AMERICAN CAPITAL STRATEGIES LTD, 10-Q, 1998-11-16

AMERICAN CAPITAL STRATEGIES LTD
10-Q, 1998-11-16

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------
FORM 10-Q

/x/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

FOR THE QUARTER ENDED SEPTEMBER 30, 1998.

/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

COMMISSION FILE NUMBER:______

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AMERICAN CAPITAL STRATEGIES, LTD.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

DELAWARE 52-145-1377
- ---------------------------------- ------------------------------------
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)

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3 BETHESDA METRO CENTER, SUITE 860
BETHESDA, MARYLAND 20814
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)

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(301) 951-6122
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes /x/ No / /

Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. The number of shares of the
issuer's Common Stock, $.01 par value, outstanding as of November 9, 1998 was
11,054,774.

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<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

TABLE OF CONTENTS

<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of September 30, 1998 (Unaudited) and December 31, 1997....................... 1
Schedules of Investments as of September 30, 1998 (Unaudited) and December 31, 1997............. 2
Statements of Operations (Unaudited) for the three and nine months ended September 30, 1998 and
1997.......................................................................................... 4
Statement of Shareholders' Equity (Unaudited) for the nine months ended September 30, 1998...... 5
Statements of Cash Flows (Unaudited) for the nine months ended September 30, 1998 and 1997...... 6
Notes to Unaudited Financial Statements......................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation
Introduction.................................................................................... 10
Results of Operations........................................................................... 10
Financial Condition, Liquidity and Capital Resources............................................ 12
Impact of the Year 2000......................................................................... 12

PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 13
Item 2. Changes in Securities........................................................................... 13
Item 3. Defaults upon Senior Securities................................................................. 13
Item 4. Submission of Matters to a Vote of Security Holders............................................. 13
Item 5. Other Information............................................................................... 13
Item 6. Exhibits and Reports on Form 8-K................................................................ 13
Signature................................................................................................... 14
</TABLE>

i
<PAGE>
PART I.

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AMERICAN CAPITAL STRATEGIES, LTD.

BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)

SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Investments at fair value (cost or initial value of $181,247 and $133,274,
respectively).................................................................... $ 182,331 $133,415
Cash and cash equivalents.......................................................... 6,897 8,862
Investment in unconsolidated operating subsidiary.................................. 6,715 6,869
Due from unconsolidated operating subsidiary....................................... 28 861
Interest receivable................................................................ 1,580 644
Other.............................................................................. 28 54
------------- ------------
Total assets....................................................................... $ 197,579 $150,705
------------- ------------
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued liabilities........................................... $ 144 $ 53
Short-term note payable............................................................ 44,993 --
------------- ------------
Total liabilities.................................................................. 45,137 53
Shareholders' equity:
Undesignated preferred stock, $0.01 par value, 5,000 shares authorized, 0
issued and outstanding....................................................... -- --
Common stock, $.01 par value, 20,000 shares authorized, and 11,077 and 11,069
respectively issued and outstanding.......................................... 111 111
Capital in excess of par value................................................ 145,036 144,940
Undistributed net realized earnings (deficit)................................. 696 (55)
Unrealized appreciation of investments........................................ 6,599 5,656
------------- ------------
Total shareholders' equity......................................................... 152,442 150,652
------------- ------------
Total liabilities and shareholders' equity......................................... $ 197,579 $150,705
------------- ------------
------------- ------------
</TABLE>

See accompanying notes.

1
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

SCHEDULE OF INVESTMENTS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)

SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
INDUSTRY COST FAIR VALUE
------------------------ -------- ----------
<S> <C> <C> <C>
SENIOR DEBT--8.0%
- -----------------
Four-S Baking Company............................................... Baking $ 1,406 $ 1,406
BIW Connector Systems, LLC.......................................... Manufacturing 3,404 3,404
Chance Coach, Inc. ................................................. Bus Manufacturer 1,339 1,339
JAG Industries, Inc. ............................................... Manufacturing 1,200 1,200
Cycle Gear, Inc. ................................................... Motor Cycle Accessories 500 500
Wilderness Systems, Inc. ........................................... Canoes & Kayaks 7,277 7,277
-------- ----------
Subtotal............................................................ 15,126 15,126

SUBORDINATED DEBT--38.3%
- ------------------------
Four-S Baking Company............................................... Baking 1,543 1,543
BIW Connector Systems, LLC.......................................... Manufacturing 6,678 6,678
Westwind Group Holdings, Inc. ...................................... Restaurant 2,946 2,946
JAG Industries, Inc. ............................................... Manufacturing 2,337 2,337
Specialty Transportation Services, Inc. ............................ Waste Hauler 7,350 7,350
Chance Coach, Inc. ................................................. Bus Manufacturer 8,127 8,127
The L.A. Studios, Inc. ............................................. Audio Post-Production 2,378 2,378
Decorative Surfaces International, Inc. ............................ Decorative Paper & Vinyl 10,466 10,466
Mfg.
New Piper Aircraft, Inc. ........................................... Aircraft Manufacturing 17,818 17,818
Electolux, LLC...................................................... Vacuum Cleaner 7,255 7,255
Cycle Gear, Inc. ................................................... Motor Cycle Accessories 876 876
Wilderness Systems, Inc. ........................................... Canoes & Kayaks 4,681 4,681
-------- ----------
Subtotal............................................................ 72,455 72,455

CONVERTIBLE PREFERRED STOCK--2.8%
- ---------------------------------
Four-S Baking Company 15% dividend convertible into 51 shares of
common stock or 10.89% of Co. ..................................... Baking 2,635 2,635
Chance Coach, Inc 12% dividend convertible into 20% of Co. ......... Bus Manufacturer 2,000 2,000
Decorative Surfaces International, Inc. 14.5% dividend convertible Decorative Paper & Vinyl
into 2.9% of Co. .................................................. Mfg. 617 617
-------- ----------
Subtotal............................................................ 5,252 5,252

COMMON STOCK WARRANTS(1)--8.8%
- ------------------------------
Four-S Baking Company 15 shares 3.26% of Co. ....................... Baking 462 694
BIW Connector Systems, LLC 8% of LLC................................ Manufacturing 652 652
Westwind Group Holdings, Inc. 5% of Co. ............................ Restaurant 350 470
JAG Industries, Inc. 75% of Co. .................................... Manufacturing 505 505
Specialty Transportation Services, Inc. 9.1% of Co. ................ Waste Hauler 694 694
Chance Coach, Inc 43.7% of Co. ..................................... Bus Manufacturer 4,041 4,041
The L.A. Studios, Inc. 17% of Co. .................................. Audio Post-Production 902 902
Decorative Surfaces International, Inc. 42.3% of Co. ............... Decorative Paper & Vinyl 4,571 4,571
Mfg.
New Piper Aircraft, Inc. 4% of Co. ................................. Aircraft Manufacturing 2,231 2,231
Electrolux LLC 2.5% of Co. ......................................... Vacuum Cleaner 246 246
Cycle Gear, Inc. 16.5% of Co. ...................................... Motor Cycle Accessories 374 374
Wilderness Systems, Inc. 18% of Co. ................................ Canoes & Kayaks 1,319 1,319
-------- ----------
Subtotal............................................................ 16,347 16,699

COMMON STOCK(1)--1.5%
- ---------------------
Four-S Baking Company(2)............................................ Baking 966 1504
Specialty Transportation Services, Inc. 9.1% of Co. ................ Waste Hauler 500 694
Chance Coach, Inc 18.3% of Co. ..................................... Bus Manufacturer 706 706
-------- ----------
Subtotal............................................................ 2,172 2,904
-------- ----------
Subtotal--non-publicly traded securities--51.4%..................... 111,352 112,436

GOVERNMENT SECURITIES--37.0%
- ----------------------------
FNMA Discount Note Due 11/14/98..................................... 19,902 19,902
FHLB Discount Note Due 10/1/98...................................... 9,999 9,999
FHLB Discount Note Due 10/1/98...................................... 39,994 39,994
-------- ----------
Total Investments................................................... 69,895 69,895

INVESTMENT IN UNCONSOLIDATED OPERATING SUBSIDIARY--3.6%
- -------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. ............. Investment Banking 403 6,715
-------- ----------
Totals.............................................................. $181,650 $189,046
-------- ----------
-------- ----------
</TABLE>

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(1) Non-income producing
(2) Affiliate

See accompanying notes.

2
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

SCHEDULE OF INVESTMENTS
(IN THOUSANDS EXCEPT PER SHARE DATA)

DECEMBER 31, 1997

<TABLE>
<CAPTION>
INDUSTRY COST FAIR VALUE
------------------ -------- ----------
<S> <C> <C> <C>
SENIOR DEBT--4.1%
- -----------------
Four-S Baking Company............................................. Baking $ 1,825 $ 1,825
BIW Connector Systems, LLC........................................ Manufacturing 3,890 3,890
-------- ----------
Subtotal.......................................................... 5,715 5,715

SUBORDINATED DEBT--7.9%
- -----------------------
Four-S Baking Company............................................. Baking 1,492 1,492
BIW Connector Systems, LLC........................................ Manufacturing 6,350 6,350
Westwind Group Holdings, Inc. .................................... Restaurant 3,206 3,206
-------- ----------
Subtotal.......................................................... 11,048 11,048

CONVERTIBLE PREFERRED STOCK--1.6%
- ---------------------------------
Four-S Baking Company 15% dividend convertible into 51 shares of
common stock or 10.89% of Co. .................................. Baking 2,303 2,303

COMMON STOCK WARRANTS(1)--1.1%
- ------------------------------
Four-S Baking Company 15 shares 3.26% of Co.(2)................... Baking 461 577
BIW Connector Systems, LLC 8% of LLC.............................. Manufacturing 652 652
Westwinds Group Holdings, Inc. 5% of Co. ......................... Restaurant 350 350
-------- ----------
Subtotal.......................................................... 1,463 1,579
-------- ----------
Subtotal--non-publicly traded securities--14.7%................... 20,529 20,645

GOVERNMENT SECURITIES--80.4%
- ----------------------------
FHLB Discount Note due 2/4/98..................................... 20,969 20,982
FHLB Discount Note due 3/6/98..................................... 10,893 10,898
FHLB Discount Note due 4/1/98..................................... 9,865 9,868
FNMA Discount Note due 4/24/98.................................... 6,877 6,883
FFCB 5.90% due 6/2/98............................................. 20,017 20,016
FHLB Discount Note due 6/8/98..................................... 14,646 14,644
FHLB Discount Note due 8/20/98.................................... 14,483 14,479
FNMA 5.71% due 9/9/98............................................. 14,995 15,000
-------- ----------
Total Investments................................................. 112,745 112,770

INVESTMENT IN UNCONSOLIDATED OPERATING SUBSIDIARY--4.9%
- -------------------------------------------------------
ACS Capital Investments Corporation(1)(2)--100% of Co. ........... Investment Banking 403 6,869
-------- ----------
Totals............................................................ $133,677 $ 140,284
-------- ----------
-------- ----------
</TABLE>

- ------------------
(1) Non-income producing
(2) Affiliate

See accompanying notes.

