ALLIED CAPITAL CORP, N-2/A, 1998-06-02

ALLIED CAPITAL CORP
N-2/A, 1998-06-02

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<PAGE> 1

As filed with the Securities and Exchange Commission on June 2, 1998

REGISTRATION NO. 333-51899

================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM N-2

REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

[X] PRE-EFFECTIVE AMENDMENT NO. 1

[ ] POST-EFFECTIVE AMENDMENT NO.

ALLIED CAPITAL CORPORATION
(Exact Name of Registrant as Specified in Charter)

1666 K STREET, N.W., NINTH FLOOR
WASHINGTON, D.C. 20006
(202) 331-1112
(Address and Telephone Number, including Area Code, of Principal Executive
Offices)

WILLIAM L. WALTON, CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
ALLIED CAPITAL CORPORATION
1666 K STREET, N.W., NINTH FLOOR
WASHINGTON, D.C. 20006
(Name and Address of Agent for Service)

Copies of information to:

<TABLE>
<S> <C>
STEVEN B. BOEHM WINTHROP B. CONRAD, JR.
SUTHERLAND, ASBILL & BRENNAN LLP DAVIS POLK & WARDWELL
1275 PENNSYLVANIA AVENUE, N.W. 450 LEXINGTON AVENUE
WASHINGTON, D.C. 20004-2415 NEW YORK, NY 10017
</TABLE>

Approximate Date of Proposed Public Offering:
As soon as possible after the Registration Statement becomes effective.

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. [ ]

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.

================================================================================
<PAGE> 2

ALLIED CAPITAL CORPORATION

CROSS-REFERENCE SHEET

SHOWING LOCATION IN PROSPECTUS AND STATEMENT OF ADDITIONAL INFORMATION OF
INFORMATION REQUIRED BY PARTS A AND B OF FORM N-2 REGISTRATION STATEMENT

<TABLE>
<CAPTION>
ITEM CAPTION OR LOCATION IN PROSPECTUS OR STATEMENT OF
NUMBER REGISTRATION STATEMENT ITEM AND HEADING ADDITIONAL INFORMATION
- ------ --------------------------------------- -------------------------------------------------
<C> <S> <C>
PART A: INFORMATION REQUIRED IN A PROSPECTUS
1. Outside Front Cover...................... Outside front cover page
2. Inside Front and Outside Back Cover
Page................................... Inside front cover page
3. Fee Table and Synopsis................... Prospectus Summary; Fees and Expenses; Additional
Information
4. Financial Highlights..................... Prospectus Summary; Selected Consolidated
Financial Data; Management's Discussion and
Analysis of Financial Condition and Results of
Operations
5. Plan of Distribution..................... Outside front cover; Underwriters
6. Selling Shareholders..................... Not Applicable
7. Use of Proceeds.......................... Use of Proceeds
8. General Description of Registrant........ Outside front cover; Prospectus Summary; The
Company; Business; Risk Factors; Price Range of
Common Stock and Distributions; Portfolio
Companies; Senior Securities; Financial
Statements
9. Management............................... Management; Safekeeping, Transfer and Dividend
Paying Agent and Registrar
10. Capital Stock, Long-Term Debt, and Other
Securities............................. Description of Capital Stock; Price Range of
Common Stock and Distributions; Dividend
Reinvestment Plan; Taxation; Certain Government
Regulations
11. Defaults and Arrears on Senior
Securities............................. Not Applicable
12. Legal Proceedings........................ Business -- Legal Proceedings
13. Table of Contents of the Statement of
Additional Information................. Table of Contents of the Statement of Additional
Information

PART B: INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION
14. Cover Page............................... Outside front cover page of Statement of
Additional Information
15. Table of Contents........................ Outside front cover page of Statement of
Additional Information
16. General Information and History.......... General Information and History
17. Investment Objective and Policies........ Investment Objectives and Policies
18. Management............................... Management
19. Control Persons and Principal
Shareholders........................... Control Persons and Principal Holders of
Securities
20. Investment Advisory and Other Services... Investment Advisory Services; Safekeeping,
Transfer and Dividend Paying Agent and
Registrar; Accounting Services
21. Brokerage Allocation and Other
Practices.............................. Brokerage Allocation and Other Practices
22. Tax Status............................... Tax Status
23. Financial Statements..................... Financial Statements in Prospectus

PART C: OTHER INFORMATION
</TABLE>

Information required to be included in Part C is set forth under the
appropriate item, so numbered, in Part C to this registration statement.
<PAGE> 3

Allied Capital Logo

PROSPECTUS (Subject to Completion)
Issued June 2, 1998

5,750,000 Shares
Allied Capital Corporation
COMMON STOCK
------------------------

OF THE 5,750,000 SHARES OF COMMON STOCK OF ALLIED CAPITAL CORPORATION BEING
OFFERED HEREBY, 4,600,000 SHARES ARE BEING OFFERED INITIALLY IN THE UNITED
STATES AND CANADA BY THE U.S. UNDERWRITERS AND 1,150,000 SHARES ARE BEING
OFFERED INITIALLY OUTSIDE OF THE UNITED STATES AND CANADA BY THE INTERNATIONAL
UNDERWRITERS. SEE "UNDERWRITERS." THE COMPANY'S COMMON STOCK IS TRADED ON THE
NASDAQ NATIONAL MARKET UNDER THE SYMBOL "ALLC." ON JUNE 1, 1998, THE LAST
REPORTED SALE PRICE FOR THE COMMON STOCK WAS $24 1/2.

------------------------

THE COMPANY, A MARYLAND CORPORATION, IS AN INTERNALLY MANAGED CLOSED-END
MANAGEMENT INVESTMENT COMPANY THAT HAS ELECTED TO BE REGULATED AS A BUSINESS
DEVELOPMENT COMPANY ("BDC") UNDER THE INVESTMENT COMPANY ACT OF 1940, AS
AMENDED. THE COMPANY'S INVESTMENT OBJECTIVE IS TO ACHIEVE CURRENT INCOME AND
CAPITAL GAINS. THE COMPANY SEEKS TO ACHIEVE ITS INVESTMENT OBJECTIVE BY
INVESTING PRIMARILY IN PRIVATE SMALL TO MEDIUM-SIZED GROWING BUSINESSES IN A
VARIETY OF INDUSTRIES AND IN DIVERSE GEOGRAPHIC LOCATIONS, PRIMARILY IN THE
UNITED STATES. SEE "BUSINESS." NO ASSURANCES CAN BE GIVEN THAT THE COMPANY WILL
CONTINUE TO ACHIEVE ITS OBJECTIVE. THIS PROSPECTUS SETS FORTH THE INFORMATION
ABOUT THE COMPANY THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING AND
SHOULD BE RETAINED FOR FUTURE REFERENCE. ADDITIONAL INFORMATION ABOUT THE
COMPANY, INCLUDING SUCH INFORMATION CONTAINED IN THE STATEMENT OF ADDITIONAL
INFORMATION ("SAI") DATED THE SAME DATE AS THIS PROSPECTUS, HAS BEEN FILED WITH
THE U.S. SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") AND IS AVAILABLE
UPON WRITTEN OR ORAL REQUEST WITHOUT CHARGE BY THE COMPANY AT 1666 K STREET,
N.W., WASHINGTON, D.C. 20006, INVESTOR RELATIONS, OR BY CALLING 1-888-818-5298.
THE COMMISSION MAINTAINS A WEB SITE (HTTP://WWW.SEC.GOV) THAT CONTAINS THE SAI,
MATERIAL INCORPORATED BY REFERENCE AND OTHER INFORMATION REGARDING THE COMPANY.
THE SAI IS INCORPORATED IN ITS ENTIRETY BY REFERENCE TO THE PROSPECTUS AND ITS
TABLE OF CONTENTS APPEARS ON PAGE 60 OF THE PROSPECTUS. SEE "ADDITIONAL
INFORMATION."

------------------------

SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR CERTAIN INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY, INCLUDING THE RISK OF LEVERAGE.

------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

------------------------

PRICE $ A SHARE
------------------------

<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
---------- -------------- -----------
<S> <C> <C> <C>
Per Share................................................. $ $ $
Total(3).................................................. $ $ $
</TABLE>

- ------------

(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriters."

(2) Before deducting expenses payable by the Company estimated at $600,000.

(3) The Company has granted to the U.S. Underwriters an option, exercisable
within 30 days of the date of this Prospectus, to purchase up to an
aggregate of 862,500 additional shares of Common Stock on the same
terms as set forth above, solely to cover over-allotments, if any. If
the U.S. Underwriters exercise the option in full, the total Price to
Public, Underwriting Discounts and Commissions, and Proceeds to Company
would be $ , $ , and $ , respectively. See
"Underwriters."

------------------------

The Shares are being offered, subject to prior sale, when, as and if
accepted by the Underwriters named herein and subject to approval of certain
legal matters by Davis Polk & Wardwell, counsel for the Underwriters. It is
expected that the delivery of the Shares will be made on or about
, 1998 at the office of Morgan Stanley & Co. Incorporated, New
York, N.Y., against payment therefor in immediately available funds.

------------------------

MORGAN STANLEY DEAN WITTER
NATIONSBANC MONTGOMERY SECURITIES LLC
THE ROBINSON-HUMPHREY COMPANY
SCOTT & STRINGFELLOW, INC.

, 1998

Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any state in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such state.
<PAGE> 4

NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER
TO BUY ANY SECURITY OTHER THAN THE COMMON STOCK OFFERED HEREBY, NOR DOES IT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES
OFFERED HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE
SUCH AN OFFER OR SOLICITATION TO SUCH PERSON. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREBY SHALL UNDER ANY CIRCUMSTANCES IMPLY THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.

------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.......................................... 1
Risk Factors................................................ 8
The Company................................................. 11
Use of Proceeds............................................. 11
Price Range of Common Stock and Distributions............... 12
Capitalization.............................................. 13
Selected Consolidated Financial Data........................ 14
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 16
Senior Securities........................................... 27
Business.................................................... 31
Portfolio Companies......................................... 40
Determination of Net Asset Value............................ 45
Management.................................................. 45
Taxation.................................................... 50
Certain Government Regulations.............................. 52
Dividend Reinvestment Plan.................................. 53
Description of Capital Stock................................ 54
Underwriters................................................ 57
Legal Matters............................................... 60
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. 60
Independent Public Accountants.............................. 60
Table of Contents of Statement of Additional Information.... 60
Index to Financial Statements............................... 61
</TABLE>

------------------------

INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS MAY
CONTAIN "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995, WHICH 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. THE MATTERS DESCRIBED IN "RISK
FACTORS" AND CERTAIN OTHER FACTORS NOTED THROUGHOUT 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.

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING,
AND MAY BID FOR, AND PURCHASE, SHARES OF THE COMMON STOCK IN THE OPEN MARKET.
SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITERS."

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS MAY ENGAGE IN
PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL
MARKET IN ACCORDANCE WITH RULE 103 UNDER REGULATION M. SEE "UNDERWRITERS."

(i)
<PAGE> 5

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by and should be read in
conjunction with the more detailed information and the financial statements and
notes thereto appearing elsewhere in this Prospectus. Unless otherwise
indicated, all information in this Prospectus assumes no exercise of the
Underwriters' over-allotment option.

The Company's current business and investment portfolio resulted from the
merger on December 31, 1997 of Allied Capital Corporation, Allied Capital
Corporation II, Allied Capital Commercial Corporation, Allied Capital Lending
Corporation and Allied Capital Advisers, Inc. Immediately following the merger,
the surviving company, Allied Capital Lending Corporation, changed its name to
"Allied Capital Corporation." All information in this Prospectus, unless
otherwise indicated, has been presented as if the predecessor companies had
merged as of the beginning of the earliest period presented. Unless the context
otherwise requires, references in this Prospectus to "ACC" or the "Company" are
to the Company and its consolidated subsidiaries. See "The Company."

THE COMPANY

The Company is a full-service lender and sources, originates and services
all of the loans it finances. The Company sources loans and investments through
its numerous relationships with regional and boutique investment banks,
mezzanine and venture capital investors, and other intermediaries, including
professional services firms. In order to increase its sourcing and origination
activities, the Company recently opened offices in Chicago and San Francisco.
The Company centralizes its credit approval function and services all of its
loans through an experienced staff of professionals at its headquarters in
Washington, D.C. In addition, the Company recently established an office in
Frankfurt to provide investment advisory services to a private investment fund
making loans in Germany.

The Company has experienced significant growth in its investment portfolio
in the past several years. The fair value of the Company's portfolio grew at an
annual compound growth rate of 20.2% to $697.0 million as of December 31, 1997
from $334.2 million as of December 31, 1993, and at December 31, 1997 included
819 borrower relationships in 40 states and the District of Columbia. The
Company's portfolio income grew at an annual compound growth rate of 23.7% to
$46.1 million from $19.7 million for the years ended December 31, 1997 and 1993,
respectively. Additionally, the Company generated a total of $45.5 million in
net realized gains during the five-year period ended December 31, 1997.

As a lender, the Company targets a market niche between the senior debt
financing provided by traditional lenders, such as banks and insurance
companies, and the equity capital provided by venture capitalists. The Company
believes that many traditional lenders, due to their overhead costs, regulatory
structure or size, are hindered from lending effectively to small and
medium-sized businesses. Many traditional lenders do not offer a long-term
financing option for small to medium-sized businesses. In addition, the Company
recognizes that entrepreneurs need an alternative to the high cost and dilutive
nature of venture equity capital. The Company is an "enterprise value" lender,
which means that it analyzes the potential equity value of a portfolio company
when making a credit decision, in addition to the customary collateral and cash
flow analyses used by traditional lenders. In its mezzanine finance operations,
the Company assesses the underlying value of a borrower's equity capital and
structures its loans to include an equity component in order to enhance its
total return on investment. In its commercial real estate operations, the
Company assesses the borrower's enterprise value to more accurately determine
the ability of the borrower to service its debt. The
1
<PAGE> 6

Company believes that its 40 years of experience operating exclusively as an
enterprise value lender provides it with a competitive advantage in originating
attractive investment opportunities.

On December 31, 1997, the Company completed the merger of five separate
Allied Capital companies, all of which were engaged in small business finance.
The objective of the merger was to create a single, large commercial finance
company and to establish a solid foundation for future growth. The increased
size of the Company's investment portfolio, equity capital base, and market
capitalization as a result of the merger has benefited the Company in many
respects. The larger portfolio has enabled the Company to increase the size of
the loans it originates while maintaining adequate portfolio size diversity.
This is expected to increase both the level of annual loan originations as well
as enhance the credit quality of the Company's portfolio. The larger equity
capital base has strengthened the Company's credit profile, and has enabled the
Company to restructure its credit facilities and obtain unsecured debt financing
at a lower cost with more favorable financing terms. In addition, the Company
believes that its larger market capitalization has increased its access to
capital. Greater access to capital at a lower cost has enabled the Company to
price its loans to borrowers more competitively.

The Company's objective is to continue to be a leader in financing growing
businesses. The Company believes that the merger created the structural and
financial foundation from which to grow, and management continues to refine its
operations. The Company has begun to streamline its operations and fully
integrate all of its lending disciplines in order to improve its efficiency and
benefit from synergies between the various lending areas. The Company has
developed certain key strategies which it believes will enable it to achieve its
objective and result in continued growth in assets and profitability. The
principal elements of the Company's strategies are: (i) growth in loan
originations, (ii) maintenance of asset quality, and (iii) efficient management
of the balance sheet in order to maximize returns to shareholders. In addition,
the Company plans to further its growth through the acquisition of portfolios
and related businesses, and through strategic partnerships with other lenders
and intermediaries. The Company is currently reviewing various acquisition
opportunities.

The Company has an advantageous structure that allows for the
"pass-through" of income to its shareholders without the imposition of a
corporate level of taxation. See "Taxation." The Company is an internally
managed closed-end management investment company that has elected to be
regulated as a business development company ("BDC") under the Investment Company
Act of 1940, as amended ("1940 Act"). The investment objective of the Company is
to achieve current income and capital gains. The Company seeks to achieve its
investment objective by investing in growing businesses in a variety of
industries and in diverse geographic locations, primarily in the United States.
See "Business."

THE OFFERING

Common Stock Offered:

U.S. Offering............ 4,600,000 Shares

International Offering... 1,150,000 Shares
==========

Total............... 5,750,000 Shares(1)
==========

==========

Common Stock to be outstanding
after the Offering........... 57,871,610 Shares(2)
- ---------------
(1) Assumes the over-allotment option granted to the Underwriters will not be
exercised.

(2) As of June 1, 1998. Excludes 3,407,386 shares of Common Stock issuable upon
the exercise of stock options granted under the Company's stock option plan,
of which options to purchase 2,800,439 shares are currently outstanding but
not exercisable and options to purchase 606,947 shares are currently
outstanding and exercisable.

2
<PAGE> 7

Nasdaq National Market
Symbol........................ ALLC

Use of Proceeds............... Origination of loans and investments and
temporary repayment of indebtedness. See "Use
of Proceeds."

Distributions................. The Company currently intends to distribute
quarterly to its shareholders substantially
all of its net income and net realized capital
gains and may annually make an additional
distribution of net investment income and
short term capital gains (and long term
capital gains, if any) realized by the Company
during the year that had not been distributed
through the quarterly dividends. See "Price
Range of Common Stock and Distributions."

Dividend Reinvestment Plan.... The Company has adopted an "opt out" dividend
reinvestment plan ("DRIP Plan"). Under the
DRIP Plan, distributions to a shareholder
owning shares registered in his or her own
name will be automatically reinvested in
additional shares of Common Stock unless a
shareholder elects to "opt out" of the DRIP
Plan. See "Dividend Reinvestment Plan."

Principal Risk Factors........ Investment in shares of Common Stock involves
certain risks relating to the structure and
investment objective of the Company that
should be considered by the prospective
purchasers of Common Stock. As a BDC, the
Company's consolidated portfolio includes
securities primarily issued by privately held
companies. These investments may involve a
high degree of business and financial risk,
and such investments are generally illiquid. A
large number of entities and individuals
compete for the same kind of investment
opportunities as does the Company. The Company
borrows funds to make investments in and loans
to small and medium-sized businesses. As a
result, the Company is exposed to the risks of
leverage, which may be considered a
speculative investment technique. In addition,
the loss of pass-through tax treatment under
Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code") could have a
materially adverse effect on the total return,
if any, obtainable from an investment in the
Company. See "Risk Factors" for a discussion
of such risks, including the effect of
leverage.

Certain Anti-Takeover
Provisions.................... The Company's 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 the Company
and thereby inhibit a change in control of the
Company in circumstances that could give the
holders of Common Stock the opportunity to
realize a premium over the then prevailing
market price for the Common Stock. See
"Description of Capital Stock -- Certain
Anti-Takeover Provisions."
3
<PAGE> 8

FEES AND EXPENSES

The purpose of the following tables is to assist an investor in
understanding the various costs and expenses that an investor in the Company
will bear directly or indirectly.

<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Sales load (as a percentage of offering price)(1)...... 5.0%
Dividend reinvestment plan fees(2)..................... None
ANNUAL EXPENSES (AS A PERCENTAGE OF CONSOLIDATED NET ASSETS
ATTRIBUTABLE TO COMMON SHARES)(3)
Operating expenses(4).................................. 3.8%
Interest payments on borrowed funds(5)................. 3.7%
-------
Total annual expenses(6).......................... 7.5%
=======
</TABLE>

- ---------------
(1) The underwriting discounts and commissions with respect to the Common Stock
sold by the Company in this Offering, which are one-time fees paid by the
Company to the Underwriters in connection with this Offering, are the only
sales load paid in connection with this Offering.
(2) The expenses of the Company's DRIP Plan are included in "Operating
expenses." The Company has no cash purchase plan. The participants in the
DRIP Plan will bear a pro rata share of brokerage commissions incurred with
respect to open market purchases, if any. See "Dividend Reinvestment Plan."

(3) "Consolidated net assets attributable to common shares" equals net assets,
as adjusted (i.e., total assets less total liabilities) at March 31, 1998.
This assumes a net asset value of $556.5 million, which will be the
Company's estimated shareholders' equity upon completion of the Offering.

(4) Operating expenses represent all operating expenses of the Company excluding
interest on indebtedness.
(5) The "Interest payments on borrowed funds" percentage is based on estimated
interest payments for the year ended December 31, 1998 divided by
consolidated net assets attributable to common shares. The Company had
outstanding borrowings of $202.2 million at March 31, 1998. This percentage
for the year ended December 31, 1997 was 6.4%. See "Risk Factors -- Risks of
Leverage."
(6) "Total annual expenses" as a percentage is based on estimated amounts for
the year ended December 31, 1998. "Total annual expenses" as a percentage of
consolidated net assets attributable to common shares are higher than the
total annual expenses percentage would be for a company that is not
leveraged. The Company borrows money to leverage its net assets and increase
its total assets. The "Total annual expenses" percentage is required by the
Commission to be calculated as a percentage of net assets, rather than the
total assets, including assets that have been funded with borrowed monies.
If the "Total annual expenses" percentage were calculated instead as a
percentage of consolidated total assets, "Total annual expenses" for the
Company would be 5.3% of consolidated total assets.

EXAMPLE

The following example, required by the Commission, demonstrates the
projected dollar amount of total cumulative expenses that would be incurred over
various periods with respect to a hypothetical investment in the Company. These
amounts assume no additional leverage and are based upon the payment by an
investor of a 5.0% sales load (the underwriting discounts and commissions paid
by the Company with respect to the Common Stock sold in this Offering) and the
payment by the Company of operating expenses at the levels set forth in the
table above.

<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000 investment,
assuming a 5.0% annual return............................. $122 $266 $409 $763
</TABLE>

Although the example assumes (as required by the Commission) a 5.0% annual
return, the Company's performance will vary and may result in a return of
greater or less than 5.0%. In addition, while the example assumes reinvestment
of all dividends and distributions at net asset value, participants in the DRIP
Plan may receive shares issued by the Company at or above net asset value or
purchased by the Plan Agent (as defined below), as administrator of the DRIP
Plan, at the market price in effect at the time, which may be higher than, at,
or below net asset value. See "Dividend Reinvestment Plan."

THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES, AND
THE ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
4
<PAGE> 9

SELECTED CONSOLIDATED FINANCIAL DATA

The consolidated financial information of the Company set forth below
should be read in conjunction with the Consolidated Financial Statements and
Notes thereto presented elsewhere in this Prospectus. Financial information for
the years ended December 31, 1997, 1996 and 1995 has been derived from audited
financial statements. Financial information for the years ended December 31,
1994 and 1993 has been derived from the audited financial statements of the
individual predecessor companies. The selected financial data reflects the
operations of the Company with all periods restated as if the predecessor
companies had merged as of the beginning of the earliest period presented.
Financial information at March 31, 1998 and for the three-month periods ended
March 31, 1998 and 1997 is derived from unaudited financial data, but in the
opinion of management, reflects all adjustments (consisting only of normal
recurring adjustments) which are necessary to present fairly the results for
such interim periods. Interim results at and for the three months ended March
31, 1998 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1998. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" ON PAGE 16 FOR MORE INFORMATION.

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
----------------- -----------------------------------------------
1998 1997 1997 1996 1995 1994 1993
------- ------- ------- ------- ------- ------- -------
OPERATING DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest and related portfolio income:
Interest..................................... $19,501 $19,630 $86,882 $77,541 $61,550 $47,065 $33,639
Net premiums from loan dispositions.......... 1,336 701 7,277 4,241 2,796 2,380 2,196
Net gain on securitization of commercial
mortgage loans............................. 14,812 -- -- -- -- -- --
Investment advisory fees and other income.... 1,248 1,068 3,246 3,155 4,471 2,710 1,833
------- ------- ------- ------- ------- ------- -------
Total interest and related portfolio
income................................. 36,897 21,399 97,405 84,937 68,817 52,155 37,668
------- ------- ------- ------- ------- ------- -------
Expenses:
Interest on indebtedness..................... 4,598 5,788 26,952 20,298 12,355 7,486 7,053
Salaries and employee benefits............... 2,850 2,057 10,258 8,774 8,031 6,929 5,510
General and administrative................... 2,757 1,586 8,970 8,289 6,888 7,170 5,441
Merger....................................... -- -- 5,159 -- -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating expenses................. 10,205 9,431 51,339 37,361 27,274 21,585 18,004
Formula and cut-off awards(1)................ 1,772 -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Portfolio income before realized and
unrealized gains........................... 24,920 11,968 46,066 47,576 41,543 30,570 19,664
------- ------- ------- ------- ------- ------- -------
Net realized and unrealized gains
Net realized gains........................... 6,421 3,677 10,704 19,155 12,000 6,236 (2,569)
Net unrealized gains (losses)................ 724 (2,159) 7,209 (7,412) 9,266 (2,244) 2,039
------- ------- ------- ------- ------- ------- -------
Total net realized and unrealized gains
(losses)............................... 7,145 1,518 17,913 11,743 21,266 3,992 (530)
------- ------- ------- ------- ------- ------- -------
Income before minority interests and income
taxes.......................................... 32,065 13,486 63,979 59,319 62,809 34,562 19,134
Minority interests............................... -- 306 1,231 2,427 546 -- --
Income tax expense............................... -- 534 1,444 1,945 1,784 672 171
------- ------- ------- ------- ------- ------- -------
Net increase in net assets resulting from
operations..................................... $32,065 $12,646 $61,304 $54,947 $60,479 $33,890 $18,963
======= ======= ======= ======= ======= ======= =======
Per Share:
Basic earnings per common share.................. $ .62 $ .27 $ 1.24 $ 1.19 $ 1.38 $ .80 $ .46
Diluted earnings per common share................ .61 .27 1.24 1.17 1.37 .79 .46
Basic earnings per common share excluding merger
expenses....................................... .62 .27 1.35 1.19 1.38 .80 .46
Total tax distributions per common share(2)...... $ .35 $ .30 $ 1.71 $ 1.23 $ 1.09 $ .94 $ .74
Weighted average common shares outstanding(3).... 51,814 46,938 49,218 46,172 43,697 42,463 40,466
</TABLE>

(Footnotes appear on the following page)

5
<PAGE> 10

<TABLE>
<CAPTION>
AT AT DECEMBER 31,
MARCH 31, ----------------------------------------------------
1998 1997 1996 1995 1994 1993
BALANCE SHEET DATA: ---------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Portfolio at value........................... $564,455 $697,021 $607,368 $528,483 $443,316 $334,193
Portfolio at cost............................ 562,006 690,720 613,276 526,979 451,078 339,711
Total assets................................. 652,710 807,775 713,360 605,434 501,817 435,268
Total debt outstanding(4).................... 202,243 347,663 274,997 200,339 130,236 69,800
Preferred stock issued to SBA(4)............. 7,000 7,000 7,000 7,000 7,000 7,000
Shareholders' equity......................... 423,248 420,060 402,134 367,192 344,043 342,904
Shareholders' equity per common
share...................................... $ 8.23 $ 8.07 $ 8.34 $ 8.26 $ 8.02 $ 8.11
Common shares outstanding at period end(3)... 51,451 52,047 48,238 44,479 42,890 42,306
</TABLE>

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------- ----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
OTHER DATA: -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Loan originations................... $107,506 $ 72,099 $364,942 $283,295 $216,175 $215,843 $147,735
Loan repayments..................... 30,773 25,104 233,005 179,292 111,731 54,097 117,305
Loan sales(5)....................... 9,706 6,425 53,912 27,715 29,726 30,160 18,796
Total assets managed at period
end............................... 990,344 877,380 935,720 822,450 702,567 583,817 501,307
Realized losses..................... -- 829 5,100 11,262 4,679 2,908 3,719
Realized gains...................... $ 6,421 $ 4,505 $ 15,804 $ 30,417 $ 16,679 $ 9,144 $ 1,150
Return on equity(6)................. -- -- 15% 14% 17% 10% 6%
</TABLE>

- ---------------
(1) See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Results of Operations -- Comparison of Three Months Ended
March 31, 1998 and 1997."
(2) Distributions are based on taxable income, which differs from income for
financial reporting purposes. In 1997, Allied Capital Corporation (old)
distributed $0.34 per share representing the 844,914 shares of Allied
Capital Lending Corporation distributed in conjunction with the Merger, as
defined below. The distribution resulted in a partial return of capital.
Also in conjunction with the Merger, the Company distributed $0.17 per share
representing the undistributed earnings of the predecessor companies at
December 31, 1997. See "The Company."
(3) Excludes 663,000 shares held in the Company's deferred compensation trust at
or for the period ended March 31, 1998. See "Management -- Compensation
Plans."

(4) See "Senior Securities" on page 27 for more information regarding the
Company's level of indebtedness.

(5) Excludes loans sold through securitization in January 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Comparison of Three Months Ended
March 31, 1998 and 1997."

(6) Return on equity is computed using the net increase in net assets resulting
from operations for the year divided by the average of beginning and ending
shareholders' equity for the year. Return on equity has not been computed on
a quarterly basis because quarterly results may fluctuate significantly and
may not be indicative of annual results.

6
<PAGE> 11

<TABLE>
<CAPTION>
1998 1997 1996
------- ------------------------------------- -------------------------------------
QTR 1 QTR 4 QTR 3 QTR 2 QTR 1 QTR 4 QTR 3 QTR 2 QTR 1
------- ------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
QUARTERLY DATA:
Total interest and
related portfolio
income................ $36,897 $25,984 $25,111 $24,911 $21,399 $23,906 $20,753 $20,866 $19,412
Portfolio income before
realized and
unrealized gains...... 24,920 7,910 12,093 14,095 11,968 13,035 11,592 11,665 11,284
Net increase in net
assets resulting from
operations............ 32,065 13,216 17,146 18,296 12,646 8,067 16,855 11,090 18,935
Basic earnings per
common share.......... .62 .25 .35 .37 .27 .18 .35 .24 .42
Diluted earnings per
common share.......... .61 .25 .35 .37 .27 .18 .34 .23 .42
Net asset value per
share(1).............. 8.23 8.07 8.42 8.50 8.39 8.34 8.58 8.46 8.37
Dividends declared per
share................. .35 .80(2) .31 .30 .30 .45(3) .27 .26 .25
</TABLE>

- ---------------

(1) Net asset value per share is determined as of the last day in the relevant
quarter. The information presented reflects the operations of the Company
with all periods restated as if the Predecessor Companies had merged as of
the beginning of the earliest period presented. The net asset values shown
are based on outstanding shares at the end of each period.

(2) During the fourth quarter of 1997, the Company declared a quarterly dividend
of $0.61 which included $0.34 per share representing the distribution of
shares of Allied Lending previously held in Allied I's portfolio. The
Company also declared an annual extra distribution of $0.02 per share, and a
special distribution of previously undistributed earnings of $0.17 per share
in conjunction with the Merger.

(3) During the fourth quarter of 1996, the Company declared a regular quarterly
dividend of $0.29 per share and an annual extra distribution of $0.16 per
share.

ADDITIONAL INFORMATION

The Company has filed with the Commission a registration statement on Form
N-2 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act") with respect to the shares of Common Stock of the Company
offered by this Prospectus. This Prospectus, which is a part of the Registration
Statement, does not contain all of the information set forth in the Registration
Statement or the exhibits and schedules thereto. For further information with
respect to the Company and the Common Stock, reference is made to the
Registration Statement, including the exhibits and schedules thereto and the
SAI, contained in the Registration Statement.

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and, in accordance therewith, files reports,
proxy statements and other information with the Commission. The Registration
Statement and the exhibits and schedules thereto filed with the Commission, as
well as such reports, proxy statements and other information, may be inspected,
without charge, at the public reference facility maintained by the Commission at
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the Commission's Regional Offices located at Seven World Trade Center, New
York, New York 10048, and 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. The Commission maintains a web site that contains reports, proxy
statements and other information regarding registrants, including the Company,
that file such information electronically with the Commission. The address of
the Commission's web site is http://www.sec.gov. Copies of such material may
also be obtained from the public reference facility of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Common
Stock is listed on the Nasdaq National Market, and such reports, proxy
statements and other information can also be inspected at the offices of the
Nasdaq Stock Market, 1735 K Street, N.W., Washington, D.C. 20006.

7
<PAGE> 12

RISK FACTORS

The purchase of the Shares offered by this Prospectus involves a number of
significant risks and other factors relating to the structure and investment
objective of the Company. As a result, there can be no assurance that the
Company will achieve its investment objective. In addition to the other
information contained in this Prospectus, prospective investors should consider
carefully the following information before making an investment in the Common
Stock.

RISKS OF DEFAULT

ACC invests in and lends to small businesses. Loans to small businesses
involve a high risk of default and generally are not rated by any nationally
recognized statistical rating organization. Small businesses usually have
narrower product lines and smaller market shares than larger companies and
therefore may be more vulnerable to competitors' actions and market conditions,
as well as general economic downturns. These businesses typically depend for
their success on the management talents and efforts of one person or a small
group of persons whose death, disability or resignation would adversely affect
the business. Because these businesses frequently have highly leveraged capital
structures, reduced cash flows resulting from adverse competitive developments,
a shift in customer preferences or an economic downturn can severely affect the
return on, or the recovery of, the Company's investments in such businesses. The
Company recently has begun originating larger loans, and as a result, any
individual event of default may have a more significant impact on the Company or
its operations.

LOSS OF PASS-THROUGH TAX TREATMENT

The Company qualifies as a regulated investment company ("RIC") under
Subchapter M of the Code and, provided it meets certain requirements under the
Code, qualifies for pass-through tax treatment. The Company would cease to
qualify for pass-through tax treatment if it is unable to comply with the
diversification or distribution requirements contained in Subchapter M of the
Code, or if it ceases to qualify as a BDC under the 1940 Act. The Company also
could be subject to a 4% excise tax (and, in certain cases, corporate level
income tax) if it fails to make certain distributions. The lack of Subchapter M
tax treatment could have a material adverse effect on the total return, if any,
obtainable from an investment in the Company. See "Taxation."

COMPETITION

Many entities and individuals compete for investments similar to those made
by the Company, some of whom have greater resources than ACC. Increased
competition would make it more difficult for the Company to purchase or
originate loans at attractive prices. As a result of this competition, ACC may
from time to time be precluded from making otherwise attractive investments on
terms considered to be prudent in light of the risks assumed.

LONG-TERM CHARACTER OF INVESTMENTS

It is generally expected that mezzanine loans will yield a current return
from the time they are made, but also will produce a realized gain, if any, from
an accompanying equity feature after approximately three to eight years. There
can be no assurance that either a current return or capital gains will actually
be achieved.

ILLIQUIDITY OF INVESTMENTS

The Company acquires securities directly from issuers in private
transactions, and the major portion of such investments ordinarily is subject to
restrictions on resale or is otherwise illiquid. In particular, there is usually
no established trading market in which such securities could be sold. In
addition, securities generally cannot be sold to the public without registration
under the Securities Act, which involves delay, uncertainty and expense.

8
<PAGE> 13

GOVERNMENT REGULATIONS

The Company is subject to regulation by the Commission and the SBA. In
addition, the Company's business may be significantly impacted by changes in the
laws or regulations that govern BDCs, RICs, real estate investment trusts
("REITs"), small business investment companies ("SBICs"), specialized small
business investment companies ("SSBICs") and small business lending companies
("SBLCs"). Laws and regulations may be changed from time to time and the
interpretations of the relevant law and regulations also are subject to change.
Any change in the laws or regulations that govern the Company could have a
material impact on the Company or its operations. See "Certain Government
Regulations."

INTEREST RATE RISK

The Company's income is materially dependent upon the "spread" between the
rate at which it borrows funds and the rate at which it loans these funds. The
Company anticipates using a combination of long-term and short-term borrowings
to finance its lending activities and engaging in interest rate risk management
techniques. At March 31, 1998, the Company's net interest spread was 4.8% (480
basis points), which represents the weighted average yield of the combined
portfolio less the weighted average cost of funds. There can be no assurance
that the Company will maintain this net interest spread or that a significant
change in market interest rates will not have a material adverse effect on the
Company's profitability.

LIMITED INFORMATION

Consistent with its operation as a BDC, the Company's portfolio is expected
to consist primarily of securities issued by small and developing privately held
companies. There is generally little or no publicly available information about
such companies, and the Company must rely on the diligence of its officers and
directors to obtain the information necessary for the Company's decision to
invest in them.

FLUCTUATIONS IN QUARTERLY RESULTS

The Company could experience fluctuations in quarterly operating results
due to a number of factors including, among others, the completion of a
securitization transaction in a particular calendar quarter, the interest rates
on the securities issued in connection with its securitization transactions,
variations in the volume of loans originated by the Company, variations in and
the timing of the recognition of realized and unrealized gains, the degree to
which the Company encounters competition in its markets and general economic
conditions. As a result of these factors, results for any one quarter should not
be relied upon as being indicative of performance in future quarters. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

RISKS OF LEVERAGE

ACC borrows funds from, and issues senior debt securities to, banks and
other lenders. Lenders of these senior securities have fixed dollar claims on
the Company's consolidated assets which are superior to the claims of the
Company's shareholders. Leverage magnifies the potential for gain and loss on
amounts invested and, therefore, increases the risks associated with an
investment in the Company's securities. If the value of the Company's
consolidated assets increases, then such leveraging techniques would cause the
net asset value attributable to the Company's Common Stock to increase more
sharply than it would have had the techniques not been utilized. Conversely, a
decrease in the value of the Company's consolidated assets would cause net asset
value to decline more sharply than it otherwise would if the amounts had not
been borrowed. Similarly, any increase in the Company's consolidated income in
excess of consolidated interest payable on the borrowed funds would cause its
net income to increase more than it would without the leverage, while any
decrease in its consolidated income would cause net income to decline more
sharply than it would have had the funds not been borrowed. Such a decline could
negatively affect the Company's ability to make Common Stock dividend payments,
and, if asset coverage for a class of senior security representing indebtedness
declines to less than 200%, the Company may be required to sell a portion of its
investments when it is disadvantageous to do so. Leverage is generally
considered a speculative investment technique. As of March 31, 1998, the

9
<PAGE> 14

Company's debt as a percentage of total liabilities and shareholders' equity was
31.0%. The ability of the Company to achieve its investment objective may depend
in part on its continued ability to maintain a leveraged capital structure by
borrowing from banks or other lenders on favorable terms, and there can be no
assurance that such leverage can be maintained. See "Certain Government
Regulations."

At March 31, 1998, the Company had $202.2 million of outstanding
indebtedness, bearing a weighted average annual interest rate of 7.6%. In order
for the Company to cover annual interest payments on its indebtedness, it must
achieve annual returns of at least 2.7% on its portfolio. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition, Liquidity and Capital
Resources -- Indebtedness."

Illustration. The purpose of the following table is to illustrate the
effect of leverage on returns to a shareholder on an investment in the Common
Stock assuming various annual returns, net of expenses. The calculations set
forth in the table are hypothetical and actual returns may be greater or less
than those appearing below.

<TABLE>
<CAPTION>
ASSUMED RETURN ON THE COMPANY'S PORTFOLIO
(NET OF EXPENSES)
--------------------------------------------------------------------------
-20% -10% -5% 0% 5% 10% 20%
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Corresponding return to
shareholder(1).............. -34.5% -19.1% -11.4% -3.7% 4.0% 11.7% 27.2%
</TABLE>

- ---------------
(1) The calculation assumes (i) $652.7 million in total assets, (ii) an
average cost of funds of 7.6%, (iii) $202.2 million in debt outstanding
and (iv) $423.2 million of shareholders' equity.

CERTAIN ANTI-TAKEOVER PROVISIONS

The Company's 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 the Company
and thereby inhibit a change in control of the Company in circumstances that
could give the holders of Common Stock the opportunity to realize a premium over
the then prevailing market price for the Common Stock. See "Description of
Capital Stock -- Certain Anti-Takeover Provisions."

10
<PAGE> 15

THE COMPANY

Allied Capital Corporation is a commercial finance company principally
engaged in lending to and investing in private small and medium-sized
businesses. The Company, a Maryland corporation, is an internally managed
closed-end management investment company that has elected to be regulated as a
business development company (as defined above, a "BDC") under the 1940 Act. The
Company has three wholly owned subsidiaries that have also elected to be
regulated as BDCs. Allied Investment Corporation ("Allied Investment") and
Allied Capital Financial Corporation ("Allied Financial") are licensed by the
Small Business Administration ("SBA") as an SBIC and an SSBIC, respectively.
Allied Capital SBLC Corporation ("Allied SBLC") is licensed by the SBA as a
small business lending company and is a participant in the SBA Section 7(a)
Guaranteed Loan Program. In addition, the Company has also established a real
estate investment trust subsidiary, Allied Capital REIT, Inc. See "Certain
Government Regulations."

The Company resulted from the merger on December 31, 1997 of Allied Capital
Corporation ("Allied I"), Allied Capital Corporation II ("Allied II"), Allied
Capital Commercial Corporation ("Allied Commercial") and Allied Capital
Advisers, Inc. ("Advisers") with and into Allied Capital Lending Corporation
("Allied Lending") in a tax free stock-for-stock exchange (the "Merger").
Immediately following the Merger, Allied Lending changed its name to "Allied
Capital Corporation." The five parties to the Merger are sometimes referred to
herein, either singularly or collectively, as the "Predecessor Company" or
"Predecessor Companies."

The Company's executive offices are located at 1666 K Street, N.W., Ninth
Floor, Washington, D.C. 20006 and its telephone number is (202) 331-1112. In
addition to its executive offices, the Company maintains offices in Chicago, San
Francisco and Frankfurt, Germany.

USE OF PROCEEDS

The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby are estimated to be approximately $133 million after deducting
underwriting discounts and commissions and estimated offering expenses payable
by the Company. The Company anticipates that net proceeds from the Offering will
be used, in accordance with the Company's investment objective, to make new
investments in small to medium-sized, private growth companies. See
"Business -- Underwriting Guidelines and Procedures." The Company may
temporarily repay amounts outstanding under its short-term lines of credit that
bear interest at rates of approximately 7.1% per annum as of the date hereof.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition, Liquidity and Capital Resources."

The Company anticipates that substantially all of the net proceeds from the
Offering will be utilized in the manner described above within six months, and
in any event within two years. Pending such utilization, the Company intends to
invest the net proceeds from this Offering 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 thereof and high quality debt securities
maturing in one year or less from the time of investment.

The Company is in the process of issuing $180 million of unsecured
long-term notes to institutional investors in a private placement. The Company
is issuing the long-term notes in order to match the maturities of its long-term
portfolio assets, and plans to use the proceeds from the issuance of the
long-term notes to repay short-term lines of credit. The issuance is expected to
close during the second quarter of 1998, although there is no assurance that the
Company will be able to complete the issuance of the notes. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition, Liquidity and Capital Resources."

11
<PAGE> 16

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

The Common Stock is traded on the Nasdaq National Market under the symbol
"ALLC." The following table sets forth the high and low closing sales prices for
the Company in 1998 and for Allied Lending, the predecessor company to ACC, in
1997 and 1996, the common stock of which was quoted on the Nasdaq National
Market under the symbol "ALCL." The stock quotations are interdealer quotations
and do not include markups, markdowns or commissions. On June 1, 1998, the last
reported closing sale price of the Common Stock was $24.50 per share.

<TABLE>
<CAPTION>
CLOSING SALE PRICE
------------------
HIGH LOW
------- -------
<S> <C> <C>
ALLIED CAPITAL LENDING CORPORATION
YEAR ENDED DECEMBER 31, 1996
First Quarter.......................................... $15.000 $12.750
Second Quarter......................................... 15.000 12.703
Third Quarter.......................................... 15.375 13.125
Fourth Quarter......................................... 15.875 14.000
YEAR ENDED DECEMBER 31, 1997
First Quarter.......................................... 17.000 14.875
Second Quarter......................................... 16.625 13.875
Third Quarter.......................................... 16.750 14.500
Fourth Quarter......................................... 22.750 15.750
ALLIED CAPITAL CORPORATION
YEAR ENDING DECEMBER 31, 1998
First Quarter.......................................... 27.688 21.000
Second Quarter (through June 1, 1998).................. 29.250 22.500
</TABLE>

The common stock of Allied Lending historically traded at prices in excess
of the net asset value and the Common Stock of the Company continues to trade in
excess of net asset value. There can be no assurance, however, that such premium
to net asset value will be maintained. The net asset value and the percentage of
the market price to net asset value for Allied Lending has not been presented
because the net asset value of the Company has been restated as if the
Predecessor Companies, including Allied Lending, had merged as of the beginning
of the earliest period presented. See "Selected Consolidated Financial
Data -- Quarterly Data."

Each Predecessor Company has distributed, and the Company currently intends
to distribute, substantially all of its net income and net realized capital
gains to shareholders quarterly, generally on the last business of day of March,
June, September and December of each year. The Company may also distribute as an
additional dividend any net investment income and short-term capital gains (and
long-term capital gains, if any) realized by the Company during the year that
had not already been distributed through the quarterly dividends. See "Selected
Consolidated Financial Data -- Quarterly Data." There can be no assurance that
the Company will achieve investment results or maintain a tax status that will
permit any particular level of cash distributions or annual increases in cash
distributions. See "Taxation." Certain of the Company's credit facilities limit
the Company's ability to declare dividends if the Company defaults under certain
provisions of the Company's credit agreements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Financial
Condition, Liquidity and Capital Resources." Pursuant to the Company's DRIP
Plan, a shareholder whose shares are registered in his or her own name is
automatically enrolled in the Company's DRIP Plan and will have all dividends
reinvested in additional shares of Common Stock. A shareholder may elect to "opt
out" of the DRIP Plan at any time. See "Dividend Reinvestment Plan."

12
<PAGE> 17

CAPITALIZATION

The following table sets forth the capitalization of the Company at March
31, 1998 (i) on a historical basis and (ii) as adjusted to give effect to (a)
the sale of the Common Stock hereby and (b) the issuance of $180 million of
unsecured long-term notes expected to be issued during the second quarter of
1998 and the application of the proceeds of (a) and (b) as described in "Use of
Proceeds." The information below should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto which are included
elsewhere herein.

<TABLE>
<CAPTION>
AT MARCH 31, 1998
----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Senior unsecured notes(1)................................... $ 28,700 $ 8,700
Debentures and notes payable(1)............................. 70,543 53,300
Revolving lines of credit(1)................................ 103,000 --
Unsecured long-term notes payable(1)........................ -- 180,000
-------- --------
Total debt............................................. 202,243 242,000
Preferred stock issued to SBA............................... 7,000 7,000
Shareholders' equity:
Common stock and additional paid-in capital(2)......... 452,728 585,959
Common stock held in deferred compensation trust....... (15,330) (15,330)
Notes receivable from sale of common stock............. (26,556) (26,556)
Net unrealized appreciation on portfolio............... 2,025 2,025
Undistributed earnings................................. 10,381 10,381
-------- --------
Total shareholders' equity............................. 423,248 556,479
-------- --------
Total capitalization........................................ $632,491 $805,479
======== ========
</TABLE>

- ---------------
(1) To record the effect of a $180 million issuance of unsecured long-term notes
payable, and the resulting repayment of certain debentures and notes payable
and revolving lines of credit. In addition, $20 million of existing senior
unsecured notes will be restructured as part of the $180 million issuance.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Financial Condition, Liquidity and Capital Resources."

(2) To record the effect of $133 million of net proceeds received from the
issuance of Common Stock in connection with the Offering. See "Use of
Proceeds."

13
<PAGE> 18

SELECTED CONSOLIDATED FINANCIAL DATA

The consolidated financial information of the Company set forth below
should be read in conjunction with the Consolidated Financial Statements and
Notes thereto presented elsewhere in this Prospectus. Financial information for
the years ended December 31, 1997, 1996 and 1995 has been derived from audited
financial statements. The financial information reflects the operations of the
Company with all periods restated as if the Predecessor Companies had merged as
of the beginning of the earliest period presented. Quarterly financial
information is derived from unaudited financial data, but in the opinion of
management, reflects all adjustments (consisting only of normal recurring
adjustments) which are necessary to present fairly the results for such interim
periods. Interim results at and for the three months ended March 31, 1998 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------- ------------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Interest and related portfolio income:
Interest...................................... $ 19,501 $ 19,630 $ 86,882 $ 77,541 $ 61,550
Net premiums from loan dispositions........... 1,336 701 7,277 4,241 2,796
Net gain on securitization of commercial
mortgage loans............................. 14,812 -- -- -- --
Investment advisory fees and other income .... 1,248 1,068 3,246 3,155 4,471
-------- -------- -------- -------- --------
Total interest and related portfolio
income................................. 36,897 21,399 97,405 84,937 68,817
-------- -------- -------- -------- --------
Expenses:
Interest on indebtedness...................... 4,598 5,788 26,952 20,298 12,355
Salaries and employee benefits................ 2,850 2,057 10,258 8,774 8,031
General and administrative.................... 2,757 1,586 8,970 8,289 6,888
Merger........................................ -- -- 5,159 -- --
-------- -------- -------- -------- --------
Total operating expenses................. 10,205 9,431 51,339 37,361 27,274
Formula and cut-off awards(1)................. 1,772 -- -- -- --
-------- -------- -------- -------- --------
Portfolio income before realized and
unrealized gains........................... 24,920 11,968 46,066 47,576 41,543
-------- -------- -------- -------- --------
Net realized and unrealized gains
Net realized gains............................ 6,421 3,677 10,704 19,155 12,000
Net unrealized gains (losses)................. 724 (2,159) 7,209 (7,412) 9,266
-------- -------- -------- -------- --------
Total net realized and unrealized
gains.................................. 7,145 1,518 17,913 11,743 21,266
-------- -------- -------- -------- --------
Income before minority interests and income
taxes........................................... 32,065 13,486 63,979 59,319 62,809
Minority interests................................ -- 306 1,231 2,427 546
Income tax expense................................ -- 534 1,444 1,945 1,784
-------- -------- -------- -------- --------
Net increase in net assets resulting from
operations...................................... $ 32,065 $ 12,646 $ 61,304 $ 54,947 $ 60,479
======== ======== ======== ======== ========
Per Share:
Basic earnings per common share................... $ .62 $ .27 $ 1.24 $ 1.19 $ 1.38
Diluted earnings per common share................. $ .61 $ .27 $ 1.24 $ 1.17 $ 1.37
Weighted average common shares outstanding(2)..... 51,814 46,938 49,218 46,172 43,697
</TABLE>

<TABLE>
<CAPTION>
AT AT DECEMBER 31,
MARCH 31, ------------------------------
1998 1997 1996 1995
--------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Portfolio at value................................ $564,455 $697,021 $607,368 $528,483
Portfolio at cost................................. 562,006 690,720 613,276 526,979
Total assets...................................... 652,710 807,775 713,360 605,434
Total debt outstanding............................ 202,243 347,663 274,997 200,339
Preferred stock issued to SBA..................... 7,000 7,000 7,000 7,000
Shareholders' equity.............................. 423,248 420,060 402,134 367,192
Shareholders' equity per common share............. $ 8.23 $ 8.07 $ 8.34 $ 8.26
Common shares outstanding at period end(2)........ 51,451 52,047 48,238 44,479
</TABLE>

14
<PAGE> 19

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------------ ------------------------------
1998 1997 1997 1996 1995
-------- ------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
OTHER DATA:
Loan originations........................................... $107,506 $72,099 $364,942 $283,295 $216,175
Loan repayments............................................. 30,773 25,104 233,005 179,292 111,731
Loan sales(3)............................................... 9,706 6,425 53,912 27,715 29,726
Total assets managed at period end.......................... 990,344 877,380 935,720 822,450 702,567
Realized losses............................................. -- 829 5,100 11,262 4,679
Realized gains.............................................. $ 6,421 $ 4,505 $ 15,804 $ 30,417 $ 16,679
Return on equity(4)......................................... -- -- 15% 14% 17%
</TABLE>

- ---------------
(1) See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Results of Operations -- Comparison of Three Months Ended
March 31, 1998 and 1997."
(2) Excludes 663,000 shares held in the Company's deferred compensation trust at
or for the period ended March 31, 1998. See "Management -- Compensation
Plans."
(3) Excludes loans sold through securitization in January 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Comparison of Three Months Ended
March 31, 1998 and 1997."
(4) Return on equity is computed using the net increase in net assets resulting
from operations for the year divided by the average of beginning and ending
shareholders' equity for the year. Return on equity has not been computed on
a quarterly basis because quarterly results may fluctuate significantly and
may not be indicative of annual results.

- ---------------
(1) Net asset value per share is determined as of the last day in the relevant
quarter. The information presented reflects the operations of the Company
with all periods restated as if the Predecessor Companies had merged as of
the beginning of the earliest period presented. The net asset values shown
are based on outstanding shares at the end of each period.
(2) During the fourth quarter of 1997, the Company declared a quarterly dividend
of $0.61 which included $0.34 per share representing the distribution of
shares of Allied Lending previously held in Allied I's portfolio. The
Company also declared an annual extra distribution of $0.02 per share, and a
special distribution of previously undistributed earnings of $0.17 per share
in conjunction with the Merger.
(3) During the fourth quarter of 1996, the Company declared a regular quarterly
dividend of $0.29 per share and an annual extra distribution of $0.16 per
share.

15
<PAGE> 20

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the Selected Consolidated
Financial Data, the Company's Consolidated Financial Statements and the Notes
thereto, and the other financial data included elsewhere in this Prospectus. The
Merger was treated as a tax-free reorganization under Section 368 (a)(1)(A) of
the Code. For federal income tax purposes, the Predecessor Companies carried
forward the historical cost basis of their assets and liabilities to the
surviving entity (Allied Capital Corporation). For financial reporting purposes,
the Predecessor Companies also carried forward the historical cost basis of
their respective assets and liabilities at the time the Merger was effected. For
financial reporting purposes, Allied I's ownership of Allied Lending has been
eliminated for all periods presented. The financial information reflects the
operations of the Company with all periods restated as if the Predecessor
Companies had merged as of the beginning of the earliest period presented.

OVERVIEW

The Company's primary business is investing in and lending to private small
and medium-sized businesses in three areas: mezzanine finance, commercial real
estate finance, and 7(a) lending. In addition, the Company earns advisory fees
from the management of private investment funds.

The Company's earnings depend primarily on the level of interest and
related portfolio income and net realized and unrealized gain income earned on
these three investment types after deducting interest paid on borrowed capital
and operating expenses. Interest income results from the stated interest rate
paid on a loan, the amortization of loan origination points and the amortization
of any market discount arising from purchased loans. The level of interest
income is directly related to the balance of the investment portfolio multiplied
by the effective yield on the portfolio. The Company's ability to generate
interest income is dependent on economic, regulatory and competitive factors
that influence interest rates, loan originations, and the Company's ability to
secure financing for its investment activities. The Company's financial results
on a quarterly basis may fluctuate significantly due to the timing of gain
recognition and the timing of securitization transactions, among other factors.
As a result, quarterly financial information may not be indicative of annual
results. See "Risk Factors -- Fluctuations in Quarterly Results."

The Company's portfolio is managed in three parts: mezzanine loans, debt
securities and equity interests; commercial mortgage loans; and 7(a) loans.

