UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Commission file number: 001-08205

Rand Capital Corporation

(Exact Name of Registrant as specified in its Charter)

(716) 853-0802

(Registrant’s Telephone No. Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.10 par value

      Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 under the Securities Act.     Yes o          No þ

      Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes o          No þ

      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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 under the Exchange Act.

Large accelerated filer o          Accelerated filer o          Non-accelerated filer þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)     Yes o          No þ

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      The aggregate market value of the registrant’s outstanding common stock held by non-affiliates of the registrant as of June 30, 2005 was approximately $5,085,615 based upon the last sale price as quoted by NASDAQ SmallCap Market on such date.

      As of March 17, 2006 there were 5,718,934 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Corporation’s definitive proxy statement for the Annual Meeting of Stockholders to be held on April 27, 2006 are incorporated by reference into certain sections of Part III herein.

RAND CAPITAL CORPORATION

TABLE OF CONTENTS FOR FORM 10-K

PART I

      Rand Capital Corporation (“Rand” or “Corporation”) was incorporated under the law of New York on February 24, 1969. Commencing in 1971, Rand operated as a publicly traded, closed-end, diversified management company that was registered under Section 8(b) of the Investment Company Act of 1940 (the “1940 Act”). On August 16, 2001, Rand filed an election to be treated as a business development company (“BDC”) under the 1940 Act, which became effective on the date of filing. On January 16, 2002, Rand formed a wholly-owned subsidiary, Rand Capital SBIC, L.P., (“Rand SBIC”) for the purpose of operating it as a small business investment company. At the same time, Rand organized another wholly owned subsidiary, Rand Capital Management, LLC (“Rand Management”), as a Delaware limited liability company, to act as the general partner of Rand SBIC. Rand transferred $5 million in cash to Rand SBIC to serve as “regulatory capital” in January 2002 and on August 16, 2002, Rand received notification that its Small Business Investment Company (“SBIC”) application had been approved and Rand SBIC had been licensed by the Small Business Administration (“SBA”). The following discussion will include Rand, Rand SBIC and Rand Management (collectively, the “Corporation”).

      Throughout the Corporation’s history, its principal business has been to make venture capital investments in small to medium sized companies that are engaged in the exploitation of new or unique products or services with a sustainable competitive advantage typically in New York and its surrounding states. The Corporation’s principal investment objective is to achieve long-term capital appreciation while maintaining a current cash flow from its debenture instruments. The Corporation invests in a mixture of debenture and equity instruments. The debt securities most often have an equity piece attached to the debenture in the form of stock, warrants or options to acquire stock or the right to convert the debt securities into stock. Rand SBIC was the primary investment vehicle in 2004 and 2005 and it is anticipated that will continue in 2006. Consistent with its status as a BDC and the purposes of the regulatory framework for BDC’s under the 1940 Act, the Corporation provides managerial assistance, often in the form of a board of director’s seat, to the portfolio companies in which it invests.

      The Corporation operates as an internally managed investment company whereby its officers and employees conduct its operations under the general supervision of its Board of Directors. It has not elected to qualify to be taxed as a regulated investment company as defined under Subchapter M of the Internal Revenue Code.

      The Corporation’s website is www.randcapital.com. Available through the website is the Corporation’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other reports filed with the Securities and Exchange Commission (“SEC”).

Regulation as a BDC

      Although the 1940 Act exempts a BDC from registration under that Act, it contains significant limitations on the operations of BDC’s. Among other things, the 1940 Act contains prohibitions and restrictions relating to transactions between a BDC and its affiliates, principal underwriters and affiliates of its affiliates or underwriters, and it requires that a majority of the BDC’s directors be persons other than “interested persons,” as defined under the 1940 Act. The 1940 Act also prohibits a BDC from changing the nature of its business so as to cease to be, or to withdraw its election as, a BDC unless so authorized by a vote of the holders of a majority of its outstanding voting securities. BDC’s are not required to maintain fundamental investment policies relating to diversification and concentration of investments within a single industry. More specifically, in order to qualify as a BDC, a company must (1) be a domestic company; (2) have registered a class of its equity securities or have filed a registration statement with the Commission pursuant to Section 12 of the Securities Exchange Act of 1934; (3) operate for the purpose of investing in the securities of certain types of portfolio companies, namely immature or emerging companies and businesses suffering or just recovering from financial distress; (4) extend significant managerial assistance to such portfolio companies; and (5) have a majority of “disinterested” directors (as defined in the 1940 Act).

Generally, a BDC must be primarily engaged in the business of furnishing capital and providing managerial expertise to companies that do not have ready access to capital through conventional financial channels. Such portfolio companies are termed “eligible portfolio companies.”

      An eligible portfolio company is, generally, a U.S. company that is not an investment company and that (1) does not have a class of securities registered on an exchange or included in the Federal Reserve Board’s over-the-counter margin list; or (2) is actively controlled by a BDC and has an affiliate of a BDC on its board of directors; or (3) meets such other criteria as may be established by the SEC. Control under the 1940 Act is generally presumed to exist where a BDC owns 25% of the outstanding voting securities of a company.

      The 1940 Act prohibits or restricts companies subject to the 1940 Act from investing in certain types of companies, such as brokerage firms, insurance companies, investment banking firms and investment companies. Moreover, the 1940 Act limits the type of assets that BDCs may acquire to “qualifying assets” and certain assets necessary for its operations (such as office furniture, equipment and facilities) if, at the time of acquisition, less than 70% of the value of the BDC’s assets consist of qualifying assets. Qualifying assets include: (1) securities of companies that were eligible portfolio companies at the time the BDC acquired their securities; (2) securities of bankrupt or insolvent companies that were eligible at the time of the BDC’s initial acquisition of their securities but are no longer eligible, provided that the BDC has maintained a substantial portion of its initial investment in those companies; (3) securities received in exchange for or distributed in or with respect to any of the foregoing; and (4) cash items, government securities and high-quality short-term debt. The 1940 Act also places restrictions on the nature of the transactions in which, and the persons from whom, securities can be purchased in order for the securities to be considered qualifying assets. These restrictions include limiting purchases to transactions not involving a public offering and acquiring securities from the portfolio company or its officers, directors, or affiliates.

