Executive Summary / Key Takeaways

• Gladstone Investment Corporation (GAIN) leverages a differentiated equity-focused buyout strategy in the lower middle market, aiming for both consistent monthly distributions from debt income and substantial supplemental distributions from realized capital gains on equity exits.
• The company reported strong financial performance for the second quarter of fiscal year 2026, with total investment income increasing by 12% to $25.3 million and adjusted net investment income covering its monthly distributions.
• GAIN maintains robust liquidity and a strong balance sheet, with $174 million available under its credit facility and an asset coverage ratio of 193.2% as of September 30, 2025, providing ample capacity for future investments and debt refinancing.
• The firm's investment methodology, including proprietary risk rating and strategic deal structuring with interest rate floors, acts as a key differentiator, mitigating interest rate risk and optimizing returns in a competitive M&A environment.
• Despite macroeconomic uncertainties, including tariffs and potential economic slowdowns, management expresses optimism for continued buyout activity and portfolio growth, supported by a healthy pipeline and a strategic focus on slightly larger, more consistent EBITDA-generating businesses.

The Buyout Blueprint: A Differentiated Approach to Middle Market Investing

Gladstone Investment Corporation (GAIN) operates as an externally managed business development company (BDC) and a regulated investment company (RIC), carving a distinct niche in the lower middle market. Incorporated in 2005, GAIN's foundational strategy centers on a "buyout blueprint"—investing in a combination of debt and equity securities of established private U.S. businesses. This dual approach is designed to generate stable current income from debt and long-term capital appreciation from equity, which is crucial for its unique distribution model. The company primarily targets businesses with annual EBITDA between $4 million and $15 million, seeking opportunities for management buyouts, growth capital, acquisitions, recapitalizations, or debt refinancing, while deliberately avoiding the higher risks associated with early-stage enterprises.

GAIN's journey has been shaped by its experiences, including navigating the 2008-2009 recession, which underscored the importance of its disciplined risk management and investment selection. Over the years, the company has consistently expanded its capital access through credit facility enhancements and public offerings of unsecured notes, demonstrating a commitment to financial flexibility. A significant development in July 2012, and further refined in September 2025, was the granting of an SEC exemptive order, which broadened GAIN's ability to co-invest with affiliates, enhancing its strategic flexibility in deal-making. This historical context underscores GAIN's evolution into a specialized player, distinct from many BDCs that primarily focus on credit-oriented lending.

The broader M&A market, where GAIN actively competes, is characterized by significant liquidity, creating a competitive environment and upward pressure on valuations. However, GAIN's competitive positioning is unique; it primarily competes with private equity funds in the middle market, rather than other BDCs that may be moving down-market for credit deals. This distinction is critical, as GAIN's "buyout blueprint" involves acquiring businesses and providing both debt and equity, allowing it to act as a sponsor. While some deals may command higher valuations (e.g., 9x EBITDA compared to GAIN's target of 7-7.5x), the company's disciplined approach to enterprise value and deal structure enables it to secure opportunities that align with its financial model.

Investment Methodology: GAIN's Differentiated "Technology"

For a BDC like Gladstone Investment, its "technology" lies not in physical products but in its sophisticated investment methodology, risk management framework, and strategic deal structuring. These differentiators are foundational to its competitive moat and ability to generate consistent returns.

GAIN employs a rigorous investment and valuation process. It utilizes a proprietary risk rating system for debt securities, scaling from 0 to 10 (with 10 being the lowest probability of default), which management believes is equivalent to a BBB rating from a Nationally Recognized Statistical Rating Organization (NRSRO). The company also leverages third-party valuation firms to provide independent assessments, particularly for debt investments where GAIN cannot effectuate a sale of the portfolio company. For valuing its investments, GAIN predominantly uses Level 3 inputs within the ASC 820 fair value hierarchy, employing techniques such as Total Enterprise Value (TEV) and Yield Analysis. This comprehensive approach to valuation and risk assessment provides tangible benefits, allowing for tailored deal structuring and a more precise understanding of portfolio health.

