Hercules Capital, Inc. (HTGC) Q1 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Hercules Capital Q1 2021 earnings conference call. At this time, all participants are in listen-only mode. Later we will conduct question-and-answer session, and instructions will follow at that time. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Michael Hara, Managing Director of Investor Relations. Please go ahead, sir.

Thank you, Charlie. Good afternoon, everyone, and welcome to Hercules conference call for the first quarter 2021. With us on the call today from Hercules are Scott Bluestein, CEO and chief Investment Officer; and Seth Meyer, CFO. Hercules' first quarter 2021 financial results were released just after today's market close and can be accessed from Hercules' investor relations section at htgc.com. We have arranged for a replay of the call at Hercules web page or by using the telephone number and passcode provided in today's earnings release. During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including without limitation, the risks and uncertainties, including the uncertainties surrounding the current market turbulence caused by the COVID-19 pandemic and other factors we identified from time to time in our filings with the SEC. Although we believe that the assumptions on which these forward-looking statements are reasonable, any of those assumptions can prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. These forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit our website. And with that, I'll turn the call over to Scott.

Thank you, Michael, and thank you all for joining us today. We hope that everyone is staying safe and healthy. Q1 2021 was another strong quarter for Hercules Capital. We delivered solid operating results, strengthened and expanded our investment platform and continue to emphasize credit discipline across our investment portfolio. Our investment team hit the ground running in 2021 with record Q1 performance for both gross new debt and equity commitments and fundings. Even as the population continues to progress with vaccinations, more states announced plans for reopenings and the broader markets continued to show strength. We continue to conservatively manage the business by maximizing liquidity, staying disciplined on new underwriting, ensuring a strong balance sheet and maintaining substantial operational flexibility. The public and private equity markets continue to perform exceptionally well, in an abundance of liquidity across our core markets requires us to prioritize prudent underwriting and investment discipline more than ever. Let me recap some of the key highlights of our performance for Q1. We originated nearly $531 million of gross new debt and equity commitments in delivered gross fundings of over $355 million. Our debt and equity commitments and fundings in Q1 were weighted towards new portfolio company relationships. And we're balanced nearly evenly between our core technology and life sciences verticals. We saw strength across each of our areas of focus during the quarter. As we saw throughout 2020, many of our portfolio companies continue to achieve certain performance and capital raise milestones during Q1, which allowed us to once again expand our lending relationships with several companies in our existing portfolio. Even though our new business originations were strong in Q1, we chose to stay disciplined and focused on strong underwriting parameters as an abundance of equity capital and loosely structured debt has continued to create certain challenges in terms of prudent new business origination. Our platform scale and brand reputation continue to give us exposure to an active pipeline that currently exceeds $1 billion of potential investments. The quality of the companies in our pipeline is the best that we have seen in some time. But we will continue to evaluate each opportunity with a focus on staying true to what has made us successful on a sustained basis over the last 16 years. Since the close of Q1, and as of April 27, 2021, Hercules has already closed $135 million of new commitments. And we have pending commitments of an additional $152.9 million in signed non-binding term sheets. We expect the majority of our Q2 funding activity to be weighted towards the back-end of the quarter. Through April 27, 2021m our closed and pending commitments total $818.8 million, which puts us on pace to comfortably exceed over $1 billion of total new commitments for the fourth consecutive year. During Q1, we continue to see strength in terms of portfolio company exits, and portfolio company liquidity events. This combined with continued very strong performance across our portfolio, again drove high levels of early pay-offs. Early loan repayments were at the high end of our guidance of $150 million to $200 million at over $191 million, but decreased from $282 million in Q4. For Q2, we again expect prepayments to be between $150 million and $200 million, although this could change materially as we progress in the quarter. Even with the continued elevated levels of early payoffs are strong fundings during the quarter produced net debt investment portfolio growth of over $82 million after allocating over $47 million of new fundings to the private fund that we now manage through our wholly owned registered