The total portfolio at value was $564.5 million, $697.0 million, $607.4
million and $528.5 million at March 31, 1998, and December 31, 1997, 1996 and
1995, respectively. During the quarter ended March 31, 1998 the Company
completed an asset securitization of approximately $295 million in commercial
mortgage loans, and as a result, the portfolio decreased by 19% from December
31, 1997 to March 31, 1998. See "-- Results of Operations -- Comparison of Three
Months Ended March 31, 1998 and 1997." The portfolio increased approximately 15%
for each of the years ended December 31, 1997 and 1996. A summary of the
composition of the Company's total assets, including its loan portfolios at
March 31, 1998 and December 31, 1997, 1996 and 1995 is shown in the following
table:

<TABLE>
<CAPTION>
AT DECEMBER 31,
AT MARCH 31, ------------------
ASSET COMPOSITION 1998 1997 1996 1995
- ----------------- ------------ ---- ---- ----
<S> <C> <C> <C> <C>
Commercial mortgage loans(1)................................ 44% 56% 52% 46%
Mezzanine investments....................................... 35 25 27 34
7(a) loans.................................................. 7 5 6 7
Cash and other assets....................................... 14 14 15 13
--- --- --- ---
100% 100% 100% 100%
=== === === ===
</TABLE>

- ---------------
(1) Includes residual interests in a securitized pool of mortgage loans and real
estate investments.

16
<PAGE> 21

Mezzanine loans, debt securities and equity interests were $225.0 million,
$207.7 million, $191.2 million and $205.2 million at March 31, 1998, and
December 31, 1997, 1996 and 1995, respectively. The effective yield on the
mezzanine portfolio was 13.2%, 12.6% and 13.2% at March 31, 1998, and December
31, 1997 and 1996, respectively. Mezzanine loan originations were $37.8 million
for the quarter ended March 31, 1998 and $66.7 million and $66.2 million for the
years ended December 31, 1997 and 1996, respectively. Mezzanine loan repayments
were $13.8 million for the quarter ended March 31, 1998. During the two years
ended December 31, 1997, mezzanine loan repayments and sales of equity interests
were approximately equal to originations, which kept the level of the portfolio
relatively constant.

Prior to the Merger, mezzanine loan originations were made through Allied I
and Allied II, which originated small ($2 million - $10 million) mezzanine loans
in order to maintain appropriate portfolio diversity for regulated investment
company purposes. Pursuant to the terms of a Commission exemptive order, Allied
I and Allied II loan originations were made pursuant to a co-investment formula,
based on relative total assets, which required identical terms for each loan
originated. As a result, Allied I and Allied II were unable to originate larger
loans or price loans based on their own capital structures. These inefficiencies
limited the ability of Allied I and Allied II to compete effectively in the
marketplace.

Subsequent to the Merger, the Company's larger overall portfolio size
enables it to compete for larger mezzanine loans while maintaining adequate
diversity within the portfolio. As a result, the Company is actively pursuing
mezzanine loans in sizes ranging from $5 million to $25 million. The Company
also is able to price its mezzanine loans using a single capital structure,
which should enable the Company to price its loans more competitively. The
Company believes that these post-Merger strategies will enable the Company to
increase mezzanine loan originations in 1998.

Commercial mortgage loans were $201.3 million, $447.2 million, $373.7
million and $277.3 million at March 31, 1998, and December 31, 1997, 1996 and
1995, respectively. The commercial mortgage loan portfolio declined by 55%
during the first quarter of 1998 due to the sale through securitization of
approximately $295 million in commercial mortgage loans. See "-- Results of
Operations -- Comparison of Three Months Ended March 31, 1998 and 1997." The
Company added to its commercial mortgage loan portfolio during the first quarter
of 1998 through the origination of new loans and investments totaling $53.9
million and decreased its portfolio due to repayments of loans totaling $16.3
million. The commercial mortgage loan portfolio increased by 20% and 35% for the
years ended December 31, 1997 and 1996. Commercial mortgage loan originations
were $249.0 million and $176.3 million for 1997 and 1996, respectively.
Commercial mortgage loan originations grew by 41% and 58% in 1997 and 1996,
respectively. Commercial mortgage loan repayments were $154.5 million and $87.5
million for 1997 and 1996, respectively.

The Company experienced a high rate of commercial mortgage loan repayments
in 1997 as many loans that had been purchased in earlier years and originated
without substantial prepayment prohibitions were repaid due to a favorable
interest rate environment. The Company now generally originates its commercial
real estate loans to require prepayment premiums, which generally take the form
of a fixed percentage of the loan amount that declines as the loan matures.

The weighted average current stated interest rate on the commercial real
estate portfolio at March 31, 1998 and at December 31, 1997 and 1996 was 9.9%,
and 9.6% and 10.3%, respectively. The weighted yield on the commercial real
estate portfolio was 11.9%, 11.4% and 13.4% at March 31, 1998 and December 31,
1997 and 1996, respectively.

The effective yield on the commercial mortgage loan portfolio is higher
than the stated interest rate due to the amortization of market discount on
purchased loans. At March 31, 1998, and December 31, 1997 and 1996, unamortized
market and original issue discount was $16.4 million, $28.0 million and $37.1
million, respectively. The Company generally prices its commercial mortgage
loans based on a fixed spread over comparable U.S. Treasury rates given the term
of the loan. During 1997, interest rates on U.S. Treasury bonds declined
significantly, and the spreads charged by commercial real estate lenders in the
marketplace narrowed. As a result, the Company's pricing was affected. Because
of the Company's defined niche as an enterprise value real estate lender,
however, ACC has experienced only a minimal decline in the overall interest
rates on loans originated in 1997 and for the first quarter of 1998. Commercial
mortgage loans originated during the

17
<PAGE> 22

first quarter of 1998 had a weighted average stated interest rate of 9.2%.
Commercial mortgage loans originated in 1997 had a weighted average stated
interest rate of 9.6% as compared to 10.0% for loans originated in 1996.

The Company will continue to aggressively originate commercial mortgage
loans but may increasingly sell loans that are originated at interest rates that
do not meet the Company's overall portfolio strategy.

The 7(a) loan portfolio was $45.9 million, $40.7 million, $42.1 million and
$43.3 million at March 31, 1998 and December 31, 1997, 1996 and 1995,
respectively. 7(a) loan originations were $15.7 million for the quarter ended
March 31, 1998 and $49.2 million and $40.8 million for the years ended December
31, 1997 and 1996, respectively. Sales of the guaranteed portions of 7(a) loan
originations were $9.7 million in the first quarter of 1998 and $43.4 million
and $25.0 million for the years ended December 31,1997 and 1996, respectively.
7(a) loans are originated with variable interest rates priced at spreads ranging
from 1.75% to 2.75% over the prime lending rate.

Prior to the Merger, 7(a) loan originations were conducted through Allied
Lending, which had a consolidated equity base of approximately $40 million.
Because of its relatively small equity base, the Company's cost of debt capital
was expensive and required the Company to price its 7(a) loans at a level that
was, in many cases, above market. Because of the Company's increased equity
base, ACC has reevaluated its pricing strategy and can offer 7(a) loans at lower
prices, and believes that this should increase loan origination activity in
1998. Also, effective January 1, 1998, the Company is no longer required to hold
the guaranteed portion of its 7(a) loans originated for 90 days before selling,
which also lowers its costs associated with this loan origination program.

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED MARCH 31, 1998 AND 1997

Net increase in net assets resulting from operations ("NIA") was $32.1
million, or $0.62 per share, and $12.6 million, or $0.27 per share, for the
three months ended March 31, 1998 and 1997, respectively. NIA results from total
interest and related portfolio income earned, less total expenses incurred, plus
net realized and unrealized gains or losses. The NIA for the three months ended
March 31, 1998 also includes a gain of $14.8 million, or $0.29 per share,
resulting from a commercial mortgage loan securitization transaction that was
completed in January 1998.

On January 30, 1998, the Company, in conjunction with Business Mortgage
Investors, Inc.("BMI"), a private REIT managed by the Company, completed a $310
million asset securitization, whereby bonds totaling $239 million were sold in
three classes rated "AAA", "AA" and "A" by Standard & Poor's Ratings Services
and Fitch IBCA, Inc. in a private placement. The Company and BMI sold a pool of
97 commercial mortgage loans totaling $310 million to a special purpose,
bankruptcy remote entity which transferred the assets to a trust which issued
the bonds. The Company contributed approximately 95%, or $295 million, of the
total assets securitized, and received cash proceeds, net of costs, of
approximately $223 million. The Company retained a trust certificate for its
residual interest (the "residual interest") in the loan pool sold, and will
receive interest income from this residual interest as well as receive the net
spread of the interest earned on the loans sold less the interest paid on the
bonds over the life of the bonds (the "residual securitization spread"). The
mortgage loan pool had an approximate weighted average stated interest rate of
9.6%. The three bond classes sold have an aggregate weighted average interest
rate of approximately 6.38%.

The Company accounted for the securitization in accordance with Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." As a result,
the Company recorded a gain of approximately $14.8 million net of the costs of
the securitization and the cost of settlement of interest rate swaps. The gain
arises from the difference between the carrying amount of the loans and the fair
market value of the assets received -- cash, residual securitization spread,
residual interest and a servicing asset. The value of the residual
securitization spread, $17.0 million, was determined based on the future
expected cash flows, assuming a constant prepayment rate for the mortgage loan
pool of 10%, discounted at 16%. The value of the residual interest was
determined to be

18
<PAGE> 23

$66.5 million and was based on the future expected cash flows less projected
losses of approximately $3.0 million. The projected losses were based upon the
attributes of the portfolio sold and the underlying collateral values. The
weighted average loan to collateral value of the 97 loans sold was 68.3%. The
expected future cash flow from the residual interest was discounted at 9.6%. The
servicing asset was valued at $0.2 million, assuming a net servicing fee of
0.04%, and was discounted at a rate of 10%.

The Company will continue to earn interest income from the residual
interest, and will receive the actual net spread from the portion of the loans
sold represented by the bonds issued. As the net spread is received, a portion
will be allocated to interest income with the remainder applied to reduce the
carrying amount of the residual securitization spread. The residual interest and
the residual securitization spread will be valued each quarter using updated
prepayment, interest rate and loss estimates.

The Company believes that it will continue to use asset securitization as a
means to enhance its returns on assets as well as increase its liquidity. The
Company expects to complete an asset securitization transaction no more
frequently than annually.

Interest income totaled $19.5 million and $19.6 million for the three
months ended March 31, 1998 and 1997, respectively. Interest income appears
relatively constant on a quarter to quarter comparison because of the assets
sold through securitization. The Company's average portfolio was approximately
$631 million and approximately $628 million during the quarters ended March 31,
1998 and 1997, respectively. The weighted average yield on the total loan
portfolio at March 31, 1998 and 1997 remained relatively constant at
approximately 12.4%. On a proforma basis, had the Company retained the 97 loans
that were securitized, interest income would have been approximately $3.0
million higher during the quarter ended March 31, 1998, for a quarterly increase
of approximately 15%. The Company originated loans totaling $107.5 million in
the first quarter of 1998 as compared to $72.1 million during the first quarter
of 1997, and received repayments on its loan portfolio totaling $30.8 million
and $25.1 million for the quarters ended March 31, 1998 and 1997, respectively.

Net premiums from loan dispositions were $1.3 million and $0.7 million for
the three months ended March 31, 1998 and 1997, respectively. Net premiums from
loan dispositions include premiums on the sale of the guaranteed portion of the
Company's 7(a) loans into the secondary market of $0.8 million and $0.4 million
for the quarters ended March 31, 1998 and 1997, respectively. The premiums
result from the Company's sale of 7(a) loans totaling $9.5 million and $4.9
million for the quarters ended March 31, 1998 and 1997, respectively. Also
included in net premiums from loan dispositions were premiums, resulting from
the early repayment of loans, totaling $0.5 million and $0.3 million for the
three months ended March 31, 1998 and 1997, respectively.

Investment advisory fees and other income were $1.2 million and $1.1
million for the three months ended March 31, 1998 and 1997, respectively.
Investment advisory fees totaled $0.5 million and $0.3 million for the quarters
ended March 31, 1998 and 1997, respectively. Three of the Company's private
managed funds are no longer making new investments and are actively distributing
fund assets to their investors. In January 1998, however, the Company entered
into a new agreement with Kreditanstalt fur Wiederaufbau (KfW), the state-owned
public development bank of Germany, to manage a fund of approximately DM 160
million (approximately $87 million at March 31, 1998). Advisory fees increased
as new fees from the German fund offset the decline in fees from liquidating
funds.

Total operating expenses were $10.2 million and $9.4 million for the three
months ended March 31, 1998 and 1997, respectively, an increase of 8.5%.
Operating expenses include interest on indebtedness, salaries and employee
benefits, and other general and administrative expenses.

Interest expense on indebtedness totaled $4.6 million and $5.8 million for
the three months ended March 31, 1998 and 1997, respectively. The decrease in
interest expense is the result of the Company repaying amounts outstanding under
its short-term credit facilities with the proceeds received from the
securitization. Average outstanding indebtedness for the quarters ended March
31, 1998 and 1997 was $246 million and $298 million, respectively. The weighted
average interest rate for the Company's combined indebtedness at March 31, 1998
was 7.6%, as compared to 7.4% at March 31, 1997.

19
<PAGE> 24

Salaries and employee benefits totaled $2.9 million and $2.1 million for
the three months ended March 31, 1998 and 1997, respectively. At March 31, 1998
and 1997, total employees were 90 and 70, respectively. The increase in salaries
and benefits reflects the increase in total employees, combined with wage
increases, and the experience level of employees hired. The Company was an
active recruiter in 1997 for experienced investment and operational personnel
and the Company continues to actively recruit and hire new professionals to
support anticipated portfolio growth.

General and administrative expenses include the lease for the Company's
headquarters in Washington, DC, leases established in 1997 for the Company's new
offices in Chicago and San Francisco, travel costs, stock record expenses, legal
and accounting fees, directors' fees and various other expenses. General and
administrative expenses totaled $2.8 million and $1.6 million, respectively, for
the three months ended March 31, 1998 and 1997. The approximate $1.2 million
increase was partially due to certain post-Merger integration expenses incurred
in the first quarter of 1998, totaling $0.2 million. These expenses included
primarily the costs of legal and accounting advice as well as the use of certain
outside consultants. The remaining increase in general and administrative
expenses results from continued growth of the Company, combined with differences
that result from the timing of expenses recognized in 1997. The first quarter of
1997 incurred a relatively low level of expense when compared to an expected
average quarterly expense based upon total 1997 actual expenses. 1997 general
and administrative expenses in total were $9.0 million, which would imply an
average estimated 1997 quarterly expense of $2.2 million.

During the first quarter of 1998, the Company began to expense a portion of
the formula and cut-off awards that were established in connection with the
Merger. Prior to the Merger, each of the Predecessor Companies had a stock
option plan (the "Old Plans"). In preparation for the Merger, the Compensation
Committees of the Predecessor Companies determined that the Old Plans should be
terminated upon the Merger, so that the new merged Company would be able to
develop a new incentive compensation plan for all officers and directors with a
single equity security. The existence of the Old Plans had resulted in certain
inequities in option grants among the various officers of the Predecessor
Companies simply because of the differences in the underlying equity securities.

To balance stock option awards among the employees, and to account for the
deviations caused by the existence of five plans supported by five different
publicly traded stocks, Advisers developed two special awards to be granted in
lieu of options under the Old Plans that would be foregone upon the cancellation
of the Old Plans.

Cut-Off Award. The first award established a cut-off dollar amount as of
the date of the announcement of the Merger (August 14, 1997) that would be
computed for all outstanding, but unvested options that would be canceled as of
the date of the Merger. The cut-off award was designed to cap the appreciated
value in unvested options at the Merger announcement date in order to set the
foundation to balance option awards upon the Merger. The cut-off award was
designed to be equal to the difference between the market prices of the shares
of stock underlying the canceled option under the Old Plans at August 14, 1997,
less the exercise prices of the options. The cut-off award was computed to be
$2.9 million in the aggregate and will be payable for each canceled option as
the canceled options would have vested. The cut-off award will only be payable
if the award recipient is employed by the Company on a future vesting date. The
cut-off award that will vest in 1998 will total $0.8 million, and approximately
one quarter of this amount, or $0.2 million, has been expensed in the first
quarter of 1998.

Formula Award. The formula award was designed to compensate officers from
the point when their unvested options would cease to appreciate in value
pursuant to the mechanics of the cut-off award (i.e., August 14, 1997) up until
the time in which they would be able to receive option awards in the Company
after the Merger became effective. In the aggregate, the formula award equaled
six percent of the difference between the combined aggregate market
capitalizations of the Predecessor Companies as of the close of the market on
December 30, 1997, and the combined aggregate market capitalizations of the
Predecessor Companies on August 14, 1997.

The formula award was designed as a long-term incentive compensation
program that would replace canceled stock options and would balance share
ownership among key officers for past and prospective service.

20
<PAGE> 25

The terms of the formula award require that the award be contributed to the
Company's deferred compensation plan, and be used to purchase shares of the
Company in the open market. The formula award will vest over a three-year
period, on the anniversary date of the Merger, beginning on December 31, 1998.

In the aggregate, the market capitalizations of the Predecessor Companies
increased by approximately $319 million from August 14, 1997 to December 30,
1997, and the total formula award was computed to be approximately $19 million.
Assuming all officers who received a formula award remain with the Company over
the vesting period, the Company will expense the formula award during 1998, 1999
and 2000 in an annual amount of approximately $6.4 million. The Company recorded
approximately one-fourth of the annual formula award expense of $1.6 million
during the first quarter of 1998.

The total expense recorded as a result of the cut-off and formula awards
during the first quarter of 1998 was $1.8 million or $0.03 per share.

Net realized gains were $6.4 million and $3.7 million for the three months
ended March 31, 1998 and 1997, respectively. The net gains resulted from the
sale of equity securities associated with certain mezzanine loans and the
realization of unamortized discount resulting from the payoff of mezzanine and
commercial mortgage loans, offset by losses on investments. Realized gains
totaled $6.4 million and $4.5 million for the quarters ended March 31, 1998 and
1997, respectively. There were no realized losses during the quarter ended March
31, 1998, and realized losses totaled $0.8 million for the quarter ended March
31, 1997. Net realized gains during the first quarter of 1998 were largely due
to the sale of securities of two portfolio companies, Labor Ready, Inc. and
Broadcast Holdings, Inc. Gains resulting from investments in these two companies
totaled $6.1 million.

The Company recorded net unrealized gains of $0.7 million for the three
months ended March 31, 1998 representing an increase in the board of directors'
valuation of the Company's assets over their aggregate cost as compared to the
prior period and the effect of valuation of interest rate swap agreements. At
March 31, 1998, net unrealized appreciation in the portfolio totaled $2.0
million, and was composed of unrealized appreciation of $25.1 million resulting
from appreciated equity interests in portfolio companies, and unrealized
depreciation of $23.1 million resulting from under-performing loans in the
portfolio. At March 31, 1998, $13.7 million of loans at value in the portfolio
were greater than 120 days delinquent, and $18.7 million of loans at value were
not accruing interest.

The Company incurred income tax expense of $0.5 million for three months
ended March 31, 1997, which resulted from the operations of Advisers, prior to
the Merger. It is the Company's current intention to distribute all of its
taxable income, and therefore no provision for income taxes has been made for
the quarter ended March 31, 1998.

The weighted average shares outstanding used to compute basic earnings per
share for the quarter ended March 31, 1998 were 51.8 million as compared to 46.9
million for the quarter ended March 31, 1997. The increase in weighted average
shares is primarily due to the exercise of stock options and new shares issued
in conjunction with the exchange of shares pursuant to the Merger. Total shares
outstanding at March 31, 1998 were 51.5 million. The weighted average shares and
the total shares outstanding are reduced by the approximately 663,000 shares
held in the Company's deferred compensation plan resulting from the formula
award.

In January 1998, the Company granted 3.4 million new stock options to
certain of the Company's officers. The shares under option have been included in
the calculation of weighted average shares used to compute diluted earnings per
share. See "Management -- Compensation Plans -- Stock Option Plan."

COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

NIA was $61.3 million, or $1.24 per share, $54.9 million, or $1.19 per
share, and $60.5 million, or $1.38 per share, for the years ended December 31,
1997, 1996, and 1995, respectively. NIA results from total interest and related
portfolio income earned, less total expenses incurred in the operations of the
Company, plus net realized and unrealized gains or losses. For 1997, NIA was
significantly impacted by certain one-time, non-recurring expenses related to
the Merger, which totaled approximately $5.2 million. Without these one-

21
<PAGE> 26

time Merger expenses, NIA would have been $66.5 million, or $1.35 per share, for
1997, a 13% increase over 1996 earnings per share.

Total interest and related portfolio income was $97.4 million, $84.9
million and $68.8 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Total interest and related portfolio income is primarily a
function of the level of interest income earned and the balance of portfolio
assets. In addition, total interest and related portfolio income includes
premiums from loan sales, prepayment premiums, and advisory fee and other
income.

Interest income totaled $86.9 million, $77.5 million, and $61.6 million for
the years ended December 31, 1997, 1996 and 1995, respectively. Interest income
increased 12% and 26% for 1997 and 1996, respectively. The increase in interest
income earned results primarily from increases in the amount of loans
outstanding during the periods presented. The Company's loan portfolio increased
by 13% to $655.8 million at December 31, 1997 from $580.9 million at December
31, 1996, and the loan portfolio increased by 17% in 1996 from $495.3 million at
December 31, 1995. The Company's total loan originations of $364.9 million for
1997 represented a 29% increase over loan originations of $283.3 million for
1996, and a 31% increase of loan originations of $216.2 million for 1995. In
addition, the weighted average yield on the total loan portfolio at December 31,
1997 was 11.7%, as compared to 13.1% at December 31, 1996. The Company also
earns interest on cash and government securities which totaled $81.5 million,
$71.8 million and $49.0 million at December 31, 1997, 1996 and 1995,
respectively. The Company for the past three years has earned approximately 4%
to 5% on its temporary cash and government securities.

Net premiums from loan dispositions were $7.3 million, $4.2 million and
$2.8 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Included in net premiums from loan dispositions are premiums from loan sales and
premiums received on the early repayment of loans. Premiums from loan sales were
$3.2 million, $2.6 million and $2.1 million for the years ended December 31,
1997, 1996 and 1995, respectively. This premium income results primarily from
the cash gain on the sale of the guaranteed portion of the Company's 7(a) loans
into the secondary market, less the costs associated with originating the loans
sold. Typically, the Company receives cash premiums on loan sales net of
origination costs ranging from 4% to 6% of the face amount of each loan sold.

Prepayment premiums were $4.0 million, $1.7 million and $0.7 million for
the years ended December 31, 1997, 1996 and 1995, respectively. Commercial
mortgage loan repayments of $154.5 million in 1997 were primarily responsible
for the large level of prepayment premiums experienced in 1997. The expected
maturity of mezzanine or commercial real estate loans ranges from five to ten
years. While it is the Company's intention to retain its borrowers for the full
expected life of the loan, it is not unusual for ACC's borrowers to refinance or
pay off their debts to the Company ahead of schedule. Because the Company seeks
to finance primarily seasoned, performing companies, such companies at times can
secure lower cost financing as their balance sheets strengthen, or as more
favorable interest rates become available.

Investment advisory fees and other income was $3.2 million, $3.2 million
and $3.2 million, for the years ended December 31, 1997, 1996 and 1995,
respectively. This income includes rental income from the Company's fully leased
commercial office building located in northern Virginia and income from
foreclosure properties. Investment advisory fees are received from the private
funds managed by ACC. Three of the Company's private managed funds are in
liquidation, and are actively distributing fund assets to their investors. In
January 1998, the Company entered into an investment advisory agreement with
Kreditanstalt fur Wiederaufbau (KfW), the state-owned public development bank of
Germany, to manage a fund of approximately DM 160 million (approximately $87
million at March 31, 1998). For its services related to sourcing, structuring,
investing, monitoring and disposing of its investments in small, German
businesses, ACC will receive a 3% per annum fee on total committed capital,
payable quarterly.

Total expenses were $51.3 million ($46.1 million without Merger expenses),
$37.4 million and $27.3 million for the years ended December 31, 1997, 1996 and
1995, respectively. Operating expenses include interest on indebtedness,
salaries and employee benefits, legal and accounting expenses, and other general
and administrative expenses.

22
<PAGE> 27

The Company's single largest expense is interest on indebtedness, which
totaled $26.9 million, $20.3 million, and $12.4 million for the years ended
December 31, 1997, 1996 and 1995, respectively. The increase in interest expense
was 33% and 64% for 1997 and 1996, respectively, and is attributable to
increased borrowings by the Company and its subsidiaries under various credit
facilities to fund new loan originations. The Company's total borrowings were
$347.7 million at December 31, 1997, $275.0 million at December 31, 1996 and
$200.3 million at December 31, 1995. Total borrowings increased by 26% and 37%
in 1997 and 1996, respectively. The Company's weighted average interest cost on
outstanding borrowings at December 31, 1997, 1996 and 1995 was 7.3%, 7.6% and
7.6%, respectively.

Salaries and employee benefits totaled $10.3 million, $8.8 million, and
$8.0 million for the years ended December 31, 1997, 1996, and 1995,
respectively. Total employees were 80, 66, and 74 at December 31, 1997, 1996 and
1995, respectively. The increase in salaries and benefits reflects the increase
in total employees, combined with wage increases, and the experience level of
employees hired. The Company was an active recruiter in 1997 for experienced
investment and operational personnel and the Company will continue to actively
recruit and hire new professionals in 1998 to support anticipated portfolio
growth.

General and administrative expenses include the lease for the Company's
headquarters in Washington, DC, leases established in 1997 for the Company's new
offices in Chicago and San Francisco, travel costs, stock record expenses,
directors' fees, legal and accounting fees and various other expenses. General
and administrative expenses totaled $9.0 million, $8.3 million and $6.9 million,
respectively, for the years ended December 31, 1997, 1996 and 1995. Legal and
accounting expenses totaled $2.3 million, $1.6 million and $1.2 million for the
years ended December 31, 1997, 1996 and 1995, respectively. Legal and accounting
expenses include the cost of corporate legal matters, portfolio workout
expenses, and routine accounting and auditing fees. The legal and accounting
expenses for 1997 include a one-time charge of $0.2 million related to the
settlement of a litigation matter associated with one portfolio company. Legal
and accounting expenses increased in 1997 because of this one-time charge and
various restructuring matters. Other than the increases in legal and accounting
fees, the Company did not experience any significant increases in general and
administrative expenses. The Company intends to move its Washington, D.C. office
to larger office space in mid-1998. The Company is increasing the size of its
Washington, D.C. office by approximately 10,000 square feet in order to
accommodate its recent and future anticipated increases in headcount. Annual
rent expense is expected to increase by approximately $0.6 million, annually.

Merger expenses totaled $5.2 million, and consisted primarily of investment
banking fees of $3.1 million, legal fees of $1.0 million and costs associated
with the solicitation of proxies of approximately $0.6 million.

Total expenses excluding interest on indebtedness and Merger expenses
represented approximately 2.5%, 2.6% and 2.7% of the Company's average assets
for the years ended December 31, 1997, 1996 and 1995, respectively.

Net realized gains were $10.7 million, $19.2 million and $12.0 million for
the years ended December 31, 1997, 1996 and 1995, respectively. These gains
resulted from the sale of equity securities associated with certain mezzanine
loans and the realization of unamortized discount resulting from the payoff of
mezzanine and commercial mortgage loans, offset by losses on investments.

Realized gains totaled $15.8 million, $30.4 million and $16.7 million, and
realized losses totaled $5.1 million, $11.3 million and $4.7 million for the
years ended December 31, 1997, 1996 and 1995, respectively. Realized losses of
$11.3 million in 1996 resulted primarily from the liquidation of two portfolio
securities. The Company made loans to these borrowers in the late 1980's and
early 1990's, and the borrowers encountered significant difficulties during the
recession of the early 1990's. Losses from loans to these borrowers included in
1996 losses totalled $6.6 million. Realized gains for 1997 resulted from the
liquidation of securities from 83 portfolio relationships, and ranged in size
from less than $100 to $2.6 million, with an average size of $188,000.

The Company recorded net unrealized gains of $7.2 million for the year
ended December 31, 1997, representing an increase in the board of directors'
valuation of the Company's assets over their aggregate cost as compared to the
prior period. Included as a component of the $7.2 million was a $5.0 million
write-down of

23
<PAGE> 28

interest rate swap agreements. For the year ended December 31, 1996, the Company
recorded net unrealized losses of $7.4 million, as the Company sold an unusual
volume of equity securities that had previously been recorded at appreciated
values. When a sale is consummated, a realized gain is recorded and a
corresponding unrealized loss is also recorded to reflect that the appreciated
asset has been sold. For the year ended December 31, 1995, net unrealized gains
were $9.3 million.

The Company incurred income tax expense of $1.4 million, $1.9 million and
$1.8 million, respectively, for the years ended December 31, 1997, 1996 and 1995
resulting from the operations of Advisers. In conjunction with the Merger,
Advisers' operations as an investment adviser to certain private funds were
assumed by the Company. The Company will be required to pay a tax on any assets
previously owned by Advisers that are subsequently sold.

During 1997, 1996 and 1995, Allied I, Allied II, Allied Commercial and
Allied Lending declared dividends to their shareholders representing all of each
company's ordinary taxable income, taxable net capital gains, and in the case of
Allied I in 1997, a partial return of capital resulting from the distribution of
Allied I's ownership of Allied Lending's shares. Tax distributions differ from
NIA due to timing differences in the recognition of income and expenses, returns
of capital and unrealized appreciation which is not included in taxable income.
Total tax distributions declared were $85.7 million, $57.4 million and $47.9
million for 1997, 1996 and 1995, respectively. Tax distributions per share were
$1.71, $1.23 and $1.09 for the three years ended December 31, 1997, 1996 and
1995, respectively. These per share distributions have been exchange adjusted
for the Merger and include the exchange-adjusted shares of Advisers for which no
tax distributions had historically been declared or paid.

Included in 1997 tax distributions was $18 million, or $0.34 per share,
representing a non-cash dividend of the shares of Allied Lending held in Allied
I's portfolio. Allied I declared and paid a dividend equal to 0.107448 shares of
Allied Lending for each share of Allied I held on the record date for such
dividend. These shares had a market value of $21.25 per share on December 30,
1997, the distribution date.

Also included in 1997 tax distributions was a special, one-time dividend
equal to $8.8 million or $0.17 per share representing all of the retained
earnings and profits of the Predecessor Companies at December 31, 1997. The
special dividend was declared in conjunction with the Merger in order for the
Company to maintain its RIC status.

Certain of the Company's credit facilities limit the Company's ability to
declare dividends if the Company has defaulted under certain provisions of the
credit agreement.

The weighted average common shares outstanding were 49.2 million, 46.2
million and 43.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The increases in the weighted average shares reflect the exercise
of employee stock options to purchase shares of the Company, the issuance of
shares pursuant to a dividend reinvestment plan, the issuance of new shares
pursuant to two separate rights offerings, and the exchange of shares pursuant
to the Merger. Allied I's ownership of Allied Lending during the periods
presented has been eliminated in the consolidation.

NIA, as a percentage of average shareholders' equity was 15%, 14% and 17%
for 1997, 1996 and 1995, respectively. NIA, excluding Merger expenses, as a
percentage of average shareholders' equity for 1997 was 16%.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

CASH AND U.S. GOVERNMENT SECURITIES

At March 31, 1998, the Company had $56.1 million in cash and government
securities. ACC invests 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 repurchase
agreements fully collateralized by such securities.

Prior to the Merger, certain of the Predecessor Companies had excess cash
resources while other of the Predecessor Companies were borrowers on credit
facilities. Subsequent to the Merger, the Company has used

24
<PAGE> 29

excess cash for new investments and in its operations; however, the Company
continues to maintain excess cash in its SBIC and SSBIC subsidiaries. This cash
may not be withdrawn from the subsidiaries because it supports the long-term
borrowings of those subsidiaries, and such borrowings carry substantial
prepayment penalties. The cash has not been invested due to a lack of quality
investment opportunities, primarily for the SSBIC subsidiary. The Company has
been working with the SBA to restructure its SBIC and SSBIC licensees so that
the excess cash may be effectively used, and the Company recently received
permission to begin financing SBIC eligible investments in its SSBIC subsidiary.
See "Certain Government Regulations -- SBA Regulations." The Company is
continuing its restructuring efforts and plans to merge its SBIC and SSBIC
subsidiaries into a single SBIC. There can be no assurance that this
restructuring will be achieved.

INDEBTEDNESS

The Company had outstanding indebtedness at March 31, 1998 as follows:

<TABLE>
<CAPTION>
ANNUAL PORTFOLIO
RETURN TO COVER
AMOUNT ANNUAL INTEREST
CLASS OUTSTANDING INTEREST RATE(1) PAYMENTS(2)
- ----- -------------- ---------------- ----------------
(IN THOUSANDS)
<S> <C> <C> <C>
Debentures and notes payable:
Master repurchase agreement................... $ 8,243 7.01% 0.09%
Master loan and security agreement............ 9,000 6.84 0.09
Senior unsecured notes........................ 28,700 8.57 0.37
SBA debentures................................ 53,300 8.36 0.68
-------- ---- ----
Total debentures and notes payable....... $ 99,243 8.17% 1.24%
======== ==== ====
Revolving line of credit........................... $103,000 7.11% 1.12%
======== ==== ====
</TABLE>

- ---------------
(1) The annual interest rate includes the cost of commitment fees and other
facility fees.
(2) The annual portfolio return to cover interest payments ("Annual Return") is
calculated as total estimated 1998 annual interest or dividend payments per
class of financing, divided by total assets at March 31, 1998. The total
Annual Return needed to cover all classes of financing at March 31, 1998
combined is 2.36%.

Master Repurchase Agreement. The Company and BMI are co-borrowers under a
master repurchase agreement whereby the two entities can borrow up to $250
million of which $100 million is committed, through repurchase agreements using
commercial mortgage loans as collateral. The Company pledges commercial mortgage
loans as collateral for the facility such that the amount borrowed is
approximately equal to 75% to 80% of the value of the collateral pledged. The
terms of the master repurchase agreement require interest-only payments with all
principal due at maturity. The master repurchase agreement bears interest at
one-month London Inter Bank Offered Rate ("LIBOR") plus 1.13% and requires an
annual commitment fee of 0.25% of the amount committed. The master repurchase
agreement matures on January 31, 1999.

Master Loan and Security Agreement. The Company, again in conjunction with
BMI, has a facility to borrow up to $250 million, of which $100 million is
committed, using its commercial mortgage loans as collateral. The agreement
generally requires interest-only payments with all principal due at maturity.
The agreement bears interest at one-month LIBOR plus 1.0% and requires an annual
commitment fee of 0.15% of the amount committed. The facility matures on August
21, 1998.

Senior Unsecured Notes. The Company has a $20 million unsecured senior
note payable to an insurance company. The note is scheduled to mature over a
five-year period commencing in 1998 with annual principal payments of $4
million. The note has a stated interest rate of 9.15% and is subject to
prepayment penalty if paid prior to maturity. In conjunction with the proposed
issuance of the unsecured long-term notes described below, the Company
anticipates that these senior notes will be restructured during the second
quarter of 1998. The Company also has senior notes payable to the Overseas
Private Investment Corporation totaling $8.7 million at March 31, 1998.

25
<PAGE> 30

SBA Debentures. The Company, through Allied Investment and Allied
Financial, has debentures totaling $53.3 million payable to the SBA, at interest
rates ranging from 6.87% to 9.80% with scheduled maturity dates as follows:
1998 -- $5.7 million; 1999 -- $0; 2000 -- $17.3 million; 2001 -- $9.4 million;
2002 -- $0; and $21.0 million thereafter. The debentures require semi-annual
interest-only payments with all principal due upon maturity. During 1997,
Congress increased the maximum leverage available to an SBIC to $101.0 million,
and the Company intends to continue to borrow under the SBIC program as the
situation warrants.

Revolving Line of Credit. The Company has a $200 million unsecured
revolving line of credit. The facility bears interest at LIBOR plus 1.25% and
requires a commitment fee equal to 0.2% of the committed unused amount. The
facility also has a facility fee equal to 0.15% of the initial commitment. The
18-month line of credit requires monthly payments of interest, and all principal
is due upon maturity. The amount that may be borrowed is based upon a borrowing
base formula generally equal to 50% of the Company's portfolio investments not
securing other credit facilities. The Company is in the process of restructuring
this facility in conjunction with the proposed issuance of the unsecured
long-term notes discussed below.

Unsecured Long-term Notes. The Company is in the process of negotiating
$180 million in unsecured long-term notes with private institutional lenders,
primarily insurance companies. The proposed terms of the notes include five and
seven year maturities, priced at approximately 7.2%. The notes require payment
of interest semiannually, and all principal is due upon maturity. The Company
plans to issue the notes during the second quarter of 1998; however, there is no
assurance that the Company will be able to complete the issuance of the notes.

FUTURE DEBT OR EQUITY OFFERINGS

The Company plans to secure additional debt and equity capital such as the
proceeds from this Offering for continued investment in growing businesses.
Because the Company is a RIC, it distributes substantially all of its income and
requires external capital for growth. Because the Company is a BDC, it is
limited in the amount of debt capital it may use to fund its growth, since it is
generally required to maintain a ratio of 200% of total assets to total
borrowings. See "Certain Government Regulations." The Company anticipates that
if the Offering is completed, the proceeds generated, together with other
sources of capital, will be sufficient to fund the anticipated growth in the
Company's operations through 1999.

The Company's cash flow from operations was $11.1 million for the quarter
ended March 31, 1998 and $58.9 million, $45.2 million and $47.3 million for the
years ended December 31, 1997, 1996 and 1995, respectively. The Company plans to
maintain a strategy of financing its operations, dividend requirements and
future investments with cash from operations, long-term debt, asset
securitizations or through use of its equity capital. The Company will utilize
its short-term credit facilities only as a means to bridge to long-term
financing. The Company hedges variable and short-term interest rate exposure
through interest rate swaps, treasury locks and other techniques. The Company
believes that it has access to capital sufficient to fund its ongoing investment
and operating activities, and from which to pay dividends.

FINANCIAL OBJECTIVES

The merged Company has set forth certain financial objectives that it
intends to use in allocating its resources and in selecting new investment
opportunities. Management's goal is to increase NIA annually by 15% to 20% and
to result in a ratio of NIA to average shareholders' equity of 18%. Management
believes that the Company will be able to achieve these goals over the next
three to five years. Factors that may impede the achievement of these objectives
include those described under "Risk Factors" and also include other factors such
as changes in the economy, competitive and market conditions, and future
business decisions.

YEAR 2000

The Company has reviewed its exposure to the risks associated with the Year
2000 issue, and has determined that there is no material risk of business
interruption as a result of errors or inefficiencies in the Company's internal
computer systems. The Company exclusively uses purchased software and has been

26
<PAGE> 31

informed by its vendors that the software will be Year 2000 compatible; however,
there is no assurance that such software will indeed address all Year 2000
compatibility issues. The Company is currently assessing the risk that its
portfolio companies may have regarding this issue. For all new loans originated,
the Company includes in its credit review a Year 2000 compatibility assessment,
and will monitor particular portfolio companies as needed.

NEW GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Statement of Financial Accounting Standards Nos. 130 and 131, "Reporting
Comprehensive Income" and "Disclosures about Segments of an Enterprise and
Related Information," respectively, were issued in June 1997. SFAS 130 requires
that certain financial activity typically disclosed in shareholders' equity be
reported in the financial statements as an adjustment to net income in
determining comprehensive income. SFAS 131 requires the reporting of selected
segmented information in quarterly and annual reports. SFAS No. 130 did not
materially impact the Company's financial statements, and the Company does not
anticipate any material financial impact from the implementation of SFAS 131.

SENIOR SECURITIES

Certain information about the various classes of senior securities issued
by the Company is set forth in the following tables. The "-- " indicates
information which the Commission expressly does not require to be disclosed for
certain types of senior securities.

<TABLE>
<CAPTION>
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)
- -------------- ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
MASTER REPURCHASE AGREEMENT AND MASTER LOAN
AND SECURITY AGREEMENT
1988....................................... $ 0 $ 0 $ -- N/A
1989....................................... 0 0 -- N/A
1990....................................... 0 0 -- N/A
1991....................................... 0 0 -- N/A
1992....................................... 0 0 -- N/A
1993....................................... 0 0 -- N/A
1994....................................... 23,210,000 3,695 -- N/A
1995....................................... 0 0 -- N/A
1996....................................... 85,775,000 2,485 -- N/A
1997....................................... 225,821,000 2,215 -- N/A
1998 (at March 31)......................... 17,243,000 3,127 -- N/A

SENIOR NOTE PAYABLE(5)
1988....................................... $ 0 $ 0 $ -- N/A
1989....................................... 0 0 -- N/A
1990....................................... 0 0 -- N/A
1991....................................... 0 0 -- N/A
1992....................................... 20,000,000 5,789 -- N/A
1993....................................... 20,000,000 6,013 -- N/A
1994....................................... 20,000,000 3,695 -- N/A
1995....................................... 20,000,000 2,868 -- N/A
1996....................................... 20,000,000 2,485 -- N/A
1997....................................... 20,000,000 2,215 -- N/A
1998 (at March 31)......................... 20,000,000 3,127 -- N/A
</TABLE>

27
<PAGE> 32

<TABLE>
<CAPTION>
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)
- -------------- ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
OVERSEAS PRIVATE INVESTMENT
CORPORATION LOAN
1988....................................... $ 0 $ 0 $ -- N/A
1989....................................... 0 0 -- N/A
1990....................................... 0 0 -- N/A
1991....................................... 0 0 -- N/A
1992....................................... 0 0 -- N/A
1993....................................... 0 0 -- N/A
1994....................................... 0 0 -- N/A
1995....................................... 0 0 -- N/A
1996....................................... 8,700,000 2,485 -- N/A
1997....................................... 8,700,000 2,215 -- N/A
1998 (at March 31)......................... 8,700,000 3,127 -- N/A

SBA DEBENTURES(6)
1988....................................... $ 24,350,000 $1,978 $ -- N/A
1989....................................... 25,350,000 4,015 -- N/A
1990....................................... 40,450,000 3,397 -- N/A
1991....................................... 49,800,000 3,834 -- N/A
1992....................................... 49,800,000 5,789 -- N/A
1993....................................... 49,800,000 6,013 -- N/A
1994....................................... 54,800,000 3,695 -- N/A
1995....................................... 61,300,000 2,868 -- N/A
1996....................................... 61,300,000 2,485 -- N/A
1997....................................... 54,300,000 2,215 -- N/A
1998 (at March 31)......................... 53,300,000 3,127 -- N/A

REVOLVING LINES OF CREDIT
1988....................................... $ 10,000,000 $1,978 $ -- N/A
1989....................................... 0 0 -- N/A
1990....................................... 0 0 -- N/A
1991....................................... 0 0 -- N/A
1992....................................... 0 0 -- N/A
1993....................................... 0 0 -- N/A
1994....................................... 32,226,000 3,695 -- N/A
1995....................................... 20,414,000 2,868 -- N/A
1996....................................... 45,099,000 2,485 -- N/A
1997....................................... 38,842,000 2,215 -- N/A
1998 (at March 31)......................... 103,000,000 3,127 -- N/A
</TABLE>

28
<PAGE> 33

<TABLE>
<CAPTION>
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)
- -------------- ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
BONDS PAYABLE
1988....................................... $ 0 $ 0 $ -- N/A
1989....................................... 0 0 -- N/A
1990....................................... 0 0 -- N/A
1991....................................... 0 0 -- N/A
1992....................................... 0 0 -- N/A
1993....................................... 0 0 -- N/A
1994....................................... 0 0 -- N/A
1995....................................... 98,625,000 2,868 -- N/A
1996....................................... 54,123,000 2,485 -- N/A
1997....................................... 0 0 -- N/A
1998 (at March 31)......................... 0 0 -- N/A

REVERSE REPURCHASE AGREEMENTS(7)
1988....................................... $ 34,321,000 $1,978 $ -- N/A
1989....................................... 29,386,000 4,015 -- N/A
1990....................................... 28,361,000 3,397 -- N/A
1991....................................... 2,761,000 3,834 -- N/A
1992....................................... 0 0 -- N/A
1993....................................... 0 0 -- N/A
1994....................................... 0 0 -- N/A
1995....................................... 0 0 -- N/A
1996....................................... 0 0 -- N/A
1997....................................... 0 0 -- N/A
1998 (at March 31)......................... 0 0 -- N/A

REDEEMABLE CUMULATIVE PREFERRED STOCK(6)
1988....................................... $ 0 $ 0 $ 0 N/A
1989....................................... 0 0 0 N/A
1990....................................... 1,000,000 308 100 N/A
1991....................................... 1,000,000 338 100 N/A
1992....................................... 1,000,000 526 100 N/A
1993....................................... 1,000,000 546 100 N/A
1994....................................... 1,000,000 351 100 N/A
1995....................................... 1,000,000 277 100 N/A
1996....................................... 1,000,000 242 100 N/A
1997....................................... 1,000,000 217 100 N/A
1998 (at March 31)......................... 1,000,000 302 100 N/A
</TABLE>

29
<PAGE> 34

<TABLE>
<CAPTION>
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)
- -------------- ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
NON-REDEEMABLE CUMULATIVE PREFERRED STOCK(6)
1988....................................... $ 5,000,000 $ 184 $ 100 N/A
1989....................................... 6,000,000 362 100 N/A
1990....................................... 6,000,000 308 100 N/A
1991....................................... 6,000,000 338 100 N/A
1992....................................... 6,000,000 526 100 N/A
1993....................................... 6,000,000 546 100 N/A
1994....................................... 6,000,000 351 100 N/A
1995....................................... 6,000,000 277 100 N/A
1996....................................... 6,000,000 242 100 N/A
1997....................................... 6,000,000 217 100 N/A
1998 (at March 31)......................... 6,000,000 302 100 N/A
</TABLE>

- ---------------
(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 the Company's 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 the Company's 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, as senior securities are not registered for public trading.
(5) The Company was the obligor on $15 million of the senior notes. The
Company's SBIC subsidiaries were the obligors on the remaining $5 million,
which is not subject to the asset coverage requirements of the 1940 Act.
(6) Issued by the Company's SBIC subsidiaries to the SBA. These categories of
senior securities are not subject to the asset coverage requirements of the
1940 Act.
(7) U.S. government agency guaranteed loans sold under agreements to
repurchase. The Company was advised by the Staff of the Commission that
these reverse repurchase agreements were not considered a class of senior
security representing indebtedness and thus were not subject to the asset
coverage requirements of the 1940 Act.

30
<PAGE> 35

BUSINESS

Allied Capital Corporation is a commercial finance company principally
engaged in lending to and investing in private small and medium-sized
businesses. The Company has been lending to private growing businesses for 40
years and has financed thousands of borrowers nationwide. In addition to its
core lending business, the Company provides advisory services to private
investment funds. The Company's lending operations are conducted in three
primary areas: mezzanine finance, commercial real estate finance, and 7(a)
lending. The principal loan products of the Company include: subordinated loans
with equity features, commercial mortgage loans and SBA 7(a) guaranteed loans.
The investment objective of the Company is to achieve current income and capital
gains. The Company seeks to achieve its investment objective by investing in
growing businesses in a variety of industries and in diverse geographic
locations primarily in the United States. This investment objective may be
changed without a vote of the Company's stockholders. The Company currently has
no policy with respect to concentration (i.e., investment of 25% or more of the
Company's total assets in any industry or group of industries) and currently its
portfolio is not concentrated. The Company may or may not concentrate in an
industry or group of industries in the future.

As a lender, ACC targets a market niche between the senior debt financing
provided by traditional lenders, such as banks and insurance companies, and the
equity capital provided by venture capitalists. The Company believes that many
traditional lenders, due to their overhead costs, regulatory structure or size
are hindered from lending effectively to small and medium-sized businesses. Many
traditional lenders do not offer a long-term financing option for small to
medium-sized businesses. In addition, the Company recognizes that entrepreneurs
need an alternative to the high cost and dilutive nature of venture equity
capital. The Company is an "enterprise value" lender, which means that it
analyzes the potential equity value of a portfolio company when making a credit
decision, in addition to the customary collateral and cash flow analyses used by
traditional lenders. In its mezzanine finance operations, the Company assesses
the underlying value of a borrower's equity capital and structures its loans to
include an equity component in order to enhance its total return on investment.
In its commercial real estate operations, the Company assesses the borrower's
enterprise value to more accurately determine the ability of the borrower to
service its debt. The Company believes that its experience as an enterprise
value lender provides the Company with a competitive advantage in originating
attractive investment opportunities.

BUSINESS STRATEGY

The Company's objective is to continue to be a leader in financing growing
businesses. The Company has developed an expertise as an enterprise value lender
over its 40-year history, and believes that it is well-positioned from a
financial and operational standpoint to take advantage of the opportunities in
the market it serves.

On December 31, 1997, the Company completed the Merger of five separate
Allied Capital companies, all of which were engaged in small business finance.
The objective of the Merger was to create a single, large

31
<PAGE> 36

commercial finance company and to establish a solid foundation for future
growth. The increased size of the Company's portfolio, equity capital base and
market capitalization as a result of the Merger has benefited the Company in
many respects. The larger portfolio has enabled the Company to increase the size
of the loans it originates while maintaining adequate portfolio size diversity.
This is expected to increase both the level of annual loan originations as well
as enhance the credit quality of the Company's portfolio. The larger equity
capital base has strengthened the Company's credit profile, and has enabled the
Company to restructure its credit facilities and obtain unsecured debt financing
at a lower cost with more favorable financing terms. In addition, the Company
believes that its larger market capitalization has increased its access to
capital. Greater access to capital at a lower cost has enabled the Company to
price its loans to borrowers more competitively.

The Company believes that the Merger created the structural and financial
foundation from which to grow, and management continues to refine its
operations. The Company has begun to streamline its operations and fully
integrate all of its lending disciplines in order to improve its efficiency and
benefit from synergies between the various lending areas. The Company has
developed certain key strategies which it believes will enable it to achieve its
objective and result in continued growth in assets and profitability. The
principal elements of the Company's strategies are:

- GROWTH IN LOAN ORIGINATIONS. During the fourth quarter of 1997, the
Company began to originate larger loans, particularly in its mezzanine
portfolio, in order to increase the growth in its total loan
originations. The Company now originates loans of up to $25 million in
size. In addition, the Company recently has implemented a new pricing
strategy in all of its lending operations reflecting its lower cost of
capital as a result of the Merger. The Company expects that more
competitive pricing will contribute to an increase in the Company's loan
originations and ultimately the Company's profitability. In addition to
its strategies related to loan size and pricing, the Company continues to
increase the scale of its sales and marketing function in order to
increase loan origination activity. The Company originated $107.5 million
in new loans in the first quarter of 1998 as compared to $72.1 million in
the first quarter of 1997, reflecting in large measure the Company's new
loan origination growth strategies.

- MAINTENANCE OF ASSET QUALITY. The Company continues to maintain its
policy of rigorous credit underwriting and maintenance of asset quality.
The Company has a corporate culture that values strong credit analysis
and believes that it has a proven and effective credit underwriting
process. Over the past ten years, the Company has experienced a low level
of losses and strives to maintain this record by employing stringent
underwriting criteria and guidelines, requiring extensive due diligence,
and approving credit decisions by committee, with no individual credit
authority. All prospective investments are approved by the Company's
investment committee, at its headquarters in Washington, D.C. The
investment committee is comprised of nine senior investment
professionals, who have an average of 17 years of experience.

- EFFICIENT MANAGEMENT OF THE BALANCE SHEET TO MAXIMIZE RETURNS TO
SHAREHOLDERS. The Company actively manages its capital structure in an
effort to minimize its cost of capital and maximize returns for its
shareholders. The Company conservatively leverages its equity capital
with debt financing to enhance shareholder returns. The Company strives
to match fund its long-term assets with long-term financing, and manages
fixed/variable interest rate exposure where appropriate. The Company's
large volume of loan originations provides it with access to alternative
funding sources. Alternative funding sources such as securitization allow
the Company to enhance the returns the Company earns on its investments,
as well as increase liquidity.

In addition, the Company plans to further its growth through the
acquisition of portfolios and related businesses, and through strategic
partnerships with other lenders and intermediaries. The Company is currently
reviewing various acquisition opportunities.

MEZZANINE FINANCE

The Company provides financing to small and medium-sized businesses to fund
growth, leveraged buyouts, acquisitions and recapitalizations. The Company's
mezzanine investments are generally structured as debt securities that carry a
relatively high fixed rate of interest, and are often combined with warrants to

32
<PAGE> 37

purchase a portion of the borrower's equity in order to earn investment
appreciation. The Company's objective for its mezzanine portfolio is to generate
a return on assets ranging from 14% to 20% from both interest income earned and
gains on sale of equity interests. At March 31, 1998, the Company's mezzanine
portfolio had $185.3 million in mezzanine loans and $39.7 million in equity
interests totaling $225.0 million, which represented 40% of the Company's total
investment portfolio.

The majority of the Company's mezzanine investments are in private growth
businesses or small public companies with revenues ranging from $20 million to
$200 million. As part of the Company's criteria for selecting a business in
which to make an investment, the Company generally requires that the business
demonstrate a history of growth, positive cash flow, and profitability.
Additionally, the Company emphasizes the quality of the borrower's management
and seeks experienced entrepreneurs with a proven management track record and
relevant industry experience. See "-- Underwriting Guidelines and Procedures."

Mezzanine investments have historically ranged in size between $2 million
and $10 million. While the Company plans to continue originating investments of
this size, it has begun to originate larger-sized transactions of up to $25
million. As an enterprise value lender, the Company assesses the underlying
value of a borrower's equity capital and structures its loans to include an
equity component to enhance its total return. The Company's primary competition
in mezzanine finance is from private equity and mezzanine investment
partnerships. The Company believes that it has certain structural and
operational advantages when compared to many of its competitors. The Company's
scale of operations, equity capital base, and successful track record as a
mezzanine lender should enable the Company to borrow long-term capital to
leverage its equity and reduce its overall cost of capital. The Company uses its
lower cost of capital to price its loans competitively. In addition, the
perpetual nature of the Company's corporate structure enables the Company to be
a better long-term partner for its borrowers than traditional mezzanine
partnerships, which typically have a limited life.

Mezzanine investments generally carry a fixed interest rate and a maturity
of five to seven years with interest-only payments in the early years and
payments of both principal and interest in the later years. The weighted average
current yield on the mezzanine loan portfolio at March 31, 1998 was
approximately 13.2%. Historically, the Company has structured its loans to
generate approximately one-half of its return on investment from current
interest income and approximately one-half from the sale of an equity "kicker."
The Company has recently modified its mezzanine lending strategy and is
structuring more loans where the majority of its investment is expected to
result from stated interest income and less of its return is expected to result
from gains on sale of equity.