3
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

STATEMENTS OF OPERATIONS
(UNAUDITED)

(IN THOUSANDS EXCEPT PER SHARE DATA)

NINE MONTHS THREE MONTHS | | NINE MONTHS THREE MONTHS
ENDED ENDED | | ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,| |SEPTEMBER 30, SEPTEMBER 30,
1998 1998 | | 1997 1997
------------- -------------| |------------- -------------
(NOTE 4) (NOTE 4) | |
Operating Income | |
<S> <C> <C> <C> <C>
Interest income........................................ $ 9,931 $ 4,090 | | $ 553 $ 553
Loan fees.............................................. 1,806 672 | | --
Financial advisory fees................................ -- -- | | 1,122 262
Financial performance fees............................. -- -- | | 798 54
Other.................................................. -- -- | | 428 90
------------- -------------| |------------- -------------
Total operating income................................. 11,737 4,762 | | 2,901 959
| |
Operating Expenses | |
Salaries and benefits.................................. 628 250 | | 1,221 594
General, administrative and other...................... 683 246 | | 1,430 418
------------- -------------| | ------------- -------------
Total operating expenses............................... 1,311 496 | | 2,651 1,012
------------- -------------| | ------------- -------------
| |
Operating income before equity in earnings of | |
unconsolidated operating subsidiary.................. 10,427 4,266 | | 250 (53)
Equity in loss of unconsolidated operating | |
subsidiary........................................... (154) (366) | | -- --
------------- -------------| | ------------- -------------
Net operating income................................... 10,273 3,900 | | 250 (53)
Change in unrealized appreciation (depreciation) of
investments.......................................... 943 924 | | 5,321 (11)
------------- -------------| | ------------- -------------
Income before income taxes............................. 11,216 4,824 | | 5,571 (64)
Income taxes provision (benefit)....................... -- -- | | 2,128 (22)
------------- -------------| | ------------- -------------
Net increase in shareholders' equity resulting from | |
operations........................................... $ 11,216 $ 4,824 | | $ 3,443 $ (42)
------------- -------------| | ------------- -------------
------------- -------------| | ------------- -------------
Net operating income per share Basic........ $ 0.93 $ 0.35 | |
Diluted...... $ 0.89 $ 0.34 | |
Net increase in shareholders' equity Basic........ $ 1.01 $ 0.44 | |
resulting from operations per share Diluted...... $ 0.97 $ 0.42 | |
Weighted average shares of common Basic........ 11,069 11,070 | |
stock outstanding Diluted...... 11,544 11,461 | |
</TABLE>

See accompanying notes.

4
<PAGE>
AMERICAN CAPITAL STRATEGIES, INC.

STATEMENT OF SHAREHOLDERS' EQUITY(1)
(IN THOUSANDS)

<TABLE>
<CAPTION>
UNDISTRIBUTED
COMMON STOCK CAPITAL NET REALIZED UNREALIZED TOTAL
----------------- IN EXCESS OF EARNINGS APPRECIATION SHAREHOLDERS'
SHARES AMOUNT PAR VALUE (DEFICIT) OF INVESTMENTS EQUITY
------- ------- ------------ ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997............. 11,069 $ 111 $144,940 $ (55) $5,656 $ 150,652
Issuance of new shares of common stock
under the 1997 Stock Option Plan....... 8 96 96
Net increase in shareholders' equity
resulting from operations.............. 10,273 943 11,216
Distributions............................ (9,522) (9,522)
------- ------- ------------ ------------- ------- -------------
Balance at September 30, 1998............ 11,077 $ 111 $145,036 $ 696 $6,599 $ 152,442
------- ------- ------------ ------------- ------- -------------
------- ------- ------------ ------------- ------- -------------
</TABLE>

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

(1) There are no adjustments to net increase in shareholders' equity resulting
from operations to determine comprehensive income for the nine months ended
September 30, 1998. For the three months ended September 30, 1998,
comprehensive income was $4,824.

5
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)

<TABLE>
<CAPTION>
NINE MONTHS | | NINE MONTHS
ENDED | | ENDED
SEPTEMBER 30, | | SEPTEMBER 30,
1998 | | 1997
------------- | | -------------
Operating activities | |
<S> <C> <C>
Net increase in shareholders' equity resulting from operations................... $ 11,216 | | $ 3,443
Adjustments to reconcile net increase in shareholders' equity resulting from | |
operations to net cash provided by operating activities: | |
Depreciation and amortization............................................... -- | | 32
Change in unrealized appreciation of investments............................ (943) | | (5,321)
Net amortization of securities.............................................. (1,347) | | (337)
Amortization of loan discounts.............................................. (563) | | --
Amortization of deferred finance costs...................................... -- | | 3
Provision for deferred income taxes......................................... -- | | 2,102
ESOP contribution........................................................... -- | | 117
Increase in interest receivable............................................. (1,291) | | (122)
Provision for doubtful accounts............................................. -- | | (177)
Decrease in due from unconsolidated operating subsidiary.................... 833 | | --
Decrease in accounts receivable............................................. -- | | 486
(Increase) decrease in other assets......................................... 26 | | (88)
Increase (decrease) in accounts payable and accrued liabilities............. 91 | | 128
Loss of unconsolidated operating subsidiary................................. 154 | | --
------------- | | -------------
Net cash provided by operating activities........................................ 8,176 | | 266
Investing activities | |
Proceeds from sale or maturity of investments.................................... 161,580 | | 60
Principal repayments............................................................. 1,313 | |
Purchase of investments.......................................................... (91,337) | | (483)
Purchase of securities........................................................... (117,308) | | (129,897)
Purchase of property and equipment, net of disposals............................. -- | | (28)
------------- | | -------------
Net cash used in investing activities.............................................. (45,752) | | (130,348)
Financing activities | |
Proceeds from notes payable...................................................... 69,749 | | 590
Principal payments of notes payable.............................................. (24,712) | | (1,020)
Decrease in due to related parties............................................... -- | | (78)
Proceeds from stock issuance..................................................... 96 | | 143,608
Distributions.................................................................... (9,522) | | --
------------- | | -------------
Net cash provided by financing activities.......................................... 35,611 | | 143,100
------------- | | -------------
Net increase (decrease) in cash and cash equivalents............................... (1,965) | | 13,018
Cash and cash equivalents at beginning of period................................... 8,862 | | 323
------------- | | -------------
Cash and cash equivalents at end of period......................................... $ 6,897 | | $ 13,341
------------- | | -------------
------------- | | -------------
Supplemental disclosure: | |
Non-cash transaction: | |
Dividends on preferred stock declared............................................ -- | | $ 81
</TABLE>

See accompanying notes.

6
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)

NOTE 1. UNAUDITED INTERIM FINANCIAL STATEMENTS

Interim financial statements of American Capital Strategies, Ltd. (the
Company) are prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and pursuant to the
requirements for reporting on Form 10-Q and Article 10 of Regulation S-X.
Accordingly, certain disclosures accompanying annual financial statements
prepared in accordance with GAAP are omitted. In the opinion of management, all
adjustments, consisting solely of normal recurring accruals, necessary for the
fair presentation of financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results that ultimately may be achieved for the year. The interim
financial statements and notes thereto should be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K/A, as
filed with the Securities and Exchange Commission.

NOTE 2. ORGANIZATION

American Capital Strategies, Ltd. is a Delaware corporation formed in 1986
to provide merchant banking services to and invest in small and medium sized
businesses.

On August 29, 1997, the Company completed an initial public offering (IPO)
of 10,382 shares of common stock, and elected to be treated as a Business
Development Company under the Investment Company Act of 1940, as amended. On
October 1, 1997, the Company began operations so as to qualify to be taxed as a
regulated investment company (RIC) as defined in Subtitle A, Chapter 1, under
Subchapter M of the Internal Revenue Code. As contemplated by these
transactions, the Company materially changed its business plan and format from
primarily structuring and arranging financing for buyout transactions on a fee
for services basis to being a lender to and investor in small and medium sized
companies. As a result of the changes, the Company's predominant source of
operating income has changed from financial performance and advisory fees to
interest and dividends earned from investing the Company's assets in debt and
equity of businesses. The Company's investment objectives are to achieve current
income from the collection of interest and dividends, as well as long-term
growth in its shareholders' equity through appreciation in value of the
Company's equity interests. The Company also provides financial advisory
services to businesses through ACS Capital Investments Corporation (CIC), a
wholly-owned subsidiary. The Company is headquartered in Bethesda, Maryland, and
has offices in New York, Boston, Pittsburgh, San Francisco, Dallas and Chicago.

NOTE 3. INVESTMENT IN UNCONSOLIDATED OPERATING SUBSIDIARY

CIC is an operating subsidiary of the Company and is accounted for under
the equity method effective October 1, 1997. The investment in CIC is carried at
fair value as determined by the Board of Directors.

7
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

(IN THOUSANDS EXCEPT PER SHARE DATA)--(CONTINUED)

NOTE 3. INVESTMENT IN UNCONSOLIDATED OPERATING SUBSIDIARY--(CONTINUED)

Condensed financial information for CIC at September 30, 1998 and for the
three and nine months then ended was as follows:

<TABLE>
<S> <C>
Assets
Investments in portfolio companies, at fair value............................. $10,419
Other assets, net............................................................. 1,298
-------
Total assets............................................................. $11,717
-------
-------
Liabilities and Shareholder's Equity
Deferred income taxes......................................................... $ 3,145
Other liabilities............................................................. 1,896
Shareholder's equity.......................................................... 6,676
-------
Total liabilities and shareholder's equity......................................... $11,717
-------
-------
</TABLE>

<TABLE>
<CAPTION>
THREE NINE
MONTHS MONTHS
ENDED ENDED
------- ------
<S> <C> <C>
Total revenue...................................................................... $ 901 $4,782
Operating expense.................................................................. 1,628 5,090
------- ------
Net operating loss................................................................. (727) (308)
Unrealized appreciation of investments............................................. 187 57
Income taxes benefit............................................................... 174 97
------- ------
Net loss........................................................................... $ (366) $ (154)
------- ------
------- ------
</TABLE>

NOTE 4. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share for the three and nine months ended September 30, 1998. For
all other periods, earnings per share is not presented since it is not
considered meaningful due to the IPO and reorganization of the Company as a RIC.

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
------------------ ------------------
<S> <C> <C>
Numerator for basic and diluted
Net increase in shareholders' equity resulting from
operations...................................................... $ 4,824 $ 11,216
---------- ----------
---------- ----------
Denominator for basic-weighted average shares.......................... 11,070 11,069
Employee stock options................................................. 304 359
Warrants............................................................... 87 116
---------- ----------
Dilutive potential common shares....................................... 391 475
---------- ----------
Denominator for diluted................................................ 11,461 11,544
---------- ----------
---------- ----------
Basic earnings per share............................................... $ 0.44 $ 1.01
Diluted earnings per share............................................. $ 0.42 $ 0.97
</TABLE>

NOTE 5. NEW ACCOUNTING PRONOUNCEMENT

As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards Number 130, "Reporting Comprehensive Income" (SFAS 130).
SFAS established new rules for the reporting and display of

8
<PAGE>
AMERICAN CAPITAL STRATEGIES, LTD.

NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)--(CONTINUED)

NOTE 5. NEW ACCOUNTING PRONOUNCEMENT--(CONTINUED)

comprehensive income and its components; however, the adoption of this statement
had no impact on the Company's net increase in shareholders' equity resulting
from operations or shareholders' equity.

NOTE 6. SHORT-TERM NOTE PAYABLE

On September 30, 1998, the Company borrowed $44,993 secured by government
securities with a fair value of $49,993. The interest rate on the short-term
Note was 6.75% and the Note was fully repaid on October 1, 1998.

9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION

AMERICAN CAPITAL STRATEGIES, LTD.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)

All statements contained herein that are not historical facts including,
but not limited to, statements regarding anticipated activity are forward
looking in nature and involve a number of risks and uncertainties. Actual
results may differ materially. Among the factors that could cause actual results
to differ materially are the following: changes in the economic conditions in
which the Company operates negatively impacting the financial resources of the
Company; certain of the Company's competitors with substantially greater
financial resources than the Company reducing the number of suitable investment
opportunities offered to the Company or reducing the yield necessary to
consummate the investment; increased costs related to compliance with laws,
including environmental laws; general business and economic conditions and other
risk factors described in the Company's report filed from time to time with the
Securities and Exchange Commission. The Company cautions readers not to place
undue reliance on any such forward looking statements, which statements are made
pursuant to the Private Securities Litigation Reform Act 1995 and, as such,
speak only as of the date made.