      A BDC is permitted to invest in the securities of public companies and other investments that are not qualifying assets, but those kinds of investments may not exceed 30% of the BDC’s total asset value at the time of the investment.

      A BDC must make significant managerial assistance available to the issuers of eligible portfolio securities in which it invests. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted does provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.

SBIC Subsidiary

      On January 16, 2002, Rand formed two wholly-owned subsidiaries, Rand SBIC and Rand Management. On August 16, 2002, Rand received notification that its Small Business Investment Company application had been approved and licensed by the Small Business Administration. The approval allows Rand SBIC to obtain loans up to two times its initial $5 million of regulatory capital from the SBA for purposes of making new investment’s in portfolio companies.

      Rand formed Rand SBIC as a subsidiary for the purpose of causing it to be licensed as a small business investment company (“SBIC”) under the Small Business Investment Act of 1958 (the “SBA Act”) by the Small Business Administration (the “SBA”), in order to have access to various forms of leverage provided by the SBA to SBIC’s.

      On May 28, 2002, the Corporation filed an Exemption Application with the SEC seeking an order under Sections 6(c), 12(d)(1)(J), 57(c), and 57(i) of, and Rule 17d-1 under, the 1940 Act for exemptions from the application of Sections 2(a)(3), 2(a)(19), 12(d)(1), 18(a), 21(b), 57(a)(1), (2), (3), and (4), and 61(a) of the 1940 Act to certain aspects of its operations. The application also seeks an order under Section 12(h) of the Securities Exchange Act of 1934 Act (the “Exchange Act”) for an exemption from

separate reporting requirements for Rand SBIC under Section 13(a) of the Exchange Act. In general, the Corporation’s applications seek orders that would permit:

      The Corporation has not identified from among the similar exemption applications on file with the SEC an example of a specific grouping of all of the exemptions requested by the Corporation in its application, but the SEC has commonly granted applications to other companies for orders applicable to each of the exemptions requested and for orders applicable to various combinations of those exemptions, and the Corporation’s applications do not appear to raise any specific policy issues that have not also been raised by applications for which exemptions have been granted.

      Rand operates Rand SBIC through Rand Management for the same investment purposes, and with investments in similar kinds of securities, as Rand. Rand SBIC’s operations are consolidated with those of Rand for both financial reporting and tax purposes.

Regulation of SBIC Subsidiary

      The SBA licenses SBICs as part of a program designed to stimulate the flow of private debt and/or equity capital to small businesses. SBICs use funds borrowed from the SBA, together with their own capital, to provide loans to, and make equity investments in, concerns that (a) do not have a net worth in excess of $18 million and do not have average net income after U.S. federal income taxes for the two years preceding any date of determination of more than $6 million, or (b) meet size standards set by the SBA that are measured by either annual receipts or number of employees, depending on the industry in which the concerns are primarily engaged. The types and dollar amounts of the loans and other investments an SBIC may make are limited by the 1940 Act, the SBA Act and SBA regulations. The SBA is authorized to examine the operations of SBICs, and a SBIC’s ability to obtain funds from the SBA is also governed by SBA regulations.

      In addition, at the end of each fiscal year, an SBIC must have at least 20% (in total dollars) invested in “Smaller Enterprises”. The SBA defines “Smaller Enterprises” as concerns that (a) do not have a net worth in excess of $6 million and have average net income after U.S. federal income taxes for the preceding two years no greater than $2 million, or (b) meet size standards set by the SBA that are measured by either annual receipts or number of employees, depending on the industry in which the concerns are primarily engaged.

      SBICs may invest directly in the equity of their portfolio companies, but they may not become a general partner of a non-incorporated entity or otherwise become jointly or severally liable for the general obligations of a non-incorporated entity. An SBIC may acquire options or warrants in its portfolio companies, and the options or warrants may have redemption provisions, subject to certain restrictions.

      The SBA raises capital to enable it to provide funds to SBICs by guaranteeing certificates or bonds that are pooled and sold to purchasers of the government guaranteed securities. The amount of funds that the SBA may lend to SBICs is determined by annual Congressional appropriations.

      In order to obtain SBA borrowings, also known as leverage, an SBIC must demonstrate its need to the SBA. To demonstrate need, an SBIC must invest 50% of its Leverageable Capital (defined as Regulatory Capital less unfunded commitments and federal funds) and any outstanding SBA leverage. Other requirements include compliance with SBA regulations, adequacy of capital, and meeting liquidity standards. An SBIC’s license entitles an SBIC to apply for SBA leverage, but does not assure that it will be available, or if available, that it will be available at the level of the relevant matching ratio. Availability depends on the SBIC’s continued regulatory compliance and sufficient SBA funds being available when the SBIC applies to draw down SBA leverage. Under the provisions of the SBIC regulations the Corporation may apply for the SBA’s conditional commitment to reserve a specific amount of leverage for future use. The Corporation may then apply to draw down leverage against the commitment. All SBIC’s must obtain a leverage commitment in order to draw leverage from the SBA. Commitments expire on September 30 of the fourth full fiscal year following issuance and require the payment of a fee equal to 1 percent of the total commitment at the time of issuance. An additional fee equal to 2 percent of the amount drawn is deducted at the time of each draw.