At March 31, 1998 the Company held equity investments in 58 companies with
a total value of $39.7 million. During the quarter ended March 31, 1998 and the
years ended December 31, 1997 and 1996, respectively, the Company converted a
portion of its equity investments into realized gains of $6.4 million, $10.7
million, and $19.2 million, respectively. Equity investments held by the
Company, which include warrants, options, and common and preferred stock,
generally do not produce a current return, but are held for potential investment
appreciation and ultimate gain on sale. The majority of the Company's mezzanine
loans include warrants to purchase common stock of the borrower. Generally, the
warrants are exercisable after a three to five year period, and the exercise
price for the purchase of common stock is a nominal amount. The warrants are
generally structured to include registration rights allowing the Company to sell
the securities in the event of a public offering by the borrower, and in many
cases carry a put option that requires the borrower to repurchase the warrants
after a specified period of time at a formula price or at the fair market value
of the shares issuable.

The Company holds a portion of its mezzanine investment portfolio in two
wholly owned subsidiaries, Allied Investment and Allied Financial. Allied
Investment and Allied Financial are licensed and regulated by the SBA to operate
as SBICs and are required to lend to certain small businesses as stipulated by
the SBA. See "Certain Government Regulations."

The Company manages its mezzanine portfolio in an effort to ensure that it
is not concentrated in any particular geographical area or region, and is
diverse in terms of the specific industries represented. The

33
<PAGE> 38

following table shows the Company's mezzanine portfolio by industry and
geographic region at March 31, 1998:

MEZZANINE PORTFOLIO
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
PERCENT OF
INDUSTRY TOTAL
- ------------------------------ ----------
<S> <C>
Industrial/Manufacturing...... 47%
Broadcasting/Communications... 17
Services...................... 17
Retail/Wholesale.............. 13
Other......................... 6
---
100%
===
</TABLE>

<TABLE>
<CAPTION>
PERCENT OF
GEOGRAPHIC REGION TOTAL
- ------------------------------ ----------
<S> <C>
Mid-Atlantic.................. 31%
Southeast..................... 28
Midwest....................... 18
West.......................... 11
Northeast..................... 7
International................. 5
---
100%
===
</TABLE>

COMMERCIAL REAL ESTATE FINANCE

The Company originates and purchases commercial loans to small businesses
secured by liens or mortgages on real estate ("commercial mortgage loans"), with
a primary focus on loans ranging in size from $1 million to $20 million. In
addition to commercial mortgage loans, the Company also provides long-term real
estate financing products, such as subordinated real estate loans and
sale-leaseback financing. The Company seeks to maximize its return on investment
by choosing either to hold loans in its commercial real estate investment
portfolio or to sell or securitize certain loans. The commercial real estate
portfolio totaled approximately $201.3 million at March 31, 1998, or 36% of the
Company's total investment portfolio. In addition, at March 31, 1998 the Company
had $87.9 million in interests in a securitization pool of commercial real
estate mortgages. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations -- Comparison of
Three Months Ended March 31, 1998 and 1997."

The Company believes that it competes successfully in the commercial real
estate finance market due to the creativity and flexibility of its loan terms.
When evaluating a potential commercial real estate investment, the Company
considers the enterprise value of the borrower in addition to the value of the
underlying collateral. The Company believes that it is able to structure and
finance more complicated credits due to its enterprise value approach and the
sophistication of its investment professionals. The Company competes with banks,
real estate conduits, equity and mortgage REITs and other lenders for the
commercial mortgage loans it originates. The Company believes that it has earned
a reputation in the commercial real estate finance market as a specialist in
credits that require more difficult structuring or underwriting techniques, and
that it competes successfully in this niche.

The Company considers a variety of information during its credit
underwriting process including: the borrower's financial statements, third party
appraisals of the related mortgage asset, rent rolls and lease information and
other third-party reports, as appropriate, to assess risks related to
engineering, environmental, seismic, or structural issues.

The Company derives income from the stated interest due on its commercial
mortgage loans and from the amortization of discounts on its portfolio of
purchased commercial mortgage loans. ACC generally prices its commercial
mortgage loans at interest rates ranging from 200 to 500 basis points over
comparable term U.S. Treasury rates. At March 31, 1998, approximately 61.4% of
the Company's portfolio of commercial mortgage loans carried a fixed rate of
interest and approximately 38.6% had adjustable rates of interest tied to
various indices. At March 31, 1998, the effective yield on ACC's portfolio of
commercial mortgage loans was approximately 11.9%, which reflects the stated
interest and amortization of discounts on loans over the expected life of the
loan. Commercial mortgage loans originated by ACC generally have a maturity of
five to ten years. Occasionally, these loans may require payments of interest
only or level payments of principal and interest calculated to amortize
principal on a 10- to 30-year basis with a balloon payment at maturity. At

34
<PAGE> 39

March 31, 1998, the average loan to value ratio for the commercial mortgage loan
portfolio, including the securitized pool, was 70.5%.

The Company experienced a high rate of commercial mortgage loan repayments
in 1997 as many loans that had been purchased in earlier years did not have
substantial prepayment prohibitions, and as a result were repaid due to a
favorable interest rate environment. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations." The Company now generally
originates its commercial real estate loans to require prepayment premiums,
which generally take the form of a fixed percentage of the loan amount that
declines as the loan matures.

In late 1995, the Company commenced securitizing portions of its commercial
real estate portfolio. Through asset securitization, the Company effectively
sells senior tranches of its mortgage loans to investors while retaining a
subordinated interest in the loans sold. Securitization effectively increases
the Company's returns on the assets it retains and provides additional
liquidity. The Company has completed two asset securitization transactions to
date, the most recent of which occurred on January 30, 1998. The Company
continues to service all loans securitized, and at March 31, 1998 was servicing
$286.8 million of securitized loans. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Results of
Operations -- Comparison of Three Months Ended March 31, 1998 and 1997."

The Company's commercial mortgage loan portfolio is diversified
geographically and is secured by various properties, including hotels, motels
and resorts, office buildings, retail establishments, industrial/manufacturing
facilities and other property types. The following tables show the composition
of the Company's commercial mortgage loan portfolio (including the Company's
interest in the securitized loan pool) by property type and geographic region at
March 31, 1998.

COMMERCIAL MORTGAGE LOAN PORTFOLIO
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
PERCENT OF
PROPERTY TYPE TOTAL
- ------------------------------ ----------
<S> <C>
Office........................ 41%
Hospitality................... 28
Retail........................ 11
Recreation.................... 5
Other......................... 15
---
100%
===
</TABLE>

<TABLE>
<CAPTION>
PERCENT OF
GEOGRAPHIC REGION TOTAL
- ------------------------------ ----------
<S> <C>
Mid-Atlantic.................. 47%
West.......................... 19
Southeast..................... 14
Midwest....................... 12
Northeast..................... 8
---
100%
===
</TABLE>

7(a) LENDING

The Company participates in the SBA's 7(a) Guaranteed Loan Program through
its wholly owned subsidiary, Allied SBLC. Allied SBLC is licensed by the SBA as
a small business lending company ("SBLC"). The SBA is no longer issuing SBLC
licenses, and the Company is one of only fourteen non-bank SBLCs operating in
the United States. Under the 7(a) program, the Company makes senior secured
loans to small businesses that are partially guaranteed by the SBA. 7(a) loans
are made to small businesses for the purposes of acquiring real estate,
purchasing machinery or equipment or to provide working capital. The loans are
secured by a mortgage or other lien on the assets of the borrower and in all
cases, the owners of the business must personally guarantee the payment of
interest on and principal of the loans. The Company focuses its 7(a) loan
origination activity on loans secured by real estate assets. The 7(a) portfolio
totaled approximately $45.9 million at March 31, 1998, or 8.1% of the Company's
total investment portfolio.

For the fiscal year ending September 30, 1998, the federal government
estimates that 7(a) loan originations will approximate $10.5 billion. This large
market is served by banks, non-bank SBLCs, and certain state-sponsored non-bank
lenders. The Company believes that it competes successfully in the 7(a) loan
market because of its focus in certain regional markets and because of its
status as a "Preferred Lender" in the markets in which it competes. As an SBA
Preferred Lender, the Company is permitted to make 7(a) loans without SBA credit
approval, thus simplifying and expediting the process of loan approval

35
<PAGE> 40

and disbursements. In order to source 7(a) loan opportunities, the Company has
established relationships with certain third-party intermediaries, or "Regional
Associates," in seven markets across the nation.

The Company's 7(a) loans typically range in size from $200,000 to $1
million. Pursuant to Section 7(a) of the Small Business Act, the SBA will
guarantee 80% of any qualified loan up to $100,000 regardless of maturity, and
75% of any such loan over $100,000 regardless of maturity, to a maximum
guarantee of $750,000 for any one borrower. SBA regulations define qualified
small businesses generally as businesses with no more than $5 million in annual
sales and no more than 500 employees. Maximum loan maturities are stipulated by
the SBA as follows: loans to acquire real estate: 25 years; loans to purchase
machinery and equipment: 15 years; and loans to provide working capital: seven
years.

The Company typically prices its 7(a) loans with interest at a variable
rate, typically 1.75% to 2.75% per annum above the prime rate, adjusted monthly.
The Company's lower cost of capital affords the Company the opportunity to
concentrate its 7(a) loan origination activity in a more competitive pricing
range, and the Company believes that this pricing strategy will increase both
the volume of its loan origination activity as well as the credit quality of its
borrowers.

The Company routinely sells the guaranteed portion of its 7(a) loans in the
well-established secondary market. The Company earns premium income from the
cash gain it receives from the sale of the guaranteed portion of the Company's
7(a) loans, less the costs associated with originating the loans sold.
Typically, the Company receives cash premiums on loan sales, net of origination
costs, ranging from 4% to 6% of the face amount of each loan sold. This premium
income enhances the return on the Company's 25% retained investment in the loan,
and the Company's retained portion is not subordinate to the guaranteed portion
sold. The Company continues to service 100% of its loans sold. The Company
receives excess interest on the loans sold. The value of such additional
interest is recorded as an excess servicing asset. At March 31, 1998, the
Company was servicing 7(a) loans sold totaling $133.4 million.

The Company also provides companion or "piggyback" loans in conjunction
with traditional 7(a) loans (i.e., the 7(a) Companion Loans). For this type of
financing, the Company provides an unguaranteed first mortgage loan for up to
60% of the real estate value and a second mortgage loan through the 7(a) program
with a 75% SBA guarantee. The total of the two loans is generally 80% or less of
the appraised value of the real estate. From time to time, the Company may
partner with local banks by providing second mortgage loans that are partially
guaranteed by the SBA in conjunction with the banks' conventional first mortgage
loans to qualifying small businesses. The 7(a) Companion Loans are included in
the Company's commercial real estate finance portfolio. The Company also
participates in the SBA Section 504 Loan Program; these loans also are included
in the Company's commercial real estate finance portfolio.

The Company has in its 7(a) portfolio loans to, among others, hotels and
motels, automotive shops and gas stations, restaurants, manufacturers,
broadcasting and communications companies, service providers, retail shops, and
other small businesses. The following tables shows the Company's 7(a) loan
portfolio by industry and geographic region at March 31, 1998:

7(a) LOAN PORTFOLIO
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
PERCENT OF
INDUSTRY TOTAL
- ------------------------------ ----------
<S> <C>
Hospitality................... 32%
Automotive Services........... 23
Restaurant/Food Services...... 8
Industrial/Manufacturing...... 8
Broadcasting/Communications... 6
Services...................... 4
Retail/Wholesale.............. 3
Other......................... 16
---
100%
===
</TABLE>

<TABLE>
<CAPTION>
PERCENT OF
GEOGRAPHIC REGION TOTAL
- ------------------------------ ----------
<S> <C>
Midwest....................... 40%
Mid-Atlantic.................. 31
Southeast..................... 14
Northeast..................... 8
West.......................... 7
---
100%
===
</TABLE>

36
<PAGE> 41

INVESTMENT ADVISORY SERVICES

The Company is registered under the Investment Advisers Act of 1940, as
amended, and provides investment advisory and related services to private
investment funds that are primarily owned by large institutional investors or
other accredited investors. These funds primarily focus on investing in small
growing entrepreneurial companies through senior or subordinated debt, a
combination of debt and equity investments, or commercial mortgage loans
collateralized by real estate. As the investment adviser to private funds, the
Company is responsible for sourcing, originating, monitoring, servicing and
liquidating investments in their portfolios. The Company generally is
compensated for its services in the form of asset-based or commitment-based
fees, and performance incentive fees. The Company is able to participate as a
co-investor in, as well as a manager to, private funds, which the Company
believes provides an advantage in competing for future advisory contracts. The
Company will selectively consider new investment advisory opportunities.

Currently, the Company acts as an investment adviser to four private funds.
Three of these funds are in the process of liquidation pursuant to the terms of
their formation, and the fourth is a new investment fund targeting investments
in Germany. In January 1998, the Company entered into an investment advisory
agreement with Kreditanstalt fur Wiederaufbau (KfW), the state-owned public
development bank of Germany, to manage a fund with committed capital of DM 160
million (approximately $87 million at March 31, 1998). For its services related
to sourcing, structuring, investing, monitoring and disposing of its investments
in small, German businesses, the Company will receive a 3% per annum fee on
total committed capital, payable quarterly, and will share in the investment
returns of the fund. The Company will also co-invest with the fund for an
aggregate co-investment commitment of DM 40 million (approximately $22 million
at March 31, 1998).

OTHER INVESTMENTS

At March 31, 1998, the Company had $56.1 million in cash and government
securities. The Company temporarily invests 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 repurchase
agreements fully collateralized by such securities. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" as well as the
Company's Consolidated Financial Statements.

MARKETING

The Company believes that its experience and reputation provide a
competitive advantage in originating new investment opportunities. The Company
has established an extensive network of investment referral relationships over
its 40-year history. The Company is recognized as a pioneer in the mezzanine
finance industry, and has developed a reputation in the commercial real estate
finance market for its ability to finance complex transactions.

During the past twelve months, the Company has increased the scope of its
sales and marketing activity by opening regional offices in Chicago and San
Francisco and by staffing a full-time sales and marketing function with seven
individuals to identify and pursue mezzanine investments, commercial mortgage
loans, and 7(a) loans. The Company maintains relationships with regional and
boutique investment banks, mezzanine and venture capital investors, and other
intermediaries, including business and mortgage brokers, banks, law firms and
accountants for loan referrals.

In addition to the Company's principal marketing channels, the Company has
developed an additional channel for its 7(a) lending operations through its
Regional Associates, who refer to the Company potential loans to small
businesses located in designated areas. If and when a loan referred by a
Regional Associate is closed, the Regional Associate is compensated by an
origination fee calculated using a formula agreed upon by the Company and the
Regional Associate. The origination fees currently paid by the Company to
Regional Associates range from 0.5% to 5.0% of the principal amount of each loan
made that was referred by the respective Regional Associate. The Regional
Associates from time to time may assist the Company in monitoring any loans
referred by them or otherwise made in their designated areas. At March 31, 1998,
the Company had eleven Regional Associates located throughout the United States.

37
<PAGE> 42

UNDERWRITING GUIDELINES AND PROCEDURES

In assessing new investment opportunities, the Company maintains a rigorous
credit policy which is based upon the underwriting guidelines described below, a
thorough due diligence process, and a credit approval policy requiring committee
review. All credit approval is obtained through the Company's investment
committee, and no one individual has the ability to approve an investment. The
Company's underwriting process is performed by an experienced staff of
professionals and is centralized at the Company's headquarters in Washington,
D.C. The Company believes that these procedures have enabled the Company
historically to maintain a high level of asset quality in its portfolio.

UNDERWRITING GUIDELINES

The Company has developed certain general criteria that serve as important
guidelines when assessing the attractiveness of new investment opportunities.
The emphasis placed on each criteria is dictated by the type of investment the
Company is considering and the terms of that investment.

Sound capital structure. The Company scrutinizes the capital structure of
its potential borrowers to assure that there is sufficient equity capital to
support its loans and to assure that the enterprise value of the borrower is
reasonable given the amount of the financing the Company intends to provide. In
the case of loans secured by real estate, the Company also seeks to have a
sufficient loan to collateral value based upon ACC internal valuations and the
appraisals received by ACC-approved appraisal firms.

Seasoned management team. The Company focuses on the experience and depth
of the borrower's management team. The Company seeks to determine that
management has demonstrated the ability to successfully operate its business
through changes in economic cycles, and has the requisite experience to execute
the borrower's business plan. The Company also looks for management that has
sufficient depth of talent. Another important aspect of the Company's evaluation
is the level of management ownership and the risk assumed by management relative
to the success of the growing business.

Solid market position and sufficient operating margins. The Company seeks
businesses that have a proven business model, and have historical operating
margins sufficient to sustain an adequate level of cash flow. The Company
typically does not lend to companies that have experimental products or are in
the early stages of their development. The Company looks for borrowers that have
defined their market niche and have established their presence in that niche.

Strong cash flow for debt service. The Company analyzes the historical
financial performance of the business with particular emphasis placed on a track
record of profitability and positive cash flow. Additionally, the Company
reviews whether the business has historically achieved the financial performance
targets set by its management.

UNDERWRITING PROCEDURES

Due Diligence. During the underwriting process, the Company conducts a
rigorous due diligence process to evaluate investment opportunities. Due
diligence focuses on four primary areas including: business due diligence;
management due diligence; financial due diligence; and collateral due diligence.
In the business due diligence process, the Company's investment professionals
challenge the borrower's business plan, assess the borrower's competitive
position, and assess the ability of the borrower to weather economic cycles. The
Company also assesses the borrower's preparation for the Year 2000. Management
due diligence includes a variety of reference checks including personal and
professional references, discussions with vendors, suppliers, customers, and
competitors, and references from employees. In the financial due diligence
process, the investment professional analyzes historical and projected financial
information and stress-tests financial information given certain adverse
assumptions. For secured loans, the Company's collateral due diligence includes
analysis of third party appraisals, environmental reports, structural and
engineering reports, when necessary, and personal inspection of collateral
properties. In addition, each investment professional is required to value
collateral independently of appraised values.

38
<PAGE> 43

Investment Committee. Upon the completion of due diligence, each
transaction is presented to the investment committee, which is comprised of nine
of the Company's most senior investment professionals. All of the Company's
lending disciplines are represented on the investment committee, and the
individuals that comprise the investment committee currently have an average of
17 years of experience. The Company benefits not only from the experience of its
investment committee members, but also from the experience of its senior
investment professionals who, on average, have over 13 years of professional
experience. In certain instances where risk/return characteristics warrant, the
Executive Committee of the board of directors will also be required to approve
investment transactions.

PORTFOLIO MONITORING

The Company services all of its loans and believes that its portfolio
monitoring and internal servicing procedures are essential to maintaining high
asset quality and low loan loss rate.

Loan Servicing. The Company maintains a staff responsible for routine loan
servicing including payment processing, borrower inquiries, escrow analysis and
processing, third-party reporting, financial statement processing and insurance
and tax administration. In addition, the Company maintains a staff responsible
for special servicing activities including delinquency monitoring and
collection, workout administration, and management of foreclosed assets.

Portfolio monitoring and valuation. In addition to routine and special
servicing activity, the Company monitors the portfolio through a grading system,
and investment professionals are required to value their loans and investments
on a quarterly basis. The grading system varies slightly for mezzanine and real
estate loans, but generally the two systems rank loans on a scale of one to
five, with one representing the highest quality assets, and five representing
assets that have been determined to be impaired, require special servicing, and
may require a valuation adjustment. The grades of two, three and four
essentially represent varying degrees of risk associated with the asset and are
not representative of any current credit problem. The Company does not employ
any such grading system for its 7(a) loan portfolio, and monitors the portfolio
through review of delinquency statistics and assessment of collateral value. At
March 31, 1998, $14.7 million, or 2.8%, of the Company's total loan portfolio
was classified as grade five.

The Company values its portfolio on a quarterly basis, and valuations are
reviewed and approved by the Company's board of directors. Investment
professionals are required to review their individual portfolios and consider
the financial performance of their borrowers, loan payment histories,
indications of potential equity realization events and current collateral
values, and determine whether the value of an asset should be increased by
unrealized appreciation or decreased through unrealized depreciation. As a
general rule, the Company does not value its loans above cost, but loans are
subject to depreciation events when the asset is considered impaired. Also, as a
general rule, equity securities may be assigned appreciation if there has been
some determinable event to indicate that an increase in value is warranted.
After the investment professional has made his or her determination, the
valuation is reviewed by members of senior management for approval, and then
presented to the board of directors for their review and approval. At March 31,
1998 the Company had recorded an aggregate of $23.1 million in unrealized
depreciation on its loans and investments, and an aggregate of $25.1 million in
unrealized appreciation on its portfolio, for a net unrealized appreciation of
$2.0 million, or 0.4% of the Company's total portfolio at value.

Delinquencies. The Company monitors loan delinquencies through weekly
review of the Company's delinquency reports. Loans that are 30 days delinquent
are monitored and contacted for collection by the Company's loan servicing
staff. Loans that are 60 days delinquent are generally transferred to investment
professionals responsible for special servicing activity for monitoring and
collection activity. Loans over 90 days delinquent are reviewed by the Company's
accounting department in conjunction with the investment professional
responsible for special servicing to determine whether the loan should be placed
on a non-accrual status or whether a valuation adjustment is required.
Generally, loans over 120 days delinquent are placed on a non-accrual status and
the Company actively monitors each individual delinquent borrower to determine
the appropriate course of action.

39
<PAGE> 44

At March 31, 1998, the Company's portfolio of delinquent assets greater
than 120 days past due totaled $13.7 million at value, or approximately 2.4% of
the total investment portfolio. Loans not accruing interest at value totaled
$18.7 million or 3.3% of the total investment portfolio at March 31, 1998. The
Company has a history of low levels of loan losses and has a demonstrated track
record of successfully resolving troubled credit situations with minimal loss.
Information concerning losses in the Company's portfolio is set forth below:

<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
-------------------- --------------------------------------------------------------------
1998 1997 1997 1996(1) 1995 1994 1993
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Realized losses...... $ -- $ 829 $ 5,100 $ 11,262 $ 4,679 $ 2,908 $ 3,719
Total assets......... 652,710 759,081 807,775 713,360 605,434 501,817 435,268
Realized losses/
total assets....... -- -- 0.6% 1.6% 0.8% 0.6% 0.9%
</TABLE>

- ---------------

(1) See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" for a discussion of the realized losses experienced in 1996.

COMPETITION

A large number of entities and individuals compete for the opportunity to
make investments similar to those made by the Company. Many of these entities
and individuals have greater financial resources than the Company. As a result
of this competition, the Company may from time to time be precluded from making
otherwise attractive loans and investments on terms considered to be prudent in
light of the risks to be assumed. In the market for providing mezzanine
financing, ACC competes against a broad array of financial institutions
including commercial banks, insurance companies, specialized mezzanine and
private equity funds, and investment banks. The commercial real estate financing
market is also competitive and includes commercial banks, niche funds and
investment banks, real estate conduits, equity and mortgage REITs and other
non-bank lenders. Competitors in the SBA 7(a) lending market include commercial
banks and other SBLCs.

EMPLOYEES

At March 31, 1998, the Company and its subsidiaries employed 90 persons. Of
that total, 43 were employed as investment personnel and 47 were in the areas of
loan servicing, finance, accounting, MIS, human resources and corporate
administration. The Company believes that its relations with its employees are
excellent.

LEGAL PROCEEDINGS

The Company is party to certain lawsuits in connection with its business.
While the outcome of these legal proceedings cannot at this time be predicted
with certainty, management does not expect that these actions will have a
material effect upon the Company's financial condition or results of operations.

PORTFOLIO COMPANIES

The following table sets forth certain information at March 31, 1998,
regarding each portfolio company in which the Company has an equity investment.
The Company makes available significant managerial assistance to its portfolio
companies. See "Certain Government Regulations." Other than loans to the
portfolio company, the only relationship between each portfolio company and the
Company is the Company's investment. For information relating to the amount and
general terms of all loans to portfolio companies, see the Company's
Consolidated Statement of Investments at March 31, 1998 at pages F-5 to F-10
herein.

40
<PAGE> 45

<TABLE>
<CAPTION>
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES PERCENTAGE OF
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY CLASS HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Acme Paging, L.P. .............. Paging Services Partnership Interests 1.8%
1336 Basswood, Suite F
Schaumburg, IL 60173

AGPAL Broadcasting, Inc. ....... Radio Stations Warrants to Purchase 5.0%
1000 S.W. 6th Street Common Stock
Pendleton, OR 97801

American Barbecue & Grill, Inc. Restaurant Chain 17.3%
7300 W. 110th Street, Suite 570 Warrants to Purchase
Overland Park, KS 66210 Common Stock

ARS, Inc. ...................... Automotive Parts Warrants to Purchase 3.0%
2775 Broadway Manufacturing Common Stock
Buffalo, NY 14227

ASW Holding Corporation......... Steel Wool Manufacturer Warrants to Purchase 5.0%
2825 W. 31st Street Common Stock
Chicago, IL 60623

Au Bon Pain Co., Inc. .......... Restaurant Chain Warrants to Purchase 1.7%
19 Fid Kennedy Avenue Common Stock
Boston, MA 02210

Brazos Sportswear, Inc. ........ Sportswear Manufacturer Common Stock 8.1%
3860 Virginia Avenue & Distribution
Cincinnati, OH 45227

Calendar Broadcasting, Inc. .... Radio Stations Warrants to Purchase 15.0%
One Independence Plaza Common Stock
Middletown, NJ 07701

Candlewood Hotel Company........ Extended Stay Series A Convertible 5.0%
9342 East Central Facilities Preferred Stock
Wichita, KS 67206

Celebrities, Inc. .............. Radio Stations Warrants to Purchase 25.0%
408-412 W. Oakland Park Common Stock
Boulevard
Ft. Lauderdale, FL 33311-1712

CeraTech Holdings Corporation... Ceramic Plate Warrants to Purchase 33.7%
10435 Seymour Avenue Manufacturer Common Stock
Franklin Park, IL 60131

Cherry Tree Toys, Inc. ......... Direct Marketer of Common Stock 19.8%
7601 France Avenue South, #225 Woodcrafts
Edina, MN 55435

Convenience Corporation of
America....................... Convenience Store Chain Series A Preferred Stock 8.0%
711 N. 108th Court
Omaha, NE 68154 Warrants to Purchase 4.5%
Common Stock

Cooper Natural Resources, Inc. . Sodium Sulfate Producer 17.5%
P.O. Box 1477 Warrants to Purchase
Seagraves, TX 79360 Common Stock
</TABLE>

41
<PAGE> 46

<TABLE>
<CAPTION>
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES PERCENTAGE OF
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY CLASS HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Cosmetic Group USA, LLC......... Cosmetic Manufacturer Options to Purchase 10.0%
11312 Penrose Street Shares
Sun Valley, CA 91352

Csabai Canning Factory Rt. ..... Food Processing Hungarian Quotas 9.2%
5600 Bekescasba
Bekis: vt 52-54 Hungary

DEH Printed Circuits, Inc. ..... Circuit Board Warrants to Purchase 12.5%
840 Church Road Manufacturer Common Stock
Elgin, IL 60123

DeVlieg-Bullard, Inc. .......... Tool Manufacturer Warrants to Purchase 1.7%
One Gorham Island Common Stock
Westport, CT 06680

Directory Investment Corporation Telephone Directories Common Stock 50.0%
1666 K Street, NW 9th floor
Washington, DC 20006

Directory Lending Corporation... Telephone Directories Common Stock 50.0%
1666 K Street, NW 9th floor Preferred Stock 50.0%
Washington, DC 20006

DMI Furniture, Inc. ............ Furniture Manufacturer Convertible Preferred
101 Bullitt Lane Stock Stock 10.8%
Louisville, KY 40222

EDM Consulting, LLC............. Environmental Equity Interest 25.0%
14 Macopin Avenue Consulting
Montclair, NJ 07043

El Dorado Communications, Inc. . Radio Stations Warrants to Purchase 4.7%
2130 Sawatelle Boulevard
Suite 307
Los Angeles, CA 90025

Esquire Communications Ltd. .... Court Reporting Warrants to Purchase 11.1%
216 E. 45th Street, 8th floor Services Common Stock
New York, NY 10017

Fairchild Industrial Products
Company....................... Industrial Controls Warrants to Purchase 21.5%
3920 Westpoint Boulevard Manufacturer Common Stock
Winston-Salem, NC 27013

Gibson Guitar Corp. ............ Guitar Manufacturer Warrants to Purchase 3.0%
1818 Elm Hill Pike Common Stock
Nashville, TN 37210

Ginsey Industries, Inc. ........ Toilet Seat Convertible Debentures 7.0%
281 Benigno Boulevard Manufacturer Warrants to Purchase 16.0%
Bellmawr, NJ 08031 Common Stock

Golden Eagle/Satellite
Archery, LLC.................. Sporting Equipment Convertible Debentures 40.0%
1733 Gunn Highway Manufacturer
Odessa, FL 33556
</TABLE>

42
<PAGE> 47

<TABLE>
<CAPTION>
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES PERCENTAGE OF
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY CLASS HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Grant Broadcasting System II.... Television Stations Warrants to Purchase 40.0%
919 Middle River Drive, Common Stock
Suite 409 Warrants to Purchase 40.0%
Ft. Lauderdale, FL 33304 Common Stock in
Affiliate Company

Grant Television, Inc. ......... Television Stations Warrants to Purchase 20.0%
(See Grant Broadcasting System II) Common Stock

Herr-Voss Industries, Inc. ..... Machinery Manufacturer Common Stock 8.5%
Arch Street Extension
Carnegie, PA 15106

IndeNet Corporation............. Broadcasting Software Warrants to Purchase 2.1%
5475 Tech Enter Drive, Suite 300 Common Stock
Colorado Springs, CO 80919

JRI Industries, Inc. ........... Machinery Manufacturer Warrants to Purchase 7.5%
2958 East Division Common Stock
Springfield, MO 65803

Julius Koch USA, Inc. .......... Cord Manufacturer Warrants to Purchase 45.0%
387 Church Street Common Stock
New Bedford, MA 02745

Kirker Enterprises, Inc. ....... Nail Enamel Warrants to Purchase 22.5%
One East 11th Street Manufacturer Common Stock
Paterson, NJ 07524 Equity Interest in 22.5%
Affiliate Company

Kirkland's, Inc. ............... Home Furnishing Warrants to Purchase 3.2%
P.O. Box 7222 Retailer Common Stock
Jackson, TN 38308-7222

Liberty-Pittsburgh Systems, Inc. Business Forms Printing Common Stock 20.0%
265 Executive Drive
Plainview, NY 11803

Love Funding Corporation........ Mortgage Services Series D Preferred Stock 60.0%
1220 19th Street, NW, Suite 801
Washington, DC 20036

MidSouth Data Systems, Inc. .... Value-Added Reseller, Warrants to Purchase 8.0%
25 Westridge Market Place Computer Systems Common Stock
Chandler, NC 28715

Midview Associates, L.P. ....... Residential Land Options to purchase 35.0%
2 Eaton Street, Suite 1101 Development partnership interests
Hampton, VA 23669

Mill-It Striping, Inc. ......... Highway Paint Striping Common Stock 8.0%
1005 Sunshine Lane
Altamonte Springs, FL 32714

MLX/SinterMet Corp. ............ Friction Materials Common Stock 0.2%
5305 Oakbrook Parkway Manufacturer
Norcross, GA 30093

Monitoring Solutions, Inc. ..... Air Emissions Common Stock 25.0%
4303 South High School Road Monitoring Warrants to Purchase 40.0%
Indianapolis, IN 46241 Common Stock
</TABLE>

43
<PAGE> 48

<TABLE>
<CAPTION>
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES PERCENTAGE OF
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY CLASS HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Nobel Education Dynamics, Inc. . Educational Services Series D Convertible 100.0%
1400 N. Providence Road, Preferred Stock
Suite 3055 Warrants to Purchase 5.1%
Media, PA 19063 Common Stock

Nursefinders, Inc. ............. Home Healthcare Warrants to Purchase 2.4%
1200 Copeland Road, Suite 200 Providers Common Stock
Arlington, TX 76011

Old Mill Holdings, Inc.......... Custom Embroidered Warrants to Purchase 30.0%
410 Severn Avenue, Suite 311 Apparel Manufacturer Common Stock
Annapolis, MD 21403

Peerless Group, Inc. ........... Commercial Banking Common Stock 7.7%
1212 Arapaho Road Software Development Warrants to Purchase 3.6%
Richardson, TX 75081 Common Stock

PIATL Holdings Inc. ............ Asbestos Testing Labs Preferred Stock 35.5%
16000 Horizon Way, Suite 100 Common Stock 28.0%
Mt. Laurel, NJ 08054

Pico Products, Inc. ............ Satellite/Television Common Stock 5.9%
12500 Foothill Boulevard Component Warrants to Purchase 28.1%
Lakeview Terr., CA 91342 Manufacturer Common Stock

Quality Software Product
Holdings, PLC................. Accounting Software Common Stock 0.7%
Talipot House 5th Avenue Developer
Gateshead Tyne & Wear, NE110XA
UNITED KINGDOM

Radio One of Atlanta, Inc. ..... Radio Stations Common Stock 14.3%
5900 Princess Garden Parkway
Lanham, MD 20706

R-Tex Decoratives Company, Inc. . Decorative Ribbon Warrants to Purchase 40.0%
5691 Rising Sun Avenue Manufacturer
Philadelphia, PA 19120

Spa Lending Corporation......... Health Spas Series A Preferred Stock 100.0%
1666 K Street, 9th floor Series B Preferred Stock 68.4%
Washington, DC 20006 Series C Preferred Stock 46.3%
Common Stock 62.1%

Total Foam, Inc. ............... Packaging Systems Common Stock 49.0%
P.O. Box 688
Ridgefield, CT 06877

Waterview Limited Partnership... Multi-tenant Office Option to Purchase 36.0%
1250 Connecticut Avenue, Building Partnership Interests
5th floor
Washington, DC 20036

West Virginia Radio Corporation of
Clarksburg, Inc. ............. Radio Stations Warrants to Purchase 20.0%
1251 Earlk L Core Road Common Stock
Morgantown, WV 26505
</TABLE>

44
<PAGE> 49

<TABLE>
<CAPTION>
NAME AND ADDRESS NATURE OF ITS TITLE OF SECURITIES PERCENTAGE OF
OF PORTFOLIO COMPANY PRINCIPAL BUSINESS HELD BY THE COMPANY CLASS HELD(1)
-------------------- ------------------ ------------------- -------------
<S> <C> <C> <C>
Williams Brothers Lumber
Company....................... Builders' Supplies Warrants to Purchase 49.0%
3165 Pleasant Hill Road Common Stock
Duluth, GA 30136

Z-Spanish Radio Network, Inc. . Radio Stations Warrants to Purchase 4.1%
1436 Auburn Boulevard Common Stock
Sacramento, CA 95814
</TABLE>

- ---------------
(1) Percentages shown for warrants and options held by the Company represent the
percentage of class of security to be owned, on a fully diluted basis, upon
exercise of the warrants or options.

DETERMINATION OF NET ASSET VALUE

The net asset value per share of Common Stock is determined quarterly, as
soon as practicable after and as of the quarter end, and is equal to the value
of total assets minus liabilities divided by the total number of shares
outstanding on the date as of which the determination is made.

In calculating the value of the Company's total assets, securities that are
traded in the over-the-counter market or on a stock exchange are valued at the
current market price. Securities in public companies that carry certain
restrictions on sale are typically valued by the board of directors at a
discount from the market value of the security. Other publicly traded securities
may also be valued at a discount due to the investment size or market liquidity
concerns. All other investments are valued at fair value as determined in good
faith by the board of directors. In making such determination, the board of
directors will value loans and non-convertible debt securities for which there
exists no public trading market at cost plus amortized original issue discount,
if any, unless adverse factors lead to a determination of a lesser value, at
which time unrealized depreciation would be recognized. Convertible debt
securities and warrants are valued to reflect the value of the underlying equity
security less the conversion or exercise price. In valuing equity securities for
which there exists no public trading market, investment cost is presumed to
represent fair value except where the board of directors may determine fair
value on the basis of other factors including financings by unaffiliated
investors, recent offers to purchase the portfolio company's securities, or
other pertinent factors.

A substantial portion of the Company's assets will consist of securities
carried at fair values determined by its board of directors. Determination of
fair value involves subjective judgments not susceptible to substantiation by
auditing procedures. Accordingly, under current standards, the accountants'
opinion on the Company's financial statements in its annual report refers to the
uncertainty with respect to the possible effect on the financial statements of
such valuation.

MANAGEMENT

The business of the Company is managed under the supervision of its board
of directors. The responsibilities of each director includes, among other
things, the oversight of the loan approval process, the quarterly valuation of
ACC's assets, and oversight of ACC's financing arrangements. The board of
directors maintains an Executive Committee, Audit Committee, Compensation
Committee, and Nominating Committee, and may establish additional committees in
the future. Certain of the Company's directors also serve as directors of the
Company's subsidiaries.

The Company's investment decisions are made by an investment committee
comprised of investment professionals representing the most senior investment
professionals currently employed by the Company. No one person is primarily
responsible for making recommendations to the investment committee.

The Company is internally managed and employs investment professionals to
manage its portfolio and the portfolios of companies for which the Company
serves as investment adviser. These investment professionals have extensive
experience in managing investments in private growing businesses in a variety of
industries and

45
<PAGE> 50

in diverse geographic locations, and are familiar with the Company's approach of
lending and investing. Because investment management services are provided
internally by employees of ACC, rather than through a contract with an outside
adviser, ACC pays no investment advisory fees, but pays the operating costs
associated with employing investment management professionals.

STRUCTURE OF BOARD OF DIRECTORS

At the March 3, 1998 meeting of the board of directors, the directors voted
to amend the Company's bylaws to set the maximum number of directors at fifteen
and to decrease the size of the board from twenty-two to twelve directors
effective at the Annual Meeting of Shareholders held on May 14, 1998 (the
"Meeting"). In connection with the Merger, the bylaws of the Company were
amended to provide that, effective at the Meeting, directors of the Company were
classified into three approximately equal classes, with each class being elected
initially for one, two or three-year terms, with the terms of office of only one
of the three classes expiring each year. At the Meeting, Class I Directors were
elected for one-year terms, Class II Directors were elected for two-year terms
and Class III Directors were elected for full three-year terms. Thereafter,
Class I Directors will be elected for full three-year terms commencing with the
1999 annual meeting of shareholders and Class II Directors will be elected for
full three-year terms commencing with the 2000 annual meeting of shareholders.
Directors serve until their successors are elected and qualified.

DIRECTORS

The following table sets forth certain information regarding the board of
directors.

<TABLE>
<CAPTION>
NAME AGE POSITION DIRECTOR SINCE(1) TERM
- ---- --- -------- ----------------- ----
<S> <C> <C> <C> <C>
William L. Walton*.................... 48 Chairman, Chief Executive
Officer and President 1986 2001
George C. Williams, Jr.*.............. 72 Chairman Emeritus 1964 2001
Brooks H. Browne...................... 48 Director 1990 2001
John D. Firestone..................... 54 Director 1993 1999
Anthony T. Garcia..................... 41 Director 1991 1999
Lawrence I. Hebert.................... 51 Director 1989 1999
John I. Leahy......................... 67 Director 1994 2000
Robert E. Long........................ 66 Director 1972 2001
Warren K. Montouri.................... 68 Director 1986 2000
Laura W. Van Roijen................... 45 Director 1992 1999
Guy T. Steuart II..................... 66 Director 1984 2000
T. Murray Toomey, Esq................. 74 Director 1959 2000
</TABLE>

- ---------------

* Interested persons of the Company, as defined in the 1940 Act.

(1) Includes service as a director of any of the Predecessor Companies.

EXECUTIVE OFFICERS

The following table sets forth certain information regarding executive
officers of the Company.

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
William L. Walton........................... 48 Chairman, Chief Executive Officer and President
Joan M. Sweeney............................. 38 Managing Director
G. Cabell Williams, III .................... 43 Managing Director
John M. Scheurer............................ 45 Managing Director
Jon A. DeLuca............................... 35 Principal and Chief Financial Officer
</TABLE>

46
<PAGE> 51

BIOGRAPHICAL INFORMATION

DIRECTORS

William L. Walton has been the Chairman, Chief Executive Officer and
President of the Company since 1997. Mr. Walton was President of Allied II from
1996 to 1997. Mr. Walton is the Chairman of BMI. Mr. Walton was Chief Executive
Officer of Success Lab, Inc. (children's educational services) from 1993 to
1996, and Chief Executive Officer of Language Odyssey (educational publishing
and services) from 1992 to 1996. Mr. Walton was Managing Director of Butler
Capital Corporation from 1987 to 1991. Mr. Walton is an interested person of the
Company, as defined in the 1940 Act, due to his position as an officer of the
Company.

George C. Williams, Jr. is Chairman Emeritus of the Company. Mr. Williams
was an officer of the Predecessor Companies from the later of 1959 or the
inception of the relevant entity and President or Chairman and Chief Executive
Officer of the Predecessor Companies from the later of 1964 or each entities'
inception until 1991. Mr. Williams is a director of BMI. Mr. Williams is an
interested person of the Company, as defined in the 1940 Act, due to his
position as an officer of the Company.

Brooks H. Browne has been the President of Environmental Enterprises
Assistance Fund since 1993. Mr. Browne was the President, Executive Vice
President or Senior Vice President of Advisers from 1984 to 1993. Mr. Browne is
a director of SEAF, International Fund for Renewable Energy and Energy
Efficiency, Corporation Financiera Ambiental (Panama), Empresas Ambientales de
Centro America (Costa Rica) and Yayasan Bina Usaha Lingkungan (Indonesia)
(environmental nonprofit or investment funds).

John D. Firestone has been a Partner of Secor Group (venture capital) since
1978. Mr. Firestone is a director of BMI and Security Storage Company of
Washington, D.C., and is a senior advisor to Gilbert Capital, Inc. Mr. Firestone
was the Chairman of Secor Investments, Inc. from 1980 to 1993, and a director of
Palmer National Bank from 1988 to 1994.

Anthony T. Garcia has been General Manager of Breen Capital Group (investor
in tax liens) since 1997. Mr. Garcia was a Senior Vice President of Lehman
Brothers Inc. from 1985 to 1996.

Lawrence I. Hebert has been a director and the President of Perpetual
Corporation (a holding and management company) since 1981. Mr. Hebert has been
Vice Chairman (since 1983) and President (since 1984) of Allbritton
Communications Company, and the President of Westfield News Advertiser, Inc.
since 1988. Mr. Hebert was Vice Chairman (from 1990 to 1993) of Riggs National
Corporation and has been a director of Riggs National Corporation (since 1988).
Mr. Hebert was a Vice President of University Bancshares, Inc. from 1975 to
1997. He has also been a director of Riggs Bank Europe, Ltd., formerly Riggs AP
Bank, Ltd. since 1986, and Riggs Investment Management Corporation (RIMCO) since
1990, and a trustee of the Allbritton Foundation.

John I. Leahy has been the President of Management and Marketing Associates
(a management consulting firm) since 1986. Mr. Leahy is also the President and
Group Executive Officer, Western Hemisphere of Black & Decker Corporation. Mr.
Leahy is a director of Kar Kraft Systems, Inc., Cavanaugh Capital, Inc., Acorn
Products, Inc., The Wills Group, Thulman-Eastern Company and Gallagher Fluid
Seals, Inc.

Robert E. Long is the Managing Director of Goodwyn & Long Investment
Management, Inc. Mr. Long has been the President and Chief Executive Officer of
Business News Network, Inc. since 1995, was 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 Inc., AHL Shipping Company, Inc., CSC
Scientific, Inc., and Global Travel, Inc.

Warren K. Montouri has been a Partner of Montouri & Roberson (real estate
investment firm) since 1980. Mr. Montouri was a director of C&S/Sovran Bank from
1970 to 1990, a director of Sovran Financial Corporation from 1989 to 1990, a
director of NationsBank, N.A. from 1990 to 1996, a trustee of Suburban Hospital
from 1991 to 1994, and a trustee of The Audubon Naturalist Society from 1979 to
1985. He has been a director of Franklin National Bank since 1996.

47
<PAGE> 52

Laura W. van Roijen has been a private real estate investor since 1992. Ms.
van Roijen was the Chairman of CWV & Associates (RTC qualified contracting firm)
from 1991 to 1994, a director and the Treasurer of Black Possum Inc. (retail
concern) from 1994 to 1996, the President of Volta Place, Inc. (real estate
advisory firm) from 1991 to 1994, and Vice President (from 1986 to 1991) and
Market Director (from 1989 to 1991) of Citicorp Real Estate, Inc.

Guy T. Steuart II has been a director and President of Steuart Investment
Company (manages, operates, and leases real and personal property and holds
stock in operating subsidiaries engaged in various businesses) since 1960. Mr.
Steuart is Trustee Emeritus of Washington and Lee University.

T. Murray Toomey, Esq. has been an attorney at law since 1949. Mr. Toomey
is a director of The National Capital Bank of Washington, Federal Center Plaza
Corporation, and The Donohoe Companies, Inc., and a trustee of The Catholic
University of America.

EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

Joan M. Sweeney has been employed by the Company since 1993. Ms. Sweeney is
also a Managing Director of BMI. Ms. Sweeney was a Senior Manager at Ernst &
Young from 1990 to 1993.

G. Cabell Williams, III has been employed by the Company since 1981. Mr.
Williams is also a Managing Director of BMI.

John M. Scheurer has been employed by the Company since 1991. Mr. Scheurer
is also President of BMI.

Jon A. DeLuca has been employed by the Company since 1994. Mr. DeLuca is
Principal and Chief Financial Officer of BMI. Mr. DeLuca was a Manager at
Coopers & Lybrand from 1986 to 1994.

COMPENSATION PLANS

STOCK OPTION PLAN

The Company (with the approval of its shareholders and independent
directors) established the Stock Option Plan (the "New Plan"), which is intended
to encourage stock ownership in the Company by officers, thus giving them a
proprietary interest in the Company's performance. The New Plan was approved by
shareholders at the Special Meeting of Shareholders of Allied Lending held on
November 26, 1997. The principal objective of the Company's Compensation
Committee in awarding stock options to the Chief Executive Officer and other
eligible officers of the Company is to align each officer's interests with the
success of the Company and the financial interests of its shareholders by
linking a portion of such executive's compensation with the performance of the
Company's stock and the value delivered to shareholders. Stock options are
granted under the New Plan at a price not less than the prevailing market value
and will have value only if the Company's stock price increases. The committee
determines the amount and features of the stock options, if any, to be awarded
to the Company's officers. Historically, when granting stock options, the
committee evaluated a number of criteria, including the recipient's current
stock holdings, years of service, position with the Company, and other factors;
the committee has not applied a formula assigning specific weights to any of
these factors when making its determination. In January 1998, officers were
granted a total of 3,415,446 options to purchase shares of Common Stock under
the New Plan, which generally vest over a five-year period. See "Control Persons
and Principal Holders of Securities" in the SAI for currently exercisable
options granted to certain executive officers.

The New Plan is designed to satisfy the conditions of Section 422 of the
Code so that options granted thereunder may qualify as "incentive stock
options." To qualify as "incentive stock options," options may not become
exercisable for the first time in any year to the extent that the number of
incentive options first exercisable in that year multiplied by the exercise
price exceeds $100,000.

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CUT-OFF AWARD AND FORMULA AWARD

Prior to the Merger, each of the five Predecessor Companies had a stock
option plan (each, an "Old Plan" and collectively, the "Old Plans"). Options
under the Old Plans had been granted to various employees of Advisers, who were
also officers of the Predecessor Companies. In preparation for the Merger, the
Compensation Committee of Advisers, in conjunction with the Compensation
Committees of the other Predecessor Companies, determined that the five Old
Plans should be terminated upon the Merger, so that the new merged Company would
be able to develop a new plan that would incent all officers and directors with
a single equity security. The existence of the Old Plans had resulted in certain
inequities in option grants among the various officers of the Predecessor
Companies simply because of the differences in the underlying equity securities.
To balance stock option awards among Advisers' employees, and to account for the
deviations caused by the existence of five plans supported by five different
publicly traded stocks, Advisers developed two special awards to be granted in
lieu of options under the Old Plans that would be forgone upon completion of the
Merger and the cancellation of the Old Plans.

Cut-Off Award. The first award established a cut-off dollar amount as of
the date of the announcement of the Merger (August 14, 1997) that would be
computed for all outstanding, but unvested options that would be canceled as of
the date of the Merger (the "Cut-Off Award"). The Cut-Off Award was designed to
cap the appreciated value in unvested options at the Merger announcement date in
order to set the foundation to balance option awards upon the Merger. The
Cut-Off Award, in the aggregate, was computed to be $2.9 million, and is equal
to the difference between the market price of the shares of stock underlying the
canceled options under the Old Plans at August 14, 1997, less the exercise
prices of the options. The Cut-Off Award will be payable for each canceled
option as the canceled options would have vested and will vest automatically in
the event of a change of control. The Cut-Off Award will only be payable if the
award recipient is employed by the Company on the future vesting date. A table
indicating the Cut-Off Award for certain officers, and the related vesting
schedule, is contained in the SAI. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Results of
Operations -- Comparison of Three Months Ended March 31, 1998 and 1997."

Formula Award. The second award (the "Formula Award") was designed to
compensate officers from the point when their unvested options would cease to
appreciate in value pursuant to the Cut-Off Award (i.e., August 14, 1997) up
until the time in which they would be able to receive option awards in the
Company after the Merger became effective. In the aggregate, the Formula Award
equaled six percent (6%) of the difference between the combined aggregate market
capitalizations of the Predecessor Companies as of the close of the market on
December 30, 1997, and the combined aggregate market capitalizations of the
Predecessor Companies on August 14, 1997. In total, the combined aggregate
market capitalization of the Predecessor Companies increased by $319 million
from August 14, 1997 to December 30, 1997, and the aggregate Formula Award was
approximately $19 million.

Advisers' Compensation Committee designed the Formula Award as a long-term
incentive compensation program to be a replacement for canceled stock options
and to balance share ownership among key officers for past and prospective
service. The terms of the Formula Award require that the award be contributed to
the Company's deferred compensation plan, and used to purchase shares of the
Company in the open market. See "-- Deferred Compensation Plan."

The Formula Award vests and accrues equally over a three-year period, on
the anniversary of the Merger date (December 31, 1997), and vests automatically
in the event of a change of control of the Company. If an officer terminates
employment with the Company prior to the vesting of any part of the Formula
Award, that amount will be forfeited to the Company. Assuming all officers meet
the vesting requirement, the Company will accrue the Formula Award over the
three-year period in equal amounts of approximately $6.4 million. A table
indicating the Formula Award for certain officers, and the related vesting
schedule, is contained in the SAI. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Results of
Operations -- Comparison of Three Months Ended March 31, 1998 and 1997."

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EMPLOYEE STOCK OWNERSHIP PLAN

In connection with the Merger, the Company adopted an amended and restated
Employee Stock Ownership Plan, or ESOP. All eligible employees (i.e., employees
with one (1) year of service who are at least 21 years of age) of the Company
are eligible participants in the ESOP. Pursuant to this qualified plan, during
1997 the Company contributed 5% of each eligible participant's total cash
compensation for the year (up to a $30,000 limit per person) to a plan account
on the participant's behalf, which fully vests over a two-year period. The ESOP
has used substantially all of these cash contributions to purchase shares of the
Company, thus aligning every employee's interest with those of the Company and
its shareholders. At December 31, 1997 the ESOP held 0.8% of the outstanding
shares of the Company, and all of these shares had been allocated to
participants' plan accounts.

DEFERRED COMPENSATION PLAN

Pursuant to the Merger, the Company succeeded to the deferred compensation
plan of Advisers (the "Deferred Compensation Plan"), and subsequently adopted
such plan as amended and restated. The Deferred Compensation Plan is intended to
be a funded plan for the purpose of providing deferred compensation to the
Company's employees and consultants. Any employee or consultant of the Company
is eligible to participate in the plan at such time and for such period as
designated by the board of directors. The Deferred Compensation Plan is
administered through a trust, and the Company funds this plan through cash and
open market purchases of the Company's Common Stock. See "-- Cut-Off Award and
Formula Award -- Formula Award," above.

TAXATION

The following discussion is a general summary of the material federal
income tax considerations applicable to the Company and to an investment in the
Common Stock and does not purport to be a complete description of the income tax
considerations applicable to such an investment. The discussion is based upon
the Code, Treasury Regulations thereunder, and administrative and judicial
interpretations thereof, each as of the date hereof, all of which are subject to
change. Prospective shareholders should consult their own tax advisors with
respect to tax considerations which pertain to their purchase of Common Stock.
This summary assumes that the investors in the Company hold shares as capital
assets. This summary does not discuss all aspects of federal income taxation
relevant to holders of the Common Stock in light of particular circumstances, or
to certain types of holders subject to special treatment under federal income
tax laws, including foreign taxpayers, dealers in securities and financial
institutions. This summary does not discuss any aspects of foreign, state or
local tax laws.

TAXATION AS A RIC

The Company intends to be treated for tax purposes as a "regulated
investment company" or "RIC" within the meaning of Section 851 of the Code. If
the Company qualifies as a RIC and distributes to its shareholders in a timely
manner at least 90% of its "investment company taxable income," as defined in
the Code, each year, it will not be subject to federal income tax on the portion
of its taxable income and gains it distributes to shareholders. In addition, if
a RIC distributes in a timely manner (or treats as "deemed distributed") 98% of
its capital gain net income for each one year period ending on December 31
(pursuant to Section 4982(e)(4)(A) of the Code), and distributes 98% of its
ordinary income for each calendar year, it will not be subject to the 4%
nondeductible federal excise tax on certain undistributed income of RICs. The
Company generally will endeavor to distribute to shareholders all of its
investment company taxable income and its net capital gain, if any, for each
taxable year so that such Company will not incur income and excise taxes on its
earnings.

In order to qualify as a RIC for federal income tax purposes, the Company
must, among other things: (i) continue to qualify as a BDC under the 1940 Act;
(ii) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans, gains from the
sale of stock or other securities or other income derived with respect to its
business of investing in such stock or securities; and

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(iii) diversify its holdings so that at the end of each quarter of the taxable
year (a) at least 50% of the value of the Company's assets consists of cash,
cash items, government securities, securities of other RICs, and other
securities if such other securities of any one issuer do not represent more than
5% of the Company's assets or 10% of the outstanding voting securities of the
issuer, and (b) no more than 25% of the value of the Company's assets are
invested in securities of one issuer (other than U.S. Government Securities or
securities of other RICs), or of two or more issuers that are controlled by the
Company and are engaged in the same or similar or related trades or businesses.
The failure of one or more of the Company's subsidiaries to continue to qualify
as RICs could adversely affect the Company's ability to satisfy foregoing
diversification requirements.

If the Company fails to satisfy the 90% Distribution Requirement or
otherwise fails to qualify as a RIC in any taxable year, it will be subject to
tax in such year on all of its taxable income, regardless of whether the Company
makes any distribution to its shareholders. In addition, in that case, all of
the Company's distributions to its shareholders will be characterized as
ordinary income (to the extent of the Company's current and accumulated earnings
and profits). In contrast, as is explained below, if the Company qualifies as a
RIC, a portion of its distributions may be characterized as long-term capital
gain in the hands of shareholders.