The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the Company's financial
statements and the notes therein. The Company completed an initial public
offering (IPO) of its common stock on August 29, 1997 and on October 1, 1997
began to operate so as to qualify to be taxed as a regulated investment company
(RIC). After the IPO, the Company changed its primary business plan and format
from structuring and arranging financing for buyout transactions on a fee for
services basis to being a lender to and investor in small and medium sized
businesses. As a result of the changes, the Company's predominant source of
operating income has changed from financial performance and advisory fees to
interest and dividends earned from investing the Company's assets in debt and
equity of businesses. Additionally, pursuant to RIC accounting requirements,
effective October 1, 1997, the Company's accounting for its operating
subsidiary, ACS Capital Investments Corp. (CIC), changed from a consolidated
basis to the equity method. The financial results of the Company for the periods
through September 30, 1997 are not comparable to periods commencing October 1,
1997 and are not expected to be representative of the financial results of the
Company in the future. Accordingly, only the post-RIC period is discussed.

RESULTS OF OPERATIONS

The Company's financial performance as reflected in its Statements of
Operations is composed of three primary elements. The first element is "Net
operating income," which for periods prior to October 1, 1997 (Pre-RIC) is the
difference between the Company's revenue earned from arranging financing for
small and medium sized businesses and other financial advisory work and its
total operating expenses including ESOP contributions, depreciation and interest
expense. For periods prior to October 1, 1997, ESOP contributions represented a
significant component of total operating expenses. All required contributions to
the Company's ESOP have been made by the Company, and further contributions will
be made at the discretion of the Company's Board of Directors. Net operating
income for periods commencing October 1, 1997 (Post-RIC) is primarily the
interest and dividends earned from investing in debt and equity securities, loan
fees and the equity in earnings of its unconsolidated operating subsidiary less
the operating expenses of the Company. The second element is "Change in
unrealized appreciation of investments," which is the net change in the fair
value of the Company's portfolio assets at the end of the period compared with
their fair values at the beginning of the period or their stated costs, as
appropriate. The third element is "Provision for income taxes," which reflects a
statutory tax rate applied to the Company's GAAP pretax income for pre-RIC
periods. Actual taxes paid have historically been lower than the provision
primarily due to the temporary difference of the unrealized appreciation of
investments which has resulted in a deferred tax liability on the Company's
balance sheet. For post-RIC periods, the Company intends to operate so as to
qualify to be taxed as a RIC. As long as the Company qualifies as a RIC, it will
be able to take a deduction against its otherwise taxable income for certain
dividends it pays, allowing it to

10
<PAGE>
substantially reduce or eliminate its corporate-level tax liability. As a
result, the provisions for income taxes for post-RIC periods are expected to be
minimal.

Operating results for the three months ended September 30, 1998 are
summarized as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1998
------------------
<S> <C>
Operating income................................................................... $4,762
Operating expenses................................................................. 496
Equity in loss of unconsolidated operating subsidiary.............................. (366)
-------
Net operating income............................................................... 3,900
Change in unrealized appreciation of investments................................... 924
Net increase in shareholders' equity resulting from operations..................... $4,824
-------
-------
</TABLE>

Total operating income consisted of $672 in loan fees and $3,393 in
interest and dividends on non-publicly traded securities and $697 in interest on
government agency securities, bank deposits and repurchase agreements. The loan
fees were earned as a result of closing three investments in private companies
totaling $22,500 during the period.

Operating expenses for the period consisted of $250 in salaries and
benefits and $246 in general and administrative expenses.

Equity in earnings of unconsolidated operating subsidiary represents CIC's
results. For the three months ended September 30, 1998, CIC's results included
$901 of operating income, $1,628 of operating expenses, $187 of unrealized
appreciation of investments and $174 in tax benefits.

The change in unrealized appreciation of investments is determined by the
Company's Board of Directors. The change in unrealized appreciation of
investments for the three month period is $924 which consists of an appreciation
of $924 in the valuation of the non-publicly traded securities.

Operating results for the nine months ended September 30, 1998 are
summarized as follows:

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1998
-----------------
<S> <C>
Operating income.................................................................... $11,737
Operating expenses.................................................................. 1,311
Equity in loss of unconsolidated operating subsidiary............................... (154)
-----------------
Net operating income................................................................ 10,273
Change in unrealized appreciation of investments.................................... 943
-----------------
Net increase in shareholders' equity resulting from operations...................... $11,216
-----------------
-----------------
</TABLE>

Total operating income consisted of $1,806 in loan fees and $6,763 in
interest and dividends on non-publicly traded securities and $3,168 in interest
on government agency securities, bank deposits and repurchase agreements. The
loan fees were earned as a result of closing eleven investments in private
companies totaling $91,300 during the period.

Operating expenses for the period consisted of $628 in salaries and
benefits and $683 in general and administrative expenses.

Equity in earnings of unconsolidated operating subsidiary represents CIC's
results. For the nine months ended September 30, 1998, CIC's results included
$4,782 of operating income, $5,090 of operating expenses, $57 of unrealized
appreciation of investments and $97 in tax benefits.

The change in unrealized appreciation of investments is determined by the
Company's Board of Directors. The change in unrealized appreciation of
investments for the nine month period is $943 which consists of an increase of
$943 in the valuation of the investments in private companies.

11
<PAGE>
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

The Company received proceeds of $143,600 in connection with its IPO which
was completed on August 29, 1997. At September 30, 1998, the Company had $6,897
in cash and cash equivalents and $19,902 in unencumbered investments in Federal
agency securities. Additionally, during November, 1998, the Company closed on a
$25 million credit facility. The Company continues to review potential
investments in the debt and equity securities of small and medium sized
businesses and the Company intends to liquidate its Federal agency securities
and draw on its credit facility to fund its investments. As a RIC, the Company
is required to distribute annually 90% or more of its net operating income and
net realized short-term capital gains to shareholders. While the Company will
provide shareholders with the option of reinvesting their distributions in the
Company, the Company anticipates having to borrow to obtain liquidity after the
proceeds of the IPO have been fully invested in the debt and equity of small and
medium sized businesses. No assurance can be given that such liquidity will be
obtainable, or obtainable at interest rates favorable to the Company.

IMPACT OF THE YEAR 2000

The "Year 2000 Issue" is the result of computer programs being written
using two digits rather than four to define the applicable year. The Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather the year 2000. This could result in a system
failure or miscalculations causing disruption of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.

The Company principally utilizes for its internal accounting and
administrative requirements software written by third parties for sale to the
public and not specifically written for the Company. Many of these software
developers are reviewing and updating their programs to address the Year 2000
issue. The Company does not anticipate that it has significant exposure to the
Year 2000 issue for its internal accounting and administrative software. The
Company invests and will continue to invest in small and medium sized
businesses. The Company is currently reviewing the Year 2000 issue with the
investee companies in order to make a determination of the potential impact. The
Company currently cannot assess its exposure or the potential impact of the Year
2000 issue on its investees but plans to have an initial assessment completed in
time to include in its 10K filing for 1998.

12
<PAGE>
PART II.

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Neither the Company, nor any of the Company's subsidiaries, is currently
subject to any material litigation nor, to the Company's knowledge, is any
material litigation threatened against the Company or any subsidiary, other than
routine litigation and administrative proceedings arising in the ordinary course
of business. Such proceedings are not expected to have a material adverse effect
on the business, financial conditions, or results of operation of the Company or
any subsidiary.

ITEM 2. CHANGES IN SECURITIES

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

ITEM 5. OTHER INFORMATION

Not Applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

Exhibit 3.1 Articles of Incorporation, incorporated herein by reference
to Exhibit 2.a of the Amendment No. 1 to Form N-2 filed by
American Capital Strategies, Ltd. dated August 12, 1997
(Commission File No. 333-29943).

Exhibit 3.2 By-Laws, incorporated herein by reference to Exhibit 2.b of
the Amendment No. 1 to Form N-2 filed by American Capital
Strategies, Ltd. dated August 12, 1997 (Commission File No.
333-29943).

Exhibit 4 Instruments defining rights of security holders, including
indentures, incorporated herein by reference to Exhibits
2.d.1 and 2.d.2 of the Amendment No. 1 to Form N-2 filed by
American Capital Strategies, Ltd. on August 12, 1997
(Commission File No. 333-29943).

Exhibit 10.1 Amended and Restated Employment Agreement between American
Capital Strategies, Ltd. and David Gladstone dated as of
August 18, 1998.

Exhibit 27 Financial Data Schedule.

(b) The registrant has not filed any reports on a Current Report on
Form 8-K during the quarter for which this report 10-Q is filed.

13
<PAGE>
SIGNATURE

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.

AMERICAN CAPITAL STRATEGIES, LTD.

By: JOHN R. ERICKSON
---------------------------------
John R. Erickson
Vice President and Chief
Financial Officer
November 16, 1998

<PAGE>
EXHIBIT INDEX

EXHIBIT NO. DESCRIPTION

Exhibit 10.1 Amended and Restated Employment Agreement between American
Capital Strategies, Ltd. and David Gladstone dated as of
August 18, 1998.

Exhibit 27 Financial Data Schedule.

Exhibit 10.1

AMENDED AND RESTATED EMPLOYMENT AGREEMENT

THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (the "Agreement") is
entered into as of August 18, 1997 (the "Effective Date") by and between
AMERICAN CAPITAL STRATEGIES, LTD., a Delaware corporation (the "Company"), and
DAVID GLADSTONE (the "Employee").

W I T N E S S E T H:

WHEREAS, the Company and the Employee entered into an Employment
Agreement dated as of April 2, 1997 (the "Old Agreement") pursuant to which the
Company employed the Employee on the terms and conditions set forth therein; and

WHEREAS, the Company and the Employee desire to amend and restate the
Old Agreement in its entirety, on the terms and conditions herein set forth;

NOW, THEREFORE, in consideration of the mutual covenants,
representations, warranties and agreements contained herein, and for other
valuable consideration, the receipt and adequacy of which are hereby
acknowledged, the parties hereto agree as follows:

ARTICLE 1
Definitions and Interpretations

1.1. Definitions

For purposes of this Agreement, except as otherwise expressly provided
or unless the context otherwise requires, the following terms shall have the
following respective meanings:

"Annual Bonus Plan" shall have the meaning specified in Section 3.2.

"Base Salary" shall have the meaning specified in Section 3.1.

"Board of Directors" shall mean the Board of Directors of the Company.

"Code" shall mean the Internal Revenue Code of 1986, as amended.

"Compensation Committee" shall mean the Compensation Committee of the
Board of Directors or such other entity as may be designated for a particular
function by the Board of Directors.

"Confidential Information" shall have the meaning specified in Section
5.1(a).

"Continuation Period" shall have the meaning specified in Section
4.4(b).

<PAGE>

-2-

"Disability" shall mean a physical or mental condition of Employee
that, in the good faith judgment of not less than a majority of the entire
membership of the Board of Directors, prevents Employee from being able to
perform the services required under this Agreement and which results in the
Employee becoming eligible for long-term disability benefits (if such benefits
are provided by the Company). If any dispute arises as to whether a Disability
has occurred, or whether a Disability has ceased and the Employee is able to
resume duties, then such dispute shall be referred to a licensed physician
appointed by the president of the Medical Society or similar organization in
Washington, D.C., at the request of either party. The Employee shall submit to
such examinations and provide information as such physician may request and the
determination of such physician as to the Employee's physical or mental
condition shall be binding and conclusive on the parties. The Company shall pay
the cost of any such physician and examination.

"Dispute" shall have the meaning specified in Article 6.

"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.

"Executive Officers" shall refer to the President, the Chairman of the
Board, the Vice-Chairman of the Board, all Executive Vice Presidents and all
other officers designated as Executive Officers by the Board of Directors.

"Expiration Date" shall have the meaning specified in Section 2.2.

