% owned		4.0			—
		Companies less than 5% owned		31.6			11.4
	Commercial real estate finance			12.2			12.9
Loans and debt securities not in workout status
	Private finance
		Companies more than 25% owned		87.1			58.0
		Companies 5% to 25% owned		7.2			0.5
		Companies less than 5% owned		38.9			49.5
	Commercial real estate finance			6.7			7.9

		Total	$	238.8		$	155.8

		Percentage of total portfolio		5.3	%		4.3	%


⁽¹⁾	Workout loans and debt securities exclude equity securities that are included in the total Grade 4 and 5 assets above.

Total loans and debt securities on non-accrual status increased to $238.8 million at December 31, 2006, from $155.8 million at December 31, 2005. The increase in non-accruals primarily relates to placing our $66.6 million investment in BLX’s 25% Class A equity interests on non-accrual status during the fourth quarter of 2006. See “— Private Finance, Business Loan Express, LLC” above.

Loans and Debt Securities Over 90 Days Delinquent. Loans and debt securities greater than 90 days delinquent at value at December 31, 2006 and 2005, were as follows:


		2006			2005

($ in millions)
Private finance		$	46.5		$	74.6
Commercial mortgage loans			1.9			6.1

	Total	$	48.4		$	80.7

	Percentage of total portfolio		1.1	%		2.2	%

In general, interest is not accrued on loans and debt securities if we have doubt about interest collection or where the enterprise value of the portfolio company may not support further accrual. In addition, interest may not accrue on loans to portfolio companies that are more than 50% owned by us depending on such company’s capital requirements. To the extent interest payments are received on a loan that is not accruing interest, we may use such payments to reduce our cost basis in the investment in lieu of recognizing interest income.

As a result of these and other factors, the amount of the portfolio that is on non-accrual status or greater than 90 days delinquent may vary from year to year. Loans and debt securities on non-accrual status and over 90 days delinquent should not be added together as they are two separate measures of portfolio asset quality. Loans and debt securities that are in

both categories (i.e., on non-accrual status and over 90 days delinquent) totaled $44.3 million and $60.7 million at December 31, 2006 and 2005, respectively.

OTHER ASSETS AND OTHER LIABILITIES

Other assets is composed primarily of fixed assets, assets held in deferred compensation trusts, deferred financing and offering costs, and accounts receivable, which includes amounts received in connection with the sale of portfolio companies, including amounts held in escrow, and other receivables from portfolio companies. At December 31, 2006 and 2005, other assets totaled $123.0 million and $87.9 million, respectively. The increase since December 31, 2005, was primarily the result of amounts received in connection with the sale of Advantage and certain other portfolio companies that are being held in escrow. See “— Private Finance” above.

Accounts payable and other liabilities is primarily composed of the liabilities related to the deferred compensation trust and accrued interest, bonus and taxes, including excise tax. At December 31, 2006 and 2005, accounts payable and other liabilities totaled $147.1 million and $102.9 million, respectively. The increase since December 31, 2005, was primarily the result of an increase in the liability related to the deferred compensation trust of $13.6 million, accrued bonus of $11.3 million, accrued interest payable of $10.3 million, and accrued excise tax of $9.2 million. Accrued interest fluctuates from period to period depending on the amount of debt outstanding and the contractual payment dates of the interest on such debt.

RESULTS OF OPERATIONS

Comparison of the Years Ended December 31, 2006, 2005, and 2004

The following table summarizes our operating results for the years ended December 31, 2006, 2005, and 2004.


											Percent											Percent
			2006			2005		Change			Change			2005		2004			Change			Change
(in thousands, except per share amounts)
Interest and Related Portfolio Income
	Interest and dividends		$	386,427		$	317,153	$	69,274			22	%	$	317,153	$	319,642		$	(2,489	)		(1	)%
	Fees and other income			66,131			56,999		9,132			16	%		56,999		47,448			9,551			20	%

		Total interest and related portfolio income		452,558			374,152		78,406			21	%		374,152		367,090			7,062			2	%

Expenses
	Interest			100,600			77,352		23,248			30	%		77,352		75,650			1,702			2	%
	Employee			92,902			78,300		14,602			19	%		78,300		53,739			24,561			46	%
	Employee stock options			15,599			—		15,599			—			—		—			—			—
	Administrative			39,005			69,713		(30,708	)		(44	)%		69,713		34,686			35,027			101	%

		Total operating expenses		248,106			225,365		22,741			10	%		225,365		164,075			61,290			37	%

		Net investment income before income taxes		204,452			148,787		55,665			37	%		148,787		203,015			(54,228	)		(27	)%
		Income tax expense (benefit), including excise tax		15,221			11,561		3,660			32	%		11,561		2,057			9,504			462	%

		Net investment income		189,231			137,226		52,005			38	%		137,226		200,958			(63,732	)		(32	)%

Net Realized and Unrealized Gains (Losses)
	Net realized gains			533,301			273,496		259,805			95	%		273,496		117,240			156,256			133	%
	Net change in unrealized appreciation or depreciation			(477,409	)		462,092		(939,501	)		*			462,092		(68,712	)		530,804			*

	Total net gains (losses)			55,892			735,588		(679,696	)		*			735,588		48,528			687,060			*

		Net income	$	245,123		$	872,814	$	(627,691	)		(72	)%	$	872,814	$	249,486		$	623,328			250	%

Diluted earnings per common share			$	1.68		$	6.36	$	(4.68	)		(74	)%	$	6.36	$	1.88		$	4.48			238	%

Weighted average common shares outstanding — diluted				145,599			137,274		8,325			6	%		137,274		132,458			4,816			4	%


	*	Net change in unrealized appreciation or depreciation and net gains (losses) can fluctuate significantly from year to year.

Total Interest and Related Portfolio Income. Total interest and related portfolio income includes interest and dividend income and fees and other income.

Interest and Dividends. Interest and dividend income for the years ended December 31, 2006, 2005, and 2004, was composed of the following:


			2006		2005		2004
($ in millions)
Interest
	Private finance loans and debt securities		$	359.9	$	251.0	$	195.2
	CMBS and CDO portfolio			—		29.4		93.3
	Commercial mortgage loans			8.3		7.6		9.4
	Cash, U.S. Treasury bills, money market and other securities			14.0		9.4		3.1

		Total interest		382.2		297.4		301.0
Dividends				4.2		19.8		18.6

		Total interest and dividends	$	386.4	$	317.2	$	319.6

The level of interest income, which includes interest paid in cash and in kind, is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The interest-bearing investments in the portfolio at value and the yield on the interest-bearing investments in the portfolio at December 31, 2006, 2005, and 2004, were as follows:


		2006					2005					2004

($ in millions)		Value		Yield⁽¹⁾			Value		Yield⁽¹⁾			Value		Yield⁽¹⁾

Private finance loans and debt securities		$	3,185.2		11.9	%	$	2,094.9		13.0	%	$	1,602.9		13.9	%
CMBS and CDO			—		—			—		—			586.4		15.4	%
Commercial mortgage loans			71.9		7.5	%		102.6		7.6	%		95.0		6.8	%

	Total	$	3,257.1		11.8	%	$	2,197.5		12.8	%	$	2,284.3		14.0	%

(1)

The weighted average yield on loans and debt securities is computed as the (a) annual stated interest on accruing loans and debt securities plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans and debt securities less the annual amortization of loan origination costs, divided by (b) total loans and debt securities at value. The weighted average yield is computed as of the balance sheet date.

Our interest income from our private finance loans and debt securities has increased year over year primarily as a result of the growth in this portfolio, net of the reduction in yield. The private finance portfolio yield at December 31, 2006, of 11.9% as compared to the private finance portfolio yield of 13.0% and 13.9% at December 31, 2005 and 2004, respectively, reflects the mix of debt investments in the private finance portfolio. The weighted average yield varies from year to year based on the current stated interest on loans and debt securities and the amount of loans and debt securities for which interest is not accruing. See the discussion of the private finance portfolio yield above under the caption “— Portfolio and Investment Activity — Private Finance.”

There was no interest income from the CMBS and real estate-related CDO portfolio in 2006 as we sold this portfolio on May 3, 2005. The CMBS and CDO portfolio sold had a cost basis of $718.1 million and a weighted average yield on the cost basis of the portfolio of approximately 13.8%. We generally reinvested the principal proceeds from the CMBS and CDO portfolio into our private finance portfolio.

Our interest income from cash, U.S. Treasury bills, money market and other securities has increased primarily as a result of the fluctuations in our level of investments in U.S. Treasury bills, money market and other securities and the weighted average yield on these securities. During the fourth quarter of 2005, we established a liquidity portfolio that is composed primarily of money market and other securities and U.S. Treasury bills. See “Financial Condition, Liquidity and Capital Resources” below. The value and weighted average yield of the liquidity portfolio was $201.8 million and 5.3%, respectively, at December 31, 2006, and $200.3 million and 4.2%, respectively, at December 31, 2005.

Dividend income results from the dividend yield on preferred equity interests, if any, or the declaration of dividends by a portfolio company on preferred or common equity interests. Dividend income will vary from year to year depending upon the timing and amount of dividends that are declared or paid by a portfolio company on preferred or common equity interests. Dividend income for the year ended December 31, 2006, did not include any dividends from BLX. See “— Private Finance, Business Loan Express, LLC” above. Dividend income for the years ended December 31, 2005 and 2004, included dividends from BLX on the Class B equity interests held by us of $14.0 million and $14.8 million, respectively. For the year ended December 31, 2005, $12.0 million of these dividends were paid in cash and $2.0 million of these dividends were paid through the issuance of additional Class B equity interests. For the year ended December 31, 2004, the dividends were paid through the issuance of additional Class B equity interests.

Fees and Other Income. Fees and other income primarily include fees related to financial structuring, diligence, transaction services, management and consulting services to portfolio companies, commitments, guarantees, and other services and loan prepayment premiums. As a business development company, we are required to make significant managerial assistance available to the companies in our investment portfolio. Managerial assistance includes, but is not limited to, management and consulting services related to corporate finance, marketing, human resources, personnel and board member recruiting, business operations, corporate governance, risk management and other general business matters.

Fees and other income for the years ended December 31, 2006, 2005, and 2004, included fees relating to the following:


		2006		2005		2004
($ in millions)
Structuring and diligence		$	37.3	$	24.6	$	18.4
Management, consulting and other services provided to portfolio companies⁽¹⁾			11.1		14.4		11.4
Commitment, guaranty and other fees from portfolio companies⁽²⁾			8.8		9.3		9.4
Loan prepayment premiums			8.8		6.3		5.5
Other income			0.1		2.4		2.7

	Total fees and other income⁽³⁾	$	66.1	$	57.0	$	47.4


⁽¹⁾	2006 includes $1.8 million in management fees from Advantage prior to its sale on March 29, 2006. See “— Portfolio and Investment Activity” above for further discussion. 2005 and 2004 include $6.5 million and $3.1 million, respectively, in management fees from Advantage.

⁽²⁾	Includes guaranty and other fees from BLX of $6.1 million, $6.3 million, and $6.0 million for 2006, 2005, and 2004, respectively. See “— Private Finance, Business Loan Express, LLC” above.

⁽³⁾	Fees and other income related to the CMBS and CDO portfolio were $4.1 million and $6.2 million for 2005 and 2004, respectively. As noted above, we sold our CMBS and CDO portfolio on May 3, 2005.

Fees and other income are generally related to specific transactions or services and therefore may vary substantially from year to year depending on the level of investment activity and types of services provided. Loan origination fees that represent yield enhancement on a loan are capitalized and amortized into interest income over the life of the loan.

Structuring and diligence fees primarily relate to the level of new investment originations. Private finance investments funded were $2.4 billion for the year ended December 31, 2006, as compared to $1.5 billion and $1.1 billion for the years ended December 31, 2005 and 2004, respectively. Structuring and diligence fees for the years ended December 31, 2006, 2005, and 2004, included structuring fees from companies more than 25% owned totaling $8.3 million, $9.1 million, and $11.4 million, respectively.

Loan prepayment premiums for the year ended December 31, 2006, included $5.0 million related to the repayment of our subordinated debt in connection with the sale of our majority equity interest in Advantage on March 29, 2006. See “— Portfolio and Investment Activity” above for further discussion. While the scheduled maturities of private finance and commercial real estate loans generally range from five to ten years, it is not unusual for our borrowers to refinance or pay off their debts to us ahead of schedule. Therefore, we generally structure our loans to require a prepayment premium for the first three to five years of the loan. Accordingly, the amount of prepayment premiums will vary depending on the level of repayments and the age of the loans at the time of repayment.

Mercury, BLX and Advantage. Mercury and BLX were our largest investments at value at December 31, 2006, and together represented 9.3% of our total assets. Advantage and BLX were our largest investments at value at December 31, 2005 and 2004, and together represented 25.3% and 19.0% of our total assets, respectively.

Total interest and related portfolio income from these investments for the years ended December 31, 2006, 2005, and 2004, was as follows:


	2006		2005		2004
($ in millions)
Mercury	$	9.9	$	9.5	$	7.4
BLX	$	19.7	$	37.5	$	50.0
Advantage⁽¹⁾	$	14.1	$	37.4	$	21.3


⁽¹⁾	Includes income from the period we had a majority interest only. See “— Portfolio and Investment Activity” above for further discussion.

See “— Portfolio and Investment Activity” above for further detail on Mercury, BLX and Advantage.

Operating Expenses. Operating expenses include interest, employee, employee stock options, and administrative expenses.

Interest Expense. The fluctuations in interest expense during the years ended December 31, 2006, 2005, and 2004, were primarily attributable to changes in the level of our borrowings under various notes payable and our revolving line of credit. Our borrowing

activity and weighted average cost of debt, including fees and debt financing costs, at and for the years ended December 31, 2006, 2005, and 2004, were as follows:


	2006			2005			2004
($ in millions)
Total outstanding debt	$	1,899.1		$	1,284.8		$	1,176.6
Average outstanding debt	$	1,491.0		$	1,087.1		$	985.6
Weighted average cost⁽¹⁾		6.5	%		6.5	%		6.6	%


⁽¹⁾	The weighted average annual interest cost is computed as the (a) annual stated interest rate on the debt plus the annual amortization of commitment fees, other facility fees and debt financing costs that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.

In addition, interest expense included interest paid to the Internal Revenue Service related to installment sale gains totaling $0.9 million and $0.6 million for the years ended December 31, 2006 and 2005, respectively. See “Dividends and Distributions” below.

Interest expense also included interest on our obligations to replenish borrowed Treasury securities related to our hedging activities of $0.7 million, $1.4 million, and $5.2 million for the years ended December 31, 2006, 2005, and 2004, respectively.

Employee Expense. Employee expenses for the years ended December 31, 2006, 2005, and 2004, were as follows:


		2006		2005		2004
($ in millions)
Salaries and employee benefits		$	73.8	$	57.3	$	40.7
Individual performance award (IPA)			8.1		7.0		13.4
IPA mark to market expense (benefit)			2.9		2.0		(0.4	)
Individual performance bonus (IPB)			8.1		6.9		—
Transition compensation, net⁽¹⁾			—		5.1		—

	Total employee expense	$	92.9	$	78.3	$	53.7

Number of employees at end of period			170		131		162

⁽¹⁾

Transition compensation for the year ended December 31, 2005, included $3.1 million of costs under retention agreements and $3.1 million of transition services bonuses awarded to certain employees in the commercial real estate group as a result of the sale of the CMBS and CDO portfolio. Transition compensation costs were reduced by $1.1 million for salary reimbursements from CWCapital under a transition services agreement.

The change in salaries and employee benefits reflects the effect of an increase in number of employees, compensation increases, and the change in mix of employees given their area of responsibility and relevant experience level. The overall increase in employee expense during 2006 also reflects the competitive environment for attracting and retaining talent in the private equity industry. Salaries and employee benefits include an accrual for employee bonuses, which are generally paid annually after the completion of the fiscal year. Salaries and employee benefits included bonus expense of $38.2 million, $26.9 million, and $12.4 million for the years ended December 31, 2006, 2005, and 2004, respectively.

At December 31, 2006 and 2005, the total accrued bonus was $38.2 million and $26.9 million, respectively, and was included in Accounts Payable and Other Liabilities on the accompanying Balance Sheet.

The Individual Performance Award (IPA) is a long-term incentive compensation program for certain officers. The IPA, which is generally determined annually at the

beginning of each year, is deposited into a deferred compensation trust generally in four equal installments, on a quarterly basis, in the form of cash. The trustee is required to use the cash to purchase shares of our common stock in the open market. The accounts of the trust are consolidated with our accounts. We are required to mark to market the liability of the trust and this adjustment is recorded to the IPA compensation expense. Because the IPA is deferred compensation, the cost of this award is not a current expense for purposes of computing our taxable income. The expense is deferred for tax purposes until distributions are made from the trust.

As a result of changes in regulation by the Jobs Creation Act of 2004 associated with deferred compensation arrangements, as well as an increase in the competitive market for recruiting talent in the private equity industry, in 2005 the Compensation Committee and the Board of Directors determined that a portion of the IPA should be replaced with an individual performance bonus (IPB). The IPB is distributed in cash to award recipients equally throughout the year (beginning in February of each respective year) as long as the recipient remains employed by us.

The Compensation Committee and the Board of Directors have determined the IPA and the IPB for 2007 and they are currently estimated to be approximately $9.9 million and $9.7 million, respectively; however, the Compensation Committee may adjust the IPA or IPB as needed, or make new awards as new officers are hired. If a recipient terminates employment during the year, any further cash contribution for the IPA or remaining cash payments under the IPB would be forfeited.

In connection with our 2006 Annual Meeting of Stockholders, the stockholders approved the issuance of up to 2.5 million shares of our common stock in exchange for the cancellation of vested “in-the-money” stock options granted to certain officers and directors under our Amended Stock Option Plan. Under the initiative, which has been reviewed and approved by our Board of Directors, all optionees who hold vested stock options with exercise prices below the market value of the stock (or “in-the-money” options), would be offered the opportunity to receive an Option Cancellation Payment (OCP) equal to the “in-the-money” value of the stock options cancelled, which would be paid one-half in cash and one-half in shares of our common stock, in exchange for their voluntary cancellation of their vested stock options. As part of this initiative, the Board of Directors has adopted a target ownership program that establishes minimum ownership levels for our senior officers and continues to further align the interests of our officers with those of our stockholders. We have not yet implemented the OCP as of February 28, 2007, but intend to do so in the future.

Based on the 13 million vested options outstanding and the market price of $30.50 of our stock on March 10, 2006, the date used for disclosure in our 2006 proxy, the OCP would be approximately $106 million if all option holders choose to cancel all vested in-the-money options in exchange for the OCP. As of December 31, 2006, there were 17 million vested options outstanding, which were all in-the-money. Using the market price of $32.68 of our stock on December 31, 2006, the OCP would be approximately $150 million if all option holders choose to cancel all vested in-the-money options in exchange for the OCP. As the consideration paid by us for the OCP will not exceed the fair value of the options to be canceled, no expense will be recorded for the transaction in accordance with the guidance in FASB Statement No. 123 (Revised 2004). However, the cash portion of the OCP, or approximately one-half of the payment, will reduce our paid in capital and will therefore reduce our net asset value. For income tax purposes, our tax expense resulting from the OCP would be similar to the tax expense that would result

from an exercise of stock options in the market. Any tax deduction for us resulting from the OCP or an exercise of stock options in the market would be limited by Section 162(m) of the Code for persons subject to Section 162(m).

Stock Options Expense. In December 2004, the FASB issued Statement No. 123 (Revised 2004), Share-Based Payment (the “Statement”), which requires companies to recognize the grant-date fair value of stock options and other equity-based compensation issued to employees in the income statement. The Statement was effective January 1, 2006, and it applies to our stock option plan. Our employee stock options are typically granted with ratable vesting provisions, and we amortize the compensation cost over the related service period. The Statement was adopted using the modified prospective method of application, which required us to recognize compensation costs on a prospective basis beginning January 1, 2006. Accordingly, the prior year financial statements have not been restated. Under this method, the unamortized cost of previously awarded options that were unvested as of January 1, 2006, is recognized over the remaining service period in the statement of operations beginning in 2006, using the fair value amounts determined for proforma disclosure under Statement No. 123. With respect to options granted on or after January 1, 2006, compensation cost based on estimated grant date fair value is recognized in the statement of operations over the service period. The effect of this adoption for the year ended December 31, 2006, was as follows:


			2006
($ in millions)
Employee Stock Option Expense:
	Previously awarded, unvested options as of January 1, 2006		$	13.2
	Options granted on or after January 1, 2006			2.4

		Total employee stock option expense	$	15.6

In addition to the employee stock option expense, for the year ended December 31, 2006, administrative expense included $0.2 million of expense related to options granted to directors during the year. Options granted to non-officer directors vest on the grant date and therefore, the full expense is recorded on the grant date.

We estimate that the employee-related stock option expense under the Statement that will be recorded in our statement of operations will be approximately $11.3 million, $3.7 million, and $0.1 million for the years ended December 31, 2007, 2008, and 2009, respectively, which includes approximately $1.9 million, $1.0 million, and $0.1 million, respectively, related to options granted during the year ended December 31, 2006. This estimate may change if our assumptions related to future option forfeitures change. This estimate does not include any expense related to future stock option grants as the fair value of those stock options will be determined at the time of grant.

Administrative Expense. Administrative expenses include legal and accounting fees, valuation assistance fees, insurance premiums, the cost of leases for our headquarters in Washington, DC, and our regional offices, portfolio origination and development expenses, travel costs, stock record expenses, directors’ fees and stock option expense, and various other expenses. Administrative expenses for the years ended December 31, 2006, 2005, and 2004, were as follows:


		2006		2005		2004
($ in millions)
Administrative expenses		$	34.0	$	33.3	$	30.1
Investigation related costs			5.0		36.4		4.6

	Total administrative expenses	$	39.0	$	69.7	$	34.7

The increase in administrative expenses, excluding investigation related costs, for the year ended December 31, 2005, over the year ended December 31, 2004, was primarily due to increased expenses related to evaluating potential new investments of $2.0 million, accounting fees of $0.8 million, recruiting and employee training costs of $0.6 million, and valuation assistance fees of $0.5 million, offset by a decrease in expenses related to a decline in portfolio workout expenses of $0.6 million.

Investigation related costs include costs associated with requests for information in connection with government investigations and other legal matters. We expect that we will continue to incur legal and other costs associated with these matters. These expenses remain difficult to predict. See “Business, Legal Proceedings” below.

Income Tax Expense (Benefit), Including Excise Tax. Income tax expense (benefit) for the years ended December 31, 2006, 2005, and 2004, was as follows:


		2006		2005		2004
($ in millions)
Income tax expense (benefit)		$	0.1	$	5.4	$	1.1
Excise tax expense⁽¹⁾			15.1		6.2		1.0

	Income tax expense (benefit), including excise tax	$	15.2	$	11.6	$	2.1


⁽¹⁾	2006 includes an accrual for estimated excise tax of $15.4 million for the year ended December 31, 2006, net of the reversal of over accrued estimated excise taxes related to 2005 of $0.3 million.

Our wholly owned subsidiary, A.C. Corporation, is a corporation subject to federal and state income taxes and records a benefit or expense for income taxes as appropriate based on its operating results in a given period. In addition, our estimated annual taxable income for 2006 exceeded our dividend distributions to shareholders for 2006 from such taxable income, and such estimated excess taxable income will be distributed in 2007. Therefore, we will be required to pay a 4% excise tax on the excess of 98% of our taxable income for 2006 over the amount of actual distributions for 2006. Accordingly, we accrued an estimated excise tax of $15.4 million for the year ended December 31, 2006, based upon our current estimate of annual taxable income for 2006. See “Dividends and Distributions.”

While excise tax expense is presented in the Consolidated Statement of Operations as a reduction to net investment income, excise tax relates to both net investment income and net realized gains. At December 31, 2006 and 2005, excise tax payable was $15.4 million and $6.2 million, respectively, which was included in Accounts Payable and Other Liabilities on the accompanying Balance Sheet.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of this interpretation to have a significant effect on our consolidated financial position or our results of operations.

Realized Gains and Losses. Net realized gains primarily result from the sale of equity securities associated with certain private finance investments, the sale of CMBS bonds and CDO bonds and preferred shares, and the realization of unamortized discount resulting from the sale and early repayment of private finance loans and commercial mortgage loans, offset by losses on investments. Net realized gains for the years ended December 31, 2006, 2005, and 2004, were as follows:


	2006			2005			2004
($ in millions)
Realized gains	$	557.5		$	343.1		$	267.7
Realized losses		(24.2	)		(69.6	)		(150.5	)

Net realized gains	$	533.3		$	273.5		$	117.2

When we exit an investment and realize a gain or loss, we make an accounting entry to reverse any unrealized appreciation or depreciation, respectively, we had previously recorded to reflect the appreciated or depreciated value of the investment. For the years ended December 31, 2006, 2005, and 2004, we reversed previously recorded unrealized appreciation or depreciation when gains or losses were realized as follows:


		2006			2005⁽¹⁾			2004
($ in millions)
Reversal of previously recorded net unrealized appreciation associated with realized gains		$	(501.5	)	$	(108.0	)	$	(210.5	)
Reversal of previously recorded net unrealized depreciation associated with realized losses			22.5			68.0			151.8

	Total reversal	$	(479.0	)	$	(40.0	)	$	(58.7	)


⁽¹⁾	Includes the reversal of net unrealized appreciation of $6.5 million on the CMBS and CDO assets sold and the related hedges. The net unrealized appreciation recorded on these assets prior to their sale was determined on an individual security-by-security basis. The net gain realized upon the sale of $227.7 million reflects the total value received for the portfolio as a whole.

Realized gains for the years ended December 31, 2006, 2005, and 2004, were as follows:

($ in millions)


2006

Portfolio Company		Amount

Private Finance:
Advantage Sales & Marketing, Inc.⁽¹⁾		$	434.4
STS Operating, Inc.			94.8
Oriental Trading Company, Inc.			8.9
Advantage Sales & Marketing, Inc.⁽²⁾			4.8
United Site Services, Inc.			3.3
Component Hardware Group, Inc.			2.8
Opinion Research Corporation			1.9
Nobel Learning Communities, Inc.			1.5
MHF Logistical Solutions, Inc.			1.2
The Debt Exchange, Inc.			1.1
Other			1.5

	Total private finance		556.2

Commercial Real Estate:
Other			1.3

	Total commercial real estate		1.3

Total realized gains		$	557.5


2005

Portfolio Company		Amount

Private Finance:
Housecall Medical Resources, Inc.		$	53.7
Fairchild Industrial Products Company			16.2
Apogen Technologies Inc.			9.0
Polaris Pool Systems, Inc.			7.4
MasterPlan, Inc.			3.7
U.S. Security Holdings, Inc.			3.3
Ginsey Industries, Inc.			2.8
E-Talk Corporation			1.6
Professional Paint, Inc.			1.6
Oriental Trading Company, Inc.			1.0
Woodstream Corporation			0.9
Impact Innovations Group, LLC			0.8
DCS Business Services, Inc.			0.7
Other			3.4

	Total private finance		106.1

Commercial Real Estate:
CMBS/CDO assets, net⁽³⁾			227.7
Other			9.3

	Total commercial real estate		237.0

Total realized gains		$	343.1


2004

Portfolio Company		Amount

Private Finance:
The Hillman Companies, Inc.		$	150.3
CorrFlex Graphics, LLC			25.7
Professional Paint, Inc.			13.7
Impact Innovations Group, LLC			11.1
The Hartz Mountain Corporation			8.3
Housecall Medical Resources, Inc.			7.2
International Fiber Corporation			5.2
CBA-Mezzanine Capital Finance, LLC			4.1
United Pet Group, Inc.			3.8
Oahu Waste Services, Inc.			2.8
Grant Broadcasting Systems II			2.7
Matrics, Inc.			2.1
SmartMail, LLC			2.1
Other			7.6

	Total private finance		246.7

Commercial Real Estate:
CMBS/CDO assets, net⁽³⁾			17.4
Other			3.6

	Total commercial real estate		21.0

Total realized gains		$	267.7


⁽¹⁾	Represents the realized gain on our majority equity investment only. See “—Private Finance” above.

⁽²⁾	Represents a realized gain on our minority equity investment only. See “—Private Finance” above.

⁽³⁾	Net of net realized losses from related hedges of $0.7 million and $3.8 million for the years ended December 31, 2005 and 2004, respectively.

Realized losses for the years ended December 31, 2006, 2005, and 2004, were as follows:

($ in millions)


2006

Portfolio Company		Amount

Private Finance:
Staffing Partners Holding Company, Inc.		$	10.6
Acme Paging, L.P.			4.7
Cooper Natural Resources, Inc.			2.2
Aspen Pet Products, Inc.			1.6
Nobel Learning Communities, Inc.			1.4
Other			1.6

	Total private finance		22.1

Commercial Real Estate:
Other			2.1

	Total commercial real estate		2.1

Total realized losses		$	24.2


2005

Portfolio Company		Amount

Private Finance:
Norstan Apparel Shops, Inc.		$	18.5
Acme Paging, L.P.			13.8
E-Talk Corporation			9.0
Garden Ridge Corporation			7.1
HealthASPex, Inc.			3.5
MortgageRamp, Inc.			3.5
Maui Body Works, Inc.			2.7
Packaging Advantage Corporation			2.2
Other			3.7

	Total private finance		64.0

Commercial Real Estate:
Other			5.6

	Total commercial real estate		5.6

Total realized losses		$	69.6


2004

Portfolio Company			Amount

Private Finance:
American Healthcare Services, Inc.			$	32.9
The Color Factory, Inc.				24.5
Executive Greetings, Inc.				19.3
Sydran Food Services II, L.P.				18.2
Ace Products, Inc.				17.6
Prosperco Finanz Holding AG				7.5
Logic Bay Corporation				5.0
Sun States Refrigerated Services, Inc.				4.7
Chickasaw Sales & Marketing, Inc.				3.8
Sure-Tel, Inc.				2.3
Liberty-Pittsburgh Systems, Inc.				2.0
EDM Consulting, LLC				1.9
Pico Products, Inc.				1.7
Impact Innovations Group, LLC				1.7
Interline Brands, Inc.				1.3
Startec Global Communications Corporation				1.1
Other				2.7

	Total private finance			148.2

Commercial Real Estate:
Other				2.3

		Total commercial real estate		2.3

Total realized losses			$	150.5

Change in Unrealized Appreciation or Depreciation. We determine the value of each investment in our portfolio on a quarterly basis, and changes in value result in unrealized appreciation or depreciation being recognized in our statement of operations. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by the Board of Directors pursuant to our valuation policy and a consistently applied valuation process. At December 31, 2006, portfolio investments recorded at fair value were approximately 92% of our total assets. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily

available market value, the fair value of our investments determined in good faith by the Board of Directors 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.

There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we are required to specifically value each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has appreciated in value. Changes in fair value are recorded in the statement of operations as net change in unrealized appreciation or depreciation.

As a business development company, we have invested in illiquid securities including debt and equity securities of companies and CDO and CLO bonds and preferred shares/income notes. The structure of each debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our investments may be subject to certain restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition, and market changing events that impact valuation.

Valuation Methodology — Private Finance. Our process for determining the fair value of a private finance investment begins with determining the enterprise value of the portfolio company. The fair value of our investment is based on the enterprise value at which the portfolio company could be sold in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The liquidity event whereby we exit a private finance investment is generally the sale, the recapitalization or, in some cases, the initial public offering of the portfolio company.

financial measures such as EBITDA or EBITDAM (Earnings Before Interest, Taxes, Depreciation, Amortization and, in some instances, Management fees) in order to assess a portfolio company’s financial performance and to value a portfolio company. EBITDA and EBITDAM are not intended to represent cash flow from operations as defined by U.S. generally accepted accounting principles and such information should not be considered as an alternative to net income, cash flow from operations, or any other measure of performance prescribed by U.S. generally accepted accounting principles. When using EBITDA to determine enterprise value, we may adjust EBITDA for non-recurring items. Such adjustments are intended to normalize EBITDA to reflect the portfolio company’s earnings power. Adjustments to EBITDA may include compensation to previous owners, acquisition, recapitalization, or restructuring related items or one-time non-recurring income or expense items.

In determining a multiple to use for valuation purposes, we generally look to private merger and acquisition statistics, the entry multiple for the transaction, discounted public trading multiples or industry practices. In estimating a reasonable multiple, we consider not only the fact that our portfolio company may be a private company relative to a peer group of public comparables, but we also consider the size and scope of our portfolio company and its specific strengths and weaknesses. In some cases, the best valuation methodology may be a discounted cash flow analysis based on future projections. If a portfolio company is distressed, a liquidation analysis may provide the best indication of enterprise value.

If there is adequate enterprise value to support the repayment of our debt, the fair value of our loan or debt security normally corresponds to cost unless the borrower’s condition or other factors lead to a determination of fair value at a different amount. The fair value of equity interests in portfolio companies is determined based on various factors, including the enterprise value remaining for equity holders after the repayment of the portfolio company’s debt and other preference capital, and other pertinent factors such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, liquidation events, or other events. The determined equity values are generally discounted when we have a minority position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

As a participant in the private equity business, we invest primarily in private middle market companies for which there is generally no publicly available information. Because of the private nature of these businesses, there is a need to maintain the confidentiality of the financial and other information that we have for the private companies in our portfolio. We believe that maintaining this confidence is important, as disclosure of such information could disadvantage our portfolio companies and could put us at a disadvantage in attracting new investments. Therefore, we do not intend to disclose financial or other information about our portfolio companies, unless required, because we believe doing so may put them at an economic or competitive disadvantage, regardless of our level of ownership or control.

We currently intend to continue to work with third-party consultants to obtain assistance in determining fair value for a portion of the private finance portfolio each quarter. We work with these consultants to obtain assistance as additional support in the preparation of our internal valuation analysis. In addition, we may receive third-party assessments of a particular private finance portfolio company’s value in the ordinary course of business, most often in the context of a prospective sale transaction or in the context of a bankruptcy process. The valuation analysis prepared by management using these third-

party valuation resources, when applicable, is submitted to our Board of Directors for its determination of fair value of the portfolio in good faith.

We receive third-party valuation assistance from Duff & Phelps, LLC (formerly S&P Corporate Value Consulting (S&P CVC)) and Houlihan Lokey Howard and Zukin for our private finance portfolio. For the years ended December 31, 2006 and 2005, we received third-party valuation assistance as follows:


	2006												2005

	Q4			Q3			Q2			Q1			Q4			Q3			Q2			Q1

Number of private finance portfolio companies reviewed		81			105			78			78			80			89			72			36
Percentage of private finance portfolio reviewed at value		82.9	%		86.5	%		89.6	%		87.0	%		92.4	%		89.3	%		83.0	%		74.5	%

Professional fees for third-party valuation assistance for the years ended December 31, 2006, 2005, and 2004, were $1.5 million, $1.4 million, and $0.9 million, respectively.

Valuation Methodology — CDO and CLO Bonds and Preferred Shares/Income Notes (CDO/CLO Assets). CDO/CLO Assets are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar bonds and preferred shares/income notes, when available. We recognize unrealized appreciation or depreciation on our CDO/CLO Assets as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment, re-investment or loss assumptions in the underlying collateral pool. We determine the fair value of our CDO/CLO Assets on an individual security-by-security basis. If we were to sell a group of these CDO/CLO Assets in a pool in one or more transactions, the total value received for that pool may be different than the sum of the fair values of the individual assets.

Net Change in Unrealized Appreciation or Depreciation. Net change in unrealized appreciation or depreciation for the years ended December 31, 2006, 2005, and 2004, consisted of the following:


		2006⁽¹⁾			2005⁽¹⁾			2004⁽¹⁾
($ in millions)
Net unrealized appreciation or depreciation		$	1.6		$	502.1		$	(10.0	)
Reversal of previously recorded unrealized appreciation associated with realized gains			(501.5	)		(108.0	)		(210.5	)
Reversal of previously recorded unrealized depreciation associated with realized losses			22.5			68.0			151.8

	Net change in unrealized appreciation or depreciation	$	(477.4	)	$	462.1		$	(68.7	)


⁽¹⁾	The net change in unrealized appreciation or depreciation can fluctuate significantly from year to year. As a result, annual comparisons may not be meaningful.

Valuation of Business Loan Express, LLC. Our investment in BLX totaled $295.3 million at cost and $210.7 million at value at December 31, 2006, and $299.4 million at cost and $357.1 million at value at December 31, 2005. To determine the value of our investment in BLX at December 31, 2006, we performed numerous valuation analyses to determine a range of values including: (1) analysis of comparable public company trading multiples; (2) analysis of BLX’s value assuming an initial public offering; (3) analysis of merger and acquisition transactions for financial services companies; (4) a

discounted dividend analysis; and (5) adding BLX’s net asset value (adjusted for certain discounts) to the value of BLX’s business operations, which was determined by using a discounted cash flow model. In performing the valuation analyses at December 31, 2006, we considered the impact of various changes in BLX’s business model due to the competitive environment for small business loans and BLX’s newer non-SBA real estate lending products. We also considered BLX’s current regulatory issues and ongoing investigations. (See “— Private Finance, Business Loan Express, LLC” above.) The competitive SBA lending environment, our estimates of future profitability, and the impact of BLX’s legal and regulatory matters resulted in a decrease in the value of our investment in BLX at December 31, 2006. We received valuation assistance from Duff & Phelps (formerly S&P CVC) for our investment in BLX at December 31, 2006, 2005, and 2004.

With respect to the analysis of comparable public company trading multiples and the analysis of BLX’s value assuming an initial public offering, we compute a median trailing and forward price earnings multiple to apply to BLX’s pro-forma net income adjusted for certain capital structure changes that we believe would likely occur should the company be sold. Each quarter we evaluate which public commercial finance companies should be included in the comparable group. The comparable group at December 31, 2006, was made up of CIT Group, Inc., Financial Federal Corporation, GATX Corporation, and Marlin Business Services Corporation, which is consistent with the comparable group at December 31, 2005.

Our investment in BLX at December 31, 2006, was valued at $210.7 million. This fair value was within the range of values determined by our valuation analyses discussed above. Unrealized depreciation on our investment was $84.6 million at December 31, 2006. Net change in unrealized appreciation or depreciation included a net decrease of $142.3 million and $32.3 million for the years ended December 31, 2006 and 2004, respectively, and a net increase of $2.9 million for the year ended December 31, 2005.

Per Share Amounts. All per share amounts included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section have been computed using the weighted average common shares used to compute diluted earnings per share, which were 145.6 million, 137.3 million, and 132.5 million for the years ended December 31, 2006, 2005, and 2004, respectively.

OTHER MATTERS

Regulated Investment Company Status. We have elected to be taxed as a regulated investment company under Subchapter M of the Code. As long as we qualify as a regulated investment company, we are not taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis.

Dividends are paid to shareholders from taxable income. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as

consideration from the sale of investments are collected in cash. See “Dividends and Distributions” below.

Dividends declared and paid by us in a year generally differ from taxable income for that year as such dividends may include the distribution of current year taxable income, the distribution of prior year taxable income carried over into and distributed in the current year, or returns of capital. We are generally required to distribute 98% of our taxable income during the year the income is earned to avoid paying an excise tax. If this requirement is not met, the Code imposes a nondeductible excise tax equal to 4% of the amount by which 98% of the current year’s taxable income exceeds the distribution for the year. The taxable income on which an excise tax is paid is generally carried over and distributed to shareholders in the next tax year. Depending on the level of taxable income earned in a tax year, we may choose to carry over taxable income in excess of current year distributions from such taxable income into the next tax year and pay a 4% excise tax on such income, as required. See “Dividends and Distributions” below.

In order to maintain our status as a regulated investment company and obtain regulated investment company tax benefits, we must, in general, (1) continue to qualify as a business development company; (2) derive at least 90% of our gross income from dividends, interest, gains from the sale of securities and other specified types of income; (3) meet asset diversification requirements as defined in the Code; and (4) timely distribute to shareholders at least 90% of our annual investment company taxable income as defined in the Code. We intend to take all steps necessary to continue to qualify as a regulated investment company. However, there can be no assurance that we will continue to qualify for such treatment in future years.

DIVIDENDS AND DISTRIBUTIONS

Total regular quarterly dividends to common shareholders were $2.42, $2.30, and $2.28 per common share for the years ended December 31, 2006, 2005, and 2004, respectively. An extra cash dividend of $0.05, $0.03 and $0.02 per common share was declared during 2006, 2005, and 2004, respectively, and was paid to shareholders on January 19, 2007, January 27, 2006, and January 28, 2005, respectively. The Board of Directors has declared a dividend of $0.63 per common share for the first quarter of 2007.

Our Board of Directors reviews the dividend rate quarterly, and may adjust the quarterly dividend throughout the year. Dividends are declared considering our estimate of annual taxable income available for distribution to shareholders and the amount of taxable income carried over from the prior year for distribution in the current year. Our goal is to declare what we believe to be sustainable increases in our regular quarterly dividends. To the extent that we earn annual taxable income in excess of dividends paid from such taxable income for the year, we may carry over the excess taxable income into the next year and such excess income will be available for distribution in the next year as permitted under the Code (see discussion below). We believe that carrying over excess taxable income into future periods may provide increased visibility with respect to taxable earnings available to pay the regular quarterly dividend.

Taxable income includes our taxable interest, dividend and fee income, as well as taxable net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition,

gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration form the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual payment-in-kind interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual payment-in-kind interest or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation and amortization expense.

The summary of our taxable income and distributions of such taxable income for the years ended December 31, 2006, 2005, and 2004, is as follows:


		2006			2005			2004
($ in millions)
		(ESTIMATED)⁽¹⁾
Taxable income⁽²⁾		$	595.5		$	445.0		$	323.2
Taxable income earned in current year and carried forward for distribution in next year			(397.1	)		(156.5	)		(26.0	)
Taxable income earned in prior year and carried forward and distributed in current year			156.5			26.0			2.1

	Total dividends to common shareholders	$	354.9		$	314.5		$	299.3


⁽¹⁾	Our taxable income for 2006 is an estimate and will not be finally determined until we file our 2006 tax return in September 2007. Therefore, the final taxable income and the taxable income earned in 2006 and carried forward for distribution in 2007 may be different than the estimate above. See “Risk Factors” above and Note 10, “Dividends and Distributions and Taxes” of our Notes to Consolidated Financial Statements.

⁽²⁾	See Note 10, “Dividends and Distributions and Taxes” of our Notes to Consolidated Financial Statements for further information on the differences between net income for book purposes and taxable income.

Our estimated annual taxable income for 2006 exceeded our dividend distributions to shareholders for 2006 from such taxable income, and, therefore, we will carry over excess taxable income, which is currently estimated to be $397.1 million, for distribution to shareholders in 2007. The maximum amount of excess taxable income that may be carried over for distribution in the next year under the Code is the total amount of dividends paid in the following year, subject to certain declaration and payment guidelines. Excess taxable income carried over and paid out in the next year is generally subject to a 4% excise tax. Accordingly, for the year ended December 31, 2006, we have accrued an estimated excise tax of $15.4 million. See “Other Matters — Regulated Investment Company Status” above.

In addition to excess taxable income available to be carried over from 2006 for distribution in 2007, we currently estimate that we have cumulative deferred taxable income related to installment sale gains of approximately $220.7 million as of December 31, 2006, which is composed of cumulative deferred taxable income of $39.6 million as of December 31, 2005, and approximately $181.1 million for the year ended December 31, 2006. These gains have been recognized for financial reporting purposes in the respective years they were realized, but generally will be deferred for tax purposes until the notes or other amounts received from the sale of the related investments are collected in cash. The installment sale gains for 2006 are estimates and will not be finally determined until we file our 2006 tax return in September 2007. See “Other Matters — Regulated Investment Company Status” above.

To the extent that installment sale gains are deferred for recognition in taxable income, we pay interest to the Internal Revenue Service. Installment-related interest expense for the years ended December 31, 2006 and 2005 was $0.9 million and $0.6 million, respectively. This interest is included in interest expense in our Consolidated Statement of Operations. We currently estimate that installment-related interest expense resulting from cumulative installment sale gains not yet recognized for tax purposes at December 31, 2006, will be approximately $5.8 million for the year ended December 31, 2007.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2006 and 2005, our liquidity portfolio (see below), cash and investments in money market and other securities, total assets, total debt outstanding, total shareholders’ equity, debt to equity ratio and asset coverage for senior indebtedness were as follows:


($ in millions)	2006			2005

Liquidity portfolio (including money market and other securities: 2006-$201.8; 2005-$100.0)	$	201.8		$	200.3
Cash and investments in money market securities (including money market and other securities: 2006-$0.4; 2005-$22.0)	$	2.1		$	53.3
Total assets	$	4,887.5		$	4,025.9
Total debt outstanding	$	1,899.1		$	1,284.8
Total shareholders’ equity	$	2,841.2		$	2,620.5
Debt to equity ratio⁽¹⁾		0.67			0.49
Asset coverage ratio⁽²⁾		250	%		309	%


⁽¹⁾	The debt to equity ratio adjusted for the liquidity portfolio was 0.60 and 0.41 at December 31, 2006 and 2005, respectively, which is calculated as (a) total debt less the value of the liquidity portfolio divided by (b) total shareholders’ equity.

⁽²⁾	As a business development company, we are generally required to maintain a minimum ratio of 200% of total assets to total borrowings.

Cash generated from the portfolio includes cash flow from net investment income and net realized gains and principal collections related to investment repayments or sales. Cash flow provided by our operating activities before new investment activity for the years ended December 31, 2006, 2005, and 2004, was as follows:


		2006			2005		2004
($ in millions)
Net cash provided by (used in) operating activities		$	(597.5	)	$	116.0	$	(179.3	)
Add: portfolio investments funded			2,257.8			1,668.1		1,472.4

	Total cash provided by operating activities before new investments	$	1,660.3		$	1,784.1	$	1,293.1

In addition to the net cash flow provided by our operating activities before funding investments, we have sources of liquidity through our liquidity portfolio and revolving line of credit as discussed below.

At December 31, 2006 and 2005, the value and yield of the securities in the liquidity portfolio were as follows:


		2006					2005

		Value		Yield			Value		Yield
($ in millions)
U.S. Treasury bills		$	—		—		$	100.3		4.3	%
Money market securities			161.2		5.3	%		100.0		4.1	%
Certificate of Deposit⁽¹⁾			40.6		5.6	%		—		—

	Total	$	201.8		5.3	%	$	200.3		4.2	%


⁽¹⁾	The certificate of deposit matures in March 2007.

The liquidity portfolio was established to provide a pool of liquid assets within our balance sheet. Our investment portfolio is primarily composed of private, illiquid assets for which there is no readily available market. Our portfolio’s liquidity was reduced when we sold our portfolio of CMBS assets in May 2005, particularly BB rated bonds, which were generally more liquid than assets in our private finance portfolio. We assess the amount held in and the composition of the liquidity portfolio throughout the year.

We invest 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 securities. We place our 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.

We employ an asset-liability management approach that focuses on matching the estimated maturities of our investment portfolio to the estimated maturities of our borrowings. We use our revolving line of credit facility as a means to bridge to long-term financing in the form of debt or equity capital, which may or may not result in temporary differences in the matching of estimated maturities. Availability on the revolving line of credit, net of amounts committed for standby letters of credit issued under the line of credit facility, was $673.8 million on December 31, 2006. We evaluate our interest rate exposure on an ongoing basis. Generally, we seek to fund our primarily fixed-rate investment portfolio with fixed-rate debt or equity capital. To the extent deemed necessary, we may hedge variable and short-term interest rate exposure through interest rate swaps or other techniques.

During the years ended December 31, 2006 and 2004, we sold new equity of $295.8 million and $70.3 million, respectively, in public offerings. We did not sell new equity in a public offering during the year ended December 31, 2005. During the years ended December 31, 2005 and 2004, we issued $7.2 million and $3.2 million, respectively, of our common stock as consideration for investments. In addition, shareholders’ equity increased by $27.7 million, $77.5 million, and $51.3 million through the exercise of stock options, the collection of notes receivable from the sale of common stock, and the issuance of shares through our dividend reinvestment plan for the years ended December 31, 2006, 2005, and 2004, respectively.

We currently target a debt to equity ratio ranging between 0.50:1.00 to 0.70:1.00 because we believe that it is prudent to operate with a larger equity capital base and less leverage.

At December 31, 2006 and 2005, we had outstanding debt as follows:


			2006										2005

										Annual										Annual
										Return to										Return to
							Annual			Cover							Annual			Cover
			Facility		Amount		Interest			Interest			Facility		Amount		Interest			Interest
			Amount		Outstanding		Cost⁽¹⁾			Payments⁽²⁾			Amount		Outstanding		Cost⁽¹⁾			Payments⁽²⁾
($ in millions)
Notes payable and debentures:
	Privately issued unsecured notes payable			$1,041.4		$1,041.4		6.1	%		1.3	%		$1,164.5		$1,164.5		6.2	%		1.8	%
	Publicly issued unsecured notes payable			650.0		650.0		6.6	%		0.9	%		—		—		—			0.1	%
	SBA debentures⁽³⁾			—		—		—	%		—	%		28.5		28.5		7.5	%		—	%

		Total notes payable and debentures		1,691.4		1,691.4		6.3	%		2.2	%		1,193.0		1,193.0		6.3	%		1.9	%
Revolving line of credit⁽⁶⁾				922.5		207.7		6.4	%⁽⁴⁾		0.3	%		772.5		91.8		5.6	%⁽⁴⁾		0.2	%

		Total debt		$2,613.9		$1,899.1		6.5	%⁽⁵⁾		2.5	%		$1,965.5		$1,284.8		6.5	% ⁽⁵⁾		2.1	%


⁽¹⁾	The weighted average annual interest cost is computed as the (a) annual stated interest on the debt plus the annual amortization of commitment fees, other facility fees and the amortization of debt financing costs that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.

⁽²⁾	The annual portfolio return to cover interest payments is calculated as the December 31, 2006 and 2005, annualized cost of debt per class of financing outstanding divided by total assets at December 31, 2006 and 2005.

⁽³⁾	The SBA debentures were repaid in full during 2006.

⁽⁴⁾	The annual interest cost reflects the interest rate payable for borrowings under the revolving line of credit. In addition to the current interest rate payable, there were annual costs of commitment fees, other facility fees and amortization of debt financing costs of $3.9 million and $3.3 million at December 31, 2006 and 2005, respectively.

⁽⁵⁾	The annual interest cost for total debt includes the annual cost of commitment fees and the amortization of debt financing costs on the revolving line of credit and other facility fees regardless of the amount outstanding on the facility as of the balance sheet date.

⁽⁶⁾	At December 31, 2006, $673.8 million remained unused and available on the revolving line of credit, net of amounts committed for standby letters of credit of $41.0 million issued under the credit facility.

Privately Issued Unsecured Notes Payable. We have privately issued unsecured long-term notes to institutional investors, primarily insurance companies. The notes have five- or seven-year maturities, with maturity dates beginning in 2008 and have fixed rates of interest. The notes generally require payment of interest only semi-annually, and all principal is due upon maturity. The notes may be prepaid in whole or in part, together with an interest premium, as stipulated in the note agreements.

We have issued five-year unsecured long-term notes denominated in Euros and Sterling for a total U.S. dollar equivalent of $15.2 million. The notes have fixed interest rates and have substantially the same terms as our other unsecured notes. The Euro notes require annual interest payments and the Sterling notes require semi-annual interest payments until maturity. Simultaneous with issuing the notes, we entered into a cross currency swap with a financial institution which fixed our interest and principal payments in U.S. dollars for the life of the debt.

On October 16, 2006, we repaid $150.0 million of unsecured long-term debt that matured. This debt had a fixed interest rate of 7.2%. We used cash generated from operations and borrowings on our revolving line of credit to repay this debt.

On May 1, 2006, we issued $50.0 million of unsecured long-term debt with a fixed interest rate of 6.8%. This debt matures in May 2013. The proceeds of this issuance were

used to repay $25 million of 7.5% unsecured long-term debt that matured on May 1, 2006, and the remainder was used to fund new portfolio investments and for general corporate purposes.

On October 13, 2005, we issued $261.0 million of five-year and $89.0 million of seven-year unsecured long-term notes, primarily to insurance companies. The five-and seven-year notes have fixed interest rates of 6.2% and 6.3%, respectively, and have substantially the same terms as our existing unsecured long-term notes. We used a portion of the proceeds from the new long-term note issuance to repay $125.0 million of our existing unsecured long-term notes that matured on October 15, 2005, and had an annual weighted average interest cost of 8.3%. During the second quarter of 2005, we repaid $40.0 million of the unsecured notes payable.

Publicly Issued Unsecured Notes Payable. During 2006, we completed public issuances of unsecured notes as follows:


		Amount		Coupon			Maturity Date
($ in millions)
July 25, 2006		$	400.0		6.625	%		July 15, 2011
December 8, 2006			250.0		6.000	%		April 1, 2012

	Total	$	650.0

The notes require payment of interest only semi-annually, and all principal is due upon maturity. We have the option to redeem these notes in whole or in part, together with a redemption premium, as stipulated in the notes.

Small Business Administration Debentures. Through our small business investment company subsidiary, we had debentures payable to the Small Business Administration (SBA) with contractual maturities of ten years. The notes required payment of interest only semi-annually, and all principal was due upon maturity. For the years ended December 31, 2006 and 2005, we repaid $28.5 million and $49.0 million, respectively, of this outstanding debt. At December 31, 2006, we had no outstanding borrowings from the SBA. Allied Investments L.P., our Small Business Investment Company (SBIC) subsidiary, surrendered its SBIC license and on October 1, 2006, Allied Investments L.P. was merged into its parent, Allied Capital Corporation. Therefore, the SBA is no longer a source of debt capital for us.

Revolving Line of Credit. At December 31, 2006, we had an unsecured revolving line of credit with a committed amount of $922.5 million that expires on September 30, 2008. The revolving line of credit generally bears interest at a rate equal to (i) LIBOR (for the period we select) plus 1.05% or (ii) the higher of the Federal Funds rate plus 0.50% or the Bank of America N.A. prime rate. The revolving line of credit requires the payment of an annual commitment fee equal to 0.20% of the committed amount (whether used or unused). The revolving line of credit generally requires payments of interest at the end of each LIBOR interest period, but no less frequently than quarterly, on LIBOR based loans and monthly payments of interest on other loans. All principal is due upon maturity.

At December 31, 2006, there was $207.7 million outstanding on our unsecured revolving line of credit. The amount available under the line at December 31, 2006, was $673.8 million, net of amounts committed for standby letters of credit of $41.0 million. Net borrowings under the revolving lines of credit for the year ended December 31, 2006, were $116.0 million.

We have various financial and operating covenants required by the revolving line of credit and the privately issued unsecured notes payable outstanding at December 31, 2006. These covenants require us to maintain certain financial ratios, including debt to equity and interest coverage, and a minimum net worth. These credit facilities provide for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, cross-defaults, bankruptcy events, failure to pay judgments, attachment of our assets, change of control and the issuance of an order of dissolution. Certain of these events of default are subject to notice and cure periods or materiality thresholds. Our credit facilities limit our ability to declare dividends if we default under certain provisions. As of December 31, 2006 and 2005, we were in compliance with these covenants.

We have certain financial and operating covenants that are required by the publicly issued unsecured notes payable, including that we will maintain a minimum ratio of 200% of total assets to total borrowings, as required by the Investment Company Act of 1940, as amended, while these notes are outstanding. At December 31, 2006, we were in compliance with these covenants.

The following table shows our significant contractual obligations for the repayment of debt and payment of other contractual obligations as of December 31, 2006.


				Payments Due By Year

														After
		Total		2007		2008		2009		2010		2011		2011
($ in millions)
Unsecured notes payable		$	1,691.4	$	—	$	153.0	$	268.9	$	408.0	$	472.5	$	389.0
Revolving line of credit⁽¹⁾			207.7		—		207.7		—		—		—		—
Operating leases			24.6		4.4		4.4		4.6		4.5		1.8		4.9

	Total contractual obligations	$	1,923.7	$	4.4	$	365.1	$	273.5	$	412.5	$	474.3	$	393.9


⁽¹⁾	At December 31, 2006, $673.8 million remained unused and available on the revolving line of credit, net of amounts committed for standby letters of credit of $41.0 million issued under the credit facility.

Off-Balance Sheet Arrangements

In the ordinary course of business, we have issued guarantees and have extended standby letters of credit through financial intermediaries on behalf of certain portfolio companies. We have generally issued guarantees of debt, rental and lease obligations. Under these arrangements, we would be required to make payments to third-party beneficiaries if the portfolio companies were to default on their related payment obligations. The following table shows our guarantees and standby letters of credit that may have the effect of creating, increasing, or accelerating our liabilities as of December 31, 2006.