investment advisor. In q1, we generated total investment income of $68.8 million and net investment income of $34.6 million or $0.30 per share. The decline in both total investment income and net investment income was consistent with our guidance, and due to the lower debt portfolio balance attributable to the record Q4 payoffs, and lower fee income as a result of a lower level of prepayments during the first quarter. Our portfolio generated a GAAP effective yield of 13.2% in Q1, and a core yield of 11.6%, which was above the midpoint of our previous guidance for 2021. With net regulatory leverage at a very conservative 83.5%, and continued robust liquidity across our platform, we remained very well positioned. Credit quality on the debt investment portfolio again improved in Q1 with a weighted average internal credit rating of 2.01 as compared to 2.16 in Q4. This was our strongest internal credit rating since 2011 and it speaks to the strength that we are seeing in our core markets. Overall, our Grade 1 and Grade 2 credits increased to 79.6% in Q1 versus 68.7% in Q4. Grade 3 credits decreased to 19.5% in q1 versus 29.7% in Q4. Our rated 4 and 5 credits made up 0.9% of the entire debt portfolio fair value. In Q1 we have four debt investments on non-accrual with a cumulative investment cost fair value of approximately $24.1 million and $8 million respectively, or 1% and 0.3% as a percentage of the company's total investment portfolio at cost and value, respectively. As a result of continued strong performance across our portfolio, the exceptionally strong equity capital markets and robust exit and IPO activity, our Q1 net asset value per share increased by nearly 1% to $11.36. We ended Q1 with strong liquidity of $550 million, which provides us with substantial coverage of our available unfunded commitments of $258 million and the ability to fund our ongoing anticipated business activity. Overall, we believe that our balance sheet is exceptionally strong and well positioned. The venture capital ecosystem continued to exhibit strength in Q1 after a record year in 2020. For Q1 venture capital funds raised a total of $32.7 billion and invested over $69 billion in the US, according to data gathered by PitchBook and the NVCA. The overall vibrancy of the VC ecosystem has continued to positively impact our portfolio. As the most recent data that we have, we estimate that approximately 80% of our portfolio continues to have at least 12-plus months of current liquidity. And since just our last earnings call, we've had an additional 12 of our debt portfolio companies raise new capital totaling over $655 million. Year-to-date , we have had four new M&A events, two of which have closed and seven companies that have either filed registrations for their initial public offerings, or have agreed to stack transactions. In addition, several of our companies are currently working on either new capital raises or strategic transactions. And we expect M&A and IPO spec activity to remain strong over the next few quarters. I would also like to discuss our supplemental shareholder distribution Program for fiscal year 2021. In addition to our ninth consecutive quarterly cash distribution of $0.32 per share, we are also declaring a supplemental distribution of $0.28 per share for fiscal 2021, which will be distributed equally at $0.07 per quarter for the next four quarters, beginning with the first quarter distribution payable in May 2021. As of Q1, 2021, we have generated undistributed earnings spillover of approximately $109.1 million or $0.94 cents per share, subject to final tax filings. This provides us with additional flexibility with respect to our variable base distribution going forward, and the ability to continue to invest in our team and platform. Finally, I would like to briefly touch on the progress that we made in the first quarter in terms of strengthening and expanding our investment platform. After establishing Hercules Advisor as a wholly own registered investment advisor in 2020, we are very pleased to have raised and closed our first institutional private credit fund. Having this first fund and potentially future funds gives us the opportunity to expand and diversify our investment platform while enhancing our level of service and capabilities to our current and future venture growth stage companies. While we anticipate that it will take time to ramp up our activities under our RIA, we do expect that over the short term, Hercules Capital will benefit from being able to share certain expenses with Hercules Advisor and having a more diverse platform for the funding of new investments. Longer term and subject to the ultimate performance and size of the funds managed by Hercules Advisor, we expect Hercules Capital to potentially benefit from distributions from the advisor as that business ramps up. In closing, our employees have continued to work tirelessly to ensure that Hercules Capital remains the premier provider of growth capital to venture and growth stage companies. I am grateful and thankful to each of them for their work, effort and commitment. I would also like to thank each of our 100-plus portfolio companies and their institutional investors that have chosen to make Hercules Capital their preferred financing partner. I will now turn the call over to Seth.

