American Capital Strategies Ltd - Definitive materials filed by investment companies. (497)

FEES AND EXPENSES

The following table will assist you in understanding the various costs and expenses that an investor in our common stock will bear directly or indirectly.

Example

The following example demonstrates the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in our common stock. These amounts are based upon payment by an investor of an assumed 4.50% sales load and payment by us of operating expenses at the levels set forth in the table above.

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This example should not be considered a representation of our future expenses, and actual expenses may be greater or less than those shown. Moreover, while the example assumes (as required by the SEC) a 5% annual return, our performance will vary and may result in a return greater or less than 5%. In addition, while the example assumes reinvestment of all dividends and distributions at net asset value, participants in our dividend reinvestment plan (the “Dividend Reinvestment Plan”) may receive shares purchased by the administrator of the Dividend Reinvestment Plan at the market price in effect at the time, which may be at, above or below net asset value. See “Dividend Reinvestment Plan” in “Recent Developments” in the accompanying prospectus.

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Dividend

On October 30, 2007, we announced a dividend of $1.00 per share for the fourth quarter of 2007. The dividend will be paid on January 16, 2008, to stockholders of record as of December 7, 2007.

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USE OF PROCEEDS

We will not initially receive any proceeds from the sale of the shares of common stock borrowed and sold by the forward purchasers under the November 2007 Forward Sale Agreements. If we elect to settle the November 2007 Forward Sale Agreements at the assumed initial forward sale price of $38.49 per share (which reflects a reduction for the underwriting discount), we estimate that we would receive net proceeds of approximately $154 million upon settlement of the November 2007 Forward Sale Agreements after deducting estimated expenses payable by us. A $1.00 increase (decrease) in the assumed initial forward sale price of $38.49 per share (which reflects a reduction for the underwriting discount) would increase (decrease) our estimated net proceeds from the settlement of the November 2007 Forward Sale Agreements by approximately $4 million, assuming the number of shares under the November 2007 Forward Sale Agreements, as set forth on the cover page of this prospectus supplement, remains the same and after deducting the underwriting discounts and commission and estimated expenses payable by us. Settlement of the November 2007 Forward Sale Agreements will occur on a date or dates specified by us within approximately twelve months of the date of this prospectus supplement. The forward sale price under the November 2007 Forward Sale Agreements is subject to daily adjustment for an interest factor, and quarterly and annual decreases, each as described below under “Underwriting—Forward Sale Agreements.” We intend to use the net proceeds that we receive from the exercise of the over-allotment option, if any, and upon the subsequent settlement of the November 2007 Forward Sale Agreements for general corporate purposes, including for our investment and lending activities and to repay indebtedness owed under our existing commercial paper conduit securitization facility administered by Wachovia Capital Markets, LLC (the “AFT I Facility”) and our unsecured line of credit administered by an affiliate of Wachovia Capital Markets, LLC (the “New Revolving Facility,” the New Revolving Facility and the AFT I Facility are collectively referred to herein as the “Current Debt Facilities”). This repayment will create availability under the Current Debt Facilities which will generally be available for funding our future investments. The interest rates on the Current Debt Facilities vary from time to time based on certain indices. As of November 9, 2007, the weighted average interest rates on the AFT I Facility and the New Revolving Facility were 5.85% and 5.68%, respectively. Our ability to make draws under the AFT I Facility and the New Revolving Facility expires in October 2008 and May 2012, respectively, unless extended.