TAXATION OF SHAREHOLDERS

Distributions of the Company are generally taxable to shareholders as
ordinary income or capital gains. Shareholders receive notification from the
Company at the end of the year as to the amount and nature of the income or
gains distributed to them for that year. The distributions from the Company to a
particular shareholder may be subject to the alternative minimum tax under the
provisions of the Code. Shareholders not subject to tax on income will not be
required to pay tax on amounts distributed to them by the Company.

Distributions of the ordinary income and net short-term capital gain of the
Company generally are taxable to shareholders as ordinary income. Distributions
of net capital gain, if any, designated by the Company as capital gain dividends
generally will be taxable to shareholders as long-term capital gain, regardless
of the length of time a shareholder has held the shares. All distributions are
taxable, whether invested in additional shares or received in cash. Dividends
declared by the Company and payable to shareholders of record in October,
November or December of a given year that are paid during the following January
will be treated as having been received by shareholders on December 31 of the
year of declaration.

The Company's ordinary income dividends to its corporate shareholders may,
if certain conditions are met, qualify for the dividends received deduction to
the extent that the Company has received qualifying dividend income during the
taxable year. Capital gain dividends distributed by the Company are not eligible
for the dividends received deduction.

In general, any gain or loss realized upon a taxable disposition of shares
of the Company, or upon receipt of a liquidating distribution will be treated as
capital gain or loss. If gain is realized, it will be subject to taxation at
various tax rates depending on the length of time the taxpayer has held such
shares and other factors. The gain or loss will be short-term capital gain or
loss if the shares have been held for one year or less. If a shareholder has
received any capital gain dividends with respect to such shares, any loss
realized upon a taxable disposition of shares treated under the Code as having
been held for six months or less, to the extent of such capital gain dividends,
will be treated as a long-term capital loss. All or a portion of any loss
realized upon a taxable disposition of shares of the Company may be disallowed
if other shares of the Company are purchased (under a DRIP Plan or otherwise)
within 30 days before or after the disposition.

A shareholder that is not a "United States person" within the meaning of
the Code (a "Non-U.S. shareholder") generally will be subject to a withholding
tax of 30% (or lower applicable treaty rate) on dividends from the Company
(other than capital gain dividends) that are not "effectively connected" with a
United States trade or business carried on by such shareholder. Accordingly,
investment in the Company is likely to be appropriate for a Non-U.S. shareholder
only if such person can utilize a foreign tax credit or corresponding tax
benefit in respect of such United States withholding tax. Non-effectively
connected capital gain dividends and gains realized from the sale of Shares will
not be subject to United States federal income tax in the case of (i) a Non-U.S.
shareholder that is a corporation and (ii) a Non-U.S. shareholder that is not

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present in the United States for more than 182 days during the taxable year
(assuming that certain other conditions are met). See "Tax Status -- Non-U.S.
Stockholders" in the Statement of Additional Information. Prospective foreign
investors should consult their U.S. tax advisors concerning the tax consequences
to them of an investment in Shares.

The Company is required to withhold and remit to the Internal Revenue
Service (the "IRS") 31% of the dividends paid to any shareholder who (i) fails
to furnish the Company with a certified taxpayer identification number; (ii) has
underreported dividend or interest income to the IRS; or (iii) fails to certify
to the Company that he, she or it is not subject to backup withholding.

CERTAIN GOVERNMENT REGULATIONS

The Company operates in a highly regulated environment. The following
discussion generally summarizes certain regulations.

BUSINESS DEVELOPMENT COMPANY ("BDC")

As a BDC, ACC may not acquire any asset other than "Qualifying Assets"
unless, at the time the acquisition is made, Qualifying Assets represent at
least 70% of the value of ACC's total investment assets (the "70% test"). The
principal categories of Qualifying Assets relevant to the business of ACC are
the following:

(1) Securities purchased in transactions not involving any public
offering, the issuer of which is an eligible portfolio company. An eligible
portfolio company is defined to include any issuer that (a) is organized
and has its principal place of business in the United States, (b) is not an
investment company other than an SBIC wholly owned by the BDC (ACC's
investments in and advances to Allied Investment, Allied Financial, Allied
SBLC and certain other subsidiaries generally would be Qualifying Assets),
and (c) does not have any class of publicly traded securities with respect
to which a broker may extend margin credit;

(2) Securities received in exchange for or distributed with respect to
securities described in (1) above, or pursuant to the exercise of options,
warrants, or rights relating to such securities; and

(3) 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.

To include certain securities described in (1) and (2) above as Qualifying
Assets for the purpose of the 70% test, a BDC must make available to the issuer
of those securities significant managerial assistance. Making available
significant managerial assistance means, among other things, (i) any arrangement
whereby the BDC, through its directors, officers, or employees, offers to
provide, and, if accepted, does provide, significant guidance and counsel
concerning the management, operations, or business objectives and policies of a
portfolio company, or (ii) in the case of an SBIC, making loans to a portfolio
company. Each portfolio company is assigned for monitoring purposes to an
investment officer, and its principals are contacted and counseled if the
portfolio company appears to be encountering business or financial difficulties.

ACC would provide managerial assistance on a continuing basis to any
portfolio company that requests it, whether or not difficulties are perceived.
ACC may not change the nature of its business so as to cease to be, or withdraw
its election as, a BDC unless authorized by vote of a "majority of the
outstanding voting securities," as defined in the 1940 Act, of ACC shares. Since
ACC made its BDC election, it has not made any substantial change in the nature
of its business.

As a BDC, ACC is entitled to issue senior securities in the form of stock
or senior securities representing indebtedness, as long as each class of senior
security has an asset coverage of at least 200% immediately after each such
issuance. This limitation is not applicable to borrowings by ACC's SBIC, SSBIC
or SBLC subsidiaries. See "Risk Factors -- Risks of Leverage."

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REGULATED INVESTMENT COMPANY ("RIC")

The Company and its subsidiaries are treated as a RIC within the meaning of
Section 851 of the Code, and provided the Company meets certain requirements
under the Code, the Company qualifies for pass-through tax treatment. See
"Taxation" for a discussion of the requirements the Company must meet to
maintain RIC status under the Code.

SBA REGULATIONS

SBIC and SSBIC Regulations. Allied Investment, a wholly owned subsidiary
of the Company, is licensed by the SBA as an SBIC under Section 301(c) of the
Small Business Investment Act of 1958, as amended (the "1958 Act"), and has
elected to be regulated as a BDC. In addition, Allied Financial, a wholly owned
subsidiary of the Company, is licensed by the SBA as an SSBIC under 301(d) of
the 1958 Act, and has also elected to be regulated as a BDC. The Company has
determined that, given certain regulatory requirements of the SSBIC program, it
is no longer economical to operate Allied Financial as an SSBIC, and the Company
has received permission from the SBA to permit Allied Financial to make SBIC
eligible investments in addition to SSBIC eligible investments. The Company is
also working with the SBA to merge Allied Investment and Allied Financial into a
single SBIC.

SBICs are authorized to stimulate the flow of private equity capital to
eligible small businesses. Under present SBA regulations, eligible small
businesses include businesses that have a net worth not exceeding $18 million
and have average annual fully-taxed profits not exceeding $6 million for the
most recent two fiscal years. In addition, an SBIC must devote 20% of its
investment activity to "smaller" concerns as defined by the SBA. A smaller
concern is one that has a net worth not exceeding $6 million and has average
annual fully-taxed profits not exceeding $2 million for the most recent two
fiscal years. SBA regulations also provide alternative size standard criteria to
determine eligibility which depend on the industry in which the business is
engaged and are based on such factors as the number of employees and gross
sales. According to SBA regulations, SBICs may make long-term loans to small
businesses, invest in the equity securities of such businesses, and provide them
with consulting and advisory services. Allied Investment provides long-term
loans to qualifying small businesses; equity investments and consulting and
advisory services are typically provided only in connection with such loans.

Allied Investment and Allied Financial have the opportunity to sell to the
SBA preferred stock and subordinated debentures with a maturity of up to ten
years, up to an aggregate principal amount of $101 million (the "$101 million
limit"). The $101 million limit generally applies to all financial assistance
provided by the SBA to any licensee and its "associates," as that term is
defined in SBA regulations. For this purpose, Allied Investment and Allied
Financial would be deemed to be "associates" of one another. As a group, Allied
Investment and Allied Financial have received $53.3 million of subordinated
debentures and $7.0 million of preferred stock investments from the SBA at March
31, 1998; as a result, the combined ability to apply for additional financing
from the SBA will be limited. Interest rates on the SBA debentures currently
outstanding range from 6.9% to 9.8%.

Both Allied Investment and Allied Financial are subject to periodic
examinations by the SBA staff for determining compliance with SBA regulations.

SBLC Regulations. Allied SBLC is licensed to operate as an SBLC and is
subject to regulation and periodic examinations by the SBA staff for purposes of
determining compliance with SBA regulations, including its participation in the
Preferred Lender Program. See "Business -- 7(a) Lending."

DIVIDEND REINVESTMENT PLAN

The Company has adopted an "opt out" dividend reinvestment plan ("DRIP
Plan"). Under the DRIP Plan, distributions to a shareholder owning shares
registered in his or her own name will be automatically reinvested in additional
shares of Common Stock by the Company's transfer agent, acting as reinvestment
plan agent (the "Plan Agent"). Shareholders may change enrollment status in the
DRIP Plan at any time by contacting either the Plan Agent or the Company. A
shareholder's ability to participate in a DRIP Plan may

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be limited according to how the shareholder's shares are registered. Beneficial
owners holding shares in street name may be precluded from participating by the
nominee. Shareholders who wish to participate in a DRIP Plan may need to
register their shares in their own name. Shareholders will be informed of their
right to elect to receive cash in the Company's annual and quarterly reports to
shareholders. Shareholders whose shares are held 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 DRIP Plan will
be paid by check mailed 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 ("AST"), 40 Wall Street, New York, New York 10005.
The telephone number for AST is 800-937-5449.

Under the DRIP Plan, the Company may issue new shares unless the market
price of the outstanding shares is less than 110% of the last reported net asset
value. Alternatively, the Plan Agent may, as agent for the participants, buy
shares in the market. Newly issued shares for the DRIP Plan will be valued at
the average of the reported closing bid prices of the outstanding shares 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,
including any brokerage commissions. There are no other charges payable in
connection with the DRIP Plan. Any distributions reinvested under the plan will
nevertheless remain taxable to the shareholders.

DESCRIPTION OF CAPITAL STOCK

COMMON STOCK

The Company is authorized to issue 100,000,000 shares of Common Stock, par
value $.0001. At June 1, 1998, there were 52,121,610 shares of Common Stock
outstanding and 6,250,000 shares of Common Stock reserved for issuance under the
New Plan. The following are the authorized classes of securities of the Company
as of June 1, 1998:

<TABLE>
<CAPTION>
(4)
(3) AMOUNT
AMOUNT HELD OUTSTANDING
(2) BY COMPANY EXCLUSIVE OF
(1) AMOUNT OR FOR ITS AMOUNTS SHOWN
TITLE OF CLASS AUTHORIZED ACCOUNT UNDER (3)
-------------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Allied Capital Corporation........ Common Stock 100,000,000 805,713* 51,315,897
</TABLE>

- ------------------
* Represents shares of the Company held in a trust for the Deferred Compensation
Plan. See "Management -- Compensation Plans."

All shares of Common Stock have equal rights as to earnings, assets,
dividends, and voting privileges and all outstanding shares of Common Stock are
fully paid and non-assessable. The shares of Common Stock have no preemptive,
conversion, or redemption rights and are freely transferable. In the event of
liquidation, each share of Common Stock is entitled to its proportion of the
Company's assets after debts and expenses. Each share is entitled to one vote
and does not have cumulative voting rights, 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 offered hereby will be, when issued and paid for,
fully paid and non-assessable.

The board of directors may classify and reclassify any unissued shares of
capital stock of the Company 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.

LIMITATION ON LIABILITY OF DIRECTORS

The Company has adopted provisions in its Charter and bylaws limiting the
liability of directors and officers of the Company for monetary damages. The
effect of these provisions in the Charter and bylaws is to

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eliminate the rights of the Company and its shareholders (through shareholders'
derivative suits on behalf of the Company) to recover monetary damages against a
director or officers for breach of the fiduciary duty of care as a director or
officer (including breaches resulting from negligent or grossly negligent
behavior) except in certain limited situations. These provisions do not limit or
eliminate the rights of the Company or any shareholder 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.

CERTAIN ANTI-TAKEOVER PROVISIONS

The Charter and bylaws of the Company and certain statutory and regulatory
requirements contain certain provisions that could make more difficult the
acquisition of the Company 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 the Company to negotiate first with the board of
directors. The Company believes 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 as a summary only and is
qualified in its entirety by reference to the Charter and the bylaws.

CLASSIFIED BOARD OF DIRECTORS

The Charter provides for the 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 the
Company or removal of incumbent management. The Company believes, however, that
the longer time required to elect a majority of a classified board of directors
will help to ensure continuity and stability of the Company's management and
policies.

ISSUANCE OF PREFERRED STOCK

The board of directors of ACC, without shareholder approval, has the
authority to reclassify Common Stock as preferred stock and to issue ACC
preferred stock. Such stock could be issued with voting, conversion or other
rights designed to have an anti-takeover effect.

MARYLAND CORPORATE LAW

The Company is subject to the Maryland 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 states for their entire terms.

Business Combination Statute. Certain provisions of the Maryland Law
establish special requirements with respect to "business combinations" between
Maryland corporations and "interested shareholders" 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 shareholder and
requires a super majority vote for such transactions after the end of such
five-year period.

"Interested shareholders" 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 shareholders
or their affiliates. Unless an exemption is available, a "business combination"
may not be consummated between a Maryland corporation and an interested
shareholder or its affiliates for a period of five years after the date on which
the shareholder first became an interested shareholder 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

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cast by all holders of outstanding shares of voting stock and 66 2/3% of the
votes entitled to be cast by all holders of outstanding shares of voting stock
other than the interested shareholder or its affiliates or associates, unless,
among other things, the corporation's shareholders 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 shareholder for its shares. A business combination with an interested
shareholder which is approved by the board of directors of a Maryland
corporation at any time before an interested shareholder first becomes an
interested shareholder is not subject to the five-year moratorium or special
voting requirements. An amendment to a Maryland corporation 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 66 2/3% of the votes entitled to be cast
by holders of outstanding shares of voting stock who are not interested
shareholders. Any such amendment is not effective until 18 months after the vote
of shareholders and does not apply to any business combination of a corporation
with a shareholder who became an interested shareholder on or prior to the date
of such vote.

Control Share Acquisition Statute. The Maryland 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: (i)
one-fifth or more but not less than one-third, (ii) one-third or more but less
than a majority or (iii) a majority of all voting power. Control shares do not
include shares which the acquiring person is entitled to vote as a result of
having previously obtained shareholder 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 shareholders 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 50 days after a request is made with the submission of an
"acquiring person statement," but only if the acquiring person (i) gives a
written undertaking and, if required by the directors of the issuing
corporation, posts a bond for the cost of the meeting and (ii) 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 statue in the event (a) there is a
shareholder vote and the grant of voting rights is not approved, or (b) 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 shareholders other than the acquiring person have
appraisal rights as provided under the Maryland 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 the Company. 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.

REGULATORY RESTRICTIONS

Allied Investment, Allied Financial and Allied SBLC are SBIC, SSBIC and
SBLC subsidiaries, respectively, of the Company. The SBA prohibits, without
prior SBA approval, a "change of control" or transfers which would result in any
person (or group of persons acting in concert) owning 10% or more of any class
of capital stock of an SBIC or SSBIC. A "change of control" is any event which
would result in a transfer of the power, direct or indirect, to direct the
management and policies of an SBIC, SSBIC or SBLC, whether through ownership,
contractual arrangements or otherwise.

56
<PAGE> 61

UNDERWRITERS

Under the terms and subject to the conditions of the Underwriting Agreement
dated the date of this Prospectus (the "Underwriting Agreement"), the Company
has agreed to sell an aggregate of 5,750,000 shares of Common Stock and the U.S.
Underwriters named below, for whom Morgan Stanley & Co. Incorporated,
NationsBanc Montgomery Securities LLC, The Robinson-Humphrey Company, LLC and
Scott & Stringfellow, Inc. are serving as U.S. Representatives, have severally
agreed to purchase, and the International Underwriters named below, for whom
Morgan Stanley & Co. International Limited, NationsBanc Montgomery Securities
LLC, The Robinson-Humphrey Company, LLC and Scott & Stringfellow, Inc. are
serving as International Representatives, have severally agreed to purchase, the
respective number of shares of Common Stock set forth opposite their names
below:

<TABLE>
NUMBER OF
NAME SHARES
- ------------------------------------------------------------ ---------
<S> <C>
U.S. Underwriters:
Morgan Stanley & Co. Incorporated.........................
NationsBanc Montgomery Securities LLC.....................
The Robinson-Humphrey Company, LLC........................
Scott & Stringfellow, Inc. ...............................
---------
Subtotal: ............................................. 4,600,000
---------
International Underwriters:
Morgan Stanley & Co. International Limited................
NationsBanc Montgomery Securities LLC.....................
The Robinson-Humphrey Company, LLC........................
Scott & Stringfellow, Inc. ...............................
---------
Subtotal: ............................................. 1,150,000
---------
Total: ................................................ 5,750,000
=========
</TABLE>

The U.S. Underwriters and the International Underwriters are collectively
referred to as the "Underwriters." The Underwriting Agreement provides that the
obligations of the several Underwriters to pay for and accept delivery of the
shares of Common Stock offered hereby are subject to the approval of certain
legal matters by counsel and to certain other conditions. The Underwriters are
obligated to take and pay for all the shares of Common Stock offered hereby
(other than those covered by the U.S. Underwriters' over-allotment option
described below), if any such shares are taken.

Pursuant to the Agreement Between U.S. Underwriters and International
Underwriters, each U.S. Underwriter has represented and agreed that, with
certain exceptions, (a) it is not purchasing any U.S. Shares (as defined below)
being sold by it for the account of anyone other than a United States or
Canadian Person (as defined below) and (b) it has not offered or sold, and will
not offer or sell, directly or indirectly, any U.S. Shares or distribute any
prospectus relating to the U.S. Shares outside the United States or Canada or to
anyone other than a United States or Canadian Person. Pursuant to the Agreement
Between U.S. and International Underwriters, each International Underwriter has
represented and agreed that, with certain exceptions, (a) it is not purchasing
any International Shares (as defined below) being sold by it for the account of
any United States or Canadian Person and (b) it has not offered or sold, and
will not offer or sell, directly or indirectly, any International Shares or
distribute any prospectus relating to the International Shares within the United
States or Canada or to any United States or Canadian Person. With respect to any
Underwriter that is a U.S. Underwriter and an International Underwriter, the
foregoing representations and agreements (i) made by it in its capacity as a
U.S. Underwriter shall apply only to shares purchased by it in its capacity as a
U.S. Underwriter, (ii) made by it in its capacity as an International
Underwriter shall apply only to shares purchased by it in its capacity as an
International Underwriter, and (iii) do not restrict its ability to distribute
any prospectus relating to the shares of Common Stock to any person. The
foregoing limitations do not apply to stabilization transactions or to certain
other transactions specified in the Agreement Between U.S. Underwriters and
International Underwriters. As used herein, "United States or Canadian Person"
means any national or resident of the United States or Canada, any corporation,
pension, profit-sharing, or other trust or

57
<PAGE> 62

other entity organized under the laws of the United States or Canada or of any
political subdivision thereof (other than a branch located outside the United
States and Canada of any United States or Canadian Person) and includes any
United States or Canadian branch of a person who is otherwise not a United
States or Canadian Person. All shares of Common Stock to be purchased by the
U.S. Underwriters and the International Underwriters under the Underwriting
Agreement are referred to herein as the "U.S. Shares" and the "International
Shares," respectively.

Pursuant to the Agreement Between U.S. Underwriters and International
Underwriters, sales may be made between the U.S. Underwriters and International
Underwriters of any number of shares of Common Stock to be purchased pursuant to
the Underwriting Agreement as may be mutually agreed. The per share price of any
shares so sold shall be the Price to Public set forth on the cover page hereof,
in United States dollars, less an amount not greater than the per share amount
of the concession to dealers set forth below.

Pursuant to the Agreement between U.S. Underwriters and International
Underwriters, each U.S. Underwriter has represented that it has not offered or
sold, and has agreed not to offer or sell, any Shares, directly or indirectly,
in any province or territory of Canada or to, or for the benefit of, any
resident of any province or territory of Canada in contravention of the
securities laws thereof and has represented that any offer or sale of Shares in
Canada will be made only pursuant to an exemption from the requirement to file a
prospectus in the province or territory of Canada in which such offer or sale is
made. Each U.S. Underwriter has further agreed to send to any dealer who
purchases from it any of the Shares a notice stating in substance that, by
purchasing such Shares, such dealer represents and agrees that it has not
offered or sold, and will not offer or sell, directly or indirectly, any of such
Shares in any province or territory of Canada or to, or for the benefit of, any
resident of any province or territory of Canada in contravention of the
securities laws thereof and that any offer or sale of Shares in Canada will be
made only pursuant to an exemption from the requirement to file a prospectus in
the province or territory of Canada in which such offer or sale is made, and
that such dealer will deliver to any other dealer to whom it sells any of such
Shares a notice containing substantially the same statement as contained in this
sentence.

Pursuant to the Agreement Between U.S. Underwriters and International
Underwriters, each International Underwriter has represented and agreed that (a)
it has not offered or sold, and, during the period of six months from the
closing date of the Offering, will not offer or sell any shares of Common Stock
to persons in the United Kingdom except to persons whose ordinary activities
involve them in acquiring, holding, managing, or disposing of investments (as
principal or agent) for the purposes of their businesses or otherwise in
circumstances which have not resulted and will not result in an offer to the
public in the United Kingdom within the meaning of the Public Offers of
Securities Regulations (1995) (the "Regulations"); (b) it has complied and will
comply with all applicable provisions of the Financial Services Act of 1986 and
the Regulations with respect to anything done by it in relation to the shares of
Common Stock offered hereby in, from, or otherwise involving the United Kingdom;
and (c) it has only issued or passed on and will only issue or pass on to any
person in the United Kingdom any document received by it in connection with the
issue of the shares of Common Stock if that person is of a kind described in
Article 11(3) of the Financial Services Act of 1986, (Investment Advertisement)
(Exemptions) Order 1996, or is a person to whom such document may otherwise
lawfully be issued or passed on.

The Underwriters propose to offer part of the shares of Common Stock
directly to the public at the Price to Public set forth on the cover page hereof
and part to certain dealers at a price which represents a concession not in
excess of $ a share below the public offering price. Any Underwriter may
allow, and such dealers may reallow, a concession not in excess of $ a
share to other Underwriters or to certain dealers. After the initial offering of
the shares of Common Stock, the offering price and other selling terms may from
time to time be varied by the Underwriters.

Pursuant to the Underwriting Agreement, the Company has granted the U.S.
Underwriters an option, exercisable for 30 days from the date of this
Prospectus, to purchase up to an aggregate of 862,500 additional shares of
Common Stock at the Price to Public on the cover page hereof, less Underwriting
Discounts and Commissions. The U.S. Underwriters may exercise such option to
purchase solely for the purpose of covering over-allotments, if any, made in
connection with the Offering. To the extent such option is exercised, each

58
<PAGE> 63

U.S. Underwriter will become obligated, subject to certain conditions, to
purchase approximately the same percentage of such additional shares of Common
Stock as the number set forth next to each U.S. Underwriter's name in the
preceding table bears to the total number of shares of Common Stock offered by
the U.S. Underwriters hereby.

The Company and all of its executive officers and directors have agreed
that, without the prior written consent of Morgan Stanley & Co. Incorporated on
behalf of the Underwriters, they will not (i) offer, pledge, sell, contract to
sell, sell any option or contract to purchase, purchase any option or contract
to sell, grant any option, right, or warrant to purchase, or otherwise transfer
or dispose of, directly or indirectly, any shares of Common Stock or any
securities convertible into or exercisable or exchangeable for Common Stock
(whether such shares or any such securities are now owned by such shareholder or
acquired after the date of the Prospectus) or (ii) enter into any swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of the Common Stock, whether any such transaction
described in clause (i) or (i) above is to be settled by delivery of Common
Stock or such other securities, in cash or otherwise, for a period of 90 days
after the date of this Prospectus, other than the sale to the Underwriters of
any shares of Common Stock pursuant to the Underwriting Agreement.

The Company and the Underwriters have agreed to indemnify each other
against certain liabilities, including liabilities under the Securities Act.

In order to facilitate the offering of the Common Stock, the Underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the Common Stock. Specifically, the Underwriters may over-allot in
connection with the Offering, creating a short position in the Common Stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of the Common Stock, the Underwriters may bid for, and purchase, shares of
Common Stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
Common Stock in the Offering if the syndicate repurchases previously distributed
Common Stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the Common Stock above independent market
levels. The Underwriters are not required to engage in these activities, and may
end any of these activities at any time.

The Underwriters and dealers may engage in passive market making
transactions in the Common Stock in accordance with Rule 103 of Regulation M
promulgated by the Commission. In general, a passive market maker may not bid
for, or purchase, the Common Stock at a price that exceeds the highest
independent bid. In addition, the net daily purchases made by any passive market
maker generally may not exceed 30% of the average daily trading volume in the
Common Stock during a specified two-month period, or 200 shares, whichever is
greater. A passive market maker must identify passive market making bids as such
on the Nasdaq National Market. Passive market making may stabilize or maintain
the market price of the Common Stock above independent market levels.
Underwriters and dealers are not required to engage in passive market making and
may end passive market making activities at any time.

The Underwriters have provided customary financial and advisory services to
the Company and the Predecessor Companies.

Morgan Stanley & Co. Incorporated was retained by each of the Predecessor
Companies as financial advisor for the Merger. In addition, Morgan Stanley & Co.
Incorporated has provided the Company with short-term financing.

Scott & Stringfellow, Inc. acted as independent financial advisor to the
board of directors of Allied Commercial in connection with the Merger.

NationsBank of Texas, N.A. ("NationsBank"), an affiliate of NationsBanc
Montgomery Securities LLC, provides financing to the Company as one of several
lenders under an unsecured revolving line of credit. NationsBank's aggregate
commitment thereunder is $50 million. A NationsBank affiliate is currently
acting as placement agent for the Company's private placement of $180 million
unsecured long-term notes.

59
<PAGE> 64

Each of Morgan Stanley & Co. Incorporated and NationsBanc Montgomery
Securities LLC will indirectly receive proceeds from the Offering through the
application of the net proceeds to the repayment of amounts outstanding under
the Company's short-term lines of credit. The Offering will be conducted in
compliance with the requirements of Rule 2720 of the National Association of
Securities Dealers, Inc. (the "NASD") regarding a NASD member firm's
participation in an offering where more than ten (10) percent of the net
proceeds will be paid to NASD members participating in the distribution.

The principal business address of each of the U.S. Representatives is as
follows: Morgan Stanley & Co. Incorporated, 1585 Broadway, New York, New York
10036; NationsBanc Montgomery Securities LLC, 600 Montgomery Street, San
Francisco, California 94111; The Robinson-Humphrey Company, LLC, 3333 Peachtree
Road, N.E., Atlanta, GA 30326, and Scott & Stringfellow, Inc., 909 East Main
Street, Richmond, VA 23219.

LEGAL MATTERS

Certain legal matters with respect to the validity of the shares of Common
Stock offered hereby will be passed upon for the Company by Sutherland, Asbill &
Brennan LLP, Washington, D.C. Certain legal matters related to the Offering will
be passed upon for the Underwriters by Davis Polk & Wardwell, New York, New
York.

SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR

The Company's and its subsidiaries' investments are held in safekeeping by
Riggs Bank, N.A. at 808 17th Street, N.W., Washington, D.C. 20006. LaSalle
National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk Grove
Village, Illinois 60007, serves as trustee with respect to assets of the Company
held for securitization purposes. American Stock Transfer and Trust Company, 40
Wall Street, 46th Floor, New York, New York 10005 acts as the Company's
transfer, dividend paying and reinvestment plan agent and registrar.

INDEPENDENT PUBLIC ACCOUNTANTS

The financial statements included in this Prospectus and elsewhere in the
Registration Statement to the extent and for the periods indicated in their
report have been audited by Arthur Andersen LLP, independent public accountants,
as indicated in their reports with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said reports.

TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION

<TABLE>
<S> <C>
General Information and History............................. B-2
Investment Objective and Policies........................... B-2
Management.................................................. B-2
Compensation of Executive Officers and Directors....... B-2
Compensation of Directors.............................. B-4
Stock Option Awards.................................... B-4
Cut-off Award and Formula Award........................ B-5
Committees of the Board of Directors................... B-6
Control Persons and Principal Holders of Securities......... B-6
Investment Advisory Services................................ B-7
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. B-8
Accounting Services......................................... B-8
Brokerage Allocation and Other Practices.................... B-8
Tax Status.................................................. B-9
</TABLE>

60
<PAGE> 65

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Balance Sheet -- March 31, 1998 (unaudited) and
December 31, 1997 and 1996................................ F-1
Consolidated Statement of Operations -- For the Three Months
Ended March 31, 1998 and 1997 (unaudited) and the Years
Ended December 31, 1997, 1996, and 1995................... F-2
Consolidated Statement of Changes in Net Assets -- For the
Three Months Ended March 31, 1998 and 1997 (unaudited) and
the Years Ended December 31, 1997, 1996, and 1995......... F-3
Consolidated Statement of Cash Flows -- For the Three Months
Ended March 31, 1998 and 1997 (unaudited) and the Years
Ended December 31, 1997, 1996, and 1995................... F-4
Consolidated Statement of Investments -- March 31, 1998
(unaudited) and December 31, 1997......................... F-5
Notes to Consolidated Financial Statements.................. F-15
Report of Independent Public Accountants.................... F-33
</TABLE>

61
<PAGE> 66

CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
----------- -------------------
1998 1997 1996
----------- -------- --------
(IN THOUSANDS, EXCEPT NUMBER OF SHARES) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Portfolio at value:
Commercial mortgage loans (cost: 1998-$201,238;
1997-$447,016; 1996-$373,378)....................... $201,349 $447,244 $373,695
Mezzanine loans and debt securities (cost:
1998-$202,951; 1997-$181,184; 1996-$178,664)........ 185,316 167,842 165,086
Small Business Administration 7(a) loans (cost:
1998-$46,249; 1997-$41,103; 1996-$42,351)........... 45,867 40,709 42,131
Interest in securitization pool of commercial mortgage
loans (cost: 1998-$87,937; 1997-$0; 1996-$0)........ 87,937 -- --
Equity interests in portfolio companies (cost:
1998-$19,289; 1997-$20,050; 1996-$18,521)........... 39,691 39,906 26,134
Other portfolio assets
(cost: 1998-$4,342; 1997-$1,367; 1996-$362)......... 4,295 1,320 322
-------- -------- --------
Total portfolio at value.......................... 564,455 697,021 607,368
-------- -------- --------
Cash and cash equivalents................................... 31,013 70,437 71,841
U.S. government securities.................................. 25,078 11,091 --
Other assets................................................ 32,164 29,226 34,151
-------- -------- --------
Total assets...................................... $652,710 $807,775 $713,360
======== ======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable.......................... $ 99,243 $308,821 $229,898
Revolving lines of credit............................. 103,000 38,842 45,099
Accounts payable and other liabilities................ 20,219 23,984 21,032
Dividends and distributions payable................... -- 9,068 8,197
-------- -------- --------
222,462 380,715 304,226
-------- -------- --------
Commitments and contingencies
Preferred stock issued to Small Business Administration..... 7,000 7,000 7,000
Shareholders' equity:
Common stock, $0.0001 par value, 100,000,000 shares
authorized; 52,113,550, 52,047,318 and 48,237,621
issued and outstanding at March 31, 1998, December
31, 1997 and 1996, respectively..................... 5 5 5
Additional paid-in capital............................ 452,723 451,044 417,670
Common stock held in deferred compensation trust
(662,948 shares at March 31, 1998).................. (15,330) -- --
Notes receivable from sale of common stock............ (26,556) (29,611) (15,491)
Net unrealized appreciation (depreciation) on
portfolio........................................... 2,025 1,301 (5,908)
Undistributed (distributions in excess of) earnings... 10,381 (2,679) 5,858
-------- -------- --------
Total shareholders' equity........................ 423,248 420,060 402,134
-------- -------- --------
Total liabilities and shareholders' equity........ $652,710 $807,775 $713,360
======== ======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
F-1
<PAGE> 67

CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31, FOR THE YEARS ENDED DECEMBER 31,
-------------------- ---------------------------------
1998 1997 1997 1996 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) --------- -------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Interest and related portfolio income:
Interest................................. $19,501 $19,630 $86,882 $77,541 $61,550
Net premiums from loan dispositions...... 1,336 701 7,277 4,241 2,796
Net gain on securitization of commercial
mortgage loans......................... 14,812 -- -- -- --
Investment advisory fees and other
income................................. 1,248 1,068 3,246 3,155 4,471
------- ------- ------- ------- -------
Total interest and related portfolio
income............................. 36,897 21,399 97,405 84,937 68,817
------- ------- ------- ------- -------
Expenses:
Interest on indebtedness................. 4,598 5,788 26,952 20,298 12,355
Salaries and employee benefits........... 2,850 2,057 10,258 8,774 8,031
General and administrative............... 2,757 1,586 8,970 8,289 6,888
Merger................................... -- -- 5,159 -- --
------- ------- ------- ------- -------
Total operating expenses............. 10,205 9,431 51,339 37,361 27,274
Formula and cut-off awards............... 1,772 -- -- -- --
------- ------- ------- ------- -------
Portfolio income before realized and unrealized
gains........................................ 24,920 11,968 46,066 47,576 41,543
------- ------- ------- ------- -------
Net realized and unrealized gains:
Net realized gains....................... 6,421 3,677 10,704 19,155 12,000
Net unrealized gains (losses)............ 724 (2,159) 7,209 (7,412) 9,266
------- ------- ------- ------- -------
Total net realized and unrealized
gains.............................. 7,145 1,518 17,913 11,743 21,266
------- ------- ------- ------- -------
Income before minority interests and income
taxes........................................ 32,065 13,486 63,979 59,319 62,809

Minority interests............................. -- 306 1,231 2,427 546
Income tax expense............................. -- 534 1,444 1,945 1,784
------- ------- ------- ------- -------
Net increase in net assets resulting from
operations................................... $32,065 $12,646 $61,304 $54,947 $60,479
======= ======= ======= ======= =======
Basic earnings per common share................ $ 0.62 $ 0.27 $ 1.24 $ 1.19 $ 1.38
======= ======= ======= ======= =======
Diluted earnings per common share.............. $ 0.61 $ 0.27 $ 1.24 $ 1.17 $ 1.37
======= ======= ======= ======= =======
Weighted average common shares outstanding..... 51,814 46,938 49,218 46,172 43,697
======= ======= ======= ======= =======
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
F-2
<PAGE> 68

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31, FOR THE YEARS ENDED DECEMBER 31,
-------------------- ---------------------------------
1998 1997 1997 1996 1995
--------- -------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operations:
Portfolio income before realized and
unrealized gains..................... $ 24,920 $ 11,968 $ 46,066 $ 47,576 $ 41,543
Net realized gains..................... 6,421 3,677 10,704 19,155 12,000
Net unrealized gains (losses).......... 724 (2,159) 7,209 (7,412) 9,266
Minority interests and income tax
expense.............................. -- (840) (2,675) (4,372) (2,330)
-------- -------- -------- -------- --------
Net increase in net assets
resulting from operations....... 32,065 12,646 61,304 54,947 60,479
-------- -------- -------- -------- --------
Shareholder distributions:
Portfolio income....................... (18,225) (14,346) (38,751) (39,030) (37,296)
Excess of portfolio income............. -- -- (605) (2,533) (451)
Net capital gains...................... -- -- (15,172) (11,546) (9,799)
Excess of net capital gains............ -- -- -- -- (374)
Return of capital...................... -- -- (22,302) (4,289) --
Undistributed earnings................. -- -- (8,848) -- --
Preferred stock dividend............... (55) (55) (220) (220) (220)
-------- -------- -------- -------- --------
Net decrease in net assets
resulting from shareholder
distributions................... (18,280) (14,401) (85,898) (57,618) (48,140)
-------- -------- -------- -------- --------
Capital share transactions:
Sale of common stock................... -- -- -- 22,365 1,156
Net decrease (increase) in notes
receivable from sale of common
stock................................ 3,055 2,717 (14,120) (8,176) (3,526)
Issuance of common stock upon the
exercise of stock options............ -- 800 28,426 12,176 5,310
Issuance of common stock in lieu of
cash distributions................... 1,678 3,296 26,612 11,986 7,506
Purchase of common stock by deferred
compensation trust................... (15,330) -- -- -- --
Other.................................. -- (102) 1,602 (738) 364
-------- -------- -------- -------- --------
Net (decrease) increase in net
assets resulting from capital
share transactions.............. (10,597) 6,711 42,520 37,613 10,810
-------- -------- -------- -------- --------
Total increase in net assets................ 3,188 4,956 17,926 34,942 23,149
-------- -------- -------- -------- --------
Net assets at beginning of period........... 420,060 402,134 402,134 367,192 344,043
-------- -------- -------- -------- --------
Net assets at end of period................. $423,248 $407,090 $420,060 $402,134 $367,192
======== ======== ======== ======== ========
Net asset value per common share............ $ 8.23 $ 8.39 $ 8.07 $ 8.34 $ 8.26
======== ======== ======== ======== ========
Common shares outstanding at end of
period.................................... 51,451 48,541 52,047 48,238 44,479
======== ======== ======== ======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 69

CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31, FOR THE YEARS ENDED DECEMBER 31,
--------------------- ---------------------------------
1998 1997 1997 1996 1995
(IN THOUSANDS) ---------- -------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net increase in net assets resulting
from operations..................... $ 32,065 $12,646 $ 61,304 $ 54,947 $ 60,479
Adjustments
Net unrealized (gains) losses....... (724) 2,159 (7,209) 7,412 (9,266)
Net gain on securitization of
commercial mortgage loans......... (14,812) -- -- -- --
Depreciation and amortization....... 173 106 450 393 319
Amortization of loan discounts and
fees.............................. (1,349) (2,086) (10,804) (9,027) (6,841)
Deferred income taxes............... -- (10) 1,087 (381) (174)
Minority interests.................. -- 306 1,231 2,427 546
Changes in other assets and
liabilities....................... (4,228) 4,400 12,881 (10,606) 2,245
--------- ------- --------- --------- ---------
Net cash provided by operating
activities..................... 11,125 17,521 58,940 45,165 47,308
--------- ------- --------- --------- ---------
Cash flows from investing activities:
Investments in small business
concerns............................ (107,506) (72,099) (364,942) (283,295) (216,175)
Collections of investment principal.... 30,773 25,104 233,005 179,292 111,731
Proceeds from the sale of loans........ 9,706 6,425 53,912 27,715 29,726
Proceeds from securitization of
commercial mortgage loans........... 223,401 -- -- -- --
Net (purchase) redemption of U.S.
government securities............... (13,987) -- (10,301) -- 35,061
Collections of notes receivable from
sale of common stock................ 3,055 2,919 6,534 2,199 1,038
Other investing activities............. (3,804) (327) (182) 2,635 2,357
--------- ------- --------- --------- ---------
Net cash provided by (used in)
investing activities........... 141,638 (37,978) (81,974) (71,454) (36,262)
--------- ------- --------- --------- ---------
Cash flows from financing activities:
Sale of common stock................... -- 500 8,615 24,166 1,074
Purchase of common stock by deferred
compensation trust.................. (15,330) -- -- -- --
Common dividends and distributions
paid................................ (16,547) (19,028) (58,194) (47,089) (36,265)
Special undistributed earnings
distribution paid................... (8,848) -- -- -- --
Preferred stock dividends.............. (275) (220) (220) (220) (220)
Net borrowings under (payments on)
debentures and notes payable........ (209,578) 37,183 78,923 (35,202) 85,636
Net borrowings under (payments on)
revolving lines of credit........... 64,158 8,614 (6,257) 110,460 (11,812)
Net payments on government securities
available for sale.................. -- -- -- -- (23,210)
Other financing activities............. (5,767) (361) (1,237) (3,029) 364
--------- ------- --------- --------- ---------
Net cash provided by (used in)
financing activities........... (192,187) 26,688 21,630 49,086 15,567
--------- ------- --------- --------- ---------
Net increase (decrease) in cash and cash
equivalents............................ $ (39,424) $ 6,231 $ (1,404) $ 22,797 $ 26,613
Cash and cash equivalents at beginning of
period................................. $ 70,437 $71,841 $ 71,841 $ 49,044 $ 22,431
--------- ------- --------- --------- ---------
Cash and cash equivalents at end of
period................................. $ 31,013 $78,072 $ 70,437 $ 71,841 $ 49,044
========= ======= ========= ========= =========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 70

CONSOLIDATED STATEMENT OF INVESTMENTS

<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES

Acme Paging, L.P. Debt Securities $ 6,060 $ 6,060
Partnership Interests 1,456 2,600
- -------------------------------------------------------------------------------------------------------
AGPAL Broadcasting, Inc. Debt Securities 928 928
Warrants -- --
- -------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Loans 1,485 1,485
Inc.
Debt Securities 2,274 2,274
Warrants 125 125
- -------------------------------------------------------------------------------------------------------
Arnold Moving Co., Inc. Loans 691 691
- -------------------------------------------------------------------------------------------------------
ARS, Inc. Debt Securities 9,730 9,730
Warrants 171 171
- -------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -------------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc.(1) Debt Securities 7,371 7,371
Warrants 227 340
- -------------------------------------------------------------------------------------------------------
Brazos Sportswear, Inc.(1) Common Stock (342,938 shares) 330 1,458
- -------------------------------------------------------------------------------------------------------
Calendar Broadcasting, Inc. Debt Securities 3,792 3,792
Warrants 150 150
- -------------------------------------------------------------------------------------------------------
Candlewood Hotel Company(1) Preferred Stock (3,250 shares) 3,250 3,250
- -------------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 359 359
Warrants 12 12
- -------------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,987 257
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,717 1,717
Common Stock (220 shares) 1 --
- -------------------------------------------------------------------------------------------------------
Chungsan Corporation Loan 76 76
- -------------------------------------------------------------------------------------------------------
Convenience Corporation of Loans 1,226 1,226
America Debt Securities 8,377 2,651
Series A Preferred Stock (27,408 shares) 337 --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Debt Securities 3,443 3,443
Inc.
Warrants -- 1,138
- -------------------------------------------------------------------------------------------------------
Cosmetic Group, USA, LLC Debt Securities 2,941 2,941
Options -- --
- -------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas 700 700
- -------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 1,440
- -------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc.(1) Warrants 350 536
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-5
<PAGE> 71

<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1998
(IN THOUSANDS EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Directory Investment Common Stock (470 shares) $ -- $ 83
Corporation
- -------------------------------------------------------------------------------------------------------
Directory Lending Corporation Series A Common Stock (1,031 shares) -- 862
Series B Common Stock (188 shares) 235 157
Series C Common Stock (292 shares) 656 245
Series A Preferred Stock (214 shares) 307 192
Series B Preferred Stock (175 shares) 931 158
Series C Preferred Stock (58 shares) 58 52
- -------------------------------------------------------------------------------------------------------
DMI Furniture, Inc.(1) Convertible Preferred Stock (199,920 shares) 500 1,068
- -------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 36 4
- -------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 30 30
Debt Securities 1,875 428
Equity Interest -- --
- -------------------------------------------------------------------------------------------------------
El Dorado Communications, Warrants -- 585
Inc.
- -------------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 40 40
- -------------------------------------------------------------------------------------------------------
Esquire Communications Warrants 6 1,492
Ltd.(1)
- -------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 57 57
- -------------------------------------------------------------------------------------------------------
Ex Terra Funding, LLC Loan 1,966 1,966
- -------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,666 5,666
Company Warrants 280 280
- -------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loan 200 200
- -------------------------------------------------------------------------------------------------------
Gibson Guitar Corp. Debt Securities 14,602 14,602
Warrants 525 525
- -------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,390 1,390
Archery, LLC Convertible Debentures 2,248 2,242
- -------------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 3,600
- -------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 8,659 8,659
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Han Hie Loan 516 516
- -------------------------------------------------------------------------------------------------------
H.B.N. Communications, Inc. Loan 255 255
- -------------------------------------------------------------------------------------------------------
Herr-Voss Industries, Inc. Debt Securities 9,490 9,490
Common Stock (132,507 shares) 1,050 1,050
- -------------------------------------------------------------------------------------------------------
Hotelevision, LLC Loan 250 250
- -------------------------------------------------------------------------------------------------------
In the Dough, Inc. Loan 2 --
- -------------------------------------------------------------------------------------------------------
IndeNet Corporation Debt Securities 8,913 8,913
Warrants -- --
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-6
<PAGE> 72

<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1998
(IN THOUSANDS EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Jeff & Chris Mufflers, Inc. Loan $ 120 $ 120
- -------------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,351 2,351
Warrants 74 74
- -------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,645 4,645
Warrants 323 2,099
- -------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Loans 793 793
Debt Securities 2,807 2,807
Warrants 348 2,350
Equity Interest 64 64
- -------------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,261 6,261
Warrants 96 96
- -------------------------------------------------------------------------------------------------------
Kjellberg's Incorporated Loan 3,146 3,146
- -------------------------------------------------------------------------------------------------------
Kurlancheek Loan 283 283
- -------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Debt Securities 3,378 3,378
Inc.
Common Stock (60,000 shares) 100 100
- -------------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 235 235
- -------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 360 214
Warrants 200 --
- -------------------------------------------------------------------------------------------------------
Magic Auto Loan 13 13
- -------------------------------------------------------------------------------------------------------
Meigher Communications Loan 4,903 4,903
- -------------------------------------------------------------------------------------------------------
MidSouth Data Systems, Inc. Debt Securities 7,554 7,554
Warrants 348 348
- -------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 309 309
Options -- --
- -------------------------------------------------------------------------------------------------------
Mihadas Loan 289 289
- -------------------------------------------------------------------------------------------------------
Mill-It Striping, Inc. Common Stock (18 shares) 250 --
- -------------------------------------------------------------------------------------------------------
MLX/SinterMet Corp.(1) Common Stock (5,835 shares) 241 111
- -------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 33 33
Debt Securities 1,822 219
Common Stock (33,333 shares) -- --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Radio City Mobil Home Park Loan 1,361 1,361
- -------------------------------------------------------------------------------------------------------
Nobel Education Dynamics, Series D Convertible Preferred Stock
Inc.(1) (265,957 shares) 2,000 2,016
Warrants -- 18
- -------------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 23 23
- -------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, Debt Securities 432 432
L.P.
- -------------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 95 95
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-7
<PAGE> 73

<TABLE>
<CAPTION>
PORTFOLIO COMPANY MARCH 31, 1998
(IN THOUSANDS EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Nursefinders, Inc. Debt Securities $ 7,482 $ 7,482
Warrants 619 619
- -------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 1,115 888
Warrants 77 --
- -------------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 320 320
- -------------------------------------------------------------------------------------------------------
Peerless Group, Inc.(1) Common Stock (379,475 shares) 17 1,142
Warrants 4 542
- -------------------------------------------------------------------------------------------------------
David Peters Loan 169 55
- -------------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loans 107 107
Preferred Stock (276 shares) 160 175
Common Stock (36 shares) -- --
- -------------------------------------------------------------------------------------------------------
Pico Products, Inc.(1) Debt Securities 5,669 5,669
Common Stock (248,000 shares) 71 210
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (94,479 shares) 901 874
Holdings, PLC(1)
- -------------------------------------------------------------------------------------------------------
Radio One of Atlanta, Inc. Loans 281 281
Debt Securities 9,959 9,959
Common Stock (1,430 shares) -- 490
- -------------------------------------------------------------------------------------------------------
Randhawa Brothers Loans 217 217
Enterprises, Inc.
- -------------------------------------------------------------------------------------------------------
R-Tex Decoratives Company, Debt Securities 1,521 479
Inc. Warrants 58 --
- -------------------------------------------------------------------------------------------------------
R.L. Singletary Loan 108 108
- -------------------------------------------------------------------------------------------------------
SerpCo., Inc. Loan 182 182
- -------------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 398 322
Common Stock (6,208 shares) 22 --
- -------------------------------------------------------------------------------------------------------
SunStates Refrigerated Loans 1,557 68
Services, Inc. Debt Securities 4,262 1,486
- -------------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,573 129
Common Stock (910 shares) 57 --
- -------------------------------------------------------------------------------------------------------
University Village Mobile Loan 146 146
Homes
- -------------------------------------------------------------------------------------------------------
Vickar Industries, Inc. Loan 5,907 5,907
- -------------------------------------------------------------------------------------------------------
Vidon, Inc. Loans 262 262
- -------------------------------------------------------------------------------------------------------
Waterview Limited Partnership Option -- 3,050
- -------------------------------------------------------------------------------------------------------
Weathertech Distributing Loans 205 205
Company, Inc.
- -------------------------------------------------------------------------------------------------------
West Virginia Radio Debt Securities 932 932
Corporation
of Clarksburg, Inc. Warrants 400 --
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-8
<PAGE> 74

<TABLE>
<CAPTION>
MARCH 31, 1998
INTEREST NUMBER OF -------------------
(IN THOUSANDS, EXCEPT NUMBER OF INVESTMENTS) RATE RANGES INVESTMENTS COST VALUE
- -------------------------------------------- ---------------- ----------- -------- --------
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 4 $ 2,049 $ 1,861
7.00%- 8.99% 21 46,777 46,777
9.00%-10.99% 99 84,764 84,854
11.00%-12.99% 60 53,093 53,302
13.00%-14.99% 6 11,068 11,068
15.00% and above 1 3,487 3,487
- --------------------------------------------------------------------------------------------------
Total commercial mortgage loans 191 $201,238 $201,349
- --------------------------------------------------------------------------------------------------
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 10 $ 111 $ 111
7.00%- 8.99% 14 188 109
9.00%-10.99% 32 6,641 6,793
11.00%-12.99% 381 39,217 38,773
13.00%-14.99% 4 92 81
15.00% and above -- -- --
- --------------------------------------------------------------------------------------------------
Total Small Business Administration
7(a) loans 441 $ 46,249 $ 45,867
- --------------------------------------------------------------------------------------------------
Interest in securitization pool of
commercial mortgage loans 1 $ 87,937 $ 87,937
- --------------------------------------------------------------------------------------------------
Other portfolio assets 8 $ 4,342 $ 4,295
- --------------------------------------------------------------------------------------------------
Total portfolio at value 733 $562,006 $564,455
- --------------------------------------------------------------------------------------------------
</TABLE>

(1) Public company.

(2) Common stock, preferred stock, warrants, options and equity interests are
generally non-income producing and restricted.
The accompanying notes are an integral part of these consolidated financial
statements.