Thank you, Scott. And good afternoon ladies and gentlemen. As Scott mentioned, the investment team gave us a great start to 2021. This was another very strong commitment in funding quarter for Hercules. We were able to grow the loan book by $82.5 million at cost during the quarter, which allowed us to replace a portion of the portfolio decline from Q4, which was the result of elevated pre-payments during the prior quarter. We delivered total investment income of $68.8 million and once again, had NAV appreciation per share triggered by the strength of our portfolio and the broader market. Our early pay-off levels reduced to $191.5 million, which was again elevated but within the guidance range. During Q1 we successfully closed our first private fund, and as a result, we allocated a portion of certain commitments and fundings to the initial private fund. This also allowed us to allocate certain expenses to Hercules Advisor, our RIA managing the private fund during the quarter. Net of allocations to the initial fund, the healthy loan growth helped our total investments grow by $88.4 million to $2.4 billion at costs. As usual, I'll focus on the following areas, income statement performance and highlights, NAV, unrealized and realized activity, leverage and liquidity and then finally the outlook. With that, let's turn our attention to the income statement performance and highlights. Net investment income was $34.6 million or $0.30 per share in Q1 a decrease compared to the prior quarter attributable to the elevated early repayments in Q4, 2020. Total investment income was $68.8 million a decrease compared to the prior quarter. The main driver for the decrease to the total investment income was lower interest and fee income as a result of the higher pay-offs and related portfolio decline experienced in Q4. Our effective and core yields in the first quarter were 13.2% and 11.6% respectively, compared to 13.3% and 11.8% in the fourth quarter. The quarter yields were largely in line with the prior quarter, with a slight decline in the core yield due to a modest decrease in income from expired unfunded commitments. Turning to expenses, our gross operating expenses for the quarter increased to $35.1 million compared to $33.2 million in the prior quarter. Net of cost recharged to the RIA, our operating expenses were $34.2 million. Interest expense and fees increased slightly to $17.5 million from $17.2 million in the prior quarter, due mainly to the acceleration of fee recognition for the partial pay down of the SBA debentures and securitizations due to the reinvestment period ending for those instruments. SG&A expenses increased to $17.6 million from $16 million in the prior quarter. The increase was driven by higher compensation expenses related to the increase in fundings and first quarter payroll taxes which normally run higher in the first quarter. Net of truck costs recharged to the RIA, the SG&A expenses were $16.7 million. Our weighted average cost of debt was 5.5%, which represented a small increase compared to the prior quarter driven by additional fees associated with early debt retirements from both our securitizations and SBA debenture loan repayments. The adjusted cost of debt, excluding the acceleration was consistent with the prior quarter at 5.1%. Let's now switch to NAV, unrealized and realized activity. During the quarter our NAV increased by $0.10 per share to $11.36 per share. This represents an NAV per share increase of 0.9% quarter-over-quarter. The main driver for the increase was the net change in unrealized appreciation of $21.9 million after reversal of prior unrealized appreciation of $7 million, mainly due to investments disposed or written-off. Our $21.9 million of net change and unrealized appreciation was primarily driven by the mark to market of our equity and warrant portfolio, which contributed $13.8 million of the movement. Our debt portfolio also benefited from declines in the market yields contributing $8.1 million of the appreciation. The net realized gains in the quarter of $7.8 million comprised of $8.8 million of net gains from the disposal of equity positions, offset by $1 million of realized loss pertaining to one loan position. Moving on to discuss leverage. Our GAAP and regulatory leverage was 94.6% and 89.2%, respectively, which decreased compared to the prior quarter due to the partial repayment of the two securitizations, which are now in runoff. Netting out leverage with the cash on the balance sheet, our GAAP and regulatory leverage was 88.9% and 83.5% respectively, putting us in a very strong position heading into the next quarter. Our leverage includes the March issuance of $50 million five-year notes in a private placement with a fixed coupon of 4.55%. This was the second tranche of the arrangement announced in November 2020, totaling up $100 million in private placement financing. In addition, we have started to utilize our third SBA license drawing down $37.5 million of debentures and has attractive annual interest rate of 0.77%. As a result, we ended the quarter with strong liquidity of $550 million. This excludes the additional amounts available via our new SBA license, as well as capital raised by the RIA. As a reminder, our liquidity continues to be enhanced by our normal course monthly principal and interest collections, as well as early repayments. Finally, on the outlook points, our core yield guidance of 11% to 12% continues to apply for Q2, 2021. For the second quarter, we expect SG&A expenses of $16 million to $17 million slightly below the prior quarter, as Q1 always has higher employer payroll taxes. We expect our second quarter borrowing costs to decrease modestly. This is dependent on whether early repayments are heavily weighted to portfolio companies assigned to the two securitizations, which are now in natural runoff, and triggering increased capitalized fee recognition. We have assumed a normal weighted allocation to the securitizations. Although very difficult to predict, as communicated by Scott, we expect $150 million to $200 million in prepayment activity in the second quarter. Now that the RIA is operational and managing outside capital, we anticipate being able to allocate expenses to the RIA on a go forward basis. For the second quarter, we expect a similar level of expense allocation to what we saw in Q1. In closing, we are pleased with the start of 2021. And look forward to building on the success of the quarter. We continue to focus on the things that we believe will position us best given the current operating environment. I will now turn the call over to Charlie to begin the Q&A portion of our call. Charlie, over to you.