Each forward purchaser under a November 2007 Forward Sale Agreement will have the right to accelerate its forward sale agreement and require us to settle physically on a date specified by such forward purchaser if (1) in its judgment, it is unable to continue to borrow a number of shares of our common stock equal to the number of shares to be delivered by us under its November 2007 Forward Sale Agreement or the cost of borrowing the common stock has increased above a specified amount, (2) we declare any dividend or distribution, in each case, on shares of our common stock payable in (i) cash in excess of a specified amount, (ii) securities of another company, or (iii) any other type of securities (other than shares of our common stock), rights, warrants or other assets, (3) the net asset value per share of our outstanding common stock, as calculated by us, exceeds a specified percentage of the then applicable forward sale price, (4) our board of directors votes to approve a merger or takeover of us or other similar transaction that would require our stockholders to exchange their shares for cash, securities or other property, or (5) certain other events of default or termination events occur, including, among other things, any material misrepresentation was made in connection with entering into that agreement, the occurrence of a nationalization or delisting of our common stock from The NASDAQ Global Select Market. Such forward purchaser’s decision to exercise its right to require us to settle its November 2007 Forward Sale Agreement will be made irrespective of our need for capital. In addition, upon certain events of bankruptcy, insolvency or reorganization relating to us, each November 2007 Forward Sale Agreement will terminate without further liability of either party. Following any such termination, we would not issue any shares and we would not receive any proceeds pursuant to the November 2007 Forward Sale Agreements. Delivery of our shares on any settlement of the November 2007 Forward Sale Agreements will result in dilution to our earnings per share and return on equity.

Before the issuance of our common stock upon settlement of the November 2007 Forward Sale Agreements, the November 2007 Forward Sale Agreements will be reflected in our diluted earnings per share calculations

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using the treasury stock method. Under this method, the number of shares of our common stock used in calculating diluted earnings per share is deemed to be increased by the excess, if any, of the number of shares that would be issued upon physical settlement of the November 2007 Forward Sale Agreements over the number of shares that could be purchased by us in the market (based on the average market price during the reporting period) using the proceeds receivable upon settlement (based on the expected lowest possible adjusted forward sale price under the forward sale agreements).

Reason for Use of Forward Sale Agreements

Our objective with the use of forward sale agreements is to allow us to manage more efficiently our debt to equity ratio, considering applicable statutory requirements and our capital needs associated with funding our investing activities. As a BDC, under the Investment Company Act of 1940, as amended (the “1940 Act”), we are able to issue debt securities and preferred stock in an amount such that our “asset coverage” (as defined in the 1940 Act) is at least 200% of the amount of our outstanding debt securities and preferred stock. Because we do not currently have any preferred stock outstanding, this provision of the 1940 Act effectively limits our ratio of debt to equity at this time to 1:1. However, as a practical matter, in order to provide sufficient flexibility to fund our projected investments and a cushion, we must generally keep our debt to equity ratio somewhat below 1:1. At September 30, 2007, for example, our ratio of debt to equity was 0.7:1.

A principal consideration in keeping our debt to equity ratio at less than 1:1 is that given the nature and variability of the equity capital markets, it is not practical to raise equity in frequent, small increments, which would match in amount and timing our needs for investment funds. Thus, we are required to raise equity in larger increments than may be immediately invested and, therefore, we repay advances on our credit facilities with the proceeds of such equity issuances. We then make investments and manage our cash needs by drawing on our credit facilities. The funding sequence of issuing equity, repaying our credit facilities and then drawing on the credit facilities to fund new investments causes our average debt to equity ratio to be materially below 1:1. Moreover, because we cannot be assured that access to equity markets will be available whenever we may need equity capital to make a new investment, we would need to generally keep our credit availability somewhat higher and our debt to equity ratio materially lower than it would otherwise be if we were more readily assured of access to equity capital.

The use of forward sale agreements generally allows us to deliver common stock and receive cash at our election, to the extent covered by outstanding agreements, without undertaking a new offering of common stock. Because we are more assured of access to equity capital, we expect to be in a position to allow our debt to equity ratio to be closer to 1:1 than without the use of forward sale agreements. During periods in which we have reported earnings, having a higher debt to equity ratio would have a beneficial effect on our overall cost of capital, which could result in increased earnings.

Example

For example, assume hypothetical XYZ Corporation had $700,000 in debt and $1,000,000 in equity resulting in a debt to equity ratio of 0.7 to 1. In addition, assume that XYZ Corporation was able to borrow additional debt capital at a cost of 4% per annum and invest the proceeds into investments that yield a 12% per annum after-tax return and it has diluted shares of common stock outstanding of 75,000 shares. If XYZ Corporation were able to increase its leverage to 0.8 to 1 by borrowing an additional $100,000 and investing the proceeds based on the terms above, it may be able to increase its earnings by $0.11 per share. Further, if XYZ Corporation were able to increase its leverage to 0.9 to 1 by borrowing an additional $200,000 and investing the proceeds based on the terms above, it may be able to increase its earnings by $0.21 per share. The preceding example is not reflective of any actual results and is intended as illustration only. For information about the risks associated with leverage, see Risk Factors, “Our business is dependent on external financing” and “We may incur additional debt that could increase your investment risks” in the accompanying prospectus.

