ALLIED CAPITAL CORP, POS 8C, 1998-11-18

ALLIED CAPITAL CORP
POS 8C, 1998-11-18

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<PAGE> 1

As filed with the Securities and Exchange Commission on November 18, 1998

REGISTRATION NO. 333-51899
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM N-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

[ ] PRE-EFFECTIVE AMENDMENT NO.

[X] POST-EFFECTIVE AMENDMENT NO. 1

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

1919 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20006-3434
(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
1919 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20006-3434
(Name and Address of Agent for Service)

Copies of information to:

<TABLE>
<S> <C>
STEVEN B. BOEHM
SUTHERLAND, ASBILL & BRENNAN LLP
1275 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20004-2415
</TABLE>

Approximate Date of Proposed Public Offering:
From time to time after the effective date of the Registration Statement.

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. [X]

It is proposed that this filing will become effective (check appropriate
box):

[X] when declared effective pursuant to Section 8(c)

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

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.

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<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; Plan of Distribution
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

PROSPECTUS

Allied Capital Logo

6,612,500 SHARES
Allied Capital Corporation

COMMON STOCK

Allied Capital Corporation (the "Company") may offer, from time to time, up
to 6,612,500 shares of common stock, par value $.0001 per share (the "Shares"),
on terms to be determined at the time of offering. The Shares may be offered at
prices and on terms to be set forth in one or more supplements to this
Prospectus (each a "Prospectus Supplement"), provided, however, that the
offering price per share less any underwriting commissions or discounts must
equal or exceed the net asset value ("NAV") per share of the Company's common
stock.

The Shares may be offered by the Company directly to one or more
purchasers, through agents designated from time to time by the Company, or to or
through underwriters or dealers. If any agents or underwriters are involved in
the sale of the Shares, their names, and any applicable purchase price, fee,
commission or discount arrangement between or among them, will be set forth, or
will be calculable from the information set forth, in an accompanying Prospectus
Supplement. See "Plan of Distribution." No Shares may be sold by the Company
through agents, underwriters or dealers without delivery of a Prospectus
Supplement describing the method and terms of the offering of such Shares. The
common stock is traded on the Nasdaq National Market under the symbol "ALLC." As
of , 1998, the last reported sales price for the common stock was $ .

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, and the accompanying Prospectus Supplement, if any, 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 1919 Pennsylvania Avenue, 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 SHARES OFFERED HEREBY, INCLUDING THE
RISK OF LEVERAGE.

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

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

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

THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF SECURITIES UNLESS
ACCOMPANIED BY A PROSPECTUS SUPPLEMENT.

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

The date of this Prospectus is , 1998

<PAGE> 4

NO DEALER, SALESMAN OR OTHER PERSON IS AUTHORIZED HEREBY TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS OR
ANY PROSPECTUS SUPPLEMENT AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY
OR ANY UNDERWRITER OR AGENT. THIS PROSPECTUS AND ANY PROSPECTUS SUPPLEMENT DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY
SECURITY OTHER THAN THE SHARES 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 OR ANY
PROSPECTUS SUPPLEMENT NOR ANY SALE MADE HEREUNDER OR THEREUNDER SHALL UNDER ANY
CIRCUMSTANCES IMPLY THAT THE INFORMATION CONTAINED HEREIN OR THEREIN IS CORRECT
AS OF ANY DATE SUBSEQUENT TO THEIR RESPECTIVE DATES.
------------------------

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
Selected Consolidated Financial Data........................ 13
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 15
Senior Securities........................................... 27
Business.................................................... 32
Portfolio Companies......................................... 42
Determination of Net Asset Value............................ 46
Management.................................................. 47
Taxation.................................................... 51
Certain Government Regulations.............................. 53
Dividend Reinvestment Plan.................................. 55
Description of Capital Stock................................ 55
Plan of Distribution........................................ 59
Legal Matters............................................... 59
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, AND
THE ACCOMPANYING PROSPECTUS SUPPLEMENT, IF ANY, 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 THE ACCOMPANYING PROSPECTUS SUPPLEMENT, IF ANY, AND IN ANY
EXHIBITS TO THE REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS, AND THE
ACCOMPANYING PROSPECTUS SUPPLEMENT, IF ANY, 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.

(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.

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

Allied Capital Corporation is a lender to and investor 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 a
variety of industries. 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 Small Business Administration ("SBA") 7(a) guaranteed loans.

The Company is a value-added full-service lender and sources, originates
and services all of the loans in its portfolio. 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 has offices in Chicago, San
Francisco and Detroit. The Company centralizes its credit approval function and
services its loans through an experienced staff of professionals at its
headquarters in Washington, D.C. In addition, the Company has an office in
Frankfurt, Germany 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. Prior to
the merger, the predecessor companies had a history of providing solid earnings
and dividend growth for their shareholders.

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 and private
equity investors. 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 an investment 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 may structure 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 it
with a competitive advantage in originating attractive investment opportunities.
1
<PAGE> 6

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 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'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 streamlined its operations and fully integrated all
of its lending disciplines in order to improve its efficiency and benefits from
synergies between the various lending areas. The Company has reallocated both
financial and human resources to increase capacity to originate higher yielding
mezzanine and SBA 7(a) loans. 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 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

The Company may offer, from time to time, up to 6,612,500 shares of common
stock, par value $.0001 per share (the "Shares"), on terms to be determined at
the time of offering. The Shares may be offered at prices and on terms to be set
forth in one or more supplements to this Prospectus (each a "Prospectus
Supplement"), provided, however, that the offering price per share less any
underwriting commissions or discounts must equal or exceed the net asset value
("NAV") per share of the Company's common stock.

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

Use of Proceeds............... Unless otherwise specified in the Prospectus
Supplement accompanying this Prospectus, the
Company intends to use the net proceeds from
the sale of the Shares for general corporate
purposes, which may include investment in
small to medium-sized, private growth
companies in accordance with the Company's
investment objective, repayment of
indebtedness outstanding from time to time,
acquisitions and other general corporate
purposes.

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 the Shares. 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 table 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)...... --%
Dividend reinvestment plan fees(2)..................... None
ANNUAL EXPENSES (AS A PERCENTAGE OF CONSOLIDATED NET ASSETS
ATTRIBUTABLE TO COMMON SHARES)(3)
Operating expenses(4).................................. 5.4%
Interest payments on borrowed funds(5)................. 5.0%
-----
Total annual expenses(6).......................... 10.4%
=====
</TABLE>

- ---------------
(1) In the event that Shares to which this Prospectus relates are sold to or
through underwriters, a corresponding Prospectus Supplement will disclose
the applicable sales load.
(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
(i.e., total assets less total liabilities) at September 30, 1998.

(4) "Operating expenses" represent all operating expenses of the Company
excluding interest on indebtedness. Operating expenses exclude the formula
and cut-off awards. See "Management -- Compensation Plans."

(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 $361.7 million at September 30, 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 5.4% 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 the payment by the Company of
operating expenses at the levels set forth in the table above. In the event that
Shares to which this Prospectus relates are sold to or through underwriters, a
corresponding Prospectus Supplement will restate this example to reflect the
applicable sales load.

<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............................. $104 $312 $517 $1,025
</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 September 30, 1998 and for the nine-month periods ended
September 30, 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 nine months ended September
30, 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 15 FOR MORE INFORMATION.

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, 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..................................... $58,428 $62,844 $86,882 $77,541 $61,550 $47,065 $33,639
Net premiums from loan dispositions.......... 2,913 5,225 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.... 4,611 3,352 3,246 3,155 4,471 2,710 1,833
------- ------- ------- ------- ------- ------- -------
Total interest and related portfolio
income................................. 80,764 71,421 97,405 84,937 68,817 52,155 37,668
------- ------- ------- ------- ------- ------- -------
Expenses:
Interest on indebtedness..................... 14,539 19,718 26,952 20,298 12,355 7,486 7,053
Salaries and employee benefits............... 8,254 6,507 10,258 8,774 8,031 6,929 5,510
General and administrative................... 8,970 7,040 8,970 8,289 6,888 7,170 5,441
Merger....................................... -- -- 5,159 -- -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating expenses................. 31,763 33,265 51,339 37,361 27,274 21,585 18,004
Formula and cut-off awards(1)................ 5,532 -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Portfolio income before realized and
unrealized gains........................... 43,469 38,156 46,066 47,576 41,543 30,570 19,664
------- ------- ------- ------- ------- ------- -------
Net realized and unrealized gains
Net realized gains........................... 20,001 7,526 10,704 19,155 12,000 6,236 (2,569)
Net unrealized gains (losses)................ (437) 4,787 7,209 (7,412) 9,266 (2,244) 2,039
------- ------- ------- ------- ------- ------- -------
Total net realized and unrealized gains
(losses)............................... 19,564 12,313 17,913 11,743 21,266 3,992 (530)
------- ------- ------- ------- ------- ------- -------
Income before minority interests and income
taxes.......................................... 63,033 50,469 63,979 59,319 62,809 34,562 19,134
Minority interests............................... -- 950 1,231 2,427 546 -- --
Income tax expense............................... 1,585 1,431 1,444 1,945 1,784 672 171
------- ------- ------- ------- ------- ------- -------
Net increase in net assets resulting from
operations..................................... $61,448 $48,088 $61,304 $54,947 $60,479 $33,890 $18,963
======= ======= ======= ======= ======= ======= =======
Per Share:
Basic earnings per common share.................. $ 1.19 $ .98 $ 1.24 $ 1.19 $ 1.38 $ .80 $ .46
Diluted earnings per common share................ 1.19 .97 1.24 1.17 1.37 .79 .46
Basic earnings per common share excluding merger
expenses....................................... 1.19 .98 1.35 1.19 1.38 .80 .46
Total tax distributions per common share(2)...... $ 1.05 $ .91 $ 1.71 $ 1.23 $ 1.09 $ .94 $ .74
Weighted average basic common shares
outstanding(3)................................. 51,502 48,759 49,218 46,172 43,697 42,463 40,466
Weighted average diluted common shares
outstanding(3)................................. 51,712 49,287 49,251 46,733 44,010 42,737 40,809
</TABLE>

(Footnotes appear on the following page)

5
<PAGE> 10

<TABLE>
<CAPTION>
AT AT DECEMBER 31,
SEPTEMBER 30, ----------------------------------------------------
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........................ $739,858 $697,021 $607,368 $528,483 $443,316 $334,193
Portfolio at cost......................... 737,872 690,720 613,276 526,979 451,078 339,711
Total assets.............................. 815,477 807,775 713,360 605,434 501,817 435,268
Total debt outstanding(4)................. 361,650 347,663 274,997 200,339 130,236 69,800
Preferred stock issued to SBA(4).......... 7,000 7,000 7,000 7,000 7,000 7,000
Shareholders' equity...................... 418,715 420,060 402,134 367,192 344,043 342,904
Shareholders' equity per common
share................................... $ 8.13 $ 8.07 $ 8.34 $ 8.26 $ 8.02 $ 8.11
Common shares outstanding at period
end(3).................................. 51,490 52,047 48,238 44,479 42,890 42,306
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
--------------------- ----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
OTHER DATA: ---------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C>
Loan originations................. $ 349,586 $262,169 $364,942 $283,295 $216,175 $215,843 $147,735
Loan repayments................... 75,817 142,515 233,005 179,292 111,731 54,097 117,305
Loan sales(5)..................... 28,957 37,954 53,912 27,715 29,726 30,160 18,796
Total assets managed at period
end............................. 1,106,552 939,739 935,720 822,450 702,567 583,817 501,307
Realized losses................... 818 972 5,100 11,262 4,679 2,908 3,719
Realized gains.................... $ 20,819 $ 8,498 $ 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 Nine Months Ended
September 30, 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 common 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
common share representing the undistributed earnings of the predecessor
companies at December 31, 1997. See "The Company."

(3) Excludes 808,000 shares held in the Company's deferred compensation trust at
or for the period ended September 30, 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 Nine Months Ended
September 30, 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
an interim basis because partial year results may fluctuate significantly
and may not be indicative of annual results.

6
<PAGE> 11

<TABLE>
<CAPTION>
1998 1997
--------------------------- ---------------------------
QTR 3 QTR 2 QTR 1 QTR 4 QTR 3 QTR 2
------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
QUARTERLY DATA:
Total interest and related portfolio
income............................... $22,546 $21,321 $36,897 $25,984 $25,111 $24,911
Portfolio income before realized and
unrealized gains..................... 9,401 9,148 24,920 7,910 12,093 14,095
Net increase in net assets resulting
from operations...................... 14,906 14,476 32,065 13,216 17,146 18,296
Basic earnings per common share....... .29 .28 .62 .25 .35 .37
Diluted earnings per common share..... .29 .28 .61 .25 .35 .37
Net asset value per common share(1)... 8.13 8.14 8.23 8.07 8.42 8.50
Dividends declared per common share... .35 .35 .35 .80(2) .31 .30

<CAPTION>
1997 1996
------- -------------------------------------
QTR 1 QTR 4 QTR 3 QTR 2 QTR 1
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
QUARTERLY DATA:
Total interest and related portfolio
income............................... $21,399 $23,906 $20,753 $20,866 $19,412
Portfolio income before realized and
unrealized gains..................... 11,968 13,035 11,592 11,665 11,284
Net increase in net assets resulting
from operations...................... 12,646 8,067 16,855 11,090 18,935
Basic earnings per common share....... .27 .18 .35 .24 .42
Diluted earnings per common share..... .27 .18 .34 .23 .42
Net asset value per common share(1)... 8.39 8.34 8.58 8.46 8.37
Dividends declared per common share... .30 .45(3) .27 .26 .25
</TABLE>

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

(1) Net asset value per common 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 per common share which included $0.34 per common 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 common share, and a special distribution of previously undistributed
earnings of $0.17 per common share in conjunction with the Merger.

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

ADDITIONAL INFORMATION

The Company has filed with the Commission a registration statement on Form
N-2 (together with all amendments and exhibits, the "Registration Statement") of
which this Prospectus is a part under the Securities Act of 1933, as amended
(the "Securities Act") with respect to the Shares 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 Shares, 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 Company's
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 Shares.

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 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"), 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 September 30, 1998, the Company's net interest spread was 4.6%
(460 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 or losses, 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 September 30, 1998, the

9
<PAGE> 14

Company's debt as a percentage of total liabilities and shareholders' equity was
44.3%. 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 September 30, 1998, the Company had $361.7 million of outstanding
indebtedness, bearing a weighted average annual interest rate of 7.2%. In order
for the Company to cover annual interest payments on its indebtedness, it must
achieve annual returns of at least 3.2% 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)............ -45.2% -25.8% -16.0% -6.3% 3.5% 13.2% 32.7%
</TABLE>

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

(1) The calculation assumes (i) $815.5 million in total assets, (ii)
an average cost of funds of 7.2%, (iii) $361.7 million in debt
outstanding and (iv) $418.7 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 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 two wholly owned
subsidiaries that have also elected to be regulated as BDCs. Allied Investment
Corporation ("Allied Investment") is licensed by the Small Business
Administration ("SBA") as a Small Business Investment Company ("SBIC"). Allied
Capital SBLC Corporation ("Allied SBLC") is licensed by the SBA as a Small
Business Lending Company ("SBLC") 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 1919 Pennsylvania Avenue,
N.W., 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, Detroit and Frankfurt, Germany.

USE OF PROCEEDS

Unless otherwise specified in the Prospectus Supplement accompanying this
Prospectus, the Company intends to use the net proceeds from the sale of the
Shares for general corporate purposes, which may include investment in small to
medium-sized, private growth companies in accordance with the Company's
investment objective, repayment of indebtedness outstanding from time to time,
acquisitions and other general corporate purposes.

The Company anticipates that substantially all of the net proceeds of any
offering of Shares 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 of any offering of Shares 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.

11
<PAGE> 16

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

The common stock of the Company (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 , 1998, the last reported closing sale price
of the Common Stock was $ 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......................................... 29.250 22.500
Third Quarter.......................................... 24.813 14.938
Fourth Quarter (through November 13, 1998)............. 18.875 12.500
</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

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 nine months ended September 30, 1998 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998.