F-9
<PAGE> 75

CONSOLIDATED STATEMENT OF INVESTMENTS

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
Acme Paging, L.P. Debt Securities $ 5,993 $ 5,993
Partnership Interests 1,456 2,600
- -------------------------------------------------------------------------------------------------------
AGPAL Broadcasting, Inc. Debt Securities 928 928
Warrants -- --
- -------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Loans 1,499 1,499
Inc. Debt Securities 2,250 2,250
Warrants 125 125
- -------------------------------------------------------------------------------------------------------
Arnold Moving Co., Inc. Loans 713 713
- -------------------------------------------------------------------------------------------------------
ARS, Inc. Debt Securities 9,723 9,723
Warrants 171 171
- -------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -------------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc.(1) Debt Securities 7,355 7,355
Warrants 227 234
- -------------------------------------------------------------------------------------------------------
Brazos Sportswear, Inc.(1) Common Stock (342,938 shares) 330 1,547
- -------------------------------------------------------------------------------------------------------
Broadcast Holdings, Inc. Debt Securities 2,696 2,696
Warrants -- 1,054
- -------------------------------------------------------------------------------------------------------
Calendar Broadcasting, Inc. Debt Securities 3,780 3,780
Warrants 144 144
- -------------------------------------------------------------------------------------------------------
Candlewood Hotel Company(1) Preferred Stock (3,250 shares) 3,250 3,250
- -------------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 365 365
Warrants 12 12
- -------------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,983 253
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,776 1,776
Common Stock (220 shares) 1 --
- -------------------------------------------------------------------------------------------------------
Chungsan Corporation Loan 78 78
- -------------------------------------------------------------------------------------------------------
Convenience Corporation of Loans 1,226 1,226
America Debt Securities 8,370 6,245
Series A Preferred Stock (22,797 shares) 265 --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Debt Securities 3,440 3,440
Inc. Warrants -- --
- -------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Debt Securities 3,140 3,140
Hungarian Quotas (9.2%) 700 700
- -------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 1,440
- -------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc.(1) Warrants 350 760
- -------------------------------------------------------------------------------------------------------
Directory Investment Common Stock (470 shares) -- 83
Corporation
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-10
<PAGE> 76

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Directory Lending Corporation Series A Common Stock (1,031 shares) $ -- $ 862
Series B Common Stock (188 shares) 235 157
Series C Common Stock (292 shares) 656 245
Series A Preferred Stock (214 shares) 307 192
Series B Preferred Stock (175 shares) 931 158
Series C Preferred Stock (58 shares) 58 52
- -------------------------------------------------------------------------------------------------------
DMI Furniture, Inc.(1) Convertible Preferred Stock (199,920 shares) 500 982
- -------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 36 4
- -------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 30 30
Debt Securities 1,875 428
Equity Interest -- --
- -------------------------------------------------------------------------------------------------------
El Dorado Communications, Warrants -- 585
Inc.
- -------------------------------------------------------------------------------------------------------
Esquire Communications Warrants 6 1,000
Ltd.(1)
- -------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 65 65
- -------------------------------------------------------------------------------------------------------
Ex Terra Funding, LLC Loan 1,960 1,960
- -------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,653 5,653
Company Warrants 280 280
- -------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loan 200 200
- -------------------------------------------------------------------------------------------------------
Gibson Guitar Corp. Debt Securities 14,475 14,475
Warrants 525 525
- -------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 550 550
Archery, LLC Convertible Debentures 2,248 2,248
- -------------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 3,600
- -------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 7,866 7,866
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Han Hie Loan 518 518
- -------------------------------------------------------------------------------------------------------
H.B.N. Communications, Inc. Loan 262 262
- -------------------------------------------------------------------------------------------------------
Herr-Voss Industries, Inc. Debt Securities 9,500 9,500
Common Stock (132,507 shares) 1,050 1,050
- -------------------------------------------------------------------------------------------------------
HFC Acquisition Sub I, Inc. Loans 232 232
- -------------------------------------------------------------------------------------------------------
In the Dough, Inc. Loan 2 --
- -------------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 128 128
- -------------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,343 2,343
Warrants 74 74
- -------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,630 4,630
Warrants 323 2,099
- -------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Loans 800 800
Debt Securities 2,784 2,784
Warrants 348 2,350
Equity Interest 40 40
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-11
<PAGE> 77

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Kirkland's, Inc. Debt Securities $ 6,250 $ 6,250
Warrants 96 96
- -------------------------------------------------------------------------------------------------------
Kjellberg's Incorporated Loan 3,146 3,146
- -------------------------------------------------------------------------------------------------------
Kurlancheek Loan 311 311
- -------------------------------------------------------------------------------------------------------
Labor Ready, Inc.(1) Common Stock (247,863 shares) 1,477 4,308
- -------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Debt Securities 3,370 3,370
Inc. Common Stock (60,000 shares) 100 100
- -------------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 235 235
- -------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 360 214
Warrants 200 --
- -------------------------------------------------------------------------------------------------------
Magic Auto Loan 17 17
- -------------------------------------------------------------------------------------------------------
MidSouth Data Systems, Inc. Debt Securities 7,550 7,550
Warrants 348 348
- -------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 326 326
Options -- --
- -------------------------------------------------------------------------------------------------------
Mihadas Loan 290 290
- -------------------------------------------------------------------------------------------------------
Mill-It Striping, Inc. Common Stock (18 shares) 250 --
- -------------------------------------------------------------------------------------------------------
MLX/SinterMet Corp.(1) Common Stock (5,835 shares) 241 109
- -------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 33 33
Debt Securities 1,822 219
Common Stock (33,333 shares) -- --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Radio City Mobil Home Park Loan 1,361 1,361
- -------------------------------------------------------------------------------------------------------
Nobel Education Dynamics, Series D Convertible Preferred Stock 2,000 2,000
Inc.(1) (265,957 shares)
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Norman's Yogurt, Inc. Loan 30 30
- -------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, Debt Securities 483 483
L.P.
- -------------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 106 106
- -------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 1,115 888
Warrants 77 --
- -------------------------------------------------------------------------------------------------------
OMA, Inc. Loans 1,931 1,931
- -------------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 323 323
- -------------------------------------------------------------------------------------------------------
Peerless Group, Inc.(1) Common Stock (379,475 shares) 17 1,405
Warrants 4 667
- -------------------------------------------------------------------------------------------------------
David Peters Loan 169 55
- -------------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loans 107 107
Preferred Stock (276 shares) 160 175
Common Stock (36 shares) -- --
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-12
<PAGE> 78

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Pico Products, Inc.(1) Debt Securities $ 5,669 $ 5,669
Common Stock (248,000 shares) 71 336
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (94,479 shares) 901 344
Holdings, PLC(1)
- -------------------------------------------------------------------------------------------------------
Radio One of Atlanta, Inc. Loans 341 341
Debt Securities 9,951 9,951
Common Stock (1,430 shares) -- --
- -------------------------------------------------------------------------------------------------------
Randhawa Brothers Loans 217 217
Enterprises, Inc.
- -------------------------------------------------------------------------------------------------------
R-Tex Decoratives Company, Debt Securities 1,513 1,170
Inc. Warrants 58 --
- -------------------------------------------------------------------------------------------------------
R.L. Singletary Loan 112 112
- -------------------------------------------------------------------------------------------------------
Saturn Chemicals, Inc. Loan -- --
- -------------------------------------------------------------------------------------------------------
SerpCo., Inc. Loan 182 182
- -------------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 398 322
Common Stock (6,208 shares) 22 --
- -------------------------------------------------------------------------------------------------------
SunStates Refrigerated Loans 1,557 68
Services, Inc. Debt Securities 4,262 1,486
- -------------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,582 129
Common Stock (910 shares) 57 --
- -------------------------------------------------------------------------------------------------------
University Village Mobile Loan 157 157
Homes
- -------------------------------------------------------------------------------------------------------
Vidon, Inc. Loans 262 262
- -------------------------------------------------------------------------------------------------------
Waterview Limited Partnership Option -- 3,050
- -------------------------------------------------------------------------------------------------------
Weathertech Distributing Loans 291 291
Company, Inc.
- -------------------------------------------------------------------------------------------------------
West Virginia Radio Debt Securities 962 962
Corporation
of Clarksburg, Inc. Warrants 400 --
- -------------------------------------------------------------------------------------------------------
William R. Dye Loan 270 270
- -------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Loans 720 720
Company Debt Securities 308 308
Warrants 24 24
- -------------------------------------------------------------------------------------------------------
Z-Spanish Radio Network, Inc. Loans 11,636 11,636
Debt Securities 750 750
Warrants 6 6
- -------------------------------------------------------------------------------------------------------
Total mezzanine loans and debt securities and equity
interests in portfolio companies (89 investments) $201,234 $207,748
- -------------------------------------------------------------------------------------------------------
(1) Public company.
(2) Common stock, preferred stock, warrants, options and equity interests are generally non-income
producing and restricted.
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-13
<PAGE> 79

<TABLE>
<CAPTION>
DECEMBER 31, 1997
INTEREST NUMBER OF -------------------
RATE RANGES INVESTMENTS COST VALUE
(IN THOUSANDS, EXCEPT NUMBER OF INVESTMENTS) ---------------- ----------- -------- --------
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 6 $ 6,129 $ 6,129
7.00%- 8.99% 49 108,313 108,313
9.00%-10.99% 156 259,203 259,221
11.00%-12.99% 72 61,681 61,891
13.00%-14.99% 7 8,196 8,196
15.00% and above 1 3,494 3,494
- --------------------------------------------------------------------------------------------------
Total commercial mortgage loans 292 $447,016 $447,244
- --------------------------------------------------------------------------------------------------
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 10 $ 111 $ 111
7.00%- 8.99% 16 192 107
9.00%-10.99% 24 2,636 2,673
11.00%-12.99% 378 38,072 37,739
13.00%-14.99% 4 92 79
15.00% and above -- -- --
- --------------------------------------------------------------------------------------------------
Total Small Business Administration
7(a) loans 432 $ 41,103 $ 40,709
- --------------------------------------------------------------------------------------------------
Other portfolio assets 6 $ 1,367 $ 1,320
- --------------------------------------------------------------------------------------------------
Total portfolio at value 819 $690,720 $697,021
- --------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-14
<PAGE> 80

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. MERGER

On December 31, 1997, Allied Capital Corporation ("Allied I"), Allied
Capital Corporation II ("Allied II"), Allied Capital Commercial Corporation
("Allied Commercial"), and Allied Capital Advisers, Inc. ("Advisers"), merged
with and into Allied Capital Lending Corporation ("Allied Lending") (each a
"Predecessor Company" and collectively the "Predecessor Companies") pursuant to
an Agreement and Plan of Merger, dated as of August 14, 1997, as amended and
restated as of September 19, 1997 in a stock-for-stock exchange (the "Merger").
Immediately following the Merger, Allied Lending changed its name to Allied
Capital Corporation ("ACC" or the "Company").

The Merger was effected through a conversion of each share of Predecessor
Company common stock into the number of shares of Allied Lending common stock
determined pursuant to the following exchange ratios: Allied I -- 1.07 shares;
Allied II -- 1.40 shares; Allied Commercial -- 1.60 shares; and Advisers -- 0.31
shares. Allied Lending's common stock outstanding prior to the Merger continues
to be outstanding, and was not converted or changed in the Merger. On December
31, 1997, subsequent to the exchange of shares, the Company had 52,047,318
shares outstanding.

The Merger was treated as a tax-free reorganization under Section 368
(a)(1)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). For
federal income tax purposes, the Predecessor Companies carried forward the
historical cost basis of their assets and liabilities to the surviving entity
(ACC). For financial reporting purposes, the Predecessor Companies also carried
forward the historical cost basis of their respective assets and liabilities at
the time the Merger was effected. The consolidated financial statements reflect
the operations of ACC with all periods presented restated as if the Predecessor
Companies had merged as of the beginning of the earliest period presented.

To facilitate the Merger, Allied Lending's charter was amended primarily to
effect: (a) an increase in the number of authorized shares of common stock, par
value one-tenth of one mil ($0.0001) per share, from 20,000,000 to 100,000,000
shares; and (b) a change in Allied Lending's name to "Allied Capital
Corporation."

Prior to the Merger, Allied I owned approximately 16 percent of Allied
Lending's total shares outstanding. These shares were distributed to the Allied
I shareholders in a dividend immediately prior to the Merger at a rate of
0.107448 shares of Allied Lending for each share of Allied I held on the record
date. For financial reporting purposes, Allied I's ownership of Allied Lending
has been eliminated for all periods presented.

NOTE 2. ORGANIZATION

Allied Capital Corporation, a Maryland corporation, is a closed-end
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 has three wholly owned subsidiaries that have
also elected to be regulated as BDCs. Allied Investment Corporation ("Allied
Investment") and Allied Capital Financial Corporation ("Allied Financial") are
licensed under the Small Business Investment Act of 1958 as a Small Business
Investment Company and a Specialized Small Business Investment Company,
respectively. Allied Capital SBLC Corporation ("Allied SBLC") is licensed by the
Small Business Administration ("SBA") as a Small Business Lending Company and is
a participant in the SBA Section 7(a) Guaranteed Loan Program. In addition, the
Company has also established a real estate investment trust subsidiary, Allied
Capital REIT, Inc. ("Allied REIT"). Allied REIT owns several single-member
limited liability companies established primarily to hold real estate
properties.

Allied Capital Corporation and its subsidiaries, collectively, are
hereinafter referred to as the "Company" or "ACC."

F-15
<PAGE> 81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2. ORGANIZATION, CONTINUED
The investment objective of the Company is to achieve current income and
capital gains. In order to achieve this objective, the Company invests primarily
in private, growing businesses in a variety of industries and in diverse
geographic locations (primarily in the United States).

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements for the periods presented have been
restated to include the accounts of the Predecessor Companies for all periods
presented. Transaction fees and expenses related to the Merger were expensed in
the fourth quarter of 1997. The consolidated financial statements include the
accounts of the Company or its wholly owned or majority owned subsidiaries. All
intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to the 1997, 1996 and 1995 balances to
conform with the 1998 financial statement presentation.

VALUATION OF PORTFOLIO INVESTMENTS

Portfolio investments are carried at fair value, as determined by the board
of directors under the Company's valuation policy.

The values of loans and debt securities are based on the board of
directors' evaluation of the financial condition of the borrowers and/or the
underlying collateral. The values assigned are considered to be amounts which
could be realized in the normal course of business which, generally, anticipates
the Company holding the loan to maturity and realizing the face value of the
loan. For debt securities and loans, value normally corresponds to cost unless
the borrower's condition or external factors lead to a determination of value at
a lower amount.

Equity interests in portfolio companies for which there is no public market
are valued based on various factors including history of positive cash flow from
operations, the market value of comparable publicly traded companies (discounted
for illiquidity), and other pertinent factors. The board of directors also
considers recent offers to purchase a portfolio company's securities when
valuing equity interests.

The Company's equity interests in public companies that carry certain
restrictions on sale are typically valued at a discount from the public market
value of the security at the balance sheet date. Other publicly traded stocks
may also be valued at a discount due to the investment size or market liquidity
concerns.

INTEREST INCOME

Interest income is recorded on the accrual basis to the extent that such
amounts are expected to be collected. Loan origination fees, original issue
discount, and market discount are amortized into interest income using the
effective interest method.

NET REALIZED AND UNREALIZED GAINS

Realized gains or losses are measured by the difference between the net
proceeds from the sale and the cost basis of the investment without regard to
unrealized gains or losses previously recognized, and include investments
charged off during the year, net of recoveries. Unrealized gains or losses
reflect the change in the valuation of the portfolio investment during the
reporting period.

DISTRIBUTIONS TO SHAREHOLDERS

Distributions to shareholders are recorded on the record date.

F-16
<PAGE> 82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FEDERAL AND STATE INCOME TAXES

With the exception of Advisers, the Predecessor Companies qualified as
regulated investment companies ("RIC") or a real estate investment trust
("REIT"); however, Advisers was a corporation subject to federal and state
income taxes. Income tax expense reported on the consolidated statement of
operations relates to the operations of Advisers for all periods presented.

The Company and its wholly owned subsidiaries intend to comply with the
requirements of the Code that are applicable to RICs and REITs. The Company and
its wholly owned subsidiaries intend to distribute annually all of their taxable
income to shareholders; therefore, the Company has made no provision for
deferred taxes.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to reduce interest rate
risk. The Company has established policies and procedures for risk assessment
and the approval, reporting and monitoring of derivative financial instrument
activities. The Company does not hold or issue derivative financial instruments
for trading purposes.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash in banks and all highly liquid
investments with original maturities of three months or less.

DEFERRED FINANCING COSTS

Financing costs are based on actual costs incurred in obtaining financing
and are deferred and amortized as part of interest expense over the term of the
related debt instrument.

PER SHARE INFORMATION

Basic earnings per share is calculated using the weighted average number of
shares outstanding for the period presented. Diluted earnings per share reflects
the potential dilution that could occur if securities to issue common stock were
exercised into common stock. Earnings per share are computed after subtracting
dividends on Preferred Shares.

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

The preparation of financial statements in conformity with 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
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from these estimates.

NOTE 4. PORTFOLIO

The Company lends and invests in growing businesses through three primary
products: mezzanine loans and debt and equity securities, commercial mortgage
loans, and 7(a) loans.

MEZZANINE FINANCE

Mezzanine investments are generally structured as loans that carry a
relatively high fixed rate of interest, which may be combined with equity
features, such as conversion privileges, warrants or options to purchase a
portion of the portfolio company's equity at a nominal price. Such an investment
would typically have a

F-17
<PAGE> 83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

maturity of five to ten years, with interest-only payments in the early years
and payments of both principal and interest in the later years, although loan
maturities and principal amortization schedules vary. At March 31, 1998 and
December 31, 1997, approximately 98 percent of the Company's mezzanine loan
portfolio was composed of fixed interest rate loans. The weighted average yield
(at value) on the mezzanine portfolio at March 31, 1998 and December 31, 1997
and 1996 equaled 13.2 percent, 12.6 percent and 13.2 percent, respectively. At
March 31, 1998 and December 31, 1997 and 1996, mezzanine loans and debt
securities with a cost basis of $25,674,000, $13,661,000 and $16,648,000,
respectively, were not accruing interest.

At March 31, 1998 and December 31, 1997, approximately 31 percent and 29
percent, 28 percent and 27 percent, 18 percent and 17 percent, 11 percent and 13
percent, and 7 percent and 8 percent of the Company's mezzanine portfolio was
located in the mid-atlantic, southeast, midwest, west, and northeast regions,
respectively. In addition, 5 percent and 6 percent, respectively, of the
mezzanine portfolio was located in other countries. Loans to businesses in the
industrial/manufacturing, broadcasting/communications, retail/wholesale, and
services industries equaled approximately 47 percent and 43 percent, 17 percent
and 26 percent, 13 percent and 15 percent, and 17 percent and 12 percent,
respectively, or 94 percent and 96 percent as of March 31, 1998 and December 31,
1997, respectively.

Equity investments consist primarily of securities issued by privately
owned companies and may be subject to restrictions on their resale or otherwise
illiquid. Equity securities generally do not produce a current return, but are
held for investment appreciation and ultimate gain on sale.

COMMERCIAL REAL ESTATE FINANCE

The commercial real estate portfolio contains loans that were originated by
the Company or were purchased from the Resolution Trust Corporation, the Federal
Deposit Insurance Corporation and other third party sellers including life
insurance companies and banks.

At March 31, 1998 and December 31, 1997, approximately 61 percent and 39
percent, and 73 percent and 27 percent of the Company's commercial mortgage loan
portfolio was composed of fixed and adjustable interest rate loans,
respectively. At March 31, 1998 and December 31, 1997, approximately 47 percent
and 38 percent, 12 percent and 18 percent, 19 percent and 18 percent, 14 percent
and 14 percent, and 8 percent and 12 percent of the Company's commercial real
estate portfolio was located in the mid-atlantic, midwest, west, southeast, and
northeast regions, respectively. In addition, commercial mortgage loans secured
by hospitality, office, retail, recreation and other properties equaled
approximately 28 percent and 33 percent, 41 percent and 31 percent, 11 percent
and 14 percent, 5 percent and 3 percent, and 15 percent and 19 percent,
respectively, of the Company's portfolio at March 31, 1998 and December 31,
1997, respectively.

The weighted average yield (at value) on the real estate portfolio as of
March 31, 1998 and December 31, 1997 and 1996 equaled 11.9 percent, 11.4 percent
and 13.4 percent, respectively. As of March 31, 1998 and December 31, 1997 and
1996, loans with a cost basis of $6,202,000, $11,987,000 and $10,978,000,
respectively, were not accruing interest.

As of March 31, 1998 and December 31, 1997 and 1996, unamortized discount
related to the real estate portfolio was $16,459,000, $27,954,000 and
$37,124,000, respectively. Unamortized discounts are considered in determining
the fair value and are amortized into income over the life of the loan.

SMALL BUSINESS LENDING

The Company, through its wholly owned subsidiary, Allied SBLC, participates
in the SBA's Section 7(a) Guaranteed Loan Program.

Pursuant to Section 7(a) of the Small Business Act of 1958, the SBA will
guarantee 80 percent of any qualified loan up to $100,000 regardless of
maturity, and 75 percent of any such loan over $100,000 regardless

F-18
<PAGE> 84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED
of maturity, to a maximum guarantee of $750,000 for any one borrower. SBA
regulations define qualified small businesses generally as businesses with no
more than $5 million in annual sales and no more than 500 employees.

The Company charges interest on these loans at a variable rate, typically
1.75 percent to 2.75 percent above the prime rate, as published in The Wall
Street Journal or other financial newspaper, adjusted monthly. All loans are
payable in equal monthly installments of principal and interest from the date on
which the loan was made to its maturity. At March 31, 1998 and December 31,
1997, approximately 94 percent and 92 percent of the Company's portfolio of 7(a)
loans were variable interest rate loans.

As permitted by SBA regulations, the Company sells to investors, without
recourse, the guaranteed portion of its loans while retaining the right to
service 100 percent of such loans.

As of March 31, 1998 and December 31, 1997 and 1996, 7(a) loans with a cost
basis of $3,984,000, $4,346,000 and $3,734,000, respectively, were not accruing
interest.

At March 31, 1998 and December 31, 1997, approximately 40 percent and 36
percent, 31 percent and 29 percent, 14 percent and 18 percent, 8 percent and 10
percent, and 7 percent and 7 percent of the Company's 7(a) loan portfolio was
located in the midwest, mid-atlantic, southeast, northeast, and west regions,
respectively. In addition, loans to businesses in the hospitality, automotive
services, broadcasting/communications, restaurant/food services,
industrial/manufacturing, services, and retail/wholesale industries equaled 32
percent and 25 percent, 23 percent and 21 percent, 6 percent and 10 percent, 8
percent and 9 percent, 8 percent and 7 percent, 4 percent and 6 percent, and 3
percent and 6 percent, respectively, or 84 percent and 84 percent of the
Company's portfolio as of March 31, 1998 and December 31, 1997.

INTEREST IN SECURITIZATION POOL OF COMMERCIAL MORTGAGE LOANS

On January 30, 1998, the Company in conjunction with Business Mortgage
Investors, Inc. ("BMI"), a private REIT managed by the Company, completed a $310
million asset securitization, whereby bonds totaling $239 million were sold in
three classes rated "AAA", "AA" and "A" by Standard & Poor's Rating Services and
Fitch IBCA, Inc. in a private placement. The Company and BMI sold a pool of 97
commercial mortgage loans totaling $310 million to a special purpose, bankruptcy
remote entity which transferred the assets to a trust which issued the bonds.
The Company contributed approximately 95%, or $295 million, of the total assets
securitized, and received cash proceeds, net of costs of approximately $223
million. The Company retained a trust certificate for its residual interest (the
"residual interest") in the loan pool sold, and will receive interest income
from this residual interest as well as receive the net spread of the interest
earned on the loans sold less the interest paid on the bonds over the life of
the bonds (the "residual securitization spread"). The mortgage loan pool had an
approximate weighted average stated interest rate of 9.6%. The three bond
classes sold have an aggregate weighted average interest rate of approximately
6.38%.

The Company accounted for the securitization in accordance with Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." As a result,
the Company recorded a gain of approximately $14.8 million net of the costs of
the securitization and the cost of settlement of interest rate swaps. The gain
arises from the difference between the carrying amount of the loans and the fair
market value of the assets received--cash, residual securitization spread,
residual interest and a servicing asset. The value of the residual
securitization spread, $17.0 million, was determined based on the future
expected cash flows, assuming a constant prepayment rate for the mortgage loan
pool of 10%, discounted at 16%. The value of the residual interest was
determined to be $66.5 million and was based on the future expected cash flows
less projected losses of approximately $3.0 million. The projected losses were
based upon the attributes of the portfolio sold and the underlying collateral
values. The weighted average loan to collateral value of the 97 loans sold was
68.3%. The expected

F-19
<PAGE> 85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED
future cash flow from the residual interest was discounted at 9.6%. The
servicing asset was valued at $227,000 assuming a net servicing fee of 0.04% and
was discounted at a rate of 10%.

NOTE 5. DEBT

At March 31, 1998 and December 31, 1997 and 1996, the Company had the
following available credit facilities:
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, -----------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
FACILITY AMOUNT FACILITY AMOUNT FACILITY AMOUNT
AMOUNT DRAWN AMOUNT DRAWN AMOUNT DRAWN
-------- -------- -------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS)

<S> <C> <C> <C> <C> <C> <C>
Notes payable and debentures:
Master repurchase
agreement................ $250,000 $ 8,243 $250,000 $202,705 $150,000 $ 85,775
Master loan and security
agreement................ 250,000 9,000 250,000 23,116 -- --
Senior note payable........ 20,000 20,000 20,000 20,000 20,000 20,000
OPIC loan.................. 8,700 8,700 20,000 8,700 20,000 8,700
SBA debentures............. 53,300 53,300 54,300 54,300 61,300 61,300
Bonds payable.............. -- -- -- -- 54,123 54,123
-------- -------- -------- -------- -------- --------
Total notes payable
and debentures...... 582,000 99,243 594,300 308,821 305,423 229,898
-------- -------- -------- -------- -------- --------
Revolving lines of credit....... 200,000 103,000 80,000 38,842 110,000 45,099
-------- -------- -------- -------- -------- --------
Total debt............ $782,000 $202,243 $674,300 $347,663 $415,423 $274,997
======== ======== ======== ======== ======== ========
</TABLE>

MASTER REPURCHASE AGREEMENT

The Company and BMI can borrow up to $250,000,000, of which $100,000,000 is
committed, through repurchase agreements using its commercial mortgage loans as
collateral. The Company pledges commercial mortgage loans as collateral for the
facility such that the amount borrowed is approximately equal to 75 percent to
80 percent of the value of the collateral pledged. The terms of the master
repurchase agreement require interest only payments with all principal due at
maturity. The master repurchase agreement bears interest at the one-month London
Inter Bank Offered Rate ("LIBOR") plus 1.13 percent, or 6.8 percent, 6.8 percent
and 6.7 percent at March 31, 1998 and December 31, 1997 and 1996, respectively.
The facility requires an annual commitment fee equal to 0.25% of the committed
amount. The average debt outstanding under the master repurchase agreement for
the three months ended March 31, 1998 and the years ended December 31, 1997 and
1996 was $70,504,000, $166,362,000 and $51,767,000, respectively. The maximum
amount borrowed under this facility was $202,705,000, $209,591,000 and
$85,775,000 during the three months ended March 31, 1998 and the years ended
December 31, 1997 and 1996, respectively. The weighted average interest rate for
this facility during the three months ended March 31, 1998 and the years ended
December 31, 1997 and 1996 was 6.8%, 6.6% and 7.3%, respectively. The master
repurchase agreement matures on January 31, 1999.

F-20
<PAGE> 86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. DEBT, CONTINUED
MASTER LOAN AND SECURITY AGREEMENT

During 1997, the Company, again in conjunction with BMI, established a
facility to borrow up to $250,000,000, of which $100,000,000 is committed, using
its commercial mortgage loans as collateral under the agreement. At March 31,
1998 and December 31, 1997, the Company's recorded investment in these loans
pledged as collateral totaled $13,165,000 and $29,193,000, which approximated
their market value. The agreement generally requires interest only payments with
all principal due at maturity. The agreement bears interest at the one-month
LIBOR plus 1.0 percent, or 6.7 percent, at March 31, 1998 and December 31, 1997.
The facility requires an annual commitment fee equal to 0.75% of the committed
amount. The average debt outstanding under this facility for the three months
ended March 31, 1998 and the year ended December 31, 1997 was $7,378,000 and
$17,899,000, respectively. The maximum amount borrowed under this facility was
$23,116,000 during the three months ended March 31, 1998 and the year ended
December 31, 1997. The weighted average interest rate for this facility during
the three months ended March 31, 1998 and the year ended December 31, 1997 was
6.6% and 6.7%, respectively. The agreement matures on August 21, 1998.

SENIOR NOTE PAYABLE

The Company has a $20,000,000 unsecured senior note payable to an insurance
company. This note bears interest at a fixed rate of 9.15 percent, payable
semi-annually. The note is scheduled to mature over a five-year period
commencing in 1998 with annual principal payments of $4,000,000. The senior note
payable is subject to a prepayment penalty if paid prior to maturity.

OVERSEAS PRIVATE INVESTMENT CORPORATION (OPIC) LOAN

The Company has a loan agreement with OPIC to provide financing for
international projects involving qualifying U.S. small businesses. Loans under
this agreement bear interest at the U.S. Treasury rate plus 0.5 percent for the
applicable period of the borrowing. In addition, OPIC is entitled to receive
from the Company a contingent fee at maturity of the loan equal to 5 percent of
the return generated by the OPIC-related investments in excess of 7 percent.
There are no required principal payments until the OPIC loans mature in January
2006.

SBA DEBENTURES

At March 31, 1998, the Company had debentures totaling $53,300,000 payable
to the SBA at interest rates ranging from 6.87 percent to 9.80 percent, with
scheduled maturity dates as follows: 1998 -- $5,650,000; 1999 -- $0;
2000 -- $17,300,000; 2001 -- $9,350,000; 2002 -- $0; and $21,000,000 thereafter.
At December 31, 1997, the Company had outstanding debentures totaling
$54,300,000 at interest rates ranging from 6.87 percent to 9.80 percent. The
debentures require semi-annual interest-only payments with all principal due
upon maturity. The SBA debentures are subject to prepayment penalties if paid
prior to maturity.

BONDS PAYABLE

The Company issued $98,810,000 of 6.92 percent series 1995-C1 Commercial
Mortgage Collateralized Bonds during November 1995. The bonds were rated "AA" by
Fitch Investors Service, L.P. The bonds were repaid in full in November 1997.

REVOLVING LINES OF CREDIT

Subsequent to the Merger, the Company repaid all of its previous unsecured
revolving lines of credit and entered into a new $200,000,000 unsecured
revolving line of credit. The new facility bears interest at LIBOR plus 1.25
percent or 6.95 percent at March 31, 1998, and requires a commitment fee equal
to 0.2 percent of

F-21
<PAGE> 87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. DEBT, CONTINUED
the committed amount, and a facility fee equal to 0.15 percent of the initial
commitment. The new line expires June 30, 1999. The new line of credit requires
monthly payments of interest and all principal is due upon its expiration. The
amount borrowed is based upon a borrowing base formula generally equal to 50
percent of the Company's portfolio investments not securing other credit
facilities.

At December 31, 1997, the Company had several revolving lines of credit
totaling $80,000,000 under which the Company had outstanding borrowings totaling
$38,842,000. At December 31, 1996, the Company had several revolving lines of
credit totaling $110,000,000 under which the Company had outstanding borrowings
totaling $45,099,000. The lines of credit charged interest at rates ranging from
LIBOR plus 1.35 percent to 2.5 percent. At December 31, 1997 and 1996 the
weighted average interest rate on the facilities was 7.7 percent and 7.8
percent, respectively. The lines required various commitment and other fees
equal to 0.39 percent of the outstanding borrowings at December 31, 1997.

The average debt outstanding on the revolving lines of credit was
$64,347,000, $30,033,000 and $28,216,000 for the three months ended March 31,
1998 and the years ended December 31, 1997 and 1996, respectively. The maximum
amount borrowed under these facilities was $103,000,000, $45,759,000 and
$45,099,000 during the same periods, respectively. The weighted average interest
rate for these facilities during the three months ended March 31, 1998 and the
years ended December 31, 1997 and 1996 was 7.0 percent, 8.1 percent and 8.2
percent, respectively.

NOTE 6. INCOME TAXES

For the years ended December 31, 1997, 1996 and 1995, the Company's
effective tax rate was 2.3 percent, 3.5 percent and 2.9 percent, respectively.

The Company's income subject to federal and state taxes relates to the
income generated by the pre-Merger operations of Advisers. The income generated
by the other Predecessor Companies is not subject to federal and state income
taxes because these companies qualify as RICs or REITs. Therefore, no income tax
expense is expected to be incurred in 1998.

NOTE 7. PREFERRED STOCK

At March 31, 1998 and December 31, 1997 and 1996, Allied Financial had
outstanding a total of 60,000 shares of $100 par value, 3 percent cumulative
preferred stock and 10,000 shares of $100 par value, 4 percent redeemable
cumulative preferred stock issued to the SBA pursuant to Section 303(c) of the
Small Business Investment Act of 1958, as amended. The 3 percent cumulative
preferred stock does not have a required redemption date. Allied Financial has
the option to redeem in whole or in part the 3 percent cumulative preferred
stock by paying the SBA the par value of such securities and any dividends
accumulated and unpaid to the date of redemption. The 4 percent redeemable
cumulative preferred stock has a required redemption date of June 4, 2005.

NOTE 8. SHAREHOLDERS' EQUITY

In 1996, the Company completed two non-transferable subscription rights
offerings to common shareholders. The Company issued 1,433,414 shares of common
stock pursuant to these offerings raising net proceeds to the Company of
$17,147,000, after costs including a 2.5 percent fee paid to eligible
broker/dealers.

In 1996, the Company also sold 400,000 shares of its common stock through
an underwriter in a registered offering for net proceeds of $5,218,000.

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 sales prices reported for the

F-22
<PAGE> 88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 8. SHAREHOLDERS' EQUITY, CONTINUED
Company's common stock for the five days on which trading in the shares takes
place immediately prior to the dividend payment date. For the three months ended
March 31, 1998 and the years ended December 31, 1997 and 1996, the Company
issued 66,232, 550,971 and 913,206 shares, respectively, at an average price of
$25.33, $15.67 and $13.13 per share, respectively.

F-23
<PAGE> 89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 9. EARNINGS PER COMMON SHARE

<TABLE>
<CAPTION>
PER COMMON
INCOME SHARES SHARE AMOUNT
-------- ------- -------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
FOR THE THREE MONTHS ENDED MARCH 31, 1998 (UNAUDITED)
Net increase in net assets resulting from operations... $32,065
Less: Preferred stock dividends........................ (55)
-------
Income available to common shareholders................ $32,010
=======
BASIC EARNINGS PER COMMON SHARE........................ 51,814 $0.62
=====
Options outstanding to officers........................ 294
------
DILUTED EARNINGS PER COMMON SHARE...................... 52,108 $0.61
====== =====
FOR THE THREE MONTHS ENDED MARCH 31, 1997 (UNAUDITED)
Net increase in net assets resulting from operations... $12,646
Less: Preferred stock dividends........................ (55)
-------
Income available to common shareholders................ $12,591
=======
BASIC EARNINGS PER COMMON SHARE........................ 46,938 $0.27
=====
Options outstanding to officers........................ 575
------
DILUTED EARNINGS PER COMMON SHARE...................... 47,513 $0.27
====== =====
1997
Net increase in net assets resulting from operations... $61,304
Less: Preferred stock dividends........................ (220)
-------
Income available to common shareholders................ $61,084
=======
BASIC EARNINGS PER COMMON SHARE........................ 49,218 $1.24
=====
Options outstanding to officers........................ 33
------
DILUTED EARNINGS PER COMMON SHARE...................... 49,251 $1.24
====== =====
1996
Net increase in net assets resulting from operations... $54,947
Less: Preferred stock dividends........................ (220)
-------
Income available to common shareholders................ $54,727
=======
BASIC EARNINGS PER COMMON SHARE........................ 46,172 $1.19
=====
Options outstanding to officers........................ 561
------
DILUTED EARNINGS PER COMMON SHARE...................... 46,733 $1.17
====== =====
1995
Net increase in net assets resulting from operations... $60,479
Less: Preferred stock dividends........................ (220)
-------
Income available to common shareholders................ $60,259
=======
BASIC EARNINGS PER COMMON SHARE........................ 43,697 $1.38
=====
Options outstanding to officers........................ 313
------
DILUTED EARNINGS PER COMMON SHARE...................... 44,010 $1.37
====== =====
</TABLE>

Basic earnings per common share was computed by dividing the net increase
in net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding each
period.

Diluted earnings per common share was computed by dividing the net increase
in net assets resulting from operations, after deducting preferred stock
dividends, by the weighted average number of common shares outstanding plus
common shares issuable upon assumed exercise of stock options outstanding each
period.

F-24
<PAGE> 90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 10. EMPLOYEE STOCK OWNERSHIP PLAN AND DEFERRED COMPENSATION PLAN

The Company has an employee stock ownership plan ("ESOP"). Pursuant to the
ESOP, the Company is obligated to contribute 5 percent of each eligible
participant's total cash compensation for the year to a plan account on the
participant's behalf, which vests over a two-year period. ESOP contributions are
used to purchase shares of ACC.

At March 31, 1998, the ESOP held 433,047 shares of the Company's common
stock, all of which had been allocated to participants' accounts. The plan is
funded annually and the total ESOP contribution expense for the years ended
December 31, 1997, 1996 and 1995 was $351,000, $1,018,000 and $864,000,
respectively, net of forfeitures of $0, $36,000 and $180,000 in 1997, 1996 and
1995, respectively.

The Company also has a deferred compensation plan (the "DC Plan"). Eligible
participants of the DC Plan may elect to defer some of their compensation and
have such compensation credited to a participant account. All amounts credited
to a participant's account shall be credited solely for purposes of accounting
and computation and shall remain assets of the Company and subject to the claims
of the Company's general creditors. Amounts credited to participants under the
DC Plan are at all times 100 percent vested and non-forfeitable except for
amounts credited to participants' accounts related to the Formula Award (see
Note 12). A participant's account shall become distributable upon his or her
separation from service, retirement, disability, death, or at a future
determined date. All DC Plan accounts will be distributed in the event of a
change of control of ACC or in the event of the Company's insolvency. Amounts
deferred by participants under the DC Plan are funded to a trust, the trustee of
which administers the DC Plan on behalf of the Company.

NOTE 11. STOCK OPTION PLAN

In conjunction with the Merger, all stock option plans that existed for
Allied Lending and the Predecessor Companies before the Merger ("Old Plans")
were cancelled on December 31, 1997, and at a special meeting of shareholders on
November 26, 1997, the Company's shareholders approved a new stock option plan
("ACC Plan") for the Company to be effected post-Merger.

THE ACC PLAN

The purpose of the ACC Plan is to provide officers and non-officer
directors of ACC with additional incentives. Options may be granted from time to
time on up to 6,250,000 shares which represents approximately 12 percent of the
outstanding shares as of December 31, 1997. Options will be exercisable at a
price equal to the fair market value of the shares on the day the option is
granted. Each option will state 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.

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 ACC for any cause other than death or total and permanent
disability. If an optionee dies or becomes totally and permanently disabled
before expiration of the options without fully exercising it, he or she or the
executors or administrators or legatees or distributees of the estate shall, as
may be provided at the time of the grant, have the right, within one year after
the optionee's death or total and permanent disability, to exercise the options
in whole or in part before the expiration of its term. In the event of a change
of control of ACC, all outstanding options will become fully vested and
exercisable as of the change of control. On January 8, 1998, the Company's
compensation committee granted a total of 3,415,446 options to officers of the
Company under the ACC Plan. The options awarded to officers were generally
non-qualified stock options that vest over a five-year period from the grant
date. The stock options granted had an exercise price equal to $21.38 per share.
At March 31, 1998, options for 610,330 shares were exercisable into common
stock. No options were exercised or canceled during the three months ended March
31, 1998. There were no options granted pursuant to the ACC Plan as of December
31, 1997.

F-25
<PAGE> 91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 11. STOCK OPTION PLAN, CONTINUED
NOTES RECEIVABLE FROM THE SALE OF COMMON STOCK

The Company provides loans to officers for the exercise of options. The
loans 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 of shareholders' equity. At March 31, 1998 and December
31, 1997, 1996 and 1995, the Company had outstanding loans to officers of
$26,556,000, $29,611,000, $15,491,000, and $7,315,000, respectively. Officers
with outstanding loans repaid principal of $3,055,000, $6,534,000, $2,199,000
and $1,038,000 for the three months ended March 31, 1998 and the years ended
December 31, 1997, 1996 and 1995, respectively. The Company recognized interest
income from these loans of $456,000, $1,031,000, $529,000 and $276,000,
respectively, during these same periods.

OLD PLAN ACTIVITY

During 1997, 1996 and 1995, the Predecessor Companies granted 1,474,000,
866,000, and 1,505,000 options, respectively, under the Old Plans at exercise
prices ranging from $9.53 to $22.58 per share. Total shares issued pursuant to
the exercise of stock options totaled 2,395,000, 1,051,000, and 576,000 during
1997, 1996 and 1995, respectively.

The Company accounts for the ACC Plan as required by the Accounting
Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," and
no compensation cost has been recognized. Had compensation cost for the plan
been determined consistent with SFAS No. 123 "Accounting for Stock Based
Compensation," the Company's net increase in net assets resulting from
operations and basic earnings per share would have been reduced to the following
pro forma amounts:

<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net increase in net assets resulting from operations:
As reported.......................................... $61,304 $54,947 $60,479
Pro forma............................................ $60,656 $53,372 $58,931
Basic earnings per common share:
As reported.......................................... $ 1.24 $ 1.19 $ 1.38
Pro forma............................................ $ 1.23 $ 1.16 $ 1.35
Diluted earnings per common share:
As reported.......................................... $ 1.24 $ 1.17 $ 1.37
Pro forma............................................ $ 1.23 $ 1.14 $ 1.34
</TABLE>

Pro forma expenses are based on the underlying value of the options granted
by the Company and the Predecessor Companies. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option pricing
model.

NOTE 12. CUT-OFF AWARD AND FORMULA AWARD

The Predecessor Companies' existing stock option plans were canceled and
the Company established a cut-off dollar amount for all existing, but unvested
options as of the date of the Merger (the "Cut-off Award"). The Cut-off Award is
computed for each unvested option as of the Merger date. The Cut-off Award is
equal to the difference between the market price on August 14, 1997 (the Merger
announcement date) of the shares of stock underlying the option less the
exercise price of the option. The Cut-off Award is payable for each unvested
option upon the future vesting date of that option. The Cut-off Award was
designed to cap the appreciated value in unvested options at the Merger
announcement date, in order to set the foundation to balance option awards upon
the Merger. The Cut-off Award approximates $2.9 million in the aggregate and

F-26
<PAGE> 92
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 12. CUT-OFF AWARD AND FORMULA AWARD, CONTINUED
will be expensed as the Cut-off Award vests. For the three months ended March
31, 1998, $189,000 of the Cut-off Award vested and $256,000 was forfeited.

The Formula Award was established to compensate employees from the point
when their unvested options would cease to appreciate in value (the Merger
announcement date), up until the time at which they would be able to receive
option awards in ACC post-Merger. In the aggregate, the Formula Award equaled 6
percent of the difference between an amount equal to the combined aggregated
market capitalizations of the Predecessor Companies as of the close of the
market on the day before the Merger date (December 30, 1997), less an amount
equal to the combined aggregate market capitalizations of the Predecessor
Companies as of the close of the market on the Merger announcement date (August
14, 1997). Advisers' compensation committee allocated the Formula Award to
individual officers on December 30, 1997. The amount of the Formula Award as
computed at December 30, 1997 approximated $19 million. For the three month
period ended March 31, 1998, the Company funded the DC Plan with approximately
$19 million in cash in connection with the Formula Award. The Trustee of the DC
Plan will use those funds to acquire the Company's stock in the open market. As
of March 31, 1998, the Trustee had purchased 662,948 shares of the Company's
stock with an aggregate cost of $15,330,000. The purchase of these shares has
been reflected in shareholders' equity. The Formula Award will vest equally in
three installments on December 31, 1998, 1999 and 2000; provided, however, that
such Formula Award vests immediately upon a change in control of the Company.
The Formula Award will be expensed in each year in which it vests. Formula Award
expense for the three months ended March 31, 1998 was $1,583,000.

NOTE 13. INVESTMENT ADVISORY SERVICES

The Company has investment advisory agreements to manage the assets of
certain private companies. The investment advisory agreements are generally
annual agreements, and may be terminated at any time on 60 days' notice, without
penalty, by the managed companies.

NOTE 14. INTEREST RATE SWAPS

The Company uses interest rate swap agreements to protect against
fluctuation in interest costs on its variable rate short-term credit facilities.
Amounts paid or received on the settlement of interest rate swap agreements are
recognized as an adjustment to interest expense. In January 1998, the Company
settled its interest rate swap agreements in connection with the asset
securitization transaction which resulted in a loss of $5,767,000 which has been
recorded against the gain on the securitization of commercial mortgage loans in
the first quarter of 1998. As of December 31, 1997, the Company had interest
swap agreements with an aggregate notional amount of $145,000,000. Pursuant to
the swap agreements, the Company paid a weighted average fixed rate equal to 6.8
percent and received payments with a weighted average variable rate equal to the
30-day LIBOR. The swap agreements had a remaining weighted average maturity of
approximately four years from December 31, 1997. As of December 31, 1997, the
Company recorded an estimated unrealized loss of $5,000,000 related to the swap
agreements in connection with the January 1998 asset securitization transaction.
The estimated unrealized loss was subsequently reversed upon consummation of the
securitization.

NOTE 15. DIVIDENDS AND DISTRIBUTIONS

The Company's Board of Directors declared and the Company paid a $0.35 per
common share dividend, or $18,225,000, for the first quarter of 1998.

F-27
<PAGE> 93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 15. DIVIDENDS AND DISTRIBUTIONS, CONTINUED
For the years ended December 31, 1997, 1996, and 1995, the Company declared
the following distributions:

<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
TOTAL TOTAL TOTAL
TOTAL PER TOTAL PER TOTAL PER
AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
------- ----- ------- ----- ------- -----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
First quarter............................ $14,347 $0.30 $11,158 $0.25 $ 8,855 $0.20
Second quarter........................... 14,795 0.30 11,911 0.26 9,344 0.21
Third quarter............................ 15,548 0.31 12,743 0.27 9,818 0.22
Fourth quarter........................... 31,022 0.61 13,678 0.29 10,355 0.24
Annual extra distribution................ 1,118 0.02 7,908 0.16 9,548 0.22
Special undistributed earnings
distribution........................... 8,848 0.17 -- -- -- --
------- ----- ------- ----- ------- -----
Total distributions to common
shareholders........................... $85,678 $1.71 $57,398 $1.23 $47,920 $1.09
======= ===== ======= ===== ======= =====
</TABLE>

For income tax purposes, distributions for 1997, 1996, and 1995 were
comprised of the following:

<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
TOTAL TOTAL TOTAL
TOTAL PER TOTAL PER TOTAL PER
AMOUNT SHARE AMOUNT SHARE AMOUNT SHARE
------- ----- ------- ----- ------- -----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Ordinary income.......................... $39,356 $0.79 $41,563 $0.89 $37,747 $0.86
Long-term capital gains.................. 31,037 0.62 15,835 0.34 10,173 0.23
Return of capital (tax).................. 6,437 0.13 -- -- -- --
------- ----- ------- ----- ------- -----
Total distributions before special
distribution........................... 76,830 1.54 57,398 1.23 47,920 1.09
------- ----- ------- ----- ------- -----
Special undistributed earnings
distribution........................... 8,848 0.17 -- -- -- --
------- ----- ------- ----- ------- -----
Total distributions to common
shareholders........................... $85,678 $1.71 $57,398 $1.23 $47,920 $1.09
======= ===== ======= ===== ======= =====
</TABLE>

The following table summarizes the differences between taxable income and
financial reporting income for the years ended December 31, 1997, 1996 and 1995:

<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Financial statement net income.............................. $61,304 $54,947 $60,479
Adjustments:
Amortization of discount............................... (1,124) (2,779) (1,206)
Gains from disposition of portfolio assets............. 17,890 874 (904)
Net unrealized (gains) losses.......................... (7,209) 7,412 (9,266)
Expenses not deductible for tax:
Merger expenses................................... 5,159 -- --
Other............................................. 853 2,306 1,176
Other.................................................. (9,050) (1,372) 930
Income tax expense..................................... 1,444 1,945 1,784
------- ------- -------
Taxable income.............................................. $69,267 $63,333 $52,993
======= ======= =======
</TABLE>

F-28
<PAGE> 94
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 16. COMMITMENTS AND CONTINGENCIES

The Company is party to certain lawsuits in connection with its business.
While the outcome of these legal proceedings cannot at this time be predicted
with certainty, management does not expect that these proceedings will have a
material effect upon the financial condition of the Company.

NOTE 17. CONCENTRATIONS OF CREDIT RISK

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. Cash and cash equivalents
consisted of the following:

<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
----------- -------------------
1998 1997 1996
----------- -------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents...................... $36,434 $76,791 $75,744
Less escrows held.............................. (5,421) (6,354) (3,903)
------- ------- -------
Total.......................................... $31,013 $70,437 $71,841
======= ======= =======
</TABLE>

NOTE 18. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The Company paid interest and income taxes of $4,014,000 for the three
months ended March 31, 1998 and $26,874,000, $21,391,000 and $13,393,000 during
1997, 1996, and 1995, respectively. For the three months ended March 31, 1998
and during 1997, 1996 and 1995, respectively, the Company's non-cash financing
activities totaled $1,678,000, $48,207,000, $22,361,000 and $15,756,000 related
primarily to common stock issuances resulting from stock option exercises and
dividend reinvestment shares issued. Additionally, during 1995, $18,062,000 in
long-term debt was consolidated from the minority interest in an asset
securitization pool. During 1997, 1996 and 1995, respectively, the Company's
non-cash investing activities totaled $12,022,000, $2,004,000 and $23,490,000,
relating to mortgage loans consolidated from the minority interests in certain
joint ventures.

NOTE 19. SELECTED QUARTERLY DATA (UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
1997
-------------------------------------
QTR 1 QTR 2 QTR 3 QTR 4
------- ------- ------- -------
<S> <C> <C> <C> <C>
Total interest and related portfolio income............. $21,399 $24,911 $25,111 $25,984
Portfolio income before realized and unrealized gains... $11,968 $14,095 $12,093 $ 7,910
Net increase in net assets resulting from operations.... $12,646 $18,296 $17,146 $13,216
Basic earnings per common share......................... $ 0.27 $ 0.37 $ 0.35 $ 0.25
Diluted earnings per common share....................... $ 0.27 $ 0.37 $ 0.35 $ 0.25
</TABLE>

<TABLE>
<CAPTION>
1996
-------------------------------------
QTR 1 QTR 2 QTR 3 QTR 4
------- ------- ------- -------
<S> <C> <C> <C> <C>
Total interest and related portfolio income............. $19,412 $20,866 $20,753 $23,906
Portfolio income before realized and unrealized gains... $11,284 $11,665 $11,592 $13,035
Net increase in net assets resulting from operations.... $18,935 $11,090 $16,855 $ 8,067
Basic earnings per common share......................... $ 0.42 $ 0.24 $ 0.35 $ 0.18
Diluted earnings per common share....................... $ 0.42 $ 0.23 $ 0.34 $ 0.18
</TABLE>

F-29
<PAGE> 95

CONSOLIDATING BALANCE SHEET

<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------------------------------------------
ALLIED ALLIED ALLIED CONSOLIDATED
ACC INVESTMENT FINANCIAL SBLC OTHERS ELIMINATIONS TOTAL
-------- ---------- --------- ------- ------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Portfolio at value:
Commercial mortgage loans........ $446,342 $ -- $ -- $ -- $ -- $ -- $446,342
Mezzanine loans and debt
securities..................... 89,707 64,486 13,649 -- -- -- 167,842
Small Business Administration
7(a) loans..................... -- -- -- 40,709 -- -- 40,709
Equity interests in portfolio
companies...................... 16,836 21,814 1,256 -- -- -- 39,906
Investments in subsidiaries...... 67,293 -- -- -- -- (67,293) --
Other portfolio assets........... 8 -- -- 43 2,171 -- 2,222
-------- -------- ------- ------- ------ --------- --------
Total portfolio at value..... 620,186 86,300 14,905 40,752 2,171 (67,293) 697,021
-------- -------- ------- ------- ------ --------- --------
Cash and cash equivalents............. 25,958 26,024 16,397 1,593 465 -- 70,437
U.S. government securities............ -- -- 11,091 -- -- -- 11,091
Intercompany notes and receivables.... 56,167 8 -- 1,386 -- (57,561) --
Other assets.......................... 13,809 2,425 761 8,696 3,535 -- 29,226
-------- -------- ------- ------- ------ --------- --------
Total assets................. $716,120 $114,757 $43,154 $52,427 $6,171 $(124,854) $807,775
======== ======== ======= ======= ====== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable..... $249,521 $ 40,183 $19,117 $ -- $ -- $ -- $308,821
Revolving lines of credit........ 20,294 -- -- 18,548 -- -- 38,842
Accounts payable and accrued
expenses....................... 12,040 3,961 152 1,828 208 -- 18,189
Dividends and distributions
payable........................ 8,848 -- 220 -- -- -- 9,068
Intercompany notes and
payables....................... 6,967 26,495 1,598 19,915 2,586 (57,561) --
Other liabilities................ 4,591 816 226 162 -- -- 5,795
-------- -------- ------- ------- ------ --------- --------
302,261 71,455 21,313 40,453 2,794 (57,561) 380,715
-------- -------- ------- ------- ------ --------- --------
Commitments and contingencies
Preferred stock issued to Small
Business Administration.......... -- -- 7,000 -- -- -- 7,000
Shareholders' equity:
Common stock..................... 5 -- -- -- 1 (1) 5
Additional paid-in capital....... 451,044 22,374 12,134 12,564 1,437 (48,509) 451,044
Notes receivable from sale of
common stock................... (29,611) -- -- -- -- -- (29,611)
Net unrealized appreciation
(depreciation) on portfolio.... 1,301 4,689 299 (394) -- (4,594) 1,301
Undistributed (distributions in
excess of) earnings............ (8,880) 16,239 2,408 (196) 1,939 (14,189) (2,679)
-------- -------- ------- ------- ------ --------- --------
Total shareholders' equity... 413,859 43,302 14,841 11,974 3,377 (67,293) 420,060
-------- -------- ------- ------- ------ --------- --------
Total liabilities and
shareholders' equity....... $716,120 $114,757 $43,154 $52,427 $6,171 $(124,854) $807,775
======== ======== ======= ======= ====== ========= ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-30
<PAGE> 96

CONSOLIDATING STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
--------------------------------------------------------------------------------
ALLIED ALLIED ALLIED CONSOLIDATED
ACC INVESTMENT FINANCIAL SBLC OTHERS ELIMINATIONS TOTAL
------- ---------- --------- ------ ------ ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest and related portfolio
income:
Interest........................ $57,067 $ 9,903 $3,637 $6,352 $9,923 $ -- $86,882
Interest income-intercompany.... 3,843 -- -- -- -- (3,843) --
Dividends from subsidiaries..... 22,960 -- -- -- -- (22,960) --
Net premiums from loan sales.... 170 -- -- 3,071 -- -- 3,241
Prepayment premiums............. 3,689 -- -- -- 347 -- 4,036
Investment advisory fees........ 15,439 -- -- -- -- (14,446) 993
Other income.................... 663 107 -- -- 1,483 -- 2,253
------- ------- ------ ------ ------ -------- -------
Total interest and related
portfolio income........... 103,831 10,010 3,637 9,423 11,753 (41,249) 97,405
------- ------- ------ ------ ------ -------- -------
Expenses:
Interest on indebtedness........ 16,950 3,897 1,781 1,511 2,813 -- 26,952
Interest on indebtedness-
intercompany.................. -- 1,555 -- 1,749 539 (3,843) --
Salaries and employee
benefits...................... 10,258 -- -- -- -- -- 10,258
Investment advisory fees........ 14,130 -- -- -- 316 (14,446) --
Legal and accounting............ 1,850 200 94 118 -- -- 2,262
General and administrative...... 5,677 157 (45) 113 806 -- 6,708
Merger.......................... 5,159 -- -- -- -- -- 5,159
------- ------- ------ ------ ------ -------- -------
Total expenses............... 54,024 5,809 1,830 3,491 4,474 (18,289) 51,339
------- ------- ------ ------ ------ -------- -------
Portfolio income before realized and
unrealized gains (losses).......... 49,807 4,201 1,807 5,932 7,279 (22,960) 46,066
------- ------- ------ ------ ------ -------- -------
Net realized and unrealized gains:
Net realized gains (losses)..... 6,777 3,104 (93) (132) 1,048 -- 10,704
Net unrealized gains (losses)... 7,919 7,425 934 (711) -- (8,358) 7,209
------- ------- ------ ------ ------ -------- -------
Total net realized and
unrealized gains
(losses)................... 14,696 10,529 841 (843) 1,048 (8,358) 17,913
------- ------- ------ ------ ------ -------- -------
Income before minority interests and
income taxes....................... 64,503 14,730 2,648 5,089 8,327 (31,318) 63,979
------- ------- ------ ------ ------ -------- -------
Minority interests................... -- -- -- -- 1,231 -- 1,231
Income tax expense................... 1,444 -- -- -- -- -- 1,444
------- ------- ------ ------ ------ -------- -------
Net increase in net assets resulting
from operations.................... $63,059 $14,730 $2,648 $5,089 $7,096 $(31,318) $61,304
======= ======= ====== ====== ====== ======== =======
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-31
<PAGE> 97

CONSOLIDATING STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------------------------------------
ALLIED ALLIED ALLIED CONSOLIDATED
ACC INVESTMENT FINANCIAL SBLC OTHERS ELIMINATIONS TOTAL
--------- ---------- --------- ------- ------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net increase in net assets
resulting from
operations................. $ 63,060 $ 7,306 $ 1,714 $ 5,088 $ 7,096 $(22,960) $ 61,304
Adjustments:
Net unrealized (gains)
losses................... (7,920) -- -- 711 -- -- (7,209)
Depreciation and
amortization............. 331 -- -- -- 119 -- 450
Amortization of loan
discounts and fees....... (7,362) (314) (666) (505) (1,957) -- (10,804)
Deferred income taxes...... 1,087 -- -- -- -- -- 1,087
Minority interests......... -- -- -- -- 1,231 -- 1,231
Amortization of deferred
financing costs.......... -- -- -- -- 957 -- 957
Changes in net assets and
liabilities.............. 656 3,475 658 (2,835) 5,254 4,716 11,924
--------- ------- ------- ------- ------- -------- --------
Net cash provided by
operating activities... 49,852 10,467 1,706 2,459 12,700 (18,244) 58,940
--------- ------- ------- ------- ------- -------- --------
Cash flows from investing
activities:
Investments in small business
concerns................... (284,563) (20,949) (257) (49,231) (9,942) -- (364,942)
Collections of investment
principal.................. 143,470 26,396 12,544 8,117 42,478 -- 233,005
Proceeds from the sale of
loans...................... 10,546 -- -- 43,366 -- -- 53,912
Net (purchase) redemption of
U.S. government
securities................. -- 254 (10,555) -- -- -- (10,301)
Collections (advances) under
intercompany notes......... (990) 1,500 -- (10) (500) -- --
Collections of notes
receivable from sale of
common stock............... 6,534 -- -- -- -- -- 6,534
Other investing activities... (182) -- -- -- -- -- (182)
--------- ------- ------- ------- ------- -------- --------
Net cash provided by
(used in) investing
activities............. (125,185) 7,201 1,732 2,242 32,036 -- (81,974)
--------- ------- ------- ------- ------- -------- --------
Cash flows from financing
activities:
Sale of common stock......... 8,615 -- -- -- -- -- 8,615
Purchase of common stock of
subsidiaries............... (15,528) -- -- -- 15,528 -- --
Common dividends and
distributions paid......... (58,194) -- -- -- -- -- (58,194)
Dividends paid to parent
company.................... -- (6,321) (5,067) (5,995) (861) 18,244 --
Preferred stock dividends.... -- -- (220) -- -- -- (220)
Net borrowings under
(payments on) debentures
and notes payable.......... 134,519 (5,000) (2,000) -- (48,596) -- 78,923
Net borrowings under
revolving lines of
credit..................... (9,144) -- -- 2,887 -- -- (6,257)
Net payments on government
securities available for
sale....................... -- -- -- -- -- -- --
Other financing activities... 10,800 -- -- -- (12,037) -- (1,237)
--------- ------- ------- ------- ------- -------- --------
Net cash provided by
(used in) financing
activities............. 71,068 (11,321) (7,287) (3,108) (45,966) 18,244 21,630
--------- ------- ------- ------- ------- -------- --------
Net increase (decrease) in cash
and cash equivalents........... (4,265) 6,347 (3,849) 1,593 (1,230) -- (1,404)
--------- ------- ------- ------- ------- -------- --------
Cash and cash equivalents at
beginning of year.............. 30,223 19,677 20,247 -- 1,694 -- 71,841
--------- ------- ------- ------- ------- -------- --------
Cash and cash equivalents at end
of year........................ $ 25,958 $26,024 $16,398 $ 1,593 $ 464 $ -- $ 70,437
========= ======= ======= ======= ======= ======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-32
<PAGE> 98

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders and Board of Directors
of Allied Capital Corporation and Subsidiaries:

We have audited the consolidated balance sheets of Allied Capital
Corporation and subsidiaries as of December 31, 1997 and 1996, including the
consolidated statement of investments as of December 31, 1997, and the related
consolidated statements of operations, changes in net assets and cash flows for
each of the three years in the period ended December 31, 1997. These
consolidated financial statements and supplementary consolidating financial
information referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and supplementary consolidating financial information
referred to below based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. These procedures
included the confirmation and physical counts of investments. 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 referred to above
present fairly, in all material respects, the financial position of Allied
Capital Corporation and subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations, changes in net assets and cash flows
for each of the three years in the period then ended in conformity with
generally accepted accounting principles.