A key aspect of GAIN's strategic deal structuring is its approach to interest rates and income generation. The company targets approximately 90% of its loan portfolio to be at variable rates or variable rates with a floor mechanism. As of September 30, 2025, 100% of its debt investment portfolio was at variable rates with a floor, with a weighted average interest rate floor of 12% for the current debt portfolio (excluding nonaccrual investments). For recent buyout debt investments, these floors are typically in the 13% to 13.5% range. This strategy is a deliberate mechanism to mitigate potential compression in net interest income during periods of declining SOFR, providing a stable income stream. Furthermore, the majority of GAIN's debt securities include a success fee component, which enhances the overall yield. Unlike many BDCs that recognize Paid-in-Kind (PIK) income, GAIN has 0 PIK income and generally does not recognize success fees as income until cash is received, reflecting a conservative approach to revenue recognition. As of September 30, 2025, unrecognized contractual success fees totaled $59.3 million, or $1.50 per common share.

Operational enhancements, such as the new SEC Co-Investment Order granted in September 2025, further bolster GAIN's investment capabilities. This order provides more flexible requirements for fair and equitable allocation and minimizes certain board approval requirements, thereby enhancing the company's ability to pursue its investment objectives and strategies more efficiently. These integrated methodologies and strategic frameworks collectively form GAIN's "technological" edge, enabling it to execute its buyout strategy effectively, manage risk, and optimize returns for its discerning investor base.

Financial Performance and Operational Resilience

Gladstone Investment delivered a strong performance for the second quarter of fiscal year 2026, ending September 30, 2025. Total investment income increased by $2.7 million, or 12%, to $25.3 million compared to the prior year period. This growth was primarily fueled by a $1.7 million increase in interest income and a $1.04 million rise in dividend and success fee income. The weighted-average principal balance of the interest-bearing investment portfolio expanded to $668.9 million, up from $572.8 million in the prior year, reflecting $222.9 million in new debt investments and $41.7 million in follow-on debt investments. While the weighted-average yield on interest-bearing investments saw a slight decrease from 14.5% to 13.4% year-over-year, adjusting for the collection of past-due interest, the yield modestly increased from 13.1% to 13.2% during the quarter, underscoring the stability provided by interest rate floors on recent deals.

Adjusted net investment income (NII), a key metric excluding capital gains-based incentive fees, stood at $9.2 million, or $0.24 per share, for the second quarter of fiscal year 2026, sufficient to cover the company's monthly distributions to shareholders. This consistent coverage highlights the strength of GAIN's income-generating assets. The portfolio also experienced significant net unrealized appreciation of $54.5 million for the three months ended September 30, 2025. This was driven by improved performance in several portfolio companies and the reversal of previously recorded unrealized depreciation related to the restructuring of J.R. Hobbs Co. - Atlanta, LLC. As a result, the fair value of the investment portfolio exceeded its cost basis by $93.7 million, with the entire portfolio fair valued at 109% of cost as of September 30, 2025.

A notable operational achievement was the restructuring of the investment in J.R. Hobbs Co. - Atlanta, LLC. This resulted in a $29.9 million realized loss but established a new $20 million term loan that is now income-producing. This strategic move reduced the number of nonaccrual companies from four to three, with nonaccrual investments now representing a manageable 3.9% of the total portfolio at cost and 1.7% at fair value. Management expressed confidence in the J.R. Hobbs team and the company's long-term success. The net asset value (NAV) per share increased to $13.53 as of September 30, 2025, from $12.99 at the end of the prior quarter, reflecting the positive impact of net unrealized appreciation and net investment income.

Liquidity and Capital Strategy

Gladstone Investment maintains a robust liquidity position and a flexible capital structure, essential for supporting its growth initiatives and navigating market conditions. As of November 4, 2025, the company had $174 million in availability under its credit facility, which has a total commitment of $270 million and an accordion feature to increase it to $300 million. This substantial liquidity provides ample capacity for new investments and operational flexibility. The company's asset coverage ratio on senior securities representing indebtedness stood at 193.2% as of September 30, 2025, well above the required 150% threshold, indicating a conservative leverage profile.