				Amount of Commitment Expiration Per Year

														After
		Total		2007		2008		2009		2010		2011		2011
($ in millions)
Guarantees		$	202.1	$	0.6	$	3.0	$	192.2	$	—	$	4.4	$	1.9
Standby letters of credit⁽¹⁾			41.0		4.0		37.0		—		—		—		—

	Total commitments⁽²⁾	$	243.1	$	4.6	$	40.0	$	192.2	$	—	$	4.4	$	1.9


⁽¹⁾	Standby letters of credit are issued under our revolving line of credit that expires in September 2008. Therefore, unless a standby letter of credit is set to expire at an earlier date, we have assumed that the standby letters of credit will expire contemporaneously with the expiration of our line of credit in September 2008.

⁽²⁾	Our most significant commitments relate to our investment in Business Loan Express, LLC (BLX), which commitments totaled $214.7 million at December 31, 2006. At December 31, 2006, we guaranteed 50% of the outstanding total obligations on BLX’s revolving line of credit for a total guaranteed amount of $189.7 million and we had also provided four standby letters of credit totaling $25.0 million in connection with four term securitizations completed by BLX. See “— Private Finance, Business Loan Express, LLC” above for further discussion.

In addition, we had outstanding commitments to fund investments totaling $435.0 million at December 31, 2006. See “— Portfolio and Investment Activity — Outstanding Commitments” above. We intend to fund these commitments and prospective investment opportunities with existing cash, through cash flow from operations before new investments, through borrowings under our line of credit or other long-term debt agreements, or through the sale or issuance of new equity capital.

CRITICAL ACCOUNTING POLICIES

The consolidated financial statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s most difficult, complex, or subjective judgments. Our critical accounting policies are those applicable to the valuation of investments, certain revenue recognition matters and certain tax matters as discussed below.

Valuation of Portfolio Investments. As a business development company, we invest in illiquid securities including debt and equity securities of companies and CDO and CLO bonds and preferred shares/income notes. Our investments may be subject to certain restrictions on resale and generally have no established trading market. We value substantially all of our investments at fair value as determined in good faith by the Board of Directors in accordance with our valuation policy. We determine fair value to be the amount for which an investment could be exchanged in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. Our valuation policy considers the fact that no ready market exists for substantially all of the securities in which we invest. Our valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investments. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/ or our equity security has also appreciated in value. The value of investments in publicly traded securities is determined using quoted market prices discounted for restrictions on resale, if any.

See “— Results of Operations — Change in Unrealized Appreciation or Depreciation” above for more discussion on portfolio valuation.

Loans and Debt Securities. For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount. The value of loan and debt securities may be greater than our cost basis if the amount that would be repaid on the loan or debt security upon the sale of the portfolio company is greater than our cost basis.

When we receive nominal cost warrants or free equity securities (nominal cost equity), we allocate our cost basis in our investment between debt securities and nominal cost equity at the time of origination. At that time, the original issue discount basis of the nominal cost equity is recorded by increasing the cost basis in the equity and decreasing the cost basis in the related debt securities.

Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. For loans and debt securities with contractual payment-in-kind interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity, we will not accrue payment-in-kind interest if the portfolio company valuation indicates that the payment-in-kind interest is not collectible. In general, interest is not accrued on loans and debt securities if we have doubt about interest collection or where the enterprise value of the portfolio company may not support further accrual. Loans in workout status do not accrue interest. In addition, interest may not accrue on loans or debt securities to portfolio companies that are more than 50% owned by us depending on such company’s capital requirements. Loan origination fees, original issue discount, and market discount are capitalized and then amortized into interest income using a method that approximates the effective interest method. Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income and any unamortized original issue discount or market discount is recorded as a realized gain. Prepayment premiums are recorded on loans and debt securities when received.

Equity Securities. Our equity securities in portfolio companies for which there is no liquid public market are valued at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including cash flow from operations of the portfolio company, multiples at which private companies are bought and sold, and other pertinent factors, such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, liquidation events, or other events. The determined equity values are generally discounted when we have a minority ownership position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

The value of our equity securities in public companies for which market quotations are readily available is based on the closing public market price on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are expected to be collected and to the extent that we have the option to receive the dividend in cash. Dividend income on common equity securities is recorded on the record date for private companies or on the ex-dividend date for publicly traded companies.

as comparable yields in the market change and/ or based on changes in estimated cash flows resulting from changes in prepayment, re-investment or loss assumptions in the underlying collateral pool. We determine the fair value of our CDO/ CLO Assets on an individual security-by-security basis.

We recognize interest income on the preferred shares/income notes using the effective interest method, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the preferred shares/income notes from the date the estimated yield was changed. CDO and CLO bonds have stated interest rates.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation. Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. Net change in unrealized appreciation or depreciation also reflects the change in the value of U.S. Treasury bills and deposits of proceeds from sales of borrowed Treasury securities, and depreciation on accrued interest and dividends receivable and other assets where collection is doubtful.

Fee Income. Fee income includes fees for loan prepayment premiums, guarantees, commitments, and services rendered by us to portfolio companies and other third parties such as diligence, structuring, transaction services, management and consulting services, and other services. Loan prepayment premiums are recognized at the time of prepayment. Guaranty and commitment fees are generally recognized as income over the related period of the guaranty or commitment, respectively. Diligence, structuring, and transaction services fees are generally recognized as income when services are rendered or when the related transactions are completed. Management, consulting and other services fees are generally recognized as income as the services are rendered.

Federal and State Income Taxes and Excise Tax. We 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). We and any of our subsidiaries that qualify as a RIC or a REIT intend to distribute or retain through a deemed distribution all of our annual taxable income to shareholders; therefore, we have made no provision for income taxes for these entities.

If we do not distribute at least 98% of our annual taxable income in the year earned, we will generally be required to pay an excise tax equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such taxable income for the year. To the extent that we determine that our estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, we accrue excise taxes, if any, on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.

Income taxes for AC Corp are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

RECENT DEVELOPMENTS

2007 Proxy Items. At our annual meeting of stockholders, to be held on May 15, 2007, our stockholders will vote, in addition to other routine matters, to: (1) approve an amendment to our Restated Articles of Incorporation to increase the total number of shares of common stock that we are authorized to issue from 200,000,000 to 400,000,000 shares; and (2) approve an amendment to our Amended Stock Option Plan to increase the number of shares of common stock authorized for issuance under our Amended Stock Option Plan to an amount which would represent approximately 20% of our outstanding common stock on a fully diluted basis.

2007 Debt Issuance. On March 28, 2007, we completed the issuance of $200.0 million of 6.875% Notes due 2047 for proceeds of $193.0 million, net of underwriting discounts and estimated offering expenses. The underwriters had the option to purchase up to an additional $30.0 million (before underwriting discounts and estimated offering expenses), which they exercised on April 2, 2007. We have applied to list the Notes on the New York Stock Exchange and we expect trading in the Notes on the New York Stock Exchange to begin within 30 days of the original issue date.

2007 Equity Issuance. On March 9, 2007, we completed the sale of 3,325,000 shares of our common stock for proceeds of $93.8 million, net of underwriting discounts and estimated offering expenses.

Business Loan Express, LLC. On March 6, 2007, Business Loan Express, LLC (BLX), one of our portfolio companies, entered into an agreement with the U.S. Small Business Administration (SBA). According to the agreement, BLX will remain a preferred lender in the SBA 7(a) Guaranteed Loan Program and will retain the ability to sell loans into the secondary market. As part of this agreement, BLX has agreed to the immediate payment of approximately $10 million to the SBA to cover amounts paid by the SBA with respect to some of the SBA-guaranteed loans that have been the subject of inquiry by the United States Attorney’s Office for the Eastern District of Michigan. The SBA will increase oversight of BLX’s SBA-related lending operations. The agreement provides that any loans originated and closed by BLX during the term of the agreement will be reviewed by an independent third party selected by the SBA prior to the sale of such loans into the secondary market. The agreement also requires BLX to repurchase the guaranteed portion of certain loans that default after having been sold into the secondary market, and subjects such loans to a similar third party review prior to any reimbursement of BLX by the SBA. In connection with this agreement, BLX also entered into an escrow agreement with the SBA and an escrow agent in which BLX agreed to deposit $10 million with the escrow agent for any additional payments BLX may be obligated to pay to the SBA in the future. BLX remains subject to SBA rules and regulations and as a result may be required to make additional payments to the SBA in the ordinary course of business. We invested a total of $19.2 million in the Class A equity interests of BLX during the first quarter of 2007.

The Office of the Inspector General of the SBA and the U.S. Department of Justice are conducting civil and criminal investigations of BLX’s lending practices in various jurisdictions. These investigations are ongoing. There may be other investigations initiated by the SBA Office of the Inspector General or the U.S. Department of Justice in the future, and government investigations and related litigation may or may not have an adverse effect on the valuation of our investment in BLX.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Private Finance, Business Loan Express, LLC” in this prospectus for additional discussion regarding BLX.

SENIOR SECURITIES

Information about our senior securities is shown in the following tables as of December 31 for the years indicated in the table, unless otherwise noted. The report of our independent registered public accounting firm on the senior securities table as of December 31, 2006, is attached as an exhibit to the registration statement of which this prospectus is a part. The “—” indicates information which the SEC 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⁾

Privately Issued Unsecured Notes Payable
1997	$	0	$	0	$	—		N/A
1998		180,000,000		2,734		—		N/A
1999		419,000,000		2,283		—		N/A
2000		544,000,000		2,445		—		N/A
2001		694,000,000		2,453		—		N/A
2002		694,000,000		2,704		—		N/A
2003		854,000,000		3,219		—		N/A
2004		981,368,000		2,801		—		N/A
2005⁽⁵⁾		1,164,540,000		3,086		—		N/A
2006⁽⁵⁾		1,041,400,000		2,496		—		N/A

Publicly Issued Unsecured Notes Payable
1997	$	0	$	0	$	—		N/A
1998		0		0		—		N/A
1999		0		0		—		N/A
2000		0		0		—		N/A
2001		0		0		—		N/A
2002		0		0		—		N/A
2003		0		0		—		N/A
2004		0		0		—		N/A
2005⁽⁵⁾		0		0		—		N/A
2006⁽⁵⁾		650,000,000		2,496		—	$	1,000

Revolving Lines of Credit
1997	$	38,842,000	$	2,215	$	—		N/A
1998		95,000,000		2,734		—		N/A
1999		82,000,000		2,283		—		N/A
2000		82,000,000		2,445		—		N/A
2001		144,750,000		2,453		—		N/A
2002		204,250,000		2,704		—		N/A
2003		0		0		—		N/A
2004		112,000,000		2,801		—		N/A
2005		91,750,000		3,086		—		N/A
2006		207,750,000		2,496		—		N/A


	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⁾

Small Business Administration Debentures⁽⁶⁾
1997	$	54,300,000	$	2,215	$	—		N/A
1998		47,650,000		2,734		—		N/A
1999		62,650,000		2,283		—		N/A
2000		78,350,000		2,445		—		N/A
2001		94,500,000		2,453		—		N/A
2002		94,500,000		2,704		—		N/A
2003		94,500,000		3,219		—		N/A
2004		77,500,000		2,801		—		N/A
2005		28,500,000		3,086		—		N/A
2006		0		0		—		N/A

Overseas Private Investment Corporation Loan
1997	$	8,700,000	$	2,215	$	—		N/A
1998		5,700,000		2,734		—		N/A
1999		5,700,000		2,283		—		N/A
2000		5,700,000		2,445		—		N/A
2001		5,700,000		2,453		—		N/A
2002		5,700,000		2,704		—		N/A
2003		5,700,000		3,219		—		N/A
2004		5,700,000		2,801		—		N/A
2005		0		0		—		N/A
2006		0		0		—		N/A

Auction Rate Reset Note
1997	$	0	$	0	$	—		N/A
1998		0		0		—		N/A
1999		0		0		—		N/A
2000		76,598,000		2,445		—		N/A
2001		81,856,000		2,453		—		N/A
2002		0		0		—		N/A
2003		0		0		—		N/A
2004		0		0		—		N/A
2005		0		0		—		N/A
2006		0		0		—		N/A

Master Repurchase Agreement and Master Loan and Security Agreement
1997	$	225,821,000	$	2,215	$	—		N/A
1998		6,000,000		2,734		—		N/A
1999		23,500,000		2,283		—		N/A
2000		0		0		—		N/A
2001		0		0		—		N/A
2002		0		0		—		N/A
2003		0		0		—		N/A
2004		0		0		—		N/A
2005		0		0		—		N/A
2006		0		0		—		N/A


	Total Amount
	Outstanding				Involuntary
	Exclusive of		Asset		Liquidating		Average
	Treasury		Coverage		Preference		Market Value
Class and Year	Securities⁽¹⁾		Per Unit⁽²⁾		Per Unit⁽³⁾		Per Unit⁽⁴⁾


Senior Note Payable⁽⁷⁾
1997	$	20,000,000	$	2,215	$	—		N/A
1998		0		0		—		N/A
1999		0		0		—		N/A
2000		0		0		—		N/A
2001		0		0		—		N/A
2002		0		0		—		N/A
2003		0		0		—		N/A
2004		0		0		—		N/A
2005		0		0		—		N/A
2006		0		0		—		N/A

Redeemable Cumulative Preferred Stock⁽⁶⁾⁽⁸⁾
1997	$	1,000,000	$	217	$	100		N/A
1998		1,000,000		267		100		N/A
1999		1,000,000		225		100		N/A
2000		1,000,000		242		100		N/A
2001		1,000,000		244		100		N/A
2002		1,000,000		268		100		N/A
2003		1,000,000		319		100		N/A
2004		0		0		—		N/A
2005		0		0		—		N/A
2006		0		0		—		N/A
Non-Redeemable Cumulative Preferred Stock⁽⁶⁾
1997	$	6,000,000	$	217	$	100		N/A
1998		6,000,000		267		100		N/A
1999		6,000,000		225		100		N/A
2000		6,000,000		242		100		N/A
2001		6,000,000		244		100		N/A
2002		6,000,000		268		100		N/A
2003		6,000,000		319		100		N/A
2004		0		0		—		N/A
2005		0		0		—		N/A
2006		0		0		—		N/A


⁽¹⁾	Total amount of each class of senior securities outstanding at the end of the period presented.

⁽²⁾	The asset coverage ratio for a class of senior securities representing indebtedness is calculated as our 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 our 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, except for publicly issued unsecured notes payable, as other senior securities are not registered for public trading. The average market value of the publicly issued unsecured notes payable is calculated as the face value of the notes.

⁽⁵⁾	See Note 4 to our consolidated financial statements for a description of the terms.

⁽⁶⁾	Issued by our small business investment company subsidiary to the Small Business Administration. These categories of senior securities were not subject to the asset coverage requirements of the 1940 Act. During 2006, our small business investment company (SBIC) subsidiary surrendered its SBIC license and was merged into its parent.

⁽⁷⁾	We were the obligor on $15 million of the senior notes. Our small business investment company subsidiary was the obligor on the remaining $5 million, which was not subject to the asset coverage requirements of the 1940 Act.

⁽⁸⁾	The Redeemable Cumulative Preferred Stock was reclassified to Other Liabilities on the accompanying financial statements during 2003 in accordance with SFAS No. 150.

BUSINESS

General

We are a business development company, or BDC, in the private equity business and we are internally managed. Specifically, we provide long-term debt and equity capital to primarily private middle market companies in a variety of industries. We believe the private equity capital markets are important to the growth of small and middle market companies because such companies often have difficulty accessing the public debt and equity capital markets. We believe that we are well positioned to be a source of capital for such companies. We provide our investors the opportunity to participate in the U.S. private equity industry through an investment in our publicly traded stock.

We have participated in the private equity business since we were founded in 1958. Since then through December 31, 2006, we have invested more than $11 billion in thousands of companies nationwide. We primarily invest in the American entrepreneurial economy, helping to build middle market businesses and support American jobs. We generally invest in established companies with adequate cash flow for debt service and well positioned for growth. We are not venture capitalists, and we generally do not provide seed, or early stage, capital. At December 31, 2006, our private finance portfolio included investments in 145 companies that generate aggregate annual revenues of over $13 billion and employ more than 90,000 people.

Our investment objective is to achieve current income and capital gains. In order to achieve this objective, we primarily invest in debt and equity securities of private companies in a variety of industries. However, from time to time, we may invest in companies that are public but lack access to additional public capital.

Private Equity Investing

As a private equity investor, we spend significant time and effort identifying, structuring, performing due diligence, monitoring, developing, valuing, and ultimately exiting our investments. We generally target companies in less cyclical industries with, among other things, high returns on invested capital, management teams with meaningful equity ownership, well-constructed balance sheets, and the ability to generate free cash flow. Each investment is subject to an extensive due diligence process. It is not uncommon for a single investment to take from two months to a full year to complete, depending on the complexity of the transaction.

Our investment activity is primarily focused on making long-term investments in the debt and equity of primarily private middle market companies. These investments are generally long-term in nature and privately negotiated, and no readily available market exists for them. This makes our investments highly illiquid and, as a result, we cannot readily trade them. When we make an investment, we enter into a long-term arrangement where our ultimate exit from that investment may be three to ten years in the future.

We believe illiquid investments generally provide better investment returns on average over time than do more liquid investments, such as public equities and public debt instruments, because of the increased liquidity risk in holding such investments. Investors in illiquid investments cannot manage risk through investment trading techniques. In order to manage our risk, we focus on careful investment selection, thorough due diligence,

portfolio monitoring and portfolio diversification. Our investment management processes have been designed to incorporate these disciplines.

We have focused on investments in the debt and equity of primarily private middle market companies because they can be structured to provide recurring cash flow to us as the investor. In addition to earning interest income, we may earn income from management, consulting, diligence, structuring or other fees. We may also enhance our total return with capital gains realized from investments in equity instruments or from equity features, such as nominal cost warrants. For the years 1998 through 2006, we have realized $1.1 billion in cumulative net realized gains from our investment portfolio. Net realized gains for this period as a percentage of total assets are shown in the chart below.

One measure of the performance of a private equity investor is the internal rate of return generated by the investor’s portfolio. Since our merger on December 31, 1997, through December 31, 2006, our combined aggregate cash flow internal rate of return, or IRR, has been approximately 22% for private finance and CMBS/CDO investments exited during this period. The IRR is calculated using the aggregate portfolio cash flow for all investments exited over this period. For investments exited during this period, we invested capital totaling $3.9 billion. The weighted average holding period of these investments was 36 months. Investments are considered to be exited when the original investment objective has been achieved through the receipt of cash and/or non-cash consideration upon the repayment of our debt investment or sale of an equity investment, or through the determination that no further consideration was collectible and, thus, a loss may have been realized. The aggregate cash flow IRR for private finance investments was approximately 21% and for CMBS/CDO investments was approximately 24% for the same period. The weighted average holding period of the private finance and CMBS/CDO investments was 48 months and 22 months, respectively, for the same period. These IRR results represent historical results. Historical results are not necessarily indicative of future results.

We believe our business model is well suited for long-term illiquid investing. Our balance sheet is capitalized with significant equity capital and we use only a modest level of debt capital, which allows us the ability to be patient and to manage through difficult market conditions with less risk of liquidity issues. Under the 1940 Act, we are restricted to a debt to equity ratio of approximately one-to-one. Thus, our capital structure, which

includes a modest level of long-term leverage, is well suited for long-term illiquid investments.

In general, we compete for investments with a large number of private equity funds and mezzanine funds, other business development companies, hedge funds, investment banks, other equity and non-equity based investment funds, and other sources of financing, including specialty finance companies and traditional financial services companies such as commercial banks. However, we primarily compete with other providers of long-term debt and equity capital to middle market companies, including private equity funds and other business development companies.

We are internally managed, led by an experienced management team with our senior officers and managing directors possessing, on average, 21 years of experience. At December 31, 2006, we had 170 employees focused on transaction sourcing, origination and execution, portfolio monitoring, accounting, valuation and other operational and administrative activities. We are headquartered in Washington, DC, with offices in New York, NY, Chicago, IL, and Los Angeles, CA and have a centralized approval process.

Private Finance Portfolio. Our private finance portfolio is primarily composed of debt and equity securities. We generally invest in private companies though, from time to time, we may invest in companies that are public but lack access to additional public capital. These investments are also generally illiquid.

Our capital is generally used to fund:


• Buyouts		• Recapitalizations
• Acquisitions		• Note purchases
• Growth		• Other types of financings

When assessing a prospective private finance investment, we generally look for companies in less cyclical industries in the middle market (i.e., generally $50 million to $500 million in revenues) with certain target characteristics, which may or may not be present in the companies in which we invest. Our target investments generally are in companies with the following characteristics:


	•	Management team with meaningful equity ownership

	•	Dominant or defensible market position

	•	High return on invested capital

	•	Stable operating margins

	•	Ability to generate free cash flow

	•	Well-constructed balance sheet

We generally invest in companies in the following industries:


• Business Services		• Industrial Products
• Consumer Products		• Consumer Services
• Financial Services

We intend to take a balanced approach to private equity investing that emphasizes a complementary mix of debt investments and buyout investments. The combination of these two types of investments provides current interest and related portfolio income and the potential for future capital gains. Our strategy is to manage risk in these investments through the structure and terms of our debt and equity investments. It is our preference to structure our investments with a focus on current recurring interest and other income, which may include management, consulting or other fees. We generally target debt investments of $10 million to $150 million and buyout investments of up to $300 million of invested capital.

Debt investments may include senior loans, unitranche debt (a single debt investment that is a blend of senior and subordinated debt terms), or subordinated debt (with or without equity features). The junior debt that we invest in that is lower in repayment priority than senior debt is also known as mezzanine debt. We may make equity investments for a minority equity stake in portfolio companies or may receive equity features, such as nominal cost warrants, in conjunction with our debt investments. We generally target a minimum weighted average portfolio yield of 10% on the debt investments in our private finance portfolio.

Senior loans generally carry a floating rate of interest, usually set as a spread over LIBOR, and generally require payments of both principal and interest throughout the life of the loan. Senior loans generally have contractual maturities of three to six years and interest is generally paid to us monthly or quarterly. Unitranche debt generally carries a fixed rate of interest and may require payments of both principal and interest throughout the life of the loan. However, unitranche instruments generally allow for principal to be repaid at a slower rate than would generally be allowed under a more traditional senior loan/subordinated debt structure. Unitranche debt generally has contractual maturities of five to six years and interest is generally paid to us quarterly. Subordinated debt generally carries a fixed rate of interest generally with contractual maturities of five to ten years and generally has interest-only payments in the early years and payments of both principal and interest in the later years, although maturities and principal amortization schedules may vary. Interest is generally paid to us quarterly.

We may underwrite or arrange senior loans related to our portfolio investments or for other companies that are not in our portfolio. When we underwrite or arrange senior loans, we may earn a fee for such activities. Senior loans originated and underwritten by us may or may not be funded by us at closing. When these senior loans are closed, we may fund all or a portion of the underwritten commitment pending sale of the loan to other investors, which may include loan sales to Callidus Capital Corporation (Callidus), a portfolio company controlled by us, or funds managed by Callidus. After completion of the sale process, we may or may not retain a position in these senior loans. We may also invest in the bonds or preferred shares/income notes of collateralized loan obligations (CLOs) or collateralized debt obligations (CDOs), where the underlying collateral pool consists of senior loans. Certain of the CLOs and CDOs in which we invest may be managed by Callidus Capital Management, a subsidiary of Callidus.

In a buyout transaction, we generally invest in senior debt, subordinated debt and equity (preferred and/or voting or non-voting common) where our equity ownership represents a significant portion of the equity, but may or may not represent a controlling interest. If we invest in non-voting equity in a buyout investment, we generally have an option to acquire a controlling stake in the voting securities of the portfolio company at fair market value. We generally structure our buyout investments such that we seek to

earn a blended current return on our total capital invested of approximately 10% through a combination of interest income on our senior loans and subordinated debt, dividends on our preferred and common equity, and management, consulting, or transaction services fees to compensate us for the managerial assistance that we may provide to the portfolio company. As a result of our significant equity investment in a buyout investment there is potential to realize larger capital gains through buyout investing as compared to debt or mezzanine investing.

The structure of each debt and equity security is specifically negotiated to enable us to protect our investment, with a focus on preservation of capital, and maximize our returns. We include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our senior loans and unitranche debt are generally secured, however in a liquidation scenario, the collateral, if any, may not be sufficient to support our outstanding investment. Our junior or mezzanine loans are generally unsecured. Our investments may be subject to certain restrictions on resale and generally have no established trading market.

At December 31, 2006, 72.8% of the private finance portfolio at value consisted of loans and debt securities and 27.2% consisted of equity securities (equity securities included 27.6% in investment cost basis and 0.4% in net unrealized depreciation). At December 31, 2006, 86% of our private finance loans and debt securities carried a fixed rate of interest and 14% carried a floating rate of interest. The mix of fixed and variable rate loans and debt securities in the portfolio may vary depending on the level of floating rate senior loans or unitranche debt in the portfolio at a given time. The weighted average yield on our private finance loans and debt securities was 11.9% at December 31, 2006.

At December 31, 2006, 34.0% of the private finance investments at value were in companies more than 25% owned, 10.3% were in companies 5% to 25% owned, and 55.7% were in companies less than 5% owned.

Our ten largest investments at value at December 31, 2006, were as follows:


		At December 31, 2006
($ in millions)
				Unrealized
Portfolio				Appreciation					Percentage of
Company	Company Information	Cost		(Depreciation)			Value		Total Assets

Mercury Air Centers, Inc. ⁽¹⁾	Owns and operates fixed base operations generally under long- term leases from local airport authorities, which consist of terminal and hangar complexes that service the needs of the general aviation community.	$	84.3	$	159.9		$	244.2		5.0%

Business Loan Express, LLC⁽¹⁾	Originates, sells, and services primarily real estate secured loans, generally for businesses with financing needs of up to $5.0 million. Provides primarily real estate secured conventional small business loans, SBA 7(a) loans, and small investment real estate loans.	$	295.3	$	(84.6	)	$	210.7		4.3%

EarthColor, Inc.	Commercial printer focused on providing a one-stop printing solution of electronic pre-press, printing and finishing primarily for promotional products such as direct mail pieces, brochures, product information and free standing inserts.	$	195.0	$	—		$	195.0		4.0%

Norwesco, Inc.	Designs, manufactures and markets a broad assortment of polyethylene tanks primarily to the agricultural and septic tank markets.	$	120.5	$	45.0		$	165.5		3.4%

Advantage Sales & Marketing, Inc.⁽²⁾	Sales and marketing agency providing outsourced sales, merchandising, and marketing services to the consumer packaged goods industry.	$	151.6	$	11.0		$	162.6		3.3%

BenefitMall, Inc.	Insurance general agency providing brokers with products, tools, and services that make selling employee benefits to small businesses more efficient.	$	155.2	$	(2.0	)	$	153.2		3.1%

Financial Pacific Company	Specialized commercial finance company that leases business- essential equipment to small businesses nationwide.	$	96.5	$	56.0		$	152.5		3.1%

Driven Brands, Inc.	Business format franchisor in the car care sector of the automotive aftermarket industry and in the general car care services with approximately 1,100 locations worldwide operating primarily under the Meineke Car Care Centers ^® and Econo Lube N’ Tune^® brands.	$	149.1	$	(9.8	)	$	139.3		2.9%

Huddle House, Inc.	Franchisor of value-priced, full service family dining restaurants primarily in the Southeast.	$	119.8	$	—		$	119.8		2.5%

Hot Stuff Foods, LLC⁽³⁾	Provider of foodservice programs predominately to convenience stores. Manufactures and distributes branded food products for on-site preparation and sale through in-store Hot Stuff branded kitchens and “grab and go” service points.	$	185.6	$	(68.4	)	$	117.2		2.4%


⁽¹⁾	See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Recent Developments”.

⁽²⁾	On March 29, 2006, we sold our majority equity interest in Advantage. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

⁽³⁾	In the first quarter of 2007, we exercised our option to acquire a majority of the voting securities of Hot Stuff Foods, LLC at fair market value.

We monitor the portfolio to maintain diversity within the industries in which we invest. We may or may not concentrate in any industry or group of industries in the future. The industry composition of the private finance portfolio at value at December 31, 2006 and 2005, was as follows:


		2006			2005

Industry
Business services			39	%		42	%
Consumer products			20			14
Financial services			9			14
Industrial products			9			10
Consumer services			6			6
Retail			6			3
Healthcare services			3			2
Energy services			2			2
Other⁽¹⁾			6			7

	Total		100	%		100	%


⁽¹⁾	Includes investments in senior debt CDO and CLO funds, which represented 3% of the private finance portfolio at value at both December 31, 2006 and 2005. These funds invest in senior debt representing a variety of industries.

Commercial Real Estate Finance Portfolio. Since 1998, our commercial real estate investments were generally in the non-investment grade tranches of commercial mortgage-backed securities, also known as CMBS, and in the bonds and preferred shares of collateralized debt obligations, also known as CDOs. On May 3, 2005, we completed the sale of our portfolio of CMBS and CDO investments to affiliates of Caisse de dépôt et placement du Québec (the Caisse). See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Simultaneous with the sale of our CMBS and CDO portfolio, we entered into a platform assets purchase agreement, under which we have agreed not to primarily invest in CMBS and real estate related CDOs and refrain from certain other real estate related investing or servicing activities for a period of three years, or through May 2008, subject to certain limitations and excluding our existing portfolio and related activities.

At December 31, 2006, our commercial real estate finance portfolio consisted of commercial mortgage loans, real estate owned and equity interests, which totaled $118.2 million at value.

Business Processes

Business Development and New Deal Origination. Over the years, we believe we have developed and maintained a strong industry reputation and an extensive network of relationships. We have a team of business development professionals dedicated to sourcing deals through our relationships with numerous private equity investors, investment banks, business brokers, merger and acquisition advisors, financial services companies, banks, law firms and accountants through whom we source investment opportunities. Through these relationships, we believe we have been able to strengthen our position as a private equity investor. We are well known in the private equity industry, and we believe that our experience and reputation provide a competitive advantage in originating new investments.

We believe that our debt portfolio relationships and sponsor relationships are a significant source for buyout investments. We generally source our buyout transactions in ways other than going to broad auctions, which include capitalizing on existing relationships with companies and sponsors to participate in proprietary buyout opportunities. We work closely with these companies and sponsors while we are debt investors so that we may be positioned to partner with them on buyout opportunities in a subsequent transaction.

From time to time, we may receive referrals for new prospective investments from our portfolio companies as well as other participants in the capital markets. We may pay referral fees to those who refer transactions to us that we consummate.

New Deal Underwriting and Investment Execution. In a typical transaction, we review, analyze, and substantiate through due diligence, the business plan and operations of the potential portfolio company. We perform financial due diligence, perform operational due diligence, study the industry and competitive landscape, and conduct reference checks with company management or other employees, customers, suppliers, and competitors, as necessary. We may work with external consultants, including accounting firms and industry or operational consultants, in performing due diligence and in monitoring our portfolio investments.

Once we have determined that a prospective portfolio company is suitable for investment, we work with the management and the other capital providers, including senior, junior, and equity capital providers, to structure a “deal.” We negotiate among these parties to agree on the rights and terms of our investment relative to the other capital in the portfolio company’s capital structure. The typical debt transaction requires approximately two to six months of diligence and structuring before funding occurs. The typical buyout transaction may take up to one year to complete because the due diligence and structuring process is significantly longer when investing in a substantial equity stake in the company.

Our investments are tailored to the facts and circumstances of each deal. The specific structure is designed to protect our rights and manage our risk in the transaction. We generally structure the debt instrument to require restrictive affirmative and negative covenants, default penalties, or other protective provisions. In addition, each debt investment is individually priced to achieve a return that reflects our rights and priorities in the portfolio company’s capital structure, the structure of the debt instrument, and our perceived risk of the investment. Our loans and debt securities have an annual stated interest rate; however, that interest rate is only one factor in pricing the investment. The annual stated interest rate may include some component of contractual payment-in-kind interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity or upon prepayment. In addition to the interest earned on loans and debt securities, our debt investments may include equity features, such as nominal cost warrants or options to buy a minority interest in the portfolio company. In a buyout transaction where our equity investment represents a significant portion of the equity, our equity ownership may or may not represent a controlling interest. If we invest in non-voting equity in a buyout, we generally have an option to acquire a controlling stake in the voting securities of the portfolio company at fair market value.

We have a centralized, credit-based approval process. The key steps in our investment process are:


	•	Initial investment screening;

	•	Initial investment committee approval;

	•	Due diligence, structuring and negotiation;

	•	Internal review of diligence results, including peer review;

	•	Final investment committee approval;

	•	Approval by the Executive Committee of the Board of Directors (for all debt investments that represent a commitment equal to or greater than $20 million and every buyout transaction); and

	•	Funding of the investment (due diligence must be completed with final investment committee approval and Executive Committee approval, as needed, before funds are disbursed).

The investment process benefits from the significant professional experience of the members of our investment committee, which is chaired by our Chief Executive Officer and includes our Chief Operating Officer, our Chief Financial Officer, our Chief Valuation Officer (non-voting member), and certain of our Managing Directors.

Portfolio Monitoring and Development. Middle market companies often lack the management expertise and experience found in larger companies. As a BDC, we are required by the 1940 Act to make available significant managerial assistance to our portfolio companies. Our senior level professionals work with portfolio company management teams to assist them in building their businesses. Managerial assistance includes, but is not limited to, management and consulting services related to corporate finance, marketing, human resources, personnel and board member recruiting, business operations, corporate governance, risk management and other general business matters. Our corporate finance assistance includes supporting our portfolio companies’ efforts to structure and attract additional capital. We believe our extensive network of industry relationships and our internal resources help make us a collaborative partner in the development of our portfolio companies.

Our team of investment professionals regularly monitors the status and performance of each investment. This portfolio company monitoring process generally includes review of the portfolio company’s financial performance against its business plan, review of current financial statements and compliance with financial covenants, evaluation of significant current developments and assessment of future exit strategies. For debt investments we may have board observation rights that allow us to attend portfolio company board meetings. For buyout investments, we generally hold a majority of the seats on the board of directors where we own a controlling interest in the portfolio company and we have board observation rights where we do not own a controlling interest in the portfolio company.

companies, reviewing and approving certain portfolio exits, reviewing and approving certain actions by portfolio companies whose voting securities are more than 50% owned by us, reviewing significant investment-related litigation matters where we are a named party, and reviewing and approving proxy votes with respect to our portfolio investments. Our portfolio management committee is chaired by our Chief Executive Officer and includes our Chief Operating Officer, Chief Financial Officer, Chief Valuation Officer (non-voting member), our private finance counsel, and certain of our Managing Directors. From time to time we will identify investments that require closer monitoring or become workout assets. We develop a workout strategy for workout assets and the portfolio management committee gauges our progress against the strategy.

We seek to price our investments to provide an investment return considering the fact that certain investments in the portfolio may underperform or result in loss of investment return or investment principal. As a private equity investor, we will incur losses from our investing activities, however we have a history of working with troubled portfolio companies in order to recover as much of our investments as is practicable.

Portfolio Grading

We employ a grading system for our entire 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; however, no loss of investment return or principal is expected. Grade 4 is for investments that are in workout and for which some loss of current investment return is expected, but no loss of principal is expected. Grade 5 is for investments that are in workout and for which some loss of principal is expected. At December 31, 2006, Grade 1, 2, and 3 investments totaled $4,287.7 million, and Grade 4 and 5 investments totaled $208.4 million.

Portfolio Valuation

We determine the value of each investment in our portfolio on a quarterly basis, and changes in value result in unrealized appreciation or depreciation being recognized in our statement of operations. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by the Board of Directors pursuant to our valuation policy and a consistently applied valuation process. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the Board of Directors 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.

including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has appreciated in value. Changes in fair value are recorded in the statement of operations as net change in unrealized appreciation or depreciation.

As a business development company, we invest in illiquid securities including debt and equity securities of companies and CDO and CLO bonds and preferred shares/income notes. The structure of each debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our investments may be subject to certain restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition, and market changing events that impact valuation.

Valuation Methodology. Our process for determining the fair value of a private finance investment begins with determining the enterprise value of the portfolio company. The fair value of our investment is based on the enterprise value at which the portfolio company could be sold in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The liquidity event whereby we exit a private finance investment is generally the sale, the recapitalization or, in some cases, the initial public offering of the portfolio company.

There is no one methodology to determine enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values. However, we must derive a single estimate of enterprise value. To determine the enterprise value of a portfolio company, we analyze its historical and projected financial results. This financial and other information is generally obtained from the portfolio companies, and may represent unaudited, projected or pro forma financial information. We generally require portfolio companies to provide annual audited and quarterly unaudited financial statements, as well as annual projections for the upcoming fiscal year. Typically in the private equity business, companies are bought and sold based on multiples of EBITDA, cash flow, net income, revenues or, in limited instances, book value. The private equity industry uses financial measures such as EBITDA or EBITDAM (Earnings Before Interest, Taxes, Depreciation, Amortization and, in some instances, Management fees) in order to assess a portfolio company’s financial performance and to value a portfolio company. EBITDA and EBITDAM are not intended to represent cash flow from operations as defined by U.S. generally accepted accounting principles and such information should not be considered as an alternative to net income, cash flow from operations, or any other measure of performance prescribed by U.S. generally accepted accounting principles. When using EBITDA to determine enterprise value, we may adjust EBITDA for non-recurring items. Such adjustments are intended to normalize EBITDA to reflect the portfolio company’s earnings power. Adjustments to EBITDA may include compensation to previous owners,

acquisition, recapitalization, or restructuring related items or one-time non-recurring income or expense items.

If there is adequate enterprise value to support the repayment of our debt, the fair value of our loan or debt security normally corresponds to cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount. The value of loan and debt securities may be greater than our cost basis if the amount that would be repaid on the loan or debt security upon the sale or liquidation of the portfolio company is greater than our cost basis. The fair value of equity interests in portfolio companies is determined based on various factors, including the enterprise value remaining for equity holders after the repayment of the portfolio company’s debt and other preference capital, and other pertinent factors such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, liquidation events, or other events. The determined equity values are generally discounted when we have a minority position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

Valuation Process. The portfolio valuation process is managed by our Chief Valuation Officer (CVO). The CVO works with the investment professionals responsible for each investment. The following is an overview of the steps we take each quarter to determine the value of our portfolio.


	•	Our valuation process begins with each portfolio company or investment being initially valued by the investment professionals, led by the Managing Director or senior officer who is responsible for the portfolio company relationship (the Deal Team).

	•	The CVO and third-party valuation consultants, as applicable (see below), review the preliminary valuation documentation as prepared by the Deal Team.


	•	The CVO, members of the valuation team, and third-party consultants, as applicable, meet with each Managing Director or responsible senior officer to discuss the preliminary valuation determined and documented by the Deal Team for each of their respective investments.

	•	The CEO, COO, CFO and the Managing Directors meet with the CVO to discuss the preliminary valuation results.

	•	Valuation documentation is distributed to the members of the Board of Directors.

	•	The Audit Committee of the Board of Directors meets separately from the full Board of Directors with the third-party consultants (see below) to discuss the assistance provided and results. The CVO attends this meeting.

	•	The CVO discusses and reviews the valuations with the Board of Directors.

	•	To the extent there are changes or if additional information is deemed necessary, a follow-up Board meeting may take place.

	•	The Board of Directors determines the fair value of the portfolio in good faith.

In connection with our valuation process to determine the fair value of a private finance investment, we work with third-party consultants to obtain assistance and advice as additional support in the preparation of our internal valuation analysis for a portion of the portfolio each quarter. In addition, we may receive other third-party assessments of a particular private finance portfolio company’s value in the ordinary course of business, most often in the context of a prospective sale transaction or in the context of a bankruptcy process. The valuation analysis prepared by management using these third-party valuation resources, when applicable, is submitted to our Board of Directors for its determination of fair value of the portfolio in good faith.

We have received third-party valuation assistance from Duff & Phelps, LLC (Duff & Phelps) and Houlihan Lokey Howard and Zukin (Houlihan Lokey). We currently intend to continue to work with third-party consultants to obtain valuation assistance for a portion of the private finance portfolio each quarter. We currently anticipate that we will generally obtain valuation assistance for all companies in the portfolio where we own more than 50% of the outstanding voting equity securities on a quarterly basis and that we will generally obtain assistance for companies where we own equal to or less than 50% of the outstanding voting equity securities at least once during the course of the calendar year. Valuation assistance may or may not be obtained for new companies that enter the portfolio after June 30 of any calendar year during that year or for investments with a cost and value less than $250,000. For the quarter ended December 31, 2006, Duff & Phelps and Houlihan Lokey assisted us by reviewing our valuation of 81 portfolio companies, which represented 82.9% of the private finance portfolio at value. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Disposition of Investments

We manage our portfolio of investments in an effort to maximize our expected returns. Our portfolio is large and we are generally repaid by our borrowers and exit our debt and equity investments as portfolio companies are sold, recapitalized or complete an initial public offering.

We may retain a position in the senior loans we originate or we may sell all or a portion of these investments. In our debt investments where we have equity features, we are generally in a minority ownership position in a portfolio company, and as a result, generally exit the investment when the majority equity stakeholder decides to sell or recapitalize the company. Where we have a control position in an investment, as we may have in buyout investments, we have more flexibility and can determine whether or not we should exit our investment. Our most common exit strategy for a buyout investment is the sale of a portfolio company to a strategic or financial buyer. If an investment has appreciated in value, we may realize a gain when we exit the investment. If an investment has depreciated in value, we may realize a loss when we exit the investment.

We are in the investment business, which includes acquiring and exiting investments. It is our policy not to comment on potential transactions in the portfolio prior to reaching a definitive agreement or, in many cases, prior to consummating a transaction. To the extent we enter into any material transactions, we would provide disclosure as required.

Dividends

We have elected to be taxed as a regulated investment company under Subchapter M of the Code. As such, we are not subject to corporate level income taxation on income we timely distribute to our stockholders as dividends. We pay regular quarterly dividends based upon an estimate of annual taxable income available for distribution to shareholders, which includes our taxable interest, dividend, and fee income, as well as taxable net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual payment-in-kind interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual payment-in-kind interest or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation and amortization expense.

As a regulated investment company, we distribute substantially all of our annual taxable income to shareholders through the payment of cash dividends. Our Board of Directors reviews the dividend rate quarterly, and may adjust the quarterly dividend throughout the year. Dividends are declared considering our estimate of annual taxable income available for distribution to shareholders and the amount of taxable income carried over from the prior year for distribution in the current year. Our goal is to declare what we believe to be sustainable increases in our regular quarterly dividends. To the extent that we earn annual taxable income in excess of dividends paid from such taxable income for the year, we may carry over the excess taxable income into the next year and such excess income will be available for distribution in the next year as permitted under the Code. The maximum amount of excess taxable income that may be carried over for distribution in the next year under the Code is the total amount of dividends paid in the following year,

subject to certain declaration and payment guidelines. Excess taxable income carried over and paid out in the next year is generally subject to a 4% excise tax (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other Matters — Regulated Investment Company Status”). We believe that carrying over excess taxable income into future periods may provide increased visibility with respect to taxable earnings available to pay the regular quarterly dividend.

We began paying quarterly dividends in 1963, and our portfolio has provided sufficient ordinary taxable income and realized net capital gains to sustain or grow our dividends over time. Since inception through December 31, 2006, our average annual total return to shareholders (assuming all dividends were reinvested) was 18.1%. Over the past one, three, five and ten years, our total return to shareholders (assuming all dividends were reinvested) has been 20.6%, 14.6%, 14.4% and 19.1%, respectively, with the dividend providing a meaningful portion of this return.

The percentage of our dividend generated by ordinary taxable income versus capital gain income will vary from year to year. The percentage of ordinary taxable income versus net capital gain income supporting the dividend since 1987 is shown below.

Corporate Structure and Offices

We are a Maryland corporation and a closed-end, non-diversified management investment company that has elected to be regulated as a business development company under the 1940 Act. We have a real estate investment trust subsidiary, Allied Capital REIT, Inc., and several subsidiaries that are single-member limited liability companies established for specific purposes, including holding real estate property. We also have a subsidiary, A.C. Corporation, that generally provides diligence and structuring services, as well as transaction, management, consulting, and other services, including underwriting and arranging senior loans, to Allied Capital and our portfolio companies.

Our executive offices are located at 1919 Pennsylvania Avenue, NW, Washington, DC 20006-3434 and our telephone number is (202) 721-6100. In addition, we have regional offices in New York, Chicago, and Los Angeles.

Employees

At December 31, 2006, we employed 170 individuals including investment and portfolio management professionals, operations professionals and administrative staff. The majority of our employees are located in our Washington, DC office. We believe that our relations with our employees are excellent.

Legal Proceedings

On June 23, 2004, we were notified by the SEC that they are conducting an informal investigation of us. On December 22, 2004, we received letters from the U.S. Attorney for the District of Columbia requesting the preservation and production of information regarding us and Business Loan Express, LLC in connection with a criminal investigation. Based on the information available to us at this time, the inquiries appear to primarily pertain to matters related to portfolio valuation and our portfolio company, Business Loan Express, LLC. To date, we have produced materials in response to requests from both the SEC and the U.S. Attorney’s office, and a director and certain current and former employees have provided testimony and have been interviewed by the staff of the SEC and, in some cases, the U.S. Attorney’s Office. We are voluntarily cooperating with these investigations.

In late December 2006, we received a subpoena from the U.S. Attorney for the District of Columbia requesting, among other things, the production of records regarding the use of private investigators by us or our agents. The Board established a committee, which was advised by its own counsel, to review this matter. In the course of gathering documents responsive to the subpoena, we became aware that an agent of Allied Capital obtained what were represented to be telephone records of David Einhorn and which purport to be records of calls from Greenlight Capital during a period of time in 2005. Also, while we were gathering documents responsive to the subpoena, allegations were made that our management had authorized the acquisition of these records and that management was subsequently advised that these records had been obtained. Our management has stated that these allegations are not true. We are cooperating fully with the inquiry by the United States Attorney’s office.

On February 13, 2007, Rena Nadoff filed a shareholder derivative action in the Superior Court of the District of Columbia, captioned Rena Nadoff v. Walton, et al., CA 001060-07, seeking unspecified compensatory and other damages, as well as equitable relief on behalf of Allied Capital Corporation. Ms. Nadoff’s complaint names as defendants the members of Allied Capital’s Board of Directors; Allied Capital is a nominal defendant for purposes of the derivative action. The complaint alleges breach of fiduciary duty by the Board of Directors arising from internal controls failures and mismanagement of Business Loan Express, LLC, an Allied Capital portfolio company. We believe the lawsuit is without merit, and we intend to defend the lawsuit vigorously.

On February 26, 2007, Dana Ross filed a class action complaint in the U.S. District Court for the District of Columbia in which she alleges that Allied Capital Corporation and certain members of management violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint is captioned Dana Ross v. Walton, et al., CV 00402. Dana Ross claims that, between March 1, 2006, and January 10, 2007, Allied Capital either failed to disclose or misrepresented information concerning the loan origination practices of Business Loan Express, LLC, an Allied Capital portfolio company. Dana Ross seeks unspecified compensatory and other damages, as well as other relief. We believe the lawsuit is without merit, and we intend to defend the lawsuit vigorously. There may be other similar class action lawsuits filed.

In addition to the above matters, we are party to certain lawsuits in the normal course of business.

While the outcome of any of the legal proceedings described above cannot at this time be predicted with certainty, we do not expect these matters will materially affect our financial condition or results of operations; however, there can be no assurances whether any pending litigation will have a material adverse effect on our financial condition or results of operations in any future reporting period.

PORTFOLIO COMPANIES

The following is a listing of each portfolio company or its affiliate, together referred to as portfolio companies, in which we had an equity investment at December 31, 2006. Percentages shown for class of securities held by us represent percentage of the class owned and do not necessarily represent voting ownership or economic ownership. Percentages shown for equity securities other than warrants or options represent the actual percentage of the class of security held before dilution. Percentages shown for warrants and options held represent the percentage of class of security we may own assuming we exercise our warrants or options before dilution.

The portfolio companies are presented in three categories: companies more than 25% owned which represent portfolio companies where we directly or indirectly own more than 25% of the outstanding voting securities of such portfolio company and, therefore, are deemed controlled by us under the 1940 Act; companies owned 5% to 25% which represent portfolio companies where we directly or indirectly own 5% to 25% of the outstanding voting securities of such portfolio company or where we hold one or more seats on the portfolio company’s board of directors and, therefore, are deemed to be an affiliated person under the 1940 Act; and companies less than 5% owned which represent portfolio companies where we directly or indirectly own less than 5% of the outstanding voting securities of such portfolio company and where we have no other affiliations with such portfolio company. We make available significant managerial assistance to our portfolio companies. We generally receive rights to observe the meetings of our portfolio companies’ board of directors, and may have one or more voting seats on their boards.

For information relating to the amount and nature of our investments in portfolio companies, see our consolidated statement of investments at December 31, 2006, at pages F-7 to F-17.