Thank you, sir. [Operator Instructions] Your first question comes from the line of Finian O'Shea with Wells Fargo Securities. Your line is now open.

Hi, everyone. Good afternoon. First question on the RIA. Scott, I saw there were some drop downs into that vehicle over the quarter. Can you provide some color on if that was just the startup type transaction or if that will be ongoing? And then for that matter, how different will the strategy of the private funds or at least this one B versus Hercules BDC?

Sure. Thanks, Fin. We're only going to speak to this fund, because that's the one that has been raised and is currently being invested out of. What you saw in Q1 was essentially an allocation of certain of the HTGC commitments and fundings to the private fund. We would anticipate that you will continue to see that to a varying degree on a go-forward basis on a quarterly basis. The reasons and the drivers are that can vary on a quarterly basis. It could be diversification, it could be the size of the deal, it could be industry or concentration issues, but we would anticipate that parts of certain deals will continue to be allocated to the private fund on a go-forward basis. And we would also anticipate at the same time that the private fund will do certain transactions on its own that will not be originally originated or funded from the HTGC business.

Okay. And just to be clear that those were new origination co-invests rather than existing issuer dropdowns?

Correct. Those are new commitments and new fundings in Q1 that were allocated to the private fund.

Okay, thank you. And then just the second on expenses. I think Seth said there were payroll taxes were up. Was that most of the driver versus -- can you kind of break that down between larger AUM market costs in general? And what if we can expect any change in the expense rate going forward? Overall compensation and such?

Yeah. So the expenses were mainly related to the increase of the funding spend. So there was a pretty significant jump quarter-on-quarter. The payroll taxes will run-off the as they regulate do. Q1 is always higher employer payroll tax quarter than the rest. And for the guidance going forward, really, we can always say $16 million to $17 million for Q2, and beyond that will give guidance as we get closer.

Okay, great. So all for me, thanks so much.

Your next question comes from the line of Crispin Love with Piper Sandler. Your line is now open.

First, can you give a little more color on the credit quality trends that you've been seeing? The 2.01 grade for the portfolios, the best quarterly metric that I think I have on record in my model. So what did you see that drove it significantly lower during the quarter? And I guess just what has changed versus recent quarters?