As discussed in Note 3, the consolidated financial statements include
investments valued at $697,021,000 as of December 31, 1997 and $607,368,000 as
of December 31, 1996, (86 percent and 85 percent, respectively, of total assets)
whose values have been estimated by the board of directors in the absence of
readily ascertainable market values. We have reviewed the procedures used by the
board of directors in arriving at its estimate of value of such investments and
have inspected the underlying documentation, and in the circumstances we believe
the procedures are reasonable and the documentation appropriate. However,
because of the inherent uncertainty of valuation, the board of directors'
estimate of 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.

Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
consolidating balance sheet and related consolidating statements of operations
and cash flows are presented for purposes of additional analysis and are not a
required part of the basic financial statements. This information has been
subjected to the auditing procedures applied in our audit of the basic
consolidated financial statements and in our opinion, is fairly stated in all
material respects in relation to the basic financial statements taken as a
whole.

/s/ ARTHUR ANDERSON LLP
Vienna, Virginia
February 20, 1998

F-33
<PAGE> 99

[ALLIED CAPITAL LOGO]
<PAGE> 100
[ALTERNATE VERSION]

PROSPECTUS (Subject to Completion)

Issued June 2, 1998

[ALLIED CAPITAL LOGO]

5,750,000 Shares

Allied Capital Corporation

COMMON STOCK

------------------------

OF THE 5,750,000 SHARES OF COMMON STOCK OF ALLIED CAPITAL CORPORATION BEING
OFFERED HEREBY, 1,150,000 SHARES ARE BEING OFFERED INITIALLY OUTSIDE THE UNITED
STATES AND CANADA BY THE INTERNATIONAL UNDERWRITERS AND 4,600,000 SHARES ARE
BEING OFFERED INITIALLY IN THE UNITED STATES AND CANADA BY THE U.S.
UNDERWRITERS. SEE "UNDERWRITERS." THE COMPANY'S COMMON STOCK IS TRADED ON THE
NASDAQ NATIONAL MARKET UNDER THE SYMBOL "ALLC." ON JUNE 1, 1998, THE LAST
REPORTED SALE PRICE FOR THE COMMON STOCK WAS $24 1/2.

------------------------

SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR CERTAIN INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY, INCLUDING THE RISK OF LEVERAGE.

------------------------

PRICE $ A SHARE

------------------------

- ------------

(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriters."

(2) Before deducting expenses payable by the Company estimated at $600,000.

------------------------

MORGAN STANLEY DEAN WITTER

NATIONSBANC MONTGOMERY SECURITIES LLC

THE ROBINSON-HUMPHREY COMPANY

SCOTT & STRINGFELLOW, INC.

, 1998

SUBJECT TO COMPLETION JUNE 2, 1998. INFORMATION CONTAINED HEREIN IS SUBJECT TO
COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES
HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY
NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION
STATEMENT BECOMES EFFECTIVE. THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT
CONSTITUTE A PROSPECTUS.

ALLIED CAPITAL CORPORATION

STATEMENT OF ADDITIONAL INFORMATION

, 1998

This Statement of Additional Information ("SAI") is not a prospectus, and
should be read in conjunction with the Prospectus dated , 1998
relating to this offering (the "Prospectus"). A copy of the Prospectus may be
obtained by calling Allied Capital Corporation at 1-888-818-5298 and asking for
Investor Relations. Terms not defined herein have the same meaning as given to
them in the Prospectus.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE IN THE LOCATION
STATEMENT OF RELATED
OF ADDITIONAL DISCLOSURE IN
INFORMATION THE PROSPECTUS
------------- --------------
<S> <C> <C>
General Information and History............................. B-2 1;11;31
Investment Objective and Policies........................... B-2 1;11;31
Management.................................................. B-2 45
Compensation of Executive Officers and Directors....... B-2 48
Compensation of Directors.............................. B-4 48
Stock Option Awards.................................... B-4 48
Cut-Off Award and Formula Award........................ B-5 48
Committees of the Board of Directors................... B-6 N/A
Control Persons and Principal Holders of Securities......... B-6 N/A
Investment Advisory Services................................ B-7 45
Safekeeping, Transfer and Dividend Paying Agent and
Registrar................................................. B-8 60
Accounting Services......................................... B-8 60
Brokerage Allocation and Other Practices.................... B-8 N/A
Tax Status.................................................. B-9 50
</TABLE>

B-1
<PAGE> 102

GENERAL INFORMATION AND HISTORY

This SAI contains information with respect to Allied Capital Corporation
(the "Company"). The Company changed its name from "Allied Capital Lending
Corporation" to "Allied Capital Corporation," effective upon the Merger, which
was consummated on December 31, 1997. The Company changed its name from "Allied
Lending Corporation" to "Allied Capital Lending Corporation" in September 1993
in anticipation of its initial public offering in November 1993. The Company is
a registered investment adviser.

INVESTMENT OBJECTIVE AND POLICIES

The investment objective of the Company is to achieve current income and
capital gains. The Company seeks to achieve its investment objective by lending
to and investing primarily in private, growing businesses in a variety of
industries and in diverse geographic locations primarily in the United States.
The Company's lending activities are organized in three areas: mezzanine
finance, commercial real estate finance and 7(a) lending. ACC's investment
portfolio, resulting from the merger of the portfolios and businesses of Allied
I, Allied II, Allied Commercial and Allied Lending, consists of small senior
loans, small and medium-sized subordinated loans with equity features, and small
and medium-sized commercial mortgage loans. At March 31, 1998, ACC's investment
portfolio totaled $564.5 million. A discussion of the selected financial data,
supplementary financial information and management's discussion and analysis of
financial condition and results of operations is included in the Prospectus. In
addition to its core lending business, the Company also provides advisory
services to private investment funds.

MANAGEMENT

COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS

Under Commission rules applicable to BDCs, the Company is required to set
forth certain information regarding the compensation of certain of its executive
officers and directors. Prior to the Merger, the Company had no employees and
did not pay any cash compensation to any of its officers (other than directors'
fees to those of its officers who also were directors). All of the Company's
officers and employees were employed by Advisers, which paid all of their cash
compensation. The information regarding compensation of the executive officers
of the Company contained in this SAI includes the compensation paid by Advisers
and the other Predecessor Companies.

The following table sets forth compensation paid by the Predecessor
Companies in all capacities during the year ended December 31, 1997, to all the
directors and the four highest paid executive officers of the Company
(collectively, the "Compensated Persons").

B-2
<PAGE> 103

COMPENSATION TABLE

<TABLE>
<CAPTION>
AGGREGATE PENSION OR DIRECTORS FEES
COMPENSATION FROM RETIREMENT BENEFITS PAID BY ALL OF THE
A PREDECESSOR ACCRUED AS PART OF PREDECESSOR
NAME AND POSITION COMPANY(1,2) COMPANY EXPENSES COMPANIES(6)
----------------- --------------------------- ------------------- ------------------
<S> <C> <C> <C>
William L. Walton, Chairman and Chief
Executive Officer..................... $765,737(3) 0 $57,000
John M. Scheurer, Managing Director..... 490,117(3) 0 18,000
Joan M. Sweeney, Managing Director...... 453,757(3) 0 9,000
G. Cabell Williams III, Managing
Director.............................. 419,864(3) 0 13,000
Jon W. Barker, Director (5)............. 8,000 0 8,000
Eleanor Deane Bierbower, Director (5)... 9,000 0 9,000
Brooks H. Browne, Director.............. 16,000 0 16,000
Joseph A. Clorety III, Director (5)..... 14,500 0 14,500
Swep T. Davis, Director (5)............. 30,250(4) 0 10,000
John D. Firestone, Director............. 12,000 0 12,000
Robert V. Fleming II, Director (5)...... 12,500 0 12,500
Michael I. Gallie, Director (5)......... 16,500 0 16,500
Anthony T. Garcia, Director............. 28,500 0 28,500
Lawrence I. Hebert, Director............ 16,500 0 16,500
Arthur H. Keeney III, Director (5)...... 7,000 0 7,000
John I. Leahy, Director................. 8,500 0 8,500
Robert E. Long, Director................ 18,000 0 18,000
Robin B. Martin, Director (5)........... 10,500 0 10,500
Warren K. Montouri, Director............ 11,500 0 11,500
John D. Reilly, Director (5)............ 35,000 0 35,000
Guy T. Steuart II, Director............. 18,000 0 18,000
T. Murray Toomey, Director.............. 14,000 0 14,000
Laura W. van Roijen, Director........... 19,000 0 19,000
George C. Williams, Jr. Director,
Chairman Emeritus..................... 217,325(3,4) 0 52,000
Smith T. Wood, Director (5)............. 15,500 0 15,500
</TABLE>

- ---------------

(1) All options issued under the Old Plans that were unexercised as of December
30, 1997 were canceled in connection with the Merger. See "Option Grants
During 1997" table below.

(2) Includes amounts paid by all the Predecessor Companies, including directors'
fees.

(3) For Mr. Walton, Mr. Scheurer, Ms. Sweeney and Mr. Williams III, amount
includes: (i) salaries for 1997 in the amounts of $277,051, $215,588,
$177,864, and $198,919, respectively; (ii) bonuses for 1997 in the amounts
of $400,000, $235,000, $250,000, and $190,000, respectively; (iii)
directors' fees in the amounts of $57,000, $18,000, $9,000 and $13,000,
respectively; and (iv) a cash contribution in the amounts of $13,269,
$21,529, $16,893, and $17,946, respectively, to the account of each under
the Company's ESOP during 1997. In addition, Mr. Walton received $18,418 in
consulting fees prior to his appointment as Chairman in February 1997. There
were no perquisites paid by the Company in excess of the lesser of $50,000
or 10% of the Compensated Person's total salary and bonus for the year. No
portion of the Formula Award has been included herein for any Compensated
Person; the Formula Award, which totaled approximately $19 million in the
aggregate, will be paid to all recipients in three equal installments on
December 31, 1998, 1999, and 2000, and will be expensed for financial
reporting purposes similarly. In addition, no portion of the Cut-Off Award
has been included herein; the Cut-Off Award, which totaled $2.9 million in
the aggregate, will be paid to individuals on the respective vesting date of
any options under the Old Plans which were canceled in connection with the
Merger. See "-- Cut-Off Award and Formula Award." No portion of the Formula
Award or Cut-Off Award was expensed in 1997; each will be expensed in future
years.

(4) Consists of directors' fees and consulting fees paid by the relevant
Predecessor Company.

(5) Director's term expired at the Meeting, and such director was not nominated
for re-election.

(6) Consists only directors' fees paid by the Predecessor Companies during 1997.
Such fees are also included in the column titled "Aggregate Compensation
from a Predecessor Company."

B-3
<PAGE> 104

COMPENSATION OF DIRECTORS

During 1997, each director received a fee of $1,000 for each meeting of the
board of directors of the Predecessor Company or Companies for which he or she
served as a director in 1997 or any separate committee meeting attended, and
$500 for each committee meeting attended on the same day as a board of directors
meeting. In addition, the directors of Allied Commercial each received an annual
retainer of $12,000; the Company does not currently pay any such retainer. In
connection with the Merger, each of the Predecessor Companies' stock option
plans were canceled, and any unexercised or unvested stock options previously
granted to directors were canceled at the end of 1997. Directors are eligible
for stock option awards under the Company's current stock option plan, provided
that the Commission grants exemptive relief to permit such awards. No grants
have been made to directors under the Company's current stock option plan. See
"-- Stock Option Awards" and "Management -- Compensation Plans -- Stock Option
Plan" in the Prospectus.

STOCK OPTION AWARDS

Prior to the Merger, each of the Predecessor Companies maintained a stock
option plan (the "Old Plans"). In connection with the Merger, the Old Plans were
terminated, and the Company adopted a new stock option plan (the "New Plan")
effective January 1, 1998. Therefore, the information contained in this SAI
regarding stock option awards to directors and executive officers during 1997
represents awards made under all the Old Plans.

The following table sets forth the details relating to option grants in
1997 to Compensated Persons of all the Predecessor Companies under the Old
Plans, and the potential realizable value of each grant, as prescribed to be
calculated by the Commission. As discussed below under "Formula Award and
Cut-Off Award," upon the consummation of the Merger, each Old Plan was
terminated, and all unexercised or unvested stock options under the Old Plans
were canceled. After the consummation of the Merger, the Company adopted the New
Plan for directors and officers. See "Management -- Compensation Plans -- Stock
Option Plan" in the Prospectus.

OPTION GRANTS DURING 1997

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED ANNUAL
NUMBER OF PERCENT RATES OF 1997
SECURITIES OF TOTAL EXERCISE STOCK APPRECIATION OPTIONS
UNDERLYING OPTIONS PRICE OVER 10-YEAR TERM(2) CANCELED
OPTIONS GRANTED PER EXPIRATION ----------------------- UPON
NAME GRANTED (1) IN 1997 SHARE DATE 5% 10% MERGER(1)
---- ----------- -------- -------- ---------- -- --- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
William L. Walton............. 150,000(3) 49.1% $15.33 5/2/07 $1,445,672 $3,663,615 112,500
100,000(4) 28.9% 18.25 5/2/07 1,147,733 2,908,580 75,000
125,000(5) 40.3% 23.13 5/12/07 1,817,899 4,606,912 93,750
200,000(6) 93.8% 4.65 5/2/07 536,005 1,404,368 150,000
100,000(7) 100% 15.13 5/9/07 951,203 2,410,535 75,000
John M. Scheurer.............. 24,996(5) 8.1% $23.75 6/24/07 $ 373,346 $ 946,133 19,996
Joan M. Sweeney............... 15,468(3) 5.1% $15.88 5/21/07 $ 154,428 $ 391,351 9,169
22,111(4) 6.4% 21.00 5/21/07 292,015 740,024 17,350
8,332(5) 2.7% 23.75 6/24/07 124,449 315,378 7,507
G. Cabell Williams III........ 25,680(4) 7.4% $21.00 5/21/07 $ 339,150 $ 859,473 21,496
4,166(5) 1.3% 23.75 6/24/07 62,224 157,689 4,166
George C. Williams, Jr. ...... 30,000(3) 9.8% $15.88 5/21/07 $ 299,511 $ 759,020 22,500
30,000(4) 8.7% 21.00 5/21/07 396,204 1,004,058 22,500
Swep T. Davis................. 13,333(6) 6.2% $ 5.33 3/19/07 $ 44,650 $ 113,153 --
</TABLE>

- ---------------

(1) All unvested and unexercised options under the Old Plans were canceled in
connection with the Merger, including those granted in 1997.

(2) Potential realizable value is calculated on 1997 options granted, and is net
of the option exercise price but before any tax liabilities that may be
incurred. These amounts represent certain assumed rates of appreciation, as
mandated by the Commission. Actual gains, if any, or stock option exercises
are dependent on the future performance of the shares, overall market
conditions, and the continued employment by the Company of the option
holder. The potential realizable value will not necessarily be realized.

(3) Options granted under Allied I's Old Plan.

B-4
<PAGE> 105

(4) Options granted under Allied II's Old Plan.

(5) Options granted under Allied Commercial's Old Plan.

(6) Options granted under Advisers' Old Plan.

(7) Options granted under Allied Lending's Old Plan.

CUT-OFF AWARD AND FORMULA AWARD

As discussed in the Prospectus, prior to the Merger options had been
granted under the Old Plans to various employees of Advisers, who were also
officers of the Predecessor Companies. In preparation for the Merger, the
Compensation Committee of Advisers, in conjunction with the Compensation
Committee of the other Predecessor Companies, determined that the five Old Plans
should be terminated upon the Merger, so that the new merged Company would be
able to develop a new plan that would incent all officers and directors with a
single equity security. The existence of the Old Plans had resulted in certain
inequities in option grants among the various officers of the Predecessor
Companies simply because of the differences in the underlying equity securities.

To balance stock option awards among Advisers' employees, and to account
for the deviations caused by the existence of five plans by five different
publicly traded stocks, Advisers developed two special awards to be granted in
lieu of options under the Old Plans that would be foregone upon the Merger and
the cancellation of the Old Plans.

Cut-Off Award. The first award established a cut-off dollar amount as of
the date of the announcement of the Merger (August 14, 1997) that would be
computed for all outstanding, but unvested options that would be canceled as of
the date of the Merger (the "Cut-Off Award"). The Cut-Off Award was designed to
cap the appreciated value in unvested options as of the Merger announcement date
in order to set the foundation to balance option awards upon the Merger. The
Cut-Off Award, in the aggregate, was computed to be $2.9 million, and is equal
to the difference between the market price of the shares of stock underlying the
canceled options under the Old Plans at August 14, 1997, less the exercise
prices of the options. The Cut-Off Award will be payable for each canceled
option as the canceled options would have vested and will vest automatically in
the event of a change of control. The Cut-Off Award will only be payable if the
award recipient is employed by the Company on the future vesting date. The
following table indicates the Cut-Off Award for each Compensated Person, and the
related vesting schedule.

<TABLE>
<CAPTION>
CUT-OFF AWARD RECIPIENT 1998 1999 2000 2001 2002 THEREAFTER
----------------------- -------- -------- -------- ------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
William L. Walton......................... $170,157 $170,157 $170,157 $ 0 $ 0 $ 0
John M. Scheurer.......................... 29,248 29,248 29,248 29,248 27,998 142,770
Joan M. Sweeney........................... 38,964 37,678 36,602 2,026 0 0
G. Cabell Williams III.................... 88,257 46,803 39,678 21,152 18,916 0
George C. Williams, Jr.................... 32,685 4,687 52,373 0 0 0
</TABLE>

Adviser's Compensation Committee designed the Formula Award as a long-term
incentive compensation program to be a replacement for canceled stock options
and to balance share ownership among key officers for past and prospective
service. The terms of the Formula Award require that the award be contributed to
the Company's deferred compensation plan, and used to purchase shares of the
Company in the open market.

B-5
<PAGE> 106

The Formula Award vests and accrues equally over a three-year period, on
the anniversary of the Merger date (December 31, 1997), and vests automatically
in the event of a change of control of the Company. If an officer terminates
employment with the Company prior to the vesting of any part of the Formula
Award, that amount will be forfeited to the Company. Assuming all officers meet
the vesting requirement, the Company will accrue the Formula Award over the
three-year period in equal amounts of approximately $6.4 million. The following
table indicates the Formula Award for each Compensated Person, and the related
vesting schedule.

<TABLE>
<CAPTION>
FORMULA AWARD RECIPIENT 1998 1999 2000
----------------------- ---- ---- ----
<S> <C> <C> <C>
William L. Walton.......................................... $1,472,451 $1,472,451 $1,472,451
John M. Scheurer........................................... 400,228 400,228 400,228
Joan M. Sweeney............................................ 862,761 862,761 862,761
G. Cabell Williams III..................................... 400,664 400,664 400,664
George C. Williams, Jr..................................... 601,068 601,068 601,068
</TABLE>

COMMITTEES OF THE BOARD OF DIRECTORS

The board of directors of the Company has established an Executive
Committee, an Audit Committee, a Nominating Committee and a Compensation
Committee. Each of the Predecessor Companies maintained similar committees (as
appropriate) prior to the consummation of the Merger.

The Executive Committee of the Company has and may exercise those rights,
powers and authority of the board of directors as may from time to time be
granted to it by the board of directors, except where action by the board of
directors is required by statute, an order of the Securities and Exchange
Commission (the "Commission") or the Company's Charter or bylaws. The Executive
Committee of the Company consists of Messrs. Walton, Leahy, Long, Montouri, and
Williams. The Executive Committee met twice during 1997.

The Audit Committee of the Company recommends the selection of independent
public accountants for the Company, reviews with such independent public
accountants the planning, scope and results of their audit of the Company's
financial statements and the fees for services performed, reviews with the
independent public accountants the adequacy of internal control systems, reviews
the annual financial statements of the Company and receives audit reports and
financial statements of the Company. The Audit Committee of the Company consists
of Messrs. Browne, Leahy and Steuart. The Audit Committee met four times during
1997.

The Compensation Committee of the Company determines the compensation for
the executive officers of the Company and the amount of salary and bonus to be
included in the compensation package for each of the Company's officers and
employees. In addition, the Compensation Committee approves stock option grants
for officers of the Company under the Company's Stock Option Plan. The
Compensation Committee of the Company consists of Messrs. Browne, Long,
Firestone and Garcia. The Compensation Committee met three times during 1997,
including one joint committee meeting with the Compensation Committees of the
Acquired Companies.

The Nominating Committee of the Company recommends candidates for election
as directors. The Nominating Committee of the Company consists of Messrs.
Walton, Herbert, Toomey and Steuart, and Ms. van Roijen. The Nominating
Committee did not meet in 1997 since it was formed late in 1997. The Nominating
Committee met on March 3, 1998.

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of June 1, 1998, there were no persons that owned 25% or more of the
Company's outstanding voting securities, and no person would be deemed to
control the Company, as such term is defined in the 1940 Act.

The following table sets forth, at June 1, 1998, the beneficial ownership
of each current director, the Chief Executive Officer, the Company's executive
officers, and the executive officers and directors as a group. At this time the
Company is unaware of any shareholder owning 5% or more of the outstanding
shares of

B-6
<PAGE> 107

Common Stock of the Company. Unless otherwise indicated, the Company believes
that each beneficial owner set forth in the table has sole voting and investment
power.

<TABLE>
<CAPTION>
NAME OF NUMBER OF SHARES PERCENTAGE OF
BENEFICIAL OWNER OWNED BENEFICIALLY CLASS (1)
- ------------------------------------------------------------ ------------------ -------------
<S> <C> <C>
DIRECTORS:
William L. Walton........................................... 589,790(2, 3) 1.1%
Brooks H. Browne............................................ 38,883 *
John D. Firestone........................................... 16,231 *
Anthony T. Garcia........................................... 52,507 *
Lawrence I. Hebert.......................................... 16,800 *
John I. Leahy............................................... 16,318 *
Robert E. Long.............................................. 12,777 *
Warren K. Montouri.......................................... 196,182 *
Guy T. Steuart II........................................... 317,065(4) *
T. Murray Toomey, Esq....................................... 33,265(5) *
Laura W. van Roijen......................................... 28,302 *
George C. Williams, Jr...................................... 342,978 *
EXECUTIVE OFFICERS:
Jon A. DeLuca............................................... 108,058(2) *
John M. Scheurer............................................ 289,903(2) *
Joan M. Sweeney............................................. 221,055(2) *
G. Cabell Williams III...................................... 680,280(2, 3) 1.3%
All directors and executive officers as a group (16 in
number)................................................... 2,636,249(6) 5.0%
</TABLE>

- ---------------
* Less than 1%

(1) Based on a total of 52,121,610 shares of the Company's common stock issued
and outstanding on June 1, 1998 and shares of the Company's common stock
issuable upon the exercise of immediately exercisable stock options held by
each individual executive officer. At this time, no options have been
granted to non-officer directors.

(2) Share ownership includes 109,865, 11,062, 52,854, 53,212, and 37,234 shares
which Mr. Walton, Mr. DeLuca, Mr. Scheurer, Ms. Sweeney, and Mr. Williams
III, respectively, have options to purchase that are exercisable within 60
days of April 30, 1998. Share ownership also includes 459, 4,616, 18,432,
7,381, and 59,499 shares, respectively, for Mr. Walton, Mr. DeLuca, Mr.
Scheurer, Ms. Sweeney and Mr. Williams III, respectively, allocated to their
respective ESOP accounts through December 31, 1997.

(3) Includes 293,716 shares held by the ESOP, of which Messrs. Walton and
Williams III are co-trustees. Participants in the ESOP may direct the voting
of these shares; however, if a participant does not direct the voting, the
co-trustees of the ESOP will vote the shares on behalf of the participants.
Messrs. Walton and Williams III disclaim beneficial ownership of such
shares. As of December 31, 1997, all shares held in the ESOP had been
allocated to participants' accounts.

(4) Includes 276,576 shares held by a corporation for which Mr. Steuart serves
as an executive officer.

(5) Shares are held by a trust for the benefit of Mr. Toomey and his wife.

(6) Includes a total of 311,359 shares underlying stock options exercisable
within 60 days of June 1, 1998, which are assumed to be outstanding for the
purpose of calculating the group's percentage ownership, and 293,716 shares
held by the ESOP.

INVESTMENT ADVISORY SERVICES

The Company is internally managed and therefore has not entered into any
advisory agreement with, nor pays advisory fees to, an outside investment
adviser. The Company is a registered investment adviser under the Advisers Act
and provides advisory services to other entities. The Company currently has 43
investment and other professionals, as well as 47 other employees, that manage
the investments of the Company as well as the investments of other managed
entities. All investments of the Company must be approved by the Company's
investment committee, which is composed of senior investment professionals of
the Company. See "Management" in the Prospectus.

B-7
<PAGE> 108

SAFEKEEPING, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR

The investments of the Company and its subsidiaries are held in safekeeping
by Riggs Bank N.A. ("Riggs") at 808 17th Street, N.W., Washington, D.C. 20006.
LaSalle National Bank, located at 25 Northwest Point Boulevard, Suite 800, Elk
Grove Village, Illinois 60007, serves as the trustee and custodian with respect
to assets of the Company held for securitization purposes. American Stock
Transfer & Trust Company, 40 Wall Street, 46th Floor, New York, New York 10005
acts as the Company's transfer, dividend paying and reinvestment plan agent and
registrar.

ACCOUNTING SERVICES

Arthur Andersen LLP ("Andersen") has served as the independent accountant
to the Company since December 31, 1997. Prior to the year ended December 31,
1997, Allied Lending's financial statements were audited by Matthews, Carter and
Boyce, P.C., or its predecessor ("Matthews"). On December 12, 1997, Matthews
resigned, effective upon the consummation of the Merger, and Andersen was
engaged and continues as the independent accountants of the Company. The
decision to change accountants was recommended by the Company's Audit Committee
and was approved by the board of directors of the Company.

For the year ended December 31, 1996, and up to the date of resignation of
Matthews, there were no disagreements with Matthews on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure which, if not resolved to the satisfaction of Matthews, would have
caused it to make reference to the subject matter of the disagreement in
connection with its report. The independent accountants' report on the 1996
financial statements did not contain an adverse opinion or a disclaimer of
opinion, and was not qualified or modified as to uncertainty, audit scope or
accounting principles. Each of Andersen and Matthews has advised the Company
that neither it nor any present member or associate of the relevant firm has any
financial interest, direct or indirect, in the Company or its subsidiaries.

BROKERAGE ALLOCATION AND OTHER PRACTICES

Since the Company generally acquires and disposes of its investments in
privately negotiated transactions, it infrequently uses brokers in the normal
course of business.

B-8
<PAGE> 109

TAX STATUS

The following discussion is a general summary of the material federal
income tax considerations applicable to the Company and to an investment in the
Common Stock and does not purport to be a complete description of the income tax
considerations applicable to such an investment. The discussion is based upon
the Code, Treasury Regulations thereunder, and administrative and judicial
interpretations thereof, each as of the date hereof, all of which are subject to
change. Prospective shareholders should consult their own tax advisors with
respect to tax considerations which pertain to their purchase of Common Stock.
This summary assumes that the investors in the Company hold shares as capital
assets. This summary does not discuss all aspects of federal income taxation
relevant to holders of the Common Stock in light of particular circumstances, or
to certain types of holders subject to special treatment under federal income
tax laws, including dealers in securities and financial institutions. This
summary does not discuss any aspects of foreign, state or local tax laws.

The Company. The Company has elected for each taxable year to be treated
as a "regulated investment company" or "RIC" under Subchapter M of the Code and
intends to continue to maintain that status. If the Company distributes to
stockholders annually in a timely manner at least 90% of its "investment company
taxable income," as defined in the Code (i.e., net investment income, including
accrued original issue discount, and net short-term capital gains) (the "90%
Distribution Requirement"), it will not be subject to federal income tax on the
portion of its investment company taxable income and net capital gains (net
long-term capital gain in excess of net short-term capital loss) distributed to
stockholders. In addition, if the Company distributes in a timely manner 98% of
its capital gain net income for each one-year period ending on December 31, and
distributes 98% of its net ordinary income for each calendar year (as well as
any income not distributed in prior years), it will not be subject to the 4%
nondeductible federal excise tax imposed with respect to certain undistributed
income of RICs. The Company generally will endeavor to distribute to
stockholders all of its investment company taxable income and its net capital
gain, if any, for each taxable year so that such Company will not incur income
and excise taxes on its earnings.

In order to qualify as a RIC for federal income tax purposes, the Company
must, among other things: (a) continue to qualify as a BDC under the 1940 Act,
(b) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, gains from the sale of
stock or securities, or other income derived with respect to its business of
investing in such stock or securities (the "90% Income Test"); and (c) diversify
its holdings so that at the end of each quarter of the taxable year (i) at least
50% of the value of the Company's assets consists of cash, cash items, U.S.
government securities, and other securities if such other securities of any one
issuer do not represent more than 5% of the Company's assets or 10% of the
outstanding voting securities of the issuer, and (ii) no more than 25% of the
value of the Company's assets is invested in the securities of one issuer (other
than U.S. government securities or securities of other RICs) or of two or more
issuers that are controlled (as determined under applicable Code rules) by the
Company and are engaged in the same or similar or related trades or businesses.
The failure of one or more of the Company's subsidiaries to continue to qualify
as RICs could adversely affect the Company's ability to satisfy the foregoing
diversification requirements.

If the Company acquires or is 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, the Company will be
required to 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 the relevant entity in the same taxable
year and to make distributions accordingly.

Although it does not presently expect to do so, the Company is authorized
to borrow funds and to sell assets in order to satisfy distribution
requirements. However, under the 1940 Act, the Company is not permitted to make
distributions to stockholders while the Company's debt obligations and other
senior securities are outstanding unless certain "asset coverage" tests are met.
Moreover, the Company's ability to dispose of assets to meet its distribution
requirements may be limited by other requirements relating to its status as a
RIC, including the diversification requirements. If the Company disposes of
assets in order to meet

B-9
<PAGE> 110

distribution requirements, the Company may make such dispositions at times
which, from an investment standpoint, are not advantageous.

If the Company fails to satisfy the 90% Distribution Requirement or
otherwise fails to qualify as a RIC in any taxable year, it will be subject to
tax in such year on all of its taxable income, regardless of whether the Company
makes any distributions to its stockholders. In addition, in that case, all of
the Company's distributions to its stockholders will be characterized as
ordinary income (to the extent of the Company's current and accumulated earnings
and profits). In contrast, as is explained below, if the Company qualifies as a
RIC, a portion of its distributions may be characterized as long-term capital
gain in the hands of stockholders.

U.S. Stockholders. Other than distributions properly designated as
"capital gain dividends" as is described below, dividends to U.S. Stockholders
(as defined below) of the investment company taxable income of the Company will
be taxable as ordinary income to stockholders to the extent of the Company's
current or accumulated earnings and profits, whether paid in cash or reinvested
in additional shares. A "U.S. Stockholder" is a stockholder who is (i) a citizen
or resident of the United States, (ii) a corporation, partnership or other
entity created in or organized under the laws of the United States or any
political subdivision thereof, (iii) an estate, the income of which is subject
to United States federal income taxation regardless of its source, or (iv) a
trust subject to the supervision of a court within the United States and the
control of a United States person. Distributions of the Company's net capital
gain properly designated by the Company as "capital gain dividends" will be
taxable to stockholders as a long-term capital gain regardless of the
stockholder's holding period for his or her shares. Distributions in excess of
the Company's earnings and profits will first reduce the adjusted tax basis of
the stockholder's shares and, after the adjusted basis is reduced to zero, will
constitute capital gains to the stockholder. For a summary of the tax rates
applicable to capital gains, including capital gains dividends, see discussion
below.

To the extent that the Company retains any net capital gain, it may
designate such retained gain as "deemed distributions" and pay a tax thereon for
the benefit of its stockholders. In that event, the stockholders will be
required to report their share of retained net capital gain on their tax returns
as if it had been distributed to them and report a credit, or claim or refund
for the tax paid thereon by the Company. The amount of the deemed distribution
net of such tax will be added to the stockholder's cost basis for his or her
shares. Since the Company expects to pay tax on net capital gain at its regular
corporate capital gain tax rate, and since that rate is in excess of the maximum
rate currently payable by individuals on net capital gain, the amount of tax
that individual stockholders will be treated as having paid will exceed the
amount of tax that such stockholders would be required to pay on net capital
gain.

Stockholders who are not subject to federal income tax or tax on capital
gains should be able to file a Form 990T or an income tax return on the
appropriate form that allows them to recover the taxes paid on their behalf.

Any dividend declared by the Company in October, November, or December of
any calendar year, payable to stockholders of record on a specified date in such
a month and actually paid during January of the following year, will be treated
as if it had been received by the stockholders on December 31 of the year in
which the dividend was declared.

Investors should be careful to consider the tax implications of buying
shares just prior to a distribution. Even if the price of the shares includes
the amount of the forthcoming distribution, the stockholder generally will be
taxed upon receipt of the distribution and will not be entitled to offset the
distribution against the tax basis in his or her shares.

A stockholder may recognize taxable gain or loss if he or she sells or
exchanges his or her shares. Any gain arising from (or, in the case of
distributions in excess of earnings and profits, treated as arising from) the
sale or exchange of shares generally will be a capital gain or loss. This
capital gain or loss normally will be treated as a long-term capital gain or
loss if the stockholder has held his or her shares for more than one year;
otherwise, it will be classified as short-term capital gain or loss. However,
any capital loss arising from the sale or exchange of shares held for six months
or less will be treated as a long-term capital loss to the extent of the

B-10
<PAGE> 111

amount of capital gain dividends received with respect to such shares and, for
this purpose, the special rules of Section 246(c)(3) and (4) of the Code
generally apply in determining the holding period of shares. It is unclear how
any such long-term capital loss offsets capital gains taxable at different
rates. All or a portion of any loss realized upon a taxable disposition of
shares of the Company may be disallowed if other shares of the Company are
purchased (under a DRIP Plan or otherwise) within 30 days before or after the
disposition.

In general, net capital gain (the excess of net long-term capital gain over
net short-term capital loss) of non-corporate taxpayers is currently subject to
a maximum federal income tax rate of 28% (subject to reduction in many
situations) while other income may be taxed at rates as high as 39.6%. Capital
gains derived from the disposition of assets held for more than 18 months
generally are subject to federal income tax at the rate of 20%. Corporate
taxpayers are currently subject to federal income tax on net capital gain at the
maximum 35% rate also applied to ordinary income. Tax rates imposed by states
and local jurisdictions on capital gain and ordinary income may differ.

The Company will send to each of its stockholders, as promptly as possible
after the end of each fiscal year, a notice detailing, on a per share and per
distribution basis, the amounts includible in such stockholder's taxable income
for such year as ordinary income and as long-term capital gain. In addition, the
federal tax status of each year's distributions generally will be reported to
the IRS. Distributions may also be subject to additional state, local, and
foreign taxes depending on a stockholder's particular situation. The Company's
ordinary income dividends to its corporate shareholders may, if certain
conditions are met, qualify for the dividends received deduction to the extent
that the Company has received qualifying dividend income during the taxable
year; capital gain dividends distributed by the Company are not eligible for the
dividends received deduction.

Non-U.S. Stockholders. A Stockholder that is not a U.S. Stockholder (a
"Non-U.S. Stockholder") generally will be subject to withholding of United
States federal income tax at a 30% rate (or lower applicable treaty rate) on
dividends from the Company (other than capital gain dividends) that are not
"effectively connected" with a United States trade or business carried on by
such stockholder. Accordingly, investment in the Company is likely to be
appropriate for a Non-U.S. Stockholder only if such person can utilize a foreign
tax credit or corresponding tax benefit in respect of such United States
withholding tax.

Non-effectively connected capital gain dividends and gains realized from
the sale of Stock will not be subject to United States federal income tax in the
case of (i) a Non-U.S. Stockholder that is a corporation and (ii) a Non-U.S.
Stockholder that is not present in the United States for more than 182 days
during the taxable year (assuming that certain other conditions are met).
However, certain Non-U.S. Stockholders may nonetheless be subject to backup
withholding on capital gain dividends and gross proceeds paid to them upon the
sale of their stock. See "Backup Withholding" below.

If income from the Company or gains realized from the sale of Stock is
effectively connected with a Non-U.S. Stockholder's United States trade or
business, then such amounts will be subject to United States federal income tax
at the tax rates applicable to United States persons. Non-U.S. Stockholders that
are corporations may also be subject to an additional "branch profits tax" with
respect to income from the Company that is effectively connected with a United
States trade or business.

The United States Treasury Department recently issued Treasury regulations
generally effective for payments made after December 31, 1999 concerning the
withholding of tax and information reporting for certain amounts paid to
nonresident alien individuals and foreign corporations (the "Final Withholding
Regulations"). Among other things, the Final Withholding Regulations may require
Non-U.S. Stockholders to furnish new certification of their foreign status after
December 31, 1999. Prospective investors should consult their tax advisors
concerning the applicability and effect of the Final Withholding Regulations on
an investment in stock.

The tax consequences to a Non-U.S. Stockholder entitled to claim the
benefits of an applicable tax treaty may be different from those described in
this section. Non-U.S. Stockholders may be required to provide appropriate
documentation to establish their entitlement to the benefits of such a treaty.
Foreign investors are

B-11
<PAGE> 112

advised to consult their tax advisors with respect to the tax implications of
purchasing, holding and disposing of stock.

Backup Withholding. The Company may be required to withhold United States
federal income tax at a rate of 31% ("backup withholding") from dividends and
redemption proceeds paid to non-corporate stockholders. This tax may be withheld
from dividends if (i) the Stockholder fails to furnish the Company with its
correct taxpayer identification number, (ii) the IRS notifies the Company that
the Stockholder has failed to properly report certain interest and dividend
income to the IRS and to respond to notices to that effect or (iii) when
required to do so, the Stockholder fails to certify that he or she is not
subject to backup withholding. Redemption proceeds may be subject to withholding
under the circumstances described in (i) above.

The Company may be required to report annually to the IRS and to each
Non-U.S. Stockholder the amount of dividends paid to such Stockholder and the
amount, if any, of tax withheld pursuant to the backup withholding rules with
respect to such dividends. This information may also be made available to the
tax authorities in the Non-U.S. Stockholder's country of residence.

Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules from payments made to a Stockholder may be refunded or
credited against such Stockholder's United States federal income tax liability,
if any, provided that the required information is furnished to the IRS.

STOCKHOLDERS ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO
THE PARTICULAR TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN THE COMPANY,
INCLUDING THE POSSIBLE EFFECT OF ANY PENDING LEGISLATION OR PROPOSED REGULATION.

B-12
<PAGE> 113

PART C

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS

1. FINANCIAL STATEMENTS.

The following financial statements of Allied Capital Corporation (the
"Company" or the "Registrant") are included in this registration statement in
"Part A: Information Required in a Prospectus":

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Balance Sheet -- March 31, 1998 (unaudited) and
as of December 31, 1997 and 1996.......................... F-1
Consolidated Statement of Operations -- For the Three Months
Ended March 31, 1998 and 1997 (unaudited) and the Years
Ended December 31, 1997, 1996 and 1995.................... F-2
Consolidated Statement of Changes in Net Assets -- For the
Three Months Ended March 31, 1998 and 1997 (unaudited) and
the Years Ended December 31, 1997, 1996 and 1995.......... F-3
Consolidated Statement of Cash Flows -- For the Three Months
Ended March 31, 1998 and 1997 (unaudited) and the Years
Ended December 31, 1997, 1996 and 1995.................... F-4
Consolidated Statement of Investments -- March 31, 1998
(unaudited) and December 31, 1997......................... F-5
Notes to Consolidated Financial Statements.................. F-15
Report of Independent Public Accountants.................... F-33
</TABLE>

2. EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
a.1(1) Articles of Amendment and Restatement of the Articles of
Incorporation.
a.2(2) Articles of Merger.
b.(3) Bylaws.
c. Not applicable.
d.+ Specimen certificate of the Company's Common Stock, par
value $0.0001, the rights of holders of which are defined in
Exhibits a.1, a.2 and b.
e.(3) Dividend Reinvestment Plan.
f.1(4) Form of debenture between certain subsidiaries of ACC and
the U.S. Small Business Administration.
f.2+ Amended and Restated Credit Agreement dated as of April 20,
1998 (the "1998 Credit Agreement") between the Company,
Allied Capital REIT, Inc., and Allied Capital SBLC
Corporation, as Borrowers, each of the financial
institutions initially a signatory thereto, as Lenders, and
BankBoston, N.A., as disbursing agent, First Union National
Bank, as syndication agent and Riggs Bank N.A., as managing
agent and NationsBank of Texas, N.A., as Co-Agent.
f.3(5) Note Agreement between Allied I and certain subsidiaries and
Massachusetts Mutual Life Insurance Company, as amended,
dated April 30, 1992. The Company has received confirmation
of the assignment of Note Agreement from Allied I to the
Company.
f.4(6) Loan Agreement between Allied I and Overseas Private
Investment Corporation, dated April 10, 1995. Letter dated
December 11, 1997 evidencing assignment of Loan Agreement
from Allied I to the Company.
f.5(3) Amended and Restated Master Repurchase Agreement dated March
22, 1996 among Allied Commercial, BMI and Merrill Lynch
Mortgage Capital Inc. Letter evidencing the assignment of
this facility to the Company dated November 6, 1997.
f.6(3) Master Loan & Security Agreement dated August 21, 1997 among
Allied Commercial, BMI and Morgan Stanley Mortgage Capital,
Inc.
f.7.a+ Sale and Servicing Agreement dated, as of January 1, 1998,
among Allied Capital CMT, Inc., Allied Capital Commercial
Mortgage Trust 1998-1 and Allied Capital Corporation and
LaSalle National Bank and ABN AMRO Bank N.V.
</TABLE>

C-1
<PAGE> 114

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
f.7.b+ Indenture dated as of January 1, 1998, between the Allied
Capital Commercial Mortgage Trust 1998-1 and LaSalle
National Bank.
f.7.c+ Amended and Restated Trust Agreement, dated January 1, 1998
between Allied Capital CMT, LaSalle National Bank Inc. and
Wilmington Trust Company.
f.7.d+ Guaranty dated as of January 1, 1998 by Allied Capital
Corporation.
g. Not applicable.
h.1* Form of Underwriting Agreement.
h.2* Form of Agreement among International Underwriters.
h.3* Form of Agreement between U.S. and International
Underwriters.
h.4* Form of International Dealer Agreement.
i.1(3) Employee Stock Ownership Plan, as amended on December 31,
1997.
i.2(3) Deferred Compensation Plan, as amended January 1, 1998.
i.3(9) Stock Option Plan.
i.4 Description of Formula Award and Cut-Off Award Arrangements.
A discussion of the Formula and Cut-off Awards is set forth
on page 48 of the Registration Statement.
j.1+ Form of Custody Agreement with Riggs Bank N.A. with respect
to safekeeping.
j.2+ Form of Custody Agreement with LaSalle National Bank.
k.1(7) Investment Management Agreement among Advisers, Mitchell
Hutchins Institutional Investors Inc. and BMI, dated January
4, 1993 (the "MH Management Agreement"). Assignment of the
MH Agreement from Mitchell Hutchins Institutional Investors
Inc. to Siguler Guff & Company LLC on August 8, 1995. Waiver
dated December 31, 1997 evidencing assignment of MH
Management Agreement from Advisers to the Company.
k.2(7) Agreement between the Company and Mitchell Hutchins
Institutional Investors Inc., dated January 4, 1993 ("MH
Agreement") Assignment of MH Agreement from Mitchell
Hutchins Institutional Investors, Inc. to Siguler Guff &
Company LLC on August 8, 1995. Assignment of MH Management
Agreement from Advisers to the Company on December 31, 1997.
Consent to assign MH Agreement to the Company.
k.3(8) Lease Agreement between 1620 K Street Associates Limited
Partnership and Advisers dated February 17, 1993 (the "1620
K Street Lease Agreement"). Assignment of Lease and
Landlord's consent to Assignment dated January 5, 1998
evidencing assignment of the 1620 K Street Lease Agreement
from Advisers to the Company.
k.4(3) Form of Regional Associate Agreement.
l.+ Opinion of counsel and consent to its use.
m. Not applicable.
n.1* Consent of Arthur Andersen LLP, independent public
accountants.
n.2* Consent of Sutherland, Asbill & Brennan LLP.
o. Not applicable.
p. Not applicable.
q. Not applicable.
r.+ Financial Data Schedule.
</TABLE>

- ---------------

<TABLE>
<S> <C>
* Filed herewith.
+ Filed previously with this Registration Statement on Form
N-2 (File No. 333-51899).
(1) Incorporated by reference to Exhibit 3(i) with Allied
Lending's Annual Report on Form 10-K for the year ended
December 31, 1996 (File No. 0-22832).
(2) Incorporated by reference from Appendix B to the Company's
registration statement on Form N-14 filed on the Company's
behalf with the Commission on September 26, 1997 (File No.
333-36459).
(3) Incorporated by reference to the exhibit of the same name
filed with the Company's report on Form 10-K for the year
ended December 31, 1997 (File No. 0-22832).
(4) Incorporated by reference to Exhibit 4.2 filed with Allied
I's Annual Report on Form 10-K for the year ended December
31, 1996 (File No. 811-00907).
</TABLE>

C-2
<PAGE> 115

(5) Incorporated by reference to Exhibit (4)(D)(i) filed with
Allied I's Annual Report on Form 10-K for the year ended
December 31, 1992. Amendments thereto are incorporated by
reference to Exhibits (4)(D)(ii), (4)(D)(iii) and (4)(D)(iv)
to Allied I's Form 8-K filed on December 9, 1993 (File No.
811-00907).
(6) Incorporated by reference to Exhibit 10.2 of Allied I's
Pre-Effective Amendment No. 2 filed with the registration
statement on Form N-2 on January 24, 1996 (File No.
33-64629). Assignment to the Company is incorporated by
reference to Exhibit 10.3 of the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1997 (File
No. 0-22832).
(7) Agreement incorporated by reference to the exhibit of the
same name to Advisers' Report on Form 10-K for the year
ended December 31, 1992. Assignment to the Company is
incorporated by reference to the exhibit of the same name
filed with Advisers' Report on Form 10-K for the year ended
December 31, 1995. (File No. 0-18826). Waiver and consent to
assign to the Company for each agreement is incorporated by
reference to the exhibit of the same name filed with the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-22832).
(8) Incorporated by reference to an exhibit of the same name
filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1994 (File No. 0-22832).
Incorporated by reference to the exhibit of the same name
filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1997 (File No. 0-22832).
(9) Incorporated by reference to Exhibit 4 of the Allied Capital
Corporation Stock Option Plan registration statement on Form
S-8, filed on behalf of such Plan on February 3, 1998 (File
No. 333-45525).

ITEM 25. MARKETING ARRANGEMENTS

The information contained under the heading "Underwriters" on pages 57-60
of the Prospectus is incorporated herein by reference.

In connection with this Offering, the Underwriters may over-allot or effect
transactions which stabilize or maintain the market price of the Common stock of
a level above that which might otherwise prevail in the open market. Such
stabilizing, if commenced, may be discontinued at any time.

ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

<TABLE>
<S> <C>
Commission registration fee*................................ $ 50,352
NASD filing fee*............................................ $ 17,568
Nasdaq National Market Additional Listing Fee*.............. $ 17,500
Accounting fees and expenses................................ $ 75,000
Legal fees and expenses..................................... $200,000
Printing and engraving...................................... $150,000
Miscellaneous fees and expenses............................. $ 89,580
--------
Total.................................................. $600,000
========
</TABLE>

- ---------------
* Estimated for filing purposes.

All of the expenses set forth above shall be borne by the Company.

ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL

Direct Subsidiaries

The following list sets forth each of the Company's subsidiaries, the state
or country under whose laws the subsidiary is organized, and the percentage of
voting securities or membership interests owned by the Company in such
subsidiary:

<TABLE>
<S> <C>
Allied Investment Corporation (Maryland).................... 100%
Allied Capital Financial Corporation (Maryland)............. 100%
Allied Capital SBLC Corporation (Maryland).................. 100%
Allied Capital REIT, Inc. ("Allied REIT") (Maryland)........ 100%
Allied Capital Beteiligungsberatung GmbH (Germany).......... 100%
</TABLE>

Each of the Company's subsidiaries are consolidated with the Company for
financial reporting purposes.

C-3
<PAGE> 116

Indirect Subsidiaries

The Company indirectly controls the entities set forth below through Allied
REIT. Allied REIT owns either all of the membership interests (in the case of a
limited liability company, "LLC") or all of the outstanding voting stock (in the
case of a corporation) of each entity. The following list sets forth each of
Allied REIT's subsidiaries, the state under whose laws the subsidiary is
organized, and the percentage of voting securities or membership interests owned
by the Allied REIT in such subsidiary:

<TABLE>
<S> <C>
Allied Capital Holdings LLC (Delaware)...................... 100%
Allied Capital Property LLC (Delaware)...................... 100%
Allied Capital Equity LLC (Delaware)........................ 100%
9586 I-25 East Frontage Road, Longmont, CO 80504 LLC
(Delaware)................................................ 100%
8930 Stanford Boulevard LLC (Delaware)...................... 100%
Allied Capital CMT, Inc. (Delaware)......................... 100%
</TABLE>

Allied REIT also indirectly owns Allied Capital Commercial Mortgage Trust
1998, a Delaware LLC that is wholly owned by Allied Capital CMT, Inc. ("CMT").
Each subsidiary of Allied REIT and CMT is not required to maintain financial and
other reports required under the Securities Act because each does not have a
class of securities registered under the Securities Act.

Other Entities Deemed to be Controlled by the Company*

The Company provides investment advisory services to the certain entities
and therefore may be deemed to control such entities and their respective
subsidiaries. The following list sets forth each such entity and its respective
subsidiaries and the state under whose laws the entity or subsidiary is
organized:

Allied Capital Germany Fund LLC (Delaware)

Business Mortgage Investors, Inc. (Maryland)
Wholly Owned Subsidiaries of Business Mortgage Investors, Inc.:
BMI Holdings, Inc. (Maryland)
BMI Acceptance Corporation (Maryland)
BMI Funding, Inc. (Delaware)
Indirect subsidiary of Business Mortgage Investors, Inc.
BMI Funding LLC (Delaware), of which BMI Funding, Inc. owns all membership
interests
- ---------------

* By so including these entities herein, the Registrant does not concede that it
controls such entities.

ITEM 28. NUMBER OF HOLDERS OF SECURITIES

The following table sets forth the number of record holders of the
Company's Common Stock at June 1, 1998.

<TABLE>
<CAPTION>
NUMBER OF
TITLE OF CLASS RECORD HOLDERS
-------------- --------------
<S> <C>
Common Stock, $0.0001 par value............................. 4,500
</TABLE>

ITEM 29. INDEMNIFICATION

The Annotated Code of Maryland, Corporations and Associations (the
"Maryland Law"), Section 2-418 provides that a Maryland corporation may
indemnify any director of the corporation and any person who, while a 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.
C-4
<PAGE> 117

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 Articles of Incorporation of the Company 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). The Company's
Bylaws, however, provide that the Company may not indemnify any director or
officer against liability to the Company 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 the
Company pursuant to the provisions described above, or otherwise, the Company
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 the Company 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, the Company 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 the court of the issue.

The Company, in conjunction with its investment adviser and other entities
managed thereby, carries liability insurance for the benefit of its directors
and officers on a claims-made basis of up to $5,000,000, subject to a $250,000
retention and the other terms thereof.

The Agreement and Plan of Merger (the "Merger Agreement") by and among
Advisers, Allied I, Allied II, Allied Lending and Allied Commercial provides
that, from and after consummation of the Merger the Company shall indemnify any
person who at the date of the Merger Agreement, or had been at any time prior to
such date or who becomes prior to the effective time of the Merger, an officer
or director of Allied I, Allied II, Allied Commercial or Advisers, or any of
their respective subsidiaries, from any and all liabilities resulting from their
acts and omissions prior to the effective time of the Merger to the full extent
permitted by Maryland Law and the 1940 Act, including but not limited to acts
and omissions arising out of or pertaining to the Merger, and shall maintain in
effect for at least 72 months directors' and officers' liability insurance
policies with respect to matters occurring prior to the effective time of the
Merger.

ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER

Not applicable.