"Good Reason" shall mean any of the following:

(1) without Employee's express written consent, a material adverse
alteration in the nature or status of Employee's position,
functions, duties or responsibilities with the Company;

(2) a material breach by the Company of any material provision of
this Agreement which, if capable of being remedied, remains
unremedied for more than 15 days after written notice thereof
is given by Employee to the Company;

(3) without Employee's express written consent, the relocation of
the principal executive offices of the Company outside the
greater Washington, D.C. area or the Company's requiring
Employee to be based other than at such principal executive
offices;

(4) any purported termination by the Company of Employee's
employment not in accordance with the provisions of this
Agreement;

(5) the failure of the Company to obtain any assumption agreement
required by Section 7.5(a);
<PAGE>

-3-

(6) the amendment, modification or repeal of any provision of the
Company's Certificate of Incorporation or by-laws, if such
amendment, modification or repeal would materially adversely
affect Employee's rights to indemnification by the Company;

(7) change of control of the Company that would result in the
control of 25% or more of the Company's voting shares by one
Person or a group of Persons acting in concert other than such
entities as may own voting securities as of August 28, 1997;
or

(8) the determination by the Employee that there exists a
significant difference between the Employee and the Board of
Directors regarding either the method of operating the Company
or the direction of the Company.

"IPO" shall mean the initial underwritten public offering of the
securities of the Company, which became effective on August 29, 1997.

"ISO Plan" shall have the meaning specified in Section 3.3.

"Misconduct" shall mean (1) the willful and continued failure by
Employee to perform substantially his duties described in Section 2.3 (other
than any such failure resulting from Employee's incapacity due to physical or
mental illness) after two (2) written notices of such failure have been given to
Employee by the Company's Board of Directors and Employee has had a reasonable
period (not to exceed 15 days from the second notice) to correct such failure;
or (2) the commission by Employee of acts that are dishonest and demonstrably
injurious to the Company (monetarily or otherwise) in any material respect. For
purposes of this definition, (i) no act or failure to act on Employee's part
shall be considered "Misconduct" if done or omitted to be done by Employee in
good faith and in the reasonable belief that such act or failure to act was in
the best interest of the Company or in furtherance of Employee's duties and
responsibilities described in Section 2.3 and (ii) no disagreements between the
Board of Directors and the Employee regarding the direction or the operations of
the Company shall be construed as "Misconduct" and, further, material breaches
or violations by Employee of any material provision of this Agreement or any
material violation by the Employee of the Company's employment policy manual
shall be defined as "Misconduct."

"Notice of Discontinuance" shall have the meaning specified in Section
2.2.

"Notice of Termination" shall mean a notice purporting to terminate
Employee's employment in accordance with Section 4.1 or 4.2. Such notice shall
specify the effective date of such termination, which date shall not be less
than 30 (one (1) day in the case of a termination by the Company for Misconduct)
or more than 60 days after the date such notice is given. If such termination is
by Employee for Good Reason or by the Company for Disability or Misconduct, such

<PAGE>

-4-

notice shall set forth in reasonable detail the reason for such termination and
the facts and circumstances claimed to provide a basis therefor. Any notice
purporting to terminate Employee's employment which is not in compliance with
the requirements of this definition shall be ineffective.

"Person" shall mean and include an individual, a partnership, a joint
venture, a corporation, a trust and an unincorporated organization.

"Target Bonus" shall have the meaning specified in Section 3.2.

"Term" shall have the meaning specified in Section 2.2.

"Termination Date" shall mean the termination date specified in a
Notice of Termination delivered in accordance with this Agreement.

1.2. Interpretations

(a) In this Agreement, unless a clear contrary intention appears,
(i) the words "herein," "hereof" and "hereunder" and other words of similar
import refer to this Agreement as a whole and not to any particular Article,
Section or other subdivision, (ii) reference to any Article or Section, means
such Article or Section hereof, (iii) the words "including" (and with
correlative meaning "include") means including, without limiting the generality
of any description preceding such term, and (iv) where any provision of this
Agreement refers to action to be taken by either party, or which such party is
prohibited from taking, such provision shall be applicable whether such action
is taken directly or indirectly by such party.

(b) The Article and Section headings herein are for convenience
only and shall not affect the construction hereof.

ARTICLE 2
Employment: Term, Positions and Duties, Etc.

2.1. Employment

The Company agrees to employ Employee and Employee agrees to accept
employment with the Company, in each case on the terms and conditions set forth
in this Agreement.

2.2. Term of Employment

Unless sooner terminated pursuant to Article 4, the term of Employee's
employment under this Agreement (the "Term") shall continue until the fifth
anniversary of the IPO (the "Expiration Date"); provided, however, that on the
third anniversary of the IPO and on each anniversary thereafter (each such
anniversary being an "Extension Anniversary"), the Expiration Date shall be
automatically extended one additional year unless, at least six months prior to
an Extension Anniversary, (i) either party shall give written notice to the
other (a "Notice of Discontinuance") that no such automatic extension shall
occur on the next succeeding Extension Anniversary and each Extension

<PAGE>

-5-

Anniversary thereafter, or (ii) either party shall give a Notice of Termination
to the other party pursuant to Section 4.1 or 4.2, as the case may be. No Notice
of Discontinuance given by the Company shall be effective unless given pursuant
to instructions set forth in a resolution duly adopted by the affirmative vote
of at least a majority of the entire membership of the Board of Directors.

2.3. Positions and Duties

(a) While employed hereunder, Employee shall serve as the
Vice-Chairman of the Board of Directors of the Company. The duties as
Vice-Chairman shall be (i) to serve as Chairman of the Board of Directors in the
Chairman's absence or inability to serve, (ii) to introduce other Executive
Officers of the Company to and facilitate communications with principal
stockholders and prospective stockholders of the Company, (iii) to serve as a
member of the Executive Committee of the Board of Directors and the Company's
Credit Committee and (iv) such additional duties and responsibilities
commensurate with such office as from time to time may be reasonably assigned to
him by the Board of Directors; provided, that such additional duties and
additional duties that may be assigned to the Employee pursuant to the Company's
By-laws shall not be inconsistent with or impose material additional duties on
the Employee than the duties set forth in clauses (i)-(iii) above. While
employed hereunder, Employee shall (i) report directly to the Board of Directors
of the Company and (ii) observe and comply with all lawful policies, directions
and instructions of the Board of Directors that are consistent with the
foregoing provisions of this paragraph (a).

(b) The Company agrees to use its reasonable best efforts to cause
Employee to be elected or appointed, or re-elected or re-appointed, as a member
of the Board of Directors and the Executive Committee of the Board of Directors
(if such a committee exists) and a nonvoting ex officio member all other
committees, other than the Compensation Committee, at all times during the Term.

(c) While employed hereunder, Employee shall devote such portion
of his business time, attention, skill and efforts as is necessary to complete
the faithful and efficient performance of his duties hereunder. It is
acknowledged and agreed that Employee serves as the Chairman of the Board and
Chief Executive Officer of American Security Inc., a Delaware corporation
("AMSE"), and that, in connection with the initial public offering of AMSE,
Employee will enter into an Employment Agreement whereunder Employee shall be
required to devote a substantial portion of his business time, attention, skill
and efforts to the faithful and efficient performance of his duties thereunder
and not accept employment with any Person (other than the Company). Accordingly,
the Company agrees that Employee's undertakings with respect to AMSE are
authorized and consistent with Employee's undertakings to the Company (as the
same are amended hereby), and that the Company hereby releases Employee from any
obligation to

<PAGE>

-6-

the Company not expressly set forth in this Agreement. In addition, Employee may
engage in the following activities: (i) serve on corporate, civic, religious,
educational or charitable boards or committees and (ii) manage his personal
investments including being a consultant, board member or adviser, to such
investments and activities.

(d) While employed hereunder and subject to his rights under
Section 2.3(c), Employee shall conduct himself in such a manner as not to
knowingly prejudice, in any material respect, the reputation of the Company in
the fields of business in which it is engaged or with the investment community
or the public at large.

2.4. Place of Employment

Employee's place of employment hereunder shall be at the Company's
principal executive offices in the greater Washington, D.C. area or such other
area that is mutually agreeable to both parties.

ARTICLE 3
Compensation and Benefits

3.1. Base Salary

(a) For services rendered by Employee under this Agreement, the
Company shall pay to Employee an annual base salary ("Base Salary") of $150,000.
The Board of Directors or its Compensation Committee shall review the Base
Salary at least annually and may adjust the amount of the Base Salary at any
time as the Board of Directors or the Compensation Committee may deem
appropriate in their sole discretion.

(b) The Base Salary shall be payable in accordance with the
Company's payroll practice for Executive Officers as earned.

3.2. Annual Bonus Plan

During the Term, the Company shall maintain and the Employee shall be
entitled to participate in an incentive bonus plan (the "Annual Bonus Plan")
which will be determined by the Board of Directors, which will provide for the
payment of cash bonuses to eligible executives of the Company at specified times
during the year and within 90 days of the end of each fiscal year based on the
Company's financial performance and other appropriate factors for that year or a
portion thereof. Under the Annual Bonus Plan, Employee shall be eligible to earn
a target bonus (the "Target Bonus") each year equal to 200% of Employee's Base
Salary for such year based on criteria established by the Compensation
Committee, and the performance of the Company against such criteria. The
establishment of such criteria and of the necessary performance targets for
partial or full earning of the Target Bonus shall be at the sole reasonable
discretion of the Compensation Committee; provided, however, that Employee shall
be entitled to a Target Bonus each year equal to at least five percent (5%) of

<PAGE>

-7-

the maximum Target Bonus. During the calendar year 1997 and the year in which
the Expiration Date occurs, the Target Bonus which would be payable shall be
prorated and paid based on the number of days in such year actually occurring
during the Term.

3.3. Long-term Incentive Compensation

The Company has established a long-term incentive compensation plan,
which provides key employees of the Company with ownership interests in the
Company (the "ISO Plan"). Under the ISO Plan, Employee was granted options to
purchase 608,782 shares of common stock. The Employee and the Company shall
enter into an Amended and Restated Option Agreement in the form of Appendix A
hereto with regard to such options. To the extent permissible, such options
shall be characterized as Incentive Stock Options as defined in Section 422 of
the Code. The Employee shall participate in all other long-term compensation
incentive plans of the Company in accordance with their terms, except that while
other Executive Officers may receive additional options under the ISO Plan and
other long-term incentive stock options, stock appreciation rights and other
similar programs adopted subsequent to the IPO, Employee has no expectation of
or right to additional options or participation in such plans.

3.4. Vacation

While employed hereunder, Employee shall be entitled to vacation
benefits in accordance with the vacation policy adopted by the Company from time
to time for senior executives in general, but in no event shall Employee's
annual vacation be less than four weeks or such greater number of vacation days
as the Board of Directors may approve from time to time in its sole discretion.
Employee shall not be entitled to accumulate and carryover unused vacation time
from year to year, except to the extent permitted in accordance with the
Company's vacation policy for senior executives in general, nor shall Employee
be entitled to compensation for unused vacation time except as provided in
Section 4.3(a).

3.5. Business Expenses

The Company shall, in accordance with the rules and policies that it
may establish from time to time for senior executives, reimburse Employee for
business expenses reasonably incurred in the performance of Employee's duties.
Requests for reimbursement for such expenses must be accompanied by appropriate
documentation. Examples of reimbursable expenses include parking, mileage
charges, air fares and hotel accommodations while traveling on Company business.

3.6. Other Benefits

Employee shall be entitled to receive all employee benefits, fringe
benefits and other perquisites that may be offered by the Company to its
Executive Officers as a group, including, without limitation, (i) participation
by Employee and, where applicable, Employee's dependents, in the various
employee benefit plans or programs (including, without limitation, pension
plans, profit sharing plans, stock plans, health plans, life insurance, parking
and disability insurance) generally provided to Executive Officers of the
Company, subject to meeting the eligibility requirements with respect to each of
such benefit plans or programs, (ii) club memberships, (iii) automobile
allowances, and (iv) financial planning allowances. However, nothing in this

<PAGE>

-8-

Section 3.6 shall be deemed to prohibit the Company from making any changes in
any of the plans, programs or benefits described herein, provided such changes
apply to all similarly situated Executive Officers.