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CAPITALIZATION

(in millions, except per share data)

The following table sets forth (a) our actual cash and capitalization at September 30, 2007, and (b) our cash and capitalization at September 30, 2007, as adjusted to reflect the effects of the assumed settlement of all of the shares outstanding as of September 30, 2007 under the forward sales agreements that we entered into in June 2007 with Citigroup Global Markets Inc. and an affiliate of each of Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wachovia Capital Markets, LLC (the “June 2007 Forward Sale Agreements”) at the forward sale price in effect as of September 30, 2007, the assumed settlement of all of the shares outstanding as of September 30, 2007 under the forward sales agreements that we entered into in September 2007 with Citigroup Global Markets Inc., UBS Securities LLC and Wachovia Capital Markets, LLC or certain of their respective affiliates (the “September 2007 Forward Sale Agreements”) at the forward sale price in effect as of September 30, 2007 and (c) our cash and cash equivalents and our capitalization at September 30, 2007 on a pro forma as adjusted basis to reflect the shares and issuances referenced in (b) above and the assumed settlement of the November 2007 Forward Sale Agreements at the assumed initial forward sale price, and the application of substantially all of the net proceeds to repay our existing indebtedness as set forth under “Use of Proceeds.”

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UNDERWRITING

Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc. and UBS Securities LLC and are the representatives of the underwriters named below. Subject to the terms and conditions stated in the underwriting agreement, dated the date of this prospectus supplement, among us, the forward purchasers and the underwriters, the forward purchasers, at our request, are borrowing and selling an aggregate of 4,000,000 shares of our common stock to the underwriters, and each underwriter named below, through their representatives, has severally agreed to purchase from the forward purchasers, the number of shares set forth opposite the underwriter’s name below.

The underwriting agreement provides that the obligations of the underwriters to purchase the shares of common stock included in this prospectus supplement are subject to certain conditions precedent, including the absence of any material adverse change in our business and the receipt of certain certificates, opinions and letters from us, our counsel and our independent registered public accounting firm. The underwriters are committed to purchase all shares of common stock offered by this prospectus supplement, other than those shares covered by the over-allotment option described below, if they purchase any shares of our common stock.

The underwriters propose to offer shares of our common stock directly to the public at the public offering price set forth on the cover page of this prospectus supplement and to dealers at the public offering price less a concession not in excess of $             per share. The underwriters may allow, and such dealers may re-allow, a discount not in excess of $             per share to certain other dealers. If all of the shares are not sold at the public offering price, the public offering price and other selling terms may change.

The offering of our common stock is made for delivery when, as and if accepted by the underwriters and subject to prior sale and to withdrawal, cancellation or modification of the offering without notice. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part.

Over-allotment Option

We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus supplement, to purchase up to 600,000 additional shares at the public offering price less the underwriting discount. The underwriters may exercise the option solely for the purpose of covering over-allotments, if any, in connection with this offering. If the underwriters exercise this option, each will be obligated, subject to conditions contained in the underwriting agreement, to purchase a number of additional shares approximately proportionate to that underwriter’s initial amount reflected in the above table.

Underwriting Discounts and Commissions

The following table shows the per share underwriting discount that we and the forward purchasers are to pay to the underwriters in connection with this offering. The initial forward sale price to be paid to us under each November 2007 Forward Sale Agreement reflects a reduction for this underwriting discount. Such amounts are shown assuming (a) both no exercise and full exercise of the underwriters’ over-allotment option to purchase

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additional shares and (b) that the November 2007 Forward Sale Agreements are settled based upon the aggregate initial forward sale price of $            , without reference to the adjustments described herein.

Based on these assumptions, we would receive proceeds of $             million, net of the underwriting discount and estimated offering expenses, subject to certain adjustments as described above, upon settlement of the November 2007 Forward Sale Agreements, which will be within twelve months of the date of this prospectus supplement. We estimate that our portion of the total expenses of this offering, excluding the underwriting discounts, will be approximately $270,000.