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 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...................................... $ 58,428 $ 62,844 $ 86,882 $ 77,541 $ 61,550
Net premiums from loan dispositions........... 2,913 5,225 7,277 4,241 2,796
Net gain on securitization of commercial
mortgage loans............................. 14,812 -- -- -- --
Investment advisory fees and other income .... 4,611 3,352 3,246 3,155 4,471
-------- -------- -------- -------- --------
Total interest and related portfolio
income................................. 80,764 71,421 97,405 84,937 68,817
-------- -------- -------- -------- --------
Expenses:
Interest on indebtedness...................... 14,539 19,718 26,952 20,298 12,355
Salaries and employee benefits................ 8,254 6,507 10,258 8,774 8,031
General and administrative.................... 8,970 7,040 8,970 8,289 6,888
Merger........................................ -- -- 5,159 -- --
-------- -------- -------- -------- --------
Total operating expenses................. 31,763 33,265 51,339 37,361 27,274
Formula and cut-off awards(1)................. 5,532 -- -- -- --
-------- -------- -------- -------- --------
Portfolio income before realized and
unrealized gains........................... 43,469 38,156 46,066 47,576 41,543
-------- -------- -------- -------- --------
Net realized and unrealized gains
Net realized gains............................ 20,001 7,526 10,704 19,155 12,000
Net unrealized gains (losses)................. (437) 4,787 7,209 (7,412) 9,266
-------- -------- -------- -------- --------
Total net realized and unrealized
gains.................................. 19,564 12,313 17,913 11,743 21,266
-------- -------- -------- -------- --------
Income before minority interests and income
taxes........................................... 63,033 50,469 63,979 59,319 62,809
Minority interests................................ -- 950 1,231 2,427 546
Income tax expense................................ 1,585 1,431 1,444 1,945 1,784
-------- -------- -------- -------- --------
Net increase in net assets resulting from
operations...................................... $ 61,448 $ 48,088 $ 61,304 $ 54,947 $ 60,479
======== ======== ======== ======== ========
Per Share:
Basic earnings per common share................... $ 1.19 $ .98 $ 1.24 $ 1.19 $ 1.38
Diluted earnings per common share................. $ 1.19 $ .97 $ 1.24 $ 1.17 $ 1.37
Weighted average basic common shares
outstanding(2).................................. 51,502 48,759 49,218 46,172 43,697
Weighted average diluted common shares
outstanding(2).................................. 51,712 49,287 49,251 46,733 44,010
</TABLE>

<TABLE>
<CAPTION>
AT AT DECEMBER 31,
SEPTEMBER 30, ------------------------------
1998 1997 1996 1995
------------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Portfolio at value............................. $739,858 $697,021 $607,368 $528,483
Portfolio at cost.............................. 737,872 690,720 613,276 526,979
Total assets................................... 815,477 807,775 713,360 605,434
Total debt outstanding......................... 361,650 347,663 274,997 200,339
Preferred stock issued to SBA.................. 7,000 7,000 7,000 7,000
Shareholders' equity........................... 418,715 420,060 402,134 367,192
Shareholders' equity per common share.......... $ 8.13 $ 8.07 $ 8.34 $ 8.26
Common shares outstanding at period end(2)..... 51,490 52,047 48,238 44,479
</TABLE>

(footnotes appear on next page)

13
<PAGE> 18

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
--------------------- ------------------------------
1998 1997 1997 1996 1995
---------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C>
OTHER DATA:
Loan originations............................ $ 349,586 $262,169 $364,942 $283,295 $216,175
Loan repayments.............................. 75,817 142,515 233,005 179,292 111,731
Loan sales(3)................................ 28,957 37,954 53,912 27,715 29,726
Total assets managed at period end........... 1,106,552 939,739 935,720 822,450 702,567
Realized losses.............................. 818 972 5,100 11,262 4,679
Realized gains............................... $ 20,819 $ 8,498 $ 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 Nine Months Ended
September 30, 1998 and 1997."

(2) Excludes 808,000 shares held in the Company's deferred compensation trust at
or for the period ended September 30, 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 Nine Months Ended
September 30, 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
an interim basis because partial year results may fluctuate significantly
and may not be indicative of annual results.

<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- ------------------------------------- -------------------------------------
QTR 3 QTR 2 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> <C> <C>
QUARTERLY DATA:
Total interest and
related portfolio
income............. $22,546 $21,321 $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... 9,401 9,148 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.... 14,906 14,476 32,065 13,216 17,146 18,296 12,646 8,067 16,855 11,090 18,935
Basic earnings per
common share....... .29 .28 .62 .25 .35 .37 .27 .18 .35 .24 .42
Diluted earnings per
common share....... .29 .28 .61 .25 .35 .37 .27 .18 .34 .23 .42
Net asset value per
common share(1).... 8.13 8.14 8.23 8.07 8.42 8.50 8.39 8.34 8.58 8.46 8.37
Dividends declared
per common share... .35 .35 .35 .80(2) .31 .30 .30 .45(3) .27 .26 .25
</TABLE>

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

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

14
<PAGE> 19

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 original issue
discount 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 equity interests;
and 7(a) loans.

The total portfolio at value was $739.9 million, $697.0 million, $607.4
million and $528.5 million at September 30, 1998, and December 31, 1997, 1996
and 1995, respectively. During the nine months ended September 30, 1998 the
Company originated loans totaling $349.6 million and received repayments of
$75.8 million. In addition in January 1998, the Company completed an asset
securitization of approximately $295 million in commercial mortgage loans. As a
result, the total portfolio decreased by 6% from December 31, 1997 to September
30, 1998. 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 September 30, 1998 and December 31,
1997, 1996 and 1995 is shown in the following table:

<TABLE>
<CAPTION>
AT DECEMBER 31,
AT SEPTEMBER 30, ------------------
ASSET COMPOSITION 1998 1997 1996 1995
----------------- ---------------- ---- ---- ----
<S> <C> <C> <C> <C>
Mezzanine investments................................ 37% 25% 27% 34%
Commercial mortgage loans(1)......................... 48 56 52 46
7(a) loans........................................... 6 5 6 7
Cash and other assets................................ 9 14 15 13
--- --- --- ---
100% 100% 100% 100%
=== === === ===
</TABLE>

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

15
<PAGE> 20

Mezzanine loans, debt securities and equity interests were $301.9 million,
$207.7 million, $191.2 million and $205.2 million at September 30, 1998, and
December 31, 1997, 1996 and 1995, respectively. The effective yield on the
mezzanine portfolio was 14.0%, 12.6% and 13.2% at September 30, 1998, and
December 31, 1997 and 1996, respectively. Mezzanine loan originations were $44.3
million for the quarter ended September 30, 1998 and $127.2 million for the
first nine months of 1998. Mezzanine loan originations were $66.7 million and
$66.2 million for the years ended December 31, 1997 and 1996, respectively.
Mezzanine loan repayments were $4.9 million for the quarter ended September 30,
1998 and $23.9 million for the first nine months of 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.

In the nine months ended September 30, 1998, the Company has made thirteen
new mezzanine investments with an average investment size of $8.8 million. On
average, these new portfolio companies had revenues of $63 million, cash flows
of $7.2 million, and had been in business for approximately 18 years.

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 enables the Company to price its loans more competitively. The Company
believes that its post-Merger strategies will enable the Company to increase
mezzanine loan originations in 1998.

Commercial mortgage loans were $302.8 million, $447.2 million, $373.7
million and $277.3 million at September 30, 1998, and December 31, 1997, 1996
and 1995, respectively. The commercial mortgage loan portfolio declined by 32%
during the first nine months of 1998 due to the sale through securitization of
approximately $295 million in commercial mortgage loans. The Company added to
its commercial mortgage loan portfolio during the third quarter of 1998 through
the origination of new loans and investments totaling $46.3 million and
decreased its portfolio due to repayments of loans totaling $15.3 million. For
the nine months ended September 30, 1998, the Company originated new commercial
mortgage loans of $182.7 million and received repayments of $48.8 million. The
commercial mortgage loan portfolio increased by 20% and 35% for the years ended
December 31, 1997 and 1996, respectively. 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 September 30, 1998 and at December 31, 1997 and 1996 was
9.6%, 9.6% and 10.3%, respectively. The weighted average yield on the commercial
real estate portfolio was 10.1%, 11.4% and 13.4% at September 30, 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. 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.

16
<PAGE> 21

During 1997 and 1998, interest rates on U.S. Treasury bonds have declined
significantly, and the spreads charged by commercial real estate lenders in the
marketplace have narrowed. As a result, the Company began to reevaluate its
strategy regarding commercial real estate lending given the fact that this type
of loan was being priced very inexpensively in the marketplace. Early in the
third quarter of 1998, the Company significantly reduced its commercial real
estate loan origination activity for its own portfolio, and began exploring an
opportunity to originate commercial real estate loans for sale to third parties.
The Company is currently pursuing various loan sale opportunities and plans to
continue to originate commercial real estate loans for sale. The Company will
also originate commercial real estate loans for its own portfolio, if such loans
meet certain threshold yield requirements.

The 7(a) loan portfolio was $48.5 million, $40.7 million, $42.1 million and
$43.3 million at September 30, 1998 and December 31, 1997, 1996 and 1995,
respectively. 7(a) loan originations were $10.2 million for the quarter ended
September 30, 1998, $39.6 million for the first nine months of 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
$7.4 million in the third quarter of 1998, $26.8 for the nine months ended
September 30, 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.

RESULTS OF OPERATIONS

Comparison of Nine Months Ended September 30, 1998 and 1997

Net increase in net assets resulting from operations ("NIA") was $61.4
million, or $1.19 per share, and $48.1 million, or $0.97 per share, for the nine
months ended September 30, 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 nine months ended
September 30, 1998 also includes a gain of $14.8 million, or $0.28 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 $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

17
<PAGE> 22

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 has evaluated the
residual interest and the residual securitization spread as of September 30,
1998 and believes these assets are fairly valued.

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 have been and will continue to be valued each
quarter using updated prepayment, interest rate and loss estimates.

As discussed above, the Company is currently pursuing a strategy of
originating commercial real estate loans for sale to third parties, and the
Company believes that because of this new strategy, in the future, it will use
asset securitization as a means to increase its liquidity on an infrequent
basis.

Interest income totaled $58.4 million and $62.8 million for the nine months
ended September 30, 1998 and 1997, respectively. Interest income declined on a
year to year comparison because of the assets sold through securitization. The
Company's average loan portfolio was approximately $581.3 million and
approximately $628.2 million during the nine months ended September 30, 1998 and
1997, respectively. The weighted average yield on the total loan portfolio at
September 30, 1998 and 1997 was approximately 11.8%.

Net premiums from loan dispositions were $2.9 million and $5.2 million for
the nine months ended September 30, 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 $2.1 million and $1.7
million for the nine months ended September 30, 1998 and 1997, respectively. The
premiums resulted from the Company's sale of 7(a) loans totaling $26.6 million
and $20.2 million for the nine months ended September 30, 1998 and 1997,
respectively. Also included in net premiums from loan dispositions were
premiums, resulting from the early repayment of loans, totaling $0.7 million and
$3.0 million for the nine months ended September 30, 1998 and 1997,
respectively.

Investment advisory fees and other income were $4.6 million and $3.4
million for the nine months ended September 30, 1998 and 1997, respectively.
Investment advisory fees totaled $1.5 million and $1.0 million for the nine
months ended September 30, 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 an agreement with Kreditanstalt fur Wiederaufbau (KfW), the
state-owned public development bank of Germany, to manage a fund of
approximately DM 160 million (approximately $95 million at September 30, 1998).
Advisory fees increased as new fees from the German fund offset the decline in
fees from liquidating funds.

Total operating expenses were $31.8 million and $33.3 million for the nine
months ended September 30, 1998 and 1997, respectively. Operating expenses
include interest on indebtedness, salaries and employee benefits, and other
general and administrative expenses.

Interest expense on indebtedness totaled $14.5 million and $19.7 million
for the nine months ended September 30, 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 nine months
ended September 30, 1998 and 1997 was $252.5 million and $326.5 million,
respectively. The weighted average interest rate for the Company's combined
indebtedness was 7.2% and 7.3% at September 30, 1998 and 1997, respectively.

Salaries and employee benefits totaled $8.3 million and $6.5 million for
the nine months ended September 30, 1998 and 1997, respectively. At September
30, 1998 and 1997, total employees were approximately 96 and 82, 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.

18
<PAGE> 23

During the quarter ended September 30, 1998, salaries and employee benefits
were decreased by $297,000, as the result of consolidating the Company's
deferred compensation plan's rabbi trust. As is required by EITF 97-14, the
Company records the investment income, capital gains, and unrealized
appreciation and depreciation of the assets owned by the rabbi trust in its
earnings as an increase or decrease to compensation expense with a corresponding
increase or decrease to other income and unrealized appreciation. During the
third quarter of 1998, due to an overall decline in stock market values, the
trust decreased in value by $297,000, and the result was a decrease in
compensation expense of $297,000, a decrease in other income of $57,000 and a
decrease in unrealized appreciation of $152,000. The effects of consolidating
the rabbi trust in previous quarters have had an immaterial effect on the
Company's consolidated statement of operations.

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 options 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 totaled $783,000 during the nine months ended September 30, 1998
with approximately $25,000 remaining to be vested during 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.

19
<PAGE> 24

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.

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 $4.7 million during the nine months ended September 30, 1998.

The total expense recorded as a result of the cut-off and formula awards
during the first nine months of 1998 was $5.5 million, or $0.11 per share.

Net realized gains were $20.0 million and $7.5 million for the nine months
ended September 30, 1998 and 1997, respectively. The net gains resulted from the
sale of equity securities associated with certain mezzanine loans, the sale of
real estate and the realization of unamortized discount resulting from the
payoff of mezzanine and commercial mortgage loans, offset by losses on
investments. Realized gains totaled $20.8 million and $8.5 million for the nine
months ended September 30, 1998 and 1997, respectively. Realized losses during
the nine months ended September 30, 1998 and 1997 totaled $0.8 million and $1.0
million, respectively. Net realized gains during the first nine months of 1998
were largely due to the disposition of securities of seven portfolio companies,
DMI Furniture ($0.5 million), Virginia Beach Associates ($2.4 million), Labor
Ready, Inc. ($5.0 million), Broadcast Holdings, Inc. ($1.1 million), Waterview
($3.0 million), Z Spanish Radio Network, Inc. ($2.7 million) and El Dorado
Communications, Inc. ($0.8 million). Gains resulting from investments in these
seven companies totaled $15.5 million. The Company also realized a gain of $4.0
million from the sale of an office building and incurred an income tax liability
related to that gain of approximately $1.6 million. The office building was
previously owned by Allied Capital Advisers, Inc. ("Advisers"), a predecessor
company to the merged Allied Capital.

The Company will realize gains when market conditions are favorable or when
dictated by other parties to the transaction. Therefore, the realization of
gains is unpredictable on a quarterly basis and quarterly results may not be
indicative of annual results.

The Company recorded net unrealized losses of $0.4 million for the nine
months ended September 30, 1998 as a result of valuation changes resulting from
the board of directors' valuation of the Company's assets, the effect of
valuation of interest rate swap agreements and the effect of reversals of
appreciation resulting from realized gains. At September 30, 1998, net
unrealized appreciation in the portfolio totaled $864,000, and was composed of
unrealized appreciation of $28.0 million resulting primarily from appreciated
equity interests in portfolio companies, and unrealized depreciation of $27.1
million resulting primarily from under-performing investments in the portfolio.

Grade 5 mezzanine investments, or those investments the Company has
identified as assets for which some loss of investment principal is expected,
totaled $6.9 million at value at September 30, 1998, or 0.9% of the Company's
total portfolio based on the quarterly valuation of the Board of Directors. The
value of these Grade 5 loans has been reduced from an aggregate cost of $25.0
million in order to reflect the Company's estimate of the net realizable value
of these investments upon disposition. This reduction in value has been recorded
previously as unrealized depreciation over several years in the Company's
earnings. The Company continues to follow its historical practices of working
with a troubled portfolio company in order to recover the maximum amount of the
Company's investment, but records unrealized depreciation for a substantial
amount of the potential exposure when such exposure is identified. The
population of Grade 5 mezzanine investments remained constant with prior periods
in 1998, and the Company currently does not see any additional credit concerns
in its mezzanine portfolio.

20
<PAGE> 25

Prior to the third quarter, the Company had employed two separate grading
systems for its mezzanine and commercial real estate loans, and did not use a
grading system for its SBA 7(a) loan portfolio. To provide greater consistency
in reporting credit quality to the Company's investors, during the third quarter
of 1998 the Company moved the real estate and SBA 7(a) loan portfolios to the
same grading system used for the mezzanine portfolio. The mezzanine grading
scale now used for the entire portfolio provides for the following
classifications. Grade 1 is used for those loans from which a capital gain is
expected. Grade 2 is used for loans performing in accordance with plan. Grade 3
is used for loans that require closer monitoring; however, no loss of interest
or principal is expected. Grade 4 is used for loans for which some loss of
contractually due interest is expected, but no loss of principal is expected.
Grade 5 is used for loans for which some loss of principal is expected and the
loan is marked down to net realizable value.

At September 30, 1998, commercial real estate Grade 5 loans totaled $1.6
million at value. The value of these Grade 5 loans has been reduced from an
aggregate cost of $2.1 million in order to reflect the Company's estimate of the
net realizable value of the underlying collateral. A Grade 5 classification for
a commercial real estate loan prior to the use of the uniform grading system
meant that the loan was in workout. Because of the collateral securing these
loans, however, few previous Grade 5 loans were ever expected to result in loss
of principal. Of the loans included in Grade 5 at June 30, 1998, only four loans
totaling $2.1 million at cost were expected to incur any loss of principal, and
these loans were valued at $1.4 million at June 30, 1998.