Sure. Thanks, Kristen. I think it's two things. Number one, it's just the overall strength from a portfolio perspective that we're seeing. Most of which is attributable to liquidity. As we've kind of highlighted on the last several earnings calls, we've had more and more companies raised larger and larger rounds of financings. Several of our companies continue to have right now record liquidity. And so if you look at the migration that we show on a quarterly basis, when we started Q1 of 2020, which is sort of the first quarter of the COVID pandemic, we had a weighted average credit rating of roughly 2.34. And then we've had now four consecutive quarters of improvement. In Q1, we were down to 2.01. The two biggest drivers were in increase in the rated one credits. Those are the companies that are either abundantly capitalized or performing well above our expectations. And the second driver was a reduction in the rated 3 credits. Those are the companies that are contemplating or are about to raise equity capital. And then our general philosophy is once those companies raise capital, we upgrade them either to a rated 2 or rated 1. So those were the two biggest drivers. And I think it just speaks to the tremendous job that our team has done in terms of identifying the right opportunities to invest in and the strengths that we're seeing across the portfolio.

Okay, great. Thanks. That's helpful. One more for me. Can you just talk about some of your recent investments? I think you said that they were geared towards new relationships. I'm curious that what caused that that it's more for new relationships, does that have to do with recovery and reopening and changing the way that your diligence processes going? Or is it just more comfortable with kind of the diligence process that you've had for the last several months during the pandemic?

Sure, I think the credit really goes to our investment team. We've just seen tremendous performance from both our technology team and our life sciences team. And we're seeing it across the venture and the growth stage parts of our markets. Our team has done a great job in terms of building and expanding our pipeline. And I made the comment that our pipeline right now is over $1 billion dollars. And from a quality perspective, we think it's the strongest pipeline that we've seen from a quality perspective in some time, both on the technology and on the life sciences side. And I think the team has been very aggressive in terms of trying to paint the ones that we want to use, we want to go after, and then finding creative, flexible solutions that allow us to get deals done with those companies. And that's what you saw in Q1. We had strong funding and commitment performance, both with respect to new portfolio investments and existing portfolio investments. But as we mentioned in the call, the numbers were weighted more towards new investments in Q1.

Your next question comes from the line if Devin Ryan with JMP. Your line is open.

Good evening, everyone.

Evening.

Most of my questions have been asked maybe one just on the SPAC mark, when you're starting to hit a little bit of indigestion and some, maybe additional sec scrutiny. So I'm just kind of curious how that may be affecting things at all with some of the companies kind of in process. And if that slows things down, are there any other considerations or things that you guys have to point in for just with some of the developments in the SPAC market boom, bigger picture kind of just your expectations going forward?

Sure. We're certainly monitoring the SPAC market pretty closely. And I think it's fair to say but there has been a little bit of a slowdown here over the last 30 to 60 days. There's a backup in terms of filings. There's a backup in terms of SEC review. The SEC is raising some new issues now primarily around accounting related to legacy warrant positions that is creating some issues for certain companies. I would tell you that within our portfolio, we have not seen much of a slowdown at all. Right now, we have five companies that have announced SPAC transactions that are that are in process. All of those remain in process as of the current date. And we're aware of several other additional portfolio companies that are an active conversations force back transaction. So we're monitoring it. We are aware of a broader slowdown in that market, but we have not seen that impact our portfolio yet.

Okay, terrific. And just a quick follow up on institutional private credit funds, obviously regulations on that. And if you can -- what is the size of that and then just expected kind of investment cadence any other color on that would be helpful?