Indemnity

We have agreed to indemnify the underwriters and the forward purchasers against certain liabilities, including liabilities under the Securities Act of 1933, or to contribute to payments the underwriters or the forward purchasers may be required to make because of any of those liabilities.

The NASDAQ Global Select Market

Our common stock is quoted on The NASDAQ Global Select Market under the symbol “ACAS.”

Forward Sale Agreements

We have entered into the November 2007 Forward Sale Agreements with Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc., and UBS Securities LLC as forward purchasers, relating to an aggregate of 4,000,000 shares of our common stock. In connection with the execution of the November 2007 Forward Sale Agreements and at our request, an affiliate of Morgan Stanley & Co. Incorporated is borrowing and selling in this offering             shares of our common stock, an affiliate of Bear, Stearns & Co. Inc. is borrowing from third party market sources and selling in this offering             shares of our common stock and an affiliate of UBS Securities LLC is borrowing from third party market sources and selling in this offering             shares of our common stock. If, in its sole judgment, a forward purchaser under a November 2007 Forward Sale Agreement is unable to borrow, at a cost not greater than a specified amount per share, and deliver for sale on the anticipated closing date of the offering all of the shares of our common stock to which that agreement relates, then the number of shares of our common stock to which that agreement relates will be reduced to the number that the forward purchaser can so borrow and deliver at such a cost. If, in its judgment, a forward purchaser under a November 2007 Forward Sale Agreement is unable to borrow, at a cost not greater than a specified amount per share, and deliver for sale on the anticipated closing date of the offering any shares of our common stock, then that agreement will be terminated in its entirety. In the event that the number of shares relating to a November 2007 Forward Sale Agreement is so reduced, or a forward sale agreement is so terminated, we will issue directly to the underwriters under the underwriting agreement a number of shares of our common stock equal to the number of shares not borrowed and delivered by any forward purchaser, so that the total number of shares offered in this offering is not reduced. In such event, the representatives of the underwriters will have the right to postpone the closing date for one day to effect any necessary changes to any documents or arrangements in connection with such closing.

Prior to settlement under the November 2007 Forward Sale Agreements, the forward purchasers or other affiliates of each of Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc. and UBS Securities LLC will hold the net proceeds from the sale of the borrowed shares of our common stock sold in this offering. We will

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receive an amount equal to the net proceeds from the sale of the borrowed shares of our common stock sold in this offering, subject to certain adjustments pursuant to the November 2007 Forward Sale Agreements, from the forward purchasers upon settlement of the November 2007 Forward Sale Agreements.

The November 2007 Forward Sale Agreements provide for settlement on a settlement date or dates to be specified at our discretion within approximately twelve months of the date of this prospectus supplement. On a settlement date under a November 2007 Forward Sale Agreement; we will issue shares of our common stock to the applicable forward purchaser at the then-applicable forward sale price. The forward sale price under each November 2007 Forward Sale Agreement will initially be $38.49 per share, which is the assumed public offering price of our shares of common stock less the underwriting discount. The November 2007 Forward Sale Agreements provide that the initial forward sale price per share will be subject to daily adjustment based on a floating interest factor equal to the federal funds rate, less a spread of 0.50%, and will be subject to decrease by $1.00, $1.01, $1.03 and $1.05 on each of December 7, 2007, March 7, 2008, June 13, 2008 and September 12, 2008, respectively. The forward sale price will also be subject to decrease if the cost to the forward purchasers of borrowing our common stock exceeds a specified amount. If the federal funds rate is less than the spread on any day, the interest factor will result in a daily reduction of the forward sale price. As of the date of this prospectus supplement, the federal funds rate was greater than the spread. Because the quarterly adjustments are expected to be larger than the cumulative effect of the interest factor, we expect the cumulative net effect of these adjustments to result in a decrease in the forward sale price over time.

Example

The following example demonstrates the effect of the daily and quarterly adjustments to the initial forward sale price at various assumed settlement dates during the applicable twelve month settlement period. The daily adjustment to the initial forward price is based on an assumed constant federal funds rate of 4.61% ¹ and a spread of 0.50%.