Grade 5 SBA 7(a) loans totaled $4.8 million at value at September 30, 1998,
and have been reduced from an aggregate cost basis of $6.3 million.

For the portfolio as a whole, at September 30, 1998, Grade 5 investments
totaled $13.3 million, or 1.8% of the total portfolio; Grade 4 investments
totaled $8.4 million, or 1.1% of the total portfolio; Grade 3 investments
totaled $25.6 million, or 3.5% of the total portfolio; Grade 2 investments
totaled $541.3 million, or 73.2% of the total portfolio; and Grade 1 investments
totaled $151.3 million, or 20.4% of the total portfolio.

For the total portfolio, loans greater than 120 days delinquent were $21.2
million at value at September 30, 1998, or 2.9% of the total portfolio. Included
in this category are loans valued at $16.4 million that are fully secured by
real estate. Loans greater than 120 days delinquent generally do not accrue
interest. Loans greater than 120 days delinquent at June 30, 1998, were $19.5
million at value or 2.9% of the total portfolio.

The Company incurred income tax expense of $1.6 million for the nine months
ended September 30, 1998, which resulted from the built-in gains tax associated
with the $4.0 million gain from the sale of the office building previously owned
by Advisers, prior to the Merger. The Company incurred income tax expense of
$1.4 million for nine months ended September 30, 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 ordinary income taxes has been made for the nine months ended September 30,
1998.

The weighted average common shares outstanding used to compute basic
earnings per common share for the nine months ended September 30, 1998 were 51.5
million as compared to 48.8 million for the nine months ended September 30,
1997. The increase in weighted average shares is primarily due to the exercise
of stock options. Total shares outstanding at September 30, 1998 were 52.3
million. The weighted average shares and the total shares outstanding are
reduced by the approximately 0.8 million shares held in the Company's deferred
compensation plan resulting primarily from the formula award.

For the nine months ended September 30, 1998, the Company's compensation
committee granted a total of 3.7 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. All per share amounts included in this management's discussion and
analysis have been computed using the weighted average shares used to compute
diluted earnings per share. See "Management -- Compensation Plans -- Stock
Option Plan."

21
<PAGE> 26

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 $1.17 per
share, and $60.5 million, or $1.37 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-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 $88
million at June 30, 1998). For its services related to

22
<PAGE> 27

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.

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 will move its Washington, D.C. office to
larger office space in August 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

23
<PAGE> 28

borrowers included in 1996 losses totaled $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 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 used to compute basic
earnings per share 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.

All per share amounts included in this management's discussion analysis
have been computed using the weighted average shares used to compute diluted
earnings per share. See "Management -- Compensation Plans -- Stock Option Plan."

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%.

24
<PAGE> 29

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents

At September 30, 1998, the Company had $43.6 million in cash and cash
equivalents. 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. The Company closed the third
quarter of 1998 with a substantial cash balance due to the timing of a loan
origination which closed two days after the quarter end, and due to certain
repayments that were received on September 30, 1998. The Company's objective is
to manage to a very low cash balance, and fund new originations with its lines
of credit.

Indebtedness

The Company had outstanding indebtedness at September 30, 1998 (unaudited)
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:
Unsecured long-term notes payable..... $180,000 7.21% 1.59%
Master loan and security agreement.... 56,000 6.38% 0.44%
OPIC Loan............................. 5,700 6.57% 0.05%
SBA debentures........................ 48,650 8.23% 0.49%
Master repurchase agreement........... 1,300 7.24% 0.00%
-------- ----- -----
Total debentures and notes
payable........................ $291,650 7.21% 2.58%
======== ===== =====
Revolving line of credit................... $ 70,000 7.21% 0.62%
======== ===== =====
</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 September 30, 1998. The total
Annual Return needed to cover all classes of financing at September 30, 1998
combined is 3.20%.

Unsecured Long-term Notes Payable. The Company obtained $180 million in
financing through the issuance of unsecured long-term notes with private
institutional lenders, primarily insurance companies. The terms of the notes
include five or seven year maturities, priced at approximately 7.2%. The notes
require payment of interest semiannually, and all principal is due upon
maturity.

Master Loan and Security Agreement. The Company, in conjunction with a
private REIT managed by the Company, 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 London
Inter Bank Offered Rate ("LIBOR") plus 1.0%. The facility matured on October 15,
1998, and has subsequently been renewed for an additional one year term.

SBA Debentures. The Company, through its SBIC subsidiary, has debentures
totaling $48.7 million payable to the SBA, at interest rates ranging from 6.9%
to 9.6% with scheduled maturity dates as follows: 1998 -- $1.0 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.

Master Repurchase Agreement. The Company and a private REIT managed by the
Company 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

25
<PAGE> 30

repurchase agreement require interest-only payments with all principal due at
maturity. The master repurchase agreement bears interest at one-month 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.

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
line of credit requires monthly payments of interest, and all principal is due
upon maturity. The facility matures on June 30, 1999.

FUTURE DEBT OR EQUITY OFFERINGS

The Company plans to secure additional debt and equity capital for
continued investment in growing businesses. Because the Company is a regulated
investment company, it distributes substantially all of its income and requires
external capital for growth. Because the Company is a business development
company, 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.

The Company's cash flow from operations was $49.8 million for the nine
months ended September 30, 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 sales or 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 evaluates its interest rate exposure on an
ongoing basis and may hedge variable and short-term interest rate exposure
through interest rate swaps, treasury locks and other techniques when
appropriate. The Company believes that it has access to capital sufficient to
fund its ongoing investment and operating activities, and from which to pay
dividends.

Because of recent turmoil in the capital markets, the Company foresees
certain unique opportunities to purchase debt instruments in both the corporate
high yield market and in the commercial mortgage-backed securities market at
significant discounts. These purchase opportunities have the potential to
increase the Company's recurring investment income in the future. Given the
magnitude of this unique opportunity the Company is presently exploring
additional debt and equity capital alternatives, so that it can aggressively
pursue this opportunity.

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% to 20%.
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
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 in the process of developing a series of
tests to validate its readiness for the Year 2000. The Company is also assessing
the viability of contingent courses of action if necessary, including the
purchase of new hardware and software applications. At the present time, the
Company does not believe that it will be adversely affected by this issue. In
addition, the Company has not made significant expenditures in anticipation of
the Year 2000 issue outside of its routine information technology budget. The
Company is currently assessing the risk that its portfolio

26
<PAGE> 31

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.

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The Statement establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. The Company does not
anticipate that the adoption of SFAS No. 133 will have any material impact to
the financial statements.

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.

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>
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 September 30)..................... 57,300,000 2,177 -- 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 September 30)..................... 0 0 -- N/A
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 September 30)..................... 5,700,000 2,177 -- 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>
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 September 30)..................... 48,650,000 2,177 -- 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 September 30)..................... 70,000,000 2,177 -- N/A
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 September 30)..................... 0 0 -- 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>
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 September 30)..................... 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 September 30)..................... 1,000,000 214 100 N/A
</TABLE>

30
<PAGE> 35

- ---------------
(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 subsidiary to the SBA. These categories of
senior securities are not subject to the asset coverage requirements of the
1940 Act. See "Certain Government Regulations -- SBA Regulations."

(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.

31
<PAGE> 36

BUSINESS

Allied Capital Corporation is a lender to and investor 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.

The Company is a value-added full-service lender and sources, originates
and services all the loans in its portfolio. 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 has offices in Chicago, San
Francisco and Detroit. The Company centralizes its credit approval function and
services its loans through an experienced staff of professionals at its
headquarters in Washington, D.C. In addition, the Company has an office in
Frankfurt, Germany 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. Prior to
the merger, the Predecessor Companies had a history of providing solid earnings
and dividend growth for their shareholders. From the time of its initial public
offering in 1960 through the date of the Merger in 1997, Allied I, the oldest of
the Predecessor Companies, provided its shareholders with an average annual
investment return, assuming reinvestment of dividends, of 18.88%.

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 and private equity investors. 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 an investment 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 may structure 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-

32
<PAGE> 37

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 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 streamlined its operations and fully integrated all
of its lending disciplines in order to improve its efficiency and benefits from
synergies between the various lending areas. The Company has also reallocated
both financial and human resources to increase its capacity to originate higher
yielding mezzanine and SBA 7(a) loans. 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 AND RETURN ON ASSETS: 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 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 has
increased the scale of its sales and marketing function in order to
increase loan origination activity. The Company originated $349.6 million
in new loans in the first nine months of 1998 as compared to $262.2
million in the first nine months of 1997, reflecting in large measure the
Company's new loan origination growth strategies.

The Company believes that it currently has an opportunity to increase
its portfolio return and thus returns on shareholders' equity by
reallocating financial and human resources to its higher yielding
mezzanine and SBA 7(a) lending areas from its commercial real estate
finance operations. At September 30, 1998, the mezzanine portfolio yield
(at value) was 14.0%, as compared to a 10.1% yield (at value) on the
commercial real estate portfolio. Recent declines in U.S. Treasury rates
and a competitive real estate lending market have lowered the rates that
the Company can charge on new commercial mortgage loans. Conversely, the
Company's post-Merger capital structure has lowered its cost of capital
as compared to private mezzanine lenders, and the Company believes that
it has a pricing advantage in the mezzanine marketplace. The Company
will continue to pursue commercial real estate finance, but may
increasingly sell loans that are originated with lower investment yields
at premiums to various financial institutions. Sale premiums received
from these loan sales are also expected to enhance the Company's
portfolio return.

- 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 loan
officer credit approval 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

33
<PAGE> 38

professionals, who have an average of 17 years of experience. In
addition, loans and investments with a total dollar amount of $10 million
or greater are approved in advance by the executive committee or the
board of directors.

- 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 loan sales and
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.

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
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 September 30, 1998, the Company's
mezzanine portfolio had $254.8 million in mezzanine loans and $47.0 million in
equity interests totaling $301.9 million, which represented 41% of the Company's
total investment portfolio.

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 may now originate larger-sized transactions of up to $25 million.

Post-Merger, the Company has targeted larger companies with greater capital
needs due to the superior credit characteristics of these larger companies when
compared to smaller, more fragile companies. The Company's target criteria for
mezzanine borrowers include: revenues of $20 million to $200 million; cash flow
margins of approximately 10% of revenues; a debt service coverage ratio of
approximately 2.0 times; average years of operation of ten years; strong equity
sponsorship; and a seasoned management team with a significant equity stake. See
"Business -- Underwriting Guidelines and Procedures."

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
yield (at value) on the mezzanine loan portfolio at September 30, 1998 was
approximately 14.0%. 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.

34
<PAGE> 39

At September 30, 1998 the Company held equity investments in 60 companies
with a total value of $47.0 million. During the nine months ended September 30,
1998 and the years ended December 31, 1997 and 1996, respectively, the Company
converted a portion of its equity investments into realized gains of $10.2
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 its
wholly owned subsidiary, Allied Investment. Allied Investment is licensed and
regulated by the SBA to operate as an SBIC and is 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 following table
shows the Company's mezzanine portfolio by industry and geographic region at
September 30, 1998:

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

<TABLE>
<CAPTION>
PERCENT OF
INDUSTRY TOTAL
- ------------------------------ ----------
<S> <C>
Industrial/Manufacturing...... 43%
Broadcasting/Communications... 17
Services...................... 21
Retail/Wholesale.............. 14
Other......................... 5
---
100%
===
</TABLE>

<TABLE>
<CAPTION>
PERCENT OF
GEOGRAPHIC REGION TOTAL
- ------------------------------ ----------
<S> <C>
Mid-Atlantic.................. 35%
Southeast..................... 26
Midwest....................... 24
West.......................... 7
Northeast..................... 5
International................. 3
---
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 $305.8 million at September 30, 1998, or 41% of
the Company's total investment portfolio. In addition, at September 30, 1998 the
Company had $83.8 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
Nine Months Ended September 30, 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

35
<PAGE> 40

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 September 30, 1998, approximately 70% of
the Company's portfolio of commercial mortgage loans carried a fixed rate of
interest and approximately 30% had adjustable rates of interest tied to various
indices. At September 30, 1998, the weighted average yield (at value) on ACC's
portfolio of commercial mortgage loans was approximately 10.1%, 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
September 30, 1998, the average loan to value ratio for the commercial mortgage
loan portfolio, including the securitized pool, was 66.2%.

The Company will sell or securitize commercial real estate loans in order
to increase the investment return earned on its portfolio and to provide
liquidity for new investments. 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
September 30, 1998 was servicing $243.0 million of securitized loans. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Comparison of Nine Months Ended September
30, 1998 and 1997."

The Company believes that it will increasingly sell lower yielding real
estate loans on a whole loan basis to various financial institutions. The
Company believes that the cash premium income from these sales will increase its
overall portfolio yield and will be a more effective means of managing its
capital resources, as opposed to maintaining these lower yielding loans in its
portfolio until such time in which a securitization pool of sufficient size
could be assembled. The Company will retain in its portfolio those commercial
mortgage loans that provide for a higher investment yield, and may continue to
securitize these loans; however, the Company does not anticipate that it will
offer a pool of loans for securitization any more frequently than annually.

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
September 30, 1998:

36
<PAGE> 41

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

<TABLE>
<CAPTION>
PERCENT OF
PROPERTY TYPE TOTAL
- ------------------------------ ----------
<S> <C>
Office........................ 31%
Hospitality................... 40
Retail........................ 9
Recreation.................... 3
Other......................... 17
---
100%
===
</TABLE>

<TABLE>
<CAPTION>
PERCENT OF
GEOGRAPHIC REGION TOTAL
- ------------------------------ ----------
<S> <C>
Mid-Atlantic.................. 34%
West.......................... 25
Southeast..................... 17
Midwest....................... 18
Northeast..................... 6
---
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 $48.5 million at September 30, 1998, or 6.6% of the
Company's total investment portfolio.

For the fiscal year ended September 30, 1998, the federal government
estimated that 7(a) loan originations would 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 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 $250,000 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 7.5% 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 September 30,
1998, the Company was servicing 7(a) loans sold totaling $132.7 million.

37
<PAGE> 42

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 September 30, 1998:

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

<TABLE>
<CAPTION>
PERCENT OF
INDUSTRY TOTAL
- ------------------------------ ----------
<S> <C>
Hospitality................... 30%
Automotive Services........... 27
Restaurant/Food Services...... 12
Industrial/Manufacturing...... 6
Broadcasting/Communications... 6
Services...................... 6
Retail/Wholesale.............. 3
Other......................... 10
---
100%
===
</TABLE>

<TABLE>
<CAPTION>
PERCENT OF
GEOGRAPHIC REGION TOTAL
- ------------------------------ ----------
<S> <C>
Midwest....................... 36%
Mid-Atlantic.................. 29
Southeast..................... 15
Northeast..................... 8
West.......................... 12
---
100%
===
</TABLE>

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 $95 million at September 30, 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, 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 $24 million at
September 30, 1998).

38
<PAGE> 43

OTHER INVESTMENTS

At September 30, 1998, the Company had $43.6 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 fifteen months, the Company has increased the scope of its
sales and marketing activity by opening regional offices in Chicago, San
Francisco and Detroit and by staffing a full-time sales and marketing function
with eight individuals to identify and pursue mezzanine investments, commercial
mortgage loans, and SBA 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 SBA 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 September 30,
1998, the Company had eleven Regional Associates located throughout the United
States.

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 loan officer 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

39
<PAGE> 44

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.

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 and
for every investment larger than $10 million, the executive committee or the
board of directors is also required to approve investment transactions.

PORTFOLIO MONITORING

The Company services all of the loans it holds for its own portfolio 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. Prior to the third quarter of 1998, the Company had
employed two separate grading systems for its mezzanine and commercial real
estate loans, and did not use a grading system for its SBA 7(a) loan portfolio.
To provide greater consistency in reporting credit quality to the Company's
investors, during the third quarter of 1998 the Company moved the real estate
and SBA 7(a) loan portfolios to the same grading system used for the mezzanine
portfolio. The mezzanine grading scale now used for the

40
<PAGE> 45

entire portfolio provides for the following classifications. Grade 1 is used for
those loans from which a capital gain is expected. Grade 2 is used for loans
performing in accordance with plan. Grade 3 is used for loans that require
closer monitoring; however, no loss of interest or principal is expected. Grade
4 is for loans for which some loss of contractually due interest is expected,
but no loss of principal is expected. Grade 5 is for loans for which some loss
of principal is expected and the loan is marked down to net realizable value. At
September 30, 1998, $13.3 million at value, or 1.8% of the Company's total
portfolio, was classified as Grade 5.

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 September
30,1998 the Company had recorded an aggregate of $27.1 million in unrealized
depreciation on its loans and investments, and an aggregate of $28.0 million in
unrealized appreciation on its portfolio, for a net unrealized appreciation of
$864,000.

