Executive Summary / Key Takeaways

• Great Elm Capital Corp. (GECC) has undergone a significant transformation since 2022, shifting from cleanup and repositioning to a focus on portfolio upgrade, scale, and optimization, culminating in record investment income in Q1 2025.
• A core strategic differentiator is the CLO Formation JV, LLC, which allows GECC to invest in CLO equity and warehouses, providing exposure to broadly syndicated first-lien loans with an innovative structure targeting high teens to 20% returns, expected to be a growing income source despite initial distribution lumpiness.
• GECC has substantially strengthened its capital structure and liquidity through significant equity raises at NAV and debt issuances in 2024, including refinancing its 2025 maturity, enhancing financial flexibility and operating scale.
• The company's portfolio quality is improving, with a focus on secured debt; first-lien loans and CLO positions now constitute a larger portion of the portfolio, and non-accruals were reduced to zero as of Q1 2025.
• Management anticipates sequential NII growth into Q2 2025 and expects to cover the increased dividend throughout 2025, supported by ramping CLO JV distributions and income from recent deployments, positioning GECC for continued growth despite macro uncertainties and market volatility.

The Evolution of Great Elm Capital: Building Scale and Income Generation

Great Elm Capital Corp., established in 2016 as a business development company (BDC), has a mandate to generate current income and capital appreciation by investing in the debt and income-generating equity of middle-market companies. Its initial focus centered on secured and senior secured debt, alongside exploring other parts of the capital structure. However, the company embarked on a notable transformation journey starting in March 2022 under new leadership.

This strategic evolution unfolded in distinct phases. The initial phase in 2022 was dedicated to cleaning up and repositioning the business, addressing portfolio concentration and reducing exposure to noncash-generating assets, supported by its external manager, Great Elm Capital Management, LLC (GECM), and Great Elm Group. This foundational work paved the way for the subsequent phase in 2023, focused on upgrading the portfolio and executing a revamped strategy aimed at enhancing cash generation and increasing scale. A key development during this period was the formation of Great Elm Specialty Finance, LLC (GESF), consolidating specialty finance assets and bringing in a strategic investor to drive synergies across its lending platforms, which include receivables factoring, asset-based lending, and healthcare real estate financing.

The most recent phase, spanning 2024 and continuing into 2025, has been characterized by optimizing the portfolio and aggressive growth initiatives. This period saw GECC significantly expand its operational scale and financial flexibility through substantial capital raises. The company successfully issued nearly $150 million in total capital in 2024 via a mix of equity, notably raised at net asset value through special purpose vehicles, and debt issuances, including the GECCI and GECCH notes. A strategic highlight was the proactive refinancing of the GECCM notes, extending the debt maturity profile well into 2026 and beyond. The filing of a new $500 million shelf registration further enhances GECC's ability to efficiently access capital markets.

Strategic Pillars and Operational Differentiators

GECC's strategy is built on several key pillars designed to enhance income generation and portfolio quality. At its core remains the direct lending business, targeting middle-market companies with secured debt. This segment continues to grow, with the corporate portfolio expanding significantly in 2024 and maintaining a strong focus on first-lien loans, which comprised 71% of the portfolio at the end of Q1 2025.

A significant strategic and operational differentiator is GECC's expansion into Collateralized Loan Obligations (CLOs) through its joint venture, the CLO Formation JV, LLC, formed in April 2024. This innovative structure allows GECC to take majority equity positions in CLOs and invest in related warehouse facilities, providing valuable exposure to a diversified pool of broadly syndicated first-lien loans. Management views this vertical as a key driver for future income, targeting attractive returns in the high teens to 20% range. While income from the CLO JV is recognized when distributions are made to GECC, leading to some initial quarterly lumpiness (e.g., Q1 2025 distributions of $3.8 million following $0.5 million in Q4 2024 and $3.2 million in Q3 2024), management expects this volatility to dampen as the JV scales and funds more CLO investments. This structure is seen as providing superior financing terms compared to typical BDC JV loan structures and helps manage book-tax differences.

The Specialty Finance segment, operating under GESF, is another crucial component. Following a period of stalled momentum in Q3 2024, early 2025 saw significant streamlining efforts. These included consolidating asset-based lending operations under the new Great Elm Commercial Finance brand, repositioning the healthcare finance business to focus on real estate financing, securing new leverage facilities, and exiting non-core holdings. These operational refinements are aimed at driving increased profitability and synergy within the segment, which contributes through both subordinated note interest and equity dividends.

GECC's competitive positioning in the BDC landscape is characterized by its focus on niche middle-market segments and its strategic structural innovations like the CLO JV. While larger competitors like Ares Capital (ARCC) and Golub Capital (GBDC) benefit from greater scale, broader networks, and potentially more advanced digital tools for risk assessment and portfolio management, GECC aims to differentiate through sector-specific expertise and a hands-on approach to portfolio management. Main Street Capital (MAIN) and Hercules Capital (HTGC) also compete in aspects of the middle-market, with MAIN focusing on lower middle-market operational integration and HTGC specializing in technology and life sciences lending. GECC's niche focus can potentially lead to higher yields and faster innovation in deal structuring in targeted sectors, offering a degree of differentiation against competitors' scale or technological alignment. However, GECC's smaller scale can result in higher operating costs relative to larger peers, and its sector dependencies introduce potential revenue volatility. Indirect competitors, including private equity and fintech platforms, pose a threat by offering alternative, potentially lower-cost financing, which could pressure margins and market share. GECC's BDC regulatory structure provides certain tax advantages and acts as a barrier to entry for some potential competitors.