3.7. Indemnification

The Company agrees to defend, indemnify and hold harmless the Employee
from and against any liability and expenses arising by reason of Employee's
acting as a director or officer of the Company or any Company subsidiary or
affiliate, or any portfolio company of the Company, in accordance with and to
the fullest extent permitted by law. The Company shall maintain Directors and
Officers liability insurance for the Employee in such amounts of coverage as are
reasonably available to the Company and to the extent such is attainable at
reasonable cost and are permitted by law.

ARTICLE 4
Termination of Employment

4.1. Termination by Employee

Employee may, at any time prior to the Expiration Date, terminate his
employment hereunder for any reason by delivering a Notice of Termination to the
Chairman of the Board of Directors.

4.2. Termination by the Company

The Company may, at any time prior to the Expiration Date, terminate
Employee's employment hereunder for any reason by delivering a Notice of
Termination to Employee; provided, however, that in no event shall the Company
be entitled to terminate Employee's employment prior to the Expiration Date
unless the Board of Directors shall duly adopt, by the affirmative vote of at
least a majority of the entire membership of the Board of Directors, a
resolution authorizing such termination Should the Company deliver a Notice of
Termination, the Employee may within five days of such notice resign in lieu of
being terminated, but such resignation shall otherwise be treated as a
termination by the Company for purposes of this Article 4.

4.3. Payment of Accrued Base Salary, Vacation Pay, etc.

(a) Promptly upon the termination of Employee's employment for any
reason (including death), the Company shall pay to Employee (or his estate) a
lump sum amount for (i) any unpaid Base Salary earned hereunder prior to the
Termination Date, (ii) all unused vacation time accrued by Employee as of the
Termination Date in accordance with Section 3.4, (iii) all unpaid benefits
earned or vested, as the case may be, by Employee as of the Termination Date
under any and all incentive or deferred compensation plans or programs of the
Company and (iv) any amounts in respect of which Employee has requested, and is
entitled to, reimbursement in accordance with Section 3.5.

(b) A termination of Employee's employment in accordance with this
Agreement shall not alter or impair any of Employee's accrued rights or benefits
as of the Termination Date under any employee benefit plan or program maintained
by the Company, in each case except as provided therein or in any written
agreement entered into between the Company and Employee pursuant thereto.

4.4. Additional Rights in Connection With Disability

In the event that the Company terminates an Employee by delivering a
Notice of Termination to Employee stating that such Termination is by reason of
a Disability, the Employee shall be entitled to the benefits and payments set
forth in this Section 4.4 in addition to such other applicable rights as may be
provided elsewhere in this Agreement:

(a) Base Salary and Target Bonus. The Company shall continue to
pay to Employee the Base Salary in effect as of the date on which the Notice of
Termination was delivered for two (2) years following the Termination Date (but
in no event less than 365 days) (such period being the "Continuation Period")
which amount shall be reduced by any amount payable to Employee under any
disability plan maintained by the Company for the benefit of Employee. In
addition, the Employee shall be entitled to continue to participate in the
Annual Bonus Plan for two (2) years following the Termination Date with the
second anniversary of the Termination Date being the Expiration Date for
purposes of Section 3.2.

<PAGE>

-9-

(c) Options. To the extent not already vested, all options of the
Employee under the ISO Plan (or similar plan) which have not vested as of
Employee's Termination Date and which would vest within one year of Employee's
Termination Date shall vest and shall become immediately exercisable. The
Company shall issue to the Employee within 30 days of the Termination Date an
amount of new options as separate securities in exchange for and in an amount
equal to the Employee's vested ISO Plan options. Such new options shall have the
same exercise price and other terms as the ISO Plan options including a
requirement that these options be registered under applicable securities laws if
the ISO Plan options are registered. All loans to the Employee in connection
with the prior exercise of any options under the ISO Plan (or similar plan)
shall remain unaffected and will remain on their original terms.

<PAGE>
-10-

Should the Employee's Disability end during the pendency of the Term,
the Company may discontinue the payments contemplated by this Section 4.4 if it
offers to reemploy Employee under the terms of this Agreement, but no such offer
shall affect the terms of Section 4.4(c) above.

4.5. Additional Rights in Connection With Terminations by Employee for
Good Reason or by the Company for Other than Misconduct or Disability

In the event that Employee terminates his employment pursuant to
Section 4.1 for Good Reason or if the Company terminates Employee's employment
with the Company pursuant to Section 4.2 for other than Misconduct or a
Disability, the Employee shall be entitled to the payments and benefits set
forth in this Section 4.5 in addition to such other applicable rights as may be
provided elsewhere in this Agreement:

(a) Base Salary and Target Bonus. The Company shall continue to
pay to Employee the Base Salary in effect as of the date on which the Notice of
Termination for the Continuation Period. In addition, the Employee shall be
entitled to continue to participate in the Annual Bonus Plan for two (2) years
following the Termination Date with the second anniversary of the Termination
Date being the Expiration Date for purposes of Section 3.2. The amount payable
to Employee under this paragraph (a) is in lieu of, and not in addition to, any
severance payment due to or become due to Employee under any separate agreement
or contract between Employee and the Company or pursuant to any severance
payment plan, program or policy of the Company.

(b) Insurance Benefits, etc. The Company shall at all times during
the Continuation Period, without charge to Employee or Employee's dependents,
cause Employee and Employee's eligible dependents to be covered by and to
participate in, to the fullest extent allowable under the terms thereof, all
life, accidental death and dismemberment and health insurance plans and programs
that may be offered to the senior officers of the Company so that Employee will
receive, at all times during the Continuation Period, the same benefits under
such plans and programs as Employee would have been entitled to receive had he
remained an Executive Officer of the Company; provided, however, in the event
Employee becomes covered during the Continuation Period by another employer's
group plan or programs which provide benefits to Employee and his dependents
comparable to those being provided to Employee under this paragraph (b)
(provided with respect to any such group health plan, such plan does not contain
any exclusion or limitation with respect to any pre-existing conditions), then
the Company's similar plans and programs shall no longer be liable for any
benefits under this paragraph (b). In no event shall Employee's COBRA
continuation period begin prior to the end of Employee's coverage under the
Company's group health plan as provided in this paragraph (b).

<PAGE>

-11-

(c) Options. All options of the Employee under the ISO Plan (or
similar plan) that have not vested as of Employee's Termination Date shall vest
and shall become immediately exercisable. The Company shall issue to the
Employee within 30 days of the Termination Date an amount of new options as
separate securities in exchange for and in an amount equal to the Employee's
vested ISO Plan options. Such new options shall have the same exercise price and
other terms as the ISO Plan options including a requirement that these options
be registered under applicable securities laws if the ISO Plan options are
registered. All loans to the Employee in connection with the prior exercise of
any options under the ISO Plan (or similar plan) shall remain unaffected and
will remain on their original terms.

(d) Release. Notwithstanding anything in this Section 4.5 to the
contrary, as a condition to the receipt of any benefit under this Section 4.5,
Employee must first execute and deliver to the Company a mutual release as set
out in exhibit 4.5(d) hereto (which the Company shall be obligated to execute
upon Employee's delivery thereof), releasing the Company, its officers, Board of
Directors, employees and agents from any and all claims and from any and all
causes of action of any kind or character that Employee may have arising out of
Employee's employment with the Company or the termination of such employment,
but excluding any claims and causes of action that Employee may have arising
under or based upon this Agreement.

4.6. Additional Rights in the Event of Death

In the event that the Employee's employment is terminated as a result
of his death, the Employee's estate and/or his beneficiaries shall be entitled
to the payments and benefits set forth in this Section 4.6 in addition to such
other applicable rights as may be set forth elsewhere in this Agreement:

(a) Target Bonus. The Employee's estate shall be entitled to
receive the Target Bonus that the deceased employee would have been entitled to
have received in the year in which the death occurred.

(b) Insurance Benefits, etc. The Company shall pay the cost for
dependents of the Employee for insurance coverage that they are entitled to
obtain from the Company following the Employee's death pursuant to COBRA but not
less than 18 months.

(c) Options. All options of the Employee under the ISO Plan (or
similar plan) that have not vested as of Employee's death and that would vest
within one year thereof shall vest immediately upon the Employee's death and
shall remain exercisable by the Employee's estate for the shorter of 18 months
following the Employee's death and their original term. All loans to the
Employee in connection with the prior exercise of any options under the ISO Plan
(or similar plan) shall be due the earlier of 18 months following the Employee's
death and their original term.

<PAGE>

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4.7. Additional Rights in the Event of Termination by Resignation Other
than for Good Reason

In the event that the Employee terminates his employment pursuant to
Section 4.1 without Good Reason, he shall be entitled to the rights set forth in
this Section 4.7 in addition to such other applicable rights as may be set forth
elsewhere in this Agreement:

(a) Options. To the extent not already vested, options of the
Employee under the ISO Plan (or similar plan) shall vest as of Employee's
Termination Date and shall become immediately exercisable so that the indicated
percentage of the total options which have been granted shall have vested based
on the elapsed time between the date of Initial Public Offering and the
Termination Date.

Elapsed Time Total % Vested
-------------- ----------------
Less than six months 0%

At least six months and less 30%
than one year

At least one year and less 60%
than two years

At least two years and less 80%
than three years

At least three years 100%

The Company shall issue to the Employee within 30 days of the Termination Date
an amount of new options as separate securities in exchange for and in an amount
equal to the Employee's vested ISO Plan options. Such new options shall have the
same exercise price and other terms as the ISO Plan options including a
requirement that these options be registered under applicable securities laws if
the ISO Plan options are registered. All loans to the Employee in connection
with the prior exercise of any options under the ISO Plan (or similar plan)
shall remain unaffected and will remain on their original terms.

4.8. Additional Rights in the Event of Termination for Employee's
Misconduct

In the event that the Company terminates Employee's employment with the
Company pursuant to Section 4.2 for Employee's Misconduct, Employee shall be
entitled to the rights set forth in this Section 4.8 in addition to such other
applicable rights as may be set forth elsewhere in this Agreement:

<PAGE>

-13-

(a) Options. All options of the Employee under the ISO Plan (or similar
plan) that have not vested as of employee's Termination Date shall lapse and
shall not be exercisable. All previously vested options shall remain exercisable
for the shorter of 90 days following the Termination Date and their original
term. All loans to the Employee in connection with the prior exercise of any
options under the ISO Plan (or similar plan) shall be due the earlier of 90 days
following the Employee's Termination Date and their original term.

4.9. Non-exclusivity of Rights

Nothing in this Agreement shall prevent or limit Employee's continuing
or future participation in any plan, program, policy or practice provided by the
Company for which Employee may qualify, nor shall anything herein limit or
otherwise affect such rights as Employee may have under any other contract or
agreement with the Company. Amounts which are vested benefits or which Employee
is otherwise entitled to receive under any plan, policy, practice or program of
or any contract or agreement with the Company at or subsequent to the
Termination Date shall be payable in accordance with such plan, policy, practice
or program or contract or agreement except as explicitly modified by this
Agreement.

4.10. Company to Pay Benefits During Pendency of Dispute

Either party may, within ten (10) days after its receipt of a Notice of
Termination given by the other party, provide notice to the other party that a
dispute exists concerning the termination, in which event such dispute shall be
resolved in accordance with Article 6. Notwithstanding the pendency of any such
dispute and notwithstanding any provision herein to the contrary, the Company
will (i) continue to pay Employee the Base Salary in effect when the notice
giving rise to the dispute was given and (ii) continue Employee as a participant
in all compensation and benefit plans in which Employee was participating when
the notice giving rise to the dispute until the dispute is finally resolved or,
with respect to a Notice of Employee, the date of termination specified in such
notice, if earlier, but, in each case, not past the Expiration Date. If (x)(i)
the Company gives a Notice of Termination to Employee and (ii) Employee disputes
the termination as contemplated by this Section 4.10, or (y)(i) the Employee
gives a Notice of Termination for Good Reason and (ii) the Company disputes such
termination as contemplated by this Section 4.10, and, in either case, (z) such
dispute is finally resolved in favor of the Company in accordance with Article
6, then Employee shall be required to repay to the Company amounts paid to
Employee under this Section 4.10 (including the value of benefits received) but
only if, and to the extent, Employee is not otherwise entitled to receive such
amounts under this Agreement.