Delinquencies. The Company monitors loan delinquencies through weekly
review of the Company's delinquency reports. Loans that are 30 days delinquent
are monitored and borrowers of such loans are 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. See note 4 of
the Company's Consolidated Financial Statements.

At September 30, 1998, the Company's portfolio of delinquent assets greater
than 120 days past due totaled $21.2 million at value, or approximately 2.9% of
total assets. Included in this category are loans valued at $16.4 million which
are secured by real estate. 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>
NINE MONTHS
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- --------------------------------------------------------------------
1998 1997 1997 1996(1) 1995 1994 1993
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Realized losses........ $ 818 $ 972 $ 5,100 $ 11,262 $ 4,679 $ 2,908 $ 3,719
Total assets........... 815,477 818,862 807,775 713,360 605,434 501,817 435,268
Realized losses/
total assets......... 0.1% 0.1% 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

41
<PAGE> 46

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 September 30, 1998, the Company and its subsidiaries employed 96
persons. 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 September 30, 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 September 30, 1998 at pages F-5 to F-9
herein.

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>
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, Woodcrafts
#225.......................
Edina, MN 55435
Convenience Corporation of
America....................... Convenience Store Chain Series A Preferred Stock 10.0%
711 N. 108th Court Warrants to Purchase 4.5%
Omaha, NE 68154 Common Stock
Cooper Natural Resources, Sodium Sulfate Producer Warrants to Purchase 25.3%
Inc. ......................... Common Stock
P.O. Box 1477
Seagraves, TX 79360
Cosmetic Manufacturing.......... Cosmetic Manufacturer Options to Purchase 10.0%
Resources, LLC Shares
11312 Penrose Street
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 Telephone Directories Common Stock 50.0%
Corporation...................
1919 Pennsylvania Avenue, N.W.
Washington, DC 20006
Directory Lending Corporation... Telephone Directories Common Stock 50.0%
1919 Pennsylvania Avenue, N.W. Preferred Stock 50.0%
Washington, DC 20006
DMI Furniture, Inc. ............ Furniture Manufacturer Common Stock 1.6%
101 Bullitt Lane Stock
Louisville, KY 40222
EDM Consulting, LLC............. Environmental Equity Interest 25.0%
14 Macopin Avenue Consulting
Montclair, NJ 07043
Esquire Communications Ltd. .... Court Reporting Warrants to Purchase 3.0%
216 E. 45th Street, 8th floor Services Common Stock
New York, NY 10017
</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>
ExTerra Funding LLC ............ Consumer Finance Preferred Stock 2.6%
35 Lennon Lane, Suite 200 Common Stock 1.1%
Walnut Creek, CA 94598 Warrants to Purchase 1.1%
Common Stock
Fairchild Industrial Products
Company....................... Industrial Controls Warrants to Purchase 21.5%
3920 Westpoint Boulevard Manufacturer Common Stock
Winston-Salem, NC 27013
Gibson Guitar Corporation ...... 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
Bellmawr, NJ 08031 Common Stock 16.0%
Golden Eagle/Satellite
Archery, LLC.................. Sporting Equipment Convertible Debentures 26.9%
1733 Gunn Highway Manufacturer
Odessa, FL 33556
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
Hotelevision, Inc. ............. Hotel Cable-TV Preferred Stock 14.2%
599 Lexington Avenue Network
Suite 2300
New York, NY 10022
IndeNet Corporation
(Enterprise Software, Inc.) .. Broadcasting Software Common Stock 2.6%
5475 Tech Enter Drive, Suite Warrants to Purchase 3.8%
300
Colorado Springs, CO 80919 Common Stock
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%
55 East 6th Street Manufacturer Common Stock
Paterson, NJ 07524 Equity Interest in 5.0%
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
</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>
Love Funding Corporation........ Mortgage Services Series D Preferred Stock 26.0%
1220 19th Street, NW, Suite
801
Washington, DC 20036
MidSouth Data Systems, Inc.
(Kyrus Corporation) .......... 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/Morton Industrial Group .... 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
Nobel Education Dynamics,
Inc. ......................... Educational Services Series D Convertible 100.0%
1400 N. Providence Road, Preferred Stock
Suite 3055 Warrants to Purchase 12.1%
Media, PA 19063 Common Stock
Nortek Aviation Support,
Inc. ......................... Aviation Services Warrants to Purchase 2.5%
c/o Trivest, Inc. Company Common Stock
2665 S. Bayshore Dr., Suite
800
Miami, FL 33133-5462
Nursefinders, Inc. ............. Home Healthcare Warrants to Purchase 3.5%
1200 Copeland Road, Suite 200 Providers Common Stock
Arlington, TX 76011
Old Mill Holdings, Inc.......... Custom Embroidered Warrants to Purchase 24.0%
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 5.8%
12500 Foothill Boulevard Component Warrants to Purchase 15.0%
Lakeview Terr., CA 91342 Manufacturer Common Stock
Precision Industrial Co.
(formerly Herr-Voss Industries,
Inc.) ..................... Machinery Manufacturer Common Stock 8.5%
Arch Street Extension
Carnegie, PA 15106
</TABLE>

45
<PAGE> 50

- ---------------
(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 common 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

46
<PAGE> 51

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 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

Effective at the Annual Meeting of Shareholders held on May 14, 1998 (the
"Meeting"), the bylaws of the Company were amended to provide that directors of
the Company would be 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.

47
<PAGE> 52

DIRECTORS

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

<TABLE>
<CAPTION>
EXPIRATION
NAME AGE POSITION DIRECTOR SINCE(1) OF TERM
- ---- --- -------- ----------------- ----------
<S> <C> <C> <C> <C>
William L. Walton*................... 49 Chairman, Chief Executive
Officer and President 1986 2001
George C. Williams, Jr.*............. 72 Chairman Emeritus 1964 2001
Brooks H. Browne..................... 49 Director 1990 2001
John D. Firestone.................... 54 Director 1993 1999
Anthony T. Garcia.................... 42 Director 1991 1999
Lawrence I. Hebert................... 52 Director 1989 1999
John I. Leahy........................ 68 Director 1994 2000
Robert E. Long....................... 67 Director 1972 2001
Warren K. Montouri................... 69 Director 1986 2000
Laura W. Van Roijen.................. 46 Director 1992 1999
Guy T. Steuart II.................... 67 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........................... 49 Chairman, Chief Executive Officer and President
Philip A. McNeill........................... 39 Managing Director
John M. Scheurer............................ 46 Managing Director
Joan M. Sweeney............................. 39 Managing Director
G. Cabell Williams, III .................... 44 Managing Director
Penni F. Roll............................... 32 Principal and Chief Financial Officer
</TABLE>

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 entity's
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).

48
<PAGE> 53

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.

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

Philip A. McNeill, Managing Director, has been employed by the Company
since 1993.

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

Joan M. Sweeney, Managing Director, 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, Managing Director, has been employed by the
Company since 1981. Mr. Williams is also a Managing Director of BMI.

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Penni F. Roll, Principal and Chief Financial Officer, has been employed by
the Company since 1995. Ms. Roll is also Principal and Chief Financial Officer
of BMI. Ms. Roll was a Manager at KPMG Peat Marwick, LLP from 1993 to 1995.

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. For the nine months ended September
30, 1998, the Company's compensation committee granted a total of 3,665,330
options, net of cancellations, to certain officers of the Company, 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 Company has filed an application with the
Commission to request approval to grant options under the New Plan to
non-officer directors. There can be no assurance that such approval will be
granted.

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.

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

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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 Nine Months Ended September 30, 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 Nine Months Ended September 30, 1998 and 1997."

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

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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 (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

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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
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 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;

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(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."

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 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. Allied Investment is the result of the merger of the
Company's two wholly owned SBIC subsidiaries in July 1998 whereby Allied
Investment Corporation merged with and into Allied Capital Financial Corporation
("Allied Financial"). Allied Financial then changed its name to Allied
Investment Corporation. Allied Financial was licensed by the SBA as a
Specialized Small Business Investment Company ("SSBIC") under 301(d) of the 1958
Act. The Company determined that, given certain regulatory requirements of the
SSBIC program, it was no longer economical to operate Allied Financial as an
SSBIC, and the Company received permission from the SBA to permit Allied
Financial to make SBIC eligible investments in addition to SSBIC eligible
investments.

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.

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Allied Investment has the opportunity to sell to the SBA 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.
Historically, an SBIC was also eligible to sell preferred stock to the SBA.
Allied Investment has received $48.7 million of subordinated debentures and $7.0
million of preferred stock investments from the SBA at September 30, 1998; as a
result, the ability to apply for additional financing from the SBA will be
limited. Interest rates on the SBA debentures currently outstanding have a
weighted average interest rate of 8.23%.

Allied Investment is 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 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 November 13, 1998, there were 52,298,351 shares of Common Stock
outstanding and 6,239,592 shares of Common Stock reserved for issuance under the
New Plan. The following are the authorized classes of securities of the Company
as of November 13, 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 100,000,000 808,348 51,490,003
</TABLE>

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

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<PAGE> 60

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 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.

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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 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

57
<PAGE> 62

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 and Allied SBLC are SBIC 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. 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
or SBLC, whether through ownership, contractual arrangements or otherwise.

58
<PAGE> 63

PLAN OF DISTRIBUTION

The Company may sell the Shares through underwriters or dealers, directly
to one or more purchasers, through agents or through a combination of any such
methods of sale. Any underwriter or agent involved in the offer and sale of the
Shares will be named in the applicable Prospectus Supplement.

The distribution of the Shares may be effected from time to time in one or
more transactions at a fixed price or prices, which may be changed, at
prevailing market prices at the time of sale, at prices related to such
prevailing market prices, or at negotiated prices, provided, however, that the
offering price less per share any commissions or discounts must equal or exceed
the net asset value ("NAV") per share of the Company's Common Stock.

In connection with the sale of the Shares, underwriters or agents may
receive compensation from the Company or from purchasers of the Shares, for whom
they may act as agents, in the form of discounts, concessions or commissions.
Underwriters may sell the Shares to or through dealers and such dealers may
receive compensation in the form of discounts, concessions or commissions from
the underwriters and/or commissions from the purchasers for whom they may act as
agents. Underwriters, dealers and agents that participate in the distribution of
the Shares may be deemed to be underwriters under the Securities Act, and any
discounts and commissions they receive from the Company and any profit realized
by them on the resale of the Shares may be deemed to be underwriting discounts
and commissions under the Securities Act. Any such underwriter or agent will be
identified and any such compensation received from the Company will be described
in the applicable Prospectus Supplement.

Any Shares sold pursuant to a Prospectus Supplement will be quoted on the
Nasdaq National Market, or another exchange on which the shares are traded.

Under agreements into which the Company may enter, underwriters, dealers
and agents who participate in the distribution of the Shares may be entitled to
indemnification by the Company against certain liabilities, including
liabilities under the Securities Act.

Underwriters, dealers and agents may engage in transactions with, or
perform services for, the Company in the ordinary course of business.

If so indicated in the applicable Prospectus Supplement, the Company will
authorize underwriters or other persons acting as the Company's agents to
solicit offers by certain institutions to purchase the Shares from the Company
pursuant to contracts providing for payment and delivery on a future date.
Institutions with which such contracts may be made include commercial and
savings banks, insurance companies, pension funds, investment companies,
educational and charitable institutions and others, but in all cases such
institutions must be approved by the Company. The obligations of any purchaser
under any such contract will be subject to the condition that the purchase of
the Shares shall not at the time of delivery be prohibited under the laws of the
jurisdiction to which such purchaser is subject. The underwriters and such other
agents will not have any responsibility in respect of the validity or
performance of such contracts. Such contracts will be subject only to those
conditions set forth in the Prospectus Supplement, and the Prospectus Supplement
will set forth the commission payable for solicitation of such contracts.

In order to comply with the securities laws of certain states, if
applicable, the Shares offered hereby will be sold in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
states, the Shares may not be sold unless they have been registered or qualified
for sale in the applicable state or an exemption from the registration or
qualification requirement is available and is complied with.

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 will be passed upon for
underwriters, if any, by the counsel named in the Prospectus Supplement.

59
<PAGE> 64

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 -- September 30, 1998 (unaudited)
and December 31, 1997 and 1996............................ F-1
Consolidated Statement of Operations -- For the Nine Months
Ended September 30, 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
Nine Months Ended September 30, 1998 and 1997 (unaudited)
and the Years Ended December 31, 1997, 1996, and 1995..... F-3
Consolidated Statement of Cash Flows -- For the Nine Months
Ended September 30, 1998 and 1997 (unaudited) and the
Years Ended December 31, 1997, 1996, and 1995............. F-4
Consolidated Statement of Investments -- September 30, 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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
SEPTEMBER 30, 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-$302,811; 1997-
$447,016; 1996-$373,378)............................ $302,773 $447,244 $373,695
Mezzanine loans and debt securities (cost:
1998-$272,621; 1997-$181,184; 1996-$178,664)........ 254,813 167,842 165,086
Small Business Administration 7(a) loans (cost:
1998-$50,084; 1997-$41,103; 1996-$42,351)........... 48,505 40,709 42,131
Interest in securitization pool of commercial mortgage
loans (cost: 1998-$85,290; 1997-$0; 1996-$0)........ 83,790 -- --
Equity interests in portfolio companies (cost:
1998-$23,977; 1997-$20,050; 1996-$18,521)........... 46,968 39,906 26,134
Other portfolio assets
(cost: 1998-$3,089; 1997-$1,367; 1996-$362)......... 3,009 1,320 322
-------- -------- --------
Total portfolio at value.......................... 739,858 697,021 607,368
-------- -------- --------
Cash and cash equivalents................................... 43,622 70,437 71,841
U.S. government securities.................................. -- 11,091 --
Other assets................................................ 31,997 29,226 34,151
-------- -------- --------
Total assets...................................... $815,477 $807,775 $713,360
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debentures and notes payable.......................... $291,650 $308,821 $229,898
Revolving lines of credit............................. 70,000 38,842 45,099
Accounts payable and other liabilities................ 28,112 23,984 21,032
Dividends and distributions payable................... -- 9,068 8,197
-------- -------- --------
389,762 380,715 304,226
-------- -------- --------
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; 52,298,351, 52,047,318 and 48,237,621
issued and outstanding at September 30, 1998,
December 31, 1997 and 1996, respectively............ 5 5 5
Additional paid-in capital............................ 456,332 451,044 417,670
Common stock held in deferred compensation trust;
808,348 shares at September 30, 1998................ (19,431) -- --
Notes receivable from sale of common stock............ (23,900) (29,611) (15,491)
Net unrealized appreciation (depreciation) on
portfolio........................................... 864 1,301 (5,908)
Undistributed (distributions in excess of) earnings... 4,845 (2,679) 5,858
-------- -------- --------
Total shareholders' equity........................ 418,715 420,060 402,134
-------- -------- --------
Total liabilities and shareholders' equity........ $815,477 $807,775 $713,360
======== ======== ========
</TABLE>

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE NINE
MONTHS ENDED FOR THE YEARS ENDED
SEPTEMBER 30, 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........................................... $58,428 $62,844 $86,882 $77,541 $61,550
Net premiums from loan dispositions................ 2,913 5,225 7,277 4,241 2,796
Net gain on securitization of commercial mortgage
loans............................................ 14,812 -- -- -- --
Investment advisory fees and other income.......... 4,611 3,352 3,246 3,155 4,471
------- ------- ------- ------- -------
Total interest and related portfolio income.... 80,764 71,421 97,405 84,937 68,817
------- ------- ------- ------- -------
Expenses:
Interest on indebtedness........................... 14,539 19,718 26,952 20,298 12,355
Salaries and employee benefits..................... 8,254 6,507 10,258 8,774 8,031
General and administrative......................... 8,970 7,040 8,970 8,289 6,888
Merger............................................. -- -- 5,159 -- --
------- ------- ------- ------- -------
Total operating expenses....................... 31,763 33,265 51,339 37,361 27,274
Formula and cut-off awards......................... 5,532 -- -- -- --
------- ------- ------- ------- -------
Portfolio income before realized and unrealized gains... 43,469 38,156 46,066 47,576 41,543
------- ------- ------- ------- -------
Net realized and unrealized gains:
Net realized gains................................. 20,001 7,526 10,704 19,155 12,000
Net unrealized gains (losses)...................... (437) 4,787 7,209 (7,412) 9,266
------- ------- ------- ------- -------
Total net realized and unrealized gains........ 19,564 12,313 17,913 11,743 21,266
------- ------- ------- ------- -------
Income before minority interests and income taxes....... 63,033 50,469 63,979 59,319 62,809
Minority interests...................................... -- 950 1,231 2,427 546
Income tax expense...................................... 1,585 1,431 1,444 1,945 1,784
------- ------- ------- ------- -------
Net increase in net assets resulting from operations.... $61,448 $48,088 $61,304 $54,947 $60,479
======= ======= ======= ======= =======
Basic earnings per common share......................... $ 1.19 $ 0.98 $ 1.24 $ 1.19 $ 1.38
======= ======= ======= ======= =======
Diluted earnings per common share....................... $ 1.19 $ 0.97 $ 1.24 $ 1.17 $ 1.37
======= ======= ======= ======= =======
Weighted average basic common shares outstanding........ 51,502 48,759 49,218 46,172 43,697
======= ======= ======= ======= =======
Weighted average diluted common shares outstanding...... 51,712 49,287 49,251 46,733 44,010
======= ======= ======= ======= =======
</TABLE>