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

PRIVATE FINANCE
Companies More Than 25% Owned
Alaris Consulting, LLC⁽¹⁾⁽²⁾		Consulting Firm	Equity Interests		100.0%
	1815 South Meyers Road
	Suite 1000
	Oakbrook, IL 60181
Avborne, Inc.⁽¹⁾⁽⁷⁾		Aviation Services	Series B Preferred Stock		23.8%
	c/o Trivest, Inc.		Common Stock		27.2%
	7500 NW 26th Street
	Miami, FL 33122
Avborne Heavy Maintenance, Inc.⁽¹⁾⁽⁷⁾		Aviation Services	Series A Preferred Stock		27.5%
	c/o Trivest, Inc.		Common Stock		27.5%
	7500 NW 26th Street
	Miami, FL 33122
Border Foods, Inc.⁽¹⁾		Mexican Ingredient & Food	Series A Preferred Stock		100.0%
	1750 Valley View Lane	Product Manufacturer	Series A Common Stock		100.0%
	Suite 350
	Farmers Branch, TX 75234
Business Loan Express, LLC⁽¹⁾		Real-Estate Secured	Class A Equity Interests		100.0%
	1633 Broadway	Small Business Lender	Class B Equity Interests		100.0%
	New York, NY 10019		Class C Equity Interests		94.9%
			Equity Interest in BLX
			Subsidiary⁽³⁾		20.0%
Calder Capital Partners, LLC⁽¹⁾		Private Investment Firm	Equity Interests		65.0%
	321 North Clark Street, 8th Floor
	Chicago, IL 60610
Callidus Capital Corporation⁽¹⁾⁽⁴⁾		Asset Manager and	Common stock		100.0%
	520 Madison Avenue	Finance Company
	New York, NY 10022


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

Coverall North America, Inc.⁽¹⁾		Corporate Cleaning Service	Common Stock		98.8%
	5201 Congress Avenue	Provider
	Suite 275
	Boca Raton, Florida 33487
CR Brands, Inc.⁽¹⁾		Household Cleaning	Common Stock		78.2%
	141 Venture Boulevard	Products
	Spartanburg, SC 29306
Financial Pacific Company⁽¹⁾		Commercial Finance	Series A Preferred Stock		99.4%
	3455 South 344th Way	Leasing	Common Stock		99.4%
	Suite 300
	Federal Way, WA 98001
ForeSite Towers, LLC⁽¹⁾		Tower Leasing	Series A Preferred
	22 Iverness Center Parkway		Equity Interest		100.0%
	Suite 500		Series B Preferred
	Birmingham, AL 35242		Equity Interest		100.0%
			Series E Preferred Equity Interest		100.0%
			Common Equity Interest		88.1%
Global Communications, LLC⁽¹⁾		Muzak Franchisee	Preferred Equity Interest		77.8%
	1000 North Dixie Highway		Options for Common
	West Palm Beach, FL 33401		Equity Interest		59.3%
Gordian Group, Inc.⁽¹⁾		Financial Advisory Services	Common Stock		100.0%
	499 Park Avenue
	New York, NY 10022
Healthy Pet Corp.⁽¹⁾		Comprehensive Veterinary	Common Stock		98.7%
	One Enterprise Drive	Services
	Suite 310
	Shelton, CT 06484
HMT, Inc.		Storage Tank	Class B Preferred Stock		33.5%
	23832 Tomball Parkway	Maintenance & Repair	Common Stock		25.0%
	Tomball, TX 77375		Warrants to Purchase
			Common Stock		9.7%
Huddle House, Inc.⁽¹⁾		Restaurant Franchisor	Common Stock		97.4%
	5901-B Peachtree-Dunwoody Road
	Suite 450
	Atlanta, Georgia 30328
Impact Innovations Group, LLC		Information Technology	Equity Interests in
	12 Piedmont Center	Services Provider	Affiliate⁽⁵⁾		50.0%
	Suite 210
	Atlanta, GA 30305
Insight Pharmaceuticals Corporation⁽¹⁾		Marketer of Over-The-	Preferred Stock		91.2%
	1170 Wheeler Way	Counter Pharmaceuticals	Common Stock		91.2%
	Suite 150
	Langhorne, PA 19047
Jakel, Inc.⁽¹⁾		Manufacturer of Electric	Series A-1 Preferred Stock		32.3%
	201 S. Madison Avenue	Motors and Blowers	Class B Common Stock		100.0%
	Aurora, MO 65605
Legacy Partners Group, LLC⁽¹⁾		Merger and Acquisition	Equity Interests		100.0%
	520 Madison Avenue, 27th Floor	Advisor
	New York, NY 10022
Litterer Beteiligungs-GmbH		Scaffolding Company	Equity Interest		25.0%
	Theodor-Heuss-Anlage 2
	68165 Manheim
	Germany
Mercury Air Centers, Inc.⁽¹⁾		Fixed Base Operations	Series A Common Stock		100.0%
	Cuyahoga County Airport		Common Stock		84.3%
	355 Richmond Road
	Richmond Heights, OH 44143
MVL Group, Inc.⁽¹⁾		Market Research	Common Stock		64.9%
	1061 E. Indiantown Road	Services
	Suite 300
	Jupiter, FL 33477


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

Penn Detroit Diesel Allison, LLC⁽¹⁾		Distributor of Engines,	Equity Interests		78.0%
	8330 State Road	Transmissions, and Parts
	Philadelphia, PA 19136
Powell Plant Farms, Inc.⁽¹⁾		Plant Producer &	Preferred Stock		100.0%
	Route 3, Box 1058	Wholesaler	Warrants to Purchase
	Troup, TX 75789		Common Stock		83.5%
Service Champ, Inc.⁽¹⁾		Wholesale Distributor of	Common Stock		63.9%
	180 New Britain Boulevard	Auto Parts
	Chalfont, PA 18914
Startec Global Communications Corporation⁽¹⁾		Telecommunications	Common Stock		68.5%
	7631 Calhoun Place	Services
	Suite 650
	Rockville, MD 20855
Sweet Traditions, LLC⁽¹⁾		Franchisor of Krispy	Class B-2 Equity Interests		100.0%
	11780 Manchester Road	Kreme Doughnut	Warrant to Purchase
	Suite 207	Corporation	Class A Common Equity
	St. Louis, MO 63131		Interests		51.0%
Triview Investments, Inc.^(1)(11)		Multi-system Cable	Common Stock		99.5%
	1919 Pennsylvania Ave, N.W.	Operator,
	Washington, DC 20006	Pharmaceutical Marketer and Hotel Management Company
Companies 5% to 25% Owned
Advantage Sales & Marketing, Inc.⁽¹⁾		Sales and Marketing	Equity Interests		4.1%
	19100 Von Karman Avenue	Agency
	Suite 600
	Irvine, CA 92612
Air Medical Group Holdings LLC		Air Ambulance Service	Series A Preferred Equity
	306 Davis Drive		Interests		6.6%
	P.O. Box 768		Series B Preferred Equity
	West Plains, MO 65775		Interests		6.2%
Alpine ESP Holdings, Inc.		Engineering and Technical	Preferred Stock		13.1%
	3361 Rouse Road	Services	Common Stock		10.8%
	Suite 165
	Orlando, FL 32817
Amerex Group, LLC⁽¹⁾		Outerwear Apparel	Class A Equity Interests		100.0%
	350 Fifth Avenue	Supplier
	Suite 1401
	New York, NY 10118
BB&T Capital Partners/ Windsor		Private Equity Fund	Class A Equity Interests		32.6%
Mezzanine Fund, LLC
	12010 Sunset Hills Road
	Suite 700
	Reston, VA 20190
Becker Underwood, Inc.		Speciality Chemical	Common Stock		5.6%
	801 Dayton Avenue	Manufacturer
	Ames, IA 50010
BI Incorporated		Electronic Monitoring	Common Stock		7.1%
	6400 Lookout Road	Equipment
	Boulder, CO 80301
CitiPostal, Inc. and Affiliates		Storage and Management	Equity Interests		10.0%
	5 North 11th Street		Equity Interests of
	Brooklyn, NY 11211		Affiliates		10.0%
Creative Group, Inc.⁽¹⁾		Concept-to-Completion	Warrants to Purchase
	1601 Broadway, 10th Floor	Development	Common Stock		28.5%
	New York, NY 10019
Drew Foam Companies, Inc.		Polystyrene Block Plastic	Preferred Stock		8.8%
	144 Industrial Drive	Foam Manufacturer	Common Stock		7.3%
	Monticello, AR 71655


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

MedBridge Healthcare, LLC⁽¹⁾		Sleep Diagnostic Facilities	Debt Convertible
	110 West North Street		into Equity Interests		75.0%
	Suite 100		Class C Equity Interest		100.0%
	Greenville, SC 29601
Multi-Ad Services, Inc.		Marketing Services	Series A Preferred Equity
	1720 W. Detweiller Drive		Interests		16.8%
	Peoria, IL 61615		Class A Common Equity Interests		10.2%
Nexcel Synthetics, LLC		Manufacturer of Synthetic	Class A Equity Interest		6.7%
	6076 Southern Industrial Drive	Yarns and Artificial Turf	Class B Equity Interest		6.7%
	Birmingham, AL 35235
PresAir LLC		Pressure Switch	Equity Interests		15.0%
	1009 W. Boston Post Road	Manufacturer
	Mamaroneck, NY 10543
Progressive International
	Corporation	Retail Kitchenware	Series A Redeemable
	6111 S. 228th Street		Preferred Stock		14.3%
	Kent, WA 98064		Class A Common Stock		1.0%
			Warrants to Purchase
			Class A Common Stock		42.3%
Regency Healthcare Group, LLC		Hospice Services	Class A Equity Interests		8.8%
	2496 Jett Ferry Road
	Suite 102
	Atlanta, GA 30338
SGT India Private Limited⁽¹⁾		Software/Business Process	Common Stock		17.4%
	5858 Westheimer Road	Developer
	Houston, TX 77057
Soteria Imaging Services, LLC		Diagnostic Imaging	Class A Preferred Equity
	6009 Brownsboro Park Blvd	Facilities Operator	Interest		10.8%
	Suite H
	Louisville, KY 40207
Universal Environmental Services, LLC		Used Oil Recycling	Preferred Equity
	411 Dividend Drive		Interests		15.0%
	Peachtree City, GA 30269
Companies Less Than 5% Owned
Axium Healthcare Pharmacy, Inc.		Pharmaceutical Services	Common Stock		14.6%
	550 Technology Park
	Lake Mary, FL 32746
Baird Capital Partners IV Limited Partnership		Private Equity Fund	Limited Partnership Interest		2.5%
	777 East Wisconsin Avenue
	P.O. Box 0672
	Milwaukee, WI 53201-0672
Benchmark Medical, Inc.		Outpatient Physical	Warrant to Purchase
	101 Lindenwood Drive, Suite 420	Therapy Services	Common Stock		2.5%
	Malvern, PA 19355
BenefitMall, Inc.		Insurance General Agency	Series B Common Stock ⁽¹⁰⁾		100.0%
	4851 LBJ Freeway, Suite 1100	to Small Businesses	Warrant to Purchase
	Dallas, TX 75244		Class C Common Stock⁽¹⁰⁾		100.0%
Callidus Debt Partners CLO Fund III, Ltd.⁽⁸⁾		Senior Debt Fund	Preferred Shares		68.4%
	520 Madison Avenue
	New York, NY 10022
Callidus Debt Partners CLO Fund IV, Ltd.⁽⁸⁾		Senior Debt Fund	Income Notes		27.5%
	520 Madison Avenue
	New York, NY 10022
Callidus Debt Partners CLO Fund V, Ltd. ⁽⁸⁾		Senior Debt Fund	Income Notes		43.1%
	520 Madison Avenue
	New York, NY 10022


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

Callidus MAPS CLO Fund I LLC⁽⁸⁾		Senior Debt Fund	Income Notes		86.5%
	520 Madison Avenue
	New York, NY 10022
Camden Partners Strategic Fund II, L.P.		Private Equity Fund	Limited Partnership
	One South Street		Interest		3.9%
	Suite 2150
	Baltimore, MD 21202
Carlisle Wide Plank Floors, Inc.		Wide Plank Wood Flooring	Class A-1 Preferred Stock		5.2%
	1676 Route 9
	Stoddard, NH 03464
Catterton Partners V, L.P.		Private Equity Fund	Limited Partnership
	7 Greenwich Office Park		Interest		0.8%
	Greenwich, CT 06830
Catterton Partners VI, L.P.		Private Equity Fund	Limited Partnership
	7 Greenwich Office Park		Interest		0.5%
	Greenwich, CT 06830
Centre Capital Investors IV, LP		Private Equity Investment	Limited Partnership
	30 Rockefeller Plaza, 50th Floor	Fund	Interest		0.6%
	New York, NY 10020
Commercial Credit Group, Inc.		Equipment Finance and	Series C Preferred Stock		100.0%
	121 West Trade Street	Leasing	Warrant to Purchase
	Suite 2100		Common Stock		28.5%
	Charlotte, NC 28202
Cook Inlet Alternative Risk, LLC		Management Services	Equity Interests		3.7%
	10 British American Boulevard
	Latham, NY 12110
Cortec Group Fund IV, L.P.		Private Equity Fund	Limited Partnership
	200 Park Avenue		Interest		2.2%
	New York, NY 10166
Distant Lands Trading Co.		Provider of Premium	Series A-1 Common Stock		10.3%
	801 Houser Way North	Coffee and Coffee	Class A Common Stock		4.4%
	Renton, WA 98055	Beans
Driven Brands, Inc. (d/b/a Meineke Car Care Centers^® and Econo Lube N’ Tune^®)		Franchisor of	Class B Common Stock⁽¹⁰⁾		97.9%
	128 South Tryon Street	Car Care Centers	Warrant to Purchase
	Suite 900		Class A Common Stock⁽¹⁰⁾		51.0%
	Charlotte, NC 28202
Digital VideoStream, LLC		Media Post Production	Debt Convertible
	2600 West Olive Avenue		into Equity Interests		20.8%
	Burbank, CA 91505
Dynamic India Fund IV		Fund Focused on Real	Equity Interests		2.4%
	International Financial Services Limited	Estate in India
	IFS Court, Twenty Eight
	Cybercity, Ebene, Mauritius
EarthColor, Inc.		Full Service Commercial	Class B Common Stock⁽¹⁰⁾		100.0%
	527 W. 34th Street, 4th Floor	Printer	Warrant to Purchase
	New York, NY 10001		Class C Common Stock⁽¹⁰⁾		100.0%
eCentury Capital Partners, L.P.		Private Equity Fund	Limited Partnership
	8270 Greensboro Drive		Interest		25.0%
	Suite 1025
	McLean, VA 22102
Elexis Beta GmbH		Distance Measurement	Options to Purchase
	Ulmenstraße 22	Device	Shares		9.8%
	60325 Frankfurt	Manufacturer
	Germany
Frozen Specialties, Inc.		Private Label Frozen	Warrants to Purchase
	720 Barre Road	Food Manufacturer	Class A Common Stock		2.7%
	Archbold, OH 43502


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

Geotrace Technologies, Inc.		Oil and Gas Reservoir	Warrant to Purchase
	1011 Highway 6 South	Analysis	Preferred Stock		8.9%
	Suite 220		Warrant to Purchase
	Houston, TX 77077		Common Stock		8.1%
Grotech Partners, VI, L.P.		Private Equity Fund	Limited Partnership
	c/o Grotech Capital Group		Interest		2.4%
	9690 Deereco Road
	Suite 800
	Timonium, MD 21093
Havco Wood Products LLC		Hardwood Flooring	Equity Interests		4.5%
	3200 East Outer Road	Products Manufacturer
	Scott City, MO 63780
The Homax Group, Inc.		Supplier of Branded	Preferred Stock		0.1%
	P.O. Box 5643	Consumer Products	Common Stock		0.1%
	Bellingham, WA 98227		Warrant to Purchase
			Preferred Stock		1.1%
			Warrant to Purchase
			Common Stock		1.1%
Hot Stuff Foods, LLC		Foodservice to	Class B Common Stock⁽¹⁰⁾		93.5%
	2930 W. Maple Street	Convenience Stores	Warrant to Purchase
	Sioux Falls, SD 57118		Class A Common Stock^{(6) (10)}		51.0%
International Fiber Corporation		Cellulose and Fiber	Series A Preferred Stock		4.7%
	50 Bridge Street	Producer
	North Tonawanda, NY 14120
Kodiak Fund LP		Real Estate Finance Fund	Equity Interests		4.0%
	2107 Wilson Boulevard
	Suite 450
	Arlington, VA 22201
MedAssets, Inc.		Healthcare Outsourcing	Series B Convertible
	100 North Point Center		Preferred Stock		7.8%
	Suite 150		Common Stock		0.4%
	Alpharetta, GA 30022
MHF Logistical Solutions, Inc.		Third-Party	Class B Common Stock⁽¹⁰⁾		84.3%
	800 Cranberry Woods Drive	Environmental Logistics	Warrants to Purchase
	Suite 450		Class C Common Stock⁽¹⁰⁾		100.0%
	Cranberry Township, PA 16066
Mid-Atlantic Venture Fund IV, L.P.		Private Equity Fund	Limited Partnership
	128 Goodman Drive		Interest		6.7%
	Bethlehem, PA 18015
Mogas Energy, LLC		Natural Gas Pipeline	Warrants to Purchase
	13137 Thunderhead Falls Lane	Operator	Equity Interests		20.0%
	Rapid City, SD 57702
Network Hardware Resale, Inc.		Provider of Pre-Owned	Debt Convertible into
	26 Castilian Drive	Networking Equipment	Common Stock		21.8%
	Suite A
	Santa Barbara, CA 93117
Norwesco, Inc.		Polyethylene Tanks	Class B Common Stock⁽¹⁰⁾		96.3%
	P.O. BOX 439	Manufacturer	Warrants to Purchase
	4365 Steiner St.		Class A Common Stock⁽¹⁰⁾		50.2%
	St. BoniFacius, MN 55375
Novak Biddle Venture Partners III, L.P.		Private Equity Fund	Limited Partnership
	7501 Wisconsin Avenue		Interest		2.5%
	East Tower, Suite 1380
	Bethesda, MD 20814
Odyssey Investment Partners Fund III, LP		Private Equity Investment	Limited Partnership
	280 Park Avenue, 38th Floor	Fund	Interest		0.7%
	West Tower
	New York, NY 10017
Palm Coast Data, LLC		Magazines and	Class B Common Stock⁽¹⁰⁾		100.0%
	11 Commerce Blvd	Subscribers Relationship	Warrants to Purchase
	Palm Coast, FL 32164	Management	Class A Common Stock⁽¹⁰⁾		56.9%


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

Passport Health Communications, Inc.		Healthcare Technology	Preferred Stock		6.7%
	720 Cool Springs Blvd
	Suite 450
	Franklin, TN 37067
Performant Financial Corporation		Collections and	Common Stock		2.1%
	333 N. Canyons Pkwy	Default Prevention
	Suite 100	Services
	Livermore, CA 94551
Postle Aluminum Company, LLC		Aluminum Extrusions	Class B Equity Interests		100.0%
	511 Pine Creek Court	Distributor and
	Elkhart, IN 46516	Manufacturer
Pro Mach, Inc.		Packaging Machinery	Equity Interests		2.3%
	1000 Abernathy Road	Manufacturer
	Suite 1110
	Atlanta, GA 30328
S.B. Restaurant Company (d/b/a Elephant Bar)		Restaurants	Series B Convertible
	14241 Firestone Boulevard		Preferred Stock		2.5%
	Suite 315		Warrants to Purchase
	LaMirada, CA 90638		Series A Common Stock		13.1%
SBBUT, LLC		Holding Company	Equity Interests in
	52 River Road		Affiliate Company		10.4%
	Stowe, VT 05672
Service Center Metals, LLC		Manufacturer Aluminum	Series C Preferred
	5850 Quality Way	Products	Equity Interests		2.8%
	Prince George, VA 23875
Soff-Cut Holdings, Inc.		Concrete Sawing	Series A Preferred Stock		14.3%
	1112 Olympic Drive	Equipment Manufacturer	Common Stock		2.7%
	Corona, CA 92881
SPP Mezzanine Fund, L.P.		Private Equity Fund	Limited Partnership
	330 Madison Avenue, 28th Floor		Interest		35.7%
	New York, NY 10017
SPP Mezzanine Fund II, L.P.		Private Equity Fund	Limited Partnership
	330 Madison Avenue, 28th Floor		Interest		31.2%
	New York, NY 10017
The Step2 Company, LLC		Manufacturer of Plastic	Preferred Equity Interests		3.3%
	10010 Aurora-Hudson Road	Childrens and Home	Common Equity Interests		3.3%
	Streetsboro, Ohio 44241	Products
Tradesmen International, Inc.		Outsourced Skilled	Warrants to Purchase
	9760 Shepard Road	Construction Craftsmen	Common Stock		4.5%
	Macedonia, OH 44056
TransAmerican Auto Parts, LLC		Auto Parts and	Preferred Equity Interests		1.4%
	801 West Artesia Blvd	Accessories Retailer	Common Equity Interests		1.4%
	Compton, CA 90220	and Wholesaler
Updata Venture Partners II, L.P.		Private Equity Fund	Limited Partnership
	11600 Sunrise Valley Drive		Interest		15.0%
	Reston, VA 20191
Venturehouse-Cibernet Investors, LLC		Third-Party Billing	Equity Interest		3.3%
	509 Seventh Street, NW
	Washington, DC 20004
Venturehouse Group, LLC		Private Equity Fund	Common Equity Interest		3.1%
	1780 Tysons Boulevard
	Suite 400
	McLean, VA 22102
VICORP Restaurants, Inc.		Restaurants	Warrant to Purchase
	400 W. 48th Avenue		Preferred Stock		1.4%
	Denver, CO 80216		Warrant to Purchase
			Common Stock		3.4%
Walker Investment Fund II, LLLP		Private Equity Fund	Limited Partnership
	3060 Washington Road		Interest		5.1%
	Suite 200
	Glenwood, MD 21738


				Percentage
Name and Address		Nature of its	Title of Securities	of Class
of Portfolio Company		Principal Business	Held by the Company	Held

Wear Me Apparel Corporation		Marketer of Children’s	Warrant to Purchase
	31 West 34th Street	Apparel	Common Stock		2.0%
	New York, NY 10001
Woodstream Corporation		Pest Control	Common Stock		4.4%
	69 North Locust Street	Manufacturer	Warrants to Purchase
	Lititz, PA 17543		Common Stock		3.7%
York Insurance Services Group, Inc.		Insurance Claims	Common Stock		2.5%
	99 Cherry Hill Road	Administrator
	Suite 102
	Parsippany, New Jersey
COMMERCIAL REAL ESTATE FINANCE⁽⁹⁾
8830 Macon Highway Holding Company, LLC⁽¹⁾		Mobile Home Park	Equity Interests		100.0%
	1919 Pennsylvania Ave, N.W.
	Washington, DC 20006
WSALD-CEH, LLC⁽¹⁾		Commercial Real	Equity Interest		50.0%
	1919 Pennsylvania Ave, N.W.	Estate Developer
	Washington, DC 20006
NPH, Inc.⁽¹⁾		Commercial Real	Common Stock		100.0%
	1919 Pennsylvania Ave, N.W.	Estate Developer
	Washington, DC 20006
Stemmons Freeway Hotel, LLC⁽¹⁾		Hotel	Equity Interests		100.0%
	1919 Pennsylvania Ave, N.W.
	Washington, DC 20006
WSA Commons LLC		Residential Real	Equity Interests		50.0%
	421 East 4th Street	Estate Development
	Cincinnati, OH 45202
Van Ness Hotel, Inc.⁽¹⁾		Hotel	Common Stock		100.0%
	1919 Pennsylvania Ave, N.W.
	Washington, DC 20006


⁽¹⁾	The portfolio company is deemed to be an affiliated person under the 1940 Act because we hold one or more seats on the portfolio company’s board of directors, are the general partner, or are the managing member.

⁽²⁾	Alaris Consulting, LLC owns 95% of Alaris Consulting, Inc.

⁽³⁾	Included in Class C Equity Interests in the Consolidated Statement of Investments.

⁽⁴⁾	Callidus Capital Corporation owns 80% of Callidus Capital Management, LLC.

⁽⁵⁾	The affiliate holds subordinated debt issued by Impact Innovations Group, LLC. We made an investment in and exchanged our existing subordinated debt for equity interests in the affiliate.

⁽⁶⁾	In the first quarter of 2007, we exercised our option to acquire a majority of the voting securities of Hot Stuff Foods, LLC at fair market value.

⁽⁷⁾	Avborne, Inc. and Avborne Heavy Maintenance, Inc. are affiliated companies.

⁽⁸⁾	Callidus Capital Management, LLC is the manager of the fund (see Note 4 above).

⁽⁹⁾	These portfolio companies are included in the Commercial Real Estate Finance — Equity Interests in the Consolidated Statement of Investments.


⁽¹⁰⁾	Common stock is non-voting. In addition to non-voting stock ownership, we have an option to acquire a majority of the voting securities of the portfolio company at fair market value.

⁽¹¹⁾	Triview Investments Inc. holds investments in Longview Cable & Data, LLC, Triax Holdings, LLC, and Crescent Hotels & Resorts, LLC and affiliates.

DETERMINATION OF NET ASSET VALUE

Quarterly Net Asset Value Determination

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 divided by the total number of common shares outstanding.

There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we are required to specifically value each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and/or our equity security has appreciated in value. Changes in fair value are recorded in the statement of operations as net change in unrealized appreciation or depreciation.

determined equity values are generally discounted when we have a minority position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

Collateralized Debt Obligations (CDO) and Collateralized Loan Obligations (CLO). CDO and CLO bonds and preferred shares/ income notes (CDO/ CLO Assets) are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar bonds and preferred shares/ income notes, when available. We recognize unrealized appreciation or depreciation on our CDO/ CLO Assets as comparable yields in the market change and/ or based on changes in estimated cash flows resulting from changes in prepayment, re-investment or loss assumptions in the underlying collateral pool. We determine the fair value of our CDO/ CLO Assets on an individual security-by-security basis.

Determinations In Connection With Offerings

In connection with each offering of shares of our common stock, the Board of Directors or a committee thereof is required to make the determination that we are not selling shares of our common stock at a price below our then current net asset value at the

time at which the sale is made. The Board of Directors considers the following factors, among others, in making such determination:


	•	the net asset value of our common stock disclosed in the most recent periodic report we filed with the SEC;

	•	our management’s assessment of whether any material change in the net asset value has occurred (including through the realization of net gains on the sale of our portfolio investments) from the period beginning on the date of the most recently disclosed net asset value to the period ending two days prior to the date of the sale of our common stock; and

	•	the magnitude of the difference between the net asset value disclosed in the most recent periodic report we filed with the SEC and our management’s assessment of any material change in the net asset value since the date of the most recently disclosed net asset value, and the offering price of the shares of our common stock in the proposed offering.

Importantly, this determination does not require that we calculate net asset value in connection with each offering of shares of our common stock, but instead it involves the determination by the Board of Directors or a committee thereof that we are not selling shares of our common stock at a price below the then current net asset value at the time at which the sale is made.

Moreover, to the extent that there is even a remote possibility that we may (i) issue shares of our common stock at a price below the then current net asset value of our common stock at the time at which the sale is made or (ii) trigger the undertaking (which we provided to the SEC in the registration statement to which this prospectus is a part) to suspend the offering of shares of our common stock pursuant to this prospectus if the net asset value fluctuates by certain amounts in certain circumstances until the prospectus is amended, the Board of Directors or a committee thereof will elect, in the case of clause (i) above, either to postpone the offering until such time that there is no longer the possibility of the occurrence of such event or to undertake to determine net asset value within two days prior to any such sale to ensure that such sale will not be below our then current net asset value, and, in the case of clause (ii) above, to comply with such undertaking or to undertake to determine net asset value to ensure that such undertaking has not been triggered.

These processes and procedures are part of our compliance policies and procedures. Records will be made contemporaneously with all determinations described in this section and these records will be maintained with other records we are required to maintain under the 1940 Act.

MANAGEMENT

Our Board of Directors oversees our management. The responsibilities of the Board of Directors include, among other things, the oversight of our investment activity, the quarterly valuation of our assets, oversight of our financing arrangements and corporate governance activities. The Board of Directors maintains an Executive Committee, Audit Committee, Compensation Committee, and Corporate Governance/Nominating Committee, and may establish additional committees from time to time as necessary. All of our directors also serve as directors of our subsidiaries.

The management of our company and our investment portfolio is the responsibility of various corporate committees, including the management committee, the investment committee, and the portfolio management committee. See “Portfolio Management.”

Structure of Board of Directors

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

Directors

Our directors have been divided into two groups — interested directors and independent directors. Interested directors are “interested persons” of Allied Capital as defined in the 1940 Act. Information regarding our Board of Directors at March 16, 2007, is as follows:


				Director		Expiration
Name	Age		Position	Since⁽¹⁾		of Term

Interested Directors
William L. Walton		57	Chairman, Chief Executive Officer and President		1986		2007
Joan M. Sweeney		47	Chief Operating Officer		2004		2007
Robert E. Long		75	Director		1972		2007
Independent Directors
Ann Torre Bates		48	Director		2003		2009
Brooks H. Browne		57	Director		1990		2007
John D. Firestone		63	Director		1993		2008
Anthony T. Garcia		50	Director		1991		2008
Edwin L. Harper		65	Director		2006		2009
Lawrence I. Hebert		60	Director		1989		2008
John I. Leahy		76	Director		1994		2009
Alex J. Pollock		64	Director		2003		2009
Marc F. Racicot		58	Director		2005		2008
Guy T. Steuart II		75	Director		1984		2009
Laura W. van Roijen		54	Director		1992		2008


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

Each director has the same address as Allied Capital, 1919 Pennsylvania Avenue, N.W., Washington, D.C. 20006.

Executive Officers

Information regarding our executive officers at March 16, 2007, is as follows:


Name	Age		Position

William L. Walton		57	Chairman, Chief Executive Officer and President
Joan M. Sweeney		47	Chief Operating Officer
Kelly A. Anderson		53	Executive Vice President and Treasurer
Scott S. Binder		52	Chief Valuation Officer
Ralph G. Blasey III		46	Executive Vice President, Chief Compliance Officer, Corporate Secretary, and Private Finance Counsel
Michael J. Grisius		43	Managing Director
Jeri J. Harman		49	Managing Director
Thomas C. Lauer		39	Managing Director
Robert D. Long		50	Managing Director
Justin S. Maccarone		47	Managing Director
Diane E. Murphy		53	Executive Vice President and Director of Human Resources
Penni F. Roll		41	Chief Financial Officer
Daniel L. Russell		42	Managing Director
John M. Scheurer		54	Managing Director
John D. Shulman		44	Managing Director
Suzanne V. Sparrow		41	Executive Vice President

Each executive officer has the same address as Allied Capital, 1919 Pennsylvania Avenue, N.W., Washington, D.C. 20006.

Biographical Information

Directors

Our directors have been divided into two groups — interested directors and independent directors. Interested directors are “interested persons” of Allied Capital as defined in the 1940 Act.

Interested Directors

William L. Walton has been Chairman, President and Chief Executive Officer of Allied Capital since 1997 and a director since 1986. Mr. Walton’s previous experience includes serving as a Managing Director of Butler Capital Corporation, as personal investment advisor to William S. Paley, founder of CBS, and as Senior Vice President in Lehman Brothers Kuhn Loeb’s Merger and Acquisition Group. He also founded two education service companies — Language Odyssey and SuccessLab. Mr. Walton currently serves on the boards of the U.S. Chamber of Commerce and the Financial Services Roundtable, and he is Treasurer of the National Symphony Orchestra. Mr. Walton is Chairman of the Kelley School of Business Dean’s Council at Indiana University.

Joan M. Sweeney is the Chief Operating Officer of Allied Capital and has been employed by Allied Capital since 1993. Ms. Sweeney oversees Allied Capital’s daily operations. Prior to joining Allied Capital, Ms. Sweeney was employed by Ernst & Young,

Coopers & Lybrand, and the Division of Enforcement of the Securities and Exchange Commission.

Robert E. Long has been the Chief Executive Officer and a director of GLB Group, Inc., an investment management firm, since 1997 and President of Ariba GLB Asset Management, Inc., the parent company of GLB Group, Inc., since 2005. He has been the Chairman of Emerald City Radio Partners, LLC since 1997. Mr. Long was the President of Business News Network, Inc. from 1995 to 1998, 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. Mr. Long is the father of Robert D. Long, an executive officer of Allied Capital.

Independent Directors

Ann Torre Bates has been a strategic and financial consultant since 1997. From 1995 to 1997, Ms. Bates served as Executive Vice President, CFO and Treasurer of NHP, Inc., a national real estate services firm. From 1991 to 1995, Ms. Bates was Vice President and Treasurer of US Airways. She currently serves on the boards of Franklin Mutual Series, Franklin Mutual Recovery, and SLM Corporation (Sallie Mae).

Brooks H. Browne has been a private investor since 2002. Mr. Browne was the President of Environmental Enterprises Assistance Fund from 1993 to 2002 and served as a director from 1991 to 2005. He currently serves as Chairman of the Board for Winrock International, a non-profit organization.

John D. Firestone has been a Partner of Secor Group, a venture capital firm since 1978. Mr. Firestone has also served as a director of Security Storage Company of Washington, DC, since 1978. He is currently a director of Cuisine Solutions, Inc., and several non-profit organizations, including the National Rehabilitation Hospital, The Washington Ballet and the Tudor Place Foundation of which he is the past president. From 1997 to 2001 he was a director of The Bryn Mawr Trust Corporation.

Anthony T. Garcia has been a private investor since March 2007. Previously, Mr. Garcia was Vice President of Finance of Kirusa, a developer of mobile services, from January to March 2007, and was a private investor from 2003 through 2006. Mr. Garcia was Vice President of Finance of Formity Systems, Inc., a developer of software products for business management of data networks, from 2002 through 2003. Mr. Garcia was a private investor from 2000 to 2001, the General Manager of Breen Capital Group, an investor in tax liens, from 1997 to 2000, and a Senior Vice President of Lehman Brothers Inc. from 1985 to 1996.

Edwin L. Harper has been an executive for Assurant, Inc., a financial services and insurance provider, since 1998. He currently serves as Senior Vice President, Public Affairs and Government Relations and previously served as Chief Operating Officer and Chief Financial Officer for Assurant’s largest subsidiary. From 1992 to 1997, Mr. Harper served as President and Chief Executive Officer of the Association of American Railroads. He also spent five years with Campbell Soup Company, serving as Chief Financial Officer from 1986 to 1991. Earlier in his career, Mr. Harper served on the White House staffs of both President Reagan and President Nixon. Mr. Harper currently serves as Director for the Council for Excellence in Government.

Lawrence I. Hebert is Senior Advisor for PNC Bank, N.A., and was a director and President and Chief Executive Officer of Riggs Bank N.A., a subsidiary of Riggs National Corporation, from 2001 to 2005. Mr. Hebert also served as Chief Executive Officer of Riggs National Corporation during 2005 and served as a director of Riggs National Corporation from 1988 to 2005. Mr. Hebert served as a director of Riggs Investment Advisors and Riggs Bank Europe Limited (both indirect subsidiaries of Riggs National Corporation). Mr. Hebert previously served as Vice Chairman from 1983 to 1998, President from 1984 to 1998, and Chairman and Chief Executive Officer from 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. Previously, Mr. Leahy spent 34 years of his career with Black & Decker Corporation, where he served as President and CEO of the United States subsidiary from 1979 to 1981 and President and Group Executive Officer of the Western Hemisphere of Black & Decker Corporation from 1982 to 1985. Mr. Leahy is currently a director of B&L Sales, Inc. and Chairman of Integra Health Management, Inc. He is also Trustee Emeritus of the Sellinger School of Business at Loyola College, Maryland.

Alex J. Pollock has been a Resident Fellow at the American Enterprise Institute since 2004. He was President and Chief Executive Officer of the Federal Home Loan Bank of Chicago from 1991 to 2004. He currently serves as a director of the Chicago Mercantile Exchange, Great Lakes Higher Education Corporation, the Great Books Foundation, the Illinois Council on Economic Education and the International Union for Housing Finance. Allied Capital has contributed $25 thousand to the American Enterprise Institute.

Marc F. Racicot has served as President and Chief Executive Officer of the American Insurance Association since August 2005. Prior to that, he was an attorney at the law firm of Bracewell & Giuliani, LLP from 2001 to 2005. He is a former Governor (1993 to 2001) and Attorney General (1989 to 1993) of the State of Montana. Mr. Racicot was appointed by President Bush to serve as the Chairman of the Republican National Committee from 2002 to 2003 and he served as Chairman of the Bush/Cheney Re-election Committee from 2003 to 2004. He presently serves on the Board of Directors for Burlington Northern Santa Fe Corporation, Massachusetts Mutual Life Insurance Company, Jobs for America’s Graduates, and the Board of Visitors for the University of Montana School of Law.

Guy T. Steuart II has been a director of Steuart Investment Company, which manages, operates, and leases real and personal property and holds stock in operating subsidiaries engaged in various businesses, since 1960 where he served as President until 2003 and currently serves as Chairman. Mr. Steuart has served as Trustee Emeritus of Washington and Lee University since 1992.

Laura W. van Roijen has been a private investor since 1992. Ms. van Roijen was a Vice President at Citicorp from 1982 to 1992.

Executive Officers who are not Directors

Kelly A. Anderson, Executive Vice President and Treasurer, has been employed by Allied Capital since 1987. Ms. Anderson’s responsibilities include Allied Capital’s infrastructure operations, business process management, and certain treasury functions.

Scott S. Binder, Chief Valuation Officer, has been employed by Allied Capital since 1997. He has served as Chief Valuation Officer since 2003. He served as a consultant to

the Company from 1991 until 1997. Prior to joining the Company, Mr. Binder formed and was President of Overland Communications Group. He also served as a board member and financial consultant for a public affairs and lobbying firm in Washington, DC. Mr. Binder founded Lonestar Cablevision in 1986, serving as President until 1991. In the early 1980’s, Mr. Binder worked for two firms specializing in leveraged lease transactions. From 1976 to 1981, he was employed by Coopers & Lybrand.

Ralph G. Blasey III, Executive Vice President, Chief Compliance Officer, and Corporate Secretary, has been employed by Allied Capital since 2004. Mr. Blasey also serves as the Company’s private finance counsel. Prior to joining Allied Capital, Mr. Blasey practiced law from 1987 to 2004. He joined the law firm of Baker & Hostetler, LLP in 1989 and was named a partner in 1996.

Michael J. Grisius, Managing Director, has been employed by Allied Capital since 1992. Prior to joining Allied Capital, Mr. Grisius worked in leveraged finance at Chemical Bank from 1989 to 1992 and held senior accountant and consultant positions with KPMG LLP from 1985 to 1988.

Jeri J. Harman, Managing Director, has been employed by Allied Capital since 2004. Prior to joining Allied Capital, Ms. Harman served as a Managing Director and Principal for American Capital Strategies, Ltd., a business development company, from 2000 until 2004. She worked as a Managing Director and Head of Private Placements for First Security Van Kasper from 1996 to 2000 and a Managing Director of Coopers & Lybrand from 1993 to 1996. From 1982 to 1993, Ms. Harman held various senior level positions in the private placement arm of The Prudential Insurance Company of America. She has served on the Board of Directors for the Association of Corporate Growth since 2000 and currently serves on the Board of the Women’s Leadership Council.

Thomas C. Lauer, Managing Director, has been employed by Allied Capital since 2004. Prior to joining Allied Capital, Mr. Lauer worked in GE Capital’s sponsor finance group from 2003 to 2004 and in the merchant banking and leveraged finance groups of Wachovia Securities (previously First Union Securities) from 1997 to 2003. He also held senior analyst positions at Intel Corporation and served as a corporate lender and credit analyst at National City Corporation.

Robert D. Long, Managing Director, has been employed by Allied Capital since 2002 and currently manages the business development activities. Prior to joining Allied Capital, Mr. Long was Managing Director and Head of Investment Banking at C.E. Unterberg from 2001 to 2002, and Managing Director at E*OFFERING/Wit SoundView from 2000 to 2001. He also held management positions at Bank of America (Montgomery Securities) from 1996 to 2000, and Nomura Securities International from 1992 to 1996, and prior to that he served as a Managing Director at CS First Boston.

Justin S. Maccarone, Managing Director, has been employed by Allied Capital since 2005. Prior to joining Allied Capital, Mr. Maccarone served as a partner with UBS Capital Americas, LLC, a private equity fund focused on middle market investments, from 1993 to 2005. Prior to that, Mr. Maccarone served as a Senior Vice President at GE Capital specializing in merchant banking and leveraged finance from 1989 to 1993 and served as Vice President of the Leveraged Finance Group at HSBC/ Marine Midland Bank from 1981 to 1989.

Diane E. Murphy, Executive Vice President and Director of Human Resources, has been employed by Allied Capital since 2000. Prior to joining Allied Capital, Ms. Murphy

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was employed by Allfirst Financial from 1982 to 1999 and served in several capacities including head of the retail banking group in the Greater Washington Metro Region from 1994 to 1996 and served as the senior human resources executive from 1996 to 1999.

Penni F. Roll, Chief Financial Officer, has been employed by Allied Capital since 1995. Ms. Roll is responsible for Allied Capital’s financial operations. Prior to joining Allied Capital, Ms. Roll was employed by KPMG LLP in the firm’s audit practice.

Daniel L. Russell, Managing Director, has been employed by Allied Capital since 1998. Prior to joining Allied Capital, Mr. Russell was employed by KPMG LLP in the firm’s financial services group.

John M. Scheurer, Managing Director, has been employed by Allied Capital since 1991. Mr. Scheurer is currently a member of the Board of Governors of the Commercial Mortgage Securities Association. He has also served as Chairman and as a Vice Chair of the Capital Markets Committee for the Commercial Real Estate Finance Committee of the Mortgage Bankers Association.

John D. Shulman, Managing Director, has been employed by Allied Capital since 2001. Prior to joining Allied Capital, Mr. Shulman served as the President and CEO of Onyx International, LLC, a private equity firm, from 1994 to 2001. He currently serves as a member of the investment committee of Greater China Private Equity Fund.

Suzanne V. Sparrow, Executive Vice President, has been employed by Allied Capital since 1987. Ms. Sparrow manages various special projects for Allied Capital and is involved in Allied Capital’s compliance and corporate governance activities.

Committees of the Board of Directors

Our Board of Directors has established an Executive Committee, an Audit Committee, a Compensation Committee, and a Corporate Governance/ Nominating Committee. The Audit Committee, Compensation Committee, and Corporate Governance/ Nominating Committee each operate pursuant to a committee charter. The charter of each Committee is available on our web site at www.alliedcapital.com in the Investor Resources section and is also available in print to any stockholder or other interested party who requests a copy.

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 Board is required by statute, an order of the Securities and Exchange Commission (the Commission), or Allied Capital’s charter or bylaws. The Executive Committee has been delegated authority from the Board to review and approve certain investments. The Executive Committee met 50 times during 2006. The Executive Committee members currently are Messrs. Walton (Chairman), Harper, Hebert, Leahy, Long, Pollock and Steuart. Messrs. Harper, Hebert, Leahy, Pollock, and Steuart are independent directors for purposes of the 1940 Act. Messrs. Walton and Long are interested persons of Allied Capital, as defined in Section 2(a)(19) of the 1940 Act.

The Audit Committee operates pursuant to a charter approved by the Board of Directors and meets the requirements of Section 3(a)(58)(A) of the Exchange Act. The charter sets forth the responsibilities of the Audit Committee. The primary function of the Audit Committee is to serve as an independent and objective party to assist the Board of Directors in fulfilling its responsibilities for overseeing and monitoring the quality and

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integrity of our financial statements, the adequacy of our system of internal controls, the review of the independence, qualifications and performance of our independent registered public accounting firm, and the performance of our internal audit function. The Audit Committee met 13 times during 2006. The Audit Committee is presently composed of five persons, including Mmes. Bates (Chairman) and van Roijen and Messrs. Browne, Garcia, and Harper, all of whom are considered independent under the rules promulgated by the New York Stock Exchange. Our Board of Directors has determined that Ms. Bates and Messrs. Browne, Garcia, and Harper are “audit committee financial experts” as defined under Item 407(d)(5) of Regulation S-K of the Securities Exchange Act of 1934, as each meets the current independence and experience requirements of Rule 10A-3 of the Exchange Act and, in addition, are not “interested persons” of the Company as defined in Section 2(a)(19) of the 1940 Act.

The Compensation Committee approves the compensation of our executive officers, and reviews the amount of salary and bonus for each of the Company’s other officers and employees. In addition, the Compensation Committee approves stock option grants for our officers under our Amended Stock Option Plan, determines the Individual Performance Awards (IPA) and Individual Performance Bonuses (IPB) for participants and determines other compensation arrangements for employees. The Compensation Committee met nine times during 2006. The Compensation Committee members currently are Messrs. Garcia (Chairman), Browne, Firestone, Leahy, and Racicot, each of whom is not an “interested person” as defined in Section 2(a)(19) of the 1940 Act.

The Corporate Governance/ Nominating Committee recommends candidates for election as directors to the Board of Directors and makes recommendations to the Board as to our corporate governance policies. The Corporate Governance/ Nominating Committee met four times during 2006. The Corporate Governance/ Nominating Committee members currently are Messrs. Hebert (Chairman), Firestone, Pollock, Racicot, and Steuart, each of whom is not an “interested person” as defined in Section 2(a)(19) of the 1940 Act.

The Corporate Governance/ Nominating Committee will consider qualified director nominees recommended by stockholders when such recommendations are submitted to the care of the Corporate Secretary in accordance with the Company’s bylaws, Corporate Governance Policy, and any other applicable law, rule or regulation regarding director nominations. When submitting a nomination to the Company for consideration, a stockholder must provide certain information that would be required under applicable Commission rules, including the following minimum information for each director nominee: full name, age and address; principal occupation during the past five years; current directorships on publicly held companies and investment companies; number of shares of Company common stock owned, if any; and, a written consent of the individual to stand for election if nominated by the Board of Directors and to serve if elected by the stockholders.

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PORTFOLIO MANAGEMENT

Our management committee is responsible for, among other things, business planning and the establishment and review of general investment criteria. The management committee is chaired by William Walton, our Chief Executive Officer (CEO), and currently includes Joan Sweeney, our Chief Operating Officer (COO), Penni Roll, our Chief Financial Officer (CFO), Scott Binder, our Chief Valuation Officer (CVO), and Michael Grisius, Jeri Harman, Thomas Lauer, Robert D. Long, Justin Maccarone, Daniel Russell, John Scheurer, and John Shulman, all managing directors. The composition of the committee may change from time to time.

Our investment committee is responsible for approving new investments. Our investment committee is chaired by William Walton, CEO, and currently includes Joan Sweeney, COO, Penni Roll, CFO, Scott Binder, CVO (non-voting), John Fruehwirth, Michael Grisius, Jeri Harman, Thomas Lauer, Robert D. Long, Justin Maccarone, Robert Monk, Daniel Russell, John Scheurer, John Shulman and Paul Tanen, all managing directors. The composition of the committee may change from time to time.

In addition to approval by the investment committee, each transaction that represents a commitment equal to or greater than $20 million, every buyout transaction, and any other investment that in our judgment demonstrates unusual risk/reward characteristics also requires the approval of the Executive Committee of the Board of Directors. Our Executive Committee is currently comprised of Messrs. Walton, Harper, Hebert, Leahy, Long, Pollock and Steuart.

Our portfolio management committee is responsible for review and oversight of the investment portfolio, including reviewing the performance of selected portfolio companies, overseeing portfolio companies in workout status, reviewing and approving certain modifications or amendments to or certain additional investments in existing portfolio companies reviewing and approving certain portfolio exits, reviewing and approving certain actions by portfolio companies whose voting securities are more than 50% owned by us, reviewing significant investment-related litigation matters where we are a named party, and reviewing and approving proxy votes with respect to our portfolio investments. From time to time we will identify investments that require closer monitoring or become workout assets. We develop a workout strategy for workout assets and the portfolio management committee gauges our progress against the strategy. Our portfolio management committee is chaired by William Walton, CEO, and currently includes Joan Sweeney, COO, Penni Roll, CFO, Scott Binder, CVO (non-voting), Ralph Blasey, Private Finance Counsel, and Christina DelDonna, Susan Mayer, John Scheurer and Paul Tanen, all managing directors. The composition of the committee may change from time to time.

We are internally managed and our investment professionals manage the investments in our portfolio. These investment professionals have extensive experience in managing investments in private businesses in a variety of industries, and are familiar with our approach of lending and investing. Because we are internally managed, we pay no external investment advisory fees, but instead we pay the operating costs associated with employing investment and other professionals.

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Biographical Information for Non-Executive Officers

Information regarding the business experience of the additional investment professionals who are directors or executive officers is contained under the caption “Management — Biographical Information.”

Christina L. DelDonna, Managing Director, has been employed by Allied Capital since 1992. Ms. DelDonna has previously worked in a number of other managerial roles during her tenure with Allied Capital. Prior to joining Allied Capital, Ms. DelDonna held several accounting, audit, and financial analyst roles within a variety of industries.

John M. Fruehwirth, Managing Director, has been employed by Allied Capital since 2003. Previously, he worked at Wachovia (formerly First Union) in several merchant banking groups including Wachovia Capital Partners, Leveraged Capital and Middle Market Capital from 1999 to 2003. Prior to that, Mr. Fruehwirth worked in First Union’s Leveraged Finance Group from 1996 to 1998.

Susan Mayer, Managing Director, has been employed by Allied Capital since 2003. Prior to joining Allied Capital, Ms. Mayer served in various investment and management positions with MCI Communications Corporation from 1993 to 2003. Before joining MCI, Ms. Mayer served in a variety of corporate development, management, and consulting roles and was employed by NHP, Inc. from 1991 to 1993, Comsat, Inc. from 1986 to 1991, and the Boston Consulting Group from 1979 to 1986.

Robert M. Monk, Managing Director, has been employed by Allied Capital since 1993. Prior to joining Allied Capital, Mr. Monk worked in the leveraged finance group at First Union National Bank (currently Wachovia Securities).

Paul R. Tanen, Managing Director, has been employed by Allied Capital since May 2006, and was also employed by Allied Capital from 2000 until 2004. From 2004 to 2006, Mr. Tanen served as a consultant to Allied Capital. Prior to working with Allied Capital, Mr. Tanen served as a Managing Director at Ridgefield Partners from 1998 to 2000, and was a Founding Member of the private equity group at Charter Oak Partners from 1992 to 1998.

Compensation

The compensation for the members of our management committee, investment committee, and portfolio management committee includes: (i) annual base salary; (ii) annual cash bonus; (iii) stock options; and (iv) individual performance award and/or individual performance bonus. Compensation for the members of our Executive Committee, with the exception of Mr. Walton, consists of: (i) annual retainer; (ii) attendance fee per committee meeting; and (iii) stock options. See “Management” and “Compensation of Directors and Executive Officers.”

Beneficial Ownership

Each member of the Executive Committee, excluding Messrs. Harper and Pollock, beneficially owns shares of our common stock with a value of more than $1,000,000, based on the closing price of $29.04 on March 16, 2007, on the New York Stock Exchange. Mr. Harper beneficially owns shares of our common stock with a value of $50,000 to $500,000 and Mr. Pollock beneficially owns shares of our common stock with a value of $500,000 to $1,000,000 based on the March 16, 2007 closing price. Each member of the

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management committee and the portfolio management committee beneficially owns shares of our common stock with a value of more than $1,000,000, based on the March 16, 2007 closing price. Each member of the investment committee beneficially owns shares of our common stock with a value of more than $1,000,000, based on the March 16, 2007 closing price.

Conflicts of Interest

Because each of the members of the Executive Committee, the management committee, the investment committee, and the portfolio management committee provide portfolio management services of this type only to us, there are no conflicts of interest with respect to their management of other accounts or investment vehicles.

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COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

Under SEC rules applicable to business development companies, we are required to set forth certain information regarding the compensation of certain executive officers and directors. The following tables set forth compensation earned during the year ended December 31, 2006, by all of our directors, our principal executive officer, our principal financial officer, and each of our three highest paid executive officers (collectively, the Named Executive Officers or NEOs) in each capacity in which each NEO served. Certain of the NEOs served as both officers and directors.

DIRECTOR COMPENSATION

The following table sets forth compensation that we paid during the year ended December 31, 2006, to our directors. Our directors have been divided into two groups — interested directors and independent directors. Interested directors are “interested persons” as defined in Section 2(a)(19) of the 1940 Act.


										Change in
										Pension Value
										and Non-
	Fees									Qualified
	Earned or							Non-Equity		Deferred
	Paid in		Stock		Option			Incentive Plan		Compensation		All Other
Name	Cash		Awards		Awards⁽¹⁾			Compensation		Earnings⁽⁴⁾		Compensation		Total

Interested Directors
William L. Walton⁽²⁾	$	—		n/a	$	—			n/a	$	—	$	—	$	—
Joan M. Sweeney⁽²⁾	$	—		n/a	$	—			n/a	$	—	$	—	$	—
Robert E. Long	$	109,000		n/a	$	18,169			n/a	$	—	$	—	$	127,169
Independent Directors
Ann Torre Bates	$	84,000		n/a	$	18,169			n/a	$	—	$	—	$	102,169
Brooks H. Browne	$	102,000		n/a	$	18,169			n/a	$	—	$	—	$	120,169
John D. Firestone	$	66,000		n/a	$	18,169			n/a	$	—	$	—	$	84,169
Anthony T. Garcia	$	102,000		n/a	$	18,169			n/a	$	—	$	—	$	120,169
Edwin L. Harper	$	86,500		n/a	$	36,337	⁽³⁾		n/a	$	—	$	—	$	122,837
Lawrence I. Hebert	$	126,500		n/a	$	18,169			n/a	$	—	$	—	$	144,669
John I. Leahy	$	138,000		n/a	$	18,169			n/a	$	—	$	—	$	156,169
Alex J. Pollock	$	115,500		n/a	$	18,169			n/a	$	—	$	—	$	133,669
Marc F. Racicot	$	64,000		n/a	$	18,169			n/a	$	—	$	—	$	82,169
Guy T. Steuart II	$	106,500		n/a	$	18,169			n/a	$	—	$	—	$	124,669
Laura W. van Roijen	$	79,000		n/a	$	18,169			n/a	$	—	$	—	$	97,169


⁽¹⁾	Reflects the annual grant of 5,000 options. Options granted vest immediately. The fair value of the options was estimated on the grant date for financial reporting purposes using the Black-Scholes option pricing model and pursuant to the requirements of FASB Statement No. 123 (Revised). See Note 2 to our consolidated financial statements for the assumptions used in determining FAS 123R values.

⁽²⁾	Mr. Walton and Ms. Sweeney did not receive any compensation for serving on the Board of Directors. See “Executive Compensation — Summary Compensation” below.

⁽³⁾	Reflects the grant of 10,000 options made upon Mr. Harper’s initial election to the Board.

⁽⁴⁾	There were no above market or preferential earnings on the non-qualified deferred compensation plans. See “Non- Qualified Deferred Compensation” below.

Each non-officer director receives an annual retainer of $40,000. In addition, committee chairs receive an annual retainer of $5,000. For each committee meeting attended, Executive Committee members receive $1,500 per meeting; Audit Committee members receive $3,000 per meeting; and members of the Compensation and Corporate Governance/Nominating Committees each receive $2,000 per meeting. For 2007, members serving on special purpose committees will receive $3,000 per meeting.

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Directors may choose to defer such fees through our Deferred Compensation Plan, and may choose to have such deferred income invested in shares of our common stock through a trust, which is owned by us. See “Non-Qualified Deferred Compensation” for additional information.

Non-officer directors are eligible for stock option awards under our Amended 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 by stockholders to the Board of Directors. 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 “Amended Stock Option Plan.” The options granted to our directors vest immediately.

EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

Overview of the Compensation Program

Compensation Philosophy. Allied Capital’s compensation and benefits programs are designed with the goal of providing compensation that is fair, reasonable and competitive. The programs are intended to help us align the compensation paid to our executive officers with the achievement of certain corporate and executive performance objectives that have been established to achieve the long-term objectives of Allied Capital. We also believe that the compensation programs should enable us to attract, motivate, and retain key officers who will contribute to our future success.

The design of our compensation programs is based on the following:


	•	Competitiveness and Market Alignment — Our compensation and benefits programs are designed to be competitive with those provided by companies with whom we compete for talent and to be sufficient to attract the best talent from an increasingly competitive market for top performers in the private equity industry. In general, programs are considered competitive when they are in a range between the median (50th percentile) and 75th percentile of market compensation levels as measured against similarly situated competitor companies. Benefit programs are designed to provide competitive levels of protection and financial security and are not based on performance. As part of its annual review process, the Committee reviews the competitiveness of our current compensation levels of its key employees and executives with a third-party compensation consultant against the competitive market and relative to overall corporate performance during the year.

	•	Achievement of Corporate and Individual Performance Objectives — We believe that the best way to accomplish alignment of compensation with the interests of our stockholders is to link pay to individual performance and individual contributions to the returns generated for stockholders. Compensation is determined by the Compensation Committee on a discretionary basis and is dependent on the achievement of certain corporate and executive performance objectives that have been established to achieve long-term objectives of Allied Capital. When individual performance exceeds expectations and performance goals established during the year, pay levels for the individual are expected to be above competitive market

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		levels. When individual performance falls below expectations, pay levels are expected to be below competitive levels.

	•	Alignment with Requirements of the 1940 Act — Our compensation program must align with the requirements of the 1940 Act, which imposes certain limitations on the structure of a BDC’s compensation program. For example, the 1940 Act prohibits a BDC from maintaining a stock option plan and a profit sharing arrangement simultaneously. As a result, if a BDC has a stock option plan, it is prohibited from using a carried interest formula, a common form of compensation in the private equity industry, as a form of compensation. Because of these and other similar limitations imposed by the 1940 Act, the Compensation Committee is limited as to the type of compensation arrangements that can be utilized in order to attract, retain and motivate employees.

Components of Total Compensation. The Compensation Committee determined that the compensation packages for 2006 for the named executive officers identified in the Summary Compensation Table (the NEOs) should generally consist of the following five key components:


	•	Annual base salary;

	•	Annual cash bonus;

	•	Stock options, priced at current market value;

	•	Individual Performance Award (IPA), which is a cash award that is generally determined at the beginning of the year based upon the individual performance of the officer, which is used exclusively to purchase shares of our common stock in the market through a deferred compensation plan; and

	•	Individual Performance Bonus (IPB), which is a cash award that is generally determined at the beginning of the year based upon the individual performance of the officer and is paid as current compensation during the year.

Base Salary. Base salary is designed to attract and retain experienced executives who can drive the achievement of our goals and objectives. While an executive’s initial base salary is determined by an assessment of competitive market levels, the factors used in determining increases in base salary include individual performance, changes in role and/or responsibility and changes in the competitive market environment.

We have entered into employment agreements with William L. Walton, our Chairman and Chief Executive Officer, Joan M. Sweeney, our Chief Operating Officer, and Penni F. Roll, our Chief Financial Officer. See “— Employment Agreements” below for information regarding the material terms of these agreements.

Annual Cash Bonus. The annual cash bonus is designed to reward those executives that have achieved certain corporate and executive performance objectives and have contributed to the achievement of certain long-term objectives of Allied Capital. The amount of the annual cash bonus is determined by the Compensation Committee on a discretionary basis. The annual cash bonus, when combined with base salary and the IPA and IPB described below, is benchmarked against a range of compensation that is competitive between the median (50th percentile) and 75th percentile of market compensation levels based on the performance of the individual.

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Stock Options. Our principal objective in awarding stock options to our officers and directors is to align each optionee’s interests with the success of Allied Capital and the financial interests of our stockholders by linking a portion of such optionee’s compensation with the performance of our stock and the value delivered to stockholders. The Compensation Committee evaluates a number of criteria, including the past service of each such optionee to Allied Capital, the present and potential contributions of such optionee to the success of Allied Capital, and such other factors as the Compensation Committee shall deem relevant in connection with accomplishing the purposes of the Amended Stock Option Plan, including the recipient’s current stock holdings, years of service, position with us, and other factors. The Compensation Committee does not apply a formula assigning specific weights to any of these factors when making its determination. The Compensation Committee awards stock options on a subjective basis and such awards depend in each case on the performance of the officer under consideration, and in the case of new hires, their potential performance. See “Amended Stock Option Plan” for additional information.

IPA and IPB. Following the enactment of The Sarbanes-Oxley Act of 2002, we were no longer permitted to provide loans to executive officers for the exercise of stock options, as is statutorily provided for in the 1940 Act. This was a significant development, since a substantial component of the total return to stockholders comes in the form of the dividend paid on our common stock. Under the former loan program, an officer could exercise vested stock options with a loan for the purpose of buying the underlying shares and would then receive dividends on the shares obtained through such exercise and pay us interest on the loan until maturity. The loan program was also desirable because it caused the officers to share in the risk of ownership of the stock, since the loan would have to be repaid. As such, under the loan program, there was a balance of the benefits and risks of share ownership for the officers. When the loan program was discontinued, the Compensation Committee established a long-term incentive compensation program whereby the Compensation Committee of the Board of Directors determines an Individual Performance Award (IPA) for certain officers annually, generally at the beginning of each year. In determining the award for any one officer, the Compensation Committee considers individual performance factors, as well as the individual’s contribution to the returns generated for stockholders, among other factors. Stockholders approved the Non-Qualified Deferred Compensation Plan II (DCP II), through which the IPA is administered, in 2004. See “Non-Qualified Deferred Compensation — The 2005 Deferred Compensation Plan II” for additional detail regarding the DCP II.

As a result of changes in the Code imposed by the American Jobs Creation Act of 2004 (JCA) regarding non-qualified deferred compensation plans, as well as an increase in the competitive market for recruiting and retaining top performers in private equity firms, beginning in 2005 the Board of Directors determined that a portion of the IPA should be paid as an Individual Performance Bonus (IPB). The IPB is determined annually, generally at the beginning of the year, and is distributed in cash in equal installments to award recipients throughout the year as long as each recipient remains employed by us. If a recipient terminates employment during the year, any remaining cash payments under the IPB would be forfeited. In determining an IPB award for any one officer, the Committee considers individual performance factors, as well as the individual’s contribution to the returns generated for stockholders, among other factors.

Employment Agreements and Severance Arrangements. We entered into employment agreements in 2004 with Mr. Walton and Mmes. Sweeney and Roll and these agreements were amended in 2007 to comply with the JCA and to address other tax related matters.

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Pursuant to each of these agreements, if the executive’s employment is terminated without cause during the term of the agreement, or within 24 months of a change in control, the executive shall be entitled to severance pay. See “Severance and Change in Control Arrangements” for more detail.

401(k) Plan. We maintain a 401(k) Plan. All full-time employees who are at least 21 years of age have the opportunity to contribute pre-tax salary deferrals to the 401(k) Plan, up to $15,500 annually for the 2007 plan year, and to direct the investment of these contributions. Plan participants who are age 50 or older during the 2007 plan year are eligible to defer an additional $5,000 during 2007. The 401(k) Plan allows eligible participants to invest in shares of an Allied Capital Common Stock Fund, consisting of Allied Capital common stock and cash, among other investment options. In addition, during the 2007 plan year, we expect to contribute up to 5% of each participant’s eligible compensation for the year, up to maximum compensation of $225,000, to each participant’s plan account on the participant’s behalf, which fully vests at the time of the contribution. The contribution with respect to compensation in excess of $225,000 will be made to The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan. See “Non-Qualified Deferred Compensation — The 2005 Deferred Compensation Plan I.” On March 16, 2007, the 401(k) Plan held less than 1% of the outstanding shares of Allied Capital.

Insurance. We also make available to all employees health insurance, dental insurance, and group life, disability, and other insurance. Prior to the Sarbanes-Oxley Act of 2002, we provided split dollar life insurance arrangements for certain senior officers. We have subsequently terminated our obligations to pay future premiums with respect to existing split-dollar life insurance arrangements.

Perquisites. We provide only limited perquisites such as company-paid parking to our NEOs. We utilize corporate aircrafts for business use in an effort to improve the efficiency of required business travel. Imputed income determined in accordance with the Internal Revenue Service (IRS) requirements is reflected in an NEO’s aggregate compensation for income tax purposes for any business trip on which a non-employee family member accompanies the NEO. For compensation disclosure purposes, the value of such travel by non-employee family members is calculated using the direct variable costs incurred.

Establishing Compensation Levels

Role of the Compensation Committee and Management. The Compensation Committee is comprised entirely of independent directors who are also non-employee directors as defined in Rule 16b-3 under the Securities Exchange Act of 1934 and independent directors as defined by New York Stock Exchange rules.