      The Corporation paid $100,000 to the SBA to reserve $10,000,000 of its approved debenture leverage. The fees were paid in two installments of $50,000 each in July 2003 and in August 2004. These fees were 1% of the face amount of the leverage reserved under the commitment. The fee represents a partial prepayment of the SBA’s nonrefundable 3% leverage fee. As of December 31, 2005, Rand SBIC had drawn $7,200,000 in leverage from the SBA.

      SBA debentures are issued with 10-year maturities. Interest only is payable semi-annually until maturity. Ten-year SBA debentures may be prepaid with a penalty during the first 5 years, and then are pre-payable without penalty. Rand initially capitalized Rand SBIC with $5 million in Regulatory Capital. Rand SBIC was approved to obtain SBA leverage at a 2:1 matching ratio, resulting in a total capital pool eligible for investment of $15 million. The Corporation expects to use Rand SBIC as its primary investment vehicle.

Employees

      As of December 31, 2005, the Corporation had four employees.

Item 1A.     Risk Factors

      Most of the investments of the Corporation are or will be either equity securities acquired directly from small companies or below investment grade subordinated debt securities. The Corporation’s portfolio of equity securities is, and will usually be, subject to restrictions on resale or otherwise have no established trading market. The illiquidity of most of the Corporation’s portfolio may adversely affect the ability of the Corporation to dispose of such securities at times when it may be advantageous for the Corporation to liquidate such investments.

      The Corporation typically invests a substantial portion of its assets in small and medium sized private companies. These private businesses may be thinly capitalized, unproven companies with risky technologies and may lack management depth and have not attained profitability. Because of the speculative nature and the lack of a public market for these investments, there is significantly greater risk of loss than is the case with traditional investment securities. The Corporation expects that some of its venture capital investments will be a complete loss or will be unprofitable and that some will appear to be likely to become successful but never realize their potential. The Corporation has been risk seeking rather than risk averse in its approach to venture capital and other investments. Neither the Corporation’s investments nor an investment in the Corporation is intended to constitute a balanced investment program.

      Even if the Corporation’s portfolio companies are able to develop commercially viable products, the market for new products and services is highly competitive and rapidly changing. Commercial success is difficult to predict and the marketing efforts of the portfolio companies may not be successful.

      There is typically no public market for equity securities of the small privately held companies in which the Corporation invests. As a result, the valuations of the equity securities in the Corporation’s portfolio are stated at fair value as determined by the good faith estimate of the Corporation’s Board of Directors in accordance with the established SBA valuation policy. In the absence of a readily ascertainable market value, the estimated value of the Corporation’s portfolio of securities may differ significantly, favorably or unfavorably, from the values that would be placed on the portfolio if a ready market for the equity securities existed. Any changes in estimated net asset value are recorded in the statement of operations as “Net (increase) decrease in unrealized depreciation.”

      The Corporation’s investments, in accordance with its investment objective and principal strategies, result in a greater than average amount of risk and volatility and may well result in loss of principal. Its investments in portfolio companies are highly speculative and aggressive and, therefore, an investment in its shares may not be suitable for investors for whom such risk is inappropriate.

      The Corporation is regulated by the SBA and the SEC. Changes in the laws or regulations that govern SBICs and BDCs could significantly affect the Corporation’s business. Regulations and laws may be changed periodically, and the interpretations of the relevant regulations and laws are also subject to change. Any change in the regulations and laws governing the Corporations business could have a material impact on its financial condition or its results of operations.

      The Corporation’s Leverageable Capital may include large amounts of debt securities issued through the SBA, and all of the debentures will have fixed interest rates. Until and unless the Corporation is able to invest substantially all of the proceeds from debentures at annualized interest or other rates of return that substantially exceed annualized interest rates that Rand SBIC must pay the SBA, the Corporation’s operating results may be adversely affected which may, in turn, depress the market price of the Corporation’s common stock.

      The value of the Corporation’s common stock may decline and may be affected by numerous market conditions, which could result in the loss of some or the entire amount invested in its shares. The securities markets frequently experience extreme price and volume fluctuations which affect market prices for securities of companies generally, and technology and very small capitalization companies in particular. General economic conditions, and general conditions in the Internet and information technology, life sciences, material sciences and other high technology industries, will also affect the stock price.

      The Corporation is dependent for the selection, structuring, closing and monitoring of its investments on the diligence and skill of its two senior officers, Allen F. Grum and Daniel P. Penberthy. The future success of the Corporation depends to a significant extent on the continued service and coordination of its senior management team. The departure of either of its executive officers could materially adversely affect its ability to implement its business strategy. The Corporation does not maintain key man life insurance on any of its officers or employees.

      The Corporation faces competition in its investing activities from many entities including other SBIC’s, private venture capital funds, investment affiliates of large companies, wealthy individuals and other domestic or foreign investors. The competition is not limited to entities that operate in the same geographical area as the Corporation. As a regulated BDC, the Corporation is required to disclose quarterly and annually the name and business description of portfolio companies and the value of its portfolio securities. Most of its competitors are not subject to this disclosure requirement. The Corporation’s obligation to disclose this information could hinder its ability to invest in certain portfolio companies. Additionally, other regulations, current and future, may make the Corporation less attractive as a potential investor to a given portfolio company than a private venture capital fund.

      The Corporation’s quarterly operating results could fluctuate as a result of a number of factors. These factors include, among others, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which portfolio companies encounter competition in their markets and general economic conditions. As a result of these factors, results for any one quarter should not be relied upon as being indicative of performance in future quarters.

      Rand maintains its offices at 2200 Rand Building, Buffalo, New York 14203, where it leases approximately 1,300 square feet of office space pursuant to a lease agreement that expires December 31, 2010. Rand believes that its leased facilities are adequate to support its current staff and expected future needs.

