Executive Summary / Key Takeaways

• GECC has executed a fundamental transformation since 2022, building a differentiated CLO platform that generated $13.6 million in distributions through Q3 2025 and targets high teens to 20% IRRs, positioning it uniquely among smaller BDCs.

• The First Brands bankruptcy in Q3 2025, which caused a $16.5 million NAV hit and 1.5% of portfolio fair value moving to non-accrual, reveals both the risks of concentration and management's commitment to reducing position sizing and enhancing diversification.

• Recent capital structure optimization—including equity raises at NAV, revolver doubling to $50 million, and refinancing 8.75% notes with 7.75% notes—provides ample liquidity with over $25 million deployable cash and positions GECC for growth.

• Trading at $7.73 versus September 30, 2025 NAV of $10.01 represents a 23% discount, while the 19.2% dividend yield appears sustainable given management's confidence in covering distributions and expected Q4 NII rebound.

• Key risks include CLO distribution volatility, scale disadvantages versus larger BDCs, and interest rate sensitivity, though the defensive portfolio structure with two-thirds first-lien loans provides downside protection.

Setting the Scene

Great Elm Capital Corp. was established on April 22, 2016, as a Maryland corporation electing to be regulated as a business development company. For its first six years, GECC operated as a conventional middle-market lender, but the appointment of Matt Kaplan as CEO in March 2022 marked a decisive inflection point. Kaplan initiated a three-phase strategy: clean up and reposition the business in year one, upgrade the portfolio and execute the revamped strategy in year two, and optimize for growth in year three. This framework has guided a systematic transformation from a struggling BDC with portfolio concentration issues into a diversified specialty finance platform with unique capabilities in collateralized loan obligations and asset-based lending.

The company operates in a crowded middle-market lending landscape dominated by giants like Ares Capital Corp. (ARCC) with its $14.94 billion market capitalization and $28.7 billion portfolio, and Golub Capital BDC (GBDC) with $3.75 billion market cap and $8.77 billion in investments. Against these behemoths, GECC's $108 million market cap and $414 million total portfolio represent a niche position. This scale disadvantage creates higher relative operating costs and limits deal flow, but it also enables greater agility in targeting smaller, underserved transactions that larger competitors overlook. GECC's average investment size of $3-10 million sits well below the $50 million-plus tickets that ARCC and GBDC typically pursue, creating a distinct market segment where the company can exercise pricing power and build specialized expertise.

GECC generates current income and capital appreciation through three core segments: direct debt and equity investments in middle-market companies, a CLO formation joint venture that invests in subordinated notes and warehouses, and Great Elm Specialty Finance which provides asset-based lending solutions. This multi-pronged approach differentiates GECC from pure-play BDCs, creating multiple income streams and reducing correlation to any single market dynamic. The strategic evolution accelerated in September 2023 with the formation of GESF to house specialty finance assets, followed by the April 2024 launch of the CLO JV, which has become the primary driver of income growth and positions GECC to capture enhanced economics from the primary CLO issuance market rather than buying secondary positions.

Technology, Products, and Strategic Differentiation

The CLO Formation Joint Venture represents GECC's most significant strategic innovation. Formed in April 2024, this structure allows GECC to invest in majority positions of CLO equity and warehouse facilities , generating distributions that totaled $13.6 million through the first three quarters of 2025. Management targets high teens to 20% IRRs over time, a return profile that substantially exceeds typical BDC lending yields. The JV structure matters because it provides access to primary issuance economics that secondary market buyers cannot capture—GECC participates in structuring, pricing, and managing the CLOs rather than simply purchasing existing positions. This creates a durable competitive advantage, though it introduces quarterly income volatility as early-stage CLOs exhibit uneven distribution patterns while ramping their portfolios.

The uneven cadence of CLO distributions creates short-term noise in net investment income, as seen in the drop from $4.3 million in Q2 2025 to $1.5 million in Q3. However, this pattern is characteristic of young CLOs with longer reinvestment periods, which management argues are the "best CLO vintages" for choppy markets because they can deploy capital opportunistically. The $52 million deployed through June 30, 2025, represents just the beginning—GECC expects quarterly fluctuations to dampen over time as the platform scales and additional CLO investments mature. This patience contrasts with competitors like ARCC and GBDC, which primarily hold static CLO debt tranches rather than equity positions, limiting their upside but also reducing volatility.