The Compensation Committee operates pursuant to a charter that sets forth the mission of the Compensation Committee and its specific goals and responsibilities. The Compensation Committee’s mission is to evaluate the compensation of our executive officers, and their performance relative to their compensation, and to assure that they are compensated effectively in a manner consistent with the compensation philosophy discussed earlier, internal equity considerations, competitive practice, and the requirements of applicable law and the appropriate regulatory bodies. In addition, the Compensation Committee evaluates and makes recommendations to the Board regarding the compensation of the directors, including their compensation for services on Board committees.

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The Compensation Committee’s charter reflects these goals and responsibilities, and the Compensation Committee annually reviews and revises its charter as necessary. To assist in carrying out its responsibilities, the Compensation Committee periodically receives reports and recommendations from management and from a third-party compensation consultant that it selects and retains. The Compensation Committee may also, from time to time, consult with legal, accounting or other advisors all in accordance with the authority granted to the Compensation Committee in its charter.

The key members of management involved in the compensation process are the Chief Executive Officer, the Chief Operating Officer and the Director of Human Resources. Management proposes certain corporate and executive performance objectives for executive management that could be established to achieve long-term objectives of Allied Capital and used to determine total compensation, and these proposals are presented to the Compensation Committee for review and approval. Management also participates in the discussion of peer companies to be used to benchmark NEO compensation, and recommends the overall funding level for the annual cash bonus, IPA and IPB, and management’s recommendations are presented to the Compensation Committee for review and approval.

Company Compensation Policies. In determining the individual compensation for our NEOs, the Compensation Committee considers the total compensation to be awarded to each NEO and may exercise discretion in determining the portion allocated to the various components of total compensation. We believe that the focus on total compensation provides the ability to align pay decisions with short- and long-term needs of the business. This approach also allows for the flexibility needed to recognize differences in performance by providing differentiated pay.

Assessment of Market Data, Peer Comparisons and Benchmarking of Compensation. The Compensation Committee annually retains a third-party compensation consultant to assess the competitiveness of the current and proposed compensation levels of our NEOs to competitive market practices. For over five years, the Committee has engaged Ernst & Young LLP’s Performance and Reward Practice for this purpose. The consultant assists with the assessment of the compensation practices of our direct competitors. Given our unique structure as a publicly traded, internally managed BDC coupled with the fact that most of our direct competitors are privately held private equity partnerships, specific compensation information with respect to our direct competitors typically is not publicly available. There are a limited number of published survey sources that have a primary focus on the private equity industry and that provide annualized information on long-term incentive plans in the industry, which typically take the form of carried interest.

As a part of the annual assessment of compensation, the Compensation Committee and its consultant analyze NEO compensation information relative to: (a) a peer group of publicly traded companies, as determined by the Compensation Committee, including internally managed BDCs, deemed similar to Allied Capital in terms of industry segment, company size and competitive market for executive talent; (b) published survey data on similarly sized private equity firms; and (c) an estimation of aggregate compensation levels paid by externally managed BDCs and similar pass-through structures, such as real estate investment trusts. Through this process, the Compensation Committee benchmarks our compensation for NEOs, including the CEO, to the median (50^th percentile) through the 75th percentile of competitive market data. However, the Compensation Committee was

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unable to benchmark the compensation data of individual NEOs from the externally managed companies because no individual compensation data is available.

Assessment of Company Performance. The Compensation Committee considered certain corporate and executive performance measures that have been established to achieve long-term total return to stockholders. During 2006, we achieved numerous strategic investment and operational goals and objectives, including the origination of $2.4 billion in new investments, achievement of approximately $533 million in net realized gains, and the payment of approximately $355 million of dividends to stockholders. We also achieved investment grade status from the primary ratings agencies.

Compensation Determination

In identifying prevailing market competitive compensation and benefit levels for similarly situated companies, Allied Capital employs a three-pronged approach as noted above. First, the Compensation Committee reviews compensation information from a proxy peer group that is composed of similarly situated publicly traded companies, including internally managed BDCs, deemed similar to us in terms of industry segment and competitive market for executive talent. Second, the Compensation Committee considers published survey data on similarly sized private equity firms. Third, the Compensation Committee reviews an estimation of aggregate compensation levels paid by externally managed BDCs and similar pass-through structures, such as real estate investment trusts.

The Compensation Committee annually reviews tally sheets that illustrate all components of the compensation provided to our NEOs, including base salary, annual cash bonus, IPAs and IPBs, stock option awards, perquisites and benefits, the accumulated balance under non-qualified deferred compensation plans, and the aggregate amounts that may be paid as the result of certain events of termination under employment agreements including a change of control. The Compensation Committee also provides a full report of all compensation program components to the Board of Directors, including the review and discussion of tally sheets.

Individual compensation levels for NEOs are determined based on individual performance and the achievement of certain corporate and executive performance objectives that have been established to achieve our long-term objectives.

Increases to base salary are awarded to address changes in the external competitive market for a given position, to recognize an executive for assuming additional responsibilities and his/her related performance, or to achieve an appropriate competitive level due to a promotion to a more senior position.

In determining the amount of an executive’s variable compensation — the annual cash bonus, IPA and IPB — the Compensation Committee uses market-based total compensation guidelines described above. Within those guidelines, the Committee considers the overall funding available for such awards, the executive’s performance, and the desired mix between the various components of total compensation. We do not use any formula-based approach in determining individual awards. Rather, discretion is exercised in determining the overall total compensation to be awarded to the executive. As a result, the amounts delivered in the form of an annual cash bonus, IPA and IPB are designed to work together in conjunction with base salary to deliver an appropriate total compensation level to the NEO.

112

We believe that the discretionary design of our variable compensation program supports its overall compensation objectives by allowing for significant differentiation of pay based on individual performance and by providing the flexibility necessary to ensure that pay packages for its NEOs are competitive relative to our market.

Determination of 2006 Compensation for the CEO and other NEOs. The compensation of our Chief Executive Officer and other NEOs is determined based on the achievement of certain corporate and executive performance objectives. 2006 was a year of continued progress in achieving the objectives that contribute to the long-term success of Allied Capital. Under Mr. Walton’s leadership in 2006, we invested $2.4 billion in over 65 total transactions, generated approximately $533 million in net realized gains, paid approximately $355 million in dividends to stockholders, raised $700 million in long-term debt and achieved investment grade status from the three primary ratings agencies.

Mr. Walton is paid an annual base salary of $1,500,000, the same rate that has been in effect since February 2004. Mr. Walton received an annual bonus for 2006 of $2,750,000, the same amount as the annual bonus that was paid for 2005, in recognition of our performance discussed above and his instrumental role in driving those results. Mr. Walton also received a 2006 IPA of $1,475,000 and a 2006 IPB of $1,475,000, which were the same amounts as the prior year. Mr. Walton did not receive any stock option grants in 2006 to help ensure that we had sufficient stock option reserves to make market competitive stock option grants to new officer hires below the NEO level.

Ms. Sweeney is paid an annual base salary of $1,000,000, the same rate that has been in effect since February 2004. Ms. Sweeney received an annual bonus for 2006 of $1,500,000, the same amount as the annual bonus that was paid for 2005, in recognition of our performance and her individual performance. Ms. Sweeney also received a 2006 IPA of $750,000 and a 2006 IPB of $750,000, which were the same amounts as the prior year. Ms. Sweeney did not receive any stock option grants in 2006 to help ensure that we had sufficient stock option reserves to make market competitive stock option grants to new officer hires below the NEO level.

For 2006, Ms. Roll was paid an annual base salary of $523,568. Ms. Roll received an annual bonus for 2006 of $850,000 in recognition of our performance and her individual performance. Ms. Roll also received a 2006 IPA of $350,000 and a 2006 IPB of $350,000. Ms. Roll did not receive any stock option grants in 2006 to help ensure that we had sufficient stock option reserves to make market competitive stock option grants to new officer hires below the NEO level.

For 2006, Mr. Shulman was paid an annual base salary of $561,250. Mr. Shulman received an annual bonus for 2006 of $3,000,000 in recognition of our performance and his individual performance. Mr. Shulman also received a 2006 IPA of $1,000,000 and a 2006 IPB of $1,000,000. Mr. Shulman did not receive any stock option grants in 2006 to help ensure that we had sufficient stock option reserves to make market competitive stock option grants to new officer hires below the NEO level.

For 2006, Mr. Grisius was paid an annual base salary of $556,538. Mr. Grisius received an annual bonus for 2006 of $1,500,000 in recognition of our performance and his individual performance. Mr. Grisius also received a 2006 IPA of $500,000 and a 2006 IPB of $500,000. Mr. Grisius did not receive any stock option grants in 2006 to help ensure that we had sufficient stock option reserves to make market competitive stock option grants to new officer hires below the NEO level.

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The Compensation Committee determined that the total compensation levels for each of these executives was within a competitive range to existing market levels.

Determination of 2007 IPA and 2007 IPB for NEOs. In determining the 2007 IPAs and IPBs, the Compensation Committee considered each NEO’s individual contribution to Allied Capital as a whole. The 2007 IPAs for Mr. Walton, Ms. Sweeney, Ms. Roll, Mr. Shulman and Mr. Grisius were determined to be $1,475,000, $750,000, $350,000, $500,000 and $400,000, respectively. The 2007 IPBs for Mr. Walton, Ms. Sweeney, Ms. Roll, Mr. Shulman and Mr. Grisius were determined to be $1,475,000, $750,000, $350,000, $500,000 and $400,000, respectively. The 2007 IPAs and IPBs for Mr. Walton, Ms. Sweeney and Ms. Roll remained unchanged from their 2006 award amounts. The 2007 IPAs and IPBs for Messrs. Shulman and Grisius were each decreased by $500,000 and $100,000, respectively, from their 2006 awards.

The IPA for 2007 for all recipients in the aggregate has been determined to be approximately $9.9 million. This amount represents IPAs expected to be expensed for financial reporting purposes for 2007 assuming each participant remains employed by us throughout the year. This amount is subject to change if there is a change in the composition of the pool of award recipients during the year, or if the Compensation Committee determines that a change to an individual award is needed. The IPAs are not paid to executive officers on a current basis. Instead, IPAs are deposited in a deferred compensation trust in approximately equal cash installments, on a quarterly basis, and the cash is used to purchase shares of our common stock in the market on the New York Stock Exchange. See “Non-Qualified Deferred Compensation — The 2005 Deferred Compensation Plan II” for additional information.

The IPB for 2007 for all recipients in the aggregate has been determined to be approximately $9.7 million. The IPB will be distributed in cash to award recipients in equal installments throughout the year as long as the recipient remains employed by us. If a recipient terminates employment during the year, any remaining cash payments under the IPB for the recipient are forfeited. This amount represents IPBs expected to be expensed for financial reporting purposes for 2007 assuming each recipient remains employed by us throughout the year. This amount is subject to change if there is a change in the composition of the pool of award recipients during the year or if the Compensation Committee determines that a change to an individual award is needed.

Stock Option Practices

Our principal objective in awarding stock options to our officers and directors is to align each optionee’s interests with the success of Allied Capital and the financial interests of our stockholders by linking a portion of such optionee’s compensation with the performance of our stock and the value delivered to stockholders. The Compensation Committee awards stock options on a subjective basis and such awards depend in each case on the performance of the officer under consideration, and in the case of new hires, their potential performance. Stock options are priced at the closing price of the stock on the date the option is granted. The Compensation Committee takes into account material non-public information, among other factors, when granting stock options. During 2006, NEOs did not receive stock option grants to help ensure that we had sufficient stock option reserves to make market competitive stock option grants to new officer hires.

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Stock Ownership Initiative

In connection with our 2006 Annual Meeting of Stockholders, our stockholders approved the issuance of up to 2,500,000 shares of our common stock in exchange for the cancellation of vested “in-the-money” stock options granted to certain officers and directors under the Amended Stock Option Plan. Under the initiative, which was reviewed and approved by our Board of Directors, all optionees who hold vested stock options with exercise prices below the market value of the stock (or “in-the-money” options), would be offered the opportunity to receive cash and unregistered common stock in exchange for their voluntary cancellation of their vested stock options. The sum of the cash and common stock to be received by each optionee would equal the “in-the-money” value of the stock option cancelled. As part of this initiative, the Board of Directors adopted a target ownership program that establishes minimum ownership levels for our senior officers, which is intended to further align the interests of our officers with those of our stockholders. We have not implemented the option cancellation program, but we intend to do so in the future.

Impact of Regulatory Requirements — Tax Deductibility of Pay

Section 162(m) of the Internal Revenue Code of 1986, as amended (the Code), places a limit of $1,000,000 on the amount of compensation that we may deduct in any one year, which applies with respect to certain of our most highly paid executive officers for 2006. There is an exception to the $1,000,000 limitation for performance-based compensation meeting certain requirements. To maintain flexibility in compensating executive officers in a manner designed to promote varying corporate goals, the Compensation Committee has not adopted a policy requiring all compensation to be deductible. Mr. Walton’s, Ms. Sweeney’s and Mr. Shulman’s total compensation is above the $1,000,000 threshold for 2006; accordingly, for 2006, a portion of their total compensation, including salaries, bonuses and IPBs, and the taxable value of their perquisites under the Code, is not deductible by us.

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Summary Compensation

The following table sets forth compensation that we paid during the year ended December 31, 2006, to our principal executive officer, principal financial officer and each of our three highest paid executive officers (collectively, the Named Executive Officers or NEOs) in each capacity in which each NEO served. Certain of the NEOs served as both officers and directors.


													Change in
													Pension Value
													and Non-
											Non-Equity		Qualified
											Incentive		Deferred
Name and Principal							Stock		Option		Plan		Compensation		All Other
Position	Year		Salary		Bonus⁽¹⁾		Awards		Awards		Compensation		Earnings⁽²⁾		Compensation⁽³⁾		Total

William L. Walton, Chief Executive Officer		2006	$	1,500,000	$	5,700,000		n/a		n/a		n/a		n/a	$	250,763	$	7,450,763

Joan M. Sweeney, Chief Operating Officer		2006	$	1,000,000	$	3,000,000		n/a		n/a		n/a		n/a	$	134,418	$	4,134,418

Penni F. Roll, Chief Financial Officer		2006	$	523,568	$	1,550,000		n/a		n/a		n/a		n/a	$	70,571	$	2,144,139

John D. Shulman, Managing Director		2006	$	561,250	$	5,000,000		n/a		n/a		n/a		n/a	$	130,772	$	5,692,022

Michael J. Grisius, Managing Director		2006	$	556,538	$	2,500,000		n/a		n/a		n/a		n/a	$	81,945	$	3,138,483


⁽¹⁾	This column includes annual cash bonus, IPA and IPB. See “Compensation Discussion and Analysis” above for a discussion of these components. The following table provides detail as to the composition of the bonus received by each of the NEOs:


	Bonus		IPA		IPB

Mr. Walton	$	2,750,000	$	1,475,000	$	1,475,000

Ms. Sweeney	$	1,500,000	$	750,000	$	750,000

Ms. Roll	$	850,000	$	350,000	$	350,000

Mr. Shulman	$	3,000,000	$	1,000,000	$	1,000,000

Mr. Grisius	$	1,500,000	$	500,000	$	500,000


⁽²⁾	There were no above market or preferential earnings on the non-qualified deferred compensation plans. See “Non-Qualified Deferred Compensation” below.

⁽³⁾	All Other Compensation is composed of the following:


	Company
	Contribution		Company
	to 401(k)		Contribution
	Plan		to DCP I		Other⁽⁴⁾

Mr. Walton	$	11,000	$	201,500	$	38,263
Ms. Sweeney	$	11,000	$	114,000	$	9,418
Ms. Roll	$	11,000	$	55,154	$	4,417
Mr. Shulman	$	11,000	$	117,000	$	2,772
Mr. Grisius	$	11,000	$	66,770	$	4,175

⁽⁴⁾

This amount includes perquisites such as Company-paid parking and the imputed income value of split dollar life insurance arrangements. For Mr. Walton, the amount also includes the premiums associated with executive long-term disability insurance. In addition, the amount includes approximately $28,000 for Mr. Walton and approximately $3,000 for Ms. Sweeney related to the direct variable costs associated with the travel of non-employee family members when they have accompanied the NEOs on trips for business purposes. The value of this perquisite is different than each NEO’s imputed income, which is calculated in accordance with IRS requirements.

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Grants of Plan-Based Awards⁽¹⁾

All Other

Estimated Future Payouts

Stock

Option

Under Non-Equity Incentive

Under Equity Incentive Plan

Awards;

Exercise

Grant Date

Plan Awards

Awards

Number of

or Base

Fair Value

Shares of

Securities

Price of

of Stock and

Grant

Stock or

Underlying

Option

Name

Date

Threshold

Target

Maximum

Threshold

Target

Maximum

Units

Options

Awards

William L. Walton

—

Joan M. Sweeney

—

Penni F. Roll

—

John D. Shulman

—

Michael J. Grisius

—


⁽¹⁾	No option grants were made to NEOs in 2006.

Employment Agreements

We entered into employment agreements in 2004 with William L. Walton, our Chairman and CEO, Joan M. Sweeney, our Chief Operating Officer, and Penni F. Roll, our Chief Financial Officer. These agreements were amended in 2007 to comply with the JCA and to address other tax-related matters. Each of the agreements provides for a three-year term that extends one day at the end of every day during its length, unless either party provides written notice of termination of such extension. In that case, the agreement would terminate three years from such notification.

Each agreement specifies each executive’s base salary compensation during the term of the agreement. The Compensation Committee has the right to increase the base salary during the term of the employment agreement. In addition, each employment agreement states that the Compensation Committee 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 Compensation Committee in its sole discretion. Under each agreement, each executive is also entitled to participate in our Amended Stock Option Plan, and to receive all other awards and benefits previously granted to each executive including, the payment of life insurance premiums.

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 us in the event of an executive’s departure for a period of two years. See “Severance and Change in Control Arrangements” for a discussion of the severance and change in control arrangements set forth in each of these agreements.

Amended Stock Option Plan

Our Amended Stock Option Plan is intended to encourage stock ownership in Allied Capital by our officers and directors, thus giving them a proprietary interest in our performance. The Amended Stock Option Plan was most recently approved by stockholders on May 12, 2004. At December 31, 2006, there were 32.2 million shares authorized under the Stock Option Plan and the number of shares available to be granted was 1.6 million.

At our annual meeting of stockholders, to be held on May 15, 2007, our stockholders will vote to approve an amendment to our Amended Stock Option Plan to increase the number of shares of common stock authorized for issuance under our Amended Stock Option Plan to an amount which would represent approximately 20% of our outstanding common stock on a fully diluted basis.

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

Stock options are granted under the Amended Stock Option Plan at a price not less than the prevailing market value at the time of the grant and will have realizable value only if our stock price increases. The Compensation Committee determines the amount, if any, and features of the stock options to be awarded to optionees. The Compensation Committee evaluates a number of criteria, including the past service of each such optionee to Allied Capital, the present and potential contributions of such optionee to the success of Allied Capital, and such other factors as the Compensation Committee shall deem relevant in connection with accomplishing the purposes of the Amended Stock Option Plan, including the recipient’s current stock holdings, years of service, position with Allied Capital, and other factors. The Compensation Committee does not apply a formula assigning specific weights to any of these factors when making its determination. The Compensation Committee awards stock options on a subjective basis and such awards depend in each case on the performance of the officer under consideration, and in the case of new hires, their potential performance.

The Amended Stock Option Plan is designed to satisfy the conditions of Section 422 of the Code so that options granted under the Amended 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.

We have received approval from the SEC to grant non-qualified options under the Amended Stock Option Plan to non-officer directors. Pursuant to the SEC order, non-officer directors receive options to purchase 10,000 shares upon election by stockholders to the Board of Directors, and options to purchase 5,000 shares each year thereafter, on the date of the Annual Meeting of Stockholders.

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Outstanding Equity Awards at Fiscal Year-end

The following table sets forth the stock option awards outstanding at December 31, 2006:

Option Awards

Stock Awards⁽⁴⁾

Equity

Incentive

Equity

Plan

Incentive

Awards:

Plan

Number

Awards:

Equity

Market or

Incentive

Unearned

Payout

Plan

Shares,

Value of

Awards:

Market

Units or

Unearned

Number of

Value of

Other

Shares,

Securities

Shares or

Rights

Units

Underlying

Units of

That

of Other

Unexercised

Option

Stock That

Have

Rights That

Options

Unearned

Exercise

Expiration

Have Not

Not

Have Not

Name

Exercisable⁽¹⁾

Unexercisable

Options

Price

Date

Vested

William L. Walton

659,188

—

21.375

01/08/2008

n/a

51,196

—

17.875

12/08/2008

n/a

90,922

—

17.750

12/30/2009

n/a

755,500

—

16.813

05/26/2010

n/a

254,274

—

21.590

09/20/2011

n/a

607,554

—

21.520

12/13/2012

n/a

300,000

100,000

⁽²⁾

—

28.980

03/11/2014

n/a

Joan M. Sweeney

310,049

—

21.375

01/08/2008

n/a

32,469

—

17.875

12/08/2008

n/a

75,511

—

17.750

12/30/2009

n/a

285,000

—

16.813

05/26/2010

n/a

151,722

—

21.590

09/20/2011

n/a

462,281

—

21.520

12/13/2012

n/a

225,000

75,000

⁽²⁾

—

28.980

03/11/2014

n/a

Penni F. Roll

19,254

—

21.375

01/08/2008

n/a

48,000

—

19.875

07/28/2008

n/a

3,656

—

17.750

12/30/2009

n/a

75,398

—

16.813

05/26/2010

n/a

58,927

—

21.590

09/20/2011

n/a

245,354

—

21.520

12/13/2012

n/a

150,000

50,000

⁽²⁾

—

28.980

03/11/2014

n/a

66,667

133,333

⁽³⁾

—

27.510

08/03/2015

n/a

John D. Shulman

295,429

—

21.875

04/05/2011

n/a

22,053

—

21.590

09/20/2011

n/a

289,620

—

21.520

12/13/2012

n/a

300,000

100,000

⁽²⁾

—

28.980

03/11/2014

n/a

50,000

100,000

⁽³⁾

—

27.510

08/03/2015

n/a

Michael J. Grisius

140,410

—

21.375

01/08/2008

n/a

140,797

—

16.813

05/26/2010

n/a

13,767

—

21.590

09/20/2011

n/a

71,746

—

21.520

12/13/2012

n/a

225,000

75,000

⁽²⁾

—

28.980

03/11/2014

n/a

66,667

133,333

⁽³⁾

—

27.510

08/03/2015

n/a


⁽¹⁾	No stock option awards have been transferred.
⁽²⁾	The options granted vest in four installments on 6/30/04, 6/30/05, 6/30/06 and 6/30/07 and vest immediately upon a change in control.
⁽³⁾	The options granted vest in three installments on 6/30/06, 6/30/07 and 6/30/08 and vest immediately upon a change in control.
⁽⁴⁾	We have not made any stock awards. As a business development company, we are prohibited by the 1940 Act from issuing stock awards except pursuant to an SEC exemptive order.

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Option Exercises and Stock Vested

The following table sets forth the stock option awards exercised by each NEO during the year ended December 31, 2006.

Option Awards⁽¹⁾

Stock Awards

Number of Shares

Acquired on

Value Realized

Acquired on

Value Realized

Name

Exercise

on Exercise⁽²⁾

Vesting

on Vesting

William L. Walton

4,646

35,588

n/a

Joan M. Sweeney

11,188

128,494

n/a

Penni F. Roll

20,871

221,644

n/a

John D. Shulman

—

n/a

Michael J. Grisius

13,306

131,751

n/a


⁽¹⁾	See “Compensation Discussion and Analysis” for more information about the options.

⁽²⁾	Represents the difference between the market price at the date of exercise and the exercise price. These options were exercised and the underlying shares were held by the individuals.

Non-Qualified Deferred Compensation


							Aggregate		Aggregate
	Executive		Company		Aggregate		Withdrawals/		Balance at
	Contributions in		Contributions in		Earnings in		Distributions in		December 31,
Name	2006⁽¹⁾		2006⁽²⁾		2006⁽³⁾		2006		2006

William L. Walton	$	1,453,612	$	100,521	$	1,565,725	$	—	$	12,027,985
Joan M. Sweeney	$	739,125	$	63,565	$	949,212	$	—	$	6,074,302
Penni F. Roll	$	344,925	$	26,609	$	252,786	$	—	$	2,257,335
John D. Shulman	$	985,500	$	34,000	$	278,929	$	—	$	2,355,683
Michael J. Grisius	$	492,750	$	26,609	$	260,040	$	—	$	1,899,901


⁽¹⁾	Executive contributions are based on the IPAs earned during the 2006 plan year (net of FICA tax) and contributed to the 2005 DCP II. There are no other executive deferrals.

⁽²⁾	Company contributions are based on the excess 401(k) employer contribution made to the 2005 DCP I in 2006 (for the 2005 plan year) and allocated to the participant’s account.

⁽³⁾	Includes interest and dividend income and realized and unrealized gains and losses.

The 2005 Deferred Compensation Plan I

Pursuant to changes in federal tax law imposed by the American Jobs Creation Act of 2004 (JCA) regarding non-qualified deferred compensation arrangements, in 2005, we restated and replaced our existing deferred compensation plan (DCP I) with The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan (2005 DCP I). The 2005 DCP I is an unfunded plan, as defined by the Code, that provides for the deferral of compensation by our directors, employees, and consultants. Any director, senior officer, or consultant is eligible to participate in the 2005 DCP I at such time and for such period as designated by the Board of Directors. The 2005 DCP I is administered through a grantor trust, and we fund this plan through cash contributions. Directors may choose to defer director’s fees through the 2005 DCP I, and may choose to have invested such deferred income in shares of our common stock through the trust. On March 16, 2007, the trust related to the 2005 DCP I held 3,412 shares of our common stock.

We continue to maintain DCP I and all deferrals made to the DCP I (through December 31, 2004) shall be distributed pursuant to the terms of that plan. In the event

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of termination of employment, the participant’s deferral account in DCP I will be immediately distributed, either in lump sum or annual installments, as previously elected by the participant. On March 16, 2007, the trust related to the DCP I held 1,612 shares of our common stock.

In the event of a change of control, all amounts in a participant’s deferral account in DCP I will be immediately distributed to the participant. For purposes of DCP I, “Change of Control” prior to the JCA (Pre-JCA) was defined as (i) the sale or other disposition of all or substantially all of our assets; or (ii) the acquisition, whether directly, indirectly, beneficially (within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934 (the 1934 Act)), or of record, as a result of a merger, consolidation or otherwise, of our securities representing fifteen percent (15%) or more of the aggregate voting power of our then outstanding common stock by any person (within the meaning of Section 13(d) and 14(d) of the 1934 Act), including, but not limited to, any corporation or group of persons acting in concert, other than (A) Allied Capital or its subsidiaries and/or (B) any employee pension benefit plan (within the meaning of Section 3(2) of the Employee Retirement Income Security Act of 1974) of our’s or our subsidiaries, including a trust established pursuant to any such plan; or (iii) the individuals who were members of the Board of Directors as of the Effective Date (the Incumbent Board) cease to constitute at least two-thirds (2/3) of the Board; provided, however, that any director appointed by at least two-thirds (2/3) of the then Incumbent Board or nominated by at least two-thirds (2/3) of the Corporate Governance/ Nominating Committee of the Board of Directors (a majority of the members of the Corporate Governance/ Nominating Committee shall be members of the then Incumbent Board or appointees thereof), other than any director appointed or nominated in connection with, or as a result of, a threatened or actual proxy or control contest, shall be deemed to constitute a member of the Incumbent Board.

For 2005 and 2006, all deferrals were made to the 2005 DCP I and shall be distributed pursuant to the terms of this plan in compliance with the JCA. In the event of termination of employment, the participant’s deferral account in 2005 DCP I will be distributed either in a lump sum or annual installments, as previously elected by the participant, however, in no event will the first payment be made earlier than six months after the date of termination of the participant’s employment.

In the event of a change of control, all amounts in a participant’s deferral account in 2005 DCP I will be immediately distributed to the participant. For purposes of 2005 DCP I, “Change of Control” following the JCA (Post-JCA) is defined as (i) the sale or other disposition of at least forty percent (40%) of our assets; or (ii) the acquisition, whether directly, indirectly, beneficially (within the meaning of Rule 13d-3 of the 1934 Act), or of record, as a result of a merger, consolidation or otherwise, of our securities representing fifty percent (50%) or more of the aggregate voting power of our then outstanding common stock by any person (within the meaning of Section 13(d) and 14(d) of the 1934 Act), including, but not limited to, any corporation or group of persons acting in concert, other than (A) Allied Capital or its subsidiaries and/or (B) any employee pension benefit plan (within the meaning of Section 3(2) of the Employee Retirement Income Security Act of 1974) of our’s or our subsidiaries, including a trust established pursuant to any such plan; or (iii) the individuals who were members of the Board of Directors as of the Effective Date (the Incumbent Board) cease to constitute at least two-thirds (2/3) of the Board of Directors; provided, however, that any director appointed by at least two-thirds (2/3) of the then Incumbent Board or nominated by at least two-thirds (2/3) of the Corporate Governance/ Nominating Committee of the Board (if a majority of the members

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of the Corporate Governance/ Nominating Committee are members of the then Incumbent Board or appointees thereof), other than any director appointed or nominated in connection with, or as a result of, a threatened or actual proxy or control contest, shall be deemed to constitute a member of the Incumbent Board.

The Compensation Committee of our Board of Directors administers DCP I and 2005 DCP I. The Board of Directors reserves the right to amend, terminate, or discontinue DCP I and 2005 DCP I, provided that no such action will adversely affect a participant’s rights under the plans with respect to the amounts paid to his or her deferral accounts.

The 2005 Deferred Compensation Plan II

In conjunction with the IPA, we established a non-qualified deferred compensation plan (DCP II) in 2004, which is administered through a grantor trust with a third-party trustee. In 2005, pursuant to recent changes in law imposed by the JCA regarding non-qualified deferred compensation arrangements, we restated and replaced DCP II with The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan II (2005 DCP II). The 2005 DCP II is an unfunded plan, as defined by the Code, that provides for the deferral of compensation by our officers. All IPA contributions made for 2005 and 2006 were made into the 2005 DCP II.

The IPAs are generally deposited in the trust in equal installments, on a quarterly basis, in the form of cash. The Compensation Committee designed both DCP II and 2005 DCP II to require the trustee to use the cash to purchase shares of our common stock in the market on the New York Stock Exchange. A participant only vests in the award as it is deposited into the trust. The Compensation Committee, in its sole discretion, shall designate the senior officers who will receive IPAs and participate in 2005 DCP II. During any period of time in which a participant has an account in either DCP II or 2005 DCP II, any dividends declared and paid on shares of common stock allocated to the participant’s accounts shall be reinvested by the trustee as soon as practicable in shares of our common stock purchased in the open market.

We continue to maintain DCP II and all contributions made to DCP II (through December 31, 2004) shall be distributed pursuant to the terms of that plan. In the event of termination of employment, one-third of the participant’s deferral account in DCP II will be immediately distributed, one half of the then current remaining balance will be distributed within 30 days of the first anniversary of his or her employment termination date, and the remainder of the account balance will be distributed within 30 days of the second anniversary of the employment termination date. In the event of a change of control (following the Pre-JCA definition for “Change in Control”), all amounts in a participant’s deferral account in DCP II will be immediately distributed to the participant.

Contributions made to the 2005 DCP II shall be distributed pursuant to the terms of this plan in compliance with the JCA. In the event of termination of employment, one-third of the participant’s deferral account in 2005 DCP II will be distributed six months after his or her employment termination date, one half of the then current remaining balance will be distributed within 30 days of the first anniversary of his or her employment termination date, and the remainder of the account balance will be distributed within 30 days of the second anniversary of the employment termination date. In the event of a change of control, (following the Post-JCA definition for “Change of Control”), all amounts in a participant’s deferral account in 2005 DCP II will be immediately distributed to the participant.

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A participant who violates certain non-solicitation covenants contained in the DCP II and 2005 DCP II during the two years after the termination of his or her employment will forfeit back to us the remaining value of his or her deferral accounts.

The aggregate maximum number of shares of our common stock that the trustee is authorized to purchase in the open market for the purpose of investing the cash from IPAs in DCP II and 2005 DCP II is 3,500,000 shares, subject to appropriate adjustments in the event of a stock dividend, stock split, or similar change in capitalization affecting our common stock. On March 16, 2007, the trust related to the DCP II held 495,821 shares of our common stock and the trust related to the 2005 DCP II held 522,591 shares of our common stock.

The Compensation Committee of our Board of Directors administers DCP II and 2005 DCP II. The Board of Directors reserves the right to amend, terminate, or discontinue DCP II and 2005 DCP II, provided that no such action will adversely affect a participant’s rights under the plans with respect to the amounts contributed to his or her deferral accounts.

Severance and Change in Control Arrangements

We entered into employment agreements in 2004 with William L. Walton, Chairman and CEO, Joan M. Sweeney, Chief Operating Officer, and Penni F. Roll, Chief Financial Officer. These agreements were amended in 2007 to comply with the JCA and to address other tax-related matters. Each of the agreements provides for a three-year term that extends one day at the end of every day during its length, unless either party provides written notice of termination of such extension. In that case, the agreement would terminate three years from such notification.

Pursuant to each of those agreements, if the executive resigns without good reason or his/her employment is terminated with cause, the executive will not receive any severance pay. If, however, employment is terminated by us without cause or by the executive for good reason, the executive will be entitled to severance pay for a period not to exceed 36 months. Severance pay will include three times the average base salary for the preceding three years, plus three times the average bonus compensation for the preceding three years, plus a lump sum severance amount, plus certain benefits for a period of one year. These benefits include COBRA premiums for Mr. Walton, Ms. Sweeney and Ms. Roll and their eligible family members for the maximum period of continuation coverage provided under COBRA, and also include the full cost for substantially equivalent health and dental insurance benefits for six months after such maximum continuation coverage expires at our sole expense. These benefits also include participation in our stock option plan, split-dollar life insurance plan, executive long term disability plan, and deferred compensation plan, if applicable. Additionally, all balances under the deferred compensation plans would be distributed in accordance with the terms of such deferred compensation plans. See “Non-Qualified Deferred Compensation” for the aggregate deferred compensation balances outstanding at December 31, 2006, for each executive. Calculated based on December 31, 2006, data, the aggregate severance value, including the value of ongoing benefits, would have been $14,537,660 for Mr. Walton, $9,711,758 for Ms. Sweeney and $5,149,142 for Ms. Roll. Severance payments will be paid in a lump sum no earlier than six months after separation.

If a termination event occurs within 24 months after a change of control, in addition to the severance value described above, Mr. Walton, Ms. Sweeney and Ms. Roll would

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each be entitled to a tax equalization payment to offset any applicable excise tax penalties imposed on the executive under Section 4999 of the Code. Under the terms of the Amended Stock Option Plan, all outstanding options will vest immediately upon a change of control. As of December 31, 2006, the value of the executives’ unvested options was $370,000 for Mr. Walton, $277,500 for Ms. Sweeney and $874,331 for Ms. Roll. Under this change of control scenario, calculated using December 31, 2006, data, the aggregate payments to the executives, including severance pay, tax equalization payments, the value of the unvested options, and the value of ongoing benefits, would have been $21,468,883 for Mr. Walton, $14,081,581 for Ms. Sweeney, and $8,399,414 for Ms. Roll. Severance payments will be paid in a lump sum no earlier than six months after separation.

If employment is terminated as a result of death or disability (as defined in the executives’ employment agreements) and no notice of non-renewal has been given, the executive will be entitled to severance pay equal to one times his/her average base salary for the preceding three years, plus one times his/her average bonus compensation for the preceding three years, plus a lump sum severance amount, plus certain benefits previously described for a period of one year. The aggregate severance value for a termination due to death or disability, calculated based on December 31, 2006, data would be $6,997,954 for Mr. Walton, $5,158,051 for Ms. Sweeney, and $2,744,021 for Ms. Roll.

If a notice of non-renewal has been given prior to death or disability of the executive, then instead of using a one times multiple of the average base salary and average bonus compensation as described above, the severance amount that relates to base salary and bonus compensation would be calculated using the number of years remaining between the date of the executive’s death or disability and the third anniversary of the notice of non-renewal, but in no event less than one year. Any severance relating to disability will be paid in a lump sum no earlier than six months after separation. Any severance relating to death will be paid in two installments: 75% of such pay will be paid at the time of separation and 25% will be paid on the first anniversary of such separation.

If the term of employment expires in accordance with the agreement after the delivery of a non-renewal notice by either party, the executive would continue to be employed for three years after the notice of non-renewal (unless otherwise terminated under the agreement). At the end of the three-year term, the executive would receive severance pay equal to one times the average base salary for the preceding three years, plus one times the average bonus compensation for the preceding three years, plus a lump sum severance amount, plus the benefits previously described. Severance payments will be paid in a lump sum no earlier than six months after separation.

If any provision of the employment agreements would cause the executive to incur any additional tax under Section 409A of the Code or any regulations or Treasury guidance promulgated thereunder, we will reform the provision in a manner that maintains, to the extent possible, the original intent of the applicable provision without violating the provisions of Section 409A of the Code. In addition, in such a situation, we will notify and consult with the executives prior to the effective date of any such change.

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Indemnification Agreements

We have entered into indemnification agreements with our directors and certain senior officers. The indemnification agreements are intended to provide these directors and senior officers the maximum indemnification permitted under Maryland law and the 1940 Act. Each indemnification agreement provides that Allied Capital shall indemnify the director or senior officer who is a party to the agreement (an “Indemnitee”), including the advancement of legal expenses, if, by reason of his or her corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding, other than a proceeding by or in the right of Allied Capital.

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CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of March 16, 2007, there were no persons that owned 25% or more of our outstanding voting securities, and no person would be deemed to control us, as such term is defined in the 1940 Act.

The following table sets forth, as of March 16, 2007, each stockholder who owned more than 5% of our outstanding shares of common stock, each director, each NEO, and our directors and executive officers as a group. Unless otherwise indicated, we believe that each beneficial owner set forth in the table has sole voting and investment power. Certain shares beneficially owned by our executive officers and directors may be held in accounts with third party brokerage firms, where such shares may from time to time be subject to a security interest for margin credit provided in accordance with such brokerage firm’s policies.

Our directors are divided into two groups — interested directors and independent directors. Interested directors are “interested persons” as defined in Section 2(a)(19) of the 1940 Act.

Dollar Range of

Equity Securities

Number of

Beneficially

Name of

Shares Owned

Percentage

Owned by

Beneficial Owner

Beneficially⁽¹⁾

of Class⁽²⁾

Directors⁽³⁾

Capital Research and Management Company

7,646,020

⁽⁴⁾

5.0

333 South Hope Street, 55th Floor

Los Angeles, CA 90071-1447

Interested Directors:

William L. Walton

3,654,739

^(5,6,7,15)

2.4

over $100,000

Joan M. Sweeney

1,989,675

^(5,15)

1.3

over $100,000

Robert E. Long

56,111

^(8,15)

over $100,000

Independent Directors:

Ann Torre Bates

29,250

^(7,8)

over $100,000

Brooks H. Browne

88,711

^(7,8,15)

over $100,000

John D. Firestone

77,426

^(7,8)

over $100,000

Anthony T. Garcia

103,512

⁽⁸⁾

over $100,000

Edwin L. Harper

11,500

^(8,13,15)

over $100,000

Lawrence I. Hebert

57,800

^(8,12)

over $100,000

John I. Leahy

62,318

⁽⁸⁾

over $100,000

Alex J. Pollock

33,224

^(7,8,9)

over $100,000

Marc F. Racicot

15,000

⁽⁸⁾

over $100,000

Guy T. Steuart II

369,044

^(8,10,15)

over $100,000

Laura W. van Roijen

79,454

^(7,8,15)

over $100,000

Named Executive Officers:

Michael J. Grisius

798,904

^(5,7,15)

Penni F. Roll

824,748

^(5,15)

John D. Shulman

1,030,106

⁽⁵⁾

All directors and executive officers as a group (28 in number)

14,652,199

^(6,11)

9.0

* Less than 1%


	⁽¹⁾	Beneficial ownership has been determined in accordance with Rule 13d-3 of the Securities Exchange Act of 1934.

	⁽²⁾	Based on a total of 151,988,669 shares of our common stock issued and outstanding on March 16, 2007, and the number of shares of our common stock issuable upon the exercise of stock options exercisable within 60 days held by each executive officer and non-officer director, which totals 11,406,294 in the aggregate.

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	⁽³⁾	Beneficial ownership has been determined in accordance with Rule 16a-1(a)(2) of the Securities Exchange Act of 1934.

	⁽⁴⁾	Information regarding share ownership was obtained from the Schedule 13F that Capital Research and Management Company filed with the SEC on February 14, 2007.

	⁽⁵⁾	Share ownership for the following executive officers includes:


			Owned		Options
			Through		Exercisable
			Deferred		Within 60 Days
	Owned		Compensation		of March 16,		Allocated to
	Directly		Plans ⁽¹⁴⁾		2007		401(k) Plan

William L. Walton		467,264		239,626		2,718,634		8,049
Joan M. Sweeney		310,154		120,125		1,542,032		17,364
Penni F. Roll		103,967		41,813		667,256		11,712
Michael J. Grisius		119,009		51,397		608,387		20,111
John D. Shulman		4,799		68,205		957,102		—


	⁽⁶⁾	Includes 229,215 shares held by the 401(k) Plan, of which Mr. Walton and Mr. Blasey are sub-trustees of the fund holding our shares. The sub-trustees disclaim beneficial ownership of such shares.

	⁽⁷⁾	Includes certain shares held in IRA or Keogh accounts: Walton — 12,015 shares; Bates — 4,250 shares; Browne — 12,280 shares; Firestone — 3,415 shares; Pollock — 1,000 shares; van Roijen — 8,998 shares; and Grisius — 1,242 shares.

	⁽⁸⁾	Beneficial ownership for these non-officer directors includes exercisable options to purchase 45,000 shares, except with respect to Ms. Bates who has exercisable options to purchase 25,000 shares, Mr. Harper who has exercisable options to purchase 10,000 shares, Mr. Leahy who has exercisable options to purchase 42,500 shares, Mr. Pollock who has exercisable options to purchase 14,000 shares, and Mr. Racicot who has exercisable options to purchase 15,000 shares.

	⁽⁹⁾	Includes 5,024 shares held in a deferred compensation plan for Mr. Pollock.


⁽¹⁰⁾	Includes 276,691 shares held by a corporation for which Mr. Steuart serves as an executive officer.

⁽¹¹⁾	Includes a total of 11,406,294 shares underlying stock options exercisable within 60 days of March 16, 2007, which are assumed to be outstanding for the purpose of calculating the group’s percentage ownership, and 229,215 shares held by the 401(k) Plan.

⁽¹²⁾	Includes 9,000 shares held in a revocable trust.

⁽¹³⁾	Includes 1,500 shares held in a revocable trust.

⁽¹⁴⁾	See “Individual Performance Award” and “The 2005 Deferred Compensation Plan II” for a discussion of shares owned through the deferred compensation plans.

⁽¹⁵⁾	Includes certain shares held in margin accounts or otherwise could be pledged: Walton — 184,891 shares; Sweeney — 192,301 shares; Long — 15,681 shares; Browne — 2,500 shares; Harper — 1,500 shares; Steuart — 276,691 shares; van Roijen — 25,456 shares; Roll — 29,427 shares; Grisius — 16,914 shares.

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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

The following table sets forth certain information, as of March 16, 2007, regarding indebtedness to Allied Capital in excess of $120,000 of any person serving as a director or executive officer of Allied Capital at any time since January 1, 2006. All of such indebtedness results from loans we made to enable the exercise of stock options. The loans are required to be fully collateralized and are full recourse against the borrower and have varying terms not exceeding ten years. The interest rates charged generally reflect the applicable federal rate on the date of the loan. As of December 31, 2006, the total loans outstanding to such executive officers of Allied Capital was $2.9 million or 0.1% of Allied Capital’s total assets at December 31, 2006.

As a business development company under the Investment Company Act of 1940, we are entitled to provide and have provided loans to our officers in connection with the exercise of stock options. However, as a result of provisions of the Sarbanes-Oxley Act of 2002, we have been prohibited from making new loans to our executive officers since July 30, 2002.


	Amount		Amount				Range of
	of Principal		of Interest		Highest Amount		Interest Rates					Amount
Name and Position	Paid During		Paid During		Outstanding							Outstanding at
with Company	2006		2006		During 2006		High			Low		March 16, 2007

Executive Officers:
Kelly A. Anderson, Executive Vice President and Treasurer	$	—	$	24,116	$	496,225		5.96%	—		3.91%	$	496,225
Michael J. Grisius, Managing Director	$	24,000	$	12,594	$	230,727		4.68%	—		3.91%	$	206,727
Penni F. Roll, Chief Financial Officer	$	344,246	$	23,179	$	875,770		5.89%	—		4.45%	$	531,524
Suzanne V. Sparrow, Executive Vice President	$	147,170	$	17,342	$	556,498		6.18%	—		4.45%	$	281,213
Joan M. Sweeney, Chief Operating Officer and Director⁽¹⁾	$	399,962	$	9,346	$	399,962		4.45%	—		4.45%	$	—


⁽¹⁾	Ms. Sweeney is an interested director. Interested directors are “interested persons” as defined by the 1940 Act.

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TAX STATUS

The following discussion is a general summary of the material United States federal income tax considerations applicable to us and to an investment in the debt securities. 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 debt securities.

Taxation as a Regulated Investment Company

We intend to be treated for tax purposes as a “regulated investment company” under Subchapter M of Chapter 1 of the Code. If we (i) qualify as a regulated investment company and (ii) distribute to stockholders in a timely manner at least 90% of our “investment company taxable income,” as defined in the Code (i.e., net ordinary investment income, including accrued original issue discount, and net realized short-term capital gain in excess of net realized long-term capital loss) (the “90% Distribution Requirement”) each year, we generally will not be subject to federal income tax on the portion of our investment company taxable income and net capital gain (i.e., net realized long-term capital gain in excess of net realized short-term capital loss) we distribute (or treat as “deemed distributed”) to stockholders. (We will, however, be subject to such tax to the extent that, prior to February 2, 2013, BLX sells property held by BLX, Inc. on the date of its corporate reorganization, but only to the extent (i) such property had a built-in gain (that is, value in excess of tax basis) on such date and (ii) such built-in gain is recognized on such sale.) In addition, we are generally required to distribute in a timely manner an amount at least equal to the sum of (i) 98% of our ordinary income for each calendar year, (ii) 98% of our capital gain net income for the one-year period ending December 31 of that calendar year, and (iii) any income realized, but not taxed or distributed in prior years, in order to avoid the 4% nondeductible federal excise tax on certain undistributed income of regulated investment companies (the “Excise Tax Avoidance Requirements”). If we do not satisfy the Excise Tax Avoidance Requirements for any year, we will be required to pay this 4% excise tax on the amount by which 98% of the current year’s taxable income exceeds the distribution for the year. The ordinary income or net capital gain income on which the excise tax is paid is generally distributed to shareholders in the next tax year. Depending on the level of ordinary income or net capital gain income for a tax year, we may choose to carry over the portion of such income in excess of our current year distributions into the next tax year and pay the 4% excise tax, as required. We will be subject to federal income tax at the regular corporate rate on any amounts of investment company taxable income or net capital gain not distributed (or deemed distributed) to our stockholders.

In order to qualify as a regulated investment company for federal income tax purposes, we must, among other things: (a) continue to qualify as a business development company under the 1940 Act; (b) derive in each taxable year at least 90% of our gross income from (i) dividends, interest, payments with respect to securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities or (ii) net income derived from an interest in a “qualified publicly traded partnership” (the “90% Income Test”); and (c) diversify our holdings so that at the end of each quarter of the taxable year (i) at least 50% of the value of our assets consists of cash, cash items, U.S. government securities, securities of other regulated investment companies, and other securities if such other securities of any one issuer do not represent more than 5% of our assets or more than 10% of the

129

outstanding voting securities of the issuer, and (ii) no more than 25% of the value of our assets is invested in the securities of any one issuer (other than U.S. government securities or securities of other regulated investment companies), the securities of two or more issuers that are controlled (as determined under applicable Code rules) by us and are engaged in the same or similar or related trades or businesses, or the securities of one or more “qualified publicly traded partnerships” (the “Diversification Tests”).

If we acquire or are 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 or market discount, we 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 us in the same taxable year. Any amount accrued as original issue discount will be included in our investment company taxable income for the year of accrual and cash or other assets equal to the amount of such original issue discount accrual may have to be distributed to our stockholders in order to satisfy the 90% Distribution Requirement or the Excise Tax Avoidance Requirements even though we have not received any cash representing such income.

To the extent we engage in certain hedging transactions, including hedging transactions in options, future contracts, and straddles, or other similar transactions, we may 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 our income, defer our losses, cause adjustments in the holding periods of our securities, convert long-term capital gains into short-term capital gains or convert short-term capital losses into long-term capital losses.

In addition, although we do not currently intend to do so, if we were to invest in certain options, futures, or forward contracts, we may be required to report income from such investments on a mark-to-market basis, which could result in us recognizing unrealized gains and losses for federal income tax purposes even though we may not realize such gains and losses when we ultimately dispose of such investments. We 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 our holding period for the investments.

These rules could affect our investment company taxable income or net capital gain for a taxable year and thus affect the amounts that we would be required to distribute to our stockholders pursuant to the 90% Distribution Requirement and the Excise Tax Avoidance Requirements for such year.

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

If we fail to satisfy the 90% Distribution Requirement or fail to qualify as a regulated investment company in any taxable year, we will be subject to tax in that year on all of our taxable income, regardless of whether we make any distributions to our stockholders. In that case, all of our income will be subject to corporate-level tax, reducing the amount

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available for debt service and distribution to our stockholders, and all of our distributions to our stockholders will be characterized as ordinary income (to the extent of our current and accumulated earnings and profits), although such distributions would constitute “qualified dividend income” to individual shareholders subject to the same reduced maximum rate of tax applicable to long-term capital gains. In contrast, if we qualify as a regulated investment company, our corporate-level federal income tax should be substantially reduced or eliminated, and a portion of our distributions or deemed distributions may be characterized as long-term capital gain in the hands of our stockholders.

Taxation of Debt Holders

We intend to describe in a prospectus supplement the United States federal income tax considerations applicable to the debt securities that will be sold by us pursuant to that supplement, including the taxation of any debt securities that will be sold at an original issue discount or acquired with market discount or amortizable bond premium and the tax treatment of sales, exchanges or retirements of our debt securities. In addition, we may describe in the applicable prospectus supplement the United States federal income tax considerations applicable to holders of our debt securities that are not “U.S. persons.”

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CERTAIN GOVERNMENT REGULATIONS

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

Business Development Company. A business development company is defined and regulated by the 1940 Act. A business development company must be organized in the United States for the purpose of investing in or lending to primarily private companies and making managerial assistance available to them. A business development company may use capital provided by public shareholders and from other sources to invest in long-term, private investments in businesses. A business development company provides shareholders the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits, if any, of investing in primarily privately owned companies.

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


	•	Securities purchased in transactions not involving any public offering, the issuer of which is an eligible portfolio company;

	•	Securities received in exchange for or distributed with respect to securities described in the bullet above or pursuant to the exercise of options, warrants or rights relating to such securities; and

	•	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.

An eligible portfolio company is generally a domestic company that is not an investment company (other than a small business investment company wholly owned by a business development company) and that:


	•	does not have a class of securities with respect to which a broker may extend margin credit at the time the acquisition is made;

	•	is controlled by the business development company and has an affiliate of a business development company on its board of directors;

	•	does not have any class of securities listed on a national securities exchange; or

	•	meets such other criteria as may be established by the SEC.

Control, as defined by the 1940 Act, is presumed to exist where a business development company beneficially owns more than 25% of the outstanding voting securities of the portfolio company.

In October 2006, the SEC re-proposed rules providing for an additional definition of eligible portfolio company. As re-proposed, the rule would expand the definition of eligible portfolio company to include certain public companies that list their securities on a national securities exchange. The SEC is seeking comment regarding the application of this proposed rule to companies with: (1) a public float of less than $75 million; (2) a market capitalization of less than $150 million; or (3) a market capitalization of less than $250 million. There is no assurance that such proposal will be adopted or what the final proposal will entail.

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To include certain securities described above as qualifying assets for the purpose of the 70% test, a business development company 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. We offer to provide significant managerial assistance to our portfolio companies.

As a business development company, we are 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. In addition, while any senior securities remain outstanding, we must make provisions to prohibit any distribution to our shareholders unless we meet the applicable asset coverage ratio at the time of the distribution.

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, at a price below the current net asset value of the common stock, or sell warrants, options or rights to acquire such common stock, at a price below the current net asset value of the common stock if our Board of Directors determines that such sale is in the best interests of the Company and our stockholders, and our stockholders approve our policy and practice of making such sales. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount).

We are also limited in the amount of stock options that may be issued and outstanding at any point in time. The 1940 Act provides that the amount of a business development company’s voting securities that would result from the exercise of all outstanding warrants, options and rights at the time of issuance may not exceed 25% of the business development company’s outstanding voting securities, except that if the amount of voting securities that would result from the exercise of all outstanding warrants, options, and rights issued to the business development company’s directors, officers, and employees pursuant to any executive compensation plan would exceed 15% of the business development company’s outstanding voting securities, then the amount of voting securities that would result from the exercise of all outstanding warrants, options, and rights at the time of issuance shall not exceed 20% of the outstanding voting securities of the business development company.

We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of the members of our Board of Directors who are not interested persons and, in some cases, prior approval by the SEC. We have been granted an exemptive order by the SEC permitting us to engage in certain transactions that would be permitted if we and our subsidiaries were one company and permitting certain transactions among our subsidiaries, subject to certain conditions and limitations.

We have designated a chief compliance officer and established a compliance program pursuant to the requirements of the 1940 Act. We are periodically examined by the SEC for compliance with the 1940 Act.

As with other companies regulated by the 1940 Act, a business development company must adhere to certain substantive regulatory requirements. A majority of our directors must be persons who are not interested persons, as that term is defined in the 1940 Act. Additionally, we are required to provide and maintain a bond issued by a reputable fidelity

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insurance company to protect us against larceny and embezzlement. Furthermore, as a business development company, we are prohibited from protecting any director or officer against any liability to us or our shareholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

We maintain a code of ethics that establishes procedures for personal investment and restricts certain transactions by our personnel. Our code of ethics generally does not permit investment by our employees in securities that have been or are contemplated to be purchased or held by us. Our code of ethics is posted on our website at www.alliedcapital.com and is also filed as an exhibit to our registration statement which is on file with the SEC. You may read and copy the code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on operations of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the code of ethics is available on the EDGAR database on the SEC Internet site at http://www.sec.gov. You may obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following email address: publicinfo@sec.gov, or by writing to the SEC’s Public Reference Section, 100 F Street, NE, Washington, D.C. 20549.

As a business development company under the 1940 Act, we are entitled to provide and have provided loans to our officers in connection with the exercise of options. However, as a result of provisions of the Sarbanes-Oxley Act of 2002, we have been prohibited from making new loans to our executive officers since July 2002.

We may not change the nature of our business so as to cease to be, or withdraw our election as, a business development company unless authorized by vote of a “majority of the outstanding voting securities,” as defined in the 1940 Act. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (i) 67% or more of such company’s shares present at a meeting if more than 50% of the outstanding shares of such company are present and represented by proxy or (ii) more than 50% of the outstanding shares of such company.

Regulated Investment Company Status. We have elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, otherwise referred to as the Code. As long as we qualify as a regulated investment company, we are not taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis.

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash.

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requirement is not met, the Code imposes a nondeductible excise tax equal to 4% of the amount by which 98% of the current year’s taxable income exceeds the distribution for the year. The taxable income on which an excise tax is paid is generally carried over and distributed to shareholders in the next tax year. Depending on the level of taxable income earned in a tax year, we may choose to carry over taxable income in excess of current year distributions from such taxable income into the next tax year and pay a 4% excise tax on such income, as required.

Compliance with the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements apply to us, including:


	•	Our Chief Executive Officer and Chief Financial Officer certify the financial statements contained in our periodic reports through the filing of Section 302 certifications;

	•	Our periodic reports disclose our conclusions about the effectiveness of our disclosure controls and procedures;

	•	Our annual report on Form 10-K contains a report from our management on internal control over financial reporting, including a statement that our management is responsible for establishing and maintaining adequate internal control over financial reporting as well as our management’s assessment of the effectiveness of our internal control over financial reporting, which must be audited by our independent registered public accounting firm;

	•	Our periodic reports disclose whether there were significant changes in our internal control over financial reporting or in other factors that could significantly affect our internal control over financial reporting subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses; and

	•	We may not make any loan to any director or executive officer and we may not materially modify any existing loans.