      None

      Not applicable

PART II

      Rand’s common stock, par value $0.10 per share (“Common Stock”), is traded on the NASDAQ Small Cap Market (“NASDAQ”) under the symbol “RAND.” The following table sets forth, for the periods indicated, the range of high and low sales prices per share as reported by NASDAQ:

      Rand did not sell any securities during the period covered by this report that were not registered under the Securities Act. Rand has not paid any cash dividends in its most recent two fiscal years, and it has no present intention of paying cash dividends in the coming fiscal year.

Profit Sharing and Stock Option Plans

      In July 2001, the shareholders of the Corporation authorized the establishment of an Employee Stock Option Plan (the “Plan”). The Plan provides for an award of options to purchase up to 200,000 common shares to eligible employees. In 2002, the Corporation placed the Plan on inactive status as it developed a new profit sharing plan for the Corporation’s employees in connection with the establishment of its SBIC subsidiary. As of December 31, 2005, no stock options had been awarded under the Plan. Because Section 57(n) of the 1940 Act prohibits maintenance of a profit sharing plan for the officers and employees of a BDC where any option, warrant or right is outstanding under an executive compensation plan, no options will be granted under the Plan while any profit sharing plan is in effect with respect to the Corporation.

      The Corporation established a Profit Sharing Plan for its executive officers in accordance with Section 57(n) of the Investment Company Act of 1940 (the “1940 Act”). There were no contributions to the profit sharing plan during the years ended December 31, 2005, 2004 or 2003.

      On March 17, 2006 the Corporation had a total of 998 shareholders, which included 126 record holders of its common stock, and an estimated 872 shareholders with shares beneficially owned in nominee name or under clearinghouse positions of brokerage firms or banks.

      On October 18, 2001 the Board of Directors authorized the repurchase of up to 5% of the Corporation’s outstanding stock through purchases on the open market which was extended through October 27, 2006. During 2003 and 2002 the Corporation purchased 44,100 treasury shares for a total cost of $47,206. No shares were repurchased during the years ended December 31, 2005 or 2004.

      The following table provides selected consolidated financial data of the Corporation for the periods indicated. You should read the selected financial data set forth below in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and with our financial statements and related notes appearing elsewhere in this report.

      Balance Sheet Data as of December 31:

Operating Data for the year ended December 31:

      You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our financial statements and related notes included elsewhere in this report.

Forward Looking Statements

      Statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this document that do not relate to present or historical conditions are “forward-looking statements” within the meaning of that term in Section 27A of the Securities Act of 1933, and in Section 21F of the Securities Exchange Act of 1934. Additional oral or written forward-looking statements may be made by the Corporation from time to time, and those statements may be included in documents that are filed with the Securities and Exchange Commission. Such forward-looking statements involve risks and uncertainties that could cause results or outcomes to differ materially from those expressed in the forward-looking statements. Forward-looking statements may include, without limitation, statements relating to the Corporation’s plans, strategies, objectives, expectations and intentions and are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as “believes,” “forecasts,” “intends,” “possible,” “expects,” “estimates,” “anticipates,” or “plans” and similar expressions are intended to identify forward-looking statements. Among the important factors on which such statements are based are assumptions concerning the state of the national economy and the local markets in which the Corporation’s portfolio companies operate, the state of the securities markets in which the securities of the Corporation’s portfolio company trade or could be traded, liquidity within the national financial markets, and inflation. Forward-looking statements are also subject to the risks and uncertainties described under the caption “Risk Factors” contained in Part I, Item 1B, which is incorporated herein by reference.

      There may be other factors that we have not identified that affect the likelihood that the forward-looking statements may prove to be accurate. Further, any forward-looking statement speaks only as of the date it is made and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances. New factors emerge from time to time that may cause our business not to develop as we expect, and we cannot predict all of them.

Overview

      The following discussion includes Rand Capital Corporation (“Rand”), Rand Capital SBIC, L.P., (“Rand SBIC”), and Rand Capital Management, LLC (“Rand Management”), (collectively the “Corporation”), its financial position and results of operations.

      Rand is incorporated under the laws of New York and is regulated under the 1940 Act as a business development company (“BDC”). In addition, a wholly-owned subsidiary, Rand SBIC is regulated as a Small Business Investment Company (“SBIC”) by the Small Business Administration (“SBA”). The Corporation

anticipates that most, if not all, of its investments in the next year will be originated through the SBIC subsidiary.

      The Corporation’s primary business is investing in businesses, usually through investments in the form of subordinated debt, preferred/common stock or membership interests. We look for small and medium-sized companies that meet certain criteria, including:

      The Corporation makes investments in portfolio companies that typically range from $250,000 to $1,000,000 and it invests either directly in the equity of a company through equity shares or through a debt instrument. The debt instruments generally have a maturity of not more than five years and usually have detachable equity warrants. Interest is either current pay (paid monthly) or deferred.

      The management team of the Corporation identifies investment opportunities. Throughout the Corporation’s history it has established an extensive network of investment referral relationships. Investment proposals may, however, come to the Corporation from many other sources, and may include unsolicited proposals from the public and referrals from banks, lawyers, accountants and other members of the financial community. The Corporation believes that its reputation in the community and experience provide a competitive advantage in originating qualified new investments.

      In a typical private financing, the management team of the Corporation will review, analyze, and confirm, through due diligence, the business plan and operations of the potential portfolio company. Additionally, the Corporation will become familiar with the portfolio company’s industry and competitive landscape and may conduct additional reference checks with customers and suppliers of the portfolio company.