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 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..................... $ 43,469 $ 38,156 $ 46,066 $ 47,576 $ 41,543
Net realized gains..................... 20,001 7,526 10,704 19,155 12,000
Net unrealized gains (losses).......... (437) 4,787 7,209 (7,412) 9,266
Minority interests and income tax
expense.............................. (1,585) (2,381) (2,675) (4,372) (2,330)
-------- -------- -------- -------- --------
Net increase in net assets
resulting from operations....... 61,448 48,088 61,304 54,947 60,479
-------- -------- -------- -------- --------
Shareholder distributions:
Portfolio income....................... (54,727) (44,683) (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............... (165) (165) (220) (220) (220)
-------- -------- -------- -------- --------
Net decrease in net assets
resulting from shareholder
distributions................... (54,892) (44,848) (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................................ 5,711 (7,619) (14,120) (8,176) (3,526)
Issuance of common stock upon the
exercise of stock options............ 222 16,653 28,426 12,176 5,310
Issuance of common stock in lieu of
cash distributions................... 4,097 7,362 26,612 11,986 7,506
Purchase of common stock by deferred
compensation trust................... (19,431) -- -- -- --
Other.................................. 1,500 739 1,602 (738) 364
-------- -------- -------- -------- --------
Net (decrease) increase in net
assets resulting from capital
share transactions.............. (7,901) 17,135 42,520 37,613 10,810
-------- -------- -------- -------- --------
Total (decrease) increase in net assets..... (1,345) 20,375 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................. $418,715 $422,509 $420,060 $402,134 $367,192
======== ======== ======== ======== ========
Net asset value per common share............ $ 8.13 $ 8.42 $ 8.07 $ 8.34 $ 8.26
======== ======== ======== ======== ========
Common shares outstanding at end of
period.................................... 51,490 50,188 52,047 48,238 44,479
======== ======== ======== ======== ========
</TABLE>

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 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................... $ 61,448 $ 48,088 $ 61,304 $ 54,947 $ 60,479
Adjustments
Net unrealized (gains) losses..... (286) (4,787) (7,209) 7,412 (9,266)
Net gain on securitization of
commercial mortgage loans....... (14,812) -- -- -- --
Depreciation and amortization..... 523 348 450 393 319
Amortization of loan discounts and
fees............................ (3,237) (7,081) (10,804) (9,027) (6,841)
Deferred income taxes............. -- 404 1,087 (381) (174)
Minority interests................ -- 949 1,231 2,427 546
Changes in other assets and
liabilities..................... 6,206 8,146 12,881 (10,606) 2,245
--------- --------- --------- --------- ---------
Net cash provided by operating
activities................... 49,842 46,067 58,940 45,165 47,308
--------- --------- --------- --------- ---------
Cash flows from investing activities:
Investments in small business
concerns.......................... (349,586) (262,169) (364,942) (283,295) (216,175)
Collections of investment
principal......................... 75,817 142,515 233,005 179,292 111,731
Proceeds from the sale of loans...... 28,957 37,954 53,912 27,715 29,726
Proceeds from securitization of
commercial mortgage loans......... 223,401 -- -- -- --
Net (purchase) redemption of U.S.
government securities............. 11,091 (24,933) (10,301) -- 35,061
Collections of notes receivable from
sale of common stock.............. 5,411 6,356 6,534 2,199 1,038
Other investing activities........... (1,431) (903) (182) 2,635 2,357
--------- --------- --------- --------- ---------
Net cash used in investing
activities................... (6,340) (101,180) (81,974) (71,454) (36,262)
--------- --------- --------- --------- ---------
Cash flows from financing activities:
Sale of common stock................. 222 2,659 8,615 24,166 1,074
Purchase of common stock by deferred
compensation trust................ (19,431) -- -- -- --
Common dividends and distributions
paid.............................. (51,107) (45,273) (58,194) (47,089) (36,265)
Special undistributed earnings
distribution paid................. (8,261) -- -- -- --
Preferred stock dividends............ (385) (220) (220) (220) (220)
Net borrowings under (payments on)
debentures and notes payable...... (17,171) 85,531 78,923 (35,202) 85,636
Net borrowings under (payments on)
revolving lines of credit......... 31,158 4,255 (6,257) 110,460 (11,812)
Net payments on government securities
available for sale................ -- -- -- -- (23,210)
Other financing activities........... (5,342) (2,667) (1,237) (3,029) 364
--------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities......... (70,317) 44,285 21,630 49,086 15,567
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and
cash equivalents..................... $ (26,815) $ (10,828) $ (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............................... $ 43,622 $ 61,013 $ 70,437 $ 71,841 $ 49,044
========= ========= ========= ========= =========
</TABLE>

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INVESTMENTS

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
<S> <C> <C> <C>
Acme Paging, L.P. Debt Securities $ 6,204 $ 6,204
Partnership Interests 1,456 2,600
- -------------------------------------------------------------------------------------------------------
American Barbecue & Grill, Loans 1,555 1,555
Inc. Debt Securities 2,186 2,186
Warrants 125 125
- -------------------------------------------------------------------------------------------------------
Arlington Square, L.P. Cash Flow Participation 0 750
- -------------------------------------------------------------------------------------------------------
Arnold Moving Co., Inc. Loans 620 620
- -------------------------------------------------------------------------------------------------------
ARS, Inc. Debt Securities 9,748 9,748
Warrants 171 768
- -------------------------------------------------------------------------------------------------------
ASW Holding Corporation Warrants 25 25
- -------------------------------------------------------------------------------------------------------
Au Bon Pain Co., Inc.(1) Debt Securities 7,415 7,415
Warrants 227 --
- -------------------------------------------------------------------------------------------------------
Brazos Sportswear, Inc.(1) Common Stock (342,938 shares) 330 412
- -------------------------------------------------------------------------------------------------------
Calendar Broadcasting, Inc. Debt Securities 3,815 3,815
Warrants 150 650
- -------------------------------------------------------------------------------------------------------
Candlewood Hotel Company(1) Preferred Stock (3,250 shares) 3,250 3,250
- -------------------------------------------------------------------------------------------------------
Celebrities, Inc. Debt Securities 345 345
Warrants 12 12
- -------------------------------------------------------------------------------------------------------
CeraTech Holdings Corporation Debt Securities 1,990 270
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cherry Tree Toys, Inc. Debt Securities 1,597 1,597
Common Stock (220 shares) 1 --
- -------------------------------------------------------------------------------------------------------
Convenience Corporation of Debt Securities 8,388 2,774
America Series A Preferred Stock (31,521 shares) 337 --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Cooper Natural Resources, Debt Securities 3,448 3,448
Inc. Warrants -- 1,138
- -------------------------------------------------------------------------------------------------------
Cosmetic Manufacturing Debt Securities 2,946 2,946
Resources, LLC Options -- --
- -------------------------------------------------------------------------------------------------------
Coverall North America Loan 8,912 8,912
- -------------------------------------------------------------------------------------------------------
Csabai Canning Factory Rt. Hungarian Quotas (9.2%) 700 700
- -------------------------------------------------------------------------------------------------------
DEH Printed Circuits, Inc. Warrants 250 950
- -------------------------------------------------------------------------------------------------------
DeVlieg-Bullard, Inc.(1) Warrants 350 231
- -------------------------------------------------------------------------------------------------------
Directory Investment Common Stock (470 shares) -- 100
Corporation
- -------------------------------------------------------------------------------------------------------
</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-5
<PAGE> 71

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Directory Lending Corporation Series A Common Stock (1,031 shares) $ -- $ 386
Series B Common Stock (188 shares) 235 70
Series C Common Stock (292 shares) 656 109
Series A Preferred Stock (214 shares) 307 214
Series B Preferred Stock (175 shares) 931 175
Series C Preferred Stock (58 shares) 58 58
- -------------------------------------------------------------------------------------------------------
DMI Furniture, Inc.(1) Common Stock (100,840 shares) 126 253
- -------------------------------------------------------------------------------------------------------
Drilltech Patents & Loans 9,902 9,902
Technologies Co., Inc.
- -------------------------------------------------------------------------------------------------------
ECM Enterprises Loan 34 4
- -------------------------------------------------------------------------------------------------------
EDM Consulting, LLC Loans 30 30
Debt Securities 1,875 431
Equity Interest -- --
- -------------------------------------------------------------------------------------------------------
El Dorado Communications, Loans 306 306
Inc.
- -------------------------------------------------------------------------------------------------------
Eparfin S.A. Loan 29 29
- -------------------------------------------------------------------------------------------------------
Esquire Communications Warrants 6 180
Ltd.(1)
- -------------------------------------------------------------------------------------------------------
Everything Yogurt Loan 42 42
- -------------------------------------------------------------------------------------------------------
Ex Terra Funding, LLC Series A Preferred Stock (500 shares) 497 497
Common Stock (2,500 shares) 3 3
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Fairchild Industrial Products Debt Securities 5,690 5,690
Company Warrants 280 3,629
- -------------------------------------------------------------------------------------------------------
FHM Distributions, Inc. Loan 200 200
- -------------------------------------------------------------------------------------------------------
Gibson Guitar Corporation Debt Securities 14,918 14,918
Warrants 525 1,000
- -------------------------------------------------------------------------------------------------------
Ginsey Industries, Inc. Loans 5,000 5,000
Convertible Debentures 500 500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Golden Eagle/Satellite Loans 1,392 1,392
Archery, LLC Convertible Debentures 2,248 2,242
- -------------------------------------------------------------------------------------------------------
Grant Broadcasting System II Warrants 139 3,600
- -------------------------------------------------------------------------------------------------------
Grant Television, Inc. Debt Securities 9,046 9,046
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Han Hie Loan 512 512
- -------------------------------------------------------------------------------------------------------
H.B.N. Communications, Inc. Loan 240 240
- -------------------------------------------------------------------------------------------------------
Hotelevision Preferred Stock (1,000,000 shares) 1,000 1,000
- -------------------------------------------------------------------------------------------------------
In the Dough, Inc. Loan 2 2
- -------------------------------------------------------------------------------------------------------
</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-6
<PAGE> 72

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
IndeNet Corporation(1) Debt Securities $ 14,872 $ 14,872
(Enterprise Software, Inc.) Common Stock (121,875 shares) 986 649
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Jeff & Chris Mufflers, Inc. Loan 102 102
- -------------------------------------------------------------------------------------------------------
JRI Industries, Inc. Debt Securities 2,361 2,361
Warrants 74 74
- -------------------------------------------------------------------------------------------------------
Julius Koch USA, Inc. Debt Securities 4,676 4,676
Warrants 324 2,100
- -------------------------------------------------------------------------------------------------------
Kirker Enterprises, Inc. Loans 3,739 3,739
Debt Securities 2,687 2,687
Warrants 348 3,500
Equity Interest 3 3
- -------------------------------------------------------------------------------------------------------
Kirkland's, Inc. Debt Securities 6,275 6,275
Warrants 96 2,850
- -------------------------------------------------------------------------------------------------------
KZSF Broadcasting, Inc. Loan 884 884
- -------------------------------------------------------------------------------------------------------
Liberty-Pittsburgh Systems, Debt Securities 3,395 3,395
Inc. Common Stock (60,000 shares) 100 100
- -------------------------------------------------------------------------------------------------------
Lingcomm, Inc. Loan 207 207
- -------------------------------------------------------------------------------------------------------
Love Funding Corporation Series D Preferred Stock (26,000 shares) 359 213
Warrants 200 --
- -------------------------------------------------------------------------------------------------------
Magic Auto Loan 3 3
- -------------------------------------------------------------------------------------------------------
May Investments Loan 47 --
- -------------------------------------------------------------------------------------------------------
Meigher Communications Loan 2,913 2,913
- -------------------------------------------------------------------------------------------------------
Mid Atlantic Telcom Plus, LLC Loan 10,342 10,342
- -------------------------------------------------------------------------------------------------------
MidSouth Data Systems, Inc. Debt Securities 7,586 7,586
Warrants 348 348
- -------------------------------------------------------------------------------------------------------
Midview Associates, L.P. Debt Securities 257 257
Options -- --
- -------------------------------------------------------------------------------------------------------
Mihadas Loan 287 287
- -------------------------------------------------------------------------------------------------------
Mill-It Striping, Inc. Common Stock (18 shares) 250 --
- -------------------------------------------------------------------------------------------------------
MLX/Morton Industrial Common Stock (5,835 shares) 241 77
Group(1)
- -------------------------------------------------------------------------------------------------------
Monitoring Solutions, Inc. Loans 33 33
Debt Securities 1,823 219
Common Stock (33,333 shares) -- --
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Nobel Education Dynamics, Debt Securities 9,402 9,402
Inc.(1) Series D Convertible Preferred Stock
(265,957 shares) 2,000 2,000
Warrants 575 575
- -------------------------------------------------------------------------------------------------------
</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-7
<PAGE> 73

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Norman's Yogurt, Inc. Loan $ 12 $ 12
- -------------------------------------------------------------------------------------------------------
Nortek Aviation Support, Inc. Debt Securities 12,500 12,500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Northeast Broadcasting Group, Debt Securities 420 420
L.P.
- -------------------------------------------------------------------------------------------------------
New York Donut Corporation Loan 73 73
- -------------------------------------------------------------------------------------------------------
Nursefinders, Inc. Debt Securities 10,829 10,829
Warrants 900 900
- -------------------------------------------------------------------------------------------------------
Old Mill Holdings, Inc. Debt Securities 589 289
Warrants 77 --
- -------------------------------------------------------------------------------------------------------
PAL Liberty, Inc. Loan 234 234
- -------------------------------------------------------------------------------------------------------
Peerless Group, Inc.(1) Common Stock (379,475 shares) 17 2,163
Warrants 4 1,031
- -------------------------------------------------------------------------------------------------------
David Peters Loan 165 55
- -------------------------------------------------------------------------------------------------------
PIATL Holdings, Inc. Loans 107 107
Preferred Stock (276 shares) 160 178
Common Stock (36 shares) -- --
- -------------------------------------------------------------------------------------------------------
Pico Products, Inc.(1) Debt Securities 4,091 4,091
Common Stock (208,000 shares) 59 69
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Precision Industrial Co. Debt Securities 9,550 9,550
(formerly Herr-Voss Common Stock (132,507 shares) 1,050 1,616
Industries, Inc.)
- -------------------------------------------------------------------------------------------------------
Progressive International Debt Securities 3,678 3,678
Corporation Preferred Stock (500 shares) 500 500
Warrants -- --
- -------------------------------------------------------------------------------------------------------
Quality Software Products Common Stock (94,479 shares) 901 653
Holdings, PLC(1)
- -------------------------------------------------------------------------------------------------------
Radio One of Atlanta, Inc. Loans 102 102
Debt Securities 11,968 11,968
Common Stock (1,430 shares) -- 2,000
- -------------------------------------------------------------------------------------------------------
Randhawa Brothers Loan 117 117
Enterprises, Inc.
- -------------------------------------------------------------------------------------------------------
R.L. Singletary Loan 101 101
- -------------------------------------------------------------------------------------------------------
Seasonal Expressions Debt Securities 540 540
Preferred Stock 993 993
Warrants -- --
- -------------------------------------------------------------------------------------------------------
SerpCo., Inc. Loan 182 182
- -------------------------------------------------------------------------------------------------------
Spa Lending Corporation Preferred Stock (28,625 shares) 399 306
Common Stock (6,208 shares) 24 --
- -------------------------------------------------------------------------------------------------------
</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-8
<PAGE> 74