<PAGE>

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ARTICLE 5
Confidential Information and Non-Solicitation

5.1. Confidential Information

(a) Employee recognizes that the services to be performed by him
hereunder are special, unique, and extraordinary and that, by reason of his
employment with the Company, he may acquire Confidential Information concerning
the operation of the Company, the use or disclosure of which would cause the
Company substantial loss and damages which could not be readily calculated and
for which no remedy at law would be adequate. Accordingly, Employee agrees that
he will not (directly or indirectly) at any time, whether during or after his
employment hereunder, (i) knowingly use for an improper personal benefit or for
the benefit of another Person with whom Employee is affiliated any Confidential
Information that he may learn or has learned by reason of his employment with
the Company or (ii) disclose any such Confidential Information to any Person
except (A) in the performance of his obligations to the Company hereunder, (B)
as required by applicable law, (C) in connection with the enforcement of his
rights under this Agreement, (D) in connection with any disagreement, dispute or
litigation (pending or threatened) between Employee and the Company or (E) with
the prior written consent of the Board of Directors. As used herein,
"Confidential Information" includes information with respect to Subject
Investments (as defined herein, but excluding for purposes of this Section 5.1
information concerning US Investigations Services, Inc. ("USIS") or information
provided by USIS); provided, however, that such term, shall not include any
information that (x) is or becomes generally known or available other than as a
result of a disclosure by Employee, (y) is or becomes known or available to
Employee on a non-confidential basis from a source (other than the Company)
which, to Employee's knowledge, is not prohibited from disclosing such
information to Employee by a legal, contractual, fiduciary or other obligation
to the Company or (z) with regard to Subject Investments, is or becomes known or
available to Employee other than by or through the Company.

(b) Employee confirms that all Confidential Information is the
exclusive property of the Company. All business records, papers and documents
kept or made by Employee while employed by the Company relating to the business
of the Company shall be and remain the property of the Company at all times.
Upon the request of the Company at any time, Employee shall promptly deliver to
the Company, and shall retain no copies of, any written materials, records and
documents made by Employee or coming into his possession while employed by the
Company concerning the business or affairs of the Company other than personal
materials, records and documents (including notes and correspondence) of
Employee not containing proprietary information relating to such business or
affairs. Notwithstanding the foregoing, Employee shall be permitted to retain
copies of, or have access to, all such materials, records and documents relating
to any disagreement, dispute or litigation (pending or threatened) between
Employee and the Company.

<PAGE>

-15-

(c) The Company recognizes that the Employee maintains his
contacts and his domain name "DAVIDGLADSTONE.COM" on the computer system and
that the list of contacts and his domain name will remain the exclusive
ownership of the Employee and that information shall not be deemed confidential
or subject to the terms of sections 5.1 or 5.2.

5.2. Covenant Not to Compete or Solicit

(a) While employed hereunder and for the period of (i) one (1)
year thereafter or (ii) two (2) years after the Termination Date, if this
Agreement is terminated earlier and the Employee is entitled to receive
compensation and benefits under Section 4.5 (the "Restricted Period"), Employee,
unless he receives the prior written consent of the Board of Directors shall not
own an interest in, manage, operate, join, control, lend money or render
financial or other assistance to or participate in or be connected with, as an
officer, employee, partner, stockholder, consultant or otherwise, any Person
(each, a "Subject Person") (i) that competes with the Company or any
wholly-owned subsidiary of the Company in investing or consulting with small or
medium sized businesses in the United States with regard to change in control
transactions, a result of which is an employee stock ownership plan that owns
more than 15% of the subject business or (ii) that solicits, for the purpose of
providing debt or equity financing, or provides debt or equity financing to any
Person (each, a "Subject Investment") (A) who is listed on Appendix B hereto,
(B) to whom the Company or a wholly-owned subsidiary of the Company is currently
a lender or in which the Company or a subsidiary of the Company is currently an
investor other than as a result of the ownership of publicly-traded securities
or (C) where the Employee first learns of a lending or investing opportunity
with regard to such Person from or through the Company. The Board of Directors
shall not unreasonably withhold its consent to a transaction whereby a Subject
Person would purchase a controlling interest in a Subject Investment, provided
that in connection with such a purchase, the Company receives an aggregate fee
(whether from the efforts of Employee or otherwise) computed at the sum of
three-quarters of one percent (0.75%) of the purchase consideration up to a
maximum of $1,750,000.

(b) Employee has carefully read and considered the provisions of
this Section 5.2 and, having done so, agrees that the restrictions set forth in
this Section 5.2 (including the Restricted Period, scope of activity to be
restrained and the geographical scope) are fair and reasonable and are
reasonably required for the protection of the interests of the Company, its
officers, directors, employees, creditors and shareholders. Employee understands
that the restrictions contained in this Section 5.2 may limit his ability to
engage in a business similar to the Company's business, but acknowledges that he
will receive sufficiently high remuneration and other benefits from the Company
hereunder to justify such restrictions.

(c) During the Restricted Period, Employee shall not, whether for
his own account or for the account of any other Person (excluding the Company),
intentionally (i) solicit, endeavor to entice or induce any employee of the
Company to terminate his employment with the Company or accept employment with
anyone else or (ii) interfere in a similar manner with the business of the
Company, except for those employees who the Company and Employee agree are
exempt from the applicability of this paragraph at the time of hiring.

<PAGE>

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(d) In the event that any provision of this Section 5.2 relating
to the Restricted Period or the areas of restriction shall be declared by a
court of competent jurisdiction to exceed the maximum time period or areas such
court deems reasonable and enforceable, the Restricted Period or areas of
restriction deemed reasonable and enforceable by the court shall become and
thereafter be the maximum time period and/or areas.

5.3. Stock Ownership

Nothing in this Agreement shall prohibit Employee from acquiring or
holding any issue of stock or securities of any Person that has any securities
registered under Section 12 of the Exchange Act, listed on a national securities
exchange or quoted on the automated quotation system of the National Association
of Securities Dealers, Inc. so long as (i) Employee is not deemed to be an
"affiliate" of such Person as such term is used in paragraphs (c) and (d) of
Rule 145 under the Securities Act of 1933, as amended, and (ii) Employee and
members of his immediate family do not own or hold more than 3% of any voting
securities of any such Person.

5.4. Injunctive Relief

Employee acknowledges that a breach of any of the covenants contained
in this Article 5 may result in material irreparable injury to the Company for
which there is no adequate remedy at law, that it will not be possible to
measure damages for such injuries precisely and that, in the event of such a
breach, any payments remaining under the terms of this Agreement shall cease and
the Company shall be entitled to obtain a temporary restraining order or a
preliminary or permanent injunction restraining Employee from engaging in
activities prohibited by this Article 5 or such other relief as may required to
specifically enforce any of the covenants contained in this Article 5. Employee
agrees to and hereby does submit to in personam jurisdiction before each and
every such court for that purpose.

ARTICLE 6
Dispute Resolution

In the event a dispute shall arise between the parties as to whether
the provisions of this Agreement have been complied with (a "Dispute"), the
parties agree to resolve such Dispute in accordance with the following
procedure:

(a) A meeting shall be held promptly between the Parties, attended
by (in the case of the Company) by one or more individuals with decision-making
authority regarding the Dispute, to attempt in good faith to negotiate a
resolution of the Dispute.

<PAGE>

-17-

(b) If, within 10 days after such meeting, the parties have not
succeeded in negotiating a resolution of the Dispute, the parties agree to
submit the Dispute to mediation in accordance with the Commercial Mediation
Rules of the American Arbitration Association except that Disputes with regard
to the existence of a Disability shall be resolved in accordance with the
definition of the term "Disability" above.

(c) The parties will jointly appoint a mutually acceptable
mediator, seeking assistance in such regard from the American Arbitration
Association if they have been unable to agree upon such appointment within 10
days following the 10-day period referred to in clause (b) above.

(d) Upon appointment of the mediator, the parties agree to
participate in good faith in the mediation and negotiations relating thereto for
15 days.

(e) If the parties are not successful in resolving the Dispute
through mediation within such 15-day period, the parties agree that the Dispute
shall be settled by arbitration in accordance with the Expedited Procedures of
the Commercial Arbitration Rules of the American Arbitration Association.

(f) The fees and expenses of the mediator/arbitrators shall be
borne solely by the non-prevailing party or, in the event there is no clear
prevailing party, as the mediator/arbitrators deem appropriate.

(g) The Company shall reimburse Employee, on a current basis, for
50% of all reasonable legal fees and expenses, if any, incurred by Employee in
connection with any Dispute; provided, however, that in the event the resolution
of such Dispute in accordance with this Article 6 includes a finding denying, in
all material respects, Employee's claims in such Dispute, Employee shall be
required to reimburse the Company, over a period not to exceed 12 months from
the date of such resolution, for all sums advanced to Employee with respect to
such Dispute pursuant to this paragraph (g).

(h) Except as provided above, each party shall pay its own costs
and expenses (including, without limitation, attorneys' fees) relating to any
mediation/arbitration proceeding conducted under this Article 6.

(i) All mediation/arbitration conferences and hearings will be
held in the greater Washington, D.C. area.

(j) In the event there is any disputed question of law involved in
any arbitration proceeding, such as the proper legal interpretation of any
provision of this Agreement, the arbitrators shall make separate and distinct
findings of all facts material to the disputed question of law to be decided
and, on the basis of the facts so found, express their conclusion of the
question of law. The facts so found shall be conclusive and binding on the
parties, but any legal conclusion reached by the arbitrators from such facts may
be submitted by either party to a court of law for final determination by
initiation of a civil action in the manner provided by law. Such action, to be
valid, must be commenced within 20 days after receipt of the arbitrators'
decision. If no such civil action is commenced within such 20-day period, the
legal conclusion reached by the arbitrators shall be conclusive and binding on
the parties. Any such civil action shall be submitted, heard and determined
solely on the basis of the facts

<PAGE>

-18-

found by the arbitrators. Neither of the parties shall, or shall be entitled to,
submit any additional or different facts for consideration by the court. In the
event any civil action is commenced under this paragraph (b), the party who
prevails or substantially prevails (as determined by the court) in such civil
action shall be entitled to recover from the other party all costs, expenses and
reasonable attorneys' fees incurred by the prevailing party in connection with
such action and on appeal.

(k) Except as limited by paragraph (b) above, the parties agree
that judgment upon the award rendered by the arbitrators may be entered in any
court of competent jurisdiction. In the event legal proceedings are commenced to
enforce the rights awarded in an arbitration proceeding, the party who prevails
or substantially prevails in such legal proceeding shall be entitled to recover
from the other party all costs, expenses and reasonable attorneys' fees incurred
by the prevailing party in connection with such legal proceeding and on appeal.

(l) Except as provided above, (i) no legal action may be brought
by either party with respect to any Dispute and (ii) all Disputes shall be
determined only in accordance with the procedures set forth above.

ARTICLE 7
Miscellaneous

7.1. No Mitigation or Offset

The provisions of this Agreement are not intended to, nor shall they be
construed to, require that Employee mitigate the amount of any payment provided
for in this Agreement by seeking or accepting other employment, nor shall the
amount of any payment provided for in this Agreement be reduced by any
compensation earned by Employee as the result of employment by another employer
or otherwise. Without limitation of the foregoing, the Company's obligations to
make the payments to Employee required under this Agreement and otherwise to
perform its obligations hereunder shall not be affected by any set off,
counterclaim, recoupment, defense or other claim, right or action that the
Company may have against Employee, except that the Company may deduct from any
amount required to be reimbursed to the Company by Employee under Section 4.7 or
Article 6(a) the amount of any payment which the Company is then required to
make to Employee hereunder.