      Following an initial investment in a portfolio company, the Corporation may be requested to make follow-on investments in the company. Follow-on investments may be made to take advantage of warrants or other preferential rights granted to the Corporation or otherwise to increase or maintain the Corporation’s position in a promising portfolio company. The Corporation may also be called upon to provide an additional investment to a portfolio company in order for that company to fully implement its business plans, to develop a new line of business or to recover from unexpected business problems. Follow-on investments in a portfolio company are evaluated individually.

      The Corporation will exit its investments generally through the maturation of the debt security or when a liquidity event takes place, such as the sale, recapitalization, or initial public offering of a portfolio company. The method and timing of the disposition of the Corporation’s portfolio investments can be critical to the realization of maximum total return. The Corporation generally expects to dispose of its equity securities through the private sales of securities to other investors or through an outright sale of the company or a merger. The Corporation anticipates its debentures will be repaid with interest and hopes to realize further appreciation from the warrants or other equity type instruments it receives in connection with the origination of the debenture. The Corporation anticipates generating cash for new investments and operating expenses through SBA leverage draw downs, and interest and principal payments from its portfolio concerns.

Critical Accounting Policies

      The Corporation prepares its financial statements in accordance with U.S. generally accepted accounting principles (GAAP), which requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities. For a summary of all of our significant accounting policies, including critical accounting policies, see Note 1 to the consolidated financial statements in Item 8.

      The increasing complexity of the business environment and applicable authoritative accounting guidance require us to closely monitor our accounting policies. The Corporation has identified three critical accounting

policies that require significant judgment. The following summary of our critical accounting policies is intended to enhance your ability to assess our financial condition and results of operations and the potential volatility due to changes in estimates.

      The most significant estimate inherent in the preparation of the Corporation’s consolidated financial statements is the valuation of its investments and the related unrealized appreciation or depreciation. The Corporation has adopted the SBA’s valuation guidelines for SBIC’s, which describe the policies and procedures used in valuing investments.

      Investments are valued in accordance with the Corporation’s established valuation policy and are stated at fair value as determined in good faith by the management of the Corporation and submitted to the Board of Directors for approval. There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for our investments. The Board of Directors considers fair value to be the amount which the Corporation may reasonably expect to receive for portfolio securities when sold on the valuation date. The Corporation analyzes and values each individual investment on a quarterly basis, and records unrealized depreciation for an investment that it believes has become impaired, including where collection of a loan or realization of an equity security is doubtful. Conversely, the Corporation will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value. Without a readily ascertainable market value and because of the inherent uncertainty of valuation, the fair value of our investments is determined in good faith by the Board of Directors. These estimated fair values may differ from the values that would have been used had a ready market for the investments existed.

      In the valuation process, the Corporation uses financial information received monthly, quarterly, and annually from its portfolio companies, which includes both audited and unaudited financial statements, annual projections and budgets prepared by the portfolio company and other financial information supplied by the portfolio companies’ management. This information is used to determine financial condition, performance, and valuation of the portfolio investments. Valuation should be reduced if a company’s performance and potential have significantly deteriorated. If the factors which led to the reduction in valuation are overcome, the valuation may be restored.

      Another key factor used in valuing equity investments is recent arms-length equity transactions entered into by the portfolio company that the Corporation utilizes to form a basis for its underlying value. Many times the terms of these equity transactions may not be identical to those of the Corporation, and the impact on these variations as it relates to market value may be impossible to quantify.

      Any changes in estimated fair value are recorded in our statement of operations as “Net (increase) decrease in unrealized depreciation.”

      Interest income generally is recognized on the accrual basis except where the investment is in default or otherwise presumed to be in doubt. In such cases, interest is recognized at the time of receipt. A reserve for possible losses on interest receivable is maintained when appropriate. Certain investments of the Corporation are structured to provide a deferred interest period where interest is not currently due.

      Rand SBIC’s interest accrual is regulated by the SBA’s “Accounting Standards and Financial Reporting Requirements for Small Business Investment Companies”. Under these rules interest income cannot be recognized if collection is doubtful, and a 100% reserve must be established. The collection of interest is presumed to be in doubt when there is substantial doubt about a portfolio company’s ability to continue as a going concern or the loan is in default more than 120 days. Management also utilizes other qualitative and quantitative measures to determine the value of a portfolio investment and the collectibility of any accrued interest.

      The deferred tax assets are primarily related to future tax benefits associated with the utilization of the Corporation’s net operating loss carryforwards (NOLs). The realization of these deferred tax assets is dependent on the Corporation generating sufficient taxable income through operations and realization of gains on its investments to utilize these NOLs. At December 31, 2005 and 2004 management has determined that a valuation allowance is not required based upon future estimated income and historical significant gains realized on the liquidation of its portfolio investments. In the event that management’s estimates or expectations regarding its future profitability do not come to fruition, the Corporation may be required to record a valuation allowance against the deferred tax asset.

Financial Condition

      The Corporation’s financial condition is dependent on the success of its portfolio holdings. It has invested a substantial portion of its assets in small and medium-sized companies. The following summarizes the Corporation’s investment portfolio at the year-ends indicated.

      The increase in investments is due to the Corporation’s new investments during the year ended December 31, 2005 in the following portfolio companies:

      Unrealized depreciation on investments before income taxes decreased in the year ended December 31, 2005 by $244,020. See the section below labeled “Net Change in Unrealized Appreciation/ Depreciation of Investments” for an explanation of this change.

      The Corporation borrowed $3,700,000 in leverage from the SBA during the year ended December 31, 2005 and the total owed to the SBA for Leverage Payable at December 31, 2005 was $7,200,000. These debentures bear a fixed interest rate, currently averaging 5.6%, payable semi-annually. The debenture principal is repayable in full 10 years from issuance.