Each of the forward purchasers under its November 2007 Forward Sale Agreement will have the right to accelerate its forward sale agreement and require us to physically settle on a date specified by such forward purchaser if (1) in its judgment, it is unable to continue to borrow a number of shares of our common stock equal to the number of shares to be delivered by us under its agreement or the cost of borrowing the common stock has increased above a specified amount, (2) we declare any dividend or distribution, in each case, on shares of our common stock payable in (i) cash in excess of a specified amount, (ii) securities of another company, or (iii) any other type of securities (other than our common stock), rights, warrants or other assets, (3) the net asset value per share of our common stock, as calculated by us, exceeds a specified percentage of the then-applicable forward sale price, (4) our board of directors votes to approve a merger or takeover of us or other similar transaction that would require our stockholders to exchange their shares of common stock for cash, securities or other property, or (5) certain other events of default or termination events occur, including, among other things, any material misrepresentation made in connection with entering into that agreement, the occurrence of a nationalization or delisting of our common stock from The NASDAQ Global Select Market. Such forward purchaser’s decision to exercise its right to require us to settle its November 2007 Forward Sale Agreement will be made irrespective of our need for capital. In addition, upon certain events of bankruptcy, insolvency or reorganization relating to us, each November 2007 Forward Sale Agreement will terminate without further liability of either party.

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Stabilization

In connection with the offering, the underwriters may purchase and sell shares of our common stock in the open market. These transactions may include short sales, covering transactions and stabilizing transactions. Short sales involve sales of our common stock in excess of the number of shares to be purchased by the underwriters in the offering, which creates a short position. “Covered” short sales are sales made in an amount up to the number of shares represented by the underwriters’ over-allotment option. In determining the source of shares to close out the covered syndicate short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market compared to the price at which they may purchase shares through the over-allotment option. Transactions to close out the covered short position involve either purchases of the common stock in the open market after the distribution has been completed or the exercise of the over-allotment option. The underwriters may also make “naked” short sales of shares in excess of the over-allotment option. The underwriters must close out any naked short position by purchasing shares of common stock in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of bids for or purchases of common shares made by the underwriters in the open market prior to completion of the offering.

The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the other underwriters a portion of the underwriting discount received by it because the representatives have repurchased shares hold by or for the account of such underwriter in stabilizing or short covering transactions.

Any of these activities may have the effect of preventing or retarding a decline in the market price of the common stock. They may also cause the price of the common stock to be higher than the price that would otherwise exist in the open market in the absence of these transactions. The underwriters may conduct these transactions on The NASDAQ Global Select Market or in the over-the-counter market, or otherwise. If the underwriters commence any of these transactions, the underwriters may discontinue them at any time.

Purchases to cover a short position and stabilizing transactions may have the effect of preventing or retarding a decline in the market price of the common stock, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on The NASDAQ Global Select Market, in the over-the-counter market or otherwise.

In addition, in connection with this offering, the underwriters may engage in passive market making transactions in the common stock on The NASDAQ Global Select Market, prior to the pricing and completion of the offering. Passive market making consists of displaying bids on The NASDAQ Global Select Market no higher than the bid prices of independent market makers and making purchases at prices no higher than those independent bids and effected in response to order flow. Net purchases by a passive market maker on each day are limited to a specified percentage of the passive market maker’s average daily trading volume in the common stock during a specified period and must be discontinued when that limit is reached. Passive market making may cause the price of the common stock to be higher than the price that otherwise would exist in the open market in the absence of those transactions. If the underwriters commence passive market making transactions, the underwriters may discontinue them at any time.

Other Relationships

Certain of the underwriters and their affiliates have performed investment banking and advisory services for us from time to time for which they have received customary fees and expenses. The underwriters and their affiliates may, from time to time, engage in transactions with and perform services for us in the ordinary course of their business. As discussed above, each of Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc. and UBS Securities LLC and or one of their affiliates have entered into the November 2007 Forward Sale Agreements.