<TABLE>
<CAPTION>
PORTFOLIO COMPANY SEPTEMBER 30, 1998
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES AND INVESTMENTS) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
SunStates Refrigerated Loans $ 1,557 $ 68
Services,
Inc. Debt Securities 4,263 676
- -------------------------------------------------------------------------------------------------------
Total Foam, Inc. Debt Securities 1,570 113
Common Stock (910 shares) 57 --
- -------------------------------------------------------------------------------------------------------
Unitel, Inc. Debt Securities 3,562 3,562
Warrants 360 360
- -------------------------------------------------------------------------------------------------------
Vickar Industries, Inc. Loan 6,098 6,098
- -------------------------------------------------------------------------------------------------------
Vidon, Inc. Loans 260 260
- -------------------------------------------------------------------------------------------------------
Weathertech Distributing Loans 92 92
Company, Inc.
- -------------------------------------------------------------------------------------------------------
West Virginia Radio Debt Securities 887 887
Corporation
of Clarksburg, Inc. Warrants 400 400
- -------------------------------------------------------------------------------------------------------
William R. Dye Loan 266 266
- -------------------------------------------------------------------------------------------------------
Williams Brothers Lumber Warrants 24 24
Company
- -------------------------------------------------------------------------------------------------------
Wilton Industries, Inc. Loan 12,000 12,000
- -------------------------------------------------------------------------------------------------------
WYCB Acquisition Corporation Loan 3,783 3,783
- -------------------------------------------------------------------------------------------------------
Total mezzanine loans and debt securities and equity
interests in portfolio companies (94 investments) $296,598 $301,781
- -------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
INTEREST NUMBER OF -------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- -------- --------
<S> <C> <C> <C> <C>
COMMERCIAL MORTGAGE LOANS
Up to 6.99% 7 $ 2,498 $ 2,125
7.00%- 8.99% 49 138,856 138,856
9.00%-10.99% 109 93,284 93,349
11.00%-12.99% 54 54,905 55,175
13.00%-14.99% 4 9,682 9,682
15.00% and above 2 3,586 3,586
- ------------------------------------------------------------------------------------------------
Total commercial mortgage loans 225 $302,811 $302,773
- ------------------------------------------------------------------------------------------------
SMALL BUSINESS ADMINISTRATION 7(a) LOANS
Up to 6.99% 11 $ 156 $ 153
7.00%- 8.99% 13 138 54
9.00%-10.99% 42 9,311 9,198
11.00%-12.99% 376 40,251 38,887
13.00%-14.99% 4 228 213
15.00% and above -- -- --
- ------------------------------------------------------------------------------------------------
Total Small Business Administration
7(a) loans 446 $ 50,084 $ 48,505
- ------------------------------------------------------------------------------------------------
Interest in securitization pool of
commercial mortgage loans 1 $ 85,290 $ 83,790
- ------------------------------------------------------------------------------------------------
Other portfolio assets 6 $ 3,089 $ 3,009
- ------------------------------------------------------------------------------------------------
Total portfolio 772 $737,872 $739,858
- ------------------------------------------------------------------------------------------------
</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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INVESTMENTS

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
MEZZANINE LOANS AND DEBT SECURITIES AND EQUITY INTERESTS IN PORTFOLIO COMPANIES
<S> <C> <C> <C>
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
- -------------------------------------------------------------------------------------------------------
</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-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 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) 500 982
- -------------------------------------------------------------------------------------------------------
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
- -------------------------------------------------------------------------------------------------------
</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-11
<PAGE> 77

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
Kirker Enterprises, Inc. Loans $ 800 $ 800
Debt Securities 2,784 2,784
Warrants 348 2,350
Equity Interest 40 40
- -------------------------------------------------------------------------------------------------------
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 (265,957
Inc.(1) shares) 2,000 2,000
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
- -------------------------------------------------------------------------------------------------------
</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-12
<PAGE> 78

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
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) 71 336
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
- -------------------------------------------------------------------------------------------------------
</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-13
<PAGE> 79

<TABLE>
<CAPTION>
PORTFOLIO COMPANY DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT NUMBER -------------------
OF SHARES AND INVESTMENTS) INVESTMENT(2) COST VALUE
- ----------------------------- --------------------------------------------------- -------- --------
<S> <C> <C> <C>
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
- -------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1997
INTEREST NUMBER OF -------------------
RATE RANGES INVESTMENTS COST VALUE
---------------- ----------- -------- --------
<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% 8 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>

(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-14
<PAGE> 80

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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 two wholly owned subsidiaries that have
also elected to be regulated as BDCs. Allied Investment Corporation is licensed
under the Small Business Investment Act of 1958 as a Small Business Investment
Company ("SBIC"). Allied Investment Corporation is the result of the merger of
the Company's two SBIC subsidiaries in July 1998 whereby Allied Investment
Corporation merged with and into Allied Capital Financial Corporation ("Allied
Financial"). Allied Financial then changed its name to Allied Investment
Corporation ("Allied Investment"). 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. ("Allied REIT"). ACC also has 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
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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 investments during the
reporting period.

DISTRIBUTIONS TO SHAREHOLDERS

Distributions to shareholders are recorded on the record date.

F-16
<PAGE> 82
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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 may use 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 SBA Section 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 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 Septem-

F-17
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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

ber 30, 1998 and December 31, 1997, respectively, approximately 100 percent and
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 September 30, 1998 and December 31, 1997 and 1996 equaled 14.0
percent, 12.6 percent and 13.2 percent, respectively. At September 30, 1998 and
December 31, 1997 and 1996, mezzanine loans and debt securities with a cost
basis of $22,725,000, $13,661,000 and $16,648,000, respectively, were not
accruing interest.

At September 30, 1998 and December 31, 1997, approximately 35 percent and
29 percent, 26 percent and 27 percent, 24 percent and 17 percent, 7 percent and
13 percent, and 5 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, 3 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 43 percent and 43 percent, 17 percent
and 26 percent, 14 percent and 15 percent, and 21 percent and 12 percent,
respectively, or 95 percent and 96 percent of the Company's mezzanine portfolio
as of September 30, 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 September 30, 1998 and December 31, 1997, approximately 70 percent and
30 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 September 30, 1998 and December 31, 1997, approximately 34
percent and 38 percent, 18 percent and 18 percent, 25 percent and 18 percent, 17
percent and 14 percent, and 6 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 40 percent and 33 percent, 31 percent and 31 percent, 9 percent
and 14 percent, 3 percent and 3 percent, and 17 percent and 19 percent,
respectively, of the Company's commercial real estate portfolio at September 30,
1998 and December 31, 1997, respectively.

The weighted average yield (at value) on the real estate portfolio as of
September 30, 1998 and December 31, 1997 and 1996 equaled 10.1 percent, 11.4
percent and 13.4 percent, respectively. As of September 30, 1998 and December
31, 1997 and 1996, loans with a cost basis of $9,466,000, $11,987,000 and
$10,978,000, respectively, were not accruing interest.

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 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.

F-18
<PAGE> 84
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

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 September 30, 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 September 30, 1998 and December 31, 1997 and 1996, 7(a) loans with a
cost basis of $8,761,000, $4,346,000 and $3,734,000, respectively, were not
accruing interest.

At September 30, 1998 and December 31, 1997, approximately 36 percent and
36 percent, 29 percent and 29 percent, 15 percent and 18 percent, 8 percent and
10 percent, and 12 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 30
percent and 25 percent, 27 percent and 21 percent, 6 percent and 10 percent, 12
percent and 9 percent, 6 percent and 7 percent, 6 percent and 6 percent, and 3
percent and 6 percent, respectively, or 90 percent and 84 percent of the
Company's 7(a) loan portfolio as of September 30, 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 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%.

F-19
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ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4. PORTFOLIO, CONTINUED

NOTE 5. DEBT

At September 30, 1998 and December 31, 1997 and 1996, the Company had the
following available credit facilities:

<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, -----------------------------------------
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>
Debentures and notes payable:
Unsecured long-term notes
payable.................. $180,000 $180,000 $ -- $ -- $ -- $ --
Master repurchase
agreement................ 250,000 1,300 250,000 202,705 150,000 85,775
Master loan and security
agreement................ 250,000 56,000 250,000 23,116 -- --
Senior note payable........ -- -- 20,000 20,000 20,000 20,000
OPIC loan.................. 5,700 5,700 20,000 8,700 20,000 8,700
SBA debentures............. 48,650 48,650 54,300 54,300 61,300 61,300
Bonds payable.............. -- -- -- -- 54,123 54,123
-------- -------- -------- -------- -------- --------
Total debentures and
notes payable....... 734,350 291,650 594,300 308,821 305,423 229,898
-------- -------- -------- -------- -------- --------
Revolving lines of credit....... 200,000 70,000 80,000 38,842 110,000 45,099
-------- -------- -------- -------- -------- --------
Total debt............ $934,350 $361,650 $674,300 $347,663 $415,423 $274,997
======== ======== ======== ======== ======== ========
</TABLE>

UNSECURED LONG-TERM NOTES PAYABLE

In June 1998 the Company issued three classes of unsecured long-term notes
held by private institutional investors. The notes have terms of 5 or 7 years
with an aggregate principal balance of $180,000,000. The weighted average
interest rate on the notes is 7.2% and interest only is payable semi-annually
until maturity. The notes may be prepaid in whole or in part together with an
interest premium as stipulated in the note agreement.

MASTER REPURCHASE AGREEMENT

The Company and Business Mortgage Investors, Inc. ("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

F-20
<PAGE> 86
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. DEBT, CONTINUED

1.13 percent, or 6.7 percent, 6.8 percent and 6.7 percent at September 30, 1998
and December 31, 1997 and 1996, respectively. The facility requires an annual
commitment fee equal to 0.25 percent of the committed amount. The average debt
outstanding under the master repurchase agreement for the nine months ended
September 30, 1998 and the years ended December 31, 1997 and 1996 was
$22,632,000, $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 nine months ended September 30, 1998 and the years ended December 31,
1997 and 1996, respectively. The weighted average interest rate for this
facility during the nine months ended September 30, 1998 and the years ended
December 31, 1997 and 1996 was 6.8 percent, 6.6 percent and 7.3 percent,
respectively. The master repurchase agreement matures on January 31, 1999.

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 September
30, 1998 and December 31, 1997, the Company's recorded investment in these loans
pledged as collateral totaled $56,000,000 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 6.4 and 6.7 percent, at September 30, 1998 and
December 31, 1997, respectively. The average debt outstanding under this
facility for the nine months ended September 30, 1998 and the year ended
December 31, 1997 was $19,066,000 and $17,899,000, respectively. The maximum
amount borrowed under this facility was $56,000,000 during the nine months ended
September 30, 1998 and $23,116,000 for the year ended December 31, 1997. The
weighted average interest rate for this facility during the nine months ended
September 30, 1998 and the year ended December 31, 1997 was 6.6 percent and 6.7
percent, respectively. The agreement matured on October 15, 1998, and has
subsequently been renewed for an additional one year term.

SENIOR NOTE PAYABLE

At December 31, 1997 the Company had a $20,000,000 unsecured senior note
payable to an insurance company with interest at a fixed rate of 9.15 percent,
payable semi-annually.

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, or 6.6 percent at September 30, 1998. 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 September 30, 1998, the Company had debentures totaling $48,650,000
payable to the SBA at interest rates ranging from 6.9 percent to 9.6 percent,
with scheduled maturity dates as follows: 1998 -- $1,000,000; 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 6.9 percent to 9.8 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.

F-21
<PAGE> 87
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5. DEBT, CONTINUED
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 as amended and restated. The new facility bears
interest at LIBOR plus 1.25 percent, or 6.6 percent at September 30, 1998, and
requires a commitment fee equal to 0.2 percent of 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.

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
$50,311,000, $30,033,000 and $28,216,000 for the nine months ended September 30,
1998 and the years ended December 31, 1997 and 1996, respectively. The maximum
amount borrowed under these facilities was $105,000,000, $45,759,000 and
$45,099,000 during the same periods, respectively. The weighted average interest
rate for these facilities during the nine months ended September 30, 1998 and
the years ended December 31, 1997 and 1996 was 6.9 percent, 8.1 percent and 8.2
percent, respectively.

NOTE 6. INCOME TAXES

For the nine months ended September 30, 1998 and for the years ended
December 31, 1997, 1996 and 1995, the Company's effective tax rate was 2.5
percent, 2.3 percent, 3.5 percent and 2.9 percent, respectively.

For the nine months ended September 30, 1998, the Company incurred income
tax expense of $1.6 million which resulted from the built-in gains tax
associated with the $4.0 million gain from the sale of an office building
previously owned by Advisers prior to the Merger.

For the years ended December 31, 1997, 1996 and 1995, 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 additional income tax expense
is expected to be incurred in 1998.

NOTE 7. PREFERRED STOCK

At September 30, 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

F-22
<PAGE> 88
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 7. PREFERRED STOCK, CONTINUED
redemption date of June 4, 2005. Subsequent to the SBIC Merger, Allied
Investment Corporation will continue to hold the preferred stock.

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
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 nine months ended
September 30, 1998 and the years ended December 31, 1997 and 1996, the Company
issued 177,290, 550,971 and 913,206 shares, respectively, at an average price
per share of $21.51, $15.67 and $13.13 per share, respectively.

F-23
<PAGE> 89
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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 NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
Net increase in net assets resulting from operations... $61,448
Less: Preferred stock dividends........................ (165)
-------
Income available to common shareholders................ $61,283
=======
BASIC EARNINGS PER COMMON SHARE........................ 51,502 $1.19
=====
Options outstanding to officers........................ 210
------
DILUTED EARNINGS PER COMMON SHARE...................... 51,712 $1.19
====== =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED)
Net increase in net assets resulting from operations... $48,088
Less: Preferred stock dividends........................ (165)
-------
Income available to common shareholders................ $47,923
=======
BASIC EARNINGS PER COMMON SHARE........................ 48,759 $0.98
=====
Options outstanding to officers........................ 528
------
DILUTED EARNINGS PER COMMON SHARE...................... 49,287 $0.97
====== =====
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
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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 September 30, 1998, the ESOP held 282,891 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. For the nine months ended September 30,
1998, the Company's compensation committee granted a total of 3,740,446 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 have been granted at the market price on
the date of grant with an average exercise price equal to $21.05 per share. At
September 30, 1998, options for 643,000 shares were exercisable into common
stock. Options were

F-25
<PAGE> 91
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 11. STOCK OPTION PLAN, CONTINUED

exercised for 10,408 shares, and 64,708 shares were canceled during the nine
months ended September 30, 1998.

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 September 30, 1998 and
December 31, 1997, 1996 and 1995, the Company had outstanding loans to officers
of $23,900,000, $29,611,000, $15,491,000, and $7,315,000, respectively. Officers
with outstanding loans repaid principal of $5,711,000, $6,534,000, $2,199,000
and $1,038,000 for the nine months ended September 30, 1998 and the years ended
December 31, 1997, 1996 and 1995, respectively. The Company recognized interest
income from these loans of $1,234,000, $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

F-26
<PAGE> 92
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 12. CUT-OFF AWARD AND FORMULA AWARD, CONTINUED

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 will be expensed as the
Cut-off Award vests. For the nine months ended September 30, 1998, $783,000 of
the Cut-off Award vested.

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 nine month
period ended September 30, 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 has used those funds to acquire the Company's stock in
the open market. As of September 30, 1998, the Trustee had purchased 790,195
shares of the Company's stock with an aggregate cost of $19,020,000. 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 nine months ended September 30,
1998 was $4,749,000.

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 $1.05 per
common share dividend, or $54,727,000, for the nine months ended September 30,
1998.

F-27
<PAGE> 93
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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
ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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>
SEPTEMBER 30, DECEMBER 31,
------------- -------------------
1998 1997 1996
------------- -------- --------
(UNAUDITED)

(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents..................... $43,622 $76,791 $75,744
Less escrows held............................. (7,105) (6,354) (3,903)
------- ------- -------
Total......................................... $36,517 $70,437 $71,841
======= ======= =======
</TABLE>

NOTE 18. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The Company paid interest and income taxes of $12,100,000 for the nine
months ended September 30, 1998 and $26,874,000, $21,391,000 and $13,393,000
during 1997, 1996, and 1995, respectively. For the nine months ended September
30, 1998 and during 1997, 1996 and 1995, respectively, the Company's non-cash
financing activities totaled $5,362,000, $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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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

ALLIED CAPITAL CORPORATION AND SUBSIDIARIES

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

Vienna, Virginia
February 20, 1998

F-33
<PAGE> 99

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") and the accompanying prospectus supplement, if
any. 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;32
Investment Objective and Policies........................... B-2 1;11;32
Management.................................................. B-2 47
Compensation of Executive Officers and Directors....... B-2 50
Compensation of Directors.............................. B-4 50
Stock Option Awards.................................... B-4 50
Cut-Off Award and Formula Award........................ B-5 50
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 47
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 51
</TABLE>

B-1
<PAGE> 100

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 is a registered investment
adviser.

The Company was initially organized as a corporation in the District of
Columbia in 1976 and was reincorporated in the state of Maryland in 1990. 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.