Sure. So it's a non-registered institutional private credit fund. We're not going to disclose the size of the fund at this time at least for the initial fund. As that fund ramps up, we will make disclosure around what level of AUM the RIA is managing. I think the bigger picture comment that I would make is that this initial fund gives us several $100 million of additional dry powder to invest with. We expect the private funds, the first one and potential future funds to be very accretive to the Hercules platform. It should give us the ability to go after larger transactions, it should give us the ability to go after select smaller transactions. It should give us the ability to offer some differentiated structures and differentiated pricing models. And it should also over time give us the ability to explore some new verticals to potentially expand into as well. So it's something that we've been working on for a number of years. And it's something that we're very excited about in terms of diversifying and expanding the HTGC investment business.

Okay, great. Well, congratulations and appreciate you taking my questions.

Sure. Thanks.

. Your next question comes from the line of Ryan Lynch with KBW. Your line is now open?

Hey, good afternoon, guys. First one, I just had another one on the private fund raised. Can you just talk about what is that strategy, comparative to the strategy at HTGC? And what I'm getting at is, if the strategy is somewhat different in what ways and what sort of new deal opportunities will that that open up? Or is it basically the same strategy that you guys currently run at HTGC that will just allow you to take down larger commitment sizes to your potential borrowers?

Sure, Ryan. I think the answer is it's both. Initially it's more ancillary and complimentary to the existing investment strategy. From having covered us for a number of years, there are certain restrictions that we have to deal with being an internally managed BDC. Having this private credit fund will allow us to manage and potentially mitigate some of those challenges and historical issues that we've had in terms of diversifying and growing and expanding the platform. Overtime, we would expect the private credit fund business to allow us to potentially go into new asset classes, new verticals. But at least initially, I think what you're going to see is that the investment strategy is very ancillary and very complimentary to what we're doing. And it will allow us to just take advantage of opportunities that we may otherwise not be able to do, because of the internally managed BDC structure.

Okay, understood. You mentioned a really strong pipeline, billion plus of deals. You also said, these are very high-quality companies and that pipeline. I guess what are the characteristics that you guys use that determine what sort of company or a potential deal could go into your pipeline? Are these just strong companies that could use that financing? Are these conversations you're already having, just because with the amount of capital that's been raised in the venture ecosystem, as well as the valuations in that space, it seems like equity financing could be a very big competitor to the venture debt side? And so, when we're just talking about a big pipeline, and a pipeline of really high-quality companies, the chance that that a good deal of those companies go the equity route versus the venture debt route given the backdrop?

It's a great question, Ryan. And look, there's no question and we've said this now for the last two or three calls that, our biggest competitor right now in the market is the equity markets, both from a public perspective and from a private round of financing perspective. I would also say and we've seen this over the years, the companies that we are investing in, are continuing to burn capital, they are continuing to invest in growth, and they have a voracious need for capital. So, yes, we are competing with equity right now at a pretty aggressive state. Yes, a lot of these companies are continuing to raise meaningful rounds of capital. But in many cases, the companies still choose to supplement that equity with structured debt as long as it can be structured and priced appropriately. And that's what our team is spending the majority of their time doing, looking at these quality opportunities that are well capitalized that may have raised equity capital recently, and trying to find creative, flexible, custom tailored solutions that worked for both sides. And I think that's what you're going to continue to see from us. In terms of what we include in that pipeline. We have an internal system that we use to sort of track opportunities. And the company that we include in that pipeline number are companies that are in markets or sectors that we are interested in pursuing, companies that are backed by institutional investors that we are comfortable working with, companies that are looking to raise debt capital, and companies that we have had at least one conversation with where we believe it's a viable opportunity.

Okay. That's really helpful color. That's all for me. I appreciate the time this afternoon.

Sure. Thanks, Ryan.

Your next question comes from the line of Sarkis Sherbetchyan with B. Riley Securities. Your line is now open.

Good afternoon, and thanks for taking my question here this morning. Just wanted to touch on origination activity for the second quarter. Do you think that's going to be in line with first quarter levels? And how do you expect the cadence of originations to play out as we think about that billion dollar of pipeline you mentioned throughout fiscal ‘21?