      Net asset value per share (NAV) was $1.51/share at December 31, 2005 versus $1.58/share at December 31, 2004.

      The Corporation’s total investments at fair value, whose fair value have been estimated by the Board of Directors, approximated 155% of net assets at December 31, 2005 and 122% of net assets at December 31, 2004. The increase in this percentage during the year ended December 31, 2005 is due to the increase in new investments funded by the additional $3,700,000 draw down on the Corporation’s SBA leverage.

      Cash and cash equivalents approximated 14% of net assets at December 31, 2005 compared to 7% at December 31, 2004.

      The effect of the increase in tax net operating loss carry forwards and the change in unrealized depreciation on investments resulted in a net increase in the net deferred tax asset from $566,000 at December 31, 2004 to a net deferred tax asset of $846,000 at December 31, 2005.

Results of Operations

     Investment Income

      The Corporation’s investment objective is to achieve long-term capital appreciation on its equity investments while maintaining a current cash flow from its debenture and pass through equity instruments. Therefore, the Corporation will invest in a mixture of debenture and equity instruments, which will provide a current return on a portion of the investment portfolio. The equity features contained in our investment portfolio are structured to realize capital appreciation over the long-term and may not necessarily generate current income in the form of dividends or interest. In addition, the Corporation earns interest income from investing its idle funds in money market instruments.

      Interest from portfolio companies — Portfolio interest income decreased $52,081 for the year ended December 31, 2005 as compared to the same period in the prior year. This is attributable to the fact that the Corporation ceased accruing interest on two WineIsIt.com (Wineisit) debt instruments in January of 2005 in anticipation of a restructuring of the Wineisit balance sheet. The total interest recognized from these two Wineisit notes for the year ended December 31, 2004 was $73,009. During 2005 this portfolio company experienced a decline in business performance and therefore the restructuring has been delayed. These two notes are technically in default due to nonpayment of principal and interest and the Corporation has revised their valuation. See further discussion on this valuation change in the section labeled “Net Change in Unrealized Appreciation/ Depreciation of Investments”.

      The current period decrease in portfolio income can also be attributed to the fact that the portfolio income for the year ended December 31, 2004 included $62,703 of income on a $900,000 convertible note from Somerset. This note had stopped accruing interest in September 2003 because it was in default and the Corporation had established a 100% reserve for the total accrued interest of $122,914. In April 2004 Somerset became current on the note, therefore the Corporation recognized all past due interest in the first quarter of 2004.

      After reviewing the portfolio companies’ performance and the circumstances surrounding the investments, the Corporation has ceased accruing interest income on the following investment instruments:

      Interest from other investments — The increase in interest income is primarily due to higher yields on idle cash balances.

      Dividend and other investment income — Dividend income is comprised of distributions from Limited Liability Companies (LLC’s) in which the Corporation has invested. The Corporation’s investment agreements with certain LLC companies require the entities to distribute funds to the Corporation for payment of income taxes on its allocable share of the entities’ profits. These dividends will fluctuate based upon the profitability of the entities and the timing of the distributions. Dividend income for the year ended December 31, 2005 consisted of distributions from Gemcor II, LLC (Gemcor) for $51,500, Topps for $28,174, Carolina Skiff LLC (Carolina Skiff) for $14,082 and Vanguard Modular Building Systems (Vanguard) for $1,174.

      Dividend income for the year ended December 31, 2004 was comprised of distributions from Topps for $35,195, Carolina Skiff for $28,384 and Vanguard for $1,244.

      Other income — Other income consists of the revenue associated with the amortization of financing fees charged to the portfolio companies upon successful closing of Rand SBIC financing. The SBA regulations limit the amount of fees that can be charged to a portfolio company, and the Corporation typically charges 1% to 3% to the portfolio concerns. These fees are amortized ratably over the life of the instrument associated with the fees. The unamortized fees are carried on the balance sheet under “Deferred revenue”. In addition, other income includes fees charged by the Corporation to its portfolio companies for attendance at the portfolio companies’ board meetings.

      Other income for the year ended December 31, 2005 decreased slightly. The decrease in financing amortization revenue can be attributed to the fact that several fees became fully amortized in early 2005 due to the instrument maturing. The annualized financing fee income based on the existing portfolio will average $29,000 annually in 2006 and 2007 and less than $10,000 annually thereafter, based on the deferred revenue balance at December 31, 2005. In addition the board attendance income amounted to $7,000 for the year ended December 31, 2005 and $0 for year ended December 31, 2004.

      Interest from portfolio companies — Portfolio interest income increased almost 75% during the year ended December 31, 2004. This reflected an increase in investments in interest earning debentures during the fiscal years ended December 31, 2004 and 2003. During the year ended December 31, 2004, 66% of the investments made, or approximately $2,900,000, were invested in debenture instruments that had a blended interest rate of approximately 10%.

      The portfolio interest income for the year ended December 31, 2004 includes $105,977 of interest income on a Somerset note. The original Somerset note matured on January 15, 2003, and went into default at an interest rate of 14%. In September 2003 the Corporation had stopped accruing interest on the Somerset note and had established a 100% reserve. In April 2004 Somerset paid the accrued interest in full. In addition, portfolio interest income for the year ended December 31, 2004 includes $99,321 in accrued interest income from Carolina Skiff LLC.

      Interest from other investments — The other interest income is comprised on interest income from idle cash balances which decreased (87.7%) during the year ended December 31, 2004. This decrease is due to the fact that the Corporation had a reduction in its idle cash balances during 2004 as a result of new investments and therefore earned little interest on the idle cash balances.