C-5
<PAGE> 118

ITEM 31. LOCATION OF ACCOUNTS AND RECORDS

The Company maintains at its 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 32. MANAGEMENT SERVICES

Not applicable.

ITEM 33. UNDERTAKINGS

The Registrant hereby undertakes:

(a) to suspend the offering of shares until the Prospectus is amended
if subsequent to the effective date of this Registration Statement, its net
asset value declines more than ten percent from its net asset value as of
the effective date of this Registration Statement;

(b) that, for the purpose of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this Registration Statement in reliance upon Rule 430A and
contained in a form of Prospectus filed by the Registrant under Rule 497(h)
under the Securities Act of 1933 shall be deemed to be part of this
Registration Statement as of the time it was declared effective; and

(c) that, for the purpose of determining any liability under the
Securities Act of 1933, each post effective amendment that contains a form
of Prospectus shall be deemed to be a new registration statement relating
to the securities offered therein, and the offering of the securities at
that time shall be deemed to be the initial bona fide offering thereof.

(d) to send by first class mail or other means designed to ensure
equally prompt delivery, within two business days of receipt of a written
or oral request, any Statement of Additional Information.

Subject to the terms and conditions of Section 15(d) of the Securities
Exchange Act of 1934, the registrant hereby undertakes to file with the
Securities and Exchange Commission such supplementary and periodic information,
documents and reports as may be prescribed by any rule or regulation of the
Commission heretofore or hereafter duly adopted pursuant to authority conferred
in that section.

Insofar as indemnification for liability arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions of its Charter and Bylaws permitting
indemnification, or otherwise, the registrant has been advised that in the
opinion of the Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant 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
Securities Act and will be governed by the final adjudication of such issue.

C-6
<PAGE> 119

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 1st day of June, 1998.

ALLIED CAPITAL CORPORATION

By: /s/ William L. Walton
----------------------------------------
William L. Walton
Chief Executive Officer and President

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 June 1, 1998.

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>

/s/ William L. Walton Chairman of the Board, Chief Executive Officer, and
- --------------------------------------------- President
William L. Walton

* Director
- ---------------------------------------------
Brooks H. Browne

* Director
- ---------------------------------------------
John D. Firestone

* Director
- ---------------------------------------------
Anthony T. Garcia

* Director
- ---------------------------------------------
Lawrence I. Hebert

* Director
- ---------------------------------------------
John I. Leahy

* Director
- ---------------------------------------------
Robert E. Long

* Director
- ---------------------------------------------
Warren K. Montouri

* Director
- ---------------------------------------------
Guy T. Steuart II

* Director
- ---------------------------------------------
T. Murray Toomey

* Director
- ---------------------------------------------
Laura W. van Roijen
</TABLE>

<PAGE> 120

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>

* Director
- ---------------------------------------------
George C. Williams

/s/ Jon A. DeLuca Principal and Chief Financial Officer (Principal
- --------------------------------------------- Financial and Accounting Officer)
Jon A. DeLuca
</TABLE>

* William L. Walton hereby signs this Amendment on June 1, 1998 on behalf of
each of the indicated persons for whom he is attorney-in-fact pursuant to a
power of attorney previously filed.

/s/ William L. Walton

- ---------------------------------------------

William L. Walton, Attorney-in-fact

<PAGE> 121

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- -----------
<S> <C>
99.2h.l Form of Underwriting Agreement
99.2h.2 Form of Agreement among International Underwriters
99.2h.3 Form of Agreement between U.S. and International
Underwriters
99.2h.4 Form of International Dealer Agreement
99.2n.1 Consent of Arthur Andersen LLP, independent public
accountants.
99.2n.2 Consent of Sutherland, Asbill & Brennan LLP.
</TABLE>

<PAGE> 1
EXHIBIT H.1

5,750,000 SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK, $0.0001 PAR VALUE PER SHARE

UNDERWRITING AGREEMENT

June __, 1998
<PAGE> 2
June __, 1998

Morgan Stanley & Co. Incorporated
NationsBanc Montgomery Securities LLC
The Robinson-Humphrey Company LLC
Scott & Stringfellow, Inc.
c/o Morgan Stanley & Co.
Incorporated
1585 Broadway
New York, New York 10036

Morgan Stanley & Co. International Limited
NationsBanc Montgomery Securities LLC
The Robinson-Humphrey Company LLC
Scott & Stringfellow, Inc.
c/o Morgan Stanley & Co.
International Limited
25 Cabot Square
Canary Wharf
London E14 4QA
England

Dear Sirs and Mesdames:

Allied Capital Corporation, a Maryland corporation (the "COMPANY"),
proposes to issue and sell to the several Underwriters (as defined below) an
aggregate of 5,750,000 shares of its common stock, $0.0001 par value per share
(the "FIRM SHARES").

It is understood that, subject to the conditions hereinafter stated,
4,600,000 Firm Shares (the "U.S. FIRM SHARES") will be sold to the several U.S.
Underwriters named in Schedule I hereto (the "U.S. UNDERWRITERS") in connection
with the offering and sale of such U.S. Firm Shares in the United States to
United States Persons (as such terms are defined in the Agreement Between U.S.
and International Underwriters of even date herewith), and 1,150,000 Firm Shares
(the "INTERNATIONAL SHARES") will be sold to the several International
Underwriters named in Schedule II hereto (the "INTERNATIONAL UNDERWRITERS") in
connection with the offering and sale of such International Shares outside the
United States to persons other than United States Persons. Morgan Stanley & Co.
Incorporated, NationsBanc Montgomery Securities LLC, The Robinson-Humphrey
Company LLC and Scott & Stringfellow, Inc. shall act as representatives (the
"U.S.
<PAGE> 3
REPRESENTATIVES") of the several U.S. Underwriters, and Morgan Stanley &
Co. International Limited, NationsBanc Montgomery Securities LLC, The
Robinson-Humphrey Company LLC and Scott & Stringfellow, Inc. shall act as
representatives (the "INTERNATIONAL REPRESENTATIVES") of the several
International Underwriters. The U.S. Underwriters and the International
Underwriters are hereinafter collectively referred to as the Underwriters.

The Company also proposes to issue and sell to the several U.S.
Underwriters not more than an additional 862,500 shares of its common stock,
$0.0001 par value per share (the "ADDITIONAL SHARES"), if and to the extent that
the U.S. Representatives shall have determined to exercise, on behalf of the
U.S. Underwriters, the right to purchase such shares of common stock granted to
the U.S. Underwriters in Section 2 hereof. The Firm Shares and the Additional
Shares are hereinafter collectively referred to as the "SHARES." The shares of
common stock, $0.0001 par value per share, of the Company to be outstanding
after giving effect to the sales contemplated hereby, are hereinafter referred
to as the "COMMON STOCK."

The Company has filed with the Securities and Exchange Commission (the
"COMMISSION") a registration statement relating to the Shares. The registration
statement contains two prospectuses to be used in connection with the offering
and sale of the Shares: the U.S. prospectus, to be used in connection with the
offering and sale of Shares in the United States to United States Persons, and
the international prospectus, to be used in connection with the offering and
sale of Shares outside the United States to persons other than United States
Persons. The international prospectus is identical to the U.S. prospectus except
for the outside front cover page. The registration statement as amended at the
time it becomes effective, including the information (if any) deemed to be part
of the registration statement at the time of effectiveness pursuant to Rule 430A
under the Securities Act of 1933, as amended (the "SECURITIES Act"), is
hereinafter referred to as the "REGISTRATION Statement"; the U.S. prospectus and
the international prospectus (as described in Rule 434(a)(1) under the
Securities Act) in the respective forms first used to confirm sales of Shares
are hereinafter collectively referred to as the "DISTRIBUTED PROSPECTUS"; the
U.S. prospectus and the international prospectus included in the Registration
Statement at the time of its effectiveness (including the information, if any,
deemed to be a part of the Registration Statement at the time of effectiveness
pursuant to Rule 430A under the Securities Act) are hereinafter collectively
referred to as the "FILED PROSPECTUS"; and the Distributed Prospectus and the
Filed Prospectus, together with the Statement of Additional Information
incorporated by reference therein, are hereinafter referred to collectively as
the "PROSPECTUS." If the Company has filed an abbreviated registration statement
to register additional shares of Common Stock pursuant to Rule 462(b) under the
Securities Act (the "RULE 462 REGISTRATION STATEMENT"), then any reference

2
<PAGE> 4
herein to the term "Registration Statement" shall be deemed to include such Rule
462 Registration Statement.

1. Representations and Warranties. The Company represents and warrants to
and agrees with each of the Underwriters that:

(a) The Registration Statement has become effective; no stop order
suspending the effectiveness of the Registration Statement is in effect,
and no proceedings for such purpose are pending before or threatened by
the Commission.

(b) (i) The Registration Statement, when it became effective, did
not contain and, as amended or supplemented, if applicable, will not
contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading, (ii) the Registration Statement and the
Prospectus and any amendment or supplement thereto will comply in all
material respects with the Securities Act and with the provisions of the
Investment Company Act of 1940, as amended (the "Investment Company Act")
applicable to business development companies and with the applicable rules
and regulations of the Commission thereunder, respectively and (iii) the
Prospectus does not contain and, as amended or supplemented, if
applicable, will not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements therein, in
the light of the circumstances under which they were made, not misleading,
except that the representations and warranties set forth in this paragraph
do not apply to statements or omissions in the Registration Statement or
the Prospectus or any amendment or supplement thereto based upon
information relating to any Underwriter furnished to the Company in
writing by such Underwriter through you expressly for use therein.

(c) The Company has been duly incorporated, is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has the corporate power and authority to own its property
and to conduct its business as described in the Prospectus and is duly
qualified to transact business and is in good standing in each
jurisdiction in which the conduct of its business or its ownership or
leasing of property requires such qualification, except to the extent that
the failure to be so qualified or be in good standing would not have a
material adverse effect on the Company and its subsidiaries, taken as a
whole.

(d) Each subsidiary of the Company has been duly incorporated or
formed, is validly existing as a corporation or a limited liability
company,

3
<PAGE> 5
as applicable, is in good standing under the laws of the jurisdiction of
its incorporation or formation, as applicable, has the power and authority
to own its property and to conduct its business, in each case as described
in the Prospectus, and is duly qualified to transact business and is in
good standing in each jurisdiction in which the conduct of its business or
its ownership or leasing of property requires such qualification, except
to the extent that the failure to be so qualified or be in good standing
would not have a material adverse effect on the Company and its
subsidiaries, taken as a whole; all of the issued shares of capital stock
of each subsidiary of the Company have been duly and validly authorized
and issued, are fully paid and non-assessable and are owned directly by
the Company, free and clear of all liens, encumbrances, equities or
claims, except with respect to the employee-owned shares of preferred
stock of Allied Capital REIT, Inc. and the Preferred Stock of Allied
Capital Financial Corporation owned by the U.S. Small Business
Administration (the "SBA");

(e) This Agreement has been duly authorized, executed and delivered
by the Company.

(f) The authorized capital stock of the Company conforms as to legal
matters to the description thereof contained in the Prospectus.

(g) The shares of Common Stock outstanding prior to the issuance of
the Shares have been duly authorized and are validly issued, fully paid
and non-assessable.

(h) The Shares have been duly authorized and, when issued and
delivered in accordance with the terms of this Agreement, will be validly
issued, fully paid and non-assessable, and the issuance of such Shares
will not be subject to any preemptive or similar rights.

(i) The execution and delivery by the Company of, and the
performance by the Company of its obligations under, this Agreement will
not contravene any provision of applicable law or the certificate of
incorporation or by-laws of the Company or any agreement or other
instrument binding upon the Company or any of its subsidiaries that is
material to the Company and its subsidiaries, taken as a whole, or any
judgment, order or decree of any governmental body, agency or court having
jurisdiction over the Company or any subsidiary, and no consent, approval,
authorization or order of, or qualification with, any governmental body or
agency is required for the performance by the Company of its obligations
under this Agreement, except such as may be required by the securities or
Blue Sky laws of the various states in connection with the offer and sale
of the Shares.

4
<PAGE> 6
(j) There has not occurred any material adverse change, or any
development involving a prospective material adverse change, in the
condition, financial or otherwise, or in the earnings, business or
operations of the Company and its subsidiaries, taken as a whole, from
that set forth in the Prospectus (exclusive of any amendments or
supplements thereto subsequent to the date of this Agreement).

(k) There are no legal or governmental proceedings pending or
threatened to which the Company or any of its subsidiaries is a party or
to which any of the properties of the Company or any of its subsidiaries
is subject that are required to be described in the Registration Statement
or the Prospectus and are not so described or any statutes, regulations,
contracts or other documents that are required to be described in the
Registration Statement or the Prospectus or to be filed as exhibits to the
Registration Statement that are not described or filed as required.

(l) Each preliminary prospectus filed as part of the registration
statement as originally filed or as part of any amendment thereto, or
filed pursuant to Rule 497 under the Securities Act, complied when so
filed in all material respects with the Securities Act and the applicable
rules and regulations of the Commission thereunder.

(m) The operations of the Company and its subsidiaries are in
compliance in all material respects with the provisions of the Investment
Company Act applicable to business development companies and the rules and
regulations of the Commission thereunder.

(n) To the best of its knowledge, the Company and its subsidiaries
(i) are in compliance with any and all applicable foreign, federal, state
and local laws and regulations relating to the protection of human health
and safety, the environment or hazardous or toxic substances or wastes,
pollutants or contaminants ("ENVIRONMENTAL LAWS"), (ii) have received all
permits, licenses or other approvals required of them under applicable
Environmental Laws to conduct their respective businesses and (iii) are in
compliance with all terms and conditions of any such permit, license or
approval, except where such noncompliance with Environmental Laws, failure
to receive required permits, licenses or other approvals or failure to
comply with the terms and conditions of such permits, licenses or
approvals would not, singly or in the aggregate, have a material adverse
effect on the Company and its subsidiaries, taken as a whole.

(o) There are no contracts, agreements or understandings between the
Company and any person granting such person the right to

5
<PAGE> 7
require the Company to file a registration statement under the Securities
Act with respect to any securities of the Company or to require the
Company to include such securities with the Shares registered pursuant to
the Registration Statement.

(p) The Company has elected to be regulated as a business
development company under the Investment Company Act and has not withdrawn
that election, and the Commission has not ordered that such election be
withdrawn. All required action has or will have been taken by the Company
under the Securities Act, the Investment Company Act, and the rules and
regulations of the Commission thereunder, respectively, to make the public
offering and consummate the sale of the Shares as provided in this
Agreement.

(q) The Company owns or possesses or has obtained all governmental
licenses, permits, consents, orders, approvals and other authorizations,
whether international or domestic, necessary to carry on its business as
contemplated, except to the extent that the failure to own or possess or
have obtained such authorizations would not have a material adverse effect
on the Company and its subsidiaries, taken as a whole.

(r) There are no material restrictions, limitations or regulations
with respect to the ability of the Company or its subsidiaries to invest
its assets as described in the Prospectus, other than as described
therein.

2. Agreements to Sell and Purchase. The Company hereby agrees to sell to
the several Underwriters, and each Underwriter, upon the basis of the
representations and warranties herein contained, but subject to the conditions
hereinafter stated, agrees, severally and not jointly, to purchase from the
Company the respective numbers of Firm Shares set forth in Schedules I and II
hereto opposite its names at U.S.$_____ a share ("PURCHASE PRICE").

On the basis of the representations and warranties contained in this
Agreement, and subject to its terms and conditions, the Company agrees to sell
to the U.S. Underwriters the Additional Shares, and the U.S. Underwriters shall
have a one-time right to purchase, severally and not jointly, up to __________
Additional Shares at the Purchase Price. If the U.S. Representatives, on behalf
of the U.S. Underwriters, elect to exercise such option, the U.S.
Representatives shall so notify the Company in writing not later than 30 days
after the date of this Agreement, which notice shall specify the number of
Additional Shares to be purchased by the U.S. Underwriters and the date on which
such shares are to be purchased. Such date may be the same as the Closing Date
(as defined below) but not earlier than the Closing Date nor later than ten
business days after the date of

6
<PAGE> 8
such notice. Additional Shares may be purchased as provided in Section 4 hereof
solely for the purpose of covering over-allotments made in connection with the
offering of the Firm Shares. If any Additional Shares are to be purchased, each
U.S. Underwriter agrees, severally and not jointly, to purchase the number of
Additional Shares (subject to such adjustments to eliminate fractional shares as
the U.S. Representatives may determine) that bears the same proportion to the
total number of Additional Shares to be purchased as the number of U.S. Firm
Shares set forth in Schedule I hereto opposite the name of such U.S. Underwriter
bears to the total number of U.S. Firm Shares.

The Company hereby agrees that, without the prior written consent of
Morgan Stanley & Co. Incorporated on behalf of the Underwriters, it will not,
during the period ending 90 days after the date of the Prospectus, (i) offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend or otherwise transfer or dispose of, directly or indirectly, any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock or (ii) enter into any swap or other arrangement
that transfers to another, in whole or in part, any of the economic consequences
of ownership of the Common Stock, whether any such transaction described in
clause (i) or (ii) above is to be settled by delivery of Common Stock or such
other securities, in cash or otherwise. The foregoing sentence shall not apply
to (A) the Shares to be sold hereunder or (B) the issuance by the Company of
shares of Common Stock upon the exercise of an option or warrant or the
conversion of a security outstanding on the date hereof of which the
Underwriters have been advised in writing.

3. Terms of Public Offering. The Company is advised by you that the
Underwriters propose to make a public offering of their respective portions of
the Shares as soon after the Registration Statement and this Agreement have
become effective as in your judgment is advisable. The Company is further
advised by you that the Shares are to be offered to the public initially at
U.S.$_____ a share (the "PUBLIC OFFERING PRICE") and to certain dealers selected
by you at a price that represents a concession not in excess of U.S.$____ a
share under the Public Offering Price, and that any Underwriter may allow, and
such dealers may reallow, a concession, not in excess of U.S.$____ a share, to
any Underwriter or to certain other dealers.

4. Payment and Delivery. Payment for the Firm Shares shall be made to the
Company in Federal or other funds immediately available in New York City against
delivery of such Firm Shares for the respective accounts of the several
Underwriters at 10:00 a.m., New York City time, on ____________, 1998, or at
such other time on the same or such other date, not later than _________, 1998,
as

7
<PAGE> 9
shall be designated in writing by you. The time and date of such payment are
hereinafter referred to as the "CLOSING DATE."

Payment for any Additional Shares shall be made to the Company in Federal
or other funds immediately available in New York City against delivery of such
Additional Shares for the respective accounts of the several Underwriters at
10:00 a.m., New York City time, on the date specified in the notice described in
Section 2 or at such other time on the same or on such other date, in any event
not later than _______, 1998, as shall be designated in writing by the U.S.
Representatives. The time and date of such payment are hereinafter referred to
as the "OPTION CLOSING DATE."

Certificates for the Firm Shares and Additional Shares shall be in
definitive form and registered in such names and in such denominations as you
shall request in writing not later than one full business day prior to the
Closing Date or the Option Closing Date, as the case may be. The certificates
evidencing the Firm Shares and Additional Shares shall be delivered to you on
the Closing Date or the Option Closing Date, as the case may be, for the
respective accounts of the several Underwriters, with any transfer taxes payable
in connection with the transfer of the Shares to the Underwriters duly paid,
against payment of the Purchase Price therefor.

5. Conditions to the Underwriters' Obligations. The obligations of the
Company to sell the Shares to the Underwriters and the several obligations of
the Underwriters to purchase and pay for the Shares on the Closing Date are
subject to the condition that the Registration Statement shall have become
effective not later than [_______] (New York City time) on the date hereof.

The several obligations of the Underwriters are subject to the following
further conditions:

(a) Subsequent to the execution and delivery of this Agreement and
prior to the Closing Date, there shall not have occurred any change, or
any development involving a prospective change, in the condition,
financial or otherwise, or in the earnings, business or operations of the
Company and its subsidiaries, taken as a whole, from that set forth in the
Prospectus (exclusive of any amendments or supplements thereto subsequent
to the date of this Agreement) that, in your judgment, is material and
adverse and that makes it, in your judgment, impracticable to market the
Shares on the terms and in the manner contemplated in the Prospectus.

(b) The Underwriters shall have received on the Closing Date a
certificate, dated the Closing Date and signed by an executive officer of
the

8
<PAGE> 10
Company, to the effect set forth in Section 5(a) above and to the effect
that the representations and warranties of the Company contained in this
Agreement are true and correct as of the Closing Date and that the Company
has complied with all of the agreements and satisfied all of the
conditions on its part to be performed or satisfied hereunder on or before
the Closing Date.

The officer signing and delivering such certificate may rely upon
the best of his or her knowledge as to proceedings threatened.

(c) The Underwriters shall have received on the Closing Date an
opinion of Sutherland, Asbill & Brennan LLP, outside counsel for the
Company, dated the Closing Date, to the effect that:

(i) the Company has been duly incorporated, is validly
existing as a corporation in good standing under the laws of the
jurisdiction of its incorporation, has the corporate power and
authority to own its property and to conduct its business, in each
case as described in the Prospectus, and is duly qualified to
transact business and is in good standing in the District of
Colombia and the States of Illinois and California;

(ii) each subsidiary of the Company has been duly incorporated
or formed, is validly existing as a corporation or a limited
liability company, as applicable, is in good standing under the laws
of the jurisdiction of its incorporation or formation, as
applicable, has the corporate power and authority to own its
property and to conduct its business, in each case as described in
the Prospectus, and is duly qualified to transact business and is in
good standing in each jurisdiction in which the conduct of its
business or its ownership or leasing of property requires such
qualification, except to the extent that the failure to be so
qualified or be in good standing would not have a material adverse
effect on the Company and its subsidiaries, taken as a whole;

(iii) the authorized capital stock of the Company conforms as
to legal matters to the description thereof contained in the
Prospectus;

(iv) the shares of Common Stock outstanding prior to the
issuance of the Shares have been duly authorized and are validly
issued, fully paid and non-assessable;

9
<PAGE> 11
(v) to such counsel's knowledge, all of the issued shares of
capital stock of each subsidiary of the Company have been duly and
validly authorized and issued, are fully paid and non-assessable and
are owned directly by the Company, free and clear of all liens,
encumbrances, equities or claims, except with respect to the
employee-owned shares of preferred stock of Allied Capital REIT,
Inc. and the Preferred Stock of Allied Capital Financial
Corporation owned by the SBA.

(vi) the Shares have been duly authorized and, when issued and
delivered in accordance with the terms of this Agreement, will be
validly issued, fully paid and non-assessable, and the issuance of
such Shares will not be subject to any preemptive or similar rights;

(vii) this Agreement has been duly authorized, executed and
delivered by the Company;

(viii) the execution and delivery by the Company of, and the
performance by the Company of its obligations under, this Agreement
will not contravene any provision of applicable law or the
certificate of incorporation or by-laws of the Company or, to the
best of such counsel's knowledge, any agreement or other instrument
binding upon the Company or any of its subsidiaries that is material
to the Company and its subsidiaries, taken as a whole, or, to the
best of such counsel's knowledge, any judgment, order or decree of
any governmental body, agency or court having jurisdiction over the
Company or any subsidiary, and no consent, approval, authorization
or order of, or qualification with, any governmental body or agency
is required for the performance by the Company of its obligations
under this Agreement, except such as may be required by the National
Association of Securities Dealers, Inc. or the securities or Blue
Sky laws of the various states or of any foreign jurisdiction in
connection with the offer and sale of the Shares by the U.S.
Underwriters and the laws of any foreign jurisdiction in connection
with the offer and sale of the Shares by the International
Underwriters;

(ix) the statements (A) in the Prospectus under the captions
"Certain Government Regulations," "Description of Capital Stock,"
"Taxation" and "Underwriters," (B) in the Statement of Additional
Information under the caption "Tax Status" and (C) in the
Registration Statement in Item 29, in each case insofar as such
statements constitute summaries of the legal

10
<PAGE> 12
matters, documents or proceedings referred to therein, fairly
present the information called for with respect to such legal
matters, documents and proceedings and fairly summarize the matters
referred to therein;

(x) after due inquiry, such counsel does not know of any legal
or governmental proceedings pending or threatened to which the
Company or any of its subsidiaries is a party or to which any of the
properties of the Company or any of its subsidiaries is subject that
are required to be described in the Registration Statement or the
Prospectus and are not so described or of any statutes, regulations,
contracts or other documents that are required to be described in
the Registration Statement or the Prospectus or to be filed as
exhibits to the Registration Statement that are not described or
filed as required;

(xi) the Company has elected to be regulated as a business
development company under the provisions of the Investment Company
Act applicable to business development companies and the Commission
has not ordered that such election be withdrawn, and all action
under the Securities Act and the Investment Company Act necessary to
make the public offering and consummate the sale of the Shares as
provided in this Agreement has been taken by the Company; and

(xii) such counsel (A) is of the opinion that the Registration
Statement and the Prospectus (except for financial statements and
schedules and other financial and statistical data included therein
as to which such counsel need not express any opinion) comply as to
form in all material respects with the Securities Act and the
applicable rules and regulations of the Commission thereunder, (B)
has no reason to believe that (except for financial statements and
schedules and other financial and statistical data as to which such
counsel need not express any belief) the Registration Statement and
the prospectus included therein at the time the Registration
Statement became effective contained any untrue statement of a
material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements therein not
misleading, (C) has no reason to believe that (except for financial
statements and schedules and other financial and statistical data as
to which such counsel need not express any belief) the Prospectus
contains any untrue statement of a material fact or omits to state a
material fact necessary in order to make the statements therein, in
the light

11
<PAGE> 13
of the circumstances under which they were made, not misleading and
(D) is of the opinion that the Distributed Prospectus is not
materially different from the Filed Prospectus.

(d) The Underwriters shall have received on the Closing Date an
opinion of Davis Polk & Wardwell, counsel for the Underwriters, dated the
Closing Date, covering the matters referred to in Sections 5(c)(vi),
5(c)(vii), 5(c)(ix) (but only as to the statements in the Prospectus under
"Description of Capital Stock" and "Underwriters") and 5(c)(xii) above.

With respect to Section 5(c)(xii) above, Sutherland, Asbill &
Brennan LLP and Davis Polk & Wardwell may state that their opinion and
belief are based upon their participation in the preparation of the
Registration Statement and Prospectus and any amendments or supplements
thereto and review and discussion of the contents thereof, but are without
independent check or verification, except as specified.

The opinion of Sutherland, Asbill & Brennan LLP described in Section
5(c) above shall be rendered to the Underwriters at the request of the
Company and shall so state therein.

(e) The Underwriters shall have received, on each of the date hereof
and the Closing Date, a letter dated the date hereof or the Closing Date,
as the case may be, in form and substance satisfactory to the
Underwriters, from Arthur Anderson LLP, independent public accountants,
containing statements and information of the type ordinarily included in
accountants' "comfort letters" to underwriters with respect to the
financial statements and certain financial information contained in the
Registration Statement and the Prospectus; provided that the letter
delivered on the Closing Date shall use a "cut-off date" not earlier than
the date hereof.

(f) The "lock-up" agreements, each substantially in the form of
Exhibit A hereto, between you and the Company and all of its executive
officers and directors relating to sales and certain other dispositions of
shares of Common Stock or certain other securities, delivered to you on or
before the date hereof, shall be in full force and effect on the Closing
Date.

(g) The several obligations of the U.S. Underwriters to purchase
Additional Shares hereunder are subject to the delivery to the U.S.
Representatives on the Option Closing Date of such documents as they may
reasonably request with respect to the good standing of the Company, the
due authorization and issuance of the Additional Shares and other matters
related to the issuance of the Additional Shares.

12
<PAGE> 14
6. Covenants of the Company. In further consideration of the agreements of
the Underwriters herein contained, the Company covenants with each Underwriter
as follows:

(a) To furnish to you, without charge, three signed copies of the
Registration Statement (including exhibits thereto) and for delivery to
each other Underwriter a conformed copy of the Registration Statement
(without exhibits thereto) and to furnish to you in New York City, without
charge, prior to 11:00 a.m. New York City time on the business day next
succeeding the date of this Agreement and during the period mentioned in
Section 6(c) below, as many copies of the Distributed Prospectus, the
Statement of Additional Information and any supplements and amendments
thereto or to the Registration Statement as you may reasonably request.

(b) Before amending or supplementing the Registration Statement or
the Prospectus, to furnish to you a copy of each such proposed amendment
or supplement and not to file any such proposed amendment or supplement to
which you reasonably object, and to file with the Commission within the
applicable period specified in Rule 497 under the Securities Act any
prospectus required to be filed pursuant to such Rule.

(c) If, during such period after the first date of the public
offering of the Shares as in the opinion of counsel for the Underwriters
the Prospectus is required by law to be delivered in connection with sales
by an Underwriter or dealer, any event shall occur or condition exist as a
result of which it is necessary to amend or supplement the Prospectus in
order to make the statements therein, in the light of the circumstances
when the Prospectus is delivered to a purchaser, not misleading, or if, in
the opinion of counsel for the Underwriters, it is necessary to amend or
supplement the Prospectus to comply with applicable law, forthwith to
prepare, file with the Commission and furnish, at its own expense, to the
Underwriters and to the dealers (whose names and addresses you will
furnish to the Company) to which Shares may have been sold by you on
behalf of the Underwriters and to any other dealers upon request, either
amendments or supplements to the Prospectus so that the statements in the
Prospectus as so amended or supplemented will not, in the light of the
circumstances when the Prospectus is delivered to a purchaser, be
misleading or so that the Prospectus, as amended or supplemented, will
comply with law.

(d) To endeavor to qualify the Shares for offer and sale under the
securities or Blue Sky laws of such jurisdictions as you shall reasonably
request.

13
<PAGE> 15
(e) To make generally available to the Company's security holders
and to you as soon as practicable an earning statement covering the
twelve-month period ending June 30, 1998 that satisfies the provisions of
Section 11(a) of the Securities Act and the rules and regulations of the
Commission thereunder.

(f) To use its best efforts to maintain its qualification as a
regulated investment company under Subchapter M of the Code.

(g) Whether or not the transactions contemplated in this Agreement
are consummated or this Agreement is terminated, to pay or cause to be
paid all expenses incident to the performance of its obligations under
this Agreement, including: (i) the fees, disbursements and expenses of the
Company's counsel and the Company's accountants in connection with the
registration and delivery of the Shares under the Securities Act and all
other fees or expenses in connection with the preparation and filing of
the Registration Statement, any preliminary prospectus, the Prospectus and
amendments and supplements to any of the foregoing, including all printing
costs associated therewith, and the mailing and delivering of copies
thereof to the Underwriters and dealers, in the quantities hereinabove
specified, (ii) all costs and expenses related to the transfer and
delivery of the Shares to the Underwriters, including any transfer or
other taxes payable thereon, if applicable, (iii) the cost of printing or
producing any Blue Sky or Legal Investment memorandum in connection with
the offer and sale of the Shares under state securities laws and all
expenses in connection with the qualification of the Shares for offer and
sale under state securities laws as provided in Section 6(d) hereof,
including filing fees and the reasonable fees and disbursements of counsel
for the Underwriters in connection with such qualification and in
connection with the Blue Sky or Legal Investment memorandum, (iv) all
filing fees and the reasonable fees and disbursements of counsel to the
Underwriters incurred in connection with the review and qualification of
the offering of the Shares by the National Association of Securities
Dealers, Inc., (v) all costs and expenses incident to listing the Shares
on the Nasdaq National Market, (vi) the cost of printing certificates
representing the Shares, (vii) the costs and charges of any transfer
agent, registrar or depositary, (viii) the costs and expenses of the
Company relating to investor presentations on any "road show" undertaken
in connection with the marketing of the offering of the Shares, including,
without limitation, expenses associated with the production of road show
slides and graphics, fees and expenses of any consultants engaged in
connection with the road show presentations with the prior approval of the
Company, travel and lodging expenses of the

14
<PAGE> 16
representatives and officers of the Company and any such consultants, and
the cost of any aircraft chartered in connection with the road show, and
(ix) all other costs and expenses incident to the performance of the
obligations of the Company hereunder for which provision is not otherwise
made in this Section. It is understood, however, that except as provided
in this Section, Section 7 entitled "Indemnity and Contribution", and the
last paragraph of Section 9 below, the Underwriters will pay all of their
costs and expenses, including fees and disbursements of their counsel,
stock transfer taxes payable on resale of any of the Shares by them and
any advertising expenses connected with any offers they may make.

7. Indemnity and Contribution. (a) The Company agrees to indemnify and
hold harmless each Underwriter and each person, if any, who controls any
Underwriter within the meaning of either Section 15 of the Securities Act or
Section 20 of the Securities Exchange Act of 1934, as amended (the "EXCHANGE
ACT"), from and against any and all losses, claims, damages and liabilities
(including, without limitation, any legal or other expenses reasonably incurred
in connection with defending or investigating any such action or claim) caused
by any untrue statement or alleged untrue statement of a material fact contained
in the Registration Statement or any amendment thereof, any preliminary
prospectus or the Prospectus (as amended or supplemented if the Company shall
have furnished any amendments or supplements thereto), or caused by any omission
or alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading, except
insofar as such losses, claims, damages or liabilities are caused by any such
untrue statement or omission or alleged untrue statement or omission based upon
information relating to any Underwriter furnished to the Company in writing by
such Underwriter through you expressly for use therein.

(b) Each Underwriter agrees, severally and not jointly, to indemnify and
hold harmless the Company, its directors, its officers who sign the Registration
Statement and each person, if any, who controls the Company within the meaning
of either Section 15 of the Securities Act or Section 20 of the Exchange Act to
the same extent as the foregoing indemnity from the Company to such Underwriter,
but only with reference to information relating to such Underwriter furnished to
the Company in writing by such Underwriter through you expressly for use in the
Registration Statement, any preliminary prospectus, the Prospectus or any
amendments or supplements thereto.

(c) In case any proceeding (including any governmental investigation)
shall be instituted involving any person in respect of which indemnity may be
sought pursuant to Section 7(a) or 7(b), such person (the "INDEMNIFIED PARTY")
shall promptly notify the person against whom such indemnity may be sought (the

15
<PAGE> 17
"INDEMNIFYING PARTY") in writing and the indemnifying party, upon request of the
indemnified party, shall retain counsel reasonably satisfactory to the
indemnified party to represent the indemnified party and any others the
indemnifying party may designate in such proceeding and shall pay the fees and
disbursements of such counsel related to such proceeding. In any such
proceeding, any indemnified party shall have the right to retain its own
counsel, but the fees and expenses of such counsel shall be at the expense of
such indemnified party unless (i) the indemnifying party and the indemnified
party shall have mutually agreed to the retention of such counsel or (ii) the
named parties to any such proceeding (including any impleaded parties) include
both the indemnifying party and the indemnified party and representation of both
parties by the same counsel would be inappropriate due to actual or potential
differing interests between them. It is understood that the indemnifying party
shall not, in respect of the legal expenses of any indemnified party in
connection with any proceeding or related proceedings in the same jurisdiction,
be liable for the fees and expenses of more than one separate firm (in addition
to any local counsel) for all such indemnified parties and that all such fees
and expenses shall be reimbursed as they are incurred. Such firm shall be
designated in writing by Morgan Stanley & Co. Incorporated, in the case of
parties indemnified pursuant to Section 7(a), and by the Company, in the case of
parties indemnified pursuant to Section 7(b). The indemnifying party shall not
be liable for any settlement of any proceeding effected without its written
consent, but if settled with such consent or if there be a final judgment for
the plaintiff, the indemnifying party agrees to indemnify the indemnified party
from and against any loss or liability by reason of such settlement or judgment.
Notwithstanding the foregoing sentence, if at any time an indemnified party
shall have requested an indemnifying party to reimburse the indemnified party
for fees and expenses of counsel as contemplated by the second and third
sentences of this paragraph, the indemnifying party agrees that it shall be
liable for any settlement of any proceeding effected without its written consent
if (i) such settlement is entered into more than 30 days after receipt by such
indemnifying party of the aforesaid request and (ii) such indemnifying party
shall not have reimbursed the indemnified party in accordance with such request
prior to the date of such settlement. No indemnifying party shall, without the
prior written consent of the indemnified party, effect any settlement of any
pending or threatened proceeding in respect of which any indemnified party is or
could have been a party and indemnity could have been sought hereunder by such
indemnified party, unless such settlement includes an unconditional release of
such indemnified party from all liability on claims that are the subject matter
of such proceeding.

(d) To the extent the indemnification provided for in Section 7(a) or 7(b)
is unavailable to an indemnified party or insufficient in respect of any losses,
claims, damages or liabilities referred to therein, then each indemnifying party
under such paragraph, in lieu of indemnifying such indemnified party thereunder,

16
<PAGE> 18
shall contribute to the amount paid or payable by such indemnified party as a
result of such losses, claims, damages or liabilities (i) in such proportion as
is appropriate to reflect the relative benefits received by the Company on the
one hand and the Underwriters on the other hand from the offering of the Shares
or (ii) if the allocation provided by clause 7(d)(i) above is not permitted by
applicable law, in such proportion as is appropriate to reflect not only the
relative benefits referred to in clause 7(d)(i) above but also the relative
fault of the Company on the one hand and of the Underwriters on the other hand
in connection with the statements or omissions that resulted in such losses,
claims, damages or liabilities, as well as any other relevant equitable
considerations. The relative benefits received by the Company on the one hand
and the Underwriters on the other hand in connection with the offering of the
Shares shall be deemed to be in the same respective proportions as the net
proceeds from the offering of the Shares (before deducting expenses) received by
the Company and the total underwriting discounts and commissions received by the
Underwriters, in each case as set forth in the table on the cover of the
Prospectus, bear to the aggregate Public Offering Price of the Shares. The
relative fault of the Company on the one hand and the Underwriters on the other
hand shall be determined by reference to, among other things, whether the untrue
or alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by the Company
or by the Underwriters and the parties' relative intent, knowledge, access to
information and opportunity to correct or prevent such statement or omission.
The Underwriters' respective obligations to contribute pursuant to this Section
7 are several in proportion to the respective number of Shares they have
purchased hereunder, and not joint.

(e) The Company and the Underwriters agree that it would not be just or
equitable if contribution pursuant to this Section 7 were determined by pro rata
allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation that does not take account of the
equitable considerations referred to in Section 7(d). The amount paid or payable
by an indemnified party as a result of the losses, claims, damages and
liabilities referred to in the immediately preceding paragraph shall be deemed
to include, subject to the limitations set forth above, any legal or other
expenses reasonably incurred by such indemnified party in connection with
investigating or defending any such action or claim. Notwithstanding the
provisions of this Section 7, no Underwriter shall be required to contribute any
amount in excess of the amount by which the total price at which the Shares
underwritten by it and distributed to the public were offered to the public
exceeds the amount of any damages that such Underwriter has otherwise been
required to pay by reason of such untrue or alleged untrue statement or omission
or alleged omission. No person guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent

17
<PAGE> 19
misrepresentation. The remedies provided for in this Section 7 are not exclusive
and shall not limit any rights or remedies which may otherwise be available to
any indemnified party at law or in equity.

(f) The indemnity and contribution provisions contained in this Section 7
and the representations, warranties and other statements of the Company
contained in this Agreement shall remain operative and in full force and effect
regardless of (i) any termination of this Agreement, (ii) any investigation made
by or on behalf of any Underwriter or any person controlling any Underwriter or
by or on behalf of the Company, its officers or directors or any person
controlling the Company and (iii) acceptance of and payment for any of the
Shares.

8. Termination. This Agreement shall be subject to termination by notice
given by you to the Company, if (a) after the execution and delivery of this
Agreement and prior to the Closing Date (i) trading generally shall have been
suspended or materially limited on or by, as the case may be, any of the New
York Stock Exchange, the American Stock Exchange, the National Association of
Securities Dealers, Inc., the Chicago Board of Options Exchange, the Chicago
Mercantile Exchange or the Chicago Board of Trade, (ii) trading of any
securities of the Company shall have been suspended on any exchange or in any
over-the-counter market, (iii) a general moratorium on commercial banking
activities in New York shall have been declared by either Federal or New York
State authorities or (iv) there shall have occurred any outbreak or escalation
of hostilities or any change in financial markets or any calamity or crisis
that, in your judgment, is material and adverse and (b) in the case of any of
the events specified in clauses 8(a)(i) through 8(a)(iv), such event, singly or
together with any other such event, makes it, in your judgment, impracticable to
market the Shares on the terms and in the manner contemplated in the Prospectus.

9. Effectiveness; Defaulting Underwriters. This Agreement shall become
effective upon the execution and delivery hereof by the parties hereto.

If, on the Closing Date or the Option Closing Date, as the case may be,
any one or more of the Underwriters shall fail or refuse to purchase Shares that
it has or they have agreed to purchase hereunder on such date, and the aggregate
number of Shares which such defaulting Underwriter or Underwriters agreed but
failed or refused to purchase is not more than one-tenth of the aggregate number
of the Shares to be purchased on such date, the other Underwriters shall be
obligated severally in the proportions that the number of Firm Shares set forth
opposite their respective names in Schedule I or Schedule II bears to the
aggregate number of Firm Shares set forth opposite the names of all such
non-defaulting Underwriters, or in such other proportions as you may specify, to
purchase the Shares which such defaulting Underwriter or Underwriters agreed but
failed or refused to

18
<PAGE> 20
purchase on such date; provided that in no event shall the number of Shares that
any Underwriter has agreed to purchase pursuant to this Agreement be increased
pursuant to this Section 9 by an amount in excess of one-ninth of such number of
Shares without the written consent of such Underwriter. If, on the Closing Date,
any Underwriter or Underwriters shall fail or refuse to purchase Firm Shares and
the aggregate number of Firm Shares with respect to which such default occurs is
more than one-tenth of the aggregate number of Firm Shares to be purchased, and
arrangements satisfactory to you and the Company for the purchase of such Firm
Shares are not made within 36 hours after such default, this Agreement shall
terminate without liability on the part of any non-defaulting Underwriter or the
Company. In any such case either you or the Company shall have the right to
postpone the Closing Date, but in no event for longer than seven days, in order
that the required changes, if any, in the Registration Statement and in the
Prospectus or in any other documents or arrangements may be effected. If, on the
Option Closing Date, any Underwriter or Underwriters shall fail or refuse to
purchase Additional Shares and the aggregate number of Additional Shares with
respect to which such default occurs is more than one-tenth of the aggregate
number of Additional Shares to be purchased, the non-defaulting Underwriters
shall have the option to (i) terminate their obligation hereunder to purchase
Additional Shares or (ii) purchase not less than the number of Additional Shares
that such non-defaulting Underwriters would have been obligated to purchase in
the absence of such default. Any action taken under this paragraph shall not
relieve any defaulting Underwriter from liability in respect of any default of
such Underwriter under this Agreement.

If this Agreement shall be terminated by the Underwriters, or any of them,
because of any failure or refusal on the part of the Company to comply with the
terms or to fulfill any of the conditions of this Agreement, or if for any
reason the Company shall be unable to perform its obligations under this
Agreement, the Company will reimburse the Underwriters or such Underwriters as
have so terminated this Agreement with respect to themselves, severally, for all
out-of-pocket expenses (including the fees and disbursements of their counsel)
reasonably incurred by such Underwriters in connection with this Agreement or
the offering contemplated hereunder.

10. Counterparts. This Agreement may be signed in two or more
counterparts, each of which shall be an original, with the same effect as if the
signatures thereto and hereto were upon the same instrument.

11. Applicable Law. This Agreement shall be governed by and construed in
accordance with the internal laws of the State of New York.

19
<PAGE> 21
12. Headings. The headings of the sections of this Agreement have been
inserted for convenience of reference only and shall not be deemed a part of
this Agreement.

Very truly yours,

ALLIED CAPITAL CORPORATION

By:_______________________________
Name:
Title:

Accepted as of the date hereof

MORGAN STANLEY & CO. INCORPORATED
THE ROBINSON-HUMPHREY COMPANY LLC
NATIONSBANC MONTGOMERY SECURITIES LLC
SCOTT & STRINGFELLOW, INC.

Acting severally on behalf of
themselves and the several U.S.
Underwriters named in Schedule I
hereto.

By: Morgan Stanley & Co. Incorporated

By:_______________________________
Name:
Title:

20
<PAGE> 22
MORGAN STANLEY & CO. INTERNATIONAL
LIMITED
THE ROBINSON-HUMPHREY COMPANY LLC
NATIONSBANC MONTGOMERY SECURITIES LLC
SCOTT & STRINGFELLOW, INC.

Acting severally on behalf of themselves and the
several International Underwriters named in
Schedule II hereto.

By: Morgan Stanley & Co. International Limited

By:_______________________________
Name:
Title:

21
<PAGE> 23
SCHEDULE I

U.S. UNDERWRITERS

<TABLE>
<CAPTION>
NUMBER OF FIRM SHARES
UNDERWRITER TO BE PURCHASED
- ---------------------------------------------------- ---------------------
<S> <C>
Morgan Stanley & Co. Incorporated...................
The Robinson-Humphrey Company LLC...................
NationsBanc Montgomery Securities LLC...............
Scott & Stringfellow, Inc...........................
[ ].................................
---------------------
Total U.S. Firm Shares........................ 4,600,000
=====================
</TABLE>
<PAGE> 24
SCHEDULE II

INTERNATIONAL UNDERWRITERS

<TABLE>
<CAPTION>
NUMBER OF FIRM SHARES
UNDERWRITER TO BE PURCHASED
- ---------------------------------------------------- ---------------------
<S> <C>
Morgan Stanley & Co. International Limited..........
The Robinson-Humphrey Company LLC,..................
NationsBanc Montgomery Securities LLC...............
Scott & Stringfellow, Inc...........................
[ ].................................
---------------------
Total International Firm Shares............... 1,150,000
=====================
</TABLE>
<PAGE> 25
EXHIBIT A

____________, 1998

Morgan Stanley & Co. International
Limited
NationsBanc Montgomery Securities LLC
The Robinson-Humphrey Company LLC
Scott & Stringfellow, Inc.

c/o Morgan Stanley & Co.
International Limited
25 Cabot Square
Canary Wharf
London E14 4QA
England

Dear Sirs and Mesdames:

The undersigned understands that Morgan Stanley & Co. Incorporated
("MORGAN STANLEY") and Morgan Stanley & Co. International Limited ("MSIL")
propose to enter into an Underwriting Agreement (the "UNDERWRITING AGREEMENT")
with Allied Capital Corporation, a Maryland corporation (the "COMPANY")
providing for the public offering (the "PUBLIC OFFERING") by the several
Underwriters, including Morgan Stanley and MSIL (the "UNDERWRITERS") of
5,750,000 shares (the "SHARES") of the common stock, $0.0001 par value per
share, of the Company (the "COMMON STOCK").

To induce the Underwriters that may participate in the Public Offering to
continue their efforts in connection with the Public Offering, the undersigned
hereby agrees that, without the prior written consent of Morgan Stanley on
behalf of the Underwriters, it will not, during the period commencing on the
date hereof
<PAGE> 26
and ending 90 days after the date of the final prospectus relating to the Public
Offering (the "PROSPECTUS"), (1) offer, pledge, sell, contract to sell, sell any
option or contract to purchase, purchase any option or contract to sell, grant
any option, right or warrant to purchase, lend, or otherwise transfer or dispose
of, directly or indirectly, any shares of Common Stock or any securities
convertible into or exercisable or exchangeable for Common Stock, or (2) enter
into any swap or other arrangement that transfers to another, in whole or in
part, any of the economic consequences of ownership of the Common Stock, whether
any such transaction described in clause (1) or (2) above is to be settled by
delivery of Common Stock or such other securities, in cash or otherwise. The
foregoing sentence shall not apply to (a) the sale of any Shares to the
Underwriters pursuant to the Underwriting Agreement or (b) transactions relating
to shares of Common Stock or other securities acquired in open market
transactions after the completion of the Public Offering.

Whether or not the Public Offering actually occurs depends on a number of
factors, including market conditions. Any Public Offering will only be made
pursuant to an Underwriting Agreement, the terms of which are subject to
negotiation between the Company and the Underwriters.

Very truly yours,

___________________________________
Name

___________________________________
Address

<PAGE> 1
EXHIBIT H.2

1,150,000 SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK, $0.0001 PAR VALUE PER SHARE

AGREEMENT AMONG INTERNATIONAL UNDERWRITERS

Exhibit A - Underwriting Agreement
Exhibit B - Agreement Between U.S. and International Underwriters
Exhibit C - International Dealer Agreement

June __, 1998

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Morgan Stanley & Co. International Limited
NationsBanc Montgomery Securities LLC
The Robinson-Humphrey Company LLC
Scott & Stringfellow, Inc.
c/o Morgan Stanley & Co. International Limited
25 Cabot Square
Canary Wharf
London E14 4QA
England

Dear Sirs:

We understand that Allied Capital Corporation, a Maryland corporation
(the "COMPANY"), proposes to issue and sell to the several Underwriters (as
defined below) an aggregate of 5,750,000 shares (the "FIRM SHARES") of its
common stock, $0.0001 par value per share ("COMMON STOCK") pursuant to an
underwriting agreement (the "UNDERWRITING AGREEMENT"), substantially in the form
attached hereto as Exhibit A, with you as representatives (the "INTERNATIONAL
REPRESENTATIVES") of the international underwriters named in Schedule II thereto
(the "INTERNATIONAL UNDERWRITERS"), and Morgan Stanley & Co. Incorporated,
NationsBanc Montgomery Securities LLC, The Robinson-Humphrey Company LLC, and
Scott & Stringfellow, Inc. as representatives (the "U.S. REPRESENTATIVES") of
the U.S. underwriters named in Schedule I thereto (the "U.S. UNDERWRITERS"). The
International Underwriters and the U.S. Underwriters are hereinafter
collectively referred to as the Underwriters.

Of such Firm Shares 1,150,000 shares are to be offered outside the
United States and Canada by the International Underwriters (the "INTERNATIONAL
SHARES") and 4,600,000 shares are to be offered by the U.S. Underwriters in the
United States and Canada (the "U.S. FIRM SHARES").

In addition, the several U.S. Underwriters will have an option to
purchase from the Company an additional 862,500 shares (the "ADDITIONAL SHARES")
to provide for over-allotments. The term "U.S. SHARES" shall mean the U.S. Firm
Shares and the Additional Shares. The U.S. Shares and the International Shares
are hereinafter collectively referred to as the "SHARES".

We further understand that the Company has filed with the U.S.
Securities and Exchange Commission (the "COMMISSION") a registration statement
including a U.S. prospectus and an international prospectus relating to the
Shares.

I.
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We hereby confirm our agreement with you that the International Shares
shall be purchased by you and the other several International Underwriters,
including ourselves, pursuant to the terms of and as set forth in the
Underwriting Agreement. We further understand that the International
Representatives propose to enter into an agreement with the U.S. Representatives
(the "AGREEMENT BETWEEN U.S. AND INTERNATIONAL UNDERWRITERS"), substantially in
the form attached hereto as Exhibit B, pursuant to Article I of which, and
subject to the conditions thereof, the several International Underwriters,
including ourselves, could become obligated to purchase Shares from, or sell
Shares to, the U.S. Underwriters.

We authorize you (a) to execute and deliver the Underwriting Agreement
and the Agreement Between U.S. and International Underwriters on our behalf in
substantially the forms of Exhibits A and B hereto, respectively, and to make
representations and agreements on our behalf as set forth therein, (b) to vary
the offering terms of the International Shares in effect at any time, including
the offering price, the concession and the reallowance, (c) to agree to the
price at which the International Shares are to be purchased from the Company,
(d) to agree, on our behalf, to any addition to, change in or waiver of any
provision of the Underwriting Agreement (other than a change in the purchase
price of the International Shares and the respective numbers of International
Shares set forth opposite our names in Schedule II thereto) or of the Agreement
Between U.S. and International Underwriters (other than a change in the price at
which the International Underwriters purchase Shares pursuant to Article I
thereof) and (e) to take any other action as may seem advisable to you in
respect of the offering of the International Shares. The number of Shares set
forth opposite each Underwriter's name in Schedule I or in Schedule II of the
Underwriting Agreement (or such amount increased as provided in the Underwriting
Agreement) is hereinafter referred to as the Original Purchase Obligation of
such Underwriter, and the ratio that such Original Purchase Obligation of any
International Underwriter bears to the total number of International Shares,
expressed as a percentage, is hereinafter referred to as the International
Underwriting Percentage of such International Underwriter.

II.

We authorize you to act as the Lead Managers of the offering by the
International Underwriters of the International Shares outside of the United
States and Canada and to take such action as may seem advisable to you in
respect thereof. The offering of the International Shares is to be made as soon
after the registration statement filed with the Commission relating to the
Shares becomes

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effective (as then amended, the "REGISTRATION STATEMENT") as in your judgment
and the judgment of the U.S. Representatives is advisable, at the offering price
set forth in, and on the other terms and conditions as you shall determine in
accordance with, the Underwriting Agreement. The offering of the International
Shares is to be made on the terms and conditions to be set forth in the
Underwriting Agreement, the Agreement Between U.S. and International
Underwriters and in the prospectus first used to confirm sales of the
International Shares (the "INTERNATIONAL PROSPECTUS"), whether or not filed
pursuant to Rule 497 under the U.S. Securities Act of 1933, as amended (the
"ACT"). During the term of this Agreement, advertisement of the offering outside
of the United States and Canada will be made only by Morgan Stanley & Co.
International Limited. Such advertisement will be made on behalf of the
International Underwriters on such dates and in such countries as Morgan Stanley
& Co. International Limited shall determine.

We authorize Morgan Stanley & Co. International Limited to determine
whether to purchase, and, if such determination is made, to purchase, any Shares
for the account of the International Underwriters pursuant to the Agreement
Between U.S. and International Underwriters. We further authorize Morgan Stanley
& Co. International Limited to determine whether to sell, and, if such
determination is made, to sell, Shares for the account of the International
Underwriters pursuant to such Agreement.

We authorize Morgan Stanley & Co. International Limited to offer or to
sell for our account to dealers selected by it (among whom may be included any
International Underwriter) such Shares purchased by us from the Company or
pursuant to the Agreement Between U.S. and International Underwriters as Morgan
Stanley & Co. International Limited shall determine. Sales of Shares to dealers
shall be made for the account of each International Underwriter approximately in
the proportion that Shares of such International Underwriter held by Morgan
Stanley & Co. International Limited for such sales bear to the total Shares so
held. Such sales shall be made pursuant to dealer agreements substantially in
the form attached as Exhibit C hereto.

We authorize Morgan Stanley & Co. International Limited to offer or
sell for our account to certain persons (other than the persons to whom Shares
are sold pursuant to the terms of the immediately preceding paragraph) such
Shares purchased by us from the Company or pursuant to the Agreement Between
U.S. and International Underwriters as it shall determine at the offering price
set forth in the International Prospectus. Except for sales for the accounts of
International Underwriters designated by a purchaser, aggregate sales of Shares
to such persons shall be made for the accounts of the several International
Underwriters as nearly as practicable in their respective International
Underwriting Percentages.