Financial Performance and Portfolio Health

GECC's strategic initiatives have begun to translate into improved financial performance. The first quarter of 2025 marked a significant milestone, achieving the highest total investment income in the company's history at $12.5 million, which was also the highest cash income quarter. This performance was primarily driven by ramping contributions from the CLO JV and income generated by new investments. Net investment income (NII) per share doubled to $0.40 in Q1 2025 from $0.20 in Q4 2024, comfortably covering the increased quarterly distribution of $0.37 per share.

The increase in investment income reflects both the growth in the debt investment portfolio and the new income streams from the CLO JV. As of March 31, 2025, the debt portfolio had an average coupon rate of 11.70% on approximately $256.2 million of principal, compared to 12.60% on $218.0 million a year prior, indicating portfolio growth offsetting a slight decrease in average coupon. Dividend income saw a substantial increase year-over-year in Q1 2025, largely attributable to the CLO JV.

While NII generation was strong in Q1 2025, NAV per share experienced a modest step down to $11.46 from $11.79 at the end of 2024. This decline was primarily driven by unrealized losses on portfolio investments, specifically the CLO JV equity and an investment in CW Opportunity 2 LP, which management attributes to market volatility picking up mid-quarter. Despite these markdowns, management remains confident in the underlying investments and expects these unrealized losses to reverse as market conditions stabilize.

Portfolio quality showed improvement, with non-accruals totaling $0 as of March 31, 2025, down from $1.3 million at year-end 2024 and $9.4 million in Q2/Q3 2024. This reflects successful restructuring efforts, including one significant position that emerged from bankruptcy and was restructured into income-generating debt instruments.

Liquidity remains adequate, with $1.3 million in cash and $12 million drawn on the $25 million revolver as of March 31, 2025. The company had $3.5 million in unfunded commitments, well within its available liquidity and revolver capacity. The successful capital raises in 2024 significantly bolstered the balance sheet, providing the capacity for continued investment and growth. As of March 31, 2025, the asset coverage ratio stood at a healthy 163.8%, comfortably above the regulatory minimum of 150%.

Outlook and Risks

Management's outlook for GECC is positive, anticipating continued growth in NII and consistent dividend coverage. Based on current expectations, NII for Q2 2025 is projected to exceed Q1 levels, and full-year 2025 NII is expected to be higher than 2024, sufficient to cover the increased dividend. This confidence is rooted in the expected increase and eventual stabilization of distributions from the scaling CLO JV, as well as the income generated from capital deployed into new investments.

The Specialty Finance segment is also expected to contribute positively, with the recent streamlining and repositioning efforts anticipated to translate into increasing returns over the remainder of 2025.

However, the investment landscape is not without risks. Market volatility remains a key concern, potentially impacting portfolio valuations and leading to further unrealized gains or losses. The uneven nature of CLO distributions, while expected to dampen, can still cause quarter-to-quarter fluctuations in reported income. Macroeconomic uncertainties, including the potential impact of tariffs and the risk of recession, could affect the performance of portfolio companies. Management is actively reunderwriting existing investments and evaluating new opportunities through the lens of potential recession severity and portfolio company defensiveness. While direct exposure to tariffs is considered minimal, the second and third-order effects on the broader economy and specific industries are being monitored. Concerns about the lower-end consumer could impact certain portfolio segments, although GECC's exposure is tilted towards more defensive areas like private label products and recession-resilient services.

Despite these risks, GECC's strengthened capital structure, diversified portfolio with an increasing allocation to secured debt and CLOs, and management's proactive approach to portfolio management and strategic evolution position the company to pursue its growth objectives and continue delivering income to shareholders.

Conclusion

Great Elm Capital Corp. has demonstrably transformed its business over the past three years, successfully executing a strategy focused on cleaning up legacy issues, upgrading portfolio quality, and significantly scaling its operations. The strategic pivot towards CLO investments through an innovative joint venture structure, coupled with the streamlining of its Specialty Finance segment and robust capital raising activities, has laid a strong foundation for future income generation. The record investment income achieved in Q1 2025 underscores the positive impact of these initiatives. While market volatility and the inherent lumpiness of early-stage CLO distributions present near-term fluctuations, management's outlook for sequential NII growth and full-year dividend coverage signals confidence in the trajectory. GECC's competitive position is evolving, leveraging niche expertise and structural advantages to navigate a landscape dominated by larger players and disrupted by fintech. For investors, the narrative centers on a BDC that has successfully repositioned itself for growth, with key drivers in its expanding CLO portfolio and a revitalized specialty finance business, supported by a strengthened balance sheet, aiming to deliver attractive risk-adjusted returns.