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 September 30, 1998, ACC's
investment portfolio totaled $739.9 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> 101

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 of 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> 102

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> 103

(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> 104

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 November 13, 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 November 13, 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. The
address for each director and executive officer is 1919 Pennsylvania Ave, NW,
Washington,

B-6
<PAGE> 105

DC 20006. At this time the Company is unaware of any shareholder owning 5% or
more of the outstanding shares of 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........................................... 582,042(2, 3) 1.1%
Brooks H. Browne............................................ 39,934 *
John D. Firestone........................................... 17,783 *
Anthony T. Garcia........................................... 52,507 *
Lawrence I. Hebert.......................................... 16,800 *
John I. Leahy............................................... 16,318 *
Robert E. Long.............................................. 9,796 *
Warren K. Montouri.......................................... 196,182 *
Guy T. Steuart II........................................... 317,180(4) *
T. Murray Toomey, Esq....................................... 33,266(5) *
Laura W. van Roijen......................................... 28,302 *
George C. Williams, Jr...................................... 332,978 *
EXECUTIVE OFFICERS:
Philip A. McNeill........................................... 126,182(2) *
Penni F. Roll............................................... 51,821(2) *
John M. Scheurer............................................ 290,901(2) *
Joan M. Sweeney............................................. 221,660(2) *
G. Cabell Williams III...................................... 667,943(2, 3) 1.3%
All directors and executive officers as a group (17 in
number)................................................... 2,683,265(6) 5.1%
</TABLE>

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

(1) Based on a total of 52,298,351 shares of the Company's common stock issued
and outstanding on November 13, 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, 17,505, 15,528, 52,854, 53,212, and 37,234
shares which Mr. Walton, Mr. McNeill, Ms. Roll, Mr. Scheurer, Ms. Sweeney,
and Mr. Williams III, respectively, have options to purchase that are
exercisable within 60 days of November 13, 1998. Share ownership also
includes 547, 7,025, 2,510, 19,430, 7,986, and 61,636 shares, respectively,
for Mr. Walton, Mr. McNeill, Ms. Roll, Mr. Scheurer, Ms. Sweeney and Mr.
Williams III, respectively, allocated to their respective ESOP accounts
through June 30, 1998.

(3) Includes 276,868 shares held by the ESOP at November 13, 1998, 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 November 13, 1998, all shares
held in the ESOP had been allocated to participants' accounts except 15,201
shares.

(4) Includes 276,691 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 333,330 shares underlying stock options exercisable
within 60 days of November 13, 1998, which are assumed to be outstanding for
the purpose of calculating the group's percentage ownership, and 276,868
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 63
investment and other professionals, as well as 38 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

B-7
<PAGE> 106

investment committee, which is composed of senior investment professionals of
the Company. See "Management" in the Prospectus.

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> 107

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> 108

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> 109

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 20% (subject to reduction in certain
situations) while other income may be taxed at rates as high as 39.6%. 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 not
later than 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. An applicable tax treaty may reduce the rate or the scope of U.S.
taxation imposed on the income of an eligible Non-U.S. Stockholder. Non-U.S.
Stockholders may be required to provide appropriate documentation to establish
their entitlement to the benefits of such a

B-11
<PAGE> 110

treaty. Foreign investors are 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> 111

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 -- September 30, 1998 (unaudited)
and December 31, 1997 and 1996............................ F-1
Consolidated Statement of Operations -- For the Nine Months
Ended September 30, 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
Nine Months Ended September 30, 1998 and 1997 (unaudited)
and the Years Ended December 31, 1997, 1996 and 1995...... F-3
Consolidated Statement of Cash Flows -- For the Nine Months
Ended September 30, 1998 and 1997 (unaudited) and the
Years Ended December 31, 1997, 1996 and 1995.............. F-4
Consolidated Statement of Investments -- September 30, 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(10) Second Amended and Restated Credit Agreement dated as of
June 4, 1998 (the "1998 Credit Agreement") between the
Company, as borrower, 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(10) Note Agreement dated as of April 30, 1998.
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(11) Amended and Restated Master Loan & Security Agreement dated
October 7, 1998 among Allied Capital, 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.
f.7.b+ Indenture dated as of January 1, 1998, between the Allied
Capital Commercial Mortgage Trust 1998-1 and LaSalle
National Bank.
</TABLE>

C-1
<PAGE> 112

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
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
i.1(3) Employee Stock Ownership Plan, as amended on December 31,
1997.
i.1a(10) First Amendment to the Allied Capital Corporation Employee
Stock Ownership Plan dated April 30, 1998.
i.2(3) Deferred Compensation Plan, as amended January 1, 1998.
i.2a(10) First Amendment to the Allied Capital Corporation Deferred
Compensation Plan dated April 30, 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 50 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 (included in
Exhibit l).
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> 113

<TABLE>
<S> <C>
(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).
(10) Incorporated by reference to exhibit of same name filed with the Company's report on Form 10-Q for the
quarterly period ended June 30, 1998 (File No. 0-22832).
(11) Incorporated by reference to exhibit of the same name with the Company's report on Form 10-Q for the quarterly
period ended September 30, 1998 (File No. 0-22832).
</TABLE>

ITEM 25. MARKETING ARRANGEMENTS

The information contained under the heading "Plan of Distribution" on page
59 of the Prospectus is incorporated herein by reference, and any information
concerning any underwriters will be contained in the accompanying Prospectus
Supplement, if any.

ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

<TABLE>
<S> <C>
Commission registration fee*................................ $ 50,352
NASD filing fee*............................................ $ 19,761
Nasdaq National Market Additional Listing Fee*.............. $ 17,500
Accounting fees and expenses................................ $ 100,000
Legal fees and expenses..................................... $ 300,000
Printing and engraving...................................... $ 210,000
Miscellaneous fees and expenses............................. $ 2,387
----------
Total.................................................. $ 700,000
==========
</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 SBLC Corporation (Maryland).................. 100%
Allied Capital REIT, Inc. ("Allied REIT") (Maryland)........ 100%
Allied Capital Beteiligungsberatung GmbH (Germany).......... 100%
Allied Capital Germany Fund LLC (Delaware).................. 100%
Allied Capital Holdings LLC (Delaware)...................... 100%
</TABLE>

C-3
<PAGE> 114

Each of the Company's subsidiaries are consolidated with the Company for
financial reporting purposes, except that Allied Capital Germany Fund LLC is
unconsolidated with the Company for financial reporting purposes.

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 Allied REIT in such subsidiary:

<TABLE>
<S> <C>
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
1998-1, a Delaware business trust 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 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 November 13, 1998.

<TABLE>
<CAPTION>
NUMBER OF
TITLE OF CLASS RECORD HOLDERS
-------------- --------------
<S> <C>
Common Stock, $0.0001 par value............................. 4,886
</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
C-4
<PAGE> 115

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.
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 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> 116

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:

(1) 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;

(2) to file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:

(i) to include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;

(ii) to reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or
the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high
end of the estimated maximum offering range may be reflected
in the form of prospectus filed with the Commission pursuant
to Rule 424(b) under the Securities Act of 1933 if, in the
aggregate, the changes in volume and price represent no more
than a 20% change in the maximum aggregate offering price
set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and

(iii) to include any material information with respect to the plan
of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement.

(3) 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;

(4) to remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering;

(5) 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.

(6) 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.

C-6
<PAGE> 117

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-7
<PAGE> 118

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 17th day of November, 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 November 17, 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> 119

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
* Director
- ---------------------------------------------
George C. Williams

/s/ Penni F. Roll Principal and Chief Financial Officer (Principal
- --------------------------------------------- Financial and Accounting Officer)
Penni F. Roll
</TABLE>

* Signed by William L. Walton pursuant to a power-of-attorney signed by the
individual on September 30, 1998 and filed with Pre-Effective Amendment No. 2
to this registration statement on September 30, 1998.

<PAGE> 120

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- -----------
<S> <C>
99.2h.1 Form of Underwriting Agreement
99.2l. Opinion of counsel and consent to its use
99.2n.1 Consent of Arthur Andersen LLP, independent public
accountants.
27 Financial Data Schedule
</TABLE>

<PAGE> 1
EXHIBIT 2h.1

FORM OF UNDERWRITING AGREEMENT

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

______________ SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK, $0.0001 PAR VALUE PER SHARE

UNDERWRITING AGREEMENT

dated ________, 1998

-------------------------------------
<PAGE> 2

___________ SHARES

ALLIED CAPITAL CORPORATION

COMMON STOCK, $0.0001 PAR VALUE PER SHARE

UNDERWRITING AGREEMENT

_______, 1998

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

Ladies and Gentlemen:

Allied Capital Corporation, a Maryland corporation (the
"COMPANY"), proposes to issue and sell to __________________________ (the
"UNDERWRITER") an aggregate of _____________ shares of its common stock,
$0.0001 par value per share (the "FIRM SHARES").

The Company also proposes to issue and sell to the Underwriter
not more than an additional _____________ shares of its common stock, $0.0001
par value per share (the "ADDITIONAL SHARES"), if and to the extent that the
Underwriter shall have determined to exercise the right to purchase such shares
of common stock granted 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 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 497 under the
Securities Act of 1933, as amended (the "SECURITIES ACT"), is hereinafter
referred to as the "REGISTRATION STATEMENT"; the prospectus (as described in
Rule 497 under the Securities Act) in the form first used to confirm sales of
Shares is hereinafter referred to as the "DISTRIBUTED PROSPECTUS"; the
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 497 under
the Securities Act) is hereinafter 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."

1. REPRESENTATIONS AND WARRANTIES. The Company represents
and warrants to and agrees with the Underwriter 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.

<PAGE> 3

(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 the
Underwriter furnished to the Company in writing by the
Underwriter 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, 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 Investment 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.

<PAGE> 4
(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 Common Stock is registered pursuant to
Section 12(g) of the Securities Exchange Act of 1934, as
amended (the "EXCHANGE ACT"), and is listed on the Nasdaq
National Market, and the Company has taken no action designed
to, or likely to have the effect of, terminating the
registration of the Common Stock under the Exchange Act or
delisting the Common Stock from the Nasdaq National Market,
nor has the Company received any notification that the
Commission or the National Association of Securities Dealers,
Inc. is contemplating terminating such registration or
listing.

(j) 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.

(k) 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).

(l) 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.

(m) 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.

(n) 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.

(o) 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

<PAGE> 5
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.

(p) There are no contracts, agreements or
understandings between the Company and any person granting
such person the right to require the Company to file a
registration statement under the Securities Act with respect
to any securities of the Company (except for sales of Common
Stock aggregating less than 100,000 shares) or to require the
Company to include such securities with the Shares registered
pursuant to the Registration Statement.

(q) 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.

(r) 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.

(s) 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.

(t) The Company is organized and operated in
conformance with the requirements of the Investment Company
Act and the requirements to be taxed as a Regulated Investment
Company (Sections 851 et seq. of the Internal Revenue Code of
1986, as amended (the "CODE")). The Company's method of
operation will permit it to continue to meet the requirements
for qualification as a business development company under the
Investment Company Act and taxation as a Regulated Investment
Company under the Code.

(u) The only significant subsidiaries for purposes of
Rule 405 under the Securities Act are Allied Investment
Corporation and Allied Capital REIT, Inc.

2. AGREEMENTS TO SELL AND PURCHASE. The Company hereby agrees to sell
to the Underwriter, and the Underwriter, upon the basis of the representations
and warranties herein contained, but subject to the conditions hereinafter
stated, agrees to purchase from the Company the number of Firm Shares set forth
in Schedules I hereto opposite its name at $_____ 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 Underwriter the Additional Shares, and the Underwriter shall have a
one-time right to purchase up to __________ Additional Shares at the Purchase

<PAGE> 6

Price. If the Underwriter elects to exercise such option, the Underwriter
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 Underwriter 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 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.

The Company hereby agrees that, without the prior written
consent of the Underwriter, 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 sale by the
Underwriter of any share of Common Stock pursuant to the Underwriting
Agreement, (B) any issuance of shares of Common Stock, options, or other
securities or rights pursuant to any employee or director compensation, option,
savings, benefit or other plan of the Company existing as of the date of the
Underwriting Agreement, (C) any issuances upon exercise, conversion or exchange
of any securities or obligations outstanding on the date of the Underwriting
Agreement, and (D) an additional issuance of equity securities aggregating not
more than $__________.

3. TERMS OF PUBLIC OFFERING. The Company is advised by you
that the Underwriter proposes to make a public offering of 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 $_____ a share (the "PUBLIC
OFFERING PRICE") and to certain dealers selected by you at a price that
represents a concession not in excess of $____ a share under the Public
Offering Price, and that any Underwriter may allow, and such dealers may
reallow, a concession, not in excess of $____ a share, to certain brokers and
dealers.

4. PAYMENT AND DELIVERY. Payment for the Firm Shares shall
be made to the Company by the wire transfer of immediately available funds to
the order of the Company against delivery of such Firm Shares for the account
of the Underwriter at ____ a.m., _________ time, on ____________, 1998, or at
such other time on the same or such other date, not later than 10:30 a.m.,
____________ time, on _________, 1998, as 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 by the wire transfer of immediately available funds to the order of
the Company against delivery of such Additional Shares for the account of the
Underwriter at _____ a.m., __________ 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 10:30 a.m., ___________ time, on _______, 1998, as
shall be designated in writing by the Underwriter. 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

<PAGE> 7

Option Closing Date, as the case may be, for the account of the Underwriter,
with any transfer taxes payable in connection with the transfer of the Shares
to the Underwriter duly paid, against payment of the Purchase Price therefor.

5. CONDITIONS TO THE UNDERWRITER'S OBLIGATIONS. The
obligations of the Company to sell the Shares to the Underwriter and the
obligation of the Underwriter 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 obligations of the Underwriter 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 Underwriter shall have received on the
Closing Date a certificate, dated the Closing Date and signed
by an executive officer of the 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 Underwriter 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, Michigan and California;

(ii) each of Allied Investment
Corporation and Allied Capital REIT, Inc. (collectively, the
"SUBSIDIARIES") 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 the
District of Columbia and the State of California, as
applicable;

(iii) the authorized capital stock of the
Company conforms as to legal matters to the description
thereof contained in the Prospectus;

<PAGE> 8

(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;

(v) all of the issued shares of capital
stock of each Subsidiary are owned directly by the Company,
and to such counsel's knowledge, are 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 Investment
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 Underwriter;

(ix) the statements (A) in the Prospectus
under the captions "Certain Government Regulations,"
"Description of Capital Stock," "Taxation" and "Underwriting,"
(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 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) to such counsel's knowledge, 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;

(xi) the Company has elected to be
regulated as a business development company under the
provisions of the Investment Company Act applicable to
business

<PAGE> 9
development companies and the Commission has not ordered that
such election be withdrawn, and all action under the
Securities 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 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 Underwriter shall have received on the
Closing Date an opinion of O'Melveny & Myers LLP, counsel for
the Underwriter, 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 O'Melveny & Myers LLP 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 Underwriter at the
request of the Company and shall so state therein.

(e) The Underwriter shall have received, on each of
the date hereof and the Closing Date, a letter dated he date
hereof or the Closing Date, as the case may be, in form and
substance satisfactory to the Underwriter, 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
certain of its executive officers 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 obligation of the Underwriter to purchase
Additional Shares hereunder is

<PAGE> 10
subject to the delivery to the Underwriter on the Option
Closing Date of such documents as it 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.

6. COVENANTS OF THE COMPANY. In further consideration of the
agreements of the Underwriter herein contained, the Company covenants with the
Underwriter as follows:

(a) To furnish to you, without charge, three signed
copies of the Registration Statement (including exhibits
thereto) and to furnish to you in __________, without charge,
prior to 11:00 a.m. _____________ time on the business day
next succeeding the date of this Agreement, or as soon as
practicable, 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 Underwriter 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
Underwriter, 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 Underwriter 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 Underwriter 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.

(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 September
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

<PAGE> 11
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 Underwriter and dealers,
in the quantities hereinabove specified, (ii) all costs and
expenses related to the transfer and delivery of the Shares to
the Underwriter, 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 Underwriter 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 Underwriter 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
depository, (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 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 Underwriter 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. INDEMNIFICATION.