We have adopted procedures to comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to monitor our compliance with all future regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith.

In addition, the New York Stock Exchange requires compliance with certain rules as part of its corporate governance listing standards. We have adopted certain policies and procedures to comply with the New York Stock Exchange’s corporate governance rules, and in 2006 we submitted the required CEO certification to the New York Stock Exchange pursuant to Section 303A.12(a) of the listed company manual.

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Proxy Voting Policies and Procedures

We vote proxies relating to our portfolio securities in the best interest of our shareholders. We review on a case-by-case basis each proposal submitted to a shareholder vote to determine its impact on the portfolio securities held by us. Although we generally vote against proposals that may have a negative impact on our portfolio securities, we may vote for such a proposal if there exists compelling long-term reasons to do so.

Our proxy voting decisions are made by our portfolio management committee. To ensure that our vote is not the product of a conflict of interest, we require that: (i) anyone involved in the decision making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (ii) employees involved in the decision making process or vote administration are prohibited from revealing how we intend to vote on a proposal in order to reduce any attempted influence from interested parties.

Stockholders may obtain information regarding how we voted proxies with respect to our portfolio securities without charge by making a written request for proxy voting information to: Corporate Secretary, Allied Capital Corporation, 1919 Pennsylvania Avenue, N.W., Washington, D.C. 20006 or by telephone at (202) 721-6100.

STOCK TRADING PLANS AND OWNERSHIP GUIDELINES

Our Board of Directors has established a policy to permit our officers and directors to enter into trading plans to sell shares of our common stock in accordance with Rule 10b5-1 of the Securities Act of 1934. The policy allows our participating officers and directors to adopt a pre-arranged stock trading plan to buy or sell pre-determined amounts of our shares of common stock over a period of time. Our Board of Directors established the policy in recognition of the liquidity and diversification objectives of our officers and directors, including the desire of certain of our officers and directors to sell certain shares of our common stock (such as shares of our common stock they acquired upon exercise of stock options).

Our Board of Directors has also established a retained stock ownership policy for our officers and directors who enter into any trading plans pursuant to Rule 10b5-1. The policy aligns the interests of our officers and directors with the interests of stockholders and further promotes our commitment to sound corporate governance. The policy requires that our officers and directors who choose to sell pursuant to Rule 10b5-1 not sell in any one year more than 10% of their owned shares of our common stock or more than 10% of their shares of our common stock issuable upon the exercise of vested stock options.

DIVIDEND REINVESTMENT PLAN

We currently maintain a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our shareholders by our transfer agent. The dividend reinvestment plan is an “opt in” plan, which means that if our Board of Directors declares a cash dividend then our shareholders that have not “opted in” to our dividend reinvestment plan will receive cash dividends, rather than reinvesting dividends in additional shares of common stock.

To enroll in the dividend reinvestment plan, each shareholder must complete an enrollment status form and return it to the plan agent. The plan agent shall then automatically reinvest any dividend in additional shares of common stock. Shareholders may change their status in the dividend reinvestment plan at any time by contacting our transfer agent and plan administrator in writing.

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A shareholder’s ability to participate in a dividend reinvestment plan may be limited according to how the shares of common stock are held. A nominee may preclude beneficial owners holding shares in street name from participating in the dividend reinvestment plan. Shareholders who wish to participate in a dividend reinvestment plan may need to hold their shares of common stock in their own name. 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 dividend reinvestment plan will be paid 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 dividend reinvestment 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 dividend reinvestment 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 dividend reinvestment plan. Any distributions reinvested under the plan will nevertheless remain taxable to the shareholders.

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DESCRIPTION OF CAPITAL STOCK

The following summary description is based on relevant portions of the Maryland General Corporation Law and our charter and bylaws. This summary is not necessarily complete, and we refer you to the Maryland General Corporation Law and our charter and bylaws for a detailed description of the provisions summarized below.

Capital Stock

Our authorized capital stock consists of 200,000,000 shares, $0.0001 par value per share, all of which has been initially designated as common stock. Our Board of Directors may classify and reclassify any unissued shares of our capital stock 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 16, 2007, there were shares of common stock outstanding and shares of common stock reserved for issuance under our amended stock option plan. The following are the outstanding classes of securities of Allied Capital as of March 16, 2007:

(4)

(3)

Amount

Amount Held

Outstanding

(2)

by Us

Exclusive of

(1)

Amount

or for Our

Amounts Shown

Title of Class

Authorized

Account

Under(3)

Allied Capital Corporation

Common Stock

200,000,000

—

151,988,669

All shares of common stock have equal rights as to earnings, assets, dividends and voting 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 our Board of Directors out of funds legally available therefor. Our common stock has no preemptive, exchange, conversion, or redemption rights and is freely transferable, except where their transfer is restricted by federal and state securities law or by contract. In the event of liquidation, dissolution or winding-up of Allied Capital, each share of common stock is entitled to share ratably in all of our assets 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 on all matters submitted to a vote of shareholders, including the election of directors. Except as provided with respect to any other class or series of capital stock, the holders of our common stock will possess exclusive voting power. There is no cumulative voting in the election of directors, 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

Our charter authorizes our Board of Directors to classify and reclassify any unissued shares of stock into other classes or series of stock, including preferred stock. Prior to issuance of shares of each class or series, the Board of Directors is required by Maryland law and by our charter to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the Board of Directors could authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our common stock or otherwise be in their best interest.

In addition, any issuance of preferred stock must comply with the requirements of the 1940 Act. The 1940 Act requires, among other things, that (1) immediately after issuance and before any dividend or other distribution is made with respect to our common stock, we maintain a coverage ratio of total assets to total senior securities, which include all of our borrowings and our preferred stock we may issue in the future, of at least 200%, and (2) 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 such preferred stock are in arrears by two years or more. The features of preferred stock will be further limited by the requirements applicable to regulated investment companies under the Code.

Limitation on Liability of Directors and Officers; Indemnification and Advance of Expenses

We have adopted provisions in our charter limiting the liability of our directors and officers for monetary damages. The effect of these provisions in the charter is to eliminate the rights of Allied Capital and its stockholders (through stockholders’ derivative suits on our behalf) to recover monetary damages against a director or officer for breach of the fiduciary duty of care as a director or officer (including breaches resulting from negligent behavior) except for liability resulting from (i) actual receipt of an improper benefit or profit in money, property or services or (ii) active and deliberate dishonesty established by a final judgment as being material to the cause of action. These provisions do not limit or eliminate the rights of Allied Capital or any stockholder 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.

Our charter and bylaws authorize us, to the maximum extent permitted by Maryland law and subject to the requirements of the 1940 Act, to indemnify any present or former director or officer or any individual who, while a director and at our request, serves or has served another corporation, real estate investment trust, partnership, joint venture, trust, employee benefit plan or other enterprise as a director, officer, partner or trustee, from and against any claim or liability to which that person may become subject or which that person may incur by reason of his or her status as a present or former director or officer and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. The charter and bylaws also permit us to indemnify and advance expenses to any person who served a predecessor of us in any of the capacities described above and any of our employees or agents or any employees or agents of our predecessor. In accordance with the 1940 Act, we will not indemnify any person for any liability to which

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such person would be subject by reason of such person’s willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his or her office.

Maryland law requires a corporation (unless its charter provides otherwise, which our charter does not) to indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service in that capacity. Maryland law permits a corporation to indemnify its present and former directors and officers, among others, against judgments, penalties, fines, settlements and reasonable expenses actually incurred by them in connection with any proceeding to which they may be made a party by reason of their service in those or other capacities unless it is established that (a) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (1) was committed in bad faith or (2) was the result of active and deliberate dishonesty, (b) the director or officer actually received an improper personal benefit in money, property or services or (c) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. However, under Maryland law, a Maryland corporation may not indemnify for an adverse judgment in a suit by or in the right of the corporation or for a judgment of liability on the basis that a personal benefit was improperly received, unless in either case a court orders indemnification, and then only for expenses. In addition, Maryland law permits a corporation to advance reasonable expenses to a director or officer upon the corporation’s receipt of (a) a written affirmation by the director or officer of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification by the corporation and (b) a written undertaking by him or her or on his or her behalf to repay the amount paid or reimbursed by the corporation if it is ultimately determined that the standard of conduct was not met.

We have entered into indemnification agreements with our directors and certain of our senior officers. The indemnification agreements provide these directors and senior officers the maximum indemnification permitted under Maryland law and the 1940 Act.

Certain Anti-Takeover Provisions

Our charter and bylaws and certain statutory and regulatory requirements contain certain provisions that could make more difficult the acquisition of Allied Capital 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 us to negotiate first with the Board of Directors. We believe that the benefits of these provisions 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 only to be a summary of certain of our anti-takeover provisions and is qualified in its entirety by reference to our charter and the bylaws.

Classified Board of Directors

Our bylaws provide for our 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 Allied Capital or removal of incumbent management. We

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believe, however, that the longer time required to elect a majority of a classified Board of Directors helps to ensure continuity and stability of our management and policies.

Issuance of Preferred Stock

Our Board of Directors, without stockholder 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.

Number of Directors; Vacancies; Removal

Our charter provides that the number of directors will be set only by the Board of Directors in accordance with our bylaws. Our bylaws provide that a majority of our entire Board of Directors may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of directors may never be less than three nor more than fifteen. Except as may be provided by the Board of Directors in setting the terms of any class or series of preferred stock, any and all vacancies on the Board of Directors may be filled only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected to fill a vacancy will serve for the remainder of the full term of the directorship in which the vacancy occurred and until a successor is elected and qualified.

Our bylaws provides that a director may be removed by stockholders only “with cause” and then only by the affirmative vote of at least a majority of the votes entitled to be cast in the election of directors.

Action by Stockholders

Under the Maryland General Corporation Law, stockholder action can be taken only at an annual or special meeting of stockholders or by unanimous written consent in lieu of a meeting. These provisions, combined with the requirements of our bylaws regarding the calling of a stockholder-requested special meeting of stockholders discussed below, may have the effect of delaying consideration of a stockholder proposal until the next annual meeting.

Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals

Our bylaws provide that with respect to an annual meeting of stockholders, nominations of persons for election to the Board of Directors and the proposal of business to be considered by stockholders may be made only (1) pursuant to our notice of the meeting, (2) by the Board of Directors or (3) by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice procedures of the bylaws. With respect to special meetings of stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of persons for election to the Board of Directors at a special meeting may be made only (1) pursuant to our notice of the meeting, (2) by the Board of Directors or (3) provided that the Board of Directors has determined that directors will be elected at the meeting, by a stockholder who is entitled to vote at the meeting and who has complied with the advance notice provisions of the bylaws.

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The purpose of requiring stockholders to give us advance notice of nominations and other business is to afford our Board of Directors a meaningful opportunity to consider the qualifications of the proposed nominees and the advisability of any other proposed business and, to the extent deemed necessary or desirable by our Board of Directors, to inform stockholders and make recommendations about such qualifications or business, as well as to provide a more orderly procedure for conducting meetings of stockholders. Although our bylaws do not give our Board of Directors any power to disapprove stockholder nominations for the election of directors or proposals recommending certain action, they may have the effect of precluding a contest for the election of directors or the consideration of stockholder proposals if proper procedures are not followed and of discouraging or deterring a third party from conducting a solicitation of proxies to elect its own slate of directors or to approve its own proposal without regard to whether consideration of such nominees or proposals might be harmful or beneficial to us and our stockholders.

Calling of Special Meetings of Stockholders

Our bylaws provide that special meetings of stockholders may be called by our Board of Directors and certain of our officers. Additionally, our bylaws provide that, subject to the satisfaction of certain procedural and informational requirements by the stockholders requesting the meeting, a special meeting of stockholders will be called by our Corporate Secretary upon the written request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast at such meeting.

Amendments; Supermajority Vote Requirements

Our bylaws impose supermajority vote requirements in connection with the amendment of provisions of our bylaws, including those provisions relating to the classified Board of Directors, the ability of stockholders to call special meetings and the advance notice provisions for stockholder meetings.

Maryland General Corporation Law

Maryland General Corporation Law provides for the 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 statutes for their entire terms.

Business Combination Statute. Certain provisions of the Maryland General Corporation Law establish special requirements with respect to “business combinations” between Maryland corporations and “interested stockholders” 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 stockholder and requires a supermajority vote for such transactions after the end of such five-year period.

“Interested stockholders” 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 stockholders or their affiliates.

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Unless an exemption is available, a “business combination” may not be consummated between a Maryland corporation and an interested stockholder or its affiliates for a period of five years after the date on which the stockholder first became an interested stockholder 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 66²/3% of the votes entitled to be cast by all holders of outstanding shares of voting stock other than the interested stockholder or its affiliates or associates, unless, among other things, the corporation’s stockholders 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 stockholder for its shares.

A business combination with an interested stockholder which is approved by the board of directors of a Maryland corporation at any time before an interested stockholder first becomes an interested stockholder is not subject to the five-year moratorium or special voting requirements. An amendment to a Maryland corporation’s 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 66²/3% of the votes entitled to be cast by holders of outstanding shares of voting stock who are not interested stockholders. Any such amendment is not effective until 18 months after the vote of stockholders and does not apply to any business combination of a corporation with a stockholder who became an interested stockholder on or prior to the date of such vote.

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


	(1)	one-tenth or more but less than one-third;

	(2)	one-third or more but less than a majority; or

	(3)	a majority of all voting power.

The requisite stockholder approval must be obtained each time an acquiror crosses one of the thresholds of voting power set forth above. Control shares do not include shares which the acquiring person is entitled to vote as a result of having previously obtained stockholder 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 stockholders 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

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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 statute in the event:


	(1)	there is a stockholder 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.

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 stockholders other than the acquiring person have appraisal rights as provided under the Maryland General Corporation 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 Allied Capital. 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.

Our Board of Directors has opted out of the Control Share Acquisition Statute through an amendment to our bylaws.

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DESCRIPTION OF PUBLIC NOTES

The following summary description is based on the indenture between us and the Bank of New York, as trustee, dated June 16, 2006 (the “Indenture”). This summary is not necessarily complete and we refer you to the Indenture for a detailed description of the provisions summarized below.

As of April 3, 2007, we have completed public issuances of unsecured notes as follows:


($ in millions)		Amount		Maturity Date

6.625% Notes due 2011⁽¹⁾⁽²⁾		$	400.0		July 15, 2011
6.000% Notes due 2012⁽¹⁾⁽²⁾			250.0		April 1, 2012
6.875% Notes due 2047⁽¹⁾⁽³⁾			230.0		April 15, 2047

	Total	$	880.0


⁽¹⁾	The terms of the notes are governed by two additional covenants, through which we have agreed to not violate Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act, as amended, while the notes are outstanding, and to provide financial information to the holders of the notes and the trustee if we should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934, as amended. The supplements to the Indenture governing the issuance of the notes also revise certain events of default. The amendments to the Indenture apply to the notes only and do not apply to any prior or future issuance of debt securities under the Indenture.

⁽²⁾	We may redeem the notes in whole at any time or in part from time to time provided that any exercise of our option to redeem the notes will be done in compliance with the 1940 Act, and the rules and regulations promulgated thereunder, to the extent applicable.

⁽³⁾	We may redeem the notes in whole or in part at any time or from time to time on or after April 15, 2012, and upon the occurrence of certain tax events provided that any exercise of our option to redeem the notes will be done in compliance with the 1940 Act, and the rules and regulations promulgated thereunder, to the extent applicable.

As required by U.S. federal law for all bonds and notes of companies that are publicly offered, our debt securities will be governed by a document called an indenture, a contract entered into between us and The Bank of New York, as trustee, dated June 16, 2006. The following discussion sets forth the general terms and provisions relating to the indenture and, therefore, the debt securities. This discussion, however, may not include a discussion of all of the terms and provisions that may be important to you. You should carefully read the indenture accompanying this prospectus and any prospectus supplement and pricing supplement, if any, for all of the terms and provisions that are applicable to any debt securities that we may offer in a particular offering.

The trustee has two main roles:


	•	First, the trustee can enforce your rights against us if we default. There are, however, some limitations on the extent to which the trustee acts on your behalf, described later under “— Events of Default — Remedies if an Event of Default Occurs”.

	•	Second, the trustee performs administrative duties for us, such as sending you interest and principal payments, transferring your securities to new buyers and sending you notices.

We may, in our discretion, issue several distinct series of debt securities, including notes, debentures, medium-term notes, commercial paper, retail notes or similar obligations evidencing indebtedness, under the indenture. Each series may be reopened and more

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securities of such series may be issued under the indenture, or under one or more supplements to the indenture. This section summarizes terms of the debt securities that are common to all series and some other terms that may be applicable. Most of the financial terms of each specific series of debt securities will be described in any prospectus supplement and pricing supplement, if any, accompanying this prospectus. Those terms may vary from the terms described here and may contain some or all of the following:


	•	the title and series of the debt securities;

	•	any limit on the aggregate principal amount of the debt securities, and whether or not such series may be reopened for additional securities of that series and on what terms;

	•	the purchase price of the debt securities, expressed as a percentage of the principal amount;

	•	the person to whom any interest on the debt security shall be payable, if other than to the registered holder at the close of business on the regular record date, and the extent to which, or the manner in which, any interest will be paid on a temporary global security;

	•	the date or dates on which the principal of, and any premium, if any, on the debt securities will be payable or the method for determining the date or dates of maturity;

	•	if the debt securities will bear interest, the interest rate or rates or the method by which the rate or rates will be determined, as well as the date or dates from which any interest will accrue, or the method by which such date or dates shall be determined, the interest payment dates, the record dates for those interest payments and the basis upon which interest shall be calculated or the method by which such date or dates shall be determined;

	•	if the debt securities will be issued at a discount, the amount of original issue discount, the method by which the accreted value of the securities will be determined and the dates from and to which original issue discount will accrue;

	•	if other than the location specified in this prospectus, the place or places where payments on the debt securities will be made and where the debt securities may be surrendered for registration of transfer or exchange;

	•	if we have the option to redeem all or any portion of the debt securities before their final maturity, the terms and conditions upon which the debt securities may be redeemed;

	•	our obligation, if any, to redeem, repay or purchase any securities pursuant to any sinking fund or analogous provisions, or at the holder’s option, and the period or periods within which or the date or dates on which, the price or prices at which, the currency or currencies in which, and the terms and conditions upon which any securities shall be redeemed, repaid or purchased, in whole or in part, pursuant to such obligation;

	•	the currency or currencies in which the debt securities are denominated and payable if other than U.S. dollars and the manner for determining the equivalent thereof;

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	•	whether the amount of any payments on the debt securities may be determined with reference to an index, a financial or economic measure or pursuant to a formula and the manner in which such amounts are to be determined;

	•	if a payment on the securities is due, at either our or the holder’s election, in a currency other than the currency in which the securities are denominated, the currency in which the payment shall be made, the periods within which and the terms and conditions upon which such election is to be made and the amount so payable (or the manner in which such amount shall be determined), and the time and manner of determining the exchange rate between the currency in which such securities are denominated and the currency in which such securities are to be paid;

	•	if other than the entire principal amount, the portion of the principal amount of any securities that shall be payable upon declaration of acceleration of the maturity thereof or the method by which such portion shall be determined;

	•	if the principal amount payable at maturity of any debt securities will not be determinable as of any date prior to maturity, the amount that will be deemed to be the principal amount of the debt securities as of any such date for any purpose under the indenture, including the principal amount that will be due and payable upon any maturity date or that will be deemed outstanding as of any date prior to maturity;

	•	whether the debt securities are to be issued in a form other than global form and any provisions relating thereto;

	•	the identity of the security registrar and paying agent for the debt securities if other than the trustee;

	•	any deletions from, modifications of or additions to the events of default, covenants or other provisions in the indenture;

	•	the applicability of the defeasance and covenant defeasance provisions of the indenture; and

	•	any other terms of the debt securities that do not conflict with the provisions of the indenture that cannot otherwise be changed or be inconsistent with the requirements of the Trust Indenture Act of 1939, as amended.

The prospectus supplement and pricing supplement, if any, accompanying this prospectus will describe special federal income tax consequences of the debt securities, including any special U.S. federal income tax, accounting and other considerations.

This section summarizes, and any prospectus supplement and pricing supplement, if any, accompanying this prospectus will summarize, all of the material terms of the indenture and your debt securities. They do not, however, describe every aspect of the indenture and your debt securities. The indenture and its associated documents, including your debt securities, contain the full text of the matters described in this section and any prospectus supplement and pricing supplement, if any, accompanying this prospectus.

General

The debt securities will be our direct unsecured obligations. The indenture permits us to issue debt securities from time to time and debt securities issued under the indenture

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will be issued as part of a series that has been established by us under such indenture. The debt securities will be unsecured and will rank equally with our other outstanding unsecured indebtedness as described under “— Ranking Compared to Other Creditors”.

Form, Exchange and Transfer

Unless otherwise specified in a prospectus supplement or pricing supplement, if any, accompanying this prospectus, the securities will be issued only in registered form without coupons; and in denominations that are even multiples of $1,000.

You may have your securities broken into more securities of smaller denominations or combined into fewer securities of larger denominations, as long as the denomination is authorized and the total principal amount is not changed. Any of these events is called an “exchange.” Whenever any securities are surrendered for exchange, we and the trustee will execute, authenticate and deliver the securities that you are entitled to receive.

You may exchange or transfer your securities at the office of the registrar, which may also be the trustee. The registrar acts as our agent for registering securities in the names of holders and for transferring and exchanging securities, as well as maintaining the list of registered holders.

We can designate additional registrars or paying agents and they would be named in the prospectus supplement or the pricing supplement, if any, accompanying this prospectus. We may cancel the designation of any particular registrar or paying agent. We may also approve a change in the office through which any registrar or paying agent acts. The trustee may act as the registrar, the paying agent or both.

Under the indenture, there is no charge for exchanges and transfers; however, brokerage charges may apply. You will not be required to pay a service charge to transfer or exchange securities, but you may be required to pay for any tax or other governmental charge associated with the exchange or transfer. The transfer or exchange will only be made if the registrar is satisfied with your proof of ownership.

At certain times, you may not be able to transfer or exchange your securities. If we redeem any series of securities, or any part of any series, then we may prevent you from transferring or exchanging these securities. We may do this during the period beginning 15 calendar days before the day we mail the notice of redemption and ending on the day of that mailing, in order to freeze the list of holders so we can prepare the mailing. We may also refuse to register transfers or exchanges of securities selected for redemption, except that we will continue to permit transfers and exchanges of the unredeemed portion of any security being partially redeemed.

We will initially issue all debt securities in global form, which form shall include master notes evidencing medium-term notes, commercial paper or retail notes.

Replacing Your Lost, Mutilated, or Destroyed Certificates

If you bring a mutilated certificate or coupon to the trustee, we will issue a new certificate or coupon to you in exchange for the mutilated one. Please note that the trustee may have additional requirements that you must meet in order to do this.

If you claim that a certificate has been lost, completely destroyed, or wrongfully taken from you, then the trustee will give you a replacement certificate if you meet the trustee’s

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requirements. Also, we may require you to provide reasonable security or indemnity to protect us from any loss we may incur from replacing your certificates. We may also charge you for our expenses in doing this.

Payment and Paying Agents

We will pay interest to you if you are a direct holder listed in the registrar’s records at the close of business on a particular day in advance of each due date for interest, even if you no longer own the security on the interest due date. That particular day, usually about two weeks in advance of the interest due date, is called the “record date” and will be stated in the prospectus supplement and pricing supplement, if any, accompanying this prospectus. Holders buying and selling securities must work out between themselves how to compensate for the fact that we will pay all the interest for an interest period to the one who is the registered holder on the record date. The most common manner is to adjust the sales price of the securities to prorate interest fairly between buyer and seller. This prorated interest amount is called “accrued interest.”

We will pay interest, principal and any other money due on the securities at the corporate trust office of the trustee in New York City. We may also choose to pay interest by mailing checks. We will provide additional information and specifics regarding the payment of interest, principal and any other sums due in the applicable prospectus supplement, or pricing supplement, if any, accompanying this prospectus.

We may also arrange for additional payment offices, and may cancel or change these offices, including our use of the trustee’s corporate trust office. These offices are called “paying agents.” We may also choose to act as our own paying agent.

Notices

We and the trustee will send notices regarding the securities only to direct holders, using their physical or e-mail addresses as listed in the trustee’s records.

Regardless of who acts as paying agent, all money we forward to a paying agent that remains unclaimed will, at our request, be repaid to the trustee at the end of two years after the amount was due to the direct holder. After that two-year period, you may look only to the trustee for payment and not to us or any other paying agent.

Special Situations

The following provisions apply to all series of debt securities issued under the indenture, except as set forth in the applicable prospectus supplement and pricing supplement, if any:

Mergers and Similar Transactions. We are generally permitted to consolidate or merge with another company. We are also permitted to sell substantially all of our assets to another company or to buy substantially all of the assets of another company. However, we may not consolidate or merge with another company or convey, transfer or lease our properties or assets substantially as an entirety or permit another company to consolidate or merge with us unless all the following conditions are met:


	•	if we do not survive such transaction or we convey, transfer or lease our properties and assets substantially as an entirety, the acquiring company must be a corporation, limited liability company, partnership or trust, or other corporate form, organized under the laws the United States of America, any country comprising the European Union, the United Kingdom or Japan and such company must agree to

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		be legally responsible for our debt securities, and, if not already subject to the jurisdiction of the United States of America, the new company must submit to such jurisdiction for all purposes with respect to this offering and appoint an agent for service of process;

	•	alternatively, we must be the surviving company;

	•	immediately after the transaction no event of default will exist; and

	•	we have delivered to the trustee a certificate of an officer and an opinion of counsel, each stating that the transaction complies with the indenture and that all conditions precedent to the transaction set forth in the indenture have been satisfied.

Modification and Waiver of Your Contractual Rights. Under certain circumstances, we can make changes to the indenture and the securities. Some types of changes require the approval of each security holder affected thereby, some require approval by a majority vote with respect to each affected series of securities and some changes do not require any approval at all.

Changes Requiring Your Specific Approval. First, there are changes that cannot be made to your securities without your specific approval. The following is a list of those types of changes:


	•	change the due date of the principal of, or any installment of interest on, any security;

	•	reduce the principal amount of, or rate of interest on, any security, including the amount payable upon acceleration of the maturity of that security;

	•	change the place or currency of any payment on any security;

	•	impair the right to institute suit for enforcement of any payment on or with respect to any security;

	•	reduce the percentage of outstanding securities that must consent to a modification or amendment of the indenture;

	•	reduce the percentage of outstanding securities that must consent to a waiver of compliance with certain provisions of the indenture, including provisions relating to quorum or voting or for waiver of certain defaults;

	•	make any change to this list of changes that requires your specific approval.

Changes Requiring a Majority Vote of the Holders of a Series of Securities. The second type of change to the indenture and the securities is the kind that requires a vote in favor of such change by security holders owning a majority of the principal amount of the particular series affected. The changes falling in this category are not expressly stated and include those changes that do not require your specific approval, as well as changes that do not fall into the category of changes that do not require any approval.

Changes Not Requiring Your Approval. The third type of change does not require any vote by the holders any of securities. These changes include, among others, changes to reflect the succession of another entity to us and the assumption by that entity of our obligations and to clarify ambiguous contract terms and other changes that would not adversely affect holders of the securities in any material respect.

Securities will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust for you money for their payment or redemption. A security does not cease to be outstanding because we or an affiliate of us is holding the security, but will be deemed not outstanding in determining whether the holders of the requisite amount of securities have acted under the indenture.

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We will generally be entitled to set any day as a record date for the purpose of determining the holders of outstanding securities that are entitled to vote or take other action under the indenture. However, the indenture does not oblige us to fix any record date at all. If we set a record date for a vote or other action to be taken by holders of a particular series, that vote or action may be taken only by persons who are holders of outstanding securities of that series on the record date, whether or not such persons remain holders after such record date, and must be taken within 180 days following the record date.

Defeasance and Covenant Defeasance. When we establish a series of debt securities, we may provide that the series be subject to the defeasance and discharge provisions of the indenture. If those provisions are made applicable, we may elect either:


	•	to defease and be discharged from, subject to some limitations, all of our obligations with respect to those debt securities; or

	•	to be released from our obligations to comply with certain covenants relating to those debt securities.

To effect the defeasance or covenant defeasance, we must irrevocably deposit in trust with the relevant trustee an amount in any combination of funds or government obligations, which, through the payment of principal and interest in accordance with their terms, will provide money sufficient to make payments on those debt securities and any mandatory sinking fund or analogous payments on those debt securities.

On such a defeasance, we will not be released from obligations:


	•	to indemnify the trustee;

	•	to pay additional amounts, if any, upon the occurrence of some events;

	•	to register the transfer or exchange of those debt securities;

	•	to replace some of those debt securities;

	•	to maintain an office or agency relating to those debt securities; or

	•	to hold moneys for payment in trust.

To establish such a trust we must, among other things, deliver to the relevant trustee an opinion of counsel to the effect that the holders of those debt securities:


	•	will not recognize income, gain or loss for U.S. federal income tax purposes as a result of the defeasance or covenant defeasance; and

	•	will be subject to U.S. federal income tax on the same amounts, in the same manner and at the same times as would have been the case if the defeasance or covenant defeasance had not occurred. In the case of defeasance, the opinion of counsel must be based upon a ruling of the IRS or a change in applicable U.S. federal income tax law occurring after the date of the applicable indenture.

If we effect covenant defeasance with respect to any debt securities, the amount on deposit with the relevant trustee will be sufficient to pay amounts due on the debt securities at the time of their stated maturity. However, those debt securities may become due and payable prior to their stated maturity if there is an event of default with respect to a covenant from which we have not been released. If that happens, the amount on deposit may not be sufficient to pay all amounts due on the debt securities at the time of the acceleration.

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The prospectus supplement and pricing supplement, if any, may further describe the provisions, if any, permitting defeasance or covenant defeasance, including any modifications to the provisions described above.

Redemption. The indenture under which your debt securities are issued may permit us to redeem your securities. If so, we may be able to pay off your securities before their scheduled maturity. If we have this right with respect to your specific securities, the right will be outlined in the prospectus supplement and/or the applicable pricing supplement. It will also specify when we can exercise this right and how much we will have to pay in order to redeem your debt securities.

If we choose to redeem your debt securities, we or the trustee will mail written notice to you not less than 20 days and not more than 50 days, unless otherwise specified in the applicable prospectus supplement and pricing supplement, if any, prior to redemption. Also, you may be prevented from exchanging or transferring your securities when they are subject to redemption, as described under “— Form, Exchange and Transfer” above. In case any securities are to be redeemed in part only, the notice will provide that, upon surrender of such security, you will receive, without a charge, a new security or securities of authorized denominations representing the principal amount of your remaining unredeemed securities.

Ranking Compared to Other Creditors

The securities are not secured by any of our property or assets. Accordingly, your ownership of debt securities means you are one of our unsecured creditors.

Unsecured debt securities will be issued under the indenture. Your securities will rank equally in right of payment with one another, with all our other outstanding unsecured indebtedness, and with our future unsecured indebtedness.

Events of Default

You will have special rights if an event of default occurs and is not cured, as described later in this subsection.

What Is an Event of Default? The following constitute events of default under the indenture, unless otherwise specified in the applicable prospectus supplement, and pricing supplement, if any:


	•	we fail to make any interest payment on a security when it is due, and we do not cure this default within 30 days;

	•	we fail to make any payment of principal when it is due at the maturity of any security, and we do not cure this default within 5 days;

	•	we fail to deposit a sinking fund payment when due, and we do not cure this default within 5 days;

	•	we fail to comply with the indenture, and after we have been notified of the default by the trustee or holders of 25% in principal amount of the series, we do not cure the default within 60 days;

	•	we file for bankruptcy, or other events in bankruptcy, insolvency or reorganization occur and remain undischarged or unstayed for a period of 60 days;

	•	on the last business day of each of twenty-four consecutive calendar months, we have an asset coverage of less than 100 per centum, or

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	•	any other event of default described as being applicable to any particular series of debt securities.

Remedies if an Event of Default Occurs. You will have the following remedies if an event of default occurs:

Acceleration. If an event of default other than an event of default relating to events in bankruptcy, insolvency or reorganization has occurred and has not been cured or waived, then the trustee or the holders of not less than 66²/3% in principal amount of the securities of the affected series may declare the entire principal amount of and any and all accrued and unpaid interest on all the securities of that series to be due and immediately payable. An acceleration of maturity may be cancelled by the holders of at least a majority in principal amount of the securities of the affected series, if all events of default have been cured or waived and certain other conditions are satisfied.

If an event of default relating to events in bankruptcy, insolvency or reorganization has occurred, all unpaid principal and accrued and unpaid interest, and liquidated damages, if any, become immediately due and payable without any declaration or other act of the trustee or any holder.

Special Duties of Trustee. If an event of default occurs, the trustee will have some special duties. In that situation, the trustee will be obligated to use those rights and powers under the indenture granted to it, and to use the same degree of care and skill in doing so, that a prudent person would use in that situation in conducting his or her own affairs.

Majority Holders May Direct the Trustee to Take Actions to Protect Their Interests. The trustee is not required to take any action under the indenture at the request of any holders unless the holders offer the trustee reasonable protection from expenses and liability. This is called an “indemnity.” If the trustee is provided with an indemnity reasonably satisfactory to it, the holders of a majority in principal amount of the relevant series of debt securities may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any remedy available to the trustee. These majority holders may also direct the trustee in performing any other action under the indenture.

Individual Actions You May Take if the Trustee Fails to Act. Before you bypass the trustee and bring your own lawsuit or other formal legal action or take other steps to enforce your rights or protect your interests relating to the debt securities, the following must occur:


	•	you must give the trustee written notice that an event of default has occurred and remains uncured;

	•	the holders of 25% in principal amount of all outstanding securities must make a written request that the trustee take action because of the default, and must offer reasonable indemnity to the trustee against the costs, expenses and other liabilities of taking that action;

	•	the trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity; and

	•	during the 60-day period, the holders of a majority in principal amount of the securities of that series do not give the trustee a direction inconsistent with the request.

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However, you are entitled at any time to bring an individual lawsuit for the payment of the money due on your security on or after its due date.

Waiver of Default. The holders of a majority in principal amount of the relevant series of debt securities may waive a default for all the relevant series of debt securities. If this happens, the default will be treated as if it has not occurred. No one can waive a payment default on your debt security, however, without your individual approval.

We Will Give the Trustee Information About Defaults Periodically

At the end of each fiscal year we will give to the trustee a written statement of one of our officers certifying that to the best of his or her knowledge we are in compliance with the indenture and the debt securities, or else specifying any default. The trustee may withhold from you notice of any uncured default, except for payment defaults, if it determines that withholding notice is in your best interest.

Certain Covenants

The indenture under which your debt securities are issued will require us to, unless otherwise specified in the applicable prospectus supplement and pricing supplement, if any:


	•	duly and punctually pay the principal of and any premium and interest on the debt securities of each series in accordance with the terms of the debt securities and the indenture;

	•	maintain an office or agency where your debt securities may be presented or surrendered for payment, registration of transfer or exchange, and where notices and demands to or upon us regarding the securities and the indenture may be served. We will give prompt written notice to the trustee of the location, and any change in the location, of such office or agency;

	•	if we act as our own paying agent at any time, segregate and hold in trust, for the benefit of the holders, an amount of money, in the currency in which the securities are payable, sufficient to pay the principal and any premium or interest due on the securities of any series on or before the due date for such payment;

	•	do all things necessary to preserve and keep in full force and effect our existence, rights (charter and statutory) and franchises unless failure to do so would not disadvantage the Holders in any material respect;

	•	deliver an officers’ certificate to the trustee, within 120 calendar days after the end of each fiscal year, stating whether or not, to the best knowledge of the persons signing the officers’ certificate, we are in default in the performance and observance of any of the terms, provisions and conditions of the indenture and, if we are, specifying all such defaults and the nature and status thereof of which we may have knowledge;

	•	maintain, preserve, and keep our material properties that are used in the conduct of our business in good repair, condition and working order, ordinary wear and tear excepted; and

	•	pay or discharge when due all taxes, assessments and governmental charges levied or imposed upon us or our income, profits or property, as well as all lawful claims

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		for labor, materials and supplies that, if unpaid, might by law become a lien upon our property, except those contested in good faith or that would not have a material adverse effect on us.

Original Issue Discount Securities

The debt securities of any series may be issued as original issue discount securities, which means they will be offered and sold at a substantial discount from their principal amount. Only a discounted amount will be due and payable when the trustee declares the acceleration of the maturity of these debt securities after an event of default has occurred and continues, as described under “— Events of Default — Remedies if an Event of Default Occurs” above.

Governing Law

The indenture and the debt securities will be governed by, and construed in accordance with, the laws of the State of New York.

Book-Entry Debt Securities

DTC will act as securities depository for the debt securities. The debt securities will be issued as fully-registered securities registered in the name of Cede & Co. (DTC’s partnership nominee) or such other name as may be requested by an authorized representative of DTC. One fully-registered certificate will be issued for the debt securities, in the aggregate principal amount of such issue, and will be deposited with DTC.

DTC is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code, and a “clearing agency” registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934. DTC holds and provides asset servicing for over 2.2 million issues of U.S. and non-U.S. equity, corporate and municipal debt issues, and money market instruments from over 100 countries that DTC’s participants (“Direct Participants”) deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation (“DTCC”).

DTCC, in turn, is owned by a number of Direct Participants of DTC and Members of the National Securities Clearing Corporation, Fixed Income Clearing Corporation, and Emerging Markets Clearing Corporation (NSCC, FICC, and EMCC, also subsidiaries of DTCC), as well as by the New York Stock Exchange, Inc., the American Stock Exchange LLC, and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others such as both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”). DTC has Standard & Poor’s highest rating: AAA. The DTC Rules applicable to its Participants are on file with the Securities and Exchange Commission. More information about DTC can be found at www.dtcc.com and www.dtc.org.

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Purchases of debt securities under the DTC system must be made by or through Direct Participants, which will receive a credit for the debt securities on DTC’s records. The ownership interest of each actual purchaser of each security (“Beneficial Owner”) is in turn to be recorded on the Direct and Indirect Participants’ records. Beneficial Owners will not receive written confirmation from DTC of their purchase. Beneficial Owners are, however, expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the debt securities are to be accomplished by entries made on the books of Direct and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in debt securities, except in the event that use of the book-entry system for the debt securities is discontinued.

To facilitate subsequent transfers, all debt securities deposited by Direct Participants with DTC are registered in the name of DTC’s partnership nominee, Cede & Co. or such other name as may be requested by an authorized representative of DTC. The deposit of debt securities with DTC and their registration in the name of Cede & Co. or such other nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the debt securities; DTC’s records reflect only the identity of the Direct Participants to whose accounts such debt securities are credited, which may or may not be the Beneficial Owners. The Direct and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers.

Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time.

Redemption notices shall be sent to DTC. If less than all of the debt securities within an issue are being redeemed, DTC’s practice is to determine by lot the amount of the interest of each Direct Participant in such issue to be redeemed.

Neither DTC nor Cede & Co. (nor such other DTC nominee) will consent or vote with respect to the debt securities unless authorized by a Direct Participant in accordance with DTC’s Procedures. Under its usual procedures, DTC mails an Omnibus Proxy to us as soon as possible after the record date. The Omnibus Proxy assigns Cede & Co.’s consenting or voting rights to those Direct Participants to whose accounts the debt securities are credited on the record date (identified in a listing attached to the Omnibus Proxy).

Redemption proceeds, distributions, and dividend payments on the debt securities will be made to Cede & Co., or such other nominee as may be requested by an authorized representative of DTC. DTC’s practice is to credit Direct Participants’ accounts, upon DTC’s receipt of funds and corresponding detail information from us or the trustee on the payment date in accordance with their respective holdings shown on DTC’s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in “street name,” and will be the responsibility of such Participant and not of DTC nor its nominee, the trustee, or us, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of redemption proceeds, distributions, and dividend payments to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of the

156

trustee, but disbursement of such payments to Direct Participants will be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners will be the responsibility of Direct and Indirect Participants.

DTC may discontinue providing its services as securities depository with respect to the debt securities at any time by giving reasonable notice to us or to the trustee. Under such circumstances, in the event that a successor securities depository is not obtained, certificates are required to be printed and delivered. We may decide to discontinue use of the system of book-entry-only transfers through DTC (or a successor securities depository). In that event, certificates will be printed and delivered to DTC.

The information in this section concerning DTC and DTC’s book-entry system has been obtained from sources that we believe to be reliable, but we take no responsibility for the accuracy thereof.

PLAN OF DISTRIBUTION

We may offer, from time to time, up to $1,500,000,000 in aggregate principal amount of our debt securities. We may sell the debt 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 debt securities will be named in the applicable prospectus supplement or pricing supplement, if any, accompanying this prospectus.

The distribution of the debt securities may be effected from time to time in one or more transactions at a fixed price equal to 100% of the principal amount thereof or such other price specified in the prospectus supplement or pricing supplement, if any, accompanying this prospectus, or at varying prices relating to prevailing market prices at the time of the offering. We may not offer our debt securities if our BDC asset coverage ratio would be less than 200% after giving effect to such offering.

In connection with the sale of the debt securities, underwriters or agents may receive compensation from us or from purchasers of our debt securities, for whom they may act as agents, in the form of discounts, concessions or commissions. Underwriters may sell debt 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 debt securities may be deemed to be underwriters under the Securities Act, and any discounts and commissions they receive from us and any profit realized by them on the resale of debt 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 us will be described in the applicable prospectus supplement or pricing supplement, if any, accompanying this prospectus.

Any debt securities sold pursuant to a prospectus supplement or pricing supplement, if any, accompanying this prospectus may be quoted on the New York Stock Exchange, or another exchange on which the debt securities are traded.

Under agreements into which we may enter, underwriters, dealers and agents who participate in the distribution of debt securities may be entitled to indemnification by us against certain liabilities, including liabilities under the Securities Act. Underwriters,

157

dealers and agents may engage in transactions with, or perform services for, us in the ordinary course of business.

If so indicated in the applicable prospectus supplement or pricing supplement, if any, accompanying this prospectus, we will authorize underwriters or other persons acting as our agents to solicit offers by certain institutions to purchase debt securities from us 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 us. The obligations of any purchaser under any such contract will be subject to the condition that the purchase of debt 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 or pricing supplement, if any, accompanying this prospectus, and such supplements will set forth the commission payable for solicitation of such contracts.

The maximum commission or discount to be received by any member of the National Association of Securities Dealers, Inc. or independent broker-dealer will not be greater than 10% for the sale of any securities being registered and 0.5% for due diligence.

In order to comply with the securities laws of certain states, if applicable, debt securities offered hereby will be sold in such jurisdictions only through registered or licensed brokers or dealers.

LEGAL MATTERS

The validity and enforceability of the debt securities offered hereby will be passed upon for us 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 or pricing supplement, if any, accompanying this prospectus.

CUSTODIANS, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR

Certain of our securities are held in safekeeping by PNC Bank, N.A., 808 17th Street, N.W., Washington, D.C. 20006. Other securities are held in custody at Chevy Chase Bank, 7501 Wisconsin Avenue, 14th Floor, Bethesda, Maryland 20814, Bank of America, 8300 Greensboro Drive, Suite 620, McLean, Virginia 22102. Union Bank of California, 350 California Street, 6th Floor, San Francisco, CA 94104 and M&T Investment Group, 25 South Charles Street MD2-CS57, Baltimore, MD 21201. American Stock Transfer and Trust Company, 59 Malden Lane, New York, New York 10038 acts as our transfer, dividend paying and reinvestment plan agent and registrar for our common stock. The Bank of New York, 101 Barclay St., New York, New York acts as our registrar, paying agent and transfer agent for our publicly issued debt securities.

158

BROKERAGE ALLOCATION AND OTHER PRACTICES

Since we generally acquire and dispose of our investments in privately negotiated transactions, we rarely use brokers in the normal course of business. In those cases where we do use a broker, we do not execute transactions through any particular broker or dealer, but will seek to obtain the best net results for Allied Capital, taking into account such factors as price (including the applicable brokerage commission or dealer spread), size of order, difficulty of execution, and operational facilities of the firm and the firm’s risk and skill in positioning blocks of securities. While we generally seek reasonably competitive execution costs, we may not necessarily pay the lowest spread or commission available. Subject to applicable legal requirements, we may select a broker based partly upon brokerage or research services provided to us. In return for such services, we may pay a higher commission than other brokers would charge if we determine in good faith that such commission is reasonable in relation to the services provided.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The consolidated financial statements as of December 31, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006, the related financial statement schedule as of December 31, 2006, and the senior securities table as of December 31, 2006, have been included herein in reliance upon the reports of KPMG LLP (KPMG), independent registered public accounting firm, located at 2001 M Street, NW, Washington, DC 20036, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. KPMG’s report on the consolidated financial statements refers to our adoption, effective January 1, 2006, of Statement of Accounting Standards No. 123 (Revised 2004), Share Based Payment.

159

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


	Page

Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheet — December 31, 2006 and 2005		F-3
Consolidated Statement of Operations — For the Years Ended December 31, 2006, 2005, and 2004		F-4
Consolidated Statement of Changes in Net Assets — For the Years Ended December 31, 2006, 2005, and 2004		F-5
Consolidated Statement of Cash Flows — For the Years Ended December 31, 2006, 2005, and 2004		F-6
Consolidated Statement of Investments — December 31, 2006		F-7
Consolidated Statement of Investments — December 31, 2005		F-18
Notes to Consolidated Financial Statements		F-28
Report of Independent Registered Public Accounting Firm		F-65
Schedule 12-14 — Investments in and Advances to Affiliates for the Year Ended December 31, 2006		F-66

F-1

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Allied Capital Corporation:

We have audited the accompanying consolidated balance sheet of Allied Capital Corporation and subsidiaries as of December 31, 2006 and 2005, including the consolidated statements of investments as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in net assets and cash flows, and the financial highlights (included in Note 14), for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements and financial highlights are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial highlights based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included physical counts of securities owned as of December 31, 2006 and 2005. 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.

In our opinion, the consolidated financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Allied Capital Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations, their cash flows, changes in their net assets, and financial highlights for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004), Share Based Payment.

Washington, D.C.

February 28, 2007

F-2

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET


				December 31,

				2006			2005
(in thousands, except per share amounts)
ASSETS
Portfolio at value:
	Private finance
		Companies more than 25% owned (cost: 2006-$1,578,822; 2005-$1,489,782)		$	1,490,180		$	1,887,651
		Companies 5% to 25% owned (cost: 2006-$438,560; 2005-$168,373)			449,813			158,806
		Companies less than 5% owned (cost: 2006-$2,479,981; 2005-$1,448,268)			2,437,908			1,432,833

			Total private finance (cost: 2006-$4,497,363; 2005-$3,106,423)		4,377,901			3,479,290
	Commercial real estate finance (cost: 2006-$103,546; 2005-$131,695)				118,183			127,065

			Total portfolio at value (cost: 2006-$4,600,909; 2005-$3,238,118)		4,496,084			3,606,355
U.S. Treasury bills (cost: 2006-$—; 2005-$100,000)					—			100,305
Investments in money market and other securities					202,210			121,967
Deposits of proceeds from sales of borrowed Treasury securities					—			17,666
Accrued interest and dividends receivable					64,566			60,366
Other assets					122,958			87,858
Cash					1,687			31,363

			Total assets	$	4,887,505		$	4,025,880

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Notes payable and debentures (maturing within one year: 2006-$—; 2005-$175,000)			$	1,691,394		$	1,193,040
	Revolving line of credit				207,750			91,750
	Obligations to replenish borrowed Treasury securities				—			17,666
	Accounts payable and other liabilities				147,117			102,878

			Total liabilities		2,046,261			1,405,334

Commitments and contingencies
Shareholders’ equity:
	Common stock, $0.0001 par value, 200,000 shares authorized; 148,575 and 136,697 shares issued and outstanding at December 31, 2006 and 2005, respectively				15			14
	Additional paid-in capital				2,493,335			2,177,283
	Common stock held in deferred compensation trust				(28,335	)		(19,460	)
	Notes receivable from sale of common stock				(2,850	)		(3,868	)
	Net unrealized appreciation (depreciation)				(123,084	)		354,325
	Undistributed earnings				502,163			112,252

			Total shareholders’ equity		2,841,244			2,620,546

			Total liabilities and shareholders’ equity		4,887,505		$	4,025,880

Net asset value per common share				$	19.12		$	19.17

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

F-3

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS


				For the Years Ended December 31,

				2006			2005		2004
(in thousands, except per share amounts)
Interest and Related Portfolio Income:
	Interest and dividends
		Companies more than 25% owned		$	102,636		$	122,450	$	91,710
		Companies 5% to 25% owned			39,754			21,924		25,702
		Companies less than 5% owned			244,037			172,779		202,230

			Total interest and dividends		386,427			317,153		319,642
	Fees and other income
		Companies more than 25% owned			29,606			27,365		29,774
		Companies 5% to 25% owned			4,447			124		2,383
		Companies less than 5% owned			32,078			29,510		15,291

			Total fees and other income		66,131			56,999		47,448

			Total interest and related portfolio income		452,558			374,152		367,090

Expenses:
	Interest				100,600			77,352		75,650
	Employee				92,902			78,300		53,739
	Employee stock options				15,599			—		—
	Administrative				39,005			69,713		34,686

			Total operating expenses		248,106			225,365		164,075

Net investment income before income taxes					204,452			148,787		203,015
Income tax expense, including excise tax					15,221			11,561		2,057

Net investment income					189,231			137,226		200,958

Net Realized and Unrealized Gains (Losses):
	Net realized gains (losses)
		Companies more than 25% owned			513,314			33,237		86,812
		Companies 5% to 25% owned			4,467			5,285		43,818
		Companies less than 5% owned			15,520			234,974		(13,390	)

			Total net realized gains		533,301			273,496		117,240
	Net change in unrealized appreciation or depreciation				(477,409	)		462,092		(68,712	)

			Total net gains		55,892			735,588		48,528

Net increase in net assets resulting from operations				$	245,123		$	872,814	$	249,486

Basic earnings per common share				$	1.72		$	6.48	$	1.92

Diluted earnings per common share				$	1.68		$	6.36	$	1.88

Weighted average common shares outstanding — basic					142,405			134,700		129,828

Weighted average common shares outstanding — diluted					145,599			137,274		132,458

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

F-4

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS


			For the Years Ended December 31,

			2006			2005			2004
(in thousands, except per share amounts)
Operations:
	Net investment income		$	189,231		$	137,226		$	200,958
	Net realized gains			533,301			273,496			117,240
	Net change in unrealized appreciation or depreciation			(477,409	)		462,092			(68,712	)

		Net increase in net assets resulting from operations		245,123			872,814			249,486

Shareholder distributions:
	Common stock dividends			(354,892	)		(314,509	)		(299,326	)
	Preferred stock dividends			(10	)		(10	)		(62	)

		Net decrease in net assets resulting from shareholder distributions		(354,902	)		(314,519	)		(299,388	)

Capital share transactions:
	Sale of common stock			295,769			—			70,251
	Issuance of common stock for portfolio investments			—			7,200			3,227
	Issuance of common stock in lieu of cash distributions			14,996			9,257			5,836
	Issuance of common stock upon the exercise of stock options			11,734			66,688			32,274
	Stock option expense			15,835			—			—
	Net decrease in notes receivable from sale of common stock			1,018			1,602			13,162
	Purchase of common stock held in deferred compensation trust			(9,855	)		(7,968	)		(13,687	)
	Distribution of common stock held in deferred compensation trust			980			2,011			184
	Other			—			3,683			3,856

		Net increase in net assets resulting from capital share transactions		330,477			82,473			115,103

		Total net increase in net assets		220,698			640,768			65,201
Net assets at beginning of year				2,620,546			1,979,778			1,914,577

Net assets at end of year			$	2,841,244		$	2,620,546		$	1,979,778

Net asset value per common share			$	19.12		$	19.17		$	14.87

Common shares outstanding at end of year				148,575			136,697			133,099

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

F-5

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS


				For the Years Ended December 31,

				2006			2005			2004
(in thousands)
Cash flows from operating activities:
	Net increase in net assets resulting from operations			$	245,123		$	872,814		$	249,486
	Adjustments:
		Portfolio investments			(2,257,828	)		(1,668,113	)		(1,472,396	)
		Principal collections related to investment repayments or sales			1,055,347			1,503,388			909,189
		Change in accrued or reinvested interest and dividends			(11,296	)		(6,594	)		(52,193	)
		Net collection (amortization) of discounts and fees			1,713			(1,564	)		(5,235	)
		Redemption of (investments in) U.S. Treasury bills			100,000			(100,000	)		—
		Redemption of (investments in) money market securities			(77,106	)		(121,967	)		—
		Stock option expense			15,835			—			—
		Changes in other assets and liabilities			36,418			33,023			18,716
		Depreciation and amortization			1,800			1,820			1,433
		Realized gains from the receipt of notes and other consideration from sale of investments, net of collections			(209,049	)		(4,293	)		(47,497	)
		Realized losses			24,169			69,565			150,462
		Net change in unrealized (appreciation) or depreciation			477,409			(462,092	)		68,712

			Net cash provided by (used in) operating activities		(597,465	)		115,987			(179,323	)

Cash flows from financing activities:
	Sale of common stock				295,769			—			70,251
	Sale of common stock upon the exercise of stock options				11,734			66,688			32,274
	Collections of notes receivable from sale of common stock				1,018			1,602			13,162
	Borrowings under notes payable				700,000			350,000			340,212
	Repayments on notes payable and debentures				(203,500	)		(219,700	)		(231,000	)
	Net borrowings under (repayments on) revolving line of credit				116,000			(20,250	)		112,000
	Redemption of preferred stock				—			—			(7,000	)
	Purchase of common stock held in deferred compensation trust				(9,855	)		(7,968	)		(13,687	)
	Other financing activities				(6,795	)		(8,333	)		(3,004	)
	Common stock dividends and distributions paid				(336,572	)		(303,813	)		(290,830	)
	Preferred stock dividends paid				(10	)		(10	)		(62	)

			Net cash provided by (used in) financing activities		567,789			(141,784	)		22,316

Net decrease in cash					(29,676	)		(25,797	)		(157,007	)
Cash at beginning of year					31,363			57,160			214,167

Cash at end of year				$	1,687		$	31,363		$	57,160

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

F-6

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Companies More Than 25% Owned

Alaris Consulting, LLC		Senior Loan (16.5%, Due 12/05 – 12/07)⁽⁶⁾	$	27,055	$	26,987	$	—
	(Business Services)	Equity Interests				5,305		—
		Guaranty ($1,100)

Avborne, Inc.⁽⁷⁾		Preferred Stock (12,500 shares)				610		918
	(Business Services)	Common Stock (27,500 shares)				—		—

Avborne Heavy Maintenance, Inc.⁽⁷⁾		Preferred Stock (1,568 shares)				2,401		—
	(Business Services)	Common Stock (2,750 shares)				—		—
		Guaranty ($2,401)				—		—

Border Foods, Inc.		Preferred Stock (100,000 shares)				12,721		—
	(Consumer Products)	Common Stock (148,838 shares)				3,848		—

Business Loan Express, LLC		Class A Equity Interests(25.0%)⁽⁶⁾		66,622		66,622		66,622
	(Financial Services)	Class B Equity Interests				119,436		79,139
		Class C Equity Interests				109,301		64,976
		Guaranty ($189,706 — See Note 3)
		Standby Letters of Credit ($25,000 — See Note 3)

Calder Capital Partners, LLC⁽⁵⁾		Senior Loan (8.0%, Due 5/09)⁽⁶⁾		975		975		975
	(Financial Services)	Equity Interests				2,076		2,076

Callidus Capital Corporation		Subordinated Debt (18.0%, Due 10/08)		5,762		5,762		5,762
	(Financial Services)	Common Stock (100 shares)				2,058		22,550

Coverall North America, Inc.		Unitranche Debt (12.0%, Due 7/11)		36,500		36,333		36,333
	(Business Services)	Subordinated Debt (15.0%, Due 7/11)		6,000		5,972		5,972
		Common Stock (884,880 shares)				16,649		19,619

CR Brands, Inc.		Subordinated Debt (16.6%, Due 2/13)		39,573		39,401		39,401
	(Consumer Products)	Common Stock (37,200,551 shares)				33,321		25,738

Financial Pacific Company		Subordinated Debt (17.4%, Due 2/12 – 8/12)		71,589		71,362		71,362
	(Financial Services)	Preferred Stock (10,964 shares)				10,276		15,942
		Common Stock (14,735 shares)				14,819		65,186

ForeSite Towers, LLC		Equity Interests				7,620		12,290
	(Tower Leasing)

Global Communications, LLC		Senior Loan (10.7%, Due 9/02 – 11/07)⁽⁶⁾		15,957		15,957		15,957
	(Business Services)	Subordinated Debt (17.0%, Due 12/03 – 9/05)⁽⁶⁾		11,339		11,336		11,237
		Preferred Equity Interest				14,067		—
		Options				1,639		—

Gordian Group, Inc.		Senior Loan (10.0%, Due 6/06 – 12/08)⁽⁶⁾		11,792		11,803		—
	(Business Services)	Common Stock (1,000 shares)				6,762		—


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.
⁽⁷⁾		Avborne, Inc. and Avborne Heavy Maintenance, Inc. are affiliated companies.