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Certain of the net proceeds from the sale of our common stock, not including underwriting compensation, will be paid to affiliates of Bear, Stearns & Co. Inc., UBS Securities LLC, RBC Capital Markets Corporation and Morgan Keegan & Company, Inc., each an underwriter, in connection with the repayment of debt owed under the New Revolving Facility. Accordingly, this offering is being conducted pursuant to Rule 2710(h) of the National Association of Securities Dealers, Inc.

Electronic Prospectus Delivery

A prospectus in electronic format may be made available on the websites maintained by one or more of the underwriters. In connection with this offering, certain of the underwriters or securities dealers may distribute prospectuses electronically. The representatives may agree to allocate a number of shares of our common stock to underwriters for sale to their online brokerage account holders. The representatives will allocate shares of our common stock to underwriters that may make Internet distributions on the same basis as other allocations. Other than the prospectus in electronic format, the information on any of these websites and any other information contained on a website maintained by an underwriter or syndicate member is not part of this prospectus.

The principal business address for Morgan Stanley & Co. Incorporated is 1585 Broadway, New York, New York, 10036. The principal business address for Bear, Stearns & Co. Inc. is 383 Madison Avenue, New York, New York, 10179. The principal business address for UBS Securities LLC is 299 Park Avenue, New York, New York 10171.

European Economic Area

In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive, each underwriter has represented and agreed that, with effect from and including the date on which the Prospectus Directive is implemented in that Member State, it has not made and will not make an offer of shares of our common stock to the public in that Member State except that it may, with effect from and including such date, make an offer of shares of our common stock to the public in that Member State:

For the purposes of the above, the expression an “offer of shares of our common stock the public” in relation to any shares of our common stock in any Member State means the communication in any form and by any means of sufficient information on the terms of the offer and the shares of our common stock to be offered so as to enable an investor to decide to purchase or subscribe the shares of our common stock, as the same may be varied in that Member State by any measure implementing the Prospectus Directive in that Member State, and the expression Prospectus Directive means Directive 2003/71/EC and includes any relevant implementing measure in that Member State.

United Kingdom

Each underwriter has represented and agreed that it has only communicated or caused to be communicated and will only communicate or cause to be communicated an invitation or inducement to engage in investment activity (within the meaning of Section 21 of the Financial Services and Markets Act 2000) in connection with the issue or sale of the shares of our common stock in circumstances in which Section 21(1) of such Act does not apply to us and it has complied and will comply with all applicable provisions of such Act with respect to anything done by it in relation to any shares of our common stock in, from or otherwise involving the United Kingdom.

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TAXATION

The following discussion is a general summary of the material U.S. federal income tax considerations applicable to us and to an investment in our common stock and does not purport to be a complete description of the income tax considerations applicable to such an investment. The discussion is based upon the Internal Revenue Code of 1986, as amended (the “Code”), Treasury Regulations thereunder, and administrative and judicial interpretations thereof, each as of the date hereof, all of which are subject to change, possibly on a retroactive basis. Prospective stockholders should consult their own tax advisors with respect to tax considerations which pertain to their purchase of our common stock. This summary assumes that the investors in our business hold our common stock as capital assets. This summary does not discuss all aspects of U.S. federal income taxation relevant to holders of our common stock in light of their particular circumstances, or to certain types of holders subject to special treatment under federal income tax laws, including foreign taxpayers (except as discussed below), dealers in securities, financial institutions, qualified plans and individual retirement accounts. This summary does not discuss any aspects of foreign, state or local tax laws. Unless otherwise stated, this summary deals only with stockholders who are United States persons. A United States person generally is:

Taxation as a RIC

We have operated since October 1, 1997, so as to qualify to be taxed as a RIC as defined in Subtitle A, Chapter 1, under Subchapter M of the Code. If we qualify as a RIC and annually distribute to our stockholders in a timely manner at least 90% of our “investment company taxable income,” as defined in the Code, we will not be subject to federal income tax on the portion of our taxable income and capital gains we distribute to stockholders. “Investment company taxable income” generally means our taxable income, including net short-term capital gains but excluding net long-term capital gains. We will be subject to U.S. federal income tax at regular corporate rates on any income or capital gain not distributed (or deemed distributed) to our stockholders. In addition, we will be liable for a nondeductible federal excise tax of 4% on our undistributed income unless for each calendar year we distribute (including through “deemed distributions” as described below) an amount equal to or greater than the sum of (a) 98% of our “ordinary income” (generally, our taxable income excluding net short-term and long-term capital gains), (b) 98% of our “capital gain net income” (including both net short-term and long-term capital gains) realized for the 12-month period ending October 31 of such calendar year, and (c) any shortfall in distributing all ordinary income and capital gain net income for the prior calendar year.