Sure, Sarkis. We're not going to provide any Q2 guidance in terms of fundings or commitments. In the subsequent events disclosure, we obviously highlighted the fact that we've already closed $135 million of commitments quarter-to-date through April 27. We have another $153 million that are signed non-binding term sheets, that gets us to approximately $819 million have closed and pending through April 27. With our pipeline, we feel pretty optimistic that Q2 will be another strong quarter from the fundings and commitments perspective, but where we end up in the spectrum of numbers, I think, is still to be determined. Our focus is on quality. Our focus is on making sure that the documentation is appropriately structured and documented. And sometimes things slip quarter-over-quarter. So I think we don't manage the business on quarterly fundings or quarterly commitments. But I think that pipeline gives us tremendous confidence in terms of our ability to have a very strong year in terms of commitments.

Now, great, thanks for that. And just want to have a follow up here on the Advisor. Maybe if you can speak to the planned economic contribution to the BDC in terms of maybe fee income generation? And at what point or at what scale would you feel comfortable providing us with more metrics along those stuffs? Thank you.

Yeah, sure. So initially, we expect that the main contribution will be the cost sharing. Like you saw in Q1 was about $900,000. So just under a million, we would expect in Q2, a similar allocation of costs may be towards the next midpoint of 2022 we would hope. Based on the amount of funds that we raise based on the performance of the fund, that we might see, some dividends start accruing to the BDC. But it'll take time to generate enough income to cover the costs that are being allocated, and then eventually a dividend stream to the BDC. But that's the way I would think about it initially, as a cost reimbursement and cost sharing that's going to happen and then eventually a dividend stream.

Great, thank you.

Your next question comes from the line of Casey Alexander with Compass Point. Your line is now open.

Good morning. Yeah, there is lot of my questions, but I do have two here. One is that the RIA is showing a value of $9.8 million with no cost basis in the schedule of investments. So I'm just curious how that value was arrived at?

Yeah, sure. We went through a discounted cash flow analysis based on the way that we see the fund developing, as originations occur and allocations occur. And really going back to the prior question Casey, when we expect dividend flows to occur? And so we did a discounted cash flow analysis based on the first fund that we've raised. And that was the result of it. And then we did a comparison of other RIA valuations in that are publicly available that we could compare it to and made sure that it made sense.

Okay. So this is done with a DCF, based upon your sort of expectation of filling out the portfolio and the fees that will eventually be generated. So we shouldn't look for a great variation to that number until there are other funds that are being managed by the RIA. Is that correct?

That's precisely right, Casey. That's a good analysis.

Okay, great. My second question is, given that the net originations after the pre-payments for the quarter were about $157 million. So about 30% of the net originations went into the external funds, which seems like a large amount. But I don't know how large the fund’s capital that is committed to the fund relative to the size of the Hercules portfolio. So I'm curious what the allocation policy is? Because when you have a co investment vehicle, my understanding is that you need to have some sort of a stated allocation policy.

Sure, Casey. So we've adopted a fairly conservative equal footing allocation policy. Deals will be allocated primarily based on available liquidity. But we do have the flexibility and the ability to change that, depending on diversification sector, and overall investment strategy and focus. I would also just point out, I think your 30% number is certainly higher than the way we think about it and the way we're looking at it. We look at the new fundings in the quarter of roughly $350 million, about $47 million of the fundings were allocated. So you're about 10% to 15% versus the 30% that you were speaking to in your comments.

Right, but the new fund doesn't have any prepayments coming back to it. Okay. So, in essence, I understand it's getting to only 15% of the new fundings, but it is drawing investments away from the BDC itself.

Sure, it is on an initial basis as it ramps up potentially taking some investments away with the two caveats that we mentioned before. Number one, there are a lot of deals that we're now able to do at the BDC level that we probably could not otherwise have done. If we didn't have the private vehicle to be investing alongside us. And then no two, this is not an externally managed private fund. This is a private fund that's managed by a wholly owned RIA. So 100% of the benefit from the riA activities accrues and accretes to the shareholders of the public BDC.