Great Elm Specialty Finance underwent a transformative simplification in 2025, combining corporate and healthcare ABL portfolios, rebranding Sterling as Great Elm Commercial Finance, and exiting the final equipment lease holding at a gain. These moves streamlined operations and enabled GECF to upsize its back leverage facility by more than 20% in July 2025, providing additional capacity to fund a robust deal pipeline. The Prestige invoice financing business delivered a "phenomenal quarter" with high ROEs, while Great Elm Healthcare Finance repositioned to focus solely on healthcare real estate opportunities. This segment generated $450,000 in distributions to GECC in Q3 2025, up from $120,000 in Q2, demonstrating accelerating profitability as the simplified structure takes hold.

The direct lending portfolio has been systematically upgraded to emphasize senior secured positions. The corporate portfolio grew 34% in 2024 to $240 million, with first-lien loans increasing to 71% of the mix from 67% previously. This defensive structure positions GECC well against tariff uncertainty and economic volatility, as senior secured creditors have priority in recovery. Management is actively reducing average position sizing to avoid the concentration risk that plagued the First Brands investment, targeting more granular diversification across industries and borrowers. The weighted average yield on debt investments decreased to 10.80% as of September 30, 2025, reflecting both the shift toward senior secured loans and the impact of non-yielding equity positions like the CoreWeave investment, which converted from preferred to common stock.

Financial Performance & Segment Dynamics

GECC's financial results in 2025 illustrate both the power of its transformed platform and the risks of concentration. For the first three quarters, net investment income per share totaled $1.11 ($0.40 in Q1, $0.51 in Q2, $0.20 in Q3), exactly matching the $1.11 in regular quarterly distributions. This coverage, while technically sufficient, masks significant quarterly volatility driven by three factors: CLO distribution patterns, the First Brands bankruptcy, and capital structure optimization costs.

The third quarter's sharp NII decline to $0.20 per share from $0.51 in Q2 resulted primarily from the anticipated CLO JV distribution drop to $1.5 million, a $2.1 million dividend omission from an insurance-related preference share that paid in Q2, and elevated interest expense from refinancing activities. The refinancing of $40 million of 8.75% notes due 2028 with $50 million of 7.75% notes due 2030 required writing off approximately $1 million of deferred offering costs and created double interest expense for most of September. While this created a $0.03 per share drag in Q3, the transaction saves $0.4 million annually in cash interest, demonstrating management's focus on long-term cost reduction over short-term earnings smoothing.

First Brands' bankruptcy filing at quarter-end delivered a severe blow, causing approximately $16.5 million in unrealized depreciation and moving the investment to non-accrual status. This single position represented a material concentration risk that management has acknowledged was "too large" in retrospect. The direct exposure comprised 1.5% of portfolio fair value as of September 30, 2025, but the mark-to-market impact on NAV was disproportionate, dropping net asset value per share to $10.01 from $12.10 at June 30. This 17% NAV decline demonstrates how a single credit loss can overwhelm the positive contributions from a diversified platform, validating management's new emphasis on reducing position sizing.

Offsetting this setback, the Nice-Pak investment generated a $4.3 million realized gain and approximately 38% IRR over a three-year holding period, exemplifying the upside convexity GECC targets in its direct lending portfolio. The investment in CW Opportunity 2 LP, which holds CoreWeave common equity, has generated nearly 200% IRR since May 2024 funding, with life-to-date distributions of $6.1 million representing 102% of the original $6 million investment. While these equity gains boost capital appreciation, they reduce portfolio yield because the converted common stock no longer pays preferred dividends, creating a trade-off between current income and long-term value creation.

Segment contributions highlight the platform's evolution. The corporate portfolio generated stable interest income from its $220 million of investments, with two-thirds in first-lien loans providing defensive positioning. The CLO JV contributed $1.5 million in Q3 distributions, down from $4.3 million in Q2 but already rebounding to $4.3 million in Q4 to date, illustrating the expected volatility. GESF contributed $450,000, up nearly fourfold from Q2, as the simplified ABL platform gains traction. Together, these segments generated total investment income of $10.6 million in Q3, down from $11.7 million in the prior year period, but the underlying cash-generating capacity remains robust with over 90% of TII coming from cash sources in Q2.