To further support its capital needs, GAIN actively utilizes its 2024 Common Stock ATM Program. During the six months ended September 30, 2025, the company raised approximately $38.9 million in gross proceeds through this program. Subsequent to the quarter end, an additional $0.8 million in net proceeds was raised from ATM sales, all at prices above NAV. Management intends to continue leveraging the ATM program as long as pricing remains accretive to NAV. Looking ahead, GAIN anticipates accessing both equity and debt markets to fund its healthy pipeline of new buyout opportunities and to refinance upcoming debt maturities, demonstrating a proactive capital management strategy.

Outlook and Growth Initiatives

Management expresses cautious optimism for the remainder of the fiscal year, citing a strong and healthy pipeline of new buyout opportunities. The company is in the final stages of diligence on several new opportunities and actively reviewing and negotiating others, suggesting a continued robust pace of investment activity. The investment pace for the first six months of fiscal year 2026, with approximately $130 million deployed into three new portfolio companies (Smart Chemical Solutions, Sun State Nursery and Landscaping, and Global GRAB Technologies), is already at a "pretty good run rate" compared to the full fiscal year 2025's total of $221 million.

A key strategic initiative is the gradual increase in the size of investments. GAIN is focusing on slightly larger businesses, typically with EBITDA between $5 million and $12 million, believing these will generate more consistent EBITDA and lead to better long-term value creation. This move is expected to allow the company to deploy more capital effectively in both debt and equity components.

The company's distribution strategy remains a core tenet of its investment thesis. GAIN ended the prior fiscal year with $55.3 million, or $1.50 per share, in spillover income, which is sufficient to cover its current monthly distribution of $0.08 per share ($0.96 annually) and the $0.54 per share supplemental distribution paid in June. Management aims to continue funding future supplemental distributions from realized capital gains generated on equity exits, reinforcing the value proposition of its buyout model. The estimated fiscal year distributions, combining monthly and supplemental payouts, are projected to yield approximately 10.9% based on recent stock prices.

Risks and Challenges

Despite the positive outlook, Gladstone Investment faces several risks inherent in its operating environment. The competitive M&A market, characterized by high liquidity, can lead to upward pressure on valuations, making it challenging to acquire new companies at attractive prices. Macroeconomic uncertainty, including the potential for a slowing economy, tariffs, and supply chain disruptions, poses a risk to the performance of its portfolio companies, particularly those in consumer-focused sectors. While management is actively working with companies to evaluate supply chain alternatives and production strategies, these factors could impact demand and margins.

Interest rate risk is another primary concern, as net investment income is sensitive to the spread between borrowing and investment rates. However, GAIN mitigates this through its strategy of having 100% variable-rate loans with interest rate floors. The presence of non-accrual investments, currently three companies representing 3.9% of the total portfolio at cost, also presents a challenge, though management is actively engaged in returning them to accrual status or pursuing exits. Some external analyses highlight the risk of a high non-accrual ratio and a heavy reliance on equity investments in a high-rate environment, suggesting potential concerns for future earnings sustainability.

Conclusion

Gladstone Investment Corporation stands as a compelling investment opportunity for those seeking a blend of consistent income and capital appreciation, driven by its specialized buyout strategy in the lower middle market. The company's disciplined investment methodology, characterized by proprietary risk assessment, strategic deal structuring with interest rate floors, and a conservative approach to income recognition, provides a robust framework for navigating a competitive and uncertain economic landscape. Recent financial performance underscores its operational resilience, with growing investment income, effective management of non-accrual assets, and a strong liquidity position to fuel future growth.

GAIN's commitment to its unique "buyout blueprint," which prioritizes generating capital gains from equity exits to fund supplemental distributions, differentiates it within the BDC sector. While macroeconomic headwinds and competitive pressures persist, the company's proactive management, healthy investment pipeline, and strategic focus on larger, more stable businesses position it for continued success. For discerning investors, GAIN offers a clear narrative of value creation, supported by a proven track record and a forward-looking strategy designed to deliver attractive returns through both its monthly dividends and opportunistic supplemental payouts.