Okay, great. All right. I appreciate your taking my questions. Thank you.

Your next question comes from the line at Christopher Nolan with Ladenburg Thalmann. Your line is now open.

Hi, quick question on the RIA again. How much leverage you're going to run-off that entity with?

So we're going to target a leverage ratio of one to one over the life of the fund.

Gotcha. And why declare the full supplemental dividend in the first quarter?

It’s something that we've talked about on the last couple of calls. And I think we stated pretty clearly on the Q4 call that one of our goals was to establish a policy for 2021 that provided a little bit more clarity and continuity to our shareholders with respect to that base distribution. We thought that the $0.28 was an appropriate number given two things. Number one, we are still sitting on a record level of spillover at $0.94. And number two, our competence in the trajectory of the business for the course of 2021. And based on those two things, we thought that it was more appropriate for us to declare the $0.28 give our shareholders sort of consistency and comfort that it would be $0.07 per quarter versus what we've done for the last two years, which is in six of the eight quarters declares a supplemental distributions on a quarterly basis. This just provides a little bit more visibility and a little bit more clarity to our shareholders, which we think is an important thing to do.

Finally, the Biden ministration is discussing significantly increasing the capital gains tax. If what they outlined were to become law, what would you think that would be the impact on the venture debt market and also an HTGC specifically?

Yeah, I don't think you'll see that much of an impact honestly with respect to HTGC. I think there could be a little bit of an impact from a native perspective on sort of not just the venture debt market, but I think the broader kind of growth market. It's still very early. These things change a lot and has to go through a process. And I think it's still very much TBD in terms of how it will play out from an overall tax reform perspective. It's something that we're watching, we don't think it has a material impact on our business or our markets. And we'll just watch it closely over the next couple of quarters.

Thanks, Scott.

Sure.

Your next question comes from the line of John Hecht with Jefferies. Your line is now open.

Yeah, the last question was similar to what I was going to ask them. But one thing I'll ask is you given kind of, I guess, what we've observed over the last year, and you're living through the pandemic. Scott, is there any kind of change in what you think your opportunity set is for focusing on within in the portfolio investing versus your biotech versus other channels of technology? Or do you think it's pretty -- going to be pretty consistent going forward?

Yeah, I think it's pretty consistent. The way we built this business, it's with a focus on diversification. And I think that's what's made us successful. We have the ability to focus on life sciences, we have the ability to focus on venture technology, we have the ability to focus on later stage sponsor-backed technology transactions, having the ability to do all three of those things is a tremendous competitive advantage. And we're going to continue to sort of focus on making sure the business is broadly diversified, and that we have the ability to outperform, irrespective of what's going on from a macro perspective.

Perfect, thanks very much.

Sure. Thanks, John.

[Operator Instructions] Your next question comes from the line of Finian O'Shea with Wells Fargo. Your line is now open.

Hi, guys, just a follow up on your dialogue with Casey a moment ago. On the allocation policy on the RIA, I think you said it would be based on liquidity. My understanding is that the convention is -- co-investment is based on applicable capital that's leveraged rather than cash available at any given fund where newer fund might be advantaged. So is that the case? Is that why the new fund got so much allocation or is it normal as described?

I think it was again -- I think it was it was fairly normal. It was about 10% to 15% of the gross fundings of the business. It was not every deal being allocated. It was done pursuant to our board approved allocation policy where the primary driver is available liquidity across both of the vehicles. And again, I wouldn't look at it as, it's deals being taken away, right? In most cases, these are deals that the BDC would have issues or challenges with doing on its own. And now that we have the vehicle, we're able to do these things that otherwise we likely could not have done.

Okay, that's helpful. Thank you.

Sure, thanks.

[Operator Instructions] And we have no further question at this time. Presentors, please continue.

Thank you, operator. And thanks to everyone for joining our call today. We look forward to reporting our progress on our next Q2, 2021 earnings call. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.