      Dividend and other investment income — Dividend income is comprised of distributions from LLC’s in which the Corporation has invested. The Corporation’s investment agreements with certain LLC’s require the entities to distribute funds to the Corporation for payment of income taxes on its allocable share of the entities’ profits. These dividends will fluctuate based upon the profitability of the entities. Dividend income was $64,823 for the year ended December 31, 2004 and $49,787 for the same period in 2003. This increase is due to the fact that the Corporation invested in three portfolio companies during 2004 and 2003 that were LLC’s that had taxable income. The LLC investment income for the year ended December 31, 2004 consisted of LLC distributions from Topps for $35,195, Carolina Skiff for $28,384 and Vanguard for $1,244. The LLC investment income for the year ended December 31, 2003 was comprised of distributions from Topps for $18,887, G-Tec for $28,781 and $2,119 for Vanguard.

      Other Income — Other income consists of the revenue associated with the amortization of financing fees charged to the portfolio companies upon successful closing of Rand SBIC financing. The increase during the year ended December 31, 2004 can be attributed to the fact that the Corporation generated more investments through Rand SBIC in 2004 and, therefore, more closing fees were collected and were being amortized.

Operating Expenses

      The operating expenses predominately consist of employee compensation and benefits, shareholder related costs, office expenses, professional fees, expenses related to identifying and reviewing investment opportunities and bad debt expense.

      The increase in operating expenses during the year ended December 31, 2005 can be mainly attributed to the establishment of a bad debt reserve for $114,870 on Vanguard, and a 158% increase in SBA interest expense.

      The Corporation’s management reviewed the interest receivable from Vanguard and believed that the collectibility of this receivable was in doubt and therefore reserved for all of the receivable balance. The portfolio company continues to perform well and is currently investigating sale opportunities. The Corporation ceased accruing interest revenue on this instrument in 2003.

      The SBA borrowings increased $3,700,000 during the year ended December 31, 2005 and the SBA interest expense increased $169,880 from $107,407 for the year ended December 31, 2004 to $277,287 for the year ended December 31, 2005. The SBA borrowing rates, which included an SBA annual charge, averaged

5.8% in 2005. The SBA annual charge during 2005 decreased from 0.887% to 0.855%. The 2004 SBA borrowing rates averaged 5.4% and the overall combined SBA borrowing rate on the $7,200,000 outstanding leverage at December 31, 2005 was 5.6%. Interest costs will continue to increase in 2006 and beyond as the Corporation continues to draw down SBA leverage up to the maximum approved leverage of $10 million.

      Increases in salaries and professional costs contributed to the remaining increase in operating expense during the year ended December 31, 2005. Professional fees increased $33,323 or 52% during the year ended December 31, 2005 due to the additional accounting and legal expenses related to the increasingly more complex regulatory environment in which the Corporation operates.

      In analyzing the change in operating expenses, the most significant changes from year to year was in the categories of interest costs and bad debt expense. During the year ended December 31, 2004, the Corporation incurred $107,407 in interest expense related to the new SBA Debentures originated during the year. The Corporation will continue to recognize interest costs going forward, which will increase as the Corporation continues to draw down on its SBA leverage to fund future investments.

      Expenses during the year ending December 31, 2003 included $122,914 in bad debt expense related to the full reserve against accrued interest receivable for the Somerset investment. This reserve was established in accordance with our established revenue recognition policy discussed above. In April 2004 Somerset paid $400,000 in principal on the $900,000 note and $190,449 in accrued interest. The remaining $500,000 balance of the note was converted to a new debenture instrument earning interest at 10%.

Net Realized Gains and Losses on Investments

      During the year ended December 31, 2005, the Corporation realized a loss of ($382,353) on its investment in D’Lisi Food Systems, Inc. (D’Lisi). The D’Lisi investment of $400,000 was written down to zero in the third quarter of 2004 due to fact it filed for bankruptcy protection on August 13, 2004. The final bankruptcy proceeds were distributed in July 2005 and resulted in a realized loss of ($382,353). Subsequent to year end the Corporation has sold, subject to Rule 144, 290,000 shares of its Minrad shares for net proceeds of approximately $581,000 and a realized gain of $201,500.

      During the year ended December 31, 2004, the Corporation realized a $32,956 gain on the sale of the remaining Advanced Digital Information Corporation (ADIC) stock. In addition, the Corporation realized a ($6,229) loss on its investment in Clearview Cable.

      During the year ended December 31, 2004, the Corporation realized a $32,956 gain on the sale of the remaining ADIC stock and realized a ($6,229) loss on its investment in Clearview Cable.

      During the year ended December 31, 2003, the Corporation realized an $87,841 gain on the sale of the ADIC stock.

Net Change in Unrealized Appreciation/ Depreciation of Investments

      The Corporation recorded a decrease in unrealized depreciation on investments before income tax expense of $244,020 during the year ended December 31, 2005, as compared to an increase of $(206,737)

during the year ended December 31, 2004. The decrease in unrealized depreciation on investments during the year ended December 31, 2005 is due to the following valuation changes made by the Corporation:

      The Corporation recognized appreciation on its equity investments in Topps and Carolina Skiff based on the improving financial condition of these portfolio companies since the Corporation’s first investments. Per the Corporation’s valuation policy a portfolio company can be valued based on a very conservative financial measure if the portfolio company has been self-financing and has had positive cash flow from operations for at least the past two fiscal years. These portfolio companies were valued on a multiple of earnings before interest, tax, depreciation and amortization (EBITDA).

      The Corporation recognized appreciation of $272,000 on its 667,981 shares of Minrad. Minrad is traded under the symbol BUF on the Amex stock exchange. The Corporation’s Minrad shares are restricted under Sec Rule 144. During the year ended December 31, 2005, Minrad’s securities traded between $1.25 and $7.00 per share. The Corporation’s policy is to record the valuation of our publicly held securities on a “mark to market” basis. The Minrad’s shares were therefore valued at $1.65 per share at December 31, 2005 which was the average closing price for the last three trading days of the year.