Outlook, Management Guidance, and Execution Risk

Management's guidance framework centers on evaluating GECC on an annual basis rather than quarter-to-quarter, recognizing that the CLO platform's early-stage unevenness and equity raise deployment lags create temporary distortions. For 2025, Kaplan anticipates full-year NII per share will exceed 2024 levels and cover the recently increased distribution rate of $1.48 per share on an annualized basis. This confidence stems from three underlying assumptions: CLO distributions will rebound and dampen over time as the platform matures, interest expense will normalize following the refinancing completion, and capital raised at NAV will be deployed into cash-generating investments.

The fourth quarter outlook appears strong based on early results. Management has already received $4.3 million in CLO JV distributions in Q4, matching Q2's record level, and expects normalized interest expense following the refinancing completion. The company maintains over $25 million of deployable cash and $50 million of revolver availability, providing substantial dry powder for new originations. Additionally, GECC expects to harvest over $20 million from non-yielding assets, including CoreWeave-related investments, to redeploy into income-generating positions by early 2026, which would boost portfolio yield and NII.

Execution risk centers on capital deployment velocity and credit selection. Management is taking a "measured approach" to new originations, prioritizing credit fundamentals and downside protection over reaching for yield in a competitive market. This discipline is essential given the scale disadvantage versus ARCC and GBDC, which can originate larger deals more efficiently. The focus on smaller, senior secured loans in the $3-10 million range creates a niche where GECC can exercise pricing power, but it also requires more transactions to move the needle, increasing operational complexity.

The CLO platform's success depends on maintaining access to primary issuance markets and managing warehouse risk during the accumulation phase. With approximately $52 million deployed through June 2025 and additional investments planned, GECC is targeting CLO exposure of around 20% of its asset base over time. This would meaningfully diversify income streams away from direct lending while capturing equity-like returns from the CLO structure. The key variable is whether management can consistently source attractive loan collateral for new CLOs while maintaining disciplined credit standards in a competitive middle-market lending environment.

Risks and Asymmetries

The First Brands bankruptcy crystallizes the primary risk to GECC's thesis: concentration in a single borrower can overwhelm the benefits of platform diversification. Management's candid admission that "our exposure to First Brands was too large" signals a learning moment that should drive meaningful changes in underwriting and position sizing. The company is actively working to reduce average position sizing and increase portfolio granularity, but this transition takes time and may temporarily limit NII growth as capital shifts from larger, concentrated positions to smaller, diversified ones. The 1.5% of portfolio fair value in non-accrual status as of September 30, 2025, remains manageable, but any additional credit losses could compound the NAV pressure and threaten dividend coverage.

CLO distribution volatility represents a structural risk that differs from traditional BDC lending. While the JV targets high teens to 20% IRRs, the uneven cadence of early-stage CLO cash flows can create quarterly NII swings of $2-3 million, as seen between Q2 and Q3 2025. This volatility may pressure the stock price and create investor uncertainty, even if annual returns meet targets. Competitors like ARCC and GBDC avoid this risk by primarily holding CLO debt tranches with predictable coupon payments, sacrificing upside for stability. GECC's approach offers superior return potential but requires investors to tolerate lumpiness and trust management's long-term view.

Scale disadvantage creates persistent competitive pressure. With $414 million in total investments versus ARCC's $28.7 billion and GBDC's $8.77 billion, GECC faces higher relative operating costs and less bargaining power with borrowers and lenders. This manifests in GECC's expense ratio and limits its ability to compete for larger, more efficiently originated deals. The external management structure with Great Elm Capital Management also creates a fee burden that internally managed BDCs like Main Street Capital (MAIN) avoid, though GECM's fee waivers during the 2022 repositioning demonstrated alignment with shareholders.

Interest rate sensitivity cuts both ways. Rising rates increase gross investment income on floating-rate loans, which comprise most of GECC's portfolio, but they also pressure borrowers' credit quality and can compress CLO arbitrage spreads if liability costs rise faster than asset yields. The portfolio's weighted average yield decreased to 10.80% as of September 30, 2025, from 12.30% a year earlier, reflecting both the shift to senior secured loans and the impact of non-yielding equity positions. If rates fall, GECC may face reinvestment risk at lower yields, pressuring NII growth.