Our income for tax purposes, which determines the required distributions, may differ from our income as measured for other purposes. If we invest in certain options, futures, and forward contracts, we may be required to recognize unrealized gains and losses on those contracts at the end of our taxable year. In such event, 60% of any net gain or loss will generally be treated as long-term capital gain or loss and the remaining 40% of such net gain or loss will be treated as short-term capital gain or loss, regardless of our holding period for the investment and of the fact that we may not eventually experience such gain or loss. If we engage in certain hedging transactions, the results may be treated as a deemed sale of appreciated property, which may accelerate the gain on the hedged transaction.

If we acquire or are deemed to have acquired debt obligations that were issued originally at a discount or that otherwise are treated under applicable tax rules as having original issue discount, we will be required to

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include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether we receive cash representing such income in the same taxable year, and to make distributions accordingly.

In order to qualify as a RIC for federal income tax purposes, we must, among other things: (a) continue to qualify as a BDC under the 1940 Act; (b) derive in each taxable year at least 90% of our gross income from dividends, interest, net income from certain publicly traded partnerships, payments with respect to securities loans, gains from the sale of stock or other securities or other income derived with respect to our business of investing in such stock or securities; and (c) diversify our holdings so that at the end of each quarter of the taxable year (i) at least 50% of the value of our assets consists of cash, cash items, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or 10% of the outstanding voting securities of the issuer, and (ii) no more than 25% of the value of our assets are invested in securities of one issuer (other than U.S. government securities or securities of other RICs), or two or more issuers that are controlled (as determined under applicable code rules) by us and are engaged in the same or similar or related trades or businesses.

If we fail to satisfy the 90% distribution requirement or otherwise fail to qualify as a RIC in any taxable year, we will be subject to tax in such year on all of our taxable income, regardless of whether we make any distributions to our stockholders. In addition, in that case, all of our distributions to our stockholders will be characterized as ordinary income (to the extent of our current and accumulated earnings and profits). In contrast, as is explained below, if we qualify as a RIC, a portion of our distributions may be characterized as long-term capital gain in the hands of stockholders.

We received a ruling from the Internal Revenue Service (the “IRS”) clarifying the tax consequences of our conversion to a RIC, especially with regard to the treatment of unrealized gain inherent in our assets (approximately $6.3 million) upon our conversion to RIC status (“built-in gain”). Under the terms of the ruling and applicable law, if we realize or are treated as realizing any of the built-in gain before October 1, 2007, we generally will be liable for corporate level federal income tax on the gain, which could not be avoided by our payment of dividends. As of September 30, 2007, none of the built-in gain from our conversion to a RIC was realized.

Our wholly-owned consolidated subsidiary, American Capital Financial Services, Inc., is an ordinary corporation that is subject to corporate level federal and state income tax. We also own all of the equity interests issued by ACS Funding Trust I, a statutory trust, ACAS Business Loan LLC, 2004-1, a limited liability company, ACAS Business Loan LLC, 2005-1, a limited liability company, ACAS Business Loan LLC, 2006-1, a limited liability company, ACAS Business Loan LLC, 2007-1, a limited liability company and ACAS Master Business Loan LLC, a limited liability company. These subsidiaries are disregarded as separate entities for federal income tax purposes.

Taxation of Stockholders

Our distributions generally are taxable to you as ordinary income or capital gains. Our stockholders receive notification from us at the end of the year as to the amount and nature of the income or gains distributed to them for that year. The distributions from us to a particular stockholder may be subject to the alternative minimum tax under the provisions of the Code.