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

F-7

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Healthy Pet Corp.		Senior Loan (9.9%, Due 8/10)	$	27,038	$	27,038	$	27,038
	(Consumer Services)	Subordinated Debt (15.0%, Due 8/10)		43,720		43,579		43,579
		Common Stock (30,142 shares)				30,142		28,921

HMT, Inc.		Preferred Stock (554,052 shares)				2,637		2,637
	(Energy Services)	Common Stock (300,000 shares)				3,000		8,664
		Warrants				1,155		3,336

Huddle House, Inc.		Senior Loan (8.9%, Due 12/11)		19,950		19,950		19,950
	(Retail)	Subordinated Debt (15.0%, Due 12/12)		58,484		58,196		58,196
		Common Stock (415,328 shares)				41,662		41,662

Impact Innovations Group, LLC		Equity Interests in Affiliate				—		873
	(Business Services)

Insight Pharmaceuticals Corporation		Subordinated Debt (16.1%, Due 9/12)		60,049		59,850		59,850
	(Consumer Products)	Preferred Stock (25,000 shares)				25,000		7,845
		Common Stock (620,000 shares)				6,325		—

Jakel, Inc.		Subordinated Debt (15.5%, Due 3/08)⁽⁶⁾		15,192		15,192		6,655
	(Industrial Products)	Preferred Stock (6,460 shares)				6,460		—
		Common Stock (158,061 shares)				9,347		—

Legacy Partners Group, LLC		Senior Loan (14.0%, Due 5/09)⁽⁶⁾		7,646		7,646		4,843
	(Financial Services)	Subordinated Debt (18.0%, Due 5/09)⁽⁶⁾		2,952		2,952		—
		Equity Interests				4,248		—

Litterer Beteiligungs-GmbH⁽⁴⁾		Subordinated Debt (8.0%, Due 3/07)		692		692		692
	(Business Services)	Equity Interest				1,809		1,199

Mercury Air Centers, Inc.		Subordinated Debt (16.0%, Due 4/09 –
	(Business Services)	11/12)		49,358		49,217		49,217
		Common Stock (57,970 shares)				35,053		195,019
		Standby Letters of Credit ($1,581)

MVL Group, Inc.		Senior Loan (12.0%, Due 6/09 – 7/09)		27,299		27,245		27,245
	(Business Services)	Subordinated Debt (14.5%, Due 6/09)		35,846		35,478		35,478
		Common Stock (648,661 shares)				643		—

Penn Detroit Diesel Allison, LLC		Subordinated Debt (15.5%, Due 8/13)		38,173		37,994		37,994
	(Business Services)	Equity Interests				21,128		25,949

Powell Plant Farms, Inc.		Senior Loan (15.0%, Due 12/07)⁽⁶⁾		35,040		26,192		26,192
	(Consumer Products)	Subordinated Debt (20.0%, Due 6/03)⁽⁶⁾		19,291		19,223		962
		Preferred Stock (1,483 shares)				—		—
		Warrants				—		—

Service Champ, Inc.		Subordinated Debt (15.5%, Due 4/12)		27,733		27,619		27,619
	(Business Services)	Common Stock (63,888 shares)				13,662		16,786


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-8

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Staffing Partners Holding
	Company, Inc.	Subordinated Debt (13.5%, Due 1/07)⁽⁶⁾	$	540	$	540	$	486
	(Business Services)

Startec Global Communications
	Corporation	Senior Loan (10.0%, Due 5/07 – 5/09)		15,965		15,965		15,965
	(Telecommunications)	Common Stock (19,180,000 shares)				37,256		11,232

Sweet Traditions, LLC		Senior Loan (9.0%, Due 8/11)		39,022		35,172		35,172
	(Retail)	Equity Interests				450		450
		Standby Letter of Credit ($120)

Triview Investments, Inc.⁽⁸⁾		Senior Loan (9.6%, Due 6/07 – 12/07)		14,758		14,747		14,747
	(Broadcasting & Cable/Business	Subordinated Debt (16.0%, Due 9/11 – 7/12)		56,288		56,008		56,008
	Services/Consumer Products)	Subordinated Debt (7.9%, Due 11/07 – 7/08)⁽⁶⁾		4,327		4,327		4,342
		Common Stock (202 shares)				98,604		31,322
		Guaranty ($800)
		Standby Letter of Credit ($200)

Total companies more than 25% owned					$	1,578,822	$	1,490,180

Companies 5% to 25% Owned

Advantage Sales & Marketing, Inc.		Subordinated Debt (12.0%, Due 3/14)	$	152,320	$	151,648	$	151,648
	(Business Services)	Equity Interests				—		11,000

Air Medical Group Holdings LLC		Senior Loan (9.9%, Due 3/11)		1,828		1,763		1,763
	(Healthcare Services)	Subordinated Debt (14.0%, Due 11/12)		35,180		35,128		35,128
		Equity Interests				3,470		5,950

Alpine ESP Holdings, Inc.		Preferred Stock (622 shares)				622		602
	(Business Services)	Common Stock (13,513 shares)				14		—

Amerex Group, LLC		Subordinated Debt (12.0%, Due 1/13)		8,400		8,400		8,400
	(Consumer Products)	Equity Interests				3,546		13,823

BB&T Capital Partners/Windsor
	Mezzanine Fund, LLC ⁽⁵⁾	Equity Interests				5,873		5,554
	(Private Equity Fund)

Becker Underwood, Inc.		Subordinated Debt (14.5%, Due 8/12)		24,244		24,163		24,163
	(Industrial Products)	Common Stock (5,073 shares)				5,813		3,700

BI Incorporated		Subordinated Debt (13.5%, Due 2/14)		30,269		30,135		30,135
	(Business Services)	Common Stock (40,000 shares)				4,000		4,100


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.
⁽⁸⁾		Triview Investments, Inc. holds investments in Longview Cable & Data, LLC (Broadcasting & Cable) with a cost of $67.3 million and a value of $7.5 million, Triax Holdings, LLC (Consumer Products) with a cost of $98.9 million and a value of $91.5 million, and Crescent Hotels & Resorts, LLC and affiliates (Business Services) with a cost of $7.5 million and a value of $7.3 million.

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

F-9

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

CitiPostal, Inc. and Affiliates		Senior Loan (11.1%, Due 8/13-11/14)	$	20,670	$	20,569	$	20,569
	(Business Services)	Equity Interests				4,447		4,700

Creative Group, Inc.		Subordinated Debt (12.0%, Due 9/13)		15,000		13,656		13,656
	(Business Services)	Warrant				1,387		1,387

Drew Foam Companies, Inc.		Preferred Stock (722 shares)				722		722
	(Business Services)	Common Stock (7,287 shares)				7		7

MedBridge Healthcare, LLC		Senior Loan (6.0%, Due 8/09)⁽⁶⁾		7,164		7,164		7,164
	(Healthcare Services)	Subordinated Debt (10.0%, Due 8/14)⁽⁶⁾		5,184		5,184		1,813
		Convertible Subordinated Debt (2.0%, Due 8/14)⁽⁶⁾		2,970		984		—
		Equity Interests				1,306		—

Multi-Ad Services, Inc.		Unitranche Debt (11.3%, Due 11/11)		20,000		19,879		19,879
	(Business Services)	Equity Interests				2,000		2,000

Nexcel Synthetics, LLC		Subordinated Debt (14.5%, Due 6/09)		10,998		10,978		10,978
	(Consumer Products)	Equity Interests				1,755		1,486

PresAir LLC		Senior Loan (7.5%, Due 12/10)⁽⁶⁾		5,810		5,492		2,206
	(Industrial Products)	Equity Interests				1,336		—

Progressive International
	Corporation	Subordinated Debt (16.0%, Due 12/09)		7,553		7,533		7,533
	(Consumer Products)	Preferred Stock (500 shares)				500		1,024
		Common Stock (197 shares)				13		2,300
		Warrants				—		—

Regency Healthcare Group, LLC		Senior Loan (11.1%, Due 6/12)		1,250		1,232		1,232
	(Healthcare Services)	Unitranche Debt (11.1%, Due 6/12)		20,000		19,908		19,908
		Equity Interests				1,500		1,616

SGT India Private Limited⁽⁴⁾		Common Stock (109,524 shares)				3,944		3,346
	(Business Services)

Soteria Imaging Services, LLC		Subordinated Debt (11.6%, Due 11/10)		18,500		17,569		17,569
	(Healthcare Services)	Equity Interests				2,163		2,541

Universal Environmental Services, LLC		Unitranche Debt (14.5%, Due 2/09)		10,989		10,962		10,211
	(Business Services)	Equity Interests				1,795		—

Total companies 5% to 25% owned					$	438,560	$	449,813

Companies Less Than 5% Owned

3SI Security Systems, Inc.		Subordinated Debt (14.5%, Due 8/13)	$	26,857	$	26,740	$	26,740
	(Consumer Products)

AgData, L.P.		Unitranche Debt (10.3%, Due 7/12)		11,330		11,269		11,269
	(Consumer Services)

Anthony, Inc.		Subordinated Debt (13.3%, Due 8/11 –
	(Industrial Products)	9/12)		14,818		14,768		14,768

Axium Healthcare Pharmacy, Inc.		Senior Loan (12.0%, Due 12/12)		200		161		161
	(Healthcare Services)	Unitranche Debt (12.0%, Due 12/12)		9,000		8,956		8,956
		Common Stock (26,500 shares)				2,650		2,650

Baird Capital Partners IV Limited Partnership⁽⁵⁾(Private Equity Fund)		Limited Partnership Interest				876		876


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-10

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Bantek West, Inc.		Subordinated Debt (11.6%, Due 1/11)⁽⁶⁾	$	30,000	$	30,000	$	21,463
	(Business Services)

Benchmark Medical, Inc.		Warrants				18		—
	(Healthcare Services)

BenefitMall, Inc.		Unitranche Debt (13.3%, Due 8/12)		110,030		109,648		109,648
	(Business Services)	Common Stock (45,528,000 shares)⁽¹¹⁾				45,528		43,578
		Warrants⁽¹¹⁾				—		—
		Standby Letters of Credit ($9,981)

Breeze-Eastern Corporation⁽³⁾		Senior Loan (10.1%, Due 5/11)		10,000		10,000		10,000
	(Industrial Products)

Broadcast Electronics, Inc.		Senior Loan (9.1%, Due 7/12)		4,963		4,930		4,930
	(Business Services)

C&K Market, Inc.		Subordinated Debt (14.0%, Due 12/08)		27,819		27,738		27,738
	(Retail)

Callidus Debt Partners
	CDO Fund I, Ltd. ⁽⁴⁾⁽⁹⁾	Class C Notes (12.9%, Due 12/13)		18,800		18,951		18,951
	(Senior Debt Fund)	Class D Notes (17.0%, Due 12/13)		9,400		9,476		9,476

Callidus Debt Partners
	CLO Fund III, Ltd.⁽⁴⁾⁽⁹⁾(Senior Debt Fund)	Preferred Shares (23,600,000 shares, 12.7%) ⁽¹²⁾				23,285		23,010

Callidus Debt Partners
	CLO Fund IV, Ltd. ⁽⁴⁾⁽⁹⁾	Income Notes (13.8%)⁽¹²⁾				12,986		12,986
	(Senior Debt Fund)

Callidus Debt Partners
	CLO Fund V, Ltd.⁽⁴⁾⁽⁹⁾	Income Notes (15.8%)⁽¹²⁾				13,769		13,769
	(Senior Debt Fund)

Callidus MAPS CLO Fund I LLC⁽⁹⁾		Class E Notes (10.9%, Due 12/17)		17,000		17,000		17,155
	(Senior Debt Fund)	Income Notes (15.9%)⁽¹²⁾				50,960		47,421

Camden Partners Strategic Fund II,
	L.P.⁽⁵⁾	Limited Partnership Interest				2,141		2,873
	(Private Equity Fund)

Carlisle Wide Plank Floors, Inc.		Unitranche Debt (10.5%, Due 6/11)		14,000		13,900		13,900
	(Consumer Products)	Preferred Stock (400,000 Shares)				400		400

Catterton Partners V, L.P.⁽⁵⁾		Limited Partnership Interest				3,306		3,412
	(Private Equity Fund)

Catterton Partners VI, L.P.⁽⁵⁾		Limited Partnership Interest				531		531
	(Private Equity Fund)

Centre Capital Investors IV, LP⁽⁵⁾		Limited Partnership Interest				1,991		1,889
	(Private Equity Fund)


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.
⁽⁹⁾		The fund is managed by Callidus Capital, a portfolio company of Allied Capital.
⁽¹¹⁾		Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.
⁽¹²⁾		Represents the effective yield earned on these preferred equity investments. The yield is included in interest income from companies less than 5% owned in the consolidated statement of operations.

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

F-11

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Commercial Credit Group, Inc.		Subordinated Debt (14.8%, Due 2/11)	$	5,000	$	4,959	$	4,959
	(Financial Services)	Preferred Stock (32,500 shares)				3,900		3,900
		Warrants				—		—

Community Education Centers, Inc.		Subordinated Debt (16.0%, Due 12/10)		34,158		34,067		34,067
	(Education Services)

Compass Group Diversified
	Holdings LLC⁽³⁾	Senior Loan (8.4%, Due 11/11)		8,500		8,375		8,375
	(Financial Services)

Component Hardware Group, Inc.		Subordinated Debt (13.5%, Due 1/13)		18,158		18,075		18,075
	(Industrial Products)

Cook Inlet Alternative Risk, LLC		Unitranche Debt (10.0%, Due 4/12)		67,500		67,146		67,146
	(Business Services)	Equity Interests				2,000		2,300

Cortec Group Fund IV, L.P.⁽⁵⁾		Limited Partnership Interest				1,137		1,137
	(Private Equity)

CSAV, Inc.		Subordinated Debt (11.9%, Due 6/13)		37,500		37,500		37,500
	(Business Services)

DCWV Acquisition Corporation		Senior Loan (8.9%, Due 7/12)		2,074		2,060		2,060
	(Consumer Products)	Unitranche Debt (11.0%, Due 7/12)		16,788		16,694		16,694

Deluxe Entertainment Services Group, Inc.		Subordinated Debt (13.6%, Due 7/11)		30,000		30,000		30,000
	(Business Services)

Distant Lands Trading Co.		Senior Loan (10.6%, Due 11/11)		2,700		2,656		2,656
	(Consumer Products)	Unitranche Debt (11.0%, Due 11/11)		54,375		54,130		54,130
		Common Stock (4,000 shares)				4,000		2,975

Drilltec Patents & Technologies
	Company, Inc.	Subordinated Debt (18.0%, Due 8/06)		4,119		4,119		4,119
	(Energy Services)	Subordinated Debt (16.5%, Due 8/06)⁽⁶⁾		10,994		10,918		9,121

Driven Brands, Inc.		Senior Loan (8.9%, Due 6/11)		37,070		36,918		36,918
	d/b/a Meineke and Econo Lube	Subordinated Debt (12.1%, Due 6/12 – 6/13)		83,000		82,684		82,684
	(Consumer Services)	Common Stock (11,675,331 shares)⁽¹¹⁾				29,455		19,702
		Warrants⁽¹¹⁾				—		—

Digital VideoStream, LLC		Unitranche Debt (11.0%, Due 2/12)		19,127		19,021		19,021
	(Business Services)	Convertible Subordinated Debt (10.0%, Due 2/16)		3,730		3,714		3,714

Dynamic India Fund IV⁽⁴⁾⁽⁵⁾		Equity Interests				3,850		3,850
	(Private Equity Fund)

EarthColor, Inc.		Senior Loan (7.4%, Due 11/11)		35,000		35,000		35,000
	(Business Services)	Subordinated Debt (15.0%, Due 11/13)		107,000		106,478		106,478
		Common Stock (53,540 shares)⁽¹¹⁾				53,540		53,540
		Warrants⁽¹¹⁾				—		—

eCentury Capital Partners, L.P.⁽⁵⁾		Limited Partnership Interest				6,274		2,090
	(Private Equity Fund)


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.
	⁽¹¹⁾			Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

F-12

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Elexis Beta GmbH⁽⁴⁾		Options			$	426	$	50
	(Industrial Products)

Farley’s & Sathers Candy Company, Inc.		Subordinated Debt (11.4%, Due 3/11)	$	20,000		19,931		19,931
	(Consumer Products)

Frozen Specialties, Inc.		Warrants				435		320
	(Consumer Products)

Garden Ridge Corporation (Retail)		Subordinated Debt (7.0%, Due 5/12)⁽⁶⁾		22,500		22,500		22,500

Geotrace Technologies, Inc.		Subordinated Debt (10.0%, Due 6/09)		23,945		22,481		22,481
	(Energy Services)	Warrants				2,350		1,900

Ginsey Industries, Inc.		Subordinated Debt (12.5%, Due 3/07)		2,743		2,743		2,743
	(Consumer Products)

Grant Broadcasting Systems II		Subordinated Debt (5.0%, Due 6/11)		3,005		3,005		3,005
	(Broadcasting & Cable)

Grotech Partners, VI, L.P.⁽⁵⁾		Limited Partnership Interest				8,223		6,088
	(Private Equity Fund)

Havco Wood Products LLC		Unitranche Debt (11.1%, Due 8/11)		19,654		18,615		18,615
	(Industrial Products)	Equity Interests				1,049		3,000

Haven Eldercare of New England, LLC ⁽¹⁰⁾		Subordinated Debt (12.0%, Due 8/09)		2,827		2,827		2,827
	(Healthcare Services)

Haven Healthcare Management, LLC⁽¹⁰⁾		Subordinated Debt (18.0%, Due 4/07)		140		140		140
	(Healthcare Services)

HealthASPex Services Inc.		Senior Loan (4.0%, Due 7/08)		500		500		500
	(Business Services)

The Hillman Companies, Inc.⁽³⁾		Subordinated Debt (10.0%, Due 9/11)		44,580		44,427		44,427
	(Consumer Products)

The Homax Group, Inc.		Senior Loan (9.2%, Due 10/12)		12,485		12,485		12,485
	(Consumer Products)	Subordinated Debt (12.0%, Due 4/14)		14,000		13,171		13,171
		Preferred Stock (89 shares)				89		89
		Common Stock (28 shares)				6		6
		Warrants				1,106		1,106

Hot Stuff Foods, LLC		Senior Loan (8.9%, Due 2/11-2/12)		48,580		48,351		48,351
	(Consumer Products)	Subordinated Debt (13.7%, Due 8/12 – 2/13)		60,606		60,353		60,353
		Subordinated Debt (16.0%, Due 2/13)⁽⁶⁾		20,841		20,749		8,460
		Common Stock (1,122,452 shares)⁽¹¹⁾				56,186		—
		Warrants⁽¹¹⁾				—		—

Ideal Snacks Corporation		Senior Loan (9.0%, Due 6/10)		5,850		5,815		5,815
	(Consumer Products)

Integrity Interactive Corporation		Unitranche Debt (10.5%, Due 2/12)		29,500		29,314		29,314
	(Business Services)

International Fiber Corporation		Subordinated Debt (14.0%, Due 6/12)		21,986		21,914		21,914
	(Industrial Products)	Preferred Stock (25,000 shares)				2,500		2,200


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.
	⁽¹⁰⁾			Haven Eldercare of New England, LLC and Haven Healthcare Management, LLC are affiliated companies.
	⁽¹¹⁾			Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

F-13

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Kodiak Fund LP⁽⁵⁾		Equity Interests			$	4,700	$	4,656
	(Private Equity Fund)

Line-X, Inc.		Senior Loan (9.1%, Due 8/11)	$	2,000		1,981		1,981
	(Consumer Products)	Unitranche Debt (10.0% Due 8/11)		48,509		48,306		48,306
		Standby Letter of Credit ($1,500)

MedAssets, Inc.		Preferred Stock (227,865 shares)				2,049		3,623
	(Business Services)	Common Stock (50,000 shares)				—		250

MHF Logistical Solutions, Inc.		Subordinated Debt (11.5%, Due 6/12)		33,600		33,448		33,448
	(Business Services)	Subordinated Debt (18.0%, Due 6/13)⁽⁶⁾		11,211		11,155		8,719
		Common Stock (20,934 shares)⁽¹¹⁾				20,942		—
		Warrants⁽¹¹⁾				—		—

Mid-Atlantic Venture Fund IV, L.P.⁽⁵⁾		Limited Partnership Interest				6,974		3,221
	(Private Equity Fund)

Mogas Energy, LLC		Subordinated Debt (9.5%, Due 3/12 – 4/12)		16,336		15,100		16,318
	(Energy Services)	Warrants				1,774		6,250

Network Hardware Resale, Inc.		Unitranche Debt (10.5%, Due 12/11)		37,154		37,357		37,357
	(Business Services)	Convertible Subordinated Debt (9.8%, Due 12/15)		12,000		12,068		12,559

Norwesco, Inc.		Subordinated Debt (12.6%, Due 1/12 – 7/12)		82,486		82,172		82,172
	(Industrial Products)	Common Stock (559,603 shares)⁽¹¹⁾				38,313		83,329
		Warrants⁽¹¹⁾				—		—

Novak Biddle Venture Partners III, L.P.⁽⁵⁾		Limited Partnership Interest				1,834		1,947
	(Private Equity Fund)

Oahu Waste Services, Inc.		Stock Appreciation Rights				239		800
	(Business Services)

Odyssey Investment Partners Fund III,
	LP⁽⁵⁾	Limited Partnership Interest				1,883		1,744
	(Private Equity Fund)

Palm Coast Data, LLC		Senior Loan (8.9%, Due 8/10)		15,306		15,243		15,243
	(Business Services)	Subordinated Debt (15.5%, Due 8/12 – 8/15)		30,396		30,277		30,277
		Common Stock (21,743 shares)⁽¹¹⁾				21,743		41,707
		Warrants⁽¹¹⁾				—		—

Passport Health
	Communications, Inc.	Subordinated Debt (14.0%, Due 4/12)		10,145		10,101		10,101
	(Healthcare Services)	Preferred Stock (651,381 shares)				2,000		2,189

Performant Financial Corporation		Common Stock (478,816 shares)				734		—
	(Business Services)


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.
	⁽¹¹⁾			Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

F-14

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Postle Aluminum Company, LLC		Unitranche Debt (11.0%, Due 10/12)	$	57,500	$	57,189	$	57,189
	(Industrial Products)	Equity Interests				2,500		2,500

Pro Mach, Inc.		Subordinated Debt (12.5%, Due 6/12)		14,471		14,402		14,402
	(Industrial Products)	Equity Interests				1,500		2,200

Promo Works, LLC		Unitranche Debt (10.3%, Due 12/11)		31,000		30,727		30,727
	(Business Services)	Guaranty ($1,200)

S.B. Restaurant Company		Unitranche Debt (9.8%, Due 4/11)		41,501		41,094		41,094
	(Retail)	Preferred Stock (54,125 shares)				135		135
		Warrants				619		1,200
		Standby Letters of Credit ($2,611)

SBBUT, LLC		Equity Interests				—		—
	(Consumer Products)

Service Center Metals, LLC		Subordinated Debt (15.5%, Due 9/11)		5,000		4,976		4,976
	(Industrial Products)	Equity Interests				312		318

Soff-Cut Holdings, Inc.		Preferred Stock (300 shares)				300		300
	(Industrial Products)	Common Stock (2,000 shares)				200		180

SPP Mezzanine Funding, L.P.⁽⁵⁾		Limited Partnership Interest				2,551		2,825
	(Private Equity Fund)

SPP Mezzanine Funding II, L.P.⁽⁵⁾		Limited Partnership Interest				326		326
	(Private Equity Fund)

Stag-Parkway, Inc.		Unitranche Debt (10.8%, Due 7/12)		63,000		62,711		62,711
	(Business Services)

STS Operating, Inc.		Subordinated Debt (15.0%, Due 1/13)		30,156		30,021		30,021
	(Industrial Products)

The Step2 Company, LLC		Unitranche Debt (10.5%, Due 4/12)		67,898		67,457		67,457
	(Consumer Products)	Equity Interests				2,000		1,763

Tradesmen International, Inc.		Subordinated Debt (12.0%, Due 12/09)		15,000		14,468		14,468
	(Business Services)	Warrants				710		3,300

TransAmerican Auto Parts, LLC		Subordinated Debt (14.0%, Due 11/12)		12,947		12,892		12,892
	(Consumer Products)	Equity Interests				1,190		747

Universal Air Filter Company		Unitranche Debt (11.0%, Due 11/11)		19,117		19,026		19,026
	(Industrial Products)

Updata Venture Partners II, L.P.⁽⁵⁾		Limited Partnership Interest				5,477		5,158
	(Private Equity Fund)

Venturehouse-Cibernet Investors, LLC		Equity Interest				42		42
	(Business Services)

Venturehouse Group, LLC⁽⁵⁾		Equity Interest				598		365
	(Private Equity Fund)

VICORP Restaurants, Inc.		Warrants				33		—
	(Retail)


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-15

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2006
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Walker Investment Fund II, LLLP⁽⁵⁾		Limited Partnership Interest			$	1,329	$	458
	(Private Equity Fund)

Wear Me Apparel Corporation		Subordinated Debt (15.0%, Due 12/10)	$	40,000		39,407		39,407
	(Consumer Products)	Warrants				1,219		5,120

Wilton Industries, Inc.		Subordinated Debt (16.0%, Due 6/08)		2,400		2,400		2,400
	(Consumer Products)

Woodstream Corporation		Subordinated Debt (13.5%, Due 11/12 – 5/13)		53,114		52,989		52,989
	(Consumer Products)	Common Stock (180 shares)				673		3,885
		Warrants				—		2,815

York Insurance Services Group, Inc.		Subordinated Debt (14.5%, Due 1/14)		44,249		44,045		44,045
	(Business Services)	Common Stock (15,000 shares)				1,500		1,500

Other companies		Other debt investments⁽⁶⁾		223		223		218
		Other equity investments				8		—

Total companies less than 5% owned					$	2,479,981	$	2,437,908

Total private finance (145 portfolio companies)					$	4,497,363	$	4,377,901


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-16

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


Commercial Real Estate Finance
(in thousands, except number of loans)


						December 31, 2006
		Interest		Number of
		Rate Ranges		Loans		Cost		Value

Commercial Mortgage Loans
			Up to 6.99%		3	$	20,470	$	19,692
			7.00%–8.99%		9		24,092		24,073
			9.00%–10.99%		4		24,117		24,117
		15.00% and above			2		3,970		3,970

	Total commercial mortgage loans⁽¹³⁾				18	$	72,649	$	71,852

Real Estate Owned						$	15,708	$	19,660

Equity Interests⁽²⁾ — Companies more than 25% owned (Guarantees — $6,871)						$	15,189	$	26,671

	Total commercial real estate finance					$	103,546	$	118,183

Total portfolio						$	4,600,909	$	4,496,084


			Yield		Cost		Value

Liquidity Portfolio
	American Beacon Money Market Select FD Fund⁽¹⁴⁾			5.3%	$	85,672	$	85,672
	Certificate of Deposit (Due March 2007)⁽¹⁴⁾			5.6%		40,565		40,565
	American Beacon Money Market Fund⁽¹⁴⁾			5.2%		40,384		40,384
	SEI Daily Income Tr Prime Obligation Fund⁽¹⁴⁾			5.2%		34,671		34,671
	Blackrock Liquidity Funds⁽¹⁴⁾			5.2%		476		476

		Total liquidity portfolio			$	201,768	$	201,768

Other Investments in Money Market Securities⁽¹⁴⁾
	Columbia Treasury Reserves Money Market Fund			5.2%	$	441	$	441
	Columbia Money Market Reserves			5.2%	$	1	$	1

⁽¹⁾ Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for
a single issuer. The maturity dates represent the earliest and the latest maturity dates.

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

⁽³⁾ Public company.

⁽⁴⁾ Non-U.S. company or principal place of business outside the U.S.

⁽⁵⁾ Non-registered investment company.

⁽¹³⁾ Commercial mortgage loans totaling $18.9 million at value were on non-accrual status and therefore were considered non-income producing.

⁽¹⁴⁾ Included in investments in money market and other securities on the accompanying Consolidated Balance Sheet.

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

F-17

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Companies More Than 25% Owned

Acme Paging, L.P.⁽⁴⁾		Senior Loan (6.0%, Due 12/07)⁽⁶⁾	$	3,750	$	3,750	$	—
	(Telecommunications)	Subordinated Debt (10.0%, Due 1/08)⁽⁶⁾		881		881		—
		Common Stock (23,513 shares)				27		—

Advantage Sales & Marketing, Inc.		Subordinated Debt (10.5%, Due 9/09)		60,000		59,787		59,787
	(Business Services)	Subordinated Debt (18.5%, Due 12/09)		124,000		124,000		124,000
		Common Stock (18,924,976 shares)				73,932		476,578

Alaris Consulting, LLC		Senior Loan (15.8%, Due 12/05 – 12/07) ⁽⁶⁾		27,055		27,050		—
	(Business Services)	Equity Interests				5,305		—
		Guaranty ($1,100)

American Healthcare Services, Inc.		Senior Loan (0.7%, Due 12/04 – 12/05) ⁽⁶⁾		4,999		4,600		4,097
	and Affiliates
	(Healthcare Services)

Avborne, Inc.⁽⁷⁾		Preferred Stock (12,500 shares)				658		892
	(Business Services)	Common Stock (27,500 shares)				—		—

Avborne Heavy Maintenance, Inc.⁽⁷⁾		Preferred Stock (1,568 shares)				2,401		—
	(Business Services)	Common Stock (2,750 shares)				—		—
		Guaranty ($2,401)

Business Loan Express, LLC		Subordinated Debt (6.9%, Due 4/06)		10,000		10,000		10,000
	(Financial Services)	Class A Equity Interests		60,693		60,693		60,693
		Class B Equity Interests				119,436		146,910
		Class C Equity Interests				109,301		139,521
		Guaranty ($135,437 — See Note 3)
		Standby Letters of Credit ($34,050 — See Note 3)

Callidus Capital Corporation		Senior Loan (12.0%, Due 12/06)		600		600		600
	(Financial Services)	Subordinated Debt (18.0%, Due 10/08)		4,832		4,832		4,832
		Common Stock (10 shares)				2,049		7,968

Diversified Group Administrators, Inc.		Preferred Stock (1,000,000 shares)				700		728
	(Business Services)	Preferred Stock (1,451,380 shares)				841		841
		Common Stock (1,451,380 shares)				—		502

Financial Pacific Company (Financial Services)		Subordinated Debt (17.4%, Due 2/12 – 8/12)		70,175		69,904		69,904
		Preferred Stock (10,964 shares)				10,276		13,116
		Common Stock (14,735 shares)				14,819		44,180

ForeSite Towers, LLC		Equity Interests				7,620		9,750
	(Tower Leasing)


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.
⁽⁷⁾		Avborne, Inc. and Avborne Heavy Maintenance, Inc. are affiliated companies.

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

F-18

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Global Communications, LLC		Senior Loan (10.7%, Due 9/02 – 11/07) ⁽⁶⁾	$	15,957	$	15,957	$	15,957
	(Business Services)	Subordinated Debt (17.0%, Due 12/03 – 9/05)⁽⁶⁾		11,201		11,198		11,198
		Preferred Equity Interest				14,067		4,303
		Options				1,639		—

Gordian Group, Inc.		Senior Loan (10.0%, Due 6/06 – 12/08) ⁽⁶⁾		11,392		11,421		4,161
	(Business Services)	Common Stock (1,000 shares)				6,542		—

Healthy Pet Corp.		Senior Loan (10.1%, Due 8/10)		4,086		4,086		4,086
	(Consumer Services)	Subordinated Debt (15.0%, Due 8/10)		38,716		38,535		38,535
		Common Stock (25,766 shares)				25,766		25,766

HMT, Inc.		Preferred Stock (554,052 shares)				2,637		2,637
	(Energy Services)	Common Stock (300,000 shares)				3,000		5,343
		Warrants				1,155		2,057

Impact Innovations Group, LLC (Business Services)		Equity Interests in Affiliate				—		742

Insight Pharmaceuticals Corporation		Subordinated Debt (16.1%, Due 9/12)		58,534		58,298		58,298
	(Consumer Products)	Preferred Stock (25,000 shares)				25,000		26,791
		Common Stock (6,200 shares)				6,325		236

Jakel, Inc.		Subordinated Debt (15.5%, Due 3/08)⁽⁶⁾		13,742		13,742		—
	(Industrial Products)	Preferred Stock (6,460 shares)				6,460		—
		Common Stock (158,061 shares)				9,347		—

Legacy Partners Group, LLC		Senior Loan (14.0%, Due 5/09)⁽⁶⁾		7,646		7,646		5,029
	(Financial Services)	Subordinated Debt (18.0%, Due 5/09)⁽⁶⁾		2,952		2,952		—
		Equity Interests				4,229		—

Litterer Beteiligungs-GmbH⁽⁴⁾		Subordinated Debt (8.0%, Due 3/07)		621		621		621
	(Business Services)	Equity Interest				1,810		2,226

Mercury Air Centers, Inc.		Senior Loan (10.0%, Due 4/09)		31,720		31,720		31,720
	(Business Services)	Subordinated Debt (16.0%, Due 4/09)		46,703		46,519		46,519
		Common Stock (57,970 shares)				35,053		88,898
		Standby Letters of Credit ($1,397)

MVL Group, Inc.		Senior Loan (12.1%, Due 7/09)		27,519		27,218		27,218
	(Business Services)	Subordinated Debt (14.4%, Due 7/09)		32,905		32,417		32,417
		Common Stock (648,661 shares)				643		3,211

Pennsylvania Avenue Investors, L.P. ⁽⁵⁾		Equity Interests				2,576		1,864
	(Private Equity Fund)

Powell Plant Farms, Inc.		Senior Loan (15.0%, Due 12/05 - 12/06)		32,640		23,792		23,792
	(Consumer Products)	Subordinated Debt (20.0%, Due 6/03)⁽⁶⁾		19,291		19,224		7,364
		Preferred Stock (1,483 shares)				—		—
		Warrants				—		—


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-19

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Redox Brands, Inc.		Preferred Stock (2,726,444 shares)			$	7,903	$	12,097
	(Consumer Products)	Warrants				584		500

Service Champ, Inc.		Subordinated Debt (15.5%, Due 4/12)	$	27,041		26,906		26,906
	(Business Services)	Common Stock (63,888 shares)				13,662		13,319

Staffing Partners Holding		Subordinated Debt (13.5%, Due 1/07)⁽⁶⁾		6,343		6,343		6,343
	Company, Inc.	Preferred Stock (439,600 shares)				4,968		1,812
	(Business Services)	Common Stock (69,773 shares)				50		—
		Warrants				10		—

Startec Global Communications		Senior Loan (10.0%, Due 5/07 – 5/09)		25,226		25,226		21,685
	Corporation	Common Stock (19,180,000 shares)				37,255		—
	(Telecommunications)

STS Operating, Inc.		Subordinated Debt (15.3%, Due 3/12)		6,593		6,593		6,593
	(Industrial Products)	Common Stock (3,000,000 shares)				3,522		64,963
		Options				—		560

Triview Investments, Inc.⁽⁸⁾		Senior Loan (8.6%, Due 12/06)		7,449		7,449		7,449
	(Broadcasting & Cable/	Subordinated Debt (15.0%, Due 7/12)		31,000		30,845		30,845
	Consumer Products)	Subordinated Debt (16.8%, Due 7/08 –
		7/12)⁽⁶⁾		19,600		19,520		19,520
		Common Stock (202 shares)				93,889		29,171
		Guaranty ($800)
		Standby Letter of Credit ($200)

Total companies more than 25% owned					$	1,489,782	$	1,887,651

Companies 5% to 25% Owned

Air Evac Lifeteam		Subordinated Debt (13.8%, Due 7/10)	$	42,414	$	42,267	$	42,267
	(Healthcare Services)	Equity Interests				3,941		4,025


Aspen Pet Products, Inc.		Subordinated Debt (19.0%, Due 6/08)		20,051		19,959		19,959
	(Consumer Products)	Preferred Stock (2,935 shares)				2,154		1,638
		Common Stock (1,400 shares)				140		17
		Warrants				—		—

Becker Underwood, Inc.		Subordinated Debt (14.5%, Due 8/12)		23,639		23,543		23,543
	(Industrial Products)	Common Stock (5,073 shares)				5,813		2,200

The Debt Exchange Inc.		Preferred Stock (921,875 shares)				1,250		3,219
	(Business Services)


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.
⁽⁸⁾		Triview Investments, Inc. (formerly GAC Investments, Inc.) holds investments in Longview Cable & Data, LLC (Broadcasting & Cable) with a cost of $66.5 million and value of $16.0 million and Triax Holdings, LLC (Consumer Products) with a cost of $85.2 million and a value of $71.0 million. The guaranty and standby letter of credit relate to Longview Cable & Data, LLC.

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

F-20

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

MedBridge Healthcare, LLC		Senior Loan (4.0%, Due 8/09)	$	7,093	$	7,093	$	7,093
	(Healthcare Services)	Subordinated Debt (10.0%, Due 8/14)⁽⁶⁾		4,809		4,809		534
		Convertible Subordinated Debt (2.0%, Due 8/14)⁽⁶⁾		2,970		984		—
		Equity Interests				800		—

Nexcel Synthetics, LLC		Subordinated Debt (14.5%, Due 6/09)		10,617		10,588		10,588
	(Consumer Products)	Equity Interests				1,708		1,367

Pres Air Trol LLC		Unitranche Debt (12.0%, Due 4/10)		6,138		5,820		5,820
	(Industrial Products)	Equity Interests				1,356		318

Progressive International		Subordinated Debt (16.0%, Due 12/09)		7,401		7,376		7,376
	Corporation	Preferred Stock (500 shares)				500		884
	(Consumer Products)	Common Stock (197 shares)				13		13
		Warrants				—		—

Soteria Imaging Services, LLC		Subordinated Debt (11.8%, Due 11/10)		14,500		13,447		13,447
	(Healthcare Services)	Equity Interests				2,153		2,308

Universal Environmental Services, LLC		Unitranche Debt (15.5%, Due 2/09)		10,900		10,862		10,862
	(Business Services)	Equity Interests				1,797		1,328

Total companies 5% to 25% owned					$	168,373	$	158,806

Companies Less Than 5% Owned

Advanced Circuits, Inc.		Senior Loans (10.1%, Due 9/11 – 3/12)	$	18,732	$	18,642	$	18,642
	(Industrial Products)	Common Stock (40,000 shares)				1,000		1,000

Anthony, Inc. (Industrial Products)		Subordinated Debt (12.9%, Due 9/11 – 9/12)		14,670		14,610		14,610

Benchmark Medical, Inc.		Warrants				18		190
	(Healthcare Services)

BI Incorporated		Subordinated Debt (14.0%, Due 2/12)		16,203		16,133		16,133
	(Business Services)

Border Foods, Inc.		Subordinated Debt (13.0%,		13,428		12,721		—
(Consumer Products)		Due 12/10)⁽⁶⁾				2,893		—
		Preferred Stock (140,214 shares)				45		—
		Common Stock (1,810 shares)				910		—
		Warrants


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-21

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

C&K Market, Inc.		Subordinated Debt (13.0%, Due 12/08)	$	14,694	$	14,638	$	14,638
	(Retail)

Callidus Debt Partners		Class C Notes (12.9%, Due 12/13)		18,800		18,973		18,973
	CDO Fund I, Ltd.⁽⁴⁾⁽⁹⁾	Class D Notes (17.0%, Due 12/13)		9,400		9,487		9,487
	(Senior Debt Fund)

Callidus Debt Partners		Preferred Shares (23,600,000 shares)				24,233		24,233
	CLO Fund III, Ltd. ⁽⁴⁾⁽⁹⁾
	(Senior Debt Fund)

Callidus MAPS CLO Fund I LLC⁽⁹⁾		Class E Notes (9.7%, Due 12/17)		17,000		17,000		17,000
	(Senior Debt Fund)	Income Notes				48,108		48,108

Camden Partners Strategic Fund II, L.P.⁽⁵⁾		Limited Partnership Interest				2,142		2,726
	(Private Equity Fund)

Catterton Partners V, L.P.⁽⁵⁾		Limited Partnership Interest				2,650		2,691
	(Private Equity Fund)

CBS Personnel Holdings, Inc. (Business Services)		Subordinated Debt (14.5%, Due 12/09)		20,617		20,541		20,541

Community Education Centers, Inc.		Subordinated Debt (16.0%, Due 12/10)		32,852		32,738		32,738
	(Education Services)

Component Hardware Group, Inc.		Preferred Stock (18,000 shares)				2,605		2,783
	(Industrial Products)	Common Stock (2,000 shares)				200		700

Cooper Natural Resources, Inc.		Subordinated Debt (0%, Due 11/07)		840		840		840
	(Industrial Products)	Preferred Stock (6,316 shares)				1,424		20
		Warrants				830		—

Coverall North America, Inc.		Subordinated Debt (14.6%, Due 2/11)		27,309		27,261		27,261
	(Business Services)	Preferred Stock (6,500 shares)				6,500		6,866
		Warrants				2,950		3,100


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.
⁽⁹⁾		The fund is managed by Callidus Capital, a portfolio company of Allied Capital.

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

F-22

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Drilltec Patents & Technologies Company, Inc.		Subordinated Debt (17.0%, Due 8/06)⁽⁶⁾	$	1,500	$	1,500	$	1,500
	(Energy Services)	Subordinated Debt (10.0%, Due 8/06)⁽⁶⁾		10,994		10,918		9,792

eCentury Capital Partners, L.P.⁽⁵⁾		Limited Partnership Interest				5,649		83
	(Private Equity Fund)

Elexis Beta GmbH⁽⁴⁾		Options				426		50
	(Industrial Products)

Event Rentals, Inc.		Senior Loans (9.9%, Due 11/11)		18,341		18,244		18,244
	(Consumer Services)

Frozen Specialties, Inc.		Warrants				435		470
	(Consumer Products)

Garden Ridge Corporation (Retail)		Subordinated Debt (7.0%, Due 5/12)⁽⁶⁾		22,500		22,500		22,500

Geotrace Technologies, Inc.		Subordinated Debt (10.0%, Due 6/09)		25,618		23,875		23,875
(Energy Services)		Warrants				2,350		2,500

Ginsey Industries, Inc.		Subordinated Debt (12.5%, Due 3/07)		3,680		3,680		3,680
	(Consumer Products)

Grant Broadcasting Systems II		Subordinated Debt (5.0%, Due 6/09)		2,756		2,756		2,756
	(Broadcasting & Cable)

Grotech Partners, VI, L.P.⁽⁵⁾		Limited Partnership Interest				6,914		4,161
	(Private Equity Fund)

Havco Wood Products LLC		Unitranche Debt (10.4%, Due 8/11)		33,000		31,794		31,794
	(Industrial Products)	Equity Interests				1,048		1,048

Haven Eldercare of New England, LLC ⁽¹⁰⁾		Subordinated Debt (12.0%, Due 8/09)⁽⁶⁾		4,320		4,320		4,320
	(Healthcare Services)

Haven Healthcare Management, LLC⁽¹⁰⁾		Subordinated Debt (18.0% Due 4/07)⁽⁶⁾		1,319		1,319		485
	(Healthcare Services)

HealthASPex Services Inc.		Senior Loans (4.0%, Due 7/08)		500		500		500
	(Business Services)

The Hillman Companies, Inc.⁽³⁾		Subordinated Debt (13.5%, Due 9/11)		44,000		43,815		43,815
	(Consumer Products)

Homax Holdings, Inc.		Subordinated Debt (12.0%, Due 8/11)		14,000		13,039		13,039
	(Consumer Products)	Preferred Stock (89 shares)				89		92
		Common Stock (28 shares)				6		6
		Warrants				1,106		1,492

Icon International, Inc.		Common Stock (25,707 shares)				76		16
	(Business Services)

International Fiber Corporation		Subordinated Debt (14.0%, Due 6/12)		21,546		21,460		21,460
	(Industrial Products)	Preferred Stock (25,000 shares)				2,500		1,900

Line-X, Inc.		Senior Loan (8.1%, Due 8/11)		4,134		4,111		4,111
	(Consumer Products)	Unitranche Debt (10.0% Due 8/11)		51,475		51,229		51,229
		Standby Letter of Credit ($1,500)


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.
	⁽¹⁰⁾			Haven Eldercare of New England, LLC and Haven Healthcare Management, LLC are affiliated companies.

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

F-23

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

MedAssets, Inc.		Preferred Stock (227,865 shares)			$	2,049	$	2,893
	(Business Services)	Warrants				136		180

Meineke Car Care Centers, Inc.		Senior Loan (8.0%, Due 6/11)	$	28,000		27,865		27,865
	(Consumer Services)	Subordinated Debt (11.9%, Due 6/12 – 6/13)		72,000		71,675		71,675
		Common Stock (10,696,308 shares)⁽¹¹⁾				26,985		26,629
		Warrants				—		—

MHF Logistical Solutions, Inc.		Unitranche Debt (10.0%, Due 5/11)		22,281		22,177		22,177
	(Business Services)	Preferred Stock (431 shares)				431		455
		Common Stock (1,438 shares)				144		211

Mid-Atlantic Venture Fund IV, L.P. ⁽⁵⁾		Limited Partnership Interest				6,600		3,339
	(Private Equity Fund)

Mogas Energy, LLC		Subordinated Debt (9.5%, Due 3/12 – 4/12)		16,855		15,472		15,472
	(Energy Services)	Warrants				1,774		3,550

Network Hardware Resale, Inc.		Unitranche Debt (10.5%, Due 12/11)		38,500		38,743		38,743
	(Business Services)	Convertible Subordinated Debt (9.8%, Due 12/15)		12,000		12,076		12,076

N.E.W. Customer Service Companies, Inc.		Subordinated Debt (11.0%, Due 7/12)		40,000		40,016		40,016
	(Business Services)

Nobel Learning Communities,		Preferred Stock (1,214,356 shares)				2,764		2,343
	Inc.⁽³⁾	Warrants				575		1,296
	(Education)

Norwesco, Inc.		Subordinated Debt (12.6%, Due 1/12 – 7/12)		82,061		81,683		81,683
	(Industrial Products)	Common Stock (559,603 shares)⁽¹¹⁾		38,313		38,313
		Warrants				—		—

Novak Biddle Venture Partners III, L.P.⁽⁵⁾		Limited Partnership Interest				1,669		1,809
	(Private Equity Fund)

Oahu Waste Services, Inc.		Stock Appreciation Rights				239		1,000
	(Business Services)

Opinion Research Corporation⁽³⁾		Warrants				996		45
	(Business Services)

Oriental Trading Company, Inc.		Common Stock (13,820 shares)				—		5,200
	(Consumer Products)

Palm Coast Data, LLC		Senior Loan (7.6%, Due 8/10)		16,100		16,024		16,024
	(Business Services)	Subordinated Debt (15.5%, Due 8/12 – 8/15)		29,600		29,461		29,461
		Common Stock (21,743 shares)⁽¹¹⁾				21,743		21,743
		Warrants				—		—

Performant Financial Corporation		Common Stock (478,816 shares)				734		2,500
	(Business Services)

Pro Mach, Inc.		Subordinated Debt (13.8%, Due 6/12)		19,275		19,193		19,193
	(Industrial Products)	Equity Interests				1,500		1,200


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.
	⁽¹¹⁾			Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

F-24

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Promo Works, LLC		Senior Loan (8.5%, Due 12/11)	$	900	$	851	$	851
	(Business Services)	Unitranche Debt (10.3%, Due 12/11)		31,000		30,728		30,728
		Guaranty ($1,650)

RadioVisa Corporation		Unitranche Debt (15.5%, Due 12/08)		27,093		26,993		26,993
	(Broadcasting & Cable)

Red Hawk Industries, LLC		Unitranche Debt (11.0%, Due 4/11)		56,343		56,063		56,063
	(Business Services)

S.B. Restaurant Company (Retail)		Subordinated Debt (14.6%, Due 11/08 – 12/09)		29,085		28,615		28,615
		Preferred Stock (54,125 shares)				135		135
		Warrants				619		700

SBBUT, LLC		Equity Interests				—		—
	(Consumer Products)

Soff-Cut Holdings, Inc.		Preferred Stock (300 shares)				300		300
	(Industrial Products)	Common Stock (2,000 shares)				200		37

SPP Mezzanine Fund, L.P.⁽⁵⁾		Limited Partnership Interest				3,007		2,969
	(Private Equity Fund)

Tradesmen International, Inc.		Subordinated Debt (12.0%, Due 12/09)		15,000		14,323		14,323
	(Business Services)	Warrants				710		1,700

TransAmerican Auto Parts, LLC		Subordinated Debt (14.0%, Due 11/12)		10,000		9,951		9,951
	(Consumer Products)	Equity Interests				889		889

United Site Services, Inc.		Subordinated Debt (12.4%, Due 8/11)		49,712		49,503		49,503
	(Business Services)	Common Stock (160,588 shares)				1,000		1,200

Universal Air Filter Company		Senior Loans (7.9%, Due 11/11)		400		390		390
	(Industrial Products)	Unitranche Debt (11.0%, Due 11/11)		19,867		19,768		19,768

Universal Tax Systems, Inc.		Subordinated Debt (14.5%, Due 7/11)		19,068		18,995		18,995
	(Business Services)

Updata Venture Partners II, L.P.⁽⁵⁾		Limited Partnership Interest				4,977		4,686
	(Private Equity Fund)

Venturehouse-Cibernet Investors, LLC		Equity Interest				42		42
	(Business Services)

Venturehouse Group, LLC⁽⁵⁾		Equity Interest				598		397
	(Private Equity Fund)

VICORP Restaurants, Inc.⁽³⁾		Warrants				33		691
	(Retail)

Walker Investment Fund II, LLLP⁽⁵⁾		Limited Partnership Interest				1,330		676
	(Private Equity Fund)


	⁽¹⁾			Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
	⁽²⁾			Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
	⁽³⁾			Public company.
	⁽⁴⁾			Non-U.S. company or principal place of business outside the U.S.
	⁽⁵⁾			Non-registered investment company.
	⁽⁶⁾			Loan or debt security is on non-accrual status and therefore is considered non-income producing.
	⁽¹¹⁾			Common stock is non-voting. In addition to non-voting stock ownership, the Company has an option to acquire a majority of the voting securities of the portfolio company at fair market value.

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

F-25

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


			December 31, 2005
Private Finance
Portfolio Company
(in thousands, except number of shares)		Investment⁽¹⁾⁽²⁾	Principal		Cost		Value

Wear Me Apparel Corporation		Subordinated Debt (15.0%, Due 12/10)	$	40,000	$	38,992	$	38,992
	(Consumer Products)	Warrants				1,219		2,000

Wilshire Restaurant Group, Inc. (Retail)		Subordinated Debt (20.0%, Due 6/07)⁽⁶⁾		22,471		21,930		21,930
		Warrants				735		538

Wilton Industries, Inc.		Subordinated Debt (19.3%, Due 6/08)		4,800		4,800		4,800
	(Consumer Products)

Woodstream Corporation (Consumer Products)		Subordinated Debt (13.2%, Due 11/12 – 5/13)		52,397		52,251		52,251
		Common Stock (180 shares)				673		3,336
		Warrants				—		2,365

Other companies		Other debt investments		382		382		382
		Other debt investments⁽⁶⁾		470		470		348
		Other equity investments				8		—
		Guaranty ($135)

Total companies less than 5% owned					$	1,448,268	$	1,432,833

Total private finance (118 portfolio companies)					$	3,106,423	$	3,479,290


⁽¹⁾		Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by nature of indebtedness for a single issuer. The maturity dates represent the earliest and the latest maturity dates.
⁽²⁾		Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted.
⁽³⁾		Public company.
⁽⁴⁾		Non-U.S. company or principal place of business outside the U.S.
⁽⁵⁾		Non-registered investment company.
⁽⁶⁾		Loan or debt security is on non-accrual status and therefore is considered non-income producing.

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

F-26

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS — (Continued)


Commercial Real Estate Finance
(in thousands, except number of loans)


						December 31, 2005
		Interest		Number of
		Rate Ranges		Loans		Cost		Value

Commercial Mortgage Loans
			Up to 6.99%		5	$	23,121	$	21,844
			7.00%–8.99%		24		48,156		48,156
			9.00%–10.99%		5		25,999		25,967
			11.00%–12.99%		1		338		338
			13.00%–14.99%		1		2,294		2,294
		15.00% and above			2		3,970		3,970

	Total commercial mortgage loans⁽¹²⁾				38	$	103,878	$	102,569

Real Estate Owned						$	14,240	$	13,932

Equity Interests⁽²⁾ — Companies more than 25% owned (Guarantees — $7,054)						$	13,577	$	10,564

	Total commercial real estate finance					$	131,695	$	127,065

Total portfolio						$	3,238,118	$	3,606,355


			Yield		Cost		Value

Liquidity Portfolio
	U.S. Treasury bills (Due June 2006)			4.25%	$	100,000	$	100,305
	SEI Daily Income Tr Prime Obligation Fund⁽¹³⁾			4.11%		100,000		100,000

		Total liquidity portfolio			$	200,000	$	200,305

Other Investments in Money Market Securities⁽¹³⁾
	PNC Bank Corporate Money Market Deposit Account			4.15%	$	21,967	$	21,967

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

⁽³⁾ Public company.

⁽⁴⁾ Non-U.S. company or principal place of business outside the U.S.

⁽⁵⁾ Non-registered investment company.

⁽¹²⁾ Commercial mortgage loans totaling $20.8 million at value were on non-accrual status and therefore were considered non-income producing.

⁽¹³⁾ Included in investments in money market securities on the accompanying Consolidated Balance Sheet.

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

F-27

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Organization

Allied Capital Corporation, a Maryland corporation, is a closed-end, non-diversified 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 real estate investment trust subsidiary, Allied Capital REIT, Inc. (“Allied REIT”), and several subsidiaries that are single member limited liability companies established for specific purposes including holding real estate properties. ACC also has a subsidiary, A.C. Corporation (“AC Corp”), that generally provides diligence and structuring services, as well as transaction, management, consulting, and other services, including underwriting and arranging senior loans, to the Company and its portfolio companies.

In addition, ACC had a subsidiary, Allied Investments L.P. (“Allied Investments”), which was licensed under the Small Business Investment Act of 1958 as a Small Business Investment Company (“SBIC”). As of September 30, 2006, Allied Investments surrendered its SBIC license and on October 1, 2006, Allied Investments was merged into ACC.

ACC and its subsidiaries, collectively, are referred to as the “Company.” The Company consolidates the results of its subsidiaries for financial reporting purposes.

Pursuant to Article 6 of Regulation S-X, the financial results of the Company’s portfolio investments are not consolidated in the Company’s financial statements. Portfolio investments are held for purposes of deriving investment income and future capital gains.

The investment objective of the Company is to achieve current income and capital gains. In order to achieve this objective, the Company has primarily invested in debt and equity securities of private companies in a variety of industries.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of the Company. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2005 and 2004 balances to conform with the 2006 financial statement presentation.

The private finance portfolio and the interest and related portfolio income and net realized gains (losses) on the private finance portfolio are presented in three categories: companies more than 25% owned, which represent portfolio companies where the Company directly or indirectly owns more than 25% of the outstanding voting securities of such portfolio company and, therefore, are deemed controlled by the Company under the 1940 Act; companies owned 5% to 25%, which represent portfolio companies where the Company directly or indirectly owns 5% to 25% of the outstanding voting securities of such portfolio company or where the Company holds one or more seats on the portfolio company’s board of directors and, therefore, are deemed to be an affiliated person under the 1940 Act; and companies less than 5% owned which represent portfolio companies where the Company directly or indirectly owns less than 5% of the outstanding voting securities of such portfolio company and where the Company has no other affiliations with such portfolio company. The interest and related portfolio income and net realized gains (losses) from the commercial real estate finance

F-28

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

portfolio and other sources are included in the companies less than 5% owned category on the consolidated statement of operations.

In the ordinary course of business, the Company enters into transactions with portfolio companies that may be considered related party transactions.