Tariff uncertainty and AI disruption represent emerging macro risks. Management monitors portfolio companies for second and third-order effects of trade policy, with a predominantly domestic focus and minimal China exposure providing some insulation. The AI hyperscaler exposure through CoreWeave creates both opportunity and volatility—the investment has generated exceptional returns but introduces correlation to public equity markets and technology sector swings. The lockup expiration on CoreWeave shares in Q2 2025 could enable monetization, but timing the exit to maximize proceeds while minimizing market impact requires skill.

Valuation Context

Trading at $7.73 per share, GECC's market capitalization of $108 million stands at a 23% discount to the September 30, 2025 net asset value of $10.01 per share. This valuation gap reflects market skepticism following the First Brands loss and concerns about quarterly NII volatility. However, the discount appears excessive when considering the transformed platform's cash-generating capacity and management's track record of covering distributions.

The stock trades at 0.77x book value, a significant discount to larger peers: ARCC at 1.04x, MAIN at 1.90x, and GBDC at 0.95x. While GECC's smaller scale and external management justify some discount, the 23% gap appears to overweight recent credit losses while underappreciating the CLO platform's long-term value. The dividend yield of 19.2% based on the $0.37 quarterly distribution ($1.48 annualized) appears elevated but may be sustainable if management executes on its guidance for full-year NII coverage.

Cash flow-based metrics provide additional context. GECC's price-to-operating-cash-flow ratio of 10.81x is higher than ARCC's 9.74x and GBDC's 9.19x, though the negative free cash flow in recent quarters reflects deployment timing rather than structural issues.

The debt-to-equity ratio of 1.43x sits near management's target of 1.5x and above ARCC's 1.09x and GBDC's 1.23x when considering the larger peers' greater access to leverage. GECC's asset coverage ratio of 168.2% exceeds the 150% regulatory minimum, providing a buffer against further credit losses.

The valuation multiple on TTM revenue of 608.68x appears distorted by the small revenue base and is not meaningful for comparison. More relevant is the relationship between NII and distributions: trailing twelve-month NII of $1.11 per share exactly covered the $1.11 in regular distributions, though the quarterly path was volatile. Management's confidence in a Q4 NII rebound and full-year coverage suggests the dividend is not at immediate risk, but sustained coverage depends on successful CLO platform scaling and avoidance of further credit losses.

Historical trading patterns show GECC's stock has ranged from a 40.4% discount to a 14.4% premium to NAV over the past two fiscal years. The current 23% discount sits toward the wider end of this range, potentially offering upside if management can demonstrate consistent NII generation and NAV stability. The $10 million share repurchase authorization provides a capital allocation tool to narrow this discount, though deployment may be limited by the need to fund portfolio growth.

Conclusion

Great Elm Capital has built a differentiated specialty finance platform that combines direct middle-market lending, a proprietary CLO formation joint venture, and a streamlined asset-based lending business. The transformation under CEO Matt Kaplan since 2022 has fundamentally improved portfolio quality, with first-lien loans comprising two-thirds of the corporate portfolio and the CLO JV targeting high teens to 20% returns that traditional BDCs cannot replicate. The First Brands bankruptcy, while painful, has reinforced management's focus on diversification and position sizing, potentially strengthening the platform's resilience going forward.

The investment thesis hinges on three variables: the CLO platform's ability to scale and dampen quarterly volatility, management's execution in deploying $25+ million of deployable cash into income-generating assets, and the avoidance of further credit losses that could erode NAV and threaten dividend coverage. The 23% discount to NAV and 19.2% dividend yield embed significant pessimism, creating potential upside if management delivers on its guidance for Q4 NII rebound and full-year distribution coverage.

Competitively, GECC's niche focus on smaller transactions and CLO equity positions it differently from scale players like ARCC and GBDC, but the size disadvantage creates persistent cost and deal flow pressures. The external management structure adds fee burden, though recent capital structure optimization demonstrates improved access to funding. For investors willing to tolerate quarterly lumpiness and credit risk, the transformed platform offers a unique combination of current income and capital appreciation potential that may not be fully reflected in the current valuation.