(a) Indemnification of the Underwriter. The Company
agrees to indemnify and hold harmless the Underwriter, its
officers and employees, and each person, if any, who controls
the Underwriter within the meaning of the Securities Act and
the Exchange Act against any loss, claim, damage, liability or
expense, as incurred, to which the Underwriter or such
controlling person may become subject, under the Securities
Act, the Exchange Act or other federal or state statutory law
or regulation, or at common law or otherwise (including in
settlement of any litigation, if such settlement is effected
with the written consent of the Company), insofar as such
loss, claim, damage, liability or expense (or actions in
respect thereof as contemplated below) arises out of or is
based (i) upon any untrue statement or alleged untrue
statement of a material fact contained in the Registration
Statement, or any amendment thereto, including any information
deemed to be a part thereof pursuant to Rule 430A or Rule 434
under the Securities Act, or the omission or alleged omission
therefrom

<PAGE> 12
of a material fact required to be stated therein or necessary
to make the statements therein not misleading; or (ii) upon
any untrue statement or alleged untrue statement of a material
fact contained in any preliminary prospectus or the Prospectus
(or any amendment or supplement thereto), or the omission or
alleged omission therefrom of a material fact necessary in
order to make the statements therein, in the light of the
circumstances under which they were made, not misleading; or
(iii) in whole or in part upon any inaccuracy in the
representations and warranties of the Company contained
herein; or (iv) in whole or in part upon any failure of the
Company to perform its obligations hereunder or under law; or
(v) any act or failure to act or any alleged act or failure to
act by the Underwriter in connection with, or relating in any
manner to, the Common Stock or the offering contemplated
hereby, and which is included as part of or referred to in any
loss, claim, damage, liability or action arising out of or
based upon any matter covered by clause (i) or (ii) above,
provided that the Company shall not be liable under this
clause (v) to the extent that a court of competent
jurisdiction shall have determined by a final judgment that
such loss, claim, damage, liability or action resulted
directly from any such acts or failures to act undertaken or
omitted to be taken by the Underwriter through its gross
negligence or willful misconduct; and to reimburse the
Underwriter and each such controlling person for any and all
expenses (including the fees and disbursements of counsel
chosen by the Underwriter) as such expenses are reasonably
incurred by the Underwriter or such controlling person in
connection with investigating, defending, settling,
compromising or paying any such loss, claim, damage,
liability, expense or action; provided, however, that the
foregoing indemnity agreement shall not apply to any loss,
claim, damage, liability or expense to the extent, but only to
the extent, arising out of or based upon any untrue statement
or alleged untrue statement or omission or alleged omission
made in reliance upon and in conformity with written
information furnished to the Company by the Underwriter
expressly for use in the Registration Statement, any
preliminary prospectus or the Prospectus (or any amendment or
supplement thereto); and provided, further, that with respect
to any preliminary prospectus, the foregoing indemnity
agreement shall not inure to the benefit of the Underwriter
from whom the person asserting any loss, claim, damage,
liability or expense purchased Common Shares, or any person
controlling the Underwriter, if copies of the Prospectus were
timely delivered to the Underwriter pursuant to Section 2 and
a copy of the Prospectus (as then amended or supplemented if
the Company shall have furnished any amendments or supplements
thereto) was not sent or given by or on behalf of the
Underwriter to such person, if required by law so to have been
delivered, at or prior to the written confirmation of the sale
of the Common Shares to such person, and if the Prospectus (as
so amended or supplemented) would have cured the defect giving
rise to such loss, claim, damage, liability or expense. The
indemnity agreement set forth in this Section 7(a) shall be in
addition to any liabilities that the Company may otherwise
have.

(b) Indemnification of the Company, its Directors and
Officers. The Underwriter agrees to indemnify and hold
harmless the Company, each of its directors, each of its
officers who signed the Registration Statement and each
person, if any, who controls the Company within the meaning of
the Securities Act or the Exchange Act, against any loss,
claim, damage, liability or expense, as incurred, to which the
Company, or any such director, officer or controlling person
may become subject, under the Securities Act, the Exchange
Act, or other federal or state statutory law or regulation, or
at common law or otherwise (including in settlement of any
litigation, if such settlement is effected with the written
consent of the Underwriter), insofar as such loss, claim,
damage, liability or expense (or actions in respect thereof as
contemplated below) arises out of or is based upon

<PAGE> 13
any untrue or alleged untrue statement of a material fact
contained in the Registration Statement, any preliminary
prospectus or the Prospectus (or any amendment or supplement
thereto), or arises out of or is based upon the omission or
alleged omission to state therein a material fact required to
be stated therein or necessary to make the statements therein
not misleading, in each case to the extent, but only to the
extent, that such untrue statement or alleged untrue statement
or omission or alleged omission was made in the Registration
Statement, any preliminary prospectus, the Prospectus (or any
amendment or supplement thereto), in reliance upon and in
conformity with written information furnished to the Company
by the Underwriter expressly for use therein; and to reimburse
the Company, or any such director, officer or controlling
person for any legal and other expense reasonably incurred by
the Company, or any such director, officer or controlling
person in connection with investigating, defending, settling,
compromising or paying any such loss, claim, damage,
liability, expense or action. The Company hereby acknowledges
that the only information that the Underwriter has furnished
to the Company expressly for use in the Registration
Statement, any preliminary prospectus or the Prospectus (or
any amendment or supplement thereto) are the statements set
forth (A) as the last [two] paragraphs on the inside front
cover page of the Prospectus concerning stabilization [and
passive market making] by the Underwriter and (B) in the table
in the first paragraph and as the second paragraph [second and
[___] paragraphs] under the caption "Underwriting" in the
Prospectus; and the Underwriter confirms that such statements
are correct. The indemnity agreement set forth in this
Section 7(b) shall be in addition to any liabilities that the
Underwriter may otherwise have.

(c) Notifications and Other Indemnification
Procedures. Promptly after receipt by an indemnified party
under this Section 7 of notice of the commencement of any
action, such indemnified party will, if a claim in respect
thereof is to be made against an indemnifying party under this
Section 7, notify the indemnifying party in writing of the
commencement thereof, but the omission so to notify the
indemnifying party will not relieve it from any liability
which it may have to any indemnified party for contribution or
otherwise than under the indemnity agreement contained in this
Section 7 or to the extent it is not prejudiced as a proximate
result of such failure. In case any such action is brought
against any indemnified party and such indemnified party seeks
or intends to seek indemnity from an indemnifying party, the
indemnifying party will be entitled to participate in, and, to
the extent that it shall elect, jointly with all other
indemnifying parties similarly notified, by written notice
delivered to the indemnified party promptly after receiving
the aforesaid notice from such indemnified party, to assume
the defense thereof with counsel reasonably satisfactory to
such indemnified party; provided, however, if the defendants
in any such action include both the indemnified party and the
indemnifying party and the indemnified party shall have
reasonably concluded that a conflict may arise between the
positions of the indemnifying party and the indemnified party
in conducting the defense of any such action or that there may
be legal defenses available to it and/or other indemnified
parties which are different from or additional to those
available to the indemnifying party, the indemnified party or
parties shall have the right to select separate counsel to
assume such legal defenses and to otherwise participate in the
defense of such action on behalf of such indemnified party or
parties. Upon receipt of notice from the indemnifying party
to such indemnified party of such indemnifying party's
election so to assume the defense of such action and approval
by the indemnified party of counsel, the indemnifying party
will not be liable to such indemnified party under this
Section 7 for any legal or other expenses subsequently
incurred by such indemnified party in connection with the
defense thereof unless (i) the

<PAGE> 14
indemnified party shall have employed separate counsel in
accordance with the proviso to the next preceding sentence (it
being understood, however, that the indemnifying party shall
not be liable for the expenses of more than one separate
counsel (together with local counsel), approved by the
indemnifying party (the Underwriter in the case of Section
7(b) and Section 8), representing the indemnified parties who
are parties to such action) or (ii) the indemnifying party
shall not have employed counsel satisfactory to the
indemnified party to represent the indemnified party within a
reasonable time after notice of commencement of the action, in
each of which cases the fees and expenses of counsel shall be
at the expense of the indemnifying party.

(d) Settlements. The indemnifying party under this
Section 7 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 against any loss, claim, damage, liability
or expense 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 Section 7(c) hereof, 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, compromise or
consent to the entry of judgment in any pending or threatened
action, suit or proceeding in respect of which any indemnified
party is or could have been a party and indemnity was or could
have been sought hereunder by such indemnified party, unless
such settlement, compromise or consent includes an
unconditional release of such indemnified party from all
liability on claims that are the subject matter of such
action, suit or proceeding.

8. CONTRIBUTION.

If the indemnification provided for in Section 7 is for any
reason held to be unavailable to or otherwise insufficient to hold harmless an
indemnified party in respect of any losses, claims, damages, liabilities or
expenses referred to therein, then each indemnifying party shall contribute to
the aggregate amount paid or payable by such indemnified party, as incurred, as
a result of any losses, claims, damages, liabilities or expenses referred to
therein (i) in such proportion as is appropriate to reflect the relative
benefits received by the Company, on the one hand, and the Underwriter, on the
other hand, from the offering of the Common Shares pursuant to this Agreement
or (ii) if the allocation provided by clause (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 (i) above but also the relative fault
of the Company, on the one hand, and the Underwriter, on the other hand, in
connection with the statements or omissions or inaccuracies in the
representations and warranties herein which resulted in such losses, claims,
damages, liabilities or expenses, as well as any other relevant equitable
considerations. The relative benefits received by the Company, on the one
hand, and the Underwriter, on the other hand, in connection with the offering
of the Common Shares pursuant to this Agreement shall be deemed to be in the
same respective proportions as the total net proceeds from the offering of the
Common Shares pursuant to this Agreement (before deducting expenses) received
by the Company, and the total underwriting discount received by the
Underwriter, in each case as set forth on the front cover page of the
Prospectus (or, if Rule 434 under the Securities Act is used, the corresponding
location on the Term Sheet) bear to the aggregate initial public offering price
of the Common Shares as set

<PAGE> 15
forth on such cover. The relative fault of the Company, on the one hand, and
the Underwriter, on the other hand, shall be determined by reference to, among
other things, whether any such untrue or alleged untrue statement of a material
fact or omission or alleged omission to state a material fact or any such
inaccurate or alleged inaccurate representation or warranty relates to
information supplied by the Company, on the one hand, or the Underwriter, on
the other hand, and the parties' relative intent, knowledge, access to
information and opportunity to correct or prevent such statement or omission.

The amount paid or payable by a party as a result of the
losses, claims, damages, liabilities and expenses referred to above shall be
deemed to include, subject to the limitations set forth in Section 7(c), any
legal or other fees or expenses reasonably incurred by such party in connection
with investigating or defending any action or claim. The provisions set forth
in Section 7(c) with respect to notice of commencement of any action shall
apply if a claim for contribution is to be made under this Section 8; provided,
however, that no additional notice shall be required with respect to any action
for which notice has been given under Section 7(c) for purposes of
indemnification.

The Company and the Underwriter agree that it would not be
just and equitable if contribution pursuant to this Section 8 were determined
by pro rata allocation or by any other method of allocation which does not take
account of the equitable considerations referred to in this Section 8.

Notwithstanding the provisions of this Section 8, the
Underwriter shall not be required to contribute any amount in excess of the
underwriting commissions received by the Underwriter in connection with the
Common Shares underwritten by it and distributed to the public. 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 misrepresentation. For purposes of this Section
8, each officer and employee of the Underwriter and each person, if any, who
controls the Underwriter within the meaning of the Securities Act and the
Exchange Act shall have the same rights to contribution as the Underwriter, and
each director of the Company, each officer of the Company who signed the
Registration Statement, and each person, if any, who controls the Company with
the meaning of the Securities Act and the Exchange Act shall have the same
rights to contribution as the Company.

9. 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.

10. EFFECTIVENESS. This Agreement shall become effective upon
the execution and delivery hereof by the parties hereto.

11. 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.

<PAGE> 16
12. APPLICABLE LAW. This Agreement shall be governed by and
construed in accordance with the internal laws of the State of New York.

13. 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

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

By:
-------------------------------------
Name:
-----------------------------------
Title:
----------------------------------

<PAGE> 17

SCHEDULE I

UNDERWRITER

Aggregate Principal
Underwriter Amount of Securities to be
Purchased
- -------------------------------------------------- ---------------------------

- ----------------------------......................
Total Firm Shares........................
===========================

<PAGE> 18

EXHIBIT A

_____________, 1998

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

Ladies and Gentlemen:

The undersigned understands that______________________________
(the "UNDERWRITER") proposes 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 Underwriter of _____________ shares (the "SHARES") of the
common stock, $0.0001 par value per share, of the Company (the "COMMON STOCK").

To induce the Underwriter to continue its efforts in
connection with the Public Offering, the undersigned hereby agrees that,
without the prior written consent of the Underwriter, it will not, during the
period commencing on the date hereof 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 Underwriter 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 Underwriter.

Very truly yours,

----------------------------------------
Name

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

<PAGE> 1
EXHIBIT 99.2L

Sutherland, Asbill & Brennan LLP
1275 Pennsylvania Avenue, N.W.
Washington, D.C. 20004

November 18, 1998

STEVEN B. BOEHM

DIRECT LINE: (202) 383-0176

Internet: [email protected]

Allied Capital Corporation
1919 Pennsylvania Avenue, N.W.
3rd Floor
Washington, D.C. 20006

Ladies and Gentlemen:

We have acted as counsel to Allied Capital Corporation, a Maryland
corporation (the "Company") in connection with the offering from time to time by
the Company of up to 6,612,500 shares of the Company's common stock, par value
$0.0001 per share (the "Shares"), which offering is the subject of a
registration statement on Form N-2, as amended (the "Registration Statement"),
under the Securities Act of 1933, as amended (the "Act") being filed by the
Company. The Registration Statement provides that the shares may be offered in
amounts, at prices, and on terms to be set forth in one or more supplements
(each a "Prospectus Supplement") to the final prospectus (the "Prospectus").

We have participated in the preparation of the Registration Statement
and have examined originals or copies, certified or otherwise identified to our
satisfaction by public officials or officers of the Company as authentic copies
of originals, of (i) the Company's charter (the "Charter") and its bylaws, (ii)
resolutions of the board of directors of the Company relating to the
authorization of the preparation and filing of the Registration Statement and
approving the offer and the issuance of the Shares, and (iii) such other
documents as in our judgment were necessary to enable us to render the opinions
expressed below. In our review and examination of all such documents, we have
assumed the legal capacity of all natural persons, the genuineness of all
signatures, the authenticity of all documents and records submitted to us as
originals, and the conformity with authentic originals of all documents and
records submitted to us as copies. To the extent we have deemed appropriate,
we have relied upon certificates of public officials and certificates and
statements of corporate officers of the Company as to certain factual matters.

We assume that prior to the issuance of any Shares there will exist,
under the Charter of the Company, the requisite number of authorized but
unissued shares of common stock of the Company. In addition, we assume that
underwriting agreements for the offerings of the Shares (an "Underwriting
Agreement") will be valid and legally binding agreements that conform to the
description thereof set forth in the applicable Prospectus Supplement.
<PAGE> 2
Allied Capital Corporation
November 18, 1998
Page 2

We assume that the issuance, sale and amount of the Shares to be
offered from time to time will be authorized and determined by proper action of
the Board of Directors of the Company in accordance with the parameters
described in the Registration Statement (each, a "Board Action") and in
accordance with the Company's Charter and Bylaws and with applicable Maryland
law.

This opinion is limited to the laws of the State of Maryland, and we
express no opinion with respect to the laws of any other jurisdiction. The
opinions expressed in this letter are based on our review of the General
Corporate Law of Maryland.

Based upon and subject to the foregoing and our investigation of such
matters of law as we have considered advisable, we are of the opinion that:

1. The Company is a corporation duly incorporated and existing under
the laws of the State of Maryland.

2. Upon due authorization by Board Action of the issuance of the
Shares, and upon the consummation of sale of Shares and the
payment of the consideration therefor in accordance with the
terms and provisions of such Board Action, the Registration
Statement (as declared effective under the Act), the Prospectus or
the applicable Prospectus Supplement and, if applicable, an
Underwriting Agreement, the Shares will be duly authorized,
validly issued, fully paid and nonassessable.

We hereby consent to the filing of this opinion 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

SSB/gth

<PAGE> 1
EXHIBIT 2n.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

Vienna, VA
November 17, 1998

<ARTICLE> 6
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ALLIED
CAPITAL CORPORATION AND SUBSIDIARIES' CONSOLIDATED BALANCE SHEET AND
CONSOLIDATED STATEMENTS OF OPERATIONS, CHANGES IN NET ASSETS AND CASH FLOWS AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
INCORPORATED BY REFERENCE IN FORM N-2.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<INVESTMENTS-AT-COST> 739,858
<INVESTMENTS-AT-VALUE> 737,872
<RECEIVABLES> 0
<ASSETS-OTHER> 31,997
<OTHER-ITEMS-ASSETS> 43,622
<TOTAL-ASSETS> 815,477
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 291,650
<OTHER-ITEMS-LIABILITIES> 70,000
<TOTAL-LIABILITIES> 389,762
<SENIOR-EQUITY> 5
<PAID-IN-CAPITAL-COMMON> 456,332
<SHARES-COMMON-STOCK> 51,490
<SHARES-COMMON-PRIOR> 52,047
<ACCUMULATED-NII-CURRENT> 4,845
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 864
<NET-ASSETS> 418,715
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 58,428
<OTHER-INCOME> 22,336
<EXPENSES-NET> 37,295
<NET-INVESTMENT-INCOME> 43,469
<REALIZED-GAINS-CURRENT> 20,001
<APPREC-INCREASE-CURRENT> (437)
<NET-CHANGE-FROM-OPS> 61,448
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 54,892
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 10
<NUMBER-OF-SHARES-REDEEMED> 808
<SHARES-REINVESTED> 177
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<PER-SHARE-NAV-BEGIN> 8.07
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<PER-SHARE-DIVIDEND> 1.06
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<AVG-DEBT-PER-SHARE> 6.89

</TABLE>