	*Valuation Of Portfolio Investments*

The Company, as a BDC, has invested in illiquid securities including debt and equity securities of companies and CDO and CLO bonds and preferred shares/income notes. The Company’s investments may be subject to certain restrictions on resale and generally have no established trading market. The Company values substantially all of its investments at fair value as determined in good faith by the Board of Directors in accordance with the Company’s valuation policy. The Company determines fair value to be the amount for which an investment could be exchanged in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The Company’s valuation policy considers the fact that no ready market exists for substantially all of the securities in which it invests. The Company’s valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio. The Company will record unrealized depreciation on investments when it believes that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of the Company’s debt or equity investments. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. The Company will record unrealized appreciation if it believes that the underlying portfolio company has appreciated in value and/or the Company’s equity security has also appreciated in value. The value of investments in publicly traded securities is determined using quoted market prices discounted for restrictions on resale, if any.


	*Loans and Debt Securities*

For loans and debt securities, fair value generally approximates cost unless the borrower’s enterprise value, overall financial condition or other factors lead to a determination of fair value at a different amount. The value of loan and debt securities may be greater than the Company’s cost basis if the amount that would be repaid on the loan or debt security upon the sale of the portfolio company is greater than the Company’s cost basis.

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

F-29

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

debt securities if the Company has doubt about interest collection or where the enterprise value of the portfolio company may not support further accrual. Loans in workout status do not accrue interest. In addition, interest may not accrue on loans or debt securities to portfolio companies that are more than 50% owned by the Company depending on such company’s capital requirements. Loan origination fees, original issue discount, and market discount are capitalized and then amortized into interest income using a method that approximates the effective interest method. Upon the prepayment of a loan or debt security, any unamortized loan origination fees are recorded as interest income and any unamortized original issue discount or market discount is recorded as a realized gain. Prepayment premiums are recorded on loans and debt securities when received.


	*Equity Securities*

The Company’s equity securities in portfolio companies for which there is no liquid public market are valued at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including cash flow from operations of the portfolio company, multiples at which private companies are bought and sold, and other pertinent factors, such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company’s equity securities, liquidation events, or other events. The determined equity values are generally discounted when the company has a minority ownership position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.

The value of the Company’s equity securities in public companies for which market quotations are readily available is based on the closing public market price on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are expected to be collected and to the extent that the Company has the option to receive the dividend in cash. Dividend income on common equity securities is recorded on the record date for private companies or on the ex-dividend date for publicly traded companies.

Commercial Mortgage-Backed Securities (“CMBS”), Collateralized Debt Obligations (“CDO”) and Collateralized Loan Obligations (“CLO”)

CDO and CLO bonds and preferred shares/income notes (“CDO/CLO Assets”) are carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for similar bonds and preferred shares/income notes, when available. The Company recognizes unrealized appreciation or deprecia-

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

tion on its CDO/CLO Assets as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment, re-investment or loss assumptions in the underlying collateral pool. The Company determines the fair value of its CDO/CLO Assets on an individual security-by-security basis.

The Company recognizes interest income on the preferred shares/income notes using the effective interest method, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the preferred share/income note from the date the estimated yield was changed. CDO and CLO bonds have stated interest rates.


	*Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation*

Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the year, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. Net change in unrealized appreciation or depreciation also reflects the change in the value of U.S. Treasury bills and deposits of proceeds from sales of borrowed Treasury securities, and depreciation on accrued interest and dividends receivable and other assets where collection is doubtful.


	*Fee Income*

Fee income includes fees for loan prepayment premiums, guarantees, commitments, and services rendered by the Company to portfolio companies and other third parties such as diligence, structuring, transaction services, management and consulting services, and other services. Loan prepayment premiums are recognized at the time of prepayment. Guaranty and commitment fees are generally recognized as income over the related period of the guaranty or commitment, respectively. Diligence, structuring, and transaction services fees are generally recognized as income when services are rendered or when the related transactions are completed. Management, consulting and other services fees are generally recognized as income as the services are rendered.


	*Guarantees*

Guarantees meeting the characteristics described in FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (the “Interpretation”) and issued or modified after December 31, 2002, are recognized at fair value at inception. However, certain guarantees are excluded from the initial recognition provisions of the Interpretation. See Note 5.

F-31

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued


	*Financing Costs*

Debt financing costs are based on actual costs incurred in obtaining debt financing and are deferred and amortized as part of interest expense over the term of the related debt instrument using a method that approximates the effective interest method. Costs associated with the issuance of common stock, such as underwriting, accounting and legal fees, and printing costs are recorded as a reduction to the proceeds from the sale of common stock.


	*Dividends to Shareholders*

Dividends to shareholders are recorded on the record date.


	*Stock Compensation Plans*

The Company has a stock-based employee compensation plan. See Note 9. Effective January 1, 2006, the Company adopted the provisions of FASB Statement No. 123 (Revised 2004), Share-Based Payment (the “Statement”). The Statement was adopted using the modified prospective method of application, which required the Company to recognize compensation costs on a prospective basis beginning January 1, 2006. Accordingly, the prior year financial statements have not been restated. Under this method, the unamortized cost of previously awarded options that were unvested as of January 1, 2006, is recognized over the remaining service period in the statement of operations beginning in 2006, using the fair value amounts determined for pro forma disclosure under Statement No. 123. With respect to options granted on or after January 1, 2006, compensation cost based on estimated grant date fair value is recognized over the related service period in the statement of operations. The effect of this adoption for the year ended December 31, 2006, was as follows:


			2006
($ in millions, except per share amounts)
Employee Stock Option Expense:
	Previously awarded, unvested options as of January 1, 2006		$	13.2
	Options granted on or after January 1, 2006			2.4

		Total employee stock option expense	$	15.6

		Per basic share	$	0.11
		Per diluted share	$	0.11

Prior to January 1, 2006, the Company accounted for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Prior to January 1, 2006, no stock-based compensation cost was reflected in net increase in net assets resulting from operations, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net increase in net assets resulting from operations and

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation for the years ended December 31, 2005 and 2004.


		2005			2004
($ in millions, except per share amounts)
Net increase in net assets resulting from operations as reported		$	872.8		$	249.5
Less total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects			(12.7	)		(16.9	)

Pro forma net increase in net assets resulting from operations			860.1			232.6
Less preferred stock dividends			—			(0.1	)

Pro forma net income available to common shareholders		$	860.1		$	232.5

Basic earnings per common share:
	As reported	$	6.48		$	1.92
	Pro forma	$	6.39		$	1.79
Diluted earnings per common share:
	As reported	$	6.36		$	1.88
	Pro forma	$	6.27		$	1.76

The stock option expense for 2006 and the pro forma expenses for 2005 and 2004 shown in the tables above were based on the underlying value of the options granted by the Company. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model and expensed over the vesting period. The following weighted average assumptions were used to calculate the fair value of options granted during the years ended December 31, 2006, 2005, and 2004:


	2006			2005			2004

Expected term (in years)		5.0			5.0			5.0
Risk-free interest rate		4.8	%		4.1	%		2.9	%
Expected volatility		29.1	%		35.1	%		37.0	%
Dividend yield		9.0	%		9.0	%		8.8	%
Weighted average fair value per option	$	3.47		$	3.94		$	4.17

The expected term of the options granted represents the period of time that such options are expected to be outstanding. To determine the expected term of the options, the Company used historical data to estimate option exercise time frames, including considering employee terminations. The risk free rate was based on the U.S. Treasury bond yield curve at the date of grant. Expected volatilities were determined based on the historical volatility of the Company’s common stock over a historical time period consistent with the expected term. The dividend yield was determined based on the Company’s historical dividend yield over a historical time period consistent with the expected term.

To determine the stock options expense, the calculated fair value of the options granted is applied to the options granted, net of assumed future option forfeitures. The Company estimates that the employee-related stock option expense under the Statement that will be recorded in the

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

Company’s statement of operations will be approximately $11.3 million, $3.7 million, and $0.1 million for the years ended December 31, 2007, 2008, and 2009, respectively, which includes approximately $1.9 million, $1.0 million, and $0.1 million, respectively, related to options granted during the year ended December 31, 2006. This estimate may change if the Company’s assumptions related to future option forfeitures change. This estimate does not include any expense related to future stock option grants as the fair value of those stock options will be determined at the time of grant. The aggregate total stock option expense remaining as of December 31, 2006, is expected to be recognized over an estimated weighted-average period of 1.08 years.


	*Federal and State Income Taxes and Excise Tax*

The Company intends to comply with the requirements of the Internal Revenue Code (“Code”) that are applicable to regulated investment companies (“RIC”) and real estate investment trusts (“REIT”). ACC and any subsidiaries that qualify as a RIC or a REIT intend to distribute or retain through a deemed distribution all of their annual taxable income to shareholders; therefore, the Company has made no provision for income taxes for these entities.

If the Company does not distribute at least 98% of its annual taxable income in the year earned, the Company will generally be required to pay an excise tax equal to 4% of the amount by which 98% of the Company’s annual taxable income exceeds the distributions from such taxable income for the year. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions, from such taxable income, the Company accrues excise taxes, if any, on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.


	*Per Share Information*

Basic earnings per common share is calculated using the weighted average number of common shares outstanding for the year presented. Diluted earnings per common 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, if any.


	*Use of Estimates in the Preparation of Financial Statements*

The preparation of financial statements in conformity with U.S. 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

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2. Summary of Significant Accounting Policies, continued

statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

The consolidated financial statements include portfolio investments at value of $4.5 billion and $3.6 billion at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, 92% and 90%, respectively, of the Company’s total assets represented portfolio investments whose fair values have been determined by the Board of Directors in good faith in the absence of readily available market values. Because of the inherent uncertainty of valuation, the Board of Directors’ determined 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.


	*Recent Accounting Pronouncements*

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of this interpretation to have a significant effect on the Company’s consolidated financial position or its results of operations.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of this statement to have a significant effect on the Company’s consolidated financial position or its results of operations.

In September 2006, the SEC released SEC Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which addresses how uncorrected errors in previous years should be considered when quantifying errors in current year financial statements and requires registrants to consider the effect of all carry over and reversing effects of prior year misstatements when quantifying errors in current year financial statements. The SAB allows registrants to record the effects of adopting the guidance as a cumulative effect adjustment which must be reported as of the beginning of the first fiscal year ending after November 15, 2006. The adoption of the SAB had no effect on the Company’s consolidated financial position or its results of operations.

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio


	*Private Finance*

At December 31, 2006 and 2005, the private finance portfolio consisted of the following:


			2006							2005

			Cost		Value		Yield⁽¹⁾			Cost		Value		Yield⁽¹⁾
($ in millions)
Loans and debt securities:
	Senior loans		$	450.0	$	405.2		8.4	%	$	284.7	$	239.8		9.5	%
	Unitranche debt⁽²⁾			800.0		799.2		11.2	%		294.2		294.2		11.4	%
	Subordinated debt			2,038.3		1,980.8		12.9	%		1,610.2		1,560.9		13.8	%

		Total loans and debt securities ⁽³⁾		3,288.3		3,185.2		11.9	%		2,189.1		2,094.9		13.0	%
Equity securities				1,209.1		1,192.7					917.3		1,384.4

		Total	$	4,497.4	$	4,377.9				$	3,106.4	$	3,479.3


⁽¹⁾	The weighted average yield on loans and debt securities is computed as the (a) annual stated interest on accruing loans and debt securities plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans and debt securities less the annual amortization of loan origination costs, divided by (b) total loans and debt securities at value. At December 31, 2006 and 2005, the cost and value of subordinated debt included the Class A equity interests in BLX and the guaranteed dividend yield on these equity interests was included in interest income. During the fourth quarter of 2006, the Class A equity interests were placed on non-accrual status. The weighted average yield is computed as of the balance sheet date.

⁽²⁾	Unitranche debt is a single debt investment that is a blend of senior and subordinated debt terms.

⁽³⁾	The total principal balance outstanding on loans and debt securities was $3,322.3 million and $2,216.3 million at December 31, 2006 and 2005, respectively. The difference between principal and cost is represented by unamortized loan origination fees and costs, original issue discounts, and market discounts totaling $34.0 million and $27.2 million at December 31, 2006 and 2005, respectively.

The Company’s private finance investment activity principally involves providing financing through privately negotiated long-term debt and equity investments. The Company’s private finance debt and equity investments are generally issued by private companies and are generally illiquid and may be subject to certain restrictions on resale.

The Company’s private finance debt investments are generally structured as loans and debt securities that carry a relatively high fixed rate of interest, which may be combined with equity features, such as conversion privileges, or warrants or options to purchase a portion of the portfolio company’s equity at a pre-determined strike price, which is generally a nominal price for warrants or options in a private company. The annual stated interest rate is only one factor in pricing the investment relative to the Company’s rights and priority in the portfolio company’s capital structure, and will vary depending on many factors, including if the Company has received nominal cost equity or other components of investment return, such as loan origination fees or market discount. The stated interest rate may include some component of contractual payment-in-kind interest, which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity.

At December 31, 2006 and 2005, 86% and 87%, respectively, of the private finance loans and debt securities had a fixed rate of interest and 14% and 13%, respectively, had a floating rate of interest. Senior loans generally carry a floating rate of interest, usually set as a spread over LIBOR, and generally require payments of both principal and interest throughout the life of the loan. Senior loans generally have contractual maturities of three to six years and interest is generally paid to the

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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

Company monthly or quarterly. Unitranche debt generally carries a fixed rate of interest and may require payments of both principal and interest throughout the life of the loan. However, unitranche instruments generally allow for principal to be repaid at a slower rate than would generally be allowed under a more traditional senior loan/subordinated debt structure. Unitranche debt generally has contractual maturities of five to six years and interest is generally paid to the Company quarterly. Subordinated debt generally carries a fixed rate of interest generally with contractual maturities of five to ten years and generally has interest-only payments in the early years and payments of both principal and interest in the later years, although maturities and principal amortization schedules may vary. Interest is generally paid to the Company quarterly.

Equity securities consist primarily of securities issued by private companies and may be subject to certain restrictions on their resale and are generally illiquid. The Company may make equity investments for minority stakes in portfolio companies or may receive equity features, such as nominal cost warrants, in conjunction with its debt investments. The Company may also invest in the equity (preferred and/or voting or non-voting common) of a portfolio company where the Company’s equity ownership may represent a significant portion of the equity, but may or may not represent a controlling interest. If the Company invests in non-voting equity in a buyout investment, the Company generally has the option to acquire a controlling stake in the voting securities of the portfolio company at fair market value. The Company may incur costs associated with making buyout investments that will be included in the cost basis of the Company’s equity investment. These include costs such as legal, accounting and other professional fees associated with diligence, referral and investment banking fees, and other costs. Equity securities generally do not produce a current return, but are held with the potential for investment appreciation and ultimate gain on sale.

Mercury Air Centers, Inc. At December 31, 2006, the Company’s investment in Mercury Air Centers, Inc. (Mercury) totaled $84.3 million at cost and $244.2 million at value, which included unrealized appreciation of $159.9 million. At December 31, 2005, the Company’s investment in Mercury totaled $113.3 million at cost and $167.1 million at value, which included unrealized appreciation of $53.8 million. The Company completed the purchase of a majority ownership in Mercury in April 2004.

Total interest and related portfolio income earned from the Company’s investment in Mercury for the years ended December 31, 2006, 2005, and 2004, was as follows:


		2006		2005		2004
($ in millions)
Interest income		$	9.3	$	8.8	$	5.5
Fees and other income			0.6		0.7		1.9

	Total interest and related portfolio income	$	9.9	$	9.5	$	7.4

Net change in unrealized appreciation or depreciation included a net increase in unrealized appreciation on the Company’s investment in Mercury of $106.1 million, $53.8 million, and zero for the years ended December 31, 2006, 2005, and 2004, respectively.

F-37

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

Business Loan Express, LLC. BLX originates, sells, and services primarily real estate secured loans, including real estate secured conventional small business loans, Small Business Administration’s 7(a) loans and small investment real estate loans. BLX is headquartered in New York, NY.

The Company’s investment in BLX totaled $295.3 million at cost and $210.7 million at value, which included unrealized depreciation of $84.6 million, at December 31, 2006, and $299.4 million at cost and $357.1 million at value, which included unrealized appreciation of $57.7 million, at December 31, 2005. At December 31, 2006 and 2005, the Company owned 94.9% of the voting Class C equity interests. BLX has an equity appreciation rights plan for management that will dilute the value available to the Class C equity interest holders. Subsequent to December 31, 2006, in the first quarter of 2007 the Company increased its investment in BLX by $12 million by acquiring additional Class A equity interests.

At December 31, 2005, the Company had a commitment to BLX of $30.0 million in the form of a subordinated revolving credit facility to provide working capital to BLX. There was $10.0 million outstanding under this facility at December 31, 2005. Outstanding borrowings under this facility were repaid in full and this facility matured on April 30, 2006.

Total interest and related portfolio income earned from the Company’s investment in BLX for the years ended December 31, 2006, 2005, and 2004, was as follows:


		2006		2005		2004
($ in millions)
Interest income on subordinated debt and Class A equity interests		$	11.9	$	14.3	$	23.2
Dividend income on Class B equity interests			—		14.0		14.8
Fees and other income			7.8		9.2		12.0

	Total interest and related portfolio income	$	19.7	$	37.5	$	50.0

Interest and dividend income from BLX for the years ended December 31, 2006, 2005, and 2004, included interest and dividend income of $5.7 million, $8.9 million, and $25.4 million, respectively, which was paid in kind. The interest and dividends paid in kind were paid to the Company through the issuance of additional debt or equity interests. In the fourth quarter of 2006, the Company placed its $66.6 million investment in BLX’s 25% Class A equity interests on non-accrual status, which resulted in lower interest income from its investment in BLX for 2006 as compared to 2005.

As a limited liability company, BLX’s taxable income flows through directly to its members. BLX’s annual taxable income generally differs from its book income for the fiscal year due to temporary and permanent differences in the recognition of income and expenses. The Company holds all of BLX’s Class A and Class B equity interests, and 94.9% of the Class C equity interests. BLX’s taxable income is first allocated to the Class A equity interests to the extent that guaranteed dividends are paid in cash or in kind on such interests, with the remainder being allocated to the Class B and C equity interests. BLX may declare dividends on its Class B equity interests. If

F-38

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

declared, BLX would determine the amount of such dividends considering its estimated annual taxable income allocable to such interests. There were no dividends declared or paid in 2006.

Net change in unrealized appreciation or depreciation included a net decrease on the Company’s investment in BLX of $142.3 million and $32.3 million for the years ended December 31, 2006 and 2004, respectively, and a net increase of $2.9 million for the year ended December 31, 2005.

BLX is a national, non-bank lender that participates in the SBA’s 7(a) Guaranteed Loan Program and is licensed by the SBA as a Small Business Lending Company (SBLC). The Office of the Inspector General of the SBA and the United States Secret Service have announced an ongoing investigation of allegedly fraudulently obtained SBA-guaranteed loans issued by BLX. Specifically, on or about January 9, 2007, BLX became aware of an indictment captioned as the United States v. Harrington, No. 2:06-CR-20662 pending in the United States District Court for the Eastern District of Michigan. The indictment alleges that a former BLX employee in the Detroit office engaged in the fraudulent origination of loans guaranteed, in substantial part, by the SBA. The Company understands that BLX is working cooperatively with the U.S. Attorney’s Office and the investigating agencies with respect to this matter. The Company understands that BLX is also working cooperatively with the SBA so that it may remain a preferred lender in the SBA 7(a) program and retain the ability to sell loans into the secondary market. The ultimate resolution of these matters could have a material adverse impact on BLX’s financial condition, and, as a result, the Company’s financial results could be negatively affected. The Company is monitoring the situation and has retained a third party to work with BLX to conduct a review of BLX’s current internal control systems, with a focus on preventing fraud and further strengthening the company’s operations.

Further, on or about January 16, 2007, BLX and Business Loan Center LLC (BLC) became aware of a lawsuit titled, United States, ex rel James R. Brickman and Greenlight Capital, Inc. v. Business Loan Express LLC f/k/a Business Loan Express, Inc.; Business Loan Center LLC f/k/a Business Loan Center, Inc.; Robert Tannenhauser; Matthew McGee; and George Harrigan, 05-CV-3147 (JEC), that is pending in the United States District Court for the Northern District of Georgia. The complaint includes allegations arising under the False Claims Act and relating to alleged fraud in connection with SBA guarantees on shrimp vessel loans made by BLX and BLC. The Company understands that BLX and BLC plan to vigorously contest the lawsuit. The Company is monitoring the litigation.

As an SBA lender, BLX is also subject to other SBA and OIG audits, investigations, and reviews. The Company has considered these matters in performing the valuation of BLX at December 31, 2006.

At the time of the corporate reorganization of BLX, Inc. from a C corporation to a limited liability company in 2003, for tax purposes BLX had a “built-in gain” representing the aggregate fair market value of its assets in excess of the tax basis of its assets. As a RIC, the Company will be subject to special built-in gain rules on the assets of BLX. Under these rules, taxes will be payable by the Company at the time and to the extent that the built-in gains on BLX’s assets at the date of reorganization are recognized in a taxable disposition of such assets in the 10-year period following the date of the reorganization. At such time, the built-in gains realized upon the disposition of these assets will be included in the Company’s taxable income, net of the corporate level taxes paid by the Company on the built-in gains. At the date of BLX’s reorganization, the Company estimated that its

F-39

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

future tax liability resulting from the built-in gains may total up to a maximum of $40 million. However, if these assets are disposed of after the 10-year period, there will be no corporate level taxes on these built-in gains. While the Company has no obligation to pay the built-in gains tax until these assets or its interests in BLX are disposed of in the future, it may be necessary to record a liability for these taxes in the future should the Company intend to sell the assets of or its interests in BLX within the 10-year period. At December 31, 2006 and 2005, the Company considered the increase in fair value of its investment in BLX due to BLX’s tax attributes as an LLC and has also considered the reduction in fair value of its investment due to these estimated built-in gain taxes in determining the fair value of its investment in BLX.

At December 31, 2006, BLX had a three-year $500.0 million revolving credit facility provided by third party lenders that matures in March 2009. The revolving credit facility may be expanded through new or additional commitments up to $600.0 million at BLX’s option. This facility provides for a sub-facility for the issuance of letters of credit for up to an amount equal to 25% of the committed facility. The Company has provided an unconditional guaranty to these revolving credit facility lenders in an amount equal to 50% of the total obligations (consisting of principal, letters of credit issued under the facility, accrued interest, and other fees) of BLX under this facility. The total obligation guaranteed by the Company at December 31, 2006, was $189.7 million.

This guaranty can be called by the lenders in the event of a default under the BLX credit facility, which includes certain defaults under the Company’s revolving credit facility. Among other requirements, the BLX facility requires that BLX maintain compliance with certain financial covenants such as interest coverage, maximum debt to net worth, asset coverage, and maintenance of certain asset quality metrics. In addition, BLX would have an event of default if BLX failed to maintain its lending status with the SBA and such failure could reasonably be expected to result in a material adverse effect on BLX, or if BLX failed to maintain certain financing programs for the sale or long-term funding of BLX’s loans. At December 31, 2006, BLX would not have met the required maximum debt to net worth covenant requirement had the Company not made the additional $12 million investment in BLX in the first quarter of 2007 discussed above. Under the terms of the facility, the $12 million investment in BLX caused BLX to satisfy the leverage covenant requirement and BLX has determined that it was in compliance with the terms of this facility at December 31, 2006.

At December 31, 2005, BLX had a $275 million revolving credit facility, which was replaced by the current facility discussed above. The Company had provided a similar unconditional guaranty to this facility’s lenders in an amount equal to 50% of BLX’s total obligations under the facility. The total obligation guaranteed by the Company at December 31, 2005, was $135.4 million.

At December 31, 2006 and 2005, the Company had also provided four standby letters of credit totaling $25.0 million and $34.1 million, respectively, in connection with four term securitization transactions completed by BLX. In consideration for providing the revolving credit facility guaranty and the standby letters of credit, the Company earned fees of $6.1 million, $6.3 million, and $6.0 million for the years ended December 31, 2006, 2005, and 2004, respectively, which were included in fees and other income above. The remaining fees and other income relate to management fees from BLX. The Company did not charge a management fee to BLX in the fourth quarter of 2006.

F-40

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

Advantage Sales and Marketing, Inc. In June 2004, the Company completed the purchase of a majority voting ownership in Advantage, which was subject to dilution by a management option pool. Advantage is a sales and marketing agency providing outsourced sales, merchandising, and marketing services to the consumer packaged goods industry. Advantage has offices across the United States and is headquartered in Irvine, CA.

At December 31, 2005, the Company’s investment in Advantage totaled $257.7 million at cost and $660.4 million at value, which included unrealized appreciation of $402.7 million.

On March 29, 2006, the Company sold its majority equity interest in Advantage. The Company was repaid its $184 million in subordinated debt outstanding and realized a gain at closing on its equity investment sold of $433.1 million, subject to post-closing adjustments. Subsequent to closing on this sale, the Company realized additional gains resulting from post-closing adjustments totaling $1.3 million in 2006. In addition, there is potential for the Company to receive additional consideration through an earn-out payment that would be based on Advantage’s 2006 audited results. The Company’s realized gain of $434.4 million as of December 31, 2006, subject to post-closing adjustments, excludes any earn-out amounts.

As consideration for the common stock sold in the transaction, the Company received a $150 million subordinated note, with the balance of the consideration paid in cash. In addition, a portion of the Company’s cash proceeds from the sale of the common stock were placed in escrow, subject to certain holdback provisions. At December 31, 2006, the amount of the escrow included in other assets in the accompanying consolidated balance sheet was approximately $24 million.

In connection with the sale transaction, the Company retained an equity investment in the business valued at $15 million at closing as a minority shareholder. During the fourth quarter of 2006, Advantage made a distribution on this minority equity investment, which resulted in a realized gain of $4.8 million.

The Company’s investment in Advantage at December 31, 2006, which was composed of subordinated debt and a minority equity interest, totaled $151.6 million at cost and $162.6 million at value. This investment was included in companies 5% to 25% owned in the consolidated financial statements as the Company continues to hold a seat on Advantage’s board of directors.

Total interest and related portfolio income earned from the Company’s investment in Advantage while the Company held a majority equity interest for the years ended December 31, 2006, 2005, and 2004, was $14.1 million, $37.4 million, and $21.3 million, respectively.

Net change in unrealized appreciation or depreciation for the year ended December 31, 2006, included the reversal of $389.7 million of previously recorded unrealized appreciation associated with the realization of a gain on the sale of the Company’s majority equity interest in Advantage and for the years ended December 31, 2005 and 2004, included an increase in unrealized appreciation of $378.4 million and $24.3 million, respectively, related to the Company’s majority equity interest investment in Advantage.

The Hillman Companies, Inc. On March 31, 2004, the Company sold its control investment in Hillman, which was one of the Company’s largest investments, for a total transaction value of $510 million, including the repayment of outstanding debt and adding the value of Hillman’s

F-41

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

outstanding trust preferred shares. The Company was repaid its existing $44.6 million in outstanding debt. Total consideration to the Company from the sale at closing, including the repayment of debt, was $244.3 million, which included net cash proceeds of $196.8 million and the receipt of a new subordinated debt instrument of $47.5 million. During the second quarter of 2004, the Company sold a $5.0 million participation in its subordinated debt in Hillman to a third party, which reduced the Company’s investment, and no gain or loss resulted from the transaction. For the year ended December 31, 2004, the Company realized a gain of $150.3 million on the transaction including a gain of $1.3 million realized after closing, resulting from post-closing adjustments, which provided additional cash consideration to the Company in the same amount.

Collateralized Loan Obligations (“CLOs”) and Collateralized Debt Obligations (“CDOs”). At December 31, 2006 and 2005, the Company owned bonds and preferred shares/income notes in collateralized loan obligations (CLOs) and a collateralized debt obligation (CDO) as follows:


		2006				2005

		Cost		Value		Cost		Value
($ in millions)
Callidus Debt Partners CDO Fund I, Ltd.		$	28.4	$	28.4	$	28.5	$	28.5
Callidus Debt Partners CLO Fund III, Ltd.			23.3		23.0		24.2		24.2
Callidus Debt Partners CLO Fund IV, Ltd.			13.0		13.0		—		—
Callidus MAPS CLO Fund I LLC			68.0		64.6		65.1		65.1
Callidus Debt Partners CLO Fund V, Ltd.			13.8		13.8		—		—

	Total	$	146.5	$	142.8	$	117.8	$	117.8

These CLO and CDO investments are managed by Callidus Capital, a portfolio company controlled by the Company.

The bonds, preferred shares and income notes of the CLOs and CDO in which the Company has invested are junior in priority for payment of interest and principal to the more senior notes issued by the CLOs and CDO. Cash flow from the underlying collateral assets in the CLOs and CDO is generally allocated first to the senior bonds in order of priority, then any remaining cash flow is generally distributed to the preferred shareholders and income note holders. To the extent there are defaults and unrecoverable losses on the underlying collateral assets that result in reduced cash flows, the preferred shares/income notes will bear this loss first and then the subordinated bonds would bear any loss after the preferred shares/income notes.

At both December 31, 2006 and 2005, the face value of the CLO and CDO bonds held by the Company were subordinate to approximately 82% to 85% of the face value of the securities issued in these CLOs and CDO. At December 31, 2006 and 2005, the face value of the CLO preferred shares/income notes held by the Company were subordinate to approximately 86% to 92% and 86% to 91%, respectively, of the face value of the securities issued in these CLOs.

F-42

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

At December 31, 2006 and 2005, the underlying collateral assets of these CLO and CDO investments, consisting primarily of senior debt, were issued by 465 issuers and 336 issuers, respectively, and had balances as follows:


		2006		2005
($ in millions)
Bonds		$	245.4	$	230.7
Syndicated loans			1,769.9		704.0
Cash⁽¹⁾			59.5		238.4

	Total underlying collateral assets	$	2,074.8	$	1,173.1


⁽¹⁾	Includes undrawn liability amounts.

At December 31, 2006, there was one defaulted obligor in the underlying collateral assets of Callidus MAPS CLO Fund I, LLC. There were no other delinquencies in the underlying collateral assets in the other CLO and CDO issuances owned by the Company. At December 31, 2006, the total face value of defaulted obligations was $9.6 million, or approximately 0.5% of the total underlying collateral assets. At December 31, 2005, there were no delinquencies in the underlying collateral assets.

The initial yields on the CLO and CDO bonds, preferred shares and income notes are based on the estimated future cash flows from the underlying collateral assets expected to be paid to these CLO and CDO classes. As each CLO and CDO bond, preferred share or income note ages, the estimated future cash flows are updated based on the estimated performance of the underlying collateral assets, and the respective yield is adjusted as necessary. As future cash flows are subject to uncertainties and contingencies that are difficult to predict and are subject to future events that may alter current assumptions, no assurance can be given that the anticipated yields to maturity will be achieved.

Loans and Debt Securities on Non-Accrual Status. At December 31, 2006 and 2005, private finance loans and debt securities at value not accruing interest were as follows:


			2006		2005
($ in millions)
Loans and debt securities in workout status
	Companies more than 25% owned		$	51.1	$	15.6
	Companies 5% to 25% owned			4.0		—
	Companies less than 5% owned			31.6		11.4
Loans and debt securities not in workout status
	Companies more than 25% owned			87.1		58.0
	Companies 5% to 25% owned			7.2		0.5
	Companies less than 5% owned			38.9		49.5

		Total	$	219.9	$	135.0

F-43

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

Industry and Geographic Compositions. The industry and geographic compositions of the private finance portfolio at value at December 31, 2006 and 2005, were as follows:


		2006			2005

Industry
Business services			39	%		42	%
Consumer products			20			14
Financial services			9			14
Industrial products			9			10
Consumer services			6			6
Retail			6			3
Healthcare services			3			2
Energy services			2			2
Other⁽¹⁾			6			7

	Total		100	%		100	%

Geographic Region⁽²⁾
Mid-Atlantic			31	%		29	%
Midwest			30			21
Southeast			18			12
West			17			34
Northeast			4			4

	Total		100	%		100	%


⁽¹⁾	Includes investments in senior debt CDO and CLO funds which represented 3% of the private finance portfolio at both December 31, 2006 and 2005. These funds invest in senior debt representing a variety of industries.

⁽²⁾	The geographic region for the private finance portfolio depicts the location of the headquarters for the Company’s portfolio companies. The portfolio companies may have a number of other locations in other geographic regions.


	*Commercial Real Estate Finance*

At December 31, 2006 and 2005, the commercial real estate finance portfolio consisted of the following:


		2006						2005

		Cost		Value		Yield⁽¹⁾		Cost		Value		Yield⁽¹⁾
($ in millions)
Commercial mortgage loans		$	72.6	$	71.9		7.5%	$	103.9	$	102.6		7.6%
Real estate owned			15.7		19.6				14.2		13.9
Equity interests			15.2		26.7				13.6		10.6

	Total	$	103.5	$	118.2			$	131.7	$	127.1

⁽¹⁾

The weighted average yield on the commercial mortgage loans is computed as the (a) annual stated interest on accruing loans plus the annual amortization of loan origination fees, original issue discount, and market discount on accruing loans less the annual amortization of origination costs, divided by (b) total interest-bearing investments at value. The weighted average yield is computed as of the balance sheet date.

Commercial Mortgage Loans and Equity Interests. The commercial mortgage loan portfolio contains loans that were originated by the Company or were purchased from third-party sellers. At December 31, 2006, approximately 96% and 4% of the Company’s commercial mortgage loan portfolio

F-44

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

was composed of fixed and adjustable interest rate loans, respectively. At December 31, 2005, approximately 97% and 3% of the Company’s commercial mortgage loan portfolio was composed of fixed and adjustable interest rate loans, respectively. At December 31, 2006 and 2005, loans with a value of $18.9 million and $20.8 million, respectively, were not accruing interest. Loans greater than 120 days delinquent generally do not accrue interest.

Equity interests consist primarily of equity securities issued by privately owned companies that invest in single real estate properties. These equity interests may be subject to certain restrictions on their resale and are generally illiquid. Equity interests generally do not produce a current return, but are generally held in anticipation of investment appreciation and ultimate realized gain on sale.

The property types and the geographic composition securing the commercial mortgage loans and equity interests at value at December 31, 2006 and 2005, were as follows:


		2006			2005

Property Type
Hospitality			45	%		37	%
Office			20			11
Retail			19			16
Housing			13			30
Other			3			6

	Total		100	%		100	%

Geographic Region
Southeast			36	%		25	%
Mid-Atlantic			35			31
Midwest			21			21
Northeast			8			5
West			—			18

	Total		100	%		100	%

CMBS Bonds and Collateralized Debt Obligation Bonds and Preferred Shares (“CDOs”). On May 3, 2005, the Company completed the sale of its portfolio of CMBS bonds and CDO bonds and preferred shares to affiliates of Caisse de dépôt et placement du Québec (the Caisse) for cash proceeds of $976.0 million and realized a net gain of $227.7 million, after transaction and other costs of $7.8 million. Transaction costs included investment banking fees, legal and other professional fees, and other transaction costs. Upon the closing of the sale, the Company settled all the hedge positions relating to these assets, which resulted in a net realized loss of $0.7 million, which has been included in the net realized gain on the sale. The value of these assets prior to their sale was determined on an individual security-by-security basis. The net gain realized upon the sale of $227.7 million reflects the total value received for the portfolio as a whole. Simultaneous with the sale of the Company’s CMBS and CDO portfolio, the Company entered into certain agreements with affiliates of the Caisse, including a platform assets purchase agreement, pursuant to which the Company agreed to sell certain additional commercial real estate-related assets to the Caisse, subject to certain adjustments and closing conditions.

The platform assets purchase agreement was completed on July 13, 2005, and the Company received total cash proceeds from the sale of the platform assets of approximately $5.3 million. No

F-45

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 3. Portfolio, continued

gain or loss resulted from the transaction. Under this agreement, the Company agreed not to primarily invest in CMBS and real estate-related CDOs and refrain from certain other real estate-related investing or servicing activities for a period of three years, or through May 2008, subject to certain limitations and excluding the Company’s existing portfolio and related activities.

Note 4. Debt

At December 31, 2006 and 2005, the Company had the following debt:


			2006							2005

							Annual							Annual
			Facility		Amount		Interest			Facility		Amount		Interest
			Amount		Drawn		Cost⁽¹⁾			Amount		Drawn		Cost⁽¹⁾
($ in millions)
Notes payable and debentures:
	Privately issued unsecured notes payable			$1,041.4		$1,041.4		6.1	%	$	1,164.5	$	1,164.5		6.2	%
	Publicly issued unsecured notes payable			650.0		650.0		6.6	%		—		—		—
	SBA debentures⁽²⁾			—		—		—	%		28.5		28.5		7.5	%

		Total notes payable and debentures		1,691.4		1,691.4		6.3	%		1,193.0		1,193.0		6.3	%
Revolving line of credit⁽⁵⁾				922.5		207.7		6.4	%⁽³⁾		772.5		91.8		5.6	%⁽³⁾

	Total debt			$2,613.9		$1,899.1		6.5	%⁽⁴⁾	$	1,965.5	$	1,284.8		6.5	%⁽⁴⁾


⁽¹⁾	The weighted average annual interest cost is computed as the (a) annual stated interest on the debt plus the annual amortization of commitment fees, other facility fees and amortization of debt financing costs that are recognized into interest expense over the contractual life of the respective borrowings, divided by (b) debt outstanding on the balance sheet date.

⁽²⁾	The SBA debentures were repaid in full during 2006.

⁽³⁾	The annual interest cost reflects the interest rate payable for borrowings under the revolving line of credit. In addition to the current interest payable, there were annual costs of commitment fees, other facility fees and amortization of debt financing costs of $3.9 million and $3.3 million at December 31, 2006 and 2005, respectively.

⁽⁴⁾	The annual interest cost for total debt includes the annual cost of commitment fees, other facility fees and amortization of debt financing costs on the revolving line of credit regardless of the amount outstanding on the facility as of the balance sheet date.

⁽⁵⁾	At December 31, 2006, $673.8 million remained unused and available on the revolving line of credit, net of amounts committed for standby letters of credit of $41.0 million issued under the credit facility.

Notes Payable and Debentures

Privately Issued Unsecured Notes Payable. The Company has privately issued unsecured long-term notes to institutional investors. The notes have five- or seven-year maturities and have fixed rates of interest. The notes generally require payment of interest only semi-annually, and all principal is due upon maturity. At December 31, 2006, the notes had maturities from May 2008 to May 2013. The notes may be prepaid in whole or in part, together with an interest premium, as stipulated in the note agreements.

The Company has also privately issued five-year unsecured long-term notes denominated in Euros and Sterling for a total U.S. dollar equivalent of $15.2 million. The notes have fixed interest rates and have substantially the same terms as the Company’s other unsecured notes. The Euro notes require annual interest payments and the Sterling notes require semi-annual interest payments until maturity. Simultaneous with issuing the notes, the Company entered into a cross currency swap with a financial institution which fixed the Company’s interest and principal payments in U.S. dollars for the life of the debt.

On October 16, 2006, the Company repaid $150.0 million of unsecured long-term debt that matured. This debt had a fixed interest rate of 7.2%.

F-46

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

On May 1, 2006, the Company issued $50.0 million of seven-year, unsecured notes with a fixed interest rate of 6.8%. This debt matures in May 2013. The proceeds from the issuance of the notes were used in part to repay $25 million of 7.5% unsecured long-term notes that matured on May 1, 2006.

On October 13, 2005, the Company issued $261.0 million of five-year and $89.0 million of seven-year unsecured long-term notes, primarily to insurance companies. The five- and seven-year notes have fixed interest rates of 6.2% and 6.3%, respectively, and have substantially the same terms as the Company’s existing unsecured long-term notes. The Company used a portion of the proceeds from the new long-term note issuance to repay $125.0 million of existing unsecured long-term notes that matured on October 15, 2005, and had an annual weighted average interest cost of 8.3%.

Publicly Issued Unsecured Notes Payable. During 2006, the Company completed public issuances of unsecured notes as follows:


		Amount		Coupon		Maturity Date
($ in millions)
July 25, 2006		$	400.0		6.625%		July 15, 2011
December 8, 2006			250.0		6.000%		April 1, 2012

	Total	$	650.0

The notes require payment of interest only semi-annually, and all principal is due upon maturity. The Company has the option to redeem these notes in whole or in part, together with a redemption premium, as stipulated in the notes.

SBA Debentures. At December 31, 2005, the Company had debentures payable to the SBA with original terms of ten years and at fixed interest rates ranging from 5.9% to 6.4%. The debentures required semi-annual interest-only payments with all principal due upon maturity. During the years ended December 31, 2006 and 2005, the Company repaid $28.5 million and $49.0 million, respectively, of the SBA debentures. At December 31, 2006, the Company had no debentures payable to the SBA.

Scheduled Maturities. Scheduled future maturities of notes payable at December 31, 2006, were as follows:


Year		Amount Maturing

		($ in millions)
2007		$	—
2008			153.0
2009			268.9
2010			408.0
2011			472.5
Thereafter			389.0


	Total	$	1,691.4

F-47

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued


	*Revolving Line of Credit*

At December 31, 2006, the Company had an unsecured revolving line of credit with a committed amount of $922.5 million that expires on September 30, 2008. At December 31, 2005, the commitments under the facility were $772.5 million. At the Company’s option, borrowings under the revolving line of credit generally bear interest at a rate equal to (i) LIBOR (for the period the Company selects) plus 1.05% or (ii) the higher of the Federal Funds rate plus 0.50% or the Bank of America, N.A. prime rate. The revolving line of credit requires the payment of an annual commitment fee equal to 0.20% of the committed amount (whether used or unused). The revolving line of credit generally requires payments of interest at the end of each LIBOR interest period, but no less frequently than quarterly, on LIBOR based loans and monthly payments of interest on other loans. All principal is due upon maturity.

The annual cost of commitment fees, other facility fees and amortization of debt financing costs was $3.9 million and $3.3 million at December 31, 2006 and 2005, respectively.

The revolving credit facility provides for a sub-facility for the issuance of letters of credit for up to an amount equal to 16.66% of the committed facility or $153.7 million. The letter of credit fee is 1.05% per annum on letters of credit issued, which is payable quarterly.

The average debt outstanding on the revolving line of credit was $142.1 million and $33.3 million, respectively, for the years ended December 31, 2006 and 2005. The maximum amount borrowed under this facility and the weighted average stated interest rate for the years ended December 31, 2006 and 2005, were $540.3 million and 6.3%, respectively, and $263.3 million and 4.4%, respectively. At December 31, 2006, the amount available under the revolving line of credit was $673.8 million, net of amounts committed for standby letters of credit of $41.0 million issued under the credit facility.


	*Fair Value of Debt*

The Company records debt at cost. The fair value of the Company’s outstanding debt was approximately $1.9 billion and $1.3 billion at December 31, 2006 and 2005, respectively. The fair value of the Company’s debt was determined using market interest rates as of the balance sheet date for similar instruments.


	*Covenant Compliance*

The Company has various financial and operating covenants required by the privately issued unsecured notes payable and the revolving line of credit outstanding at December 31, 2006. These covenants require the Company to maintain certain financial ratios, including debt to equity and interest coverage, and a minimum net worth. These credit facilities provide for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, cross-defaults, bankruptcy events, failure to pay judgments, attachment of the Company’s assets, change of control and the issuance of an order of dissolution. Certain of these events of default are subject to notice and cure periods or materiality thresholds. The Company’s credit facilities limit its ability to declare dividends if the Company defaults under certain provisions. As of December 31, 2006 and 2005, the Company was in compliance with these covenants.

F-48

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 4. Debt, continued

The Company has certain financial and operating covenants that are required by the publicly issued unsecured notes payable, including that the Company will maintain a minimum ratio of 200% of total assets to total borrowings, as required by the Investment Company Act of 1940, as amended, while these notes are outstanding. As of December 31, 2006, the Company was in compliance with these covenants.

Note 5. Guarantees and Commitments

In the ordinary course of business, the Company has issued guarantees and has extended standby letters of credit through financial intermediaries on behalf of certain portfolio companies. All standby letters of credit have been issued through Bank of America, N.A. As of December 31, 2006 and 2005, the Company had issued guarantees of debt, rental obligations, and lease obligations aggregating $202.1 million and $148.6 million, respectively, and had extended standby letters of credit aggregating $41.0 million and $37.1 million, respectively. Under these arrangements, the Company would be required to make payments to third-party beneficiaries if the portfolio companies were to default on their related payment obligations. The maximum amount of potential future payments was $243.1 million and $185.7 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, $2.4 million and $2.5 million, respectively, had been recorded as a liability for the Company’s guarantees and no amounts had been recorded as a liability for the Company’s standby letters of credit.

As of December 31, 2006, the guarantees and standby letters of credit expired as follows:


		Total		2007		2008		2009		2010		2011		After 2011
(in millions)
Guarantees		$	202.1	$	0.6	$	3.0	$	192.2	$	—	$	4.4	$	1.9
Standby letters of credit⁽¹⁾			41.0		4.0		37.0		—		—		—		—

	Total⁽²⁾	$	243.1	$	4.6	$	40.0	$	192.2	$	—	$	4.4	$	1.9


⁽¹⁾	Standby letters of credit are issued under the Company’s revolving line of credit that expires in September 2008. Therefore, unless a standby letter of credit is set to expire at an earlier date, it is assumed that the standby letters of credit will expire contemporaneously with the expiration of the Company’s line of credit in September 2008.
⁽²⁾	The Company’s most significant commitments relate to its investment in Business Loan Express, LLC (BLX), which commitments totaled $214.7 million at December 31, 2006. At December 31, 2006, the Company guaranteed 50% of the outstanding total obligations on BLX’s revolving line of credit for a total guaranteed amount of $189.7 million and had also provided four standby letters of credit totaling $25.0 million in connection with four term securitizations completed by BLX. See Note 3.

In the ordinary course of business, the Company enters into agreements with service providers and other parties that may contain provisions for the Company to indemnify such parties under certain circumstances.

At December 31, 2006, the Company had outstanding commitments to fund investments totaling $435.0 million, including $426.0 million related to private finance investments and $9.0 related to commercial real estate finance investments. In addition, during the fourth quarter of 2004 and the first quarter of 2005, the Company sold certain commercial mortgage loans that the Company may be required to repurchase under certain circumstances. These recourse provisions expire by April 2007.

F-49

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 5. Guarantees and Commitments, continued

The aggregate outstanding principal balance of these sold loans was $4.2 million at December 31, 2006.

Note 6. Shareholders’ Equity

Sales of common stock for the years ended December 31, 2006, 2005, and 2004, were as follows:


		2006			2005⁽¹⁾		2004
(in millions)
Number of common shares			10.9			—		3.0

Gross proceeds		$	310.2		$	—	$	75.0
Less costs, including underwriting fees			(14.4	)		—		(4.7	)

	Net proceeds	$	295.8		$	—	$	70.3


⁽¹⁾	The Company did not sell any common stock during the year ended December 31, 2005.

The Company issued 0.3 million shares of common stock with a value of $7.2 million as consideration for an additional investment in Mercury Air Centers, Inc. during the year ended December 31, 2005, and 0.1 million shares of common stock with a value of $3.2 million as consideration for an investment in Legacy Partners Group, LLC during the year ended December 31, 2004.

The Company issued 0.5 million shares, 3.0 million shares, and 1.6 million shares of common stock upon the exercise of stock options during the years ended December 31, 2006, 2005, and 2004, respectively.

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 trading days immediately prior to the dividend payment date. For the years ended December 31, 2006, 2005, and 2004, the Company issued new shares in order to satisfy dividend reinvestment requests. Dividend reinvestment plan activity for the years ended December 31, 2006, 2005, and 2004, was as follows:


	2006		2005		2004
(in millions, except per share amounts)
Shares issued		0.5		0.3		0.2
Average price per share	$	30.58	$	28.00	$	26.34

F-50

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 7. Earnings Per Common Share

Earnings per common share for the years ended December 31, 2006, 2005, and 2004, were as follows:


	2006		2005		2004
(in millions, except per share amounts)
Net increase in net assets resulting from operations	$	245.1	$	872.8	$	249.5
Less preferred stock dividends		—		—		(0.1	)

Income available to common shareholders	$	245.1	$	872.8	$	249.4

Weighted average common shares outstanding — basic		142.4		134.7		129.8
Dilutive options outstanding		3.2		2.6		2.7

Weighted average common shares outstanding — diluted		145.6		137.3		132.5

Basic earnings per common share	$	1.72	$	6.48	$	1.92

Diluted earnings per common share	$	1.68	$	6.36	$	1.88

Note 8. Employee Compensation Plans

The Company’s 401(k) retirement investment plan is open to all of its full-time employees who are at least 21 years of age. The employees may elect voluntary pre-tax wage deferrals ranging from 0% to 100% of eligible compensation for the year up to $15 thousand annually for the 2006 plan year. Plan participants who were age 50 or older during the 2006 plan year were eligible to defer an additional $5 thousand during the year. The Company makes contributions to the 401(k) plan of up to 5% of each participant’s eligible compensation for the year up to a maximum compensation permitted by the IRS, which fully vests at the time of contribution. For the year ended December 31, 2006, the maximum compensation was $0.2 million. Employer contributions that exceed the IRS limitation are directed to the participant’s deferred compensation plan account as discussed below. Total 401(k) contribution expense for the years ended December 31, 2006, 2005, and 2004, was $1.2 million, $1.0 million, and $0.9 million, respectively.

The Company also has a deferred compensation plan. Eligible participants in the deferred compensation plan may elect to defer some of their compensation and have such compensation credited to a participant account. In addition, the Company makes contributions to the deferred compensation plan on compensation deemed ineligible for a 401(k) contribution. Contribution expense for the deferred compensation plan for the years ended December 31, 2006, 2005, and 2004, was $1.5 million, $0.7 million, and $0.7 million, respectively. All amounts credited to a participant’s account are credited solely for purposes of accounting and computation and remain assets of the Company and subject to the claims of the Company’s general creditors. Amounts credited to participants under the deferred compensation plan are at all times 100% vested and non-forfeitable. A participant’s account shall become distributable upon his or her separation from service, retirement, disability, death, or at a future determined date. All deferred compensation plan accounts will be distributed in the event of a change of control of the Company or in the event of the Company’s insolvency. Amounts deferred by participants under the deferred compensation plan are funded to a trust, which is administered by trustees. The accounts of the deferred compensation trust are

F-51

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 8. Employee Compensation Plans, continued

consolidated with the Company’s accounts. The assets of the trust are classified as other assets and the liability to the plan participants is included in other liabilities in the accompanying financial statements. The deferred compensation plan accounts at December 31, 2006 and 2005, totaled $18.6 million and $16.6 million, respectively.

The Company has an Individual Performance Award (“IPA”), which was established as a long-term incentive compensation program for certain officers. In conjunction with the program, the Board of Directors has approved a non-qualified deferred compensation plan (“DCP II”), which is administered through a trust by a third-party trustee. The administrator of the DCP II is the Compensation Committee of the Company’s Board of Directors (“DCP II Administrator”).

The IPA is deposited in the trust in four equal installments, generally on a quarterly basis, in the form of cash. The Compensation Committee of the Board of Directors designed the DCP II to require the trustee to use the cash to purchase shares of the Company’s common stock in the open market. During the years ended December 31, 2006, 2005, and 2004, 0.3 million shares, 0.3 million shares, and 0.5 million shares, respectively, were purchased in the DCP II.

All amounts deposited and then credited to a participant’s account in the trust, based on the amount of the IPA received by such participant, are 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 DCP II are immediately vested and generally non-forfeitable once deposited by the Company into the trust. A participant’s account shall generally become distributable only after his or her termination of employment, or in the event of a change of control of the Company. Upon the participant’s termination of employment, one-third of the participant’s account will be immediately distributed in accordance with the plan, one-half of the then current remaining balance will be distributed on the first anniversary of his or her employment termination date and the remainder of the account balance will be distributed on the second anniversary of the employment termination date. Distributions are subject to the participant’s adherence to certain non-solicitation requirements. All DCP II accounts will be distributed in a single lump sum in the event of a change of control of the Company. To the extent that a participant has an employment agreement, such participant’s DCP II account will be fully distributed in the event that such participant’s employment is terminated for good reason as defined under that participant’s employment agreement. Sixty days following a distributable event, the Company and each participant may, at the discretion of the Company, and subject to the Company’s trading window during that time, redirect the participant’s account to other investment options.

During any period of time in which a participant has an account in the DCP II, any dividends declared and paid on shares of the Company’s common stock allocated to the participant’s account shall be reinvested by the trustee as soon as practicable in shares of the Company’s common stock.

The IPA amounts are contributed into the DCP II trust and invested in the Company’s common stock. The accounts of the DCP II are consolidated with the Company’s accounts. The common stock is classified as common stock held in deferred compensation trust in the accompanying financial statements and the deferred compensation obligation, which represents the amount owed to the employees, is included in other liabilities. Changes in the value of the Company’s common stock held in the deferred compensation trust are not recognized. However, the liability is marked to market with a corresponding charge or credit to employee compensation expense. At December 31, 2006 and

F-52

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 8. Employee Compensation Plans, continued

2005, common stock held in DCP II was $28.3 million and $19.5 million, respectively, and the IPA liability was $33.9 million and $22.3 million, respectively. At December 31, 2006 and 2005, the DCP II held 1.0 million shares and 0.7 million shares, respectively, of the Company’s common stock.

The IPA expense for the years ended December 31, 2006, 2005, and 2004, were as follows:


		2006		2005		2004
($ in millions)
IPA contributions		$	8.1	$	7.0	$	13.4
IPA mark to market expense (benefit)			2.9		2.0		(0.4	)

	Total IPA expense	$	11.0	$	9.0	$	13.0

The Company also has an individual performance bonus (“IPB”) which was established in 2005. The IPB is distributed in cash to award recipients equally throughout the year as long as the recipient remains employed by the Company. If a recipient terminated employment during the year, any remaining cash payments under the IPB were forfeited. For the years ended December 31, 2006 and 2005, the IPB expense was $8.1 million and $6.9 million, respectively. The IPA and IPB expenses are included in employee expenses.

Note 9. Stock 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. 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. The options granted to officers generally vest ratably over a three year period. Options granted to non-officer directors vest on the grant date.

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.

At both December 31, 2006 and 2005, there were 32.2 million shares authorized under the Option Plan. At December 31, 2006 and 2005, the number of shares available to be granted under the Option Plan was 1.6 million and 3.0 million, respectively.

F-53

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 9. Stock Option Plan, continued

Information with respect to options granted, exercised and forfeited under the Option Plan for the years ended December 31, 2006, 2005, and 2004, was as follows:


				Weighted		Weighted
				Average		Average
				Exercise		Contractual		Aggregate Intrinsic
				Price Per		Remaining		Value at
	Shares			Share		Term (Years)		December 31, 2006⁽¹⁾

(in millions, except per share amounts)
Options outstanding at January 1, 2004		14.9		$	20.68
Granted		8.2		$	28.34
Exercised		(1.6	)	$	19.73
Forfeited		(1.1	)	$	26.07

Options outstanding at December 31, 2004		20.4		$	23.55

Granted		6.8		$	27.37
Exercised		(3.0	)	$	22.32
Forfeited		(1.9	)	$	27.83

Options outstanding at December 31, 2005		22.3		$	24.52
Granted		1.8		$	29.88
Exercised		(0.5	)	$	22.99
Forfeited		(0.4	)	$	27.67

Options outstanding at December 31, 2006		23.2		$	24.92		6.27	$	180.1

Exercisable at December 31, 2006		16.7		$	23.70		5.60	$	150.2

Exercisable and expected to be exercisable at December 31, 2006⁽²⁾		22.7		$	24.85		6.24	$	178.0


⁽¹⁾	Represents the difference between the market value of the options at December 31, 2006, and the cost for the option holders to exercise the options.

⁽²⁾	The amount of options expected to be exercisable at December 31, 2006, is calculated based on an estimate of expected forfeitures.

The fair value of the shares vested during the years ended December 31, 2006, 2005, and 2004, was $16.1 million, $16.2 million, and $18.7 million, respectively. The total intrinsic value of the options exercised during the years ended December 31, 2006, 2005, and 2004, was $3.6 million, $18.4 million, and $12.2 million, respectively.

F-54

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 9. Stock Option Plan, continued

The following table summarizes information about stock options outstanding at December 31, 2006:


	Outstanding
							Exercisable
			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 millions, except per share amounts and years)
$16.81 — $17.88		2.4		3.28	$	16.97		2.4	$	16.97
$19.00 — $21.38		1.8		1.04	$	21.30		1.8	$	21.30
$21.52		3.3		5.95	$	21.52		3.3	$	21.52
$21.59 — $24.98		2.6		5.49	$	22.43		2.4	$	22.23
$25.50 — $27.38		1.8		7.35	$	26.49		1.4	$	26.47
$27.51		5.2		8.59	$	27.51		1.7	$	27.51
$28.98		4.3		7.19	$	28.98		3.2	$	28.98
$29.23 — $30.52		1.8		7.18	$	29.88		0.5	$	29.77

		23.2		6.27	$	24.92		16.7	$	23.70

Notes Receivable from the Sale of Common Stock

As a business development company under the 1940 Act, the Company is entitled to provide and has provided loans to the Company’s officers in connection with the exercise of options. However, as a result of provisions of the Sarbanes-Oxley Act of 2002, the Company is prohibited from making new loans to its executive officers. The outstanding loans are full recourse, 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, 2006 and 2005, the Company had outstanding loans to officers of $2.9 million and $3.9 million, respectively. Officers with outstanding loans repaid principal of $1.0 million, $1.6 million, and $13.2 million, for the years ended December 31, 2006, 2005, and 2004, respectively. The Company recognized interest income from these loans of $0.2 million, $0.2 million, and $0.5 million, respectively, during these same periods. This interest income is included in interest and dividends for companies less than 5% owned.