Our dividends that are derived from interest income or short-term capital gains are taxable to you as ordinary income. Dividends paid to individuals before January 1, 2009 are eligible to be taxed at the tax rates applicable to long-term capital gains to the extent, if any, such dividends are derived from dividend income we receive. Distributions of net long-term capital gain, if any, that we designate as capital gain dividends generally will be taxable to you as a long-term capital gain, regardless of the length of time you have held the shares. All distributions are taxable, whether invested in additional shares or received in cash.

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If we retain any net long-term capital gains, we may designate them as “deemed distributions” and pay tax on them for the benefit of our stockholders. Stockholders would then report their share of the retained capital gains on their tax returns as if it had been received, and report a credit for the tax paid thereon by us. Stockholders add the amount of the deemed distribution, net of such tax, to the stockholder’s basis in his, her or its shares. If we elect to retain any net long-term capital gains and pay tax on such capital gains at the regular corporate tax rate and the maximum rate payable by individuals on such gains is lower, the amount of the credit that individual stockholders may report would exceed the amount of tax that they would be required to pay on the capital gains, allowing recovery of the difference in the tax otherwise owed by, or refunds due to, such stockholders.

In general, any gain or loss realized upon a taxable disposition of our shares, or upon receipt of a liquidating distribution, will be treated as capital gain or loss. If you realize a gain, it will be subject to taxation at various tax rates depending on the length of time you have held such shares and other factors. The gain or loss will be short-term capital gain or loss if you have held the shares for one year or less. If you receive a capital gain dividend, or deemed distributions, with respect to such shares, any loss you realize upon a taxable disposition of shares you held for six months or less will be treated as a long-term capital loss, to the extent of such capital gain dividends, or deemed distributions. Capital losses can be deducted by corporations only to the extent of capital gains. Individuals can deduct capital losses to the extent of capital gains, and then up to $3,000 of other income annually. All or a portion of any loss you realize upon a taxable disposition of our shares may be disallowed if you purchase other shares of ours, under the Dividend Reinvestment Plan or otherwise, within 30 days before or after the disposition.

If you are not a “United States person” (a “Non-U.S. stockholder”) you will generally be subject to a withholding tax of 30%, or lower applicable treaty rate, on dividends from us, other than capital gain dividends, that are not “effectively connected” with your United States trade or business. Non-effectively connected capital gain dividends and gains realized from the sale of the common stock will not be subject to United States federal income tax in the case of (a) a Non-U.S. stockholder that is a corporation, and (b) a Non-U.S. stockholder that is not present in the United States for more than 182 days during the taxable year, assuming that certain other conditions are met. Special rules exempt certain dividends we pay before October 1, 2008 from withholding tax. Under those rules, a Non-U.S. stockholder will not be subject to United States withholding tax on any “interest-related dividend,” or “short-term capital gain dividend.” An interest-related dividend is any dividend (or portion thereof) which is attributable to qualified net interest income we received, as long as the interest is not attributable to indebtedness owed to the Non-U.S. stockholder or any corporation or partnership in which the Non-U.S. stockholder owns a 10% or greater interest and the Non-U.S. stockholder certifies to us that it is not a United States person. A “short-term capital gain dividend,” is any dividend (or portion thereof) which is attributable to the excess of our short-term capital gain over our short-term capital loss if the dividend is received by a Non-U.S. shareholder that is a corporation or an individual who has not been present in the United States for more than 182 days during the taxable year. We must designate a dividend as an interest-related dividend or a short-term capital gain dividend in a written notice mailed to our stockholders within 60 days after the close of our taxable year.

Prospective foreign investors should consult their U.S. tax advisors concerning the tax consequences to them of an investment in the common stock.

We are required to withhold and remit to the IRS a portion of the dividends paid to any stockholder who (a) fails to furnish us with a certified taxpayer identification number; (b) has underreported dividend or interest income to the IRS; or (c) fails to certify to us that he, she or it is not subject to backup withholding.

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LEGAL MATTERS

We were represented in this offering by Arnold & Porter LLP, Washington, D.C. The underwriters were represented in this offering by Troutman Sanders LLP. From time to time, Troutman Sanders LLP has performed legal services for certain of our portfolio companies.

Samuel A. Flax, our Executive Vice President and General Counsel, served as counsel to Arnold & Porter LLP through December 31, 2005, and was previously a partner at that firm.

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