7.2. Assignability

The obligations of Employee hereunder are personal and may not be
assigned or delegated by Employee or transferred in any manner whatsoever, nor
are such obligations subject to involuntary alienation, assignment or transfer.
The Company shall have the right to assign this Agreement and to delegate all
rights, duties and obligations hereunder as provided in Section 7.5.

<PAGE>

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7.3. Notices

All notices and all other communications provided for in the Agreement
shall be in writing and addressed (i) if to the Company, at its principal office
address or such other address as it may have designated by written notice to
Employee for purposes hereof, directed to the attention of the Board of
Directors with a copy to the Secretary of the Company and (ii) if to Employee,
at his residence address on the records of the Company or to such other address
as he may have designated to the Company in writing for purposes hereof. Each
such notice or other communication shall be deemed to have been duly given when
delivered or mailed by United States registered mail, return receipt requested,
postage prepaid, except that any notice of change of address shall be effective
only upon receipt.

7.4. Severability

The invalidity or unenforceability of any provision of this Agreement
shall not affect the validity or enforceability of any other provision of this
Agreement, which shall remain in full force and effect.

7.5. Successors: Binding Agreement

(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business or assets of the Company, by agreement in form
and substance reasonable acceptable to Employee, to expressly assume and agree
to perform this Agreement in the same manner and to the same extent that the
Company would be required to perform it if no such succession had taken place.
Failure of the Company to obtain such agreement prior to the effectiveness of
any such succession shall be a breach of this Agreement. As used herein, the
term "Company" shall include any successor to its business and/or assets as
aforesaid which executes and delivers the Agreement provided for in this Section
7.5 or which otherwise becomes bound by all terms and provisions of this
Agreement by operation of law.

(b) This Agreement and all rights of Employee hereunder shall
inure to the benefit of and be enforceable by Employee's personal or legal
representatives, executors, administrators, successors, heirs, distributes,
devisees and legatees. If Employee should die while any amounts would be payable
to him hereunder if he had continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement to
Employee's devisee, legatee, or other designee or, if there be no such designee,
to Employee's estate.

<PAGE>
-20-

7.6. Tax Matters

(a) The Company shall withhold from all payments hereunder all
applicable taxes (federal, state or other) which it is required to withhold
therefrom unless Employee has otherwise paid (or made other arrangements
satisfactory) to the Company the amount of such taxes.

(b) Notwithstanding anything to the contrary in this Agreement, in
the event that any payment or distribution by Company or any affiliate of
Company to or for the benefit of Employee, whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement or
otherwise (a "Payment"), would be subject to the excise tax imposed by Section
4999 of the Internal Revenue Code of 1986, as amended, or any interest or
penalties with respect to such excise tax (such excise tax, together with any
such interest or penalties, are hereinafter collectively referred to as the
"Excise Tax"), Company shall pay to Employee an additional payment (a "Gross-up
Payment") in an amount such that after payment by Employee of all taxes
(including any interest or penalties imposed with respect to such taxes),
including any Excise Tax imposed on any Gross-up Payment, Employee retains an
amount of the Gross-up Payment equal to the Excise Tax imposed upon the
Payments. Company and Employee shall make an initial determination as to whether
a Gross-up Payment is required and the amount of any such Gross-up Payment.
Employee shall notify Company immediately in writing of any claim by the
Internal Revenue Service which, if successful, would require Company to make a
Gross-up Payment (or a Gross-up Payment in excess of that, if any, initially
determined by Company and Employee) promptly and in any event within 15 days of
the receipt of such claim. Company shall notify Employee in writing at least
five days prior to the due date of any response required with respect to such
claim if it plans to contest the claim. If Company decides to contest such
claim, Employee shall cooperate fully with Company in such action; provided,
however, Company shall bear and pay directly or indirectly all costs and
expenses (including additional interest and penalties) incurred in connection
with such action and shall indemnify and hold Employee harmless, on an after-tax
basis, for any Excise Tax or income tax, including interest and penalties with
respect thereto, imposed as a result of Company's action. If, as a result of
Company's action with respect to a claim, Employee receives a refund of any
amount paid by Company with respect to such claim, Employee shall promptly pay
such refund to Company. If Company fails to timely notify Employee whether it
will contest such claim or Company determines not to contest such claim, then
Company shall immediately pay to Employee the portion of such claim, if any,
which it has not previously paid to Employee.

7.7. Amendments and Waivers

No provision of this Agreement may be modified, waived or discharged
unless such waiver, modification or discharge is agreed to in writing and signed
by Employee and such member of the Board of Directors as may be specifically
authorized by the Board of Directors. No waiver by either party hereto at any
time of any breach by the other party hereto of, or in compliance with, any
condition or provision of this Agreement to be performed by such other party
shall be deemed a waiver of similar or dissimilar provisions or conditions at
the same or at any prior or subsequent time.

<PAGE>

-21-

7.8. Entire Agreement, Termination of Other Agreements

This Agreement is an integration of the parties' agreement and no
agreement or representations, oral or otherwise, express or implied, with
respect to the subject matter hereof have been made by either party which are
not set forth expressly in this Agreement.

7.9. Governing Law

THE VALIDITY, INTERPRETATION, CONSTRUCTION AND PERFORMANCE OF THIS
AGREEMENT SHALL BE GOVERNED BY THE LAWS OF THE STATE OF MARYLAND WITHOUT REGARD
TO ITS CONFLICT OF LAWS PROVISION.

7.10. Counterparts

This Agreement may be executed in or more counterparts, each of which
shall be deemed to be an original, but all of which together will constitute one
and the same instrument.

<PAGE>

-22-

IN WITNESS WHEREOF, the parties have executed this Agreement effective
as of the date first above written.

AMERICAN CAPITAL STRATEGIES, LTD.

By: /S/
------------------------------
Malon Wilkus, President

EMPLOYEE:

/S/
---------------------------
David Gladstone
1161 Crest Lane
McLean, VA 22101

<PAGE>

APPENDIX A

OPTION NO.: 1997-1

OPTIONEE: David J. Gladstone

DATE OF GRANT: August 29, 1997

OPTION PRICE: $15.00

COVERED SHARES: 608,782

AMERICAN CAPITAL STRATEGIES, LTD.
1997 STOCK OPTION PLAN

* * *

AMENDED AND RESTATED STOCK OPTION AGREEMENT

WHEREAS, as of August 29, 1997, David Gladstone, as Optionee, and the
Company entered into a certain Option Agreement (the "Old Option Agreement");
and

WHEREAS, Optionee and the Company wish to amend and restate the Old
Option Agreement in its entirety.

NOW THEREFORE, BE IT RESOLVED, that the Old Option Agreement is deemed
to be amended and restated in its entirety as follows as of the 18th day of
August, 1998:

1. Definitions. In this Agreement, except where the context otherwise
indicates, the following definitions apply:

1.1. "Affiliate" means parent or subsidiary corporations of the
Company, as defined in Sections 424(e) and (f) of the Code (but substituting
"the Company" for "employer corporation").

1.2. "Agreement" means this Amended and Restated Stock Option
Agreement.

1.3. "Board" means the Board of Directors of the Company.

1.4. A "Change of Control" means the occurrence of any of the
following events after the Date of Grant: (i) any person or group of persons (as
defined in Section 13(d) and 14(d) of the Exchange Act) together with its
affiliates, excluding employee benefit plans of the Company, becomes, directly
or indirectly, the "beneficial owner" (as defined in Rule 13d-3 under the
Exchange Act) of securities of the Company representing 51% or more of the
combined voting power of the Company's then outstanding securities; (ii) the
stockholders of the Company approve a merger or consolidation of the Company
with any other corporation or entity regardless of which entity is the survivor,
other than a merger or consolidation which would result in the voting securities
of the Company outstanding immediately prior thereto continuing to represent
(either by

<PAGE>

remaining outstanding or being converted into voting securities of the surviving
entity) at least 50% of the combined voting power of the voting securities of
the Company or such surviving entity outstanding immediately after such merger
or consolidation; or (iv) the stockholders of the Company approve a plan of
complete liquidation or winding-up of the Company or an agreement for the sale
or disposition by the Company of all or substantially all of the Company's
assets.

1.5. "Code" means the Internal Revenue Code of 1986, as amended.

1.6. "Committee" means the committee charged, pursuant to the
provisions of the Plan, with the administration of the Plan. Unless otherwise
determined by the Board, the Compensation Committee of the Board shall be the
Committee.

1.7. "Common Stock" means the common stock, par value $0.01 per
share, of the Company.

1.8. "Company" means American Capital Strategies, Ltd., a Delaware
corporation.

1.9. "Covered Shares" means the number of Shares subject to the
Option set forth as the "Covered Shares" on page 1 of this Agreement.

1.10. "Date of Exercise" means the date on which the Company
receives notice pursuant to Section 4.1 of the exercise, in whole or in part, of
the Option.

1.11. "Date of Expiration" means the date on which the Option
shall expire, which shall be the earliest of the following times:

(a) ninety (90) days after the termination of the Optionee's
Employment by reason of termination for Misconduct (as defined in the Optionee's
Employment Agreement);

(b) eighteen (18) months after the date the Optionee's
Employment is terminated by reason of Optionee's death; or

1.12. "Date of Grant" means the date set forth as the "Date of
Grant" on page 1 of this Agreement.

1.13. "Disability" means a physical or mental condition of
Optionee that, in the good faith judgment of not less than a majority of the
entire membership of the Board of Directors, prevents Optionee from being able
to perform the services required under his Employment Agreement with the Company
and which results in the Optionee becoming eligible for long-term disability
benefits (if such benefits are provided by the Company). If any dispute arises
as to whether a Disability has occurred, or whether a Disability has ceased and
the Optionee is able to resume duties, then such dispute shall be referred to a
licensed physician appointed by the president of the Medical Society or similar
organization in Washington, D.C., at the request of either party. The Optionee
shall submit to such examinations and provide information as such physician may

-2-
<PAGE>

request and the determination of such physician as to the Optionee's physical or
mental condition shall be binding and conclusive on the parties. The Company
shall pay the cost of any such physician and examination.

1.14. "Employment" means the Optionee's employment with the
Company and its Affiliates.

1.15. "Employment Agreement" means the Optionee's Employment
Agreement with the Company, as such may be amended, extended or supplemented
from time to time.

1.16. "Exchange Act" means the Securities Exchange Act of 1934, as
amended.

1.17. "Fair Market Value" means the amount equal to the closing
price for a share of Common Stock on the NASDAQ National Market System as
reported by such source as the Committee may select or, if such price is not so
reported, then the fair market value of a Share as determined by the Committee
pursuant to a reasonable method adopted in good faith for such purpose.

1.18. "NSO" shall have the meaning set forth in Section 3.1.

1.19. "Option" means the stock option granted to the Optionee in
Section 2 of this Agreement.

1.20. "Option Price" means the dollar amount per Share set forth
as the "Option Price" on page 1 of this Agreement.

1.21. "Optionee" means the person identified as the "Optionee" on
page 1 of this Agreement.

1.22. "Plan" means the American Capital Strategies, Ltd., 1997
Stock Option Plan.

1.23. "Securities Act" means the Securities Act of 1933, as
amended.

1.24. "Share" means a share of Common Stock.

2. Grant of Option. Pursuant to the Plan and subject to the terms of
this Agreement, the Company hereby grants to the Optionee the Option to purchase
from the Company that number of Shares equal to the Covered Shares, exercisable
at the Option Price.