F-55

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Dividends and Distributions and Taxes

For the years ended December 31, 2006, 2005, and 2004, the Company’s Board of Directors declared the following distributions:


		2006				2005				2004

		Total		Total Per		Total		Total Per		Total		Total Per
		Amount		Share		Amount		Share		Amount		Share

(in millions, except per share amounts)
First quarter		$	82.5	$	0.59	$	76.1	$	0.57	$	73.3	$	0.57
Second quarter			84.1		0.60		76.2		0.57		73.5		0.57
Third quarter			88.8		0.61		78.8		0.58		74.0		0.57
Fourth quarter			92.0		0.62		79.3		0.58		75.8		0.57
Extra dividend			7.5		0.05		4.1		0.03		2.7		0.02

	Total distributions to common shareholders	$	354.9	$	2.47	$	314.5	$	2.33	$	299.3	$	2.30

For income tax purposes, distributions for 2006, 2005, and 2004, were composed of the following:


		2006				2005				2004

		Total		Total Per		Total		Total Per		Total		Total Per
		Amount		Share		Amount		Share		Amount		Share

(in millions, except per share amounts)
Ordinary income		$	177.4	$	1.23	$	157.3	$	1.17	$	145.3	$	1.12
Long-term capital gains			177.5		1.24		157.2		1.16		154.0		1.18

	Total distributions to common shareholders⁽¹⁾	$	354.9	$	2.47	$	314.5	$	2.33	$	299.3	$	2.30


⁽¹⁾	For the years ended December 31, 2006, 2005 and 2004, ordinary income included dividend income of approximately $0.04 per share, $0.03 per share, and $0.04 per share, respectively, that qualified to be taxed at the 15% maximum capital gains rate.

⁽²⁾	For certain eligible corporate shareholders, the dividend received deduction for 2006, 2005, and 2004, was $0.042 per share, $0.034 per share, and $0.038 per share, respectively.

The Company’s Board of Directors also declared a dividend of $0.63 per common share for the first quarter of 2007.

F-56

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Dividends and Distributions and Taxes, continued

The following table summarizes the differences between financial statement net increase in net assets resulting from operations and taxable income available for distribution to shareholders for the years ended December 31, 2006, 2005, and 2004:


			2006			2005			2004

($ in millions)			(ESTIMATED)⁽¹⁾
Financial statement net increase in net assets resulting from operations			$	245.1		$	872.8		$	249.5
Adjustments:
	Net change in unrealized appreciation or depreciation			477.4			(462.1	)		68.7
	Amortization of discounts and fees			(0.3	)		4.7			(5.4	)
	Interest- and dividend-related items			7.3			5.5			6.3
	Employee compensation-related items			18.1			3.0			7.7
	Nondeductible excise tax			15.1			6.2			1.0
	Realized gains recognized (deferred) through installment treatment⁽²⁾			(181.1	)		(5.9	)		(33.7	)
	Other realized gain or loss related items			11.5			18.6			5.5
	Net income (loss) from partnerships and limited liability companies⁽³⁾			(1.9	)		18.0			8.6
	Net loss from consolidated SBIC subsidiary			—			(8.4	)		15.2
	Net (income) loss from consolidated taxable subsidiary, net of tax			3.9			(5.0	)		(1.0	)
	Other			0.4			(2.4	)		0.8

		Taxable income	$	595.5		$	445.0		$	323.2


⁽¹⁾	The Company’s taxable income for 2006 is an estimate and will not be finally determined until the Company files its 2006 tax return in September 2007. Therefore, the final taxable income may be different than this estimate.

⁽²⁾	2006 includes the deferral of long-term capital gains through installment treatment related to the Company’s sale of its control equity investment in Advantage and certain other portfolio companies.

⁽³⁾	Includes taxable income passed through to the Company from BLX in excess of interest and related portfolio income from BLX included in the financial statements totaling $3.7 million, $15.4 million, and $10.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. See Note 3 for additional related disclosure.

F-57

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Dividends and Distributions and Taxes, continued

The Company must distribute at least 90% of its investment company taxable income to qualify for pass-through tax treatment and maintain its RIC status. The Company has distributed and currently intends to distribute or retain through a deemed distribution sufficient dividends to eliminate taxable income. Dividends declared and paid by the Company in a year generally differ from taxable income for that year as such dividends may include the distribution of current year taxable income, less amounts carried over into the following year, and the distribution of prior year taxable income carried over into and distributed in the current year. For income tax purposes, distributions for 2006, 2005, and 2004, were made from taxable income as follows:


		2006			2005			2004

($ in millions)		(ESTIMATED)⁽¹⁾
Taxable income		$	595.5		$	445.0		$	323.2
Taxable income earned in current year and carried forward for distribution in next year⁽²⁾			(397.1	)		(156.5	)		(26.0	)
Taxable income earned in prior year and carried forward and distributed in current year			156.5			26.0			2.1

	Total distributions to common shareholders	$	354.9		$	314.5		$	299.3


⁽¹⁾	The Company’s taxable income for 2006 is an estimate and will not be finally determined until the Company files its 2006 tax return in September 2007. Therefore, the final taxable income and the taxable income earned in 2006 and carried forward for distribution in 2007 may be different than this estimate.

⁽²⁾	Estimated taxable income for 2006 includes undistributed income of $397.1 million that is being carried over for distribution in 2007, which represents approximately $120.6 million of ordinary income and approximately $276.5 million of net long-term capital gains.

The Company will generally be required to pay an excise tax equal to 4% of the amount by which 98% of the Company’s annual taxable income exceeds the distributions for the year. The Company’s 2006 (estimated), 2005, and 2004, annual taxable income were in excess of its dividend distributions from such taxable income in 2006, 2005, and 2004, and accordingly, the Company accrued an excise tax of $15.4 million, $6.2 million, and $1.0 million, respectively, on the excess taxable income carried forward. In 2006, the Company reversed $0.3 million of excise tax which was over accrued in 2005, resulting in excise tax expense of $15.1 million for the year ended December 31, 2006.

In addition to excess taxable income carried forward, the Company currently estimates that it has cumulative deferred taxable income related to installment sale gains of approximately $220.7 million as of December 31, 2006, which is composed of cumulative deferred taxable income of $39.6 million as of December 31, 2005, and approximately $181.1 million for the year ended December 31, 2006. These gains have been recognized for financial reporting purposes in the respective years they were realized, but are generally deferred for tax purposes until the notes or other amounts received from the sale of the related investments are collected in cash. The realized gains deferred through installment treatment for 2006 are estimates and will not be finally determined until the Company files its 2006 tax return in September 2007.

The Company’s undistributed book earnings of $502.2 million as of December 31, 2006, resulted from undistributed ordinary income and long-term capital gains. The difference between undistributed book earnings at the end of the year and taxable income carried over from the current year into the

F-58

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Dividends and Distributions and Taxes, continued

next year relates to a variety of timing and permanent differences in the recognition of income and expenses for book and tax purposes as discussed above.

At December 31, 2006 and 2005, the aggregate gross unrealized appreciation of the Company’s investments above cost for federal income tax purposes was $613.1 million (estimated) and $789.1 million, respectively. At December 31, 2006 and 2005, the aggregate gross unrealized depreciation of the Company’s investments below cost for federal income tax purposes was $418.8 million (estimated) and $308.8 million, respectively. The aggregate net unrealized appreciation of the Company’s investments over cost for federal income tax purposes was $194.3 million (estimated) and $480.3 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, the aggregate cost of securities, for federal income tax purposes was $4.3 billion (estimated) and $3.1 billion, respectively.

The Company’s consolidated subsidiary, AC Corp, is subject to federal and state income taxes. For the years ended December 31, 2006, 2005, and 2004, AC Corp’s income tax expense (benefit) was $(0.1) million, $5.3 million, and $1.0 million, respectively. For the years ended December 31, 2005, and 2004, paid in capital was increased for the tax benefit of amounts deducted for tax purposes but not for financial reporting purposes primarily related to stock-based compensation by $3.7 million and $3.8 million, respectively.

The net deferred tax asset at December 31, 2006, was $6.9 million, consisting of deferred tax assets of $13.7 million and deferred tax liabilities of $6.8 million. The net deferred tax asset at December 31, 2005, was $4.1 million, consisting of deferred tax assets of $8.9 million and deferred tax liabilities of $4.8 million. At December 31, 2006, the deferred tax assets primarily related to compensation-related items and the deferred tax liabilities primarily related to depreciation. Management believes that the realization of the net deferred tax asset is more likely than not based on expectations as to future taxable income and scheduled reversals of temporary differences. Accordingly, the Company did not record a valuation allowance at December 31, 2006, 2005, or 2004.

Note 11. Cash

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, 2006 and 2005, cash consisted of the following:


		2006			2005
($ in millions)
Cash		$	2.3		$	33.4
Less escrows held			(0.6	)		(2.0	)

	Total cash	$	1.7		$	31.4

F-59

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 12. Supplemental Disclosure of Cash Flow Information

The Company paid interest of $90.6 million, $75.2 million, and $74.6 million, respectively, for the years ended December 31, 2006, 2005, and 2004.

Principal collections related to investment repayments or sales include the collection of discounts previously amortized into interest income and added to the cost basis of a loan or debt security totaling $0.2 million, $8.4 million, and $11.4 million, for the years ended December 31, 2006, 2005, and 2004, respectively.

Non-cash operating activities for the year ended December 31, 2006, included the following:


	•	a note received as consideration from the sale of the Company’s equity investment in Advantage of $150.0 million;

	•	a note received as consideration from the sale of the Company’s equity investment in STS Operating, Inc. of $30.0 million;

	•	the exchange of existing debt securities and accrued interest of S.B. Restaurant Company with a cost basis of $29.2 million for new debt securities;

	•	the exchange of existing debt securities, preferred stock and common stock of Border Foods, Inc. with a cost basis of $16.6 million for new preferred and common equity securities; and

	•	the exchange of existing preferred stock and common stock of Redox Brands, Inc. with a cost basis of $10.2 million for common stock in CR Brands, Inc.

Non-cash operating activities for the year ended December 31, 2005, included the following:


	•	the exchange of existing subordinated debt securities and accrued interest of BLX with a cost basis of $44.8 million for additional Class B equity interests (see Note 3);

	•	the exchange of debt securities and accrued interest of Coverall North America, Inc. with a cost basis of $24.2 million for new debt securities and warrants with a total cost basis of $26.8 million;

	•	the exchange of debt securities of Garden Ridge Corporation with a cost basis of $25.0 million for a new loan with a cost basis of $22.5 million; and

	•	the contribution to capital of existing debt securities of GAC Investments, Inc. (“GAC”) with a cost basis of $11.0 million, resulting in a decrease in the Company’s debt cost basis and an increase in the Company’s common stock cost basis in GAC. During the third quarter of 2005, GAC changed its name to Triview Investments, Inc.

Non-cash operating activities for the year ended December 31, 2004, included the following:


	•	notes or other securities received as consideration from the sale of investments of $56.6 million. Notes received included a note received for $47.5 million in conjunction with the sale of the Company’s investment in Hillman. During the second quarter of 2004, the Company sold a $5.0 million participation in its subordinated debt in Hillman to a third party, which reduced its investment, and no gain or loss resulted from the transaction;

F-60

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 12. Supplemental Disclosure of Cash Flow Information, continued


	•	an exchange of $93.7 million of subordinated debt in certain predecessor companies of Advantage Sales & Marketing, Inc. for new subordinated debt in Advantage;

	•	an exchange of existing debt securities with a cost basis of $46.4 million for new debt and common stock in Startec Global Communications Corporation;

	•	an exchange of existing debt securities with a cost basis of $13.1 million for new debt of $11.3 million with the remaining cost basis attributed to equity in Fairchild Industrial Products Company;

	•	an exchange of existing loans with a cost basis of $11.1 million for a new loan and equity in Gordian Group, Inc.;

	•	the repayment in kind of $12.7 million of existing debt in American Healthcare Services, Inc. with $10.0 million of debt in MedBridge Healthcare, LLC and $2.7 million of debt and equity from other companies;

	•	an exchange of existing subordinated debt with a cost basis of $7.3 million for equity interests in an affiliate of Impact Innovations Group, LLC;

	•	GAC acquired certain assets of Galaxy out of bankruptcy during the third quarter of 2004. The Company exchanged its $50.7 million outstanding debt in Galaxy for debt and equity in GAC to facilitate the asset acquisition; and

	•	$25.5 million of CMBS bonds and LLC interests received from the securitization of commercial mortgage loans.

Non-cash financing activities included the issuance of common stock in lieu of cash distributions totaling $15.0 million, $9.3 million, and $5.8 million, for the years ended December 31, 2006, 2005, and 2004, respectively. In addition, the non-cash financing activities included the issuance of $7.2 million of the Company’s common stock as consideration for an additional investment in Mercury Air Centers, Inc. for the year ended December 31, 2005, and the issuance of $3.2 million of the Company’s common stock as consideration for an investment in Legacy Partners Group, LLC for the year ended December 31, 2004.

Note 13. Hedging Activities

At December 31, 2005, the Company had invested in commercial mortgage loans that were purchased at prices that were based in part on comparable Treasury rates and the Company had entered into transactions with one or more financial institutions to hedge against movement in Treasury rates on certain of these commercial mortgage loans. These transactions, referred to as short sales, involved the Company receiving the proceeds from the short sales of borrowed Treasury securities, with the obligation to replenish the borrowed Treasury securities at a later date based on the then current market price. Borrowed Treasury securities and the related obligations to replenish

F-61

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 13. Hedging Activities, continued

the borrowed Treasury securities at value, including accrued interest payable on the obligations, as of December 31, 2005, consisted of the following:


($ in millions)
Description of Issue	2005

5-year Treasury securities, due April 2010	$	17.7

During the fourth quarter of 2006, the Company sold commercial mortgage loans with a total outstanding principal balance of $21.1 million and realized a gain of $0.7 million. As these loans were purchased at prices that were based in part on comparable Treasury rates, the Company had a related hedge in place to protect against movements in Treasury rates. Upon the loan sale, the Company settled the related hedge, which resulted in a realized gain of $0.5 million, which was included in the realized gain on the sale of $0.7 million. At December 31, 2006, the Company did not have any similar hedges in place.

Note 14. Financial Highlights


			At and for the Years
			Ended December 31,

			2006			2005			2004

Per Common Share Data
Net asset value, beginning of year			$	19.17		$	14.87		$	14.94

	Net investment income⁽¹⁾			1.30			1.00			1.52
	Net realized gains⁽¹⁾⁽²⁾			3.66			1.99			0.88

		Net investment income plus net realized gains⁽¹⁾		4.96			2.99			2.40
		Net change in unrealized appreciation or depreciation⁽¹⁾⁽²⁾		(3.28	)		3.37			(0.52	)

Net increase in net assets resulting from operations ⁽¹⁾				1.68			6.36			1.88

Net decrease in net assets from shareholder distributions				(2.47	)		(2.33	)		(2.30	)
Net increase in net assets from capital share transactions⁽¹⁾				0.74			0.27			0.35

Net asset value, end of year			$	19.12		$	19.17		$	14.87

Market value, end of year			$	32.68		$	29.37		$	25.84
Total return⁽³⁾				20.6	%		23.5	%		1.1	%
Ratios and Supplemental Data
($ and shares in millions, except per share amounts)
Ending net assets			$	2,841.2		$	2,620.5		$	1,979.8
Common shares outstanding at end of year				148.6			136.7			133.1
Diluted weighted average common shares outstanding				145.6			137.3			132.5

F-62

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 14. Financial Highlights, continued


	At and for the Years
	Ended December 31,

	2006			2005			2004

Employee, employee stock option and administrative expenses/average net assets		5.38	%		6.56	%		4.65	%
Total operating expenses/average net assets		9.05	%		9.99	%		8.53	%
Net investment income/average net assets		6.90	%		6.08	%		10.45	%
Net increase in net assets resulting from operations/average net assets		8.94	%		38.68	%		12.97	%
Portfolio turnover rate		27.05	%		47.72	%		32.97	%
Average debt outstanding	$	1,491.0		$	1,087.1		$	985.6
Average debt per share⁽¹⁾	$	10.24		$	7.92		$	7.44


⁽¹⁾	Based on diluted weighted average number of common shares outstanding for the year.

⁽²⁾	Net realized gains and net change in unrealized appreciation or depreciation can fluctuate significantly from year to year.

⁽³⁾	Total return assumes the reinvestment of all dividends paid for the periods presented.

Note 15. Selected Quarterly Data (Unaudited)


	2006

($ in millions, except per share amounts)	Qtr. 1		Qtr. 2		Qtr. 3		Qtr. 4

Total interest and related portfolio income	$	111.0	$	110.5	$	113.4	$	117.7
Net investment income	$	41.3	$	50.2	$	48.7	$	49.1
Net increase in net assets resulting from operations	$	99.6	$	33.7	$	77.9	$	33.9
Basic earnings per common share	$	0.72	$	0.24	$	0.54	$	0.23
Diluted earnings per common share	$	0.70	$	0.24	$	0.53	$	0.23


	2005

	Qtr. 1		Qtr. 2		Qtr. 3		Qtr. 4

Total interest and related portfolio income	$	94.9	$	86.2	$	94.9	$	98.2
Net investment income	$	38.8	$	15.3	$	46.1	$	37.1
Net increase in net assets resulting from operations	$	119.6	$	311.9	$	113.2	$	328.1
Basic earnings per common share	$	0.90	$	2.33	$	0.84	$	2.40
Diluted earnings per common share	$	0.88	$	2.29	$	0.82	$	2.36

Note 16. Litigation

On June 23, 2004, the Company was notified by the SEC that the SEC is conducting an informal investigation of the Company. On December 22, 2004, the Company received letters from the U.S. Attorney for the District of Columbia requesting the preservation and production of information regarding the Company and Business Loan Express, LLC in connection with a criminal investigation. Based on the information available to the Company at this time, the inquiries appear to primarily pertain to matters related to portfolio valuation and the Company’s portfolio company, Business Loan Express, LLC. To date, the Company has produced materials in response to requests

F-63

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 16. Litigation, continued

from both the SEC and the U.S. Attorney’s office, and a director and certain current and former employees have provided testimony and have been interviewed by the staff of the SEC and, in some cases, the U.S. Attorney’s Office. The Company is voluntarily cooperating with these investigations.

In late December 2006, the Company received a subpoena from the U.S. Attorney for the District of Columbia requesting, among other things, the production of records regarding the use of private investigators by the Company or its agents. The Board established a committee, which was advised by its own counsel, to review this matter. In the course of gathering documents responsive to the subpoena, the Company became aware that an agent of the Company obtained what were represented to be telephone records of David Einhorn and which purport to be records of calls from Greenlight Capital during a period of time in 2005. Also, while the Company was gathering documents responsive to the subpoena, allegations were made that the Company’s management had authorized the acquisition of these records and that management was subsequently advised that these records had been obtained. The Company’s management has stated that these allegations are not true. The Company is cooperating fully with the inquiry by the United States Attorney’s office.

On February 13, 2007, Rena Nadoff filed a shareholder derivative action in the Superior Court of the District of Columbia, captioned Rena Nadoff v. Walton, et al., CA 001060-07, seeking unspecified compensatory and other damages, as well as equitable relief on behalf of Allied Capital Corporation. Ms. Nadoff’s complaint names as defendants the members of Allied Capital’s Board of Directors; Allied Capital is a nominal defendant for purposes of the derivative action. The complaint alleges breach of fiduciary duty by the Board of Directors arising from internal controls failures and mismanagement of Business Loan Express, LLC, an Allied Capital portfolio company. The Company believes the lawsuit is without merit, and intends to defend the lawsuit vigorously.

On February 26, 2007, Dana Ross filed a class action complaint in the U.S. District Court for the District of Columbia in which she alleges that Allied Capital Corporation and certain members of management violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint is captioned Dana Ross v. Walton, et al., CV 00402. Dana Ross claims that, between March 1, 2006, and January 10, 2007, Allied Capital either failed to disclose or misrepresented information concerning the loan origination practices of Business Loan Express, LLC, an Allied Capital portfolio company. Dana Ross seeks unspecified compensatory and other damages, as well as other relief. The Company believes the lawsuit is without merit, and intends to defend the lawsuit vigorously.

In addition, the Company is party to certain lawsuits in the normal course of business.

While the outcome of any of the legal proceedings described above cannot at this time be predicted with certainty, the Company does not expect these matters will materially affect its financial condition or results of operations.

F-64

Report of Independent Registered Public Accounting Firm

The Board of Directors
Allied Capital Corporation:

Under date of February 28, 2007, we reported on the consolidated balance sheet of Allied Capital Corporation and subsidiaries as of December 31, 2006 and 2005, including the consolidated statements of investments as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in net assets and cash flows, and the financial highlights (included in Note 14), for each of the years in the three-year period ended December 31, 2006, which are included in the registration statement on Form N-2. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule as of and for the year ended December 31, 2006. This financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.

In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.

Washington, D.C.

February 28, 2007

F-65

Schedule 12-14

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES


			Amount of Interest or
			Dividends
PRIVATE FINANCE
Portfolio Company			Credited					December 31, 2005		Gross		Gross			December 31, 2006
(in thousands)		Investment(1)	to Income(6)			Other(2)		Value		Additions(3)		Reductions(4)			Value

Companies More Than 25% Owned

Acme Paging, L.P.		Senior Loan(5)	$	(176	)			$	—	$	3,750	$	(3,750	)	$	—
	(Telecommunications)	Subordinated Debt (5)		(3	)				—		881		(881	)		—
		Common Stock							—		27		(27	)		—

Advantage Sales &		Subordinated Debt		1,712					59,787		213		(60,000	)		—
	Marketing, Inc.(7)	Subordinated Debt		5,555					124,000		374		(124,374	)		—
	(Business Services)	Common Stock							476,578		—		(476,578	)		—

Alaris Consulting, LLC		Senior Loan(5)		(63	)				—		—		—			—
	(Business Services)	Equity Interests							—		—		—			—

American Healthcare		Senior Loan(5)				$	1		4,097		502		(4,599	)		—
	Services, Inc. and Affiliates
	(Healthcare Services)

Avborne, Inc.		Preferred Stock							892		73		(47	)		918
	(Business Services)	Common Stock							—		—		—			—

Avborne Heavy Maintenance, Inc.		Preferred Stock							—		—		—			—
	(Business Services)	Common Stock							—		—		—			—

Border Foods, Inc.		Preferred Stock							—		—		—			—
	(Consumer Products)	Common Stock							—		—		—			—

Business Loan Express, LLC		Subordinated Debt		38					10,000		15,000		(25,000	)		—
	(Financial Services)	Class A Equity
		Interests(5)		11,889					60,693		5,929		—			66,622
		Class B Equity Interests							146,910		—		(67,771	)		79,139
		Class C Equity Interests							139,521		—		(74,545	)		64,976

Calder Capital Partners, LLC		Senior Loan(5)							—		975		—			975
	(Financial Services)	Equity Interests							—		2,076		—			2,076

Callidus Capital Corporation		Senior Loan		441					600		8,705		(9,305	)		—
	(Financial Services)	Subordinated Debt		972					4,832		930		—			5,762
		Common Stock							7,968		14,582		—			22,550

Coverall North America, Inc.		Unitranche Debt		1,926					—		36,333		—			36,333
	(Business Services)	Subordinated Debt		395					—		5,972		—			5,972
		Common Stock							—		19,729		(110	)		19,619
		Warrants							—		—		—			—

CR Brands, Inc.		Senior Loan		1,109					—		37,219		(37,219	)		—
	(Consumer Products)	Subordinated Debt		5,700					—		39,401		—			39,401
		Common Stock							—		33,321		(7,583	)		25,738

Diversified Group		Preferred Stock		87					728		—		(728	)		—
	Administrators, Inc.	Preferred Stock							841		—		(841	)		—
	(Business Services)	Common Stock		68					502		—		(502	)		—

Financial Pacific Company		Subordinated Debt		12,415					69,904		1,458		—			71,362
	(Financial Services)	Preferred Stock							13,116		2,826		—			15,942
		Common Stock							44,180		21,006		—			65,186

ForeSite Towers, LLC		Equity Interests		329					9,750		2,540		—			12,290
	(Tower Leasing)

Global Communications, LLC		Senior Loan(5)							15,957		—		—			15,957
	(Business Services)	Subordinated Debt (5)							11,198		138		(99	)		11,237
		Preferred Equity
		Interest							4,303		—		(4,303	)		—
		Options							—		—		—			—

Gordian Group, Inc.		Senior Loan(5)		(18	)				4,161		392		(4,553	)		—
	(Business Services)	Common Stock							—		220		(220	)		—

Healthy Pet Corp.		Senior Loan		1,746					4,086		24,252		(1,300	)		27,038
	(Consumer Services)	Subordinated Debt		6,549					38,535		5,230		(186	)		43,579
		Common Stock							25,766		4,500		(1,345	)		28,921

HMT, Inc.		Preferred Stock							2,637		—		—			2,637
	(Energy Services)	Common Stock							5,343		3,321		—			8,664
		Warrants							2,057		1,279		—			3,336

See related footnotes at the end of this schedule.

F-66


			Amount of Interest or
			Dividends
PRIVATE FINANCE
Portfolio Company			Credited				December 31, 2005		Gross		Gross			December 31, 2006
(in thousands)		Investment(1)	to Income(6)		Other(2)		Value		Additions(3)		Reductions(4)			Value

Huddle House, Inc.		Senior Loan	$	59			$	—	$	19,950	$	—		$	19,950
	(Retail)	Subordinated Debt		296				—		58,196		—			58,196
		Common Stock						—		41,662		—			41,662

Impact Innovations Group, LLC		Equity Interests in
	(Business Services)	Affiliate						742		131		—			873

Insight Pharmaceuticals		Subordinated Debt		9,724				58,298		1,552		—			59,850
	Corporation	Preferred Stock						26,791		—		(18,946	)		7,845
	(Consumer Products)	Common Stock						236		—		(236	)		—

Jakel, Inc.		Subordinated Debt (5)						—		6,655		—			6,655
	(Industrial Products)	Preferred Stock						—		—		—			—
		Common Stock						—		—		—			—

Legacy Partners Group, LLC		Senior Loan (5)						5,029		—		(186	)		4,843
	(Financial Services)	Subordinated Debt (5)						—		—		—			—
		Equity Interests						—		18		(18	)		—

Litterer Beteiligungs-GmbH		Subordinated Debt		43				621		71		—			692
	(Business Services)	Equity Interest						2,226		—		(1,027	)		1,199

Mercury Air Centers, Inc.		Senior Loan		1,231				31,720		4,000		(35,720	)		—
	(Business Services)	Subordinated Debt		8,076				46,519		5,698		(3,000	)		49,217
		Common Stock						88,898		106,121		—			195,019

MVL Group, Inc.		Senior Loan		3,605				27,218		1,000		(973	)		27,245
	(Business Services)	Subordinated Debt		5,052				32,417		3,061		—			35,478
		Common Stock						3,211		—		(3,211	)		—

Penn Detroit Diesel Allison, LLC		Subordinated Debt		2,473				—		37,994		—			37,994
	(Business Services)	Equity Interests						—		25,949		—			25,949

Pennsylvania Avenue
	Investors, L.P.	Equity Interests						1,864		1,193		(3,057	)		—
	(Private Equity Fund)

Powell Plant Farms, Inc.		Senior Loan(5)		2,394				23,792		10,625		(8,225	)		26,192
	(Consumer Products)	Subordinated Debt (5)						7,364		—		(6,402	)		962
		Preferred Stock						—		—		—			—
		Warrants						—		—		—			—

Redox Brands, Inc.		Preferred Stock		363				12,097		1,708		(13,805	)		—
	(Consumer Products)	Warrants						500		84		(584	)		—

Service Champ, Inc.		Subordinated Debt		4,339				26,906		713		—			27,619
	(Business Services)	Common Stock						13,319		3,467		—			16,786

Staffing Partners Holding		Subordinated Debt (5)			$	355		6,343		—		(5,857	)		486
	Company, Inc.	Preferred Stock						1,812		3,156		(4,968	)		—
	(Business Services)	Common Stock						—		60		(60	)		—
		Warrants						—		—		—			—

Startec Global Communications
	Corporation	Senior Loan		2,165				21,685		3,540		(9,260	)		15,965
	(Telecommunications)	Common Stock						—		11,232		—			11,232

STS Operating, Inc.		Subordinated Debt		328				6,593		123		(6,716	)		—
	(Industrial Products)	Common Stock						64,963		—		(64,963	)		—
		Options						560		—		(560	)		—

Sweet Traditions, LLC		Senior Loan		1,755				—		36,150		(978	)		35,172
	(Consumer Products)	Equity Interests						—		450		—			450

Triview Investments, Inc.		Senior Loan		1,302				7,449		7,298		—			14,747
	(Broadcasting & Cable/	Subordinated Debt		8,692				30,845		25,163		—			56,008
	Consumer Products/	Subordinated Debt (5)						19,520		742		(15,920	)		4,342
	Business Services)	Common Stock		68				29,171		11,516		(9,365	)		31,322

Total companies more than 25% owned			$	102,636			$	1,887,651						$	1,490,180

Companies 5% to 25% Owned

Advantage Sales &		Subordinated Debt	$	14,050			$	—	$	151,648	$	—		$	151,648
	Marketing, Inc.(7)	Equity Interests						—		15,272		(4,272	)		11,000
	(Business Services)

Air Medical Group Holdings LLC		Senior Loan		3,298				—		8,097		(6,334	)		1,763
	(Healthcare Services)	Subordinated Debt		2,145				42,267		35,488		(42,627	)		35,128
		Equity Interests		1,694				4,025		3,393		(1,468	)		5,950

Alpine ESP Holdings, Inc.		Preferred Stock						—		622		(20	)		602
	(Business Services)	Common Stock						—		14		(14	)		—

See related footnotes at the end of this schedule.

F-67


			Amount of Interest or
			Dividends
PRIVATE FINANCE
Portfolio Company			Credited				December 31, 2005		Gross		Gross			December 31, 2006
(in thousands)		Investment(1)	to Income(6)		Other(2)		Value		Additions(3)		Reductions(4)			Value

Amerex Group, LLC		Subordinated Debt	$	669			$	—	$	8,400	$	—		$	8,400
	(Consumer Products)	Equity Interests						—		13,860		(37	)		13,823

Aspen Pet Products, Inc.		Subordinated Debt		1,130				19,959		399		(20,358	)		—
	(Consumer Products)	Preferred Stock		29				1,638		516		(2,154	)		—
		Common Stock						17		123		(140	)		—
		Warrants						—		—		—			—

BB&T Capital
	Partners/Windsor
	Mezzanine Fund, LLC	Equity Interests						—		5,867		(313	)		5,554
	(Private Equity Fund)

Becker Underwood, Inc.		Subordinated Debt		3,545				23,543		620		—			24,163
	(Industrial Products)	Common Stock						2,200		1,500		—			3,700

BI Incorporated		Senior Loan		125				—		15,000		(15,000	)		—
	(Business Services)	Subordinated Debt		3,484				—		30,135		—			30,135
		Common Stock						—		4,100		—			4,100

CitiPostal, Inc. and Affiliates		Senior Loan		1,061				—		20,689		(120	)		20,569
	(Business Services)	Common Stock						—		4,700		—			4,700

Creative Group, Inc.		Subordinated Debt		583				—		13,656		—			13,656
	(Business Services)	Warrants						—		1,387		—			1,387

Drew Foam Companies, Inc.		Preferred Stock						—		722		—			722
	(Business Services)	Common Stock						—		7		—			7

The Debt Exchange Inc.		Preferred Stock						3,219		—		(3,219	)		—
	(Business Services)

MedBridge Healthcare, LLC		Senior Loan(5)						7,093		71		—			7,164
	(Healthcare Services)	Subordinated Debt (5)						534		1,279		—			1,813
		Convertible
		Subordinated Debt (5)						—		—		—			—
		Equity Interests						—		501		(501	)		—

Multi-Ad Services, Inc.		Unitranche Debt		348				—		19,879		—			19,879
	(Business Services)	Equity Interests						—		2,000		—			2,000

Nexcel Synthetics, LLC		Subordinated Debt		1,604				10,588		390		—			10,978
	(Consumer Products)	Equity Interests						1,367		119		—			1,486

PresAir LLC		Senior Loan(5)			$	261		—		5,492		(3,286	)		2,206
	(Industrial Products)	Unitranche Debt (5)						5,820		328		(6,148	)		—
		Equity Interests						318		5		(323	)		—

Progressive International
	Corporation	Subordinated Debt		1,223				7,376		157		—			7,533
	(Consumer Products)	Preferred Stock						884		140		—			1,024
		Common Stock						13		2,287		—			2,300
		Warrants						—		—		—			—

Regency Healthcare Group, LLC		Senior Loan		72				—		1,232		—			1,232
	(Healthcare Services)	Unitranche Debt		1,152				—		19,908		—			19,908
		Equity Interests						—		1,616		—			1,616

SGT India Private Limited		Common Stock						—		3,944		(598	)		3,346
	(Business Services)

Soteria Imaging Services, LLC		Subordinated Debt		2,013				13,447		4,122		—			17,569
	(Healthcare Services)	Equity Interests						2,308		233		—			2,541

Universal Environmental
	Services, LLC	Unitranche Debt		1,529				10,862		101		(752	)		10,211
	(Business Services)	Equity Interests						1,328		13		(1,341	)		—

Total companies 5% to 25% owned			$	39,754			$	158,806						$	449,813

This schedule should be read in conjunction with the Company’s consolidated financial statements, including the consolidated statement of investments and Note 3 to the consolidated financial statements. Note 3 includes additional information regarding activities in the private finance portfolio.


(1)	Common stock, preferred stock, warrants, options, and equity interests are generally non-income producing and restricted. The principal amount for loans and debt securities and the number of shares of common stock and preferred stock is shown in the consolidated statement of investments as of December 31, 2006 and 2005.

F-68


(2)	Other includes interest, dividend, or other income which was applied to the principal of the investment and therefore reduced the total investment. These reductions are also included in the Gross Reductions for the investment, as applicable.

(3)	Gross additions include increased in the cost basis of investments resulting from new portfolio investments, paid-in-kind interest or dividends, the amortization of discounts and closing fees, the exchange of one or more existing securities for one or more new securities and the movement of an existing portfolio company into this category from a different category. Gross additions also include net increases in unrealized appreciation or net decreases in unrealized depreciation.

(4)	Gross reductions include decreases in the cost basis of investments resulting from principal collections related to investment repayments or sales, the exchange of one or more existing securities for one or more new securities and the movement of an existing portfolio company out of this category into a different category. Gross reductions also include net increases in unrealized depreciation or net decreases in unrealized appreciation.

(5)	Loan or debt security is on non-accrual status at December 31, 2006, and is therefore considered non-income producing. Loans or debt securities on non-accrual status at the end of the period may or may not have been on non-accrual status for the full period.

(6)	Represents the total amount of interest or dividends credited to income for the portion of the year an investment was included in the companies more than 25% owned or companies 5% to 25% owned categories, respectively.

(7)	Included in the companies more than 25% owned category while the Company held a majority equity interest. On March 29, 2006, the Company sold its majority equity interest in Advantage. The Company’s investment in Advantage after the sale transaction is included in the companies 5% to 25% owned category. See Note 3 to the consolidated financial statements for further information.

F-69

PART C

OTHER INFORMATION

Item 25. Financial Statements and Exhibits

1. Financial Statements.

The following financial statements of Allied Capital Corporation are included in this registration statement in “Part A: Information Required in a Prospectus”:


	Page

Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheet — December 31, 2006 and 2005		F-3
Consolidated Statement of Operations — For the Years Ended December 31, 2006, 2005 and 2004		F-4
Consolidated Statement of Changes in Net Assets — For the Years Ended December 31, 2006, 2005 and 2004		F-5
Consolidated Statement of Cash Flows — For the Years Ended December 31, 2006, 2005 and 2004		F-6
Consolidated Statement of Investments — December 31, 2006		F-7
Consolidated Statement of Investments — December 31, 2005		F-18
Notes to Consolidated Financial Statements		F-28
Report of Independent Registered Public Accounting Firm		F-65
Schedule 12-14 — Investments in and Advances to Affiliates for the Year Ended December 31, 2006		F-66

2. Exhibits


Exhibit
Number		Description

a.1		Restated Articles of Incorporation. (Incorporated by reference to Exhibit a.1 filed with Allied Capital’s Post-Effective Amendment No. 2 to registration statement on Form N-2 (File No. 333-67336) filed on March 22, 2002).
b.		Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3.1 filed with Allied Capital’s Form 8-K on January 24, 2006).
c.		Not applicable.
d.		Specimen Certificate of Allied Capital’s Common Stock, par value $0.0001 per share. (Incorporated by reference to Exhibit d. filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
d.1		Form of Note under the Indenture relating to the issuance of debt securities. (Contained in Exhibit d.4). (Incorporated by reference to Exhibit d.1 filed with Allied Capital’s registration statement on Form N-2/A (File No. 333-133755) filed on June 21, 2006).
d.2		Indenture by and between Allied Capital Corporation and The Bank of New York, dated June 16, 2006.(Incorporated by reference to Exhibit d.2 filed with Allied Capital’s registration statement on Form N-2/A (File No. 333-133755) filed on June 21, 2006).

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Exhibit
Number		Description

d.3		Statement of Eligibility of Trustee on Form T-1.(Incorporated by reference to Exhibit d.3 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-133755) filed on May 3, 2006).
d.4		Form of First Supplemental Indenture by and between Allied Capital Corporation and The Bank of New York, dated as of July 25, 2006. (Incorporated by reference to Exhibit d.4 filed with Allied Capital’s Post-Effective Amendment No. 1 to the registration statement on Form N-2/A (File No. 333-133755) filed on July 25, 2006).
d.5		Form of 6.625% Notes due 2011. (Incorporated by reference to Exhibit d.5 filed with Allied Capital’s Post-Effective Amendment No. 1 to the registration statement on Form N-2/A (File No. 333-133755) filed on July 25, 2006).
d.6		Form of Second Supplemental Indenture by and between Allied Capital Corporation and The Bank of New York, dated as of December 8, 2006. (Incorporated by reference to Exhibit d.6 filed with Allied Capital’s Post-Effective Amendment No. 2 to the registration statement on Form N-2/A (File No. 333-133755) filed on December 8, 2006).
d.7		Form of 6.000% Notes due 2012. (Incorporated by reference to Exhibit d.7 filed with Allied Capital’s Post-Effective Amendment No. 2 to the registration statement on Form N-2/A (File No. 333-133755) filed on December 8, 2006).
d.8		Form of Third Supplemental Indenture by and between Allied Capital Corporation and The Bank of New York, dated as of March 28, 2007. (Incorporated by reference to Exhibit d.8 filed with Allied Capital’s Post-Effective Amendment No. 3 to the registration statement on Form N-2/A (File No. 333-133755) filed on March 28, 2007).
d.9		Form of 6.875% Notes due 2047. (Incorporated by reference to Exhibit d.9 filed with Allied Capital’s Post-Effective Amendment No. 3 to the registration statement on Form N-2/A (File No. 333-133755) filed on March 28, 2007).
d.9(a)		Form of 6.875% Notes due 2047. (Incorporated by reference to Exhibit d.9(a) filed with Allied Capital’s Past Effective Amendment No. 4 to the registration statement on Form N-2/A (File No. 333-133755) filed on April 2, 2007).
e.		Dividend Reinvestment Plan, as amended. (Incorporated by reference to Exhibit e. filed with Allied Capital’s registration statement on Form N-2 (File No. 333-87862) filed on May 8, 2002).
f.2		Credit Agreement, dated September 30, 2005. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K on October 3, 2005).
f.2(a)		First Amendment to Credit Agreement, dated November 4, 2005. (Incorporated by reference to Exhibit 10.2(a) filed with Allied Capital’s Form 10-Q for the period ended September 30, 2005).
f.2(b)		Second Amendment to Credit Agreement, dated May 11, 2006. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on May 12, 2006).
f.2(c)		Third Amendment to Credit Agreement, dated May 19, 2006. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on May 23, 2006).

C-2


Exhibit
Number		Description

f.3		Note Agreement, dated October 13, 2005. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on October 14, 2005).
f.11		Note Agreement, dated May 1, 2006. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K on May 1, 2006).
f.15		Control Investor Guaranty Agreement, dated as of March 17, 2006, between Allied Capital and Citibank, N.A. and Business Loan Express LLC, (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on March 23, 2006).
f.19		Note Agreement, dated as of May 14, 2003. (Incorporated by reference to Exhibit 10.31 filed with Allied Capital’s Form 10-Q for the quarter ended March 31, 2003).
f.25		Note Agreement, dated as of March 25, 2004. (Incorporated by reference to Exhibit 10.38 filed with Allied Capital’s Form 10-Q for the period ended March 31,2004.)
f.26		Note Agreement, dated as of November 15, 2004. (Incorporated by reference to Exhibit 99.1 filed with Allied Capital’s current report on Form 8-K filed on November 18, 2004).
f.27		Real Estate Securities Purchase Agreement. (Incorporated by reference to Exhibit 2.1 filed with Allied Capital’s Form 8-K filed on May 4, 2005.)
f.28		Platform Assets Purchase Agreement. (Incorporated by reference to Exhibit 2.2 filed with Allied Capital’s Form 8-K filed on May 4, 2005.)
f.29		Transition Services Agreement. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on May 4, 2005.)
g.		Not applicable.
h.**		Form of Distribution Agreement.
i.2		The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan II. (Incorporated by reference to Exhibit 10.2 filed with Allied Capital’s Form 8-K filed on December 21, 2005).
i.2(a)		Amendment to The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan II, dated January 20, 2006. (Incorporated by reference to Exhibit 10.17(a) filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
i.3		The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on December 21, 2005).
i.3(a)		Amendment to The 2005 Allied Capital Corporation Non-Qualified Deferred Compensation Plan, dated January 20, 2006. (Incorporated by reference to Exhibit 10.18(a) filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
i.4		Amended Stock Option Plan. (Incorporated by reference to Exhibit B of Allied Capital’s definitive proxy statement for Allied Capital’s 2004 Annual Meeting of Stockholders filed on March 30, 2004).
i.5		Allied Capital Corporation 401(k) Plan, dated September 1, 1999. (Incorporated by reference to Exhibit 4.4 filed with Allied Capital’s registration statement on Form S-8 (File No. 333-88681) filed on October 8, 1999).

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Exhibit
Number		Description

i.5(a)		Amendment to Allied Capital Corporation 401(k) Plan, dated April 15, 2004. (Incorporated by reference to Exhibit 10.20(b) filed with Allied Capital’s Form 10-Q for the period ended June 30, 2004).
i.5(b)		Amendment to Allied Capital Corporation 401(k) Plan, dated November 1, 2005. (Incorporated by reference to Exhibit 10.20(c) filed with Allied Capital’s Form 10-Q for the quarter ended September 30, 2005).
i.5(c)		Amendment to Allied Capital Corporation 401(k) plan, dated April 21, 2006. (Incorporated by reference to Exhibit i.4(c) filed with Allied Capital’s Form N-2 (File No. 333-133755) filed on May 3, 2006).
i.5(d)		Amendment to Allied Capital Corporation 401(k) plan, adopted December 18, 2006. (Incorporated by reference to Exhibit 10.20(e) filed with Allied Capital’s Form 10-K for the year ended December 31, 2006).
i.6		Employment Agreement, dated January 1, 2004, between Allied Capital and William L. Walton. (Incorporated by reference to Exhibit 10.21 filed with Allied Capital’s Form 10-K for the year ended December 31, 2003).
i.6(a)		Amendment to Employment Agreement, dated March 29, 2007, between Allied Capital and William L. Walton. (Incorporated by reference to Exhibit 10.1 filed with Allied Capital’s Form 8-K filed on April 3, 2007).
i.7		Employment Agreement, dated January 1, 2004, between Allied Capital and Joan M. Sweeney. (Incorporated by reference to Exhibit 10.22 filed with Allied Capital’s Form 10-K for the year ended December 31, 2003).
i.7(a)		Amendment to Employment Agreement, dated March 29, 2007, between Allied Capital and Joan M. Sweeney. (Incorporated by reference to Exhibit 10.2 filed with Allied Capital’s Form 8-K filed on April 3, 2007).
i.8		Employment Agreement, dated January 1, 2004, between Allied Capital and Penelope F. Roll. (Incorporated by reference to Exhibit 10.23 filed with Allied Capital’s Form 10-K for the year ended December 31, 2006).
i.8(a)		Amendment to Employment Agreement, dated March 29, 2007, between Allied Capital and Penelope F. Roll. (Incorporated by reference to Exhibit 10.3 filed with Allied Capital’s Form 8-K filed on April 3, 2007).
j.1		Form of Custody Agreement with Riggs Bank N.A., which was assumed by PNC Bank through merger. (Incorporated by reference to Exhibit j.1 filed with Allied Capital’s registration statement on Form N-2 (File No. 333-51899) filed on May 6, 1998).
j.2		Custodian Agreement with Chevy Chase Trust. (Incorporated by reference to Exhibit 10.26 filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
j.3		Custodian Agreement with Bank of America. (Incorporated by reference to Exhibit 10.27 filed with Allied Capital’s Form 10-K for the year ended December 31, 2005).
j4		Custodian Agreement with Union Bank of California. (Incorporated by reference to Exhibit 10.29 filed with Allied Capital’s Form 10-Q for the quarter ended June 30, 2006).
j.5		Custodian Agreement with M&T Bank. (Incorporated by reference to Exhibit 10.30 filed with Allied Capital’s Form 10-Q for the quarter ended June 30, 2006).

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Exhibit
Number		Description

k.2		Form of Indemnification Agreement between Allied Capital and its directors and certain officers. (Incorporated by reference to Exhibit 10.37 filed with Allied Capital’s Form 10-K for the year ended December 31, 2003).
l.**		Opinion of counsel and consent to its use.
m.		Not applicable.
n.1**		Consent of Sutherland Asbill & Brennan LLP. (Contained in exhibit 1).
n.2*		Consent of KPMG LLP, independent registered public accounting firm.
n.3*		Opinion of KPMG LLP, independent registered public accounting firm, regarding “Senior Securities” table contained herein.
o.		Not applicable.
p.		Not applicable.
q.		Not applicable.
r.		Code of Ethics. (Incorporated by reference to Exhibit 10.28 filed with Allied Capital’s Form 10-K for the year ended December 31, 2006).
99.1*		Statement re: computation of earnings to fixed charges.

* Filed herewith.

** To be filed by amendment.

Item 26. Marketing Arrangements

The information contained under the heading “Plan of Distribution” of the prospectus is incorporated herein by reference, and any information concerning any underwriters will be contained in any prospectus supplement, if any, accompanying this prospectus.

Item 27. Other Expenses of Issuance and Distribution*


SEC registration fee		$	42,366
NASD filing fee			**
New York Stock Exchange Additional Listing Fee			**
Accounting fees and expenses			**
Legal fees and expenses			**
Printing and engraving			**
Miscellaneous fees and expenses			**

	Total	$	**

* Estimated for filing purposes and excludes fees previously paid.

** To be filed by amendment.

All of the expenses set forth above shall be borne by us.

C-5

Item 28. Persons Controlled by or Under Common Control

Direct Subsidiaries

The following list sets forth each of our subsidiaries, the state or country under whose laws the subsidiary is organized, and the percentage of voting securities or membership interests owned by us in such subsidiary:


Allied Capital REIT, Inc. (“Allied REIT”) (Maryland)			100%
A.C. Corporation (Delaware)			100%
Allied Capital Holdings, LLC (Delaware)			100%
Allied Capital Beteiligungsberatung GmbH (Germany) (inactive)			100%
Allied Investment Holdings, LLC (Delaware)			100%

Each of our subsidiaries is consolidated for financial reporting purposes, except as noted below.

Indirect Subsidiaries

We indirectly control the entities set forth below through A.C. Corporation, which is the sole member and manager of each entity. The following list sets forth each of A.C. Corporation’s subsidiaries, the state under whose laws the subsidiary is organized, and the percentage of voting securities or membership interests owned by A.C. Corporation of such subsidiary:


Allied Capital Investors, LLC (Delaware)			100%
AC Management Services LLC (Delaware)			100%
AC Finance LLC (Delaware)			100%
ACSM, LLC (Delaware)			100%

We indirectly control Allied Capital Property LLC (Delaware) through Allied REIT, which owns all of the membership interests.

Other Entities Deemed to be Controlled by the Company

We have also established certain limited purpose entities in order to facilitate certain portfolio transactions. In addition, we may be deemed to control certain portfolio companies. See “Portfolio Companies” in the prospectus.

Item 29. Number of Holders of Securities

The following table sets forth the approximate number of record holders of our common stock at March 16, 2007.


	Number of
Title of Class	Record Holders

Common stock, $0.0001 par value		4,300
Publicly issued notes		60

At March 16, 2007, we have privately issued long-term debt securities to approximately 40 institutional lenders, primarily insurance companies.

Item 30. Indemnification

Section 2-418 of the Maryland General Corporation Law provides that a Maryland corporation may indemnify any director of the corporation and any person who, while a

C-6

director of the corporation, is or was serving at the request of the corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, other enterprise or employee benefit plan, made a party to any proceeding by reason of service in that capacity unless it is established that the act or omission of the director was material to the matter giving rise to the proceeding and was committed in bad faith or was the result of active and deliberate dishonesty; or the director actually received an improper personal benefit in money, property or services; or, in the case of any criminal proceeding, the director had reasonable cause to believe that the act or omission was unlawful. Indemnification may be made against judgments, penalties, fines, settlements, and reasonable expenses actually incurred by the director in connection with the proceeding, but if the proceeding was one by or in the right of the corporation, indemnification may not be made in respect of any proceeding in which the director shall have been adjudged to be liable to the corporation. Such indemnification may not be made unless authorized for a specific proceeding after a determination has been made, in the manner prescribed by the law, that indemnification is permissible in the circumstances because the director has met the applicable standard of conduct. On the other hand, the director must be indemnified for expenses if he or she has been successful in the defense of the proceeding or as otherwise ordered by a court. The law also prescribes the circumstances under which the corporation may advance expenses to, or obtain insurance or similar cover for, directors.

The law also provides for comparable indemnification for corporate officers and agents.

The Restated Articles of Incorporation of Allied Capital provide that its directors and officers shall, and its agents in the discretion of the board of directors may be indemnified to the fullest extent permitted from time to time by the laws of Maryland (with such power to indemnify officers and directors limited to the scope provided for in Section 2-418 as currently in force), provided, however, that such indemnification is limited by the Investment Company Act of 1940 or by any valid rule, regulation or order of the Securities and Exchange Commission thereunder. Allied Capital’s bylaws, however, provide that Allied Capital may not indemnify any director or officer against liability to Allied Capital or its security holders to which he or she might otherwise be subject by reason of such person’s willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his or her office unless a determination is made by final decision of a court, by vote of a majority of a quorum of directors who are disinterested, non-party directors or by independent legal counsel that the liability for which indemnification is sought did not arise out of such disabling conduct.

Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of Allied Capital pursuant to the provisions described above, or otherwise, Allied Capital has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by Allied Capital of expenses incurred or paid by a director, officer or controlling person in the successful defense of an action, suit or proceeding) is asserted by a director, officer or controlling person in connection with the securities being registered, Allied Capital will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.

C-7

Allied Capital carries liability insurance for the benefit of its directors, officers and certain controlled portfolio companies on a claims-made basis of up to $50,000,000, subject to a $1,000,000 retention and the other terms thereof. Allied Capital also maintains an additional $20,000,000 of insurance coverage for the benefit of its directors and officers.

We have entered into indemnification agreements with our directors and certain senior officers. The indemnification agreements attempt to provide these directors and senior officers the maximum indemnification permitted under Maryland law and the Investment Company Act of 1940. Each indemnification agreement provides that Allied Capital shall indemnify the director or senior officer who is a party to the agreement (an “Indemnitee”) if, by reason of his corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding, other than a proceeding by or in the right of Allied Capital.

At present, these is no pending litigation or proceeding involving an Indemnitee where indemnification would be required or permitted under the indemnification agreement.

Item 31. Business and Other Connections of Investment Adviser

Not applicable.

Item 32. Location of Accounts and Records

We maintain at our principal office physical possession of each account, book or other document required to be maintained by Section 31(a) of the 1940 Act and the rules thereunder.

Item 33. Management Services

Not applicable.

Item 34. Undertakings

We hereby undertake:


	(1) to suspend the offering of shares until the prospectus is amended if: (1) subsequent to the effective date of this registration statement, our net asset value declines more than ten percent from our net asset value as of the effective date of this registration statement; or (2) our net asset value increases to an amount greater than our net proceeds as stated in the prospectus;

	(2) to file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement:


	(i)	to include any prospectus required by Section 10(a)(3) of the Securities Act of 1933;

	(ii)	to reflect in the prospectus any facts or events after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; and

	(iii)	to include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement.

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	(3) that, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of those securities at that time shall be deemed to be the initial bona fide offering thereof;

	(4) to remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering; and

	(5) that, for the purpose of determining liability under the Securities Act of 1933 to any purchaser, if the Registrant is subject to Rule 430C [17 CFR 230.430C]: Each prospectus filed pursuant to Rule 497(b), (c), (d) or (e) under the Securities Act of 1933 [17 CFR 230.497(b), (c), (d) or (e)] as part of a registration statement relating to an offering, other than prospectuses filed in reliance on Rule 430A under the Securities Act of 1933 [17 CFR 230.430A], shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use.

	(6) that for the purpose of determining liability of the Registrant under the Securities Act of 1933 to any purchaser in the initial distribution of securities: The undersigned Registrant undertakes that in a primary offering of securities of the undersigned Registrant pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser by means of any of the following communications, the undersigned Registrant will be a seller to the purchaser and will be considered to offer or sell such securities to the purchaser:


	(i)	any preliminary prospectus or prospectus of the undersigned Registrant relating to the offering required to be filed pursuant to Rule 497 under the Securities Act of 1933 [17 CFR 230.497];

	(ii)	the portion of any advertisement pursuant to Rule 482 under the Securities Act of 1933 [17 CFR 230.482] relating to the offering containing material information about the undersigned Registrant or its securities provided by or on behalf of the undersigned Registrant; and

	(iii)	any other communication that is an offer in the offering made by the undersigned Registrant to the purchaser.

C-9

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Washington, in the District of Columbia, on the 3rd day of April, 2007.


	ALLIED CAPITAL CORPORATION


	By:	/s/ William L. Walton



	William L. Walton,
	Chairman of the Board, Chief


	Executive Officer and President

KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below hereby constitutes and appoints William L. Walton and Joan M. Sweeney and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place, and stead, in any and all capacities, to sign any and all amendments to this Registration Statement, and to file the same, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities indicated on April 3, 2007.


Signature		Title


/s/ William L. Walton William L. Walton		Chairman of the Board, Chief Executive Officer, and President

/s/ Ann Torre Bates Ann Torre Bates		Director

/s/ Brooks H. Browne Brooks H. Browne		Director

/s/ John D. Firestone John D. Firestone		Director

/s/ Anthony T. Garcia Anthony T. Garcia		Director

/s/ Edwin L. Harper Edwin L. Harper		Director

/s/ Lawrence I. Hebert Lawrence I. Hebert		Director

/s/ John I. Leahy John I. Leahy		Director


Signature		Title


/s/ Robert E. Long Robert E. Long		Director

/s/ Alex J. Pollock Alex J. Pollock		Director

/s/ Marc F. Racicot Marc F. Racicot		Director

/s/ Guy T. Steuart II Guy T. Steuart II		Director

/s/ Joan M. Sweeney Joan M. Sweeney		Director

/s/ Laura W. van Roijen Laura W. van Roijen		Director

/s/ Penni F. Roll Penni F. Roll		Chief Financial Officer (Principal Financial and Accounting Officer)

INDEX TO EXHIBITS


Exhibit
Number		Description

n.2		Consent of KPMG LLP, independent registered public accounting firm.
n.3		Opinion of KPMG LLP, independent registered public accounting firm, regarding “Senior Securities” table contained herein.
99.1		Statement re: computation of earnings to fixed charges.