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Morgan Stanley & Co. International Limited will advise us promptly as
to the number of Shares purchased by us that we shall retain for direct sale. At
any time prior to the termination of this Agreement, any Shares purchased by us
that are held by Morgan Stanley & Co. International Limited for sale for our
account as set forth above but not sold may, upon our request and at Morgan
Stanley & Co. International Limited's discretion, be released to us for direct
sale, and Shares so released to us shall no longer be deemed held for sale by
you.

From time to time prior to the termination of this Agreement, at Morgan
Stanley & Co. International Limited's request, we will advise it of the number
of Shares remaining unsold that were retained by or released to us for direct
sale and of the number of Shares remaining unsold that were delivered to us
pursuant to Article III and, at Morgan Stanley & Co. International Limited's
request, we will release to it any such Shares remaining unsold for sale by it
(i) for our account to dealers or certain other persons or (ii) if in its
opinion, such Shares are needed to make delivery against sales made pursuant to
Article III.

III.

We authorize Morgan Stanley & Co. Incorporated to buy and sell for the
accounts of the several Underwriters, including the International Underwriters,
(i) Common Stock and (ii) any securities convertible into or exercisable or
exchangeable for the Common Stock in the open market or otherwise, for long or
short account, on such terms as it shall deem advisable and to over-allot in
arranging sales. Any shares of Common Stock or other securities that may have
been purchased by the U.S. Representatives for stabilizing purposes in
connection with the offering of the Shares prior to the execution of this
Agreement and the Agreement Between U.S. and International Underwriters shall be
treated as having been purchased pursuant to this paragraph and the Agreement
Between U.S. and International Underwriters for the accounts of the several
Underwriters. We authorize Morgan Stanley & Co. International Limited to
over-allot in arranging sales. We recognize that the International Primary
Market Association (IPMA) limits will not be complied with in connection with
stabilization losses and expenses. Subject to the provisions of the Agreement
Between U.S. and International Underwriters, all such purchases, sales and
over-allotments for the International Underwriters as a group shall be for the
accounts of the several International Underwriters as nearly as practicable in
their respective International Underwriting Percentages. At no time shall our
net commitment pursuant to the foregoing authorization exceed 15% of our
Original Purchase Obligation, and, in determining our net commitment for short
account, there shall be subtracted any Shares that you have agreed to purchase
for our account pursuant to Article I of

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the Agreement Between U.S. and International Underwriters. On demand we will
take up and pay for any securities so purchased for our account and deliver
against payment any securities so sold or over-allotted for our account. The
International Representatives agree to notify us of the date of termination of
stabilization when so notified by Morgan Stanley & Co. Incorporated pursuant to
the Agreement Between U.S. and International Underwriters.

If pursuant to the provisions of the preceding paragraph and prior to
the termination of this Agreement (or prior to such earlier date as the
International Representatives may have determined), the U.S. Representatives
purchase or contract to purchase in the open market or otherwise any Shares that
were retained by or released to us for direct sale, or any Shares that may have
been issued on transfer of or in exchange for such Shares, and which Shares were
therefore not effectively placed for investment by us, we authorize the
International Representatives either to charge our account with an amount equal
to the selling concession with respect thereto, which amount shall be credited
against the cost of such Shares, or to require us to repurchase such Shares at a
price equal to the total cost of such purchase, including commissions, if any,
and any taxes on redelivery.

IV.

On the Closing Date (as defined in the Underwriting Agreement), prior
to 8:45 A.M. (New York City time) we will deliver to Morgan Stanley & Co.
International Limited, Federal or other funds immediately available in New York
City in the manner as you shall advise for (i) an amount equal to the offering
price less the selling concession in respect of the Shares to be purchased by
us, (ii) an amount equal to the offering price less the selling concession in
respect of such of the Shares to be purchased by us as shall have been retained
by or released to us for direct sale or (iii) the amount set forth or indicated
in a telex to us, as you shall advise. You will make payment to the Company
against delivery to you for our account of the Shares to be purchased by us and
you will deliver to us the Shares paid for by us which shall have been retained
by or released to us for direct sale. Unless we promptly give you written
instructions otherwise, if transactions in the Shares may be settled through the
facilities of The Depository Trust Company, payment for and delivery of Shares
purchased by us will be made through such facilities, if we are a member, or, if
we are not a member, settlement may be made through our ordinary correspondent
who is a member.

We authorize you as Lead Managers to charge our account, as
compensation for your services in connection with this issue, including the

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purchase from the Company and the management of the offering, $____ a share for
each Share that we have agreed to purchase pursuant to the Underwriting
Agreement.

We authorize you to charge to our account (i) our International
Underwriting Percentage of all expenses incurred by you under the terms of this
Agreement or in connection with or attributable to the purchase, carrying and
sale of any securities pursuant to this Agreement (including all expenses, if
any, incurred for the account of the International Underwriters pursuant to the
Agreement Between U.S. and International Underwriters), and (ii) all transfer
taxes paid or payable on our behalf on purchases, sales or transfers made for
our account pursuant to this Agreement.

VI.

We authorize you to advance your own funds for our account, charging
interest rates prevailing from time to time, or to arrange loans for our account
for the purpose of carrying out the provisions of this Agreement or the
Agreement Between U.S. and International Underwriters and in connection
therewith to hold or pledge as security therefor all or any securities which you
may be holding for our account under this Agreement.

Out of payment received by you for Shares sold for our account which
have been paid for by us, you will remit to us promptly an amount equal to the
price paid by us for such Shares.

Morgan Stanley & Co. International Limited and Morgan Stanley & Co.
Incorporated may each deliver to us or transfer to our account from time to time
against payment, for carrying purposes only, any securities purchased by us or
for our account under this Agreement that it is holding for sale for our account
but that are not sold and paid for. We will transfer back to Morgan Stanley &
Co. International Limited or Morgan Stanley & Co. Incorporated against payment
any securities so transferred to us for carrying purposes at such times as it
may demand.

VII.

This Agreement shall terminate 30 days from the date hereof, unless
sooner terminated by you, provided that you may in your discretion extend this
Agreement for a further period or periods not exceeding an aggregate of 30 days.

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You may at your discretion on notice to us prior to the termination of this
Agreement alter any of the terms or conditions of offering determined pursuant
to Article II hereof or Article III of the Agreement Between U.S. and
International Underwriters, or terminate or suspend in whole or in part the
effectiveness of Article III hereof or paragraphs five through nine of Article
IV thereof. No termination or suspension pursuant to this paragraph shall affect
your or Morgan Stanley & Co. Incorporated's authority under Article III to cover
any short or close any long position incurred under this Agreement prior to such
termination or suspension.

Upon termination of this Agreement, or prior thereto at your
discretion, Morgan Stanley & Co. International Limited shall deliver to us or
transfer to our account any Shares purchased by us from the Company or pursuant
to the Agreement Between U.S. and International Underwriters and held by Morgan
Stanley & Co. International Limited for sale for our account to dealers or
others but not sold and paid for and Morgan Stanley & Co. Incorporated shall
deliver to us or transfer to our account any securities which are held by Morgan
Stanley & Co. Incorporated for our account pursuant to Article III. If at the
termination of this Agreement, the aggregate amount of any securities (including
any Shares) so held and not sold and paid for does not exceed 15% of the
aggregate amount of the International Shares, Morgan Stanley & Co. International
Limited and Morgan Stanley & Co. Incorporated may each, in its discretion, sell
for the account of the several International Underwriters any such securities
(including any Shares) so held, at such price, on such terms and in such manner
as it may determine. As soon as practicable after termination of this Agreement
our account hereunder shall be settled and paid. Morgan Stanley & Co.
International Limited may reserve from distribution such amount as it deems
advisable to cover possible additional amounts due from us. Determination by
Morgan Stanley & Co. International Limited of amounts to be paid to or by us
shall be final and conclusive. Any of our funds in Morgan Stanley & Co.
International Limited's or Morgan Stanley & Co. Incorporated's hands may be held
with its general funds without accountability for interest.

Notwithstanding any settlement on the termination of this Agreement,
each International Underwriter agrees to pay its International Underwriting
Percentage of (i) all expenses incurred by you in investigating or defending
against any claim or proceeding which is asserted or instituted by any party
(including any governmental or regulatory body) other than an Underwriter
relating to the Registration Statement or the Prospectus (as defined in the
Underwriting Agreement) (or any amendment or supplement thereto) or any
preliminary prospectus and (ii) any liability, including attorneys' fees,
incurred by you in respect of any such claim or proceeding, whether such
liability shall be the result of a judgment or as a result of any settlement
agreed to by you, other than

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any such expense or liability as to which you receive indemnity payments
pursuant to the following paragraph, Article III of the Agreement Between U.S.
and International Underwriters or of the Underwriting Agreement.

We agree to indemnify and hold harmless each other Underwriter and each
person, if any, who controls any such Underwriter within the meaning of either
Section 15 of the Act or Section 20 of the U.S. Securities Exchange Act of 1934,
as amended, to the extent and upon the terms which we agree to indemnify and
hold harmless the Company, its directors, the officers of the Company who sign
the Registration Statement and any person controlling the Company as set forth
in the Underwriting Agreement.

Our agreements contained in the second through fourth paragraphs of
Article II and this Article VII shall remain operative and in full force and
effect regardless of any termination of this Agreement or the occurrence of any
of the events described in clauses (i) through (iii) of the last paragraph of
Section 7 of the Underwriting Agreement.

VIII.

We have examined the prospectus included in the Registration Statement
as amended to date and we are familiar with the terms of the securities being
offered and the other terms of offering which are to be reflected in the
International Prospectus. In addition, we confirm that the information relating
to us which has been furnished to the Company for use therein is correct. You
are authorized, with the approval of counsel for the Underwriters, to approve on
our behalf the International Prospectus and any further amendments or
supplements to the Registration Statement or the International Prospectus.

We represent that our commitment to purchase Shares hereunder and under
the Agreement Between U.S. and International Underwriters will not result in a
violation of any financial responsibility requirements of any laws, rules or
regulations applicable to us, including applicable rules of any securities
exchange.

IX.

If the Underwriting Agreement is terminated as permitted by the terms
thereof, our obligations hereunder shall immediately terminate except that (i)
our obligations as set forth in the last paragraph of Article VII shall remain
in full force and effect, (ii) we shall remain liable for our International
Underwriting

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Percentage of all expenses and for any purchases or sales which may have been
made for our account pursuant to the provisions of Article III, including any
taxes on any such purchases or sales and (iii) such termination shall not affect
any obligation of any defaulting International Underwriter.

In the event that any International Underwriter shall default in its
obligations (i) pursuant to the second paragraph of Article II or the first
paragraph of Article III, (ii) to pay amounts owed by it pursuant to Article V
or (iii) pursuant to the third or fourth paragraph of Article VII or the first
paragraph of this Article IX, we will assume our proportionate share (determined
on the basis of the International Underwriting Percentages of the non-defaulting
International Underwriters) of such obligations, but no such assumption shall
affect any obligation of any defaulting International Underwriter.

If any one or more of the Underwriters shall fail or refuse to purchase
any Shares which it or they have agreed to purchase under the Underwriting
Agreement, we agree, in the proportion which the number of Firm Shares set forth
opposite our name in Schedule II to the Underwriting Agreement bears to the
aggregate number of Firm Shares set forth opposite the names of all
non-defaulting Underwriters, or in such other proportions as you may specify, to
purchase the Shares which such defaulting Underwriter or Underwriters agreed but
failed or refused to purchase; provided that, in no event shall the Shares to be
purchased by any International Underwriter be increased pursuant to this Article
IX to an amount in excess of the maximum number of Shares which such
International Underwriter has agreed to purchase pursuant to the Underwriting
Agreement upon such a default or defaults, unless such International Underwriter
consents in writing to the increase. Morgan Stanley & Co. International Limited
is authorized to arrange for the purchase by others (including itself and any
other International Underwriter) of any Shares not purchased by any defaulting
International Underwriter or by the other International Underwriters as provided
in this paragraph and in Section 9 of the Underwriting Agreement. If such
arrangements are made, the respective numbers of Shares to be purchased by the
remaining International Underwriters and such other person or persons, if any,
shall be taken as the basis for all rights and obligations hereunder. Any action
taken under this paragraph shall not relieve any defaulting International
Underwriter from liability in respect of any default of such International
Underwriter under the Underwriting Agreement or this Agreement.

Nothing herein contained shall constitute us partners with you or with
the other Underwriters and the obligations of ourselves and of each of the other
Underwriters are several and not joint. If for United States federal income tax
purposes the International Underwriters shall be deemed to constitute a
partnership, each International Underwriter elects to be excluded from the

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application of Subchapter K, Chapter 1, Subtitle A, of the United States
Internal Revenue Code, as amended.

You shall be under no liability to us for any act or omission except in
respect of obligations expressly assumed by you herein.

This Agreement is being executed by us and delivered to you in
duplicate. Upon your confirmation hereof and agreements in identical form with
each of the other Underwriters, this Agreement shall constitute a valid and
binding contract between us.

Your authority hereunder and under the Underwriting Agreement and the
Agreement Between U.S. and International Underwriters may be exercised by Morgan
Stanley & Co. International Limited, NationsBanc Montgomery Securities LLC, The
Robinson-Humphrey Company LLC and Scott & Stringfellow, Inc., jointly or by
Morgan Stanley & Co. International Limited alone. The authority of the U.S.
Representatives hereunder and under the Agreement Between U.S. and International
Underwriters may be exercised by Morgan Stanley & Co. Incorporated, NationsBanc
Montgomery Securities LLC, The Robinson-Humphrey Company LLC and Scott &
Stringfellow, Inc., either jointly or alone.

This Agreement may be executed in two or more counterparts which
together shall constitute one and the same instrument. If this Agreement is
executed by or on behalf of any party hereto by a person acting under the power
of attorney given him by such party, such person hereby states that at the time
of execution hereof he has no notice of revocation of the power of attorney by
which he has executed this Agreement as such attorney.

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This Agreement shall be governed by and construed in accordance with
the laws of the State of New York and United States federal law.

Very truly yours,

MORGAN STANLEY & CO.
INTERNATIONAL LIMITED

By:_________________________________________
Attorney-in-fact for each of the several
International Underwriters named in
Schedule II to the Underwriting
Agreement

Confirmed as of the date hereof

MORGAN STANLEY & CO. INTERNATIONAL LIMITED
NATIONSBANC MONTGOMERY SECURITIES LLC
THE ROBINSON-HUMPHREY COMPANY LLC
SCOTT & STRINGFELLOW, INC.

By: MORGAN STANLEY & CO. INTERNATIONAL LIMITED

By:_____________________________________
Name:
Title:

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EXHIBIT H.3

5,750,000 SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK ($0.0001 PAR VALUE)

AGREEMENT BETWEEN
U.S. AND INTERNATIONAL UNDERWRITERS

June __, 1998
<PAGE> 2
June __, 1998

To each of the Underwriters named in Schedules I and II to the Underwriting
Agreement referred to below.

Dear Sirs:

We understand that Allied Capital Corporation (the "COMPANY") has
entered into an underwriting agreement (the "UNDERWRITING AGREEMENT") with
Morgan Stanley & Co. Incorporated, NationsBanc Montgomery Securities LLC, The
Robinson-Humphrey Company LLC and Scott & Stringfellow, Inc., acting as
representatives (the "U.S. REPRESENTATIVES") of the U.S. underwriters named in
Schedule I thereto (the "U.S. UNDERWRITERS") and Morgan Stanley & Co.
International Limited, NationsBanc Montgomery Securities LLC, The
Robinson-Humphrey Company LLC and Scott & Stringfellow, Inc., as representatives
(the "INTERNATIONAL REPRESENTATIVES") of the international underwriters named in
Schedule II thereto (the "INTERNATIONAL UNDERWRITERS" and, together with the
U.S. Underwriters, the "UNDERWRITERS"), pursuant to which the several
Underwriters have agreed to purchase from the Company an aggregate of 5,750,000
shares of common stock, $0.0001 par value per share of the Company ("COMMON
STOCK"). In addition, the Company has granted the U.S. Underwriters the option
to purchase up to 862,500 additional shares of Common Stock (the "ADDITIONAL
SHARES"). All shares of Common Stock to be purchased by the U.S. Underwriters
and the International Underwriters under the Underwriting Agreement, including
any Additional Shares, are herein called the "U.S. SHARES" and the
"INTERNATIONAL SHARES," respectively. The U.S. Shares and the International
Shares are collectively referred to herein as the "SHARES."

The U.S. Underwriters, acting through the U.S. Representatives, and the
International Underwriters, acting through the International Representatives,
agree that, in order to provide an orderly marketing effort for the offering,
they will consult with each other as to the availability of the Shares for sale
to the public, from time to time until the earlier of (a) notice from the U.S.
Representatives to the U.S. Underwriters of the completion of the distribution
of the U.S. Shares and (b) notice from the International Representatives to the
International Underwriters
<PAGE> 3
of the completion of the distribution of the International Shares. From time to
time as mutually agreed among the U.S. Underwriters and the International
Underwriters, acting through Morgan Stanley & Co. Incorporated and Morgan
Stanley & Co. International Limited, respectively, the Underwriters may purchase
and sell among each other such number of Shares to be purchased pursuant to the
Underwriting Agreement as may be so mutually agreed.

The price and currency of settlement of any Shares so purchased or sold
shall be the public offering price, in United States dollars, less an amount not
greater than the selling concession. Settlement with respect to any Shares
transferred hereunder prior to the Closing Date (as defined in the Underwriting
Agreement) shall be made on the Closing Date, and in the case of purchases and
sales made thereafter, as promptly as practicable but in no event later than
three business days after the transfer date. Certificates representing the
Shares so purchased shall be delivered on the respective settlement dates. The
liability of the Underwriters under the Underwriting Agreement for payment of
the purchase price of the Shares purchased thereunder shall not be affected by
the provisions of this Agreement.

The obligations of each U.S. Underwriter in respect of any purchase or
sale of Shares under this Article I by the U.S. Underwriters shall be pro rata
in accordance with the proportion of the total number of U.S. Shares that such
U.S. Underwriter is obligated to purchase under the Underwriting Agreement. The
obligations of each International Underwriter in respect of any purchase or sale
of Shares under this Article I by the International Underwriters shall be pro
rata in accordance with the proportion of the total number of International
Shares that such International Underwriter is obligated to purchase under the
Underwriting Agreement.

II.

Each of the Underwriters represents that it is a member in good
standing of the U.S. National Association of Securities Dealers, Inc. (the
"NASD") or that it is a foreign bank or dealer not eligible for membership in
the NASD. In making sales of Shares, if it is such a member, such Underwriter
agrees to comply with all applicable rules of the NASD, including, without
limitation, the NASD's Interpretation with Respect to Free-Riding and
Withholding (IM-2110-1) and NASD Rule 2740, or, if it is such a foreign bank or
dealer, such Underwriter agrees to comply with such Interpretation and NASD
Rules 2730, 2740 and 2750 as though it were such a member and NASD Rule 2420 as
it applies to a nonmember broker or dealer in a foreign country.

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III.

Each U.S. Underwriter represents and agrees that, except for (x) sales
between the U.S. Underwriters and the International Underwriters pursuant to
Article I of this Agreement and (y) stabilization transactions, contemplated in
Article IV of this Agreement, conducted through the U.S. Representatives as part
of the distribution of the Shares, (a) it is not purchasing any Shares for the
account of anyone other than a United States or Canadian Person and (b) it has
not offered or sold, and will not offer or sell, directly or indirectly, any
Shares or distribute any prospectus relating to the Shares outside the United
States or Canada or to anyone other than a United States or Canadian Person, and
any dealer to whom it may sell any Shares will represent that it is not
purchasing any Shares for the account of anyone other than a United States or
Canadian Person and will agree that it will not offer or resell any Shares
directly or indirectly outside the United States or Canada or to anyone other
than a United States or Canadian Person or to any other dealer who does not so
represent and agree.

Each International Underwriter represents and agrees that, except for
(x) sales between the U.S. Underwriters and the International Underwriters
pursuant to Article I of this Agreement and (y) stabilization transactions,
contemplated in Article IV of this Agreement, conducted through the U.S.
Representatives as part of the distribution of the Shares, (a) it is not
purchasing any Shares for the account of any United States or Canadian Person
and (b) it has not offered or sold, and will not offer or sell, directly or
indirectly, any Shares or distribute any prospectus relating to the Shares in
the United States or Canada or to any United States or Canadian Person, and any
dealer to whom it may sell any Shares will represent that it is not purchasing
any Shares for the account of any United States or Canadian Person and will
agree that it will not offer or resell any Shares directly or indirectly in the
United States or Canada or to any United States or Canadian Person or to any
other dealer who does not so represent and agree.

With respect to any Underwriter that is a U.S. Underwriter and an
International Underwriter, the foregoing representations and agreements (i) made
by it in its capacity as a U.S. Underwriter shall apply only to it in its
capacity as a U.S. Underwriter and (ii) made by it in its capacity as an
International Underwriter shall apply only to it in its capacity as an
International Underwriter. In addition, notwithstanding the foregoing
representations and agreements, if an Underwriter (including its affiliates) is
both a U.S. Underwriter and an International Underwriter, then the U.S.
Underwriter and its corresponding International Underwriter may, with the
consent of Morgan Stanley & Co. Incorporated, transfer between themselves at
cost any Shares allocated to them for direct sale by the U.S. Representatives or
the International Representatives so long as any Shares so transferred are
treated as U.S. Shares while held by the U.S.

3
<PAGE> 5
Underwriter and International Shares while held by the International Underwriter
for purposes of the foregoing representations and agreements.

"UNITED STATES OR CANADIAN PERSON" shall mean any national or resident
of the United States or Canada, or any corporation, pension, profit-sharing or
other trust or other entity organized under the laws of the United States or
Canada or of any political subdivision thereof (other than a branch located
outside the United States and Canada of any United States or Canadian Person),
and shall include any United States or Canadian branch of a person who is
otherwise not a United States or Canadian Person. "UNITED STATES" shall mean the
United States of America, its territories, its possessions and all areas subject
to its jurisdiction.

The agreements of the Underwriters set forth in the first and second
paragraphs of this Article III shall terminate upon the earlier of (a) the
mutual agreement of the U.S. Representatives and the International
Representatives and (b) 30 days after the date hereof, unless the U.S.
Representatives or the International Representatives shall have given notice to
the other to the effect that the distribution of the Shares by the U.S.
Underwriters or the International Underwriters, as the case may be, has not yet
been completed. If such notice is given, the agreements set forth in such
preceding paragraphs shall survive until the earlier of (x) the mutual agreement
referred to in the preceding sentence and (y) 30 days after the date of any such
notice.

Each U.S. Underwriter represents that it has not offered or sold, and
agrees not to offer or sell, any Shares, directly or indirectly, in any province
or territory of Canada or to, or for the benefit of, any resident of any
province or territory of Canada in contravention of the securities laws thereof
and, without limiting the generality of the foregoing, represents that any offer
or sale of Shares in Canada will be made only pursuant to an exemption from the
requirement to file a prospectus in the province or territory of Canada in which
such offer or sale is made. Each U.S. Underwriter further agrees to send to any
dealer who purchases from it any of the Shares a notice stating in substance
that, by purchasing such Shares, such dealer represents and agrees that it has
not offered or sold, and will not offer or sell, directly or indirectly, any of
such Shares in any province or territory of Canada or to, or for the benefit of,
any resident of any province or territory of Canada in contravention of the
securities laws thereof and that any offer or sale of Shares in Canada will be
made only pursuant to an exemption from the requirement to file a prospectus in
the province or territory of Canada in which such offer or sale is made, and
that such dealer will deliver to any other dealer to whom it sells any of such
Shares a notice containing substantially the same statement as is contained in
this sentence.

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<PAGE> 6
The Underwriters understand that no action has been or will be taken in
any jurisdiction by the Underwriters or the Company that would permit a public
offering of the Shares, or possession or distribution of the Prospectus (as
defined in the Underwriting Agreement), in preliminary or final form, in any
jurisdiction where, or in any circumstances in which, action for that purpose is
required, other than the United States.

Each International Underwriter agrees that it will comply with all
applicable laws and regulations, and make or obtain all necessary filings,
consents or approvals, in each jurisdiction in which it purchases, offers, sells
or delivers Shares (including, without limitation, any applicable requirements
relating to the delivery of the international prospectus, in preliminary or
final form), in each case at its own expense. In connection with sales of and
offers to sell Shares made by it, each International Underwriter will either
furnish to each person to whom any such sale or offer is made a copy of the then
current international prospectus (in preliminary or final form and as then
amended or supplemented if the Company shall have furnished any amendments or
supplements thereto), or inform such person that such international prospectus,
in preliminary or final form, will be made available upon request, and will keep
an accurate record of the names and addresses of all persons to whom it gives
copies of the registration statement relating to the offering of the Shares, the
international prospectus, in preliminary or final form, or any amendment or
supplement thereto, and, when furnished with any subsequent amendment to such
registration statement, any subsequent prospectus or any medium outlining
changes in the registration statement or any prospectus, will upon request of
the International Representatives, promptly forward copies thereof to such
persons or inform such persons that such amendment, subsequent prospectus or
other medium will be made available upon request.

Each International Underwriter further represents that it has not
offered or sold, and agrees not to offer or sell, directly or indirectly, in
Japan or to or for the account of any resident thereof, any of the Shares
acquired in connection with the distribution contemplated hereby, except for
offers or sales to Japanese International Underwriters or dealers and except
pursuant to any exemption from the registration requirements of the Securities
and Exchange Law and otherwise in compliance with applicable provisions of
Japanese law. Each International Underwriter further agrees to send to any
dealer who purchases from it any of the Shares a notice stating in substance
that, by purchasing such Shares, such dealer represents and agrees that it has
not offered or sold, and will not offer or sell, any of such Shares, directly or
indirectly, in Japan or to or for the account of any resident thereof except for
offers or sales to Japanese International Underwriters or dealers and except
pursuant to any exemption from the registration requirements of the Securities
and Exchange Law and otherwise in compliance

5
<PAGE> 7
with applicable provisions of Japanese law, and that such dealer will send to
any other dealer to whom it sells any of such Shares a notice containing
substantially the same statement as is contained in this sentence.

Each International Underwriter further represents and agrees that (i)
it has not offered or sold and, prior to the date six months after the Closing
Date, will not offer or sell, any Shares to persons in the United Kingdom except
to persons whose ordinary activities involve them in acquiring, holding,
managing or disposing of investments (as principal or agent) for the purposes of
their businesses or otherwise in circumstances which have not resulted and will
not result in an offer to the public in the United Kingdom within the meaning of
the Public Offers of Securities Regulations 1995; (ii) it has complied and will
comply with all applicable provisions of the Financial Services Act 1986 with
respect to anything done by it in relation to the Shares in, from or otherwise
involving the United Kingdom; and (iii) it has only issued or passed on and will
only issue or pass on in the United Kingdom any document received by it in
connection with the offering of the Shares to a person who is of a kind
described in Article 11(3) of the Financial Services Act 1986 (Investment
Advertisements) (Exemptions) Order 1996 or is a person to whom such document may
otherwise lawfully be issued or passed on.

Each International Underwriter agrees to indemnify and hold harmless
each Underwriter and each person controlling any Underwriter from and against
any and all losses, claims, damages and liabilities (including fees and
disbursements of counsel) arising from any breach by it of any of the provisions
of paragraphs eight, nine and ten of this Article III.

IV.

The overall direction and planning of the stabilization transactions
contemplated herein shall be the responsibility of the U.S. Representatives and
the International Representatives, which will consult with one another on a
continuous basis so that such stabilization transactions shall be conducted in
accordance with such direction and planning as is mutually agreed upon.

All stabilization transactions shall be conducted only by Morgan
Stanley & Co. Incorporated and shall be conducted in compliance with any
applicable laws and regulations. Morgan Stanley & Co. Incorporated agrees to
notify the International Representatives of the date of termination of
stabilization. Each Underwriter agrees to file with Morgan Stanley & Co.
Incorporated any reports required of such Underwriter pursuant to Rule 17a-2
under the U.S. Securities Exchange Act of 1934 and authorizes Morgan Stanley &
Co. Incorporated to file

6
<PAGE> 8
with the U.S. Securities and Exchange Commission any reports required by such
Rule on behalf of such Underwriter.

The International Primary Market Association (IPMA) limits will not be
complied with in connection with stabilization losses and expenses. All
stabilization transactions shall be for the respective accounts of the several
Underwriters and shall be allocated between the U.S. Underwriters and the
International Underwriters in the respective proportions that the number of U.S.
Shares and International Shares purchased pursuant to the Underwriting Agreement
bears to the total number of Shares purchased. In no event shall the net
commitment of any Underwriter, for either long or short account, resulting from
such stabilization transactions and from the over-allotments referred to in
Article V, exceed 15% of the total number of Shares that such Underwriter is
obligated to purchase under the Underwriting Agreement; provided that the net
commitment of any Underwriter for short account shall be calculated (x) in the
case of any U.S. Underwriter, after giving effect to the purchase of (i) any
Shares that the U.S. Representatives have agreed to purchase for the account of
such U.S. Underwriter pursuant to Article I of this Agreement and (ii) the
maximum number of Additional Shares that such U.S. Underwriter is entitled to
purchase under the Underwriting Agreement and (y) in the case of any
International Underwriter, after giving effect to the purchase of any Shares
that the International Representatives have agreed to purchase for the account
of such International Underwriter pursuant to Article I of this Agreement.

Each U.S. Underwriter represents that it has not offered or sold, and
agrees that it will not offer or sell, directly or indirectly, Shares to any
person at less than the public offering price, other than to (i) the
International Underwriters pursuant to Article I hereof or (ii) other U.S.
Underwriters or to dealers who have entered into the Master Dealer Agreement
with Morgan Stanley & Co. Incorporated and who have received a pricing wire from
the U.S. Representatives with respect to this offering that, among other things,
sets forth such dealer"s agreement that it is not purchasing Shares for the
account of any persons other than United States or Canadian Persons and that it
will not offer or resell Shares outside the United States and Canada. Such sales
to U.S. dealers and other U.S. Underwriters shall be made in conformity with the
provisions of Article II and at a price that is not below the public offering
price less the maximum permissible reallowance to be specified in the
Prospectus. Each U.S. Underwriter agrees that prior to offering Shares to any
dealer at the public offering price less the reallowance, it will either
ascertain that such dealer has entered into such Master Dealer Agreement and
received such a pricing wire or make arrangements to ensure that such dealer
will enter into such Master Dealer Agreement and receive such a pricing wire.

7
<PAGE> 9
Each International Underwriter represents that it has not offered or
sold and agrees that it will not offer or sell, directly or indirectly, Shares
to any person at less than the public offering price, other than to (i) the U.S.
Underwriters pursuant to Article I hereof or (ii) other International
Underwriters or to dealers who have entered into International Dealer Agreements
(the "INTERNATIONAL DEALERS") with the International Representatives in the form
of Exhibit C to the Agreement Among International Underwriters. Such sales to
International Dealers and other International Underwriters shall be made in
conformity with the provisions of Article II and at a price that is not below
the public offering price less the maximum permissible reallowance to be
specified in the Prospectus. Each International Underwriter agrees that prior to
offering Shares to any dealer at the public offering price less the reallowance,
it will either ascertain that such dealer has entered into such an International
Dealer Agreement or make arrangements to ensure that such dealer will enter into
an International Dealer Agreement.

The agreements of the Underwriters set forth in the foregoing two
paragraphs shall terminate upon the earlier of (a) the mutual agreement of the
U.S. Representatives and the International Representatives and (b) 30 days after
the date hereof, unless the U.S. Representatives or the International
Representatives shall have given notice to the other to the effect that the
distribution of the Shares by the U.S. Underwriters or the International
Underwriters, as the case may be, has not yet been completed. If such notice is
given, the agreements set forth in such preceding paragraphs shall survive until
the earlier of (x) the mutual agreement referred to in the preceding sentence
and (y) 30 days after the date of any such notice.

Each Underwriter agrees that it will not, without the advance approval
of Morgan Stanley & Co. Incorporated, for its own account or the account of a
customer, offer, bid for, buy, sell, deal, trade in or attempt to induce any
person to bid for or buy any Covered Security, except (a) as provided in the
Agreement Among International Underwriters, the Master Agreement Among
Underwriters, this Agreement, the Underwriting Agreement, the Master Dealer
Agreement or the International Dealer Agreement, (b) in brokerage transactions
on unsolicited orders which have not resulted from activities on its part in
connection with the solicitation of purchases and which are executed by it in
the ordinary course of its brokerage business, (c) in market making transactions
on Nasdaq or any similar market or quotation system executed by it in the
ordinary course of its business so long as its bids and purchases are made
consistent with the pricing restrictions set forth in Rule 103 of Regulation M
of the U.S. Securities and Exchange Commission ("REGULATION M") and the volumes
of such transactions are consistent with its past practice as a market maker,
(d) in basket transactions that meet the standards set forth in Rule 101(b)(6)
of Regulation M, (e) that it may convert, exchange or exercise any security
owned by it prior to the

8
<PAGE> 10
commencement of this restriction and that it may sell any security obtained upon
any such conversion, exchange or exercise, (f) that it may deliver securities
owned by it upon the exercise of any option written by it as permitted by the
provisions set forth herein, (g) that on or after the date of the initial public
offering of the Shares, it may execute covered writing transactions for the
accounts of customers in options to acquire Common Stock, when such transactions
are covered by Shares and (h) that it may engage in principal purchases or sales
with the intent of offsetting the market risk of principal positions in
over-the-counter derivatives on solicited orders that were executed by it prior
to the commencement of this restriction, and on unsolicited orders that were
executed by it at any time, so long as such orders were executed by it in the
ordinary course of its principal over-the-counter derivatives business. "COVERED
SECURITY" means (a) the Common Stock and (b) any securities convertible into or
exercisable or exchangeable for the Common Stock.

An opening uncovered writing transaction in options to acquire Common
Stock for an Underwriter"s account or for the account of a customer shall be
deemed, for purposes of this Article IV, to be a sale of Common Stock which is
not unsolicited. The term "opening uncovered writing transaction in options to
acquire" as used above means a transaction in which the seller intends to become
a writer of an option to purchase Common Stock which he does not own. An opening
uncovered purchase transaction in options to sell Common Stock for an
Underwriter"s account or for the account of a customer shall be deemed, for
purposes of this paragraph, to be a sale of Common Stock which is not
unsolicited. The term "opening uncovered purchase transaction in options to
sell" as used above means a transaction where the purchaser intends to become an
owner of an option to sell Common Stock which he does not own.

Each Underwriter represents that it has not participated, from the time
trading restrictions were imposed by Morgan Stanley & Co. Incorporated or Morgan
Stanley & Co. International Limited, in any transaction prohibited by this
Article IV and that it has at all times complied and agrees that it will at all
times comply with the provisions of Regulation M applicable to this offering.

The overall direction and planning of any over-allotments to be made by
the Underwriters in arranging for sales of Shares, and the related transactions
required to cover such over-allotments, shall be the responsibility of the U.S.
Representatives. All profits and losses arising from such over-allotments
(excluding the excess, if any, of (i) the public selling price of any Additional
Shares and any Shares purchased pursuant to Article I of this Agreement over
(ii)

9
<PAGE> 11
the cost of such Additional Shares and such other Shares to the Underwriters
making such sales) shall be for the respective accounts of the several
Underwriters and shall be allocated between the U.S. Underwriters and the
International Underwriters in the respective proportions that the number of U.S.
Shares and International Shares purchased pursuant to the Underwriting Agreement
bears to the total number of Shares purchased.

VI.

Each of the Underwriters agrees that the expenses incurred in
connection with or attributable to the purchase, carrying or sale of the Shares,
including the fees and disbursements of counsel to the Underwriters, shall be
for the respective accounts of the several Underwriters and shall be allocated
between the U.S. Underwriters and the International Underwriters in the
respective proportions that the number of U.S. Shares and International Shares
purchased pursuant to the Underwriting Agreement bears to the total number of
Shares purchased.

VII.

Changes in the public offering price and in the concessions and
reallowances to dealers will be made only upon the mutual agreement of the
Underwriters during the period referred to in the first sentence of Article I
hereof.

VIII.

The Representatives will keep one another fully informed of the
progress of the offering of the Shares.

The agreements of the Underwriters contained in Article II, the sixth
through eleventh paragraphs of Article III, the last paragraph of Article IV,
Article V and Article VI shall remain operative and in full force and effect
regardless of (i) any termination of this Agreement, (ii) any termination of the
Underwriting Agreement, (iii) any investigation made by or on behalf of any
Underwriter or any person controlling any Underwriter or by or on behalf of the
Company, its officers or directors or any other person controlling the Company
and (iv) acceptance of and payment for any Shares.

IX.

10
<PAGE> 12
This Agreement may be signed in counterparts, which together shall
constitute one and the same instrument.

This Agreement shall be governed and construed in all respects in
accordance with the laws of the State of New York and United States federal law.

11
<PAGE> 13
IN WITNESS WHEREOF, this Agreement has been executed as of the date and
year first above written by the undersigned for themselves and for the
Underwriters as set forth above.

MORGAN STANLEY & CO. INCORPORATED
NATIONSBANC MONTGOMERY SECURITIES LLC
THE ROBINSON-HUMPHREY COMPANY LLC
SCOTT & STRINGFELLOW, INC.

Acting severally on behalf of themselves
and the several U.S. Underwriters named in
Schedule I to the Underwriting Agreement
referred to herein.

By: MORGAN STANLEY & CO. INCORPORATED

By:__________________________________

MORGAN STANLEY & CO. INTERNATIONAL LIMITED
NATIONSBANC MONTGOMERY SECURITIES LLC
THE ROBINSON-HUMPHREY COMPANY LLC
SCOTT & STRINGFELLOW, INC.

Acting severally on behalf of themselves
and the several International Underwriters
named in Schedule II to the Underwriting
Agreement referred to herein.

By: MORGAN STANLEY & CO.
INTERNATIONAL LIMITED

By:__________________________________

<PAGE> 1
EXHIBIT H.4

1,150,000 SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK, $0.0001 PAR VALUE PER SHARE

INTERNATIONAL DEALER AGREEMENT

June __, 1998
<PAGE> 2
Morgan Stanley & Co. International Limited
NationsBanc Montgomery Securities LLC
The Robinson-Humphrey Company LLC
Scott & Stringfellow, Inc.
c/o Morgan Stanley & Co. International Limited
25 Cabot Square
Canary Wharf
London E14 4QA
England

Dear Sirs:

We understand that Allied Capital Corporation, a Maryland corporation (the
"COMPANY"), proposes to issue and sell to the several Underwriters (as defined
below) an aggregate of 5,750,000 shares (the "FIRM SHARES") of its common stock,
$0.0001 par value per share ("COMMON STOCK") pursuant to an underwriting
agreement (the "UNDERWRITING AGREEMENT") with you as representatives (the
"INTERNATIONAL REPRESENTATIVES") of the international underwriters named in
Schedule II thereto (the "INTERNATIONAL UNDERWRITERS"), and with Morgan Stanley
& Co. Incorporated, NationsBanc Montgomery Securities LLC, The Robinson-Humphrey
Company LLC and Scott & Stringfellow, Inc., as representatives (the "U.S.
REPRESENTATIVES") of the U.S. underwriters named in Schedule I thereto (the
"U.S. UNDERWRITERS"). The Firm Shares to be sold to the several U.S.
Underwriters and to the several International Underwriters shall hereinafter be
referred to, respectively, as the U.S. Firm Shares and the International Shares.
The International Underwriters and the U.S. Underwriters are hereinafter
collectively referred to as the Underwriters.

In addition, the several U.S. Underwriters will have an option to purchase
from the Company an additional 862,500 shares (the "ADDITIONAL SHARES") to
provide for over-allotments. The term "U.S. SHARES" shall mean the U.S. Firm
Shares and the Additional Shares. The U.S. Shares and the International Shares
are hereinafter collectively referred to as the "SHARES".

We acknowledge receipt of the Prospectus dated June __, 1998 (hereinafter
called the international prospectus) relating to the offering of the
International Shares.

We understand that the International Underwriters are severally offering,
through you, certain of the Shares for sale to certain dealers at the offering
price
<PAGE> 3
of U.S. $_____ less a concession not in excess of U.S. $_____(1) under the
offering price, and that any International Underwriter may allow, and dealers
may reallow, a concession not in excess of U.S. $_____(2) under the offering
price to other International Underwriters or to other dealers who enter into an
agreement in this form.

We hereby agree with you as follows with respect to any purchase of Shares
from you or from any other International Underwriter or from any dealer at a
concession from the offering price.

In purchasing Shares, we will rely only on the international prospectus
and on no other statements whatsoever, written or oral.

We understand that no action has been or will be taken in any jurisdiction
by the International Underwriters or the Company that would permit a public
offering of the Shares, or possession or distribution of the international
prospectus, in preliminary or final form, in any jurisdiction where, or in any
circumstances in which, action for that purpose is required, other than the
United States. We agree that we will comply with all applicable laws and
regulations, and make or obtain all necessary filings, consents or approvals, in
each jurisdiction in which we purchase, offer, sell or deliver Shares
(including, without limitation, any applicable requirements relating to the
delivery of the international prospectus, in preliminary or final form), in each
case at our own expense. In connection with sales of and offers to sell Shares
made by us, we will either furnish to each person to whom any such sale or offer
is made a copy of the then current international prospectus (in preliminary or
final form and as then amended or supplemented if the Company shall have
furnished any amendments or supplements thereto), or inform such person that
such international prospectus will be made available upon request and we will
keep an accurate record of the names and addresses of all persons to whom we
give copies of the registration statement relating to the offering of the
Shares, the international prospectus, in preliminary or final form, or any
amendment or supplement thereto, and, when furnished with any subsequent
amendment to such registration statement, any subsequent prospectus or any
medium outlining changes in the registration statement or any prospectus,

- ----------
(1) Insert amount of selling concession.
(2) Insert amount of reallowance.

2
<PAGE> 4
we will upon request of the International Representatives, promptly forward
copies thereof to such persons or inform such persons that such amendment,
subsequent prospectus or other medium will be made available upon request.

We will not give any information or make any representation other than as
contained in the international prospectus, or act for the Company, any
International Underwriter or you.

We represent and agree that, except for (x) sales between the U.S.
Underwriters and the International Underwriters pursuant to Article I of the
Agreement Between U.S. and International Underwriters of even date herewith
(hereinafter called the Agreement Between U.S. and International Underwriters)
and (y) stabilization transactions contemplated in Article IV of the Agreement
Between U.S. and International Underwriters conducted through the U.S.
Representatives as part of the distribution of the Shares, (a) we are not
purchasing and have not purchased and will not purchase any Shares for the
account of any United States or Canadian Person and (b) we have not offered or
sold, and will not offer or sell, directly or indirectly, any Shares or
distribute any prospectus relating to the Shares, in the United States or Canada
or to any United States or Canadian Person and any dealer to whom we may sell
any Shares will represent that it is not purchasing any Shares for the account
of any United States or Canadian Person and will agree that it will not offer or
resell any Shares directly or indirectly in the United States or Canada or to
any United States or Canadian Person or to any other dealer who does not so
represent and agree. "UNITED STATES OR CANADIAN PERSON" shall mean any national
or resident of the United States or Canada, or any corporation, pension,
profit-sharing or other trust or other entity organized under the laws of the
United States or Canada or of any political subdivision thereof (other than a
branch located outside the United States and Canada of any United States or
Canadian Person), and shall include any United States or Canadian branch of a
person who is otherwise not a United States or Canadian Person. "UNITED STATES"
shall mean the United States of America, its territories, its possessions and
all areas subject to its jurisdiction. Our agreement set forth in this paragraph
shall terminate upon the earlier of (a) notice from you to such effect and (b)
30 days after the date of the initial offering of the Shares, unless you have
given notice that the distribution of the Shares has not yet been completed. If
such latter notice is given, the agreement set forth in this paragraph shall
survive until the earlier of (x) the notice of termination referred to in (a)
above and (y) 30 days after the date of any notice that the distribution of the
Shares has not yet been completed.

We further represent that we have not offered or sold, and agree not to
offer or sell, directly or indirectly, in Japan or to or for the account of any
resident thereof, any of the Shares acquired in connection with the distribution

3
<PAGE> 5
contemplated hereby, except for offers or sales to Japanese International
Underwriters or dealers and except pursuant to any exemption from the
registration requirements of the Securities and Exchange Law and otherwise in
compliance with applicable provisions of Japanese law. We further agree to send
to any dealer who purchases from us any of such Shares a notice stating in
substance that, by purchasing such Shares, such dealer represents and agrees
that it has not offered or sold, and will not offer or sell, any of such Shares,
directly or indirectly, in Japan or to or for the account of any resident
thereof, except for offers or sales to Japanese International Underwriters or
dealers and except pursuant to any exemption from the registration requirements
of the Securities and Exchange Law and otherwise in compliance with applicable
provisions of Japanese law, and that such dealer will send to any other dealer
to whom it sells any of such Shares a notice containing substantially the same
statement as is contained in this sentence.

We further represent and agree that (i) we have not offered or sold and,
prior to the date six months after the closing date for the sale of the Firm
Shares to the Underwriters, will not offer or sell, any Shares to persons in the
United Kingdom except to persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (as principal or agent)
for the purposes of their businesses or otherwise in circumstances which have
not resulted and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulations 1995; (ii) we
have complied and will comply with all applicable provisions of the Financial
Services Act 1986 with respect to anything done by us in relation to the Shares
in, from or otherwise involving the United Kingdom; and (iii) we have only
issued or passed on and will only issue or pass on in the United Kingdom any
document received by us in connection with the offering of the Shares to a
person who is of a kind described in Article 11(3) of the Financial Services Act
1986 (Investment Advertisements) (Exemptions) Order 1996 or is a person to whom
such document may otherwise lawfully be issued or passed on.

We represent that we are a foreign bank or dealer not eligible for
membership in the U.S. National Association of Securities Dealers, Inc.
(hereinafter called the NASD), and we agree not to offer to sell or sell any
Shares in, or to persons who are nationals or residents of, the United States,
except for offers and Shares referred to in clause (x) of the third paragraph of
this Article I. In making sales of Shares, we agree to comply with the NASD's
Interpretation with Respect to Free-Riding and Withholding (IM-2110-1) and NASD
Rules 2730, 2740 and 2750 as though we were a member in good standing of the
NASD and NASD Rule 2420 as it applies to a non-member broker or dealer in a
foreign country.

4
<PAGE> 6
We agree that we will not, during the period continuing until the
International Representatives shall have notified us of the completion of the
distribution of the Shares, for our own account or the account of a customer,
offer, bid for, buy, sell, deal, trade in or attempt to induce any person to bid
for or buy any Covered Security, except (a) as provided in the Agreement Among
International Underwriters, the Morgan Stanley & Co. Incorporated Master
Agreement Among Underwriters, the Agreement between U.S. and International
Underwriters, this Agreement, the Morgan Stanley & Co. Master Dealer Agreement
or the Underwriting Agreement, (b) in brokerage transactions on unsolicited
orders which have not resulted from activities on our part in connection with
the solicitation of purchases and which are executed by us in the ordinary
course of our brokerage business, (c) in market making transactions on Nasdaq or
any similar market or quotation system executed by us in the ordinary course of
our business so long as our bids and purchases are made consistent with the
pricing restrictions set forth in Rule 103 of Regulation M of the U.S.
Securities and Exchange Commission ("REGULATION M") and the volumes of such
transactions are consistent with our past practice as a market maker, (d) in
basket transactions that meet the standards set forth in Rule 101(b)(6) of
Regulation M, (e) that we may convert, exchange or exercise any security owned
by us prior to the commencement of this restriction and that we may sell any
security obtained upon any such conversion, exchange or exercise, (f) that we
may deliver securities owned by us upon the exercise of any option written by us
as permitted by the provisions set forth herein, (g) that on or after the date
of the initial public offering of the Shares, we may execute covered writing
transactions for the accounts of customers in options to acquire Common Stock,
when such transactions are covered by Shares and (h) that we may engage in
principal purchases or sales with the intent of offsetting the market risk of
principal positions in over-the-counter derivatives on solicited orders that
were executed by us prior to the commencement of this restriction, and on
unsolicited orders that were executed by us at any time, so long as such orders
were executed by us in the ordinary course of our principal over-the-counter
derivatives business. "COVERED SECURITY" means (a) the Common Stock and (b) any
securities convertible into or exercisable or exchangeable for the Common Stock.

An opening uncovered writing transaction in options to acquire Common
Stock for our account or for the account of a customer shall be deemed, for
purposes of this Article I, to be a sale of Common Stock which is not
unsolicited. The term "opening uncovered writing transaction in options to
acquire" as used above means a transaction where the seller intends to become a
writer of an option to purchase any Common Stock which he does not own. An
opening uncovered purchase transaction in options to sell Common Stock for our
account or for the account of a customer shall be deemed, for purposes of this
paragraph, to be a sale of Common Stock which is not unsolicited. The term
"opening uncovered

5
<PAGE> 7
purchase transaction in options to sell" as used above means a transaction where
the purchaser intends to become an owner of an option to sell Common Stock which
he does not own.

We represent that we have not participated, since we were invited to
participate in the offering of the Shares, in any transaction prohibited by this
Article I and that we have at all times complied and agree that we will at all
times comply with the provisions of Regulation M applicable to this offering.

We agree to indemnify and hold harmless the Company, each Underwriter and
each person controlling the Company or any Underwriter from and against any and
all losses, claims, damages and liabilities (including fees and disbursements of
counsel) arising from any breach by us of any of the provisions of this Article
I.

II.

Shares purchased by us at a concession from the offering price shall be
promptly offered upon the terms set forth in the international prospectus or for
sale at a concession not in excess of the reallowance under the offering price
to any International Underwriter or to any other dealer who enters into an
agreement with you in this form with respect to this offering that, among other
things, sets forth such dealer's agreement that it is not purchasing Shares for
the account of any United States or Canadian Persons and that it will not offer
or resell Shares in the United States and Canada. Prior to offering Shares to
any dealer at the public offering price less the reallowance, you must either
ascertain that such dealer has entered into such an agreement or assure that
such dealer will enter into such an agreement.

We agree to advise you from time to time upon request, prior to the
termination of this Agreement, of the number of Shares remaining unsold which
were purchased by us from you or from any other International Underwriter or
dealer at a concession from the offering price and, on your request, we will
resell to you any such Shares remaining unsold at the purchase price thereof if,
in your opinion, such Shares are needed to make delivery against sales made to
others.

If prior to the termination of this Agreement (or prior to such earlier
date as you have determined) a U.S. Representative or International
Representative purchases or contracts to purchase in the open market or
otherwise any Shares which were purchased by us from you or from any other
International Underwriter or dealer at a concession from the offering price
(including any Shares represented by certificates which may have been issued on
transfer or in exchange for

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<PAGE> 8
certificates originally representing such Shares), and which Shares were
therefore not effectively placed for investment by us, we authorize you either
to charge our account with an amount equal to such concession which shall be
credited against the cost of such Shares, or to require us to repurchase such
Shares at a price equal to the total cost of such purchase, including any
commissions and any taxes on redelivery.

We have not offered or sold, and we will not offer or sell, directly or
indirectly, Shares that were purchased by us from you or from any other
International Underwriter or dealer at a concession from the offering price
(including any Shares represented by certificates which may have been issued on
transfer or in exchange for certificates originally representing such Shares) to
any person at less than the offering price, other than to (i) U.S. Underwriters
pursuant to Article I of the Agreement Between U.S. and International
Underwriters or (ii) other International Underwriters or to dealers who have
entered into International Dealer Agreements with the International
Representatives (hereinafter called the International Dealer Agreements) and
then only in conformity with the provisions of Article I and at a price that is
not below the offering price less the maximum permissible reallowance to be
specified in the international prospectus. We agree that prior to offering
Shares to any dealer at the public offering price less the reallowance, we will
either ascertain that such dealer has entered into such an International Dealer
Agreement or make arrangements to assure that such dealer will enter into an
International Dealer Agreement.

We agree that without the consent of Morgan Stanley & Co. International
Limited, we will not sell to any account over which we exercise discretionary
authority any of the Shares.

III.

If we purchase any Shares from you hereunder, we agree that such purchases
will be evidenced by your written confirmation and will be subject to the terms
and conditions set forth in the confirmation and in the international
prospectus.

Shares purchased by us from you in connection with our participation as
dealer in the offering shall be paid for in full at (i) the offering price, (ii)
such price less the applicable concession or (iii) the price set forth or
indicated in the pricing wire, as you shall advise, in Federal or other funds
immediately available in New York City in the manner, at such time and on such
day as you may advise us against delivery of the Shares. If we are called upon
to pay the offering price for the Shares purchased by us, the applicable
concession will be paid to us, less

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<PAGE> 9
any amounts charged to our account pursuant to Article II above, after
termination of this Agreement. Unless we promptly give you written instruction
otherwise, if transactions in the Shares may be settled through the facilities
of The Depository Trust Company, payment for and delivery of Shares purchased by
us will be made through such facilities, if we are a member, or, if we are not a
member, settlement may be made through our ordinary correspondent who is a
member.

We authorize the International Representatives as principals to advance,
or to arrange the advance of, funds to us to cover any delay in the receipt of
funds necessary for payment for the Shares to be purchased by us and to charge,
or to arrange for the charging of, interest on such funds at current rates.

IV.

You will advise us of the date and time of termination of this Agreement
or of any designated provisions hereof. This Agreement shall in any event
terminate 30 days after the date of the initial offering of the Shares unless
sooner terminated by you, provided that you may in your discretion extend this
Agreement for a further period or periods not exceeding an aggregate of 30 days,
and provided further that the provisions of Article I hereof shall survive any
termination of this Agreement.

We agree that you, as International Representatives, have full authority
to take such action as may seem advisable to you in respect of all matters
pertaining to the offering of the Shares. Neither you, as International
Representatives, nor any of the International Underwriters shall be under any
liability to us for any act or omission, except in respect of obligations
expressly assumed in this Agreement.

All communications to you relating to the subject matter of this Agreement
shall be addressed to the Syndicate Department, Morgan Stanley & Co.
International Limited, 25 Cabot Square, Canary Wharf, London E14 4QA, England,
and any notices to us shall be deemed to have been duly given if mailed or
telegraphed to us at the address shown below.

VI.

GOVERNING LAW

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This Agreement shall be governed by and construed in accordance with the
laws of the State of New York and United States federal law.

Very truly yours,

______________________________________

______________________________________
(ADDRESS)

By:___________________________________

<PAGE> 1
EXHIBIT N.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the use of our report
dated February 20, 1998, and to all references to our Firm included in this
registration statement.

/s/ Arthur Andersen LLP

Washington, DC
June 1, 1998

<PAGE> 1
EXHIBIT N.2

[SUTHERLAND, ASBILL & BRENNAN LLP LETTERHEAD]

June 1, 1998

Allied Capital Corporation
1666 K Street, N.W.
9th Floor
Washington, D.C. 20006

Ladies and Gentlemen:

We hereby consent to the filing of this consent as an exhibit to the
Registration Statement and to the reference to our firm in the "Legal Matters"
section of the prospectus included in the Registration Statement. We do not
admit by giving this consent that we are in the category of persons whose
consent is required under Section 7 of the Securities Act of 1933, as amended.

Very truly yours,

SUTHERLAND, ASBILL & BRENNAN LLP

By: /s/ Steven B. Boehm
-------------------------------
Steven B. Boehm