-3-
<PAGE>

3. Terms of the Option.

3.1. Type of Option. The Option is intended to be an incentive stock
option within the meaning of Section 422 of the Code; provided, however, that to
the extent that, during any calendar year, the Option becomes exercisable for
the first time with respect Shares having an aggregate fair market value in
excess of the limit imposed by Section 422(d) of the Code, (a) the Option shall
be treated as a nonstatutory stock option (an "NSO") and not as an incentive
stock option to the extent required by Section 422(d) of the Code, and (b) upon
any exercise of the Option, the Optionee shall be required to designate the
extent to which, if any, the exercise of the Option is with respect that portion
of the Option that is a nonstatutory stock option pursuant to the preceding
clause (a). If, as of the same date, the Optionee exercises the Option with
respect to a portion of the Option that is an incentive stock option and with
respect to a portion of the Option that is a nonstatutory stock option, the
Company shall issue separate certificates to the Optionee representing (i) those
Shares that were acquired pursuant to the exercise of an incentive stock option
(which Shares shall be identified on the Company's stock transfer records as
such), and (ii) those Shares that were acquired pursuant to the exercise of a
nonstatutory stock option.

3.2. Exercise Period. During the period commencing on the Date of Grant
and terminating on the Date of Expiration, the Option may be exercised with
respect to all or a portion of the Covered Shares (in full shares), to the
extent that the Option has not been previously exercised with respect to such
Covered Shares.

3.3. Vesting Schedule. The Option to purchase all of the Covered Shares
shall be deemed to be vested as of the date of this Agreement, regardless of
whether such Covered Shares vested under the Old Option Agreement.

4. Exercise.

4.1. Notice. The Option shall be exercised, in whole or in part, by the
delivery to the Company of written notice of such exercise, in the form of
Exhibit A hereto or such other form as the Committee may from time to time
prescribe (an "Exercise Notice"), accompanied by (i) full payment of the Option
Price with respect to that portion of the Option being exercised and (ii) any
amounts required to be withheld pursuant to applicable tax laws in connection
with such exercise. Options may be exercised only with respect to whole numbers
of Shares. Until the Committee notifies the Optionee to the contrary, the form
attached to this Agreement as Exhibit A shall be used to exercise the Option.

4.2. Payment of the Option Price.

(a) Upon exercise of the Option, the Optionee shall pay the Option
Price and any applicable withholding tax amounts in cash or by a use of a
promissory note as contemplated by Section 7.3 of the Plan.

(b) The Optionee may also pay the Option Price, in whole or in
part, by delivering duly endorsed certificates representing, or duly executed
stock transfer instruments in respect of, a whole number of Shares (the
"Delivered Shares") having an aggregate value on the Date of Exercise
(determined based on the Fair Market Value) not more than the portion of the
Option Price being paid by delivery of such Shares, or in a combination of cash
and Shares. Notwithstanding the preceding sentence, no Shares may be used to pay
any portion of the Option Price unless those Shares were issued to the Optionee
at least six months prior to the Date of Exercise. In addition, with the prior

-4-
<PAGE>

written approval of the Committee, which approval shall be in the Committee's
sole discretion, the Optionee may also pay any applicable withholding tax
amounts, in whole or in part, by (i) authorizing the Company upon exercise of
the Option to withhold, or (ii) delivering duly endorsed certificates
representing or duly executed stock transfer instruments in respect of, a whole
number of Shares having an aggregate value on the Date of Exercise (determined
based on the Fair Market Value) not more than such withholding tax amounts. Upon
any exercise of an NSO in accordance with this Section 4.2(b), the Optionee, at
the option of the Committee, will be entitled to an increase in the number of
Covered Shares which are NSOs equal to the Delivered Shares.

(c) In addition, the Optionee may complete a "Net Issue Exercise"
by so indicating on the Exercise Notice and specifying the number of Shares to
be purchased. Upon such Net Issue Exercise, the Optionee shall be entitled to
receive Shares having an aggregate Fair Market Value equal to the product of (i)
the excess of the Fair Market Value per share over the sum of the Option Price
and any applicable tax withholding amounts per share and (ii) the number of
Shares to be purchased.

5. Restrictions on Transfer. Except by will or the laws of descent and
distribution, the Option may not be sold, transferred, assigned, pledged or
otherwise disposed of or encumbered by the Optionee, and any attempt to do so
shall be null and void. The Option may be exercised during the Optionee's
lifetime only by the Optionee or, in the event of the Optionee's legal
disability, by the Optionee's legal representative. Following Optionee's death,
the Option may be exercised by any transferee permitted by the first sentence of
this paragraph 5 or by the legal representative of Optionee's estate. The terms
of the Option shall be binding upon any successor or permitted assignee of the
Optionee.

6. Capital Adjustments. In the event of any change in the outstanding
Common Stock by reason of any stock dividend, split-up (or reverse stock split),
reclassification, reincorporation, liquidation or similar change in corporate
structure, the Committee shall, in its discretion, provide for a substitution
for or adjustment in (i) the number and class of Covered Shares and (ii) the
Option Price.

7. Restriction on Exercise and Upon Shares of Common Stock Issued Upon
Exercise. If requested by Optionee, the Company will use all reasonable efforts
to file promptly a registration statement under the Securities Act of 1933, as
amended, relating to the offer of Common Stock to the Optionee under the Plan
and to keep in effect such a registration statement until the Optionee has sold
all shares of Common Stock realized upon exercise of the Option. The Optionee
further agrees, for himself and his successors, that, upon the issuance of any
shares of Common Stock upon the exercise of the Option if such a registration is
not in effect, he will, upon the request of the Company, agree in writing that
he is acquiring such shares for investment only and not with a view to resale,
and that he will not sell, pledge or otherwise dispose of such shares so issued

-5-
<PAGE>

unless and until any of (a) the Company is furnished with an opinion of counsel
to the effect that registration of such shares pursuant to the Securities Act of
1933, as amended, is not required by that Act and the rules and regulations
thereunder; (b) the staff of the Securities and Exchange Commission has issued a
"no-action" letter with respect to such disposition; or (c) such registration or
notification as is, in the opinion of counsel for the Company, required for the
lawful disposition of such shares has been filed by the Company and has become
effective. The Optionee further agrees that under such circumstances the Company
may place a legend embodying such restriction on the certificates evidencing
such shares.

8. Rights as Stockholder. The Optionee shall have no rights as a
stockholder with respect to any Covered Shares until and unless a certificate or
certificates representing such shares are issued to the Optionee pursuant to
this Agreement. Except as provided in Section 6, no adjustment shall be made for
dividends or other rights for which the record date is prior to the issuance of
such certificate or certificates.

9. Employment. Neither the granting of the Option evidenced by this
Agreement nor any term or provision of this Agreement shall constitute or be
evidence of any understanding, express or implied, on the part of the Company or
any of its Affiliates to employ the Optionee (or have the Optionee serve as a
director) for any period.

10. Subject to the Plan. The Option evidenced by this Agreement and the
exercise thereof are subject to the terms and conditions of the Plan, which are
incorporated herein by reference and made a part hereof, but the terms of the
Plan shall not be considered an enlargement of any benefits under this
Agreement; provided, however, that the Plan shall not be amended in a manner
that would be adverse to the rights of Optionee hereunder unless such amendment
is required by law. In addition, the Option is subject to any rules and
regulations promulgated by the Committee pursuant to the Plan.

11. Notice. All notices or other communications which are required or
permitted hereunder shall be in writing and sufficient if delivered personally,
by facsimile or sent by overnight express or by registered or certified mail,
postage prepaid, addressed as follows:

If to the Company to:

American Capital Strategies, Ltd.
3 Bethesda Metro Center, Suite 860
Bethesda, MD 20814
Attention: Chief Financial Officer
Facsimile: 301-654-6714

If to the Optionee, to the address set forth beneath the Optionee's signature on
the signature page hereof.

-6-

<PAGE>

All deliveries of notice shall be deemed effective when received by the
person entitled to such receipt or when delivery has been attempted but refused
by such person. Any party may change the person or address to which such
deliveries shall be made with respect to such party by delivering notice thereof
to the other party hereto in accordance with this Section 11.

IN WITNESS WHEREOF, the Company has caused this Agreement to be signed
on its behalf effective as of the 18th day of August, 1998.

AMERICAN CAPITAL
STRATEGIES, LTD.

By:
---------------------------
Malon Wilkus, President

Accepted and agreed to as of the 18th day of August, 1998.

- ----------------------------
David J. Gladstone
1161 Crest Lane
McLean, Virginia 22101

-7-
<PAGE>

EXHIBIT A

EXERCISE OF OPTION

Board of Directors
American Capital Strategies, Ltd.
3 Bethesda Metro Center, Suite 860
Bethesda, MD 20814

Ladies and Gentlemen:

The undersigned, the Optionee under the Stock Option Agreement, as
amended to date, identified as Option No. ______ (the "Agreement"), granted
pursuant to the American Capital Strategies, Ltd. 1997 Stock Option Plan (the
"Plan"), hereby irrevocably elects to exercise the option granted in such
Agreement (the "Option") to purchase [whole numbers only] shares of Common
Stock, par value $0.01 per share, (the "Shares") of American Capital Strategies,
Ltd. (the "Company"), and herewith [makes payment of $ in cash] [delivers Shares
with a values of $_______] [makes a "Net Exercise"]

The Optionee hereby represents and warrants that he has received and
reviewed a copy of the Plan.

Dated: ---------------------------
--------------------- Signature of Optionee)

Date Received by
American Capital Strategies, Ltd.:

Received by:
------------------

<PAGE>

APPENDIX B
CERTAIN SUBJECT INVESTMENTS
-----------------------------

US Investigations Services, Inc.

Arrow Shirt Company

Gans Tire, Inc.

National Forge Co.

Those entities listed on the attached Company deal stream report

<PAGE>

Deal Stream Report

1 7-Iron - 02
2 Piedmont - 91
3 Porky - 54
4 Bike - 97
5 Fast - 63
6 Tyco - 59
7 Bicycle - 22
8 Cowboy
9 Knish
10 Cats
11 Blue Angel - 18
12 Expansion - 82
13 Tonka - 25
14 Shamu
15 On Time - 30
16 Horse
17 Sweepstakes
18 Nightlight - 5
19 Portage - 94
20 Knights - 57
21 Cheese
22 Laurel - 17
23 Homestead
24 Spurs - 98
25 Wire - 65
26 Upstream - 87
27 Robinson
28 Suround - 62
29 Dough - 53
30 Bridge - 92

<ARTICLE> 6
<LEGEND>
This schedule contains financial information extracted from the financial
statement of American Capital Strategies, Ltd. for the three months ended
September 30, 1998 and is qualified in entirety by reference to such financial
statements.
</LEGEND>
<CIK> 0000817473
<NAME> American Capital Strategies, Ltd.
<MULTIPLIER> 1000
<CURRENCY> U.S. Dollars

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1.000
<INVESTMENTS-AT-COST> 181,247
<INVESTMENTS-AT-VALUE> 182,331
<RECEIVABLES> 1,580
<ASSETS-OTHER> 28
<OTHER-ITEMS-ASSETS> 6,897
<TOTAL-ASSETS> 197,579
<PAYABLE-FOR-SECURITIES> 44,993
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 144
<TOTAL-LIABILITIES> 45,137
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 145,147
<SHARES-COMMON-STOCK> 11,077
<SHARES-COMMON-PRIOR> 11,069
<ACCUMULATED-NII-CURRENT> 696
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 6,599
<NET-ASSETS> 152,442
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 4,090
<OTHER-INCOME> 672
<EXPENSES-NET> 496
<NET-INVESTMENT-INCOME> 3,900
<REALIZED-GAINS-CURRENT> 0
<APPREC-INCREASE-CURRENT> 924
<NET-CHANGE-FROM-OPS> 4,824
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 3,545
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 8
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> 0
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 0
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 496
<AVERAGE-NET-ASSETS> 151,755
<PER-SHARE-NAV-BEGIN> 13.65
<PER-SHARE-NII> 0.35
<PER-SHARE-GAIN-APPREC> 0.08
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> .32
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 13.76
<EXPENSE-RATIO> 0.003
<AVG-DEBT-OUTSTANDING> 34,868
<AVG-DEBT-PER-SHARE> 3.15

</TABLE>