      Kionix was revalued during the second quarter of 2005 due to the fact that the portfolio company failed to achieve certain performance milestones, therefore changing the liquidation preferences of the Series A and B securities. This caused the Corporation to reprice its shares in Kionix from $0.35/share to $0.25/share.

      The WineIsIt investment was revalued during the year ended December 31, 2005 after a review by management which identified that WineIsIt business model had deteriorated since the time of the original funding, as compared to their original plan.

      The Corporation’s investment in Vanguard was written down to $135,000 during the year ended December 31, 2005 based on a financial review of the portfolio company.

      The Ultrascan and Somerset investment valuations were adjusted based on recent rounds of financing that lowered the prices per share.

      Photonics is a public stock (NASDAQ symbol: PHPG.OB) and is marked to market at the end of each quarter.

      All of these value adjustments were done in accordance with the Corporation’s established valuation policy.

      The Corporation recorded an increase in unrealized depreciation on investments before income tax benefits of ($206,737) during the year ended December 31, 2004, as compared to ($230,045) during the year ended December 31, 2003. The increase in unrealized depreciation on investments of ($206,737) is the net effect of decreases in fair value of five portfolio companies totaling ($674,859), increases in fair value of three

portfolio companies totaling $491,578, and the reversal of unrealized appreciation related to the sale of ADIC stock of ($23,456). The increase in unrealized depreciation on investments is due to the following valuation changes made by the Corporation:

      The Corporation recognized appreciation of $338,500 on its investment in Minrad following its recent equity financing at a price greater than the fair value previously recorded by the Corporation. On December 16, 2004 Minrad merged into a publicly traded shell company, Technology Acquisition Corporation (TAC) which was previously traded under the symbol TAQC.OB. The new trading symbol after the merger is MNRD.OB and the new name of the company is Minrad International, Inc. The Corporation currently holds 677,980 shares of Minrad. The Corporation is restricted in its ability to immediately trade its shares in Minrad and therefore has not priced its holding in Minrad at the December 31, 2004 closing price of $3.50

      The Corporation also increased the valuation of its 0.88 membership interest in Somerset Gas Transmission Company, LLC (Somerset) by $118,000. The Somerset membership units were previously written down in September 2003 to zero. Additionally, the Corporation increased the fair value of its investment in Clearview Cable (Clearview) by $27,541 to reflect the amount received in October 2004 from the sale and realized exit in the Clearview investment. These adjustments were done in accordance with the Corporation’s established valuation policies.

      The write downs of Dataview, SmartPill and G-Tec were done in accordance with the Corporation’s established valuation policies. Management of the Corporation evaluated its investment in these portfolio companies and determined that each company’s performance and potential have significantly deteriorated. In the future, if the factors which led to the reduction in valuations are overcome, the valuations may be restored.

      The write down of D’Lisi was precipitated by the fact that D’Lisi filed for Chapter 11 bankruptcy protection on August 13, 2004. Accordingly, the collection of our subordinated debenture principal was presumed in doubt and/or there is substantial doubt about the ability for D’Lisi to pay the principal. The D’Lisi bankruptcy was final in July 2005 and a realized loss was recognized.

      The unrealized depreciation increase before income tax benefits of ($230,045) for the year ended December 31, 2003 is attributable to:

      A majority of the 2003 change in unrealized depreciation is attributable to a reserve that was established on the Somerset membership interest for ($183,333) based on a review of the portfolio company at December 31, 2003. These .88 membership units of Somerset were subsequently revalued in 2004.

      These adjustments were done in accordance with the Corporation’s established valuation policies.

Net Decrease in Net Assets from Operations

      The Corporation accounts for its operations under U.S. generally accepted accounting principles for investment companies. The principal measure of its financial performance is “net decrease in net assets from operations” on its consolidated statements of operations. During the year ended December 31, 2005, the net decrease was ($411,120), as compared to a net decrease in net assets from operations of ($211,434) in 2004 and ($344,643) in 2003.

      The net decrease in net assets from operations in 2005 can primarily be attributed to the net investment loss of ($175,179), a realized loss on investments of ($382,353) and an unrealized gain on investments after tax of 146,412. The 2004 decrease is primarily due to the net investment loss of ($112,384) and the increase in unrealized depreciation after tax of ($125,777). The 2003 net decrease in net assets from operations is primarily due to the investment loss of ($346,043).

Liquidity and Capital Resources

      The Corporation’s principal objective is to achieve capital appreciation. Therefore, a significant portion of the investment portfolio is structured to maximize the potential for capital appreciation and certain of the Corporation’s portfolio investments may be structured to provide little or no current yield in the form of dividends or interest payments.

      As of December 31, 2005, the Corporation’s total liquidity, consisting of cash and cash equivalents, was $1,209,839.

      As of December 31, 2005 the Corporation had paid $100,000 to the SBA to reserve its approved $10,000,000 leverage. It has drawn down $7,200,000 of this leverage as of December 31, 2005. Subsequent to December 31, 2005 the Corporation has expended $800,000 of its cash for new investments. Management expects that it will be necessary to draw down SBA leverage in the next fiscal year in order to fund operations and new investments.

      Net cash used in operating activities has averaged approximately $455,000 over the last three years and management anticipates this amount will continue at similar levels. The cash flow may fluctuate based on possible expenses associated with compliance with potential new regulations. Management believes that the cash and cash equivalents at December 31, 2005, coupled with the anticipated additional SBIC leverage draw downs and interest and dividend payments on its portfolio investments, will provide the Corporation with the liquidity necessary to fund operations over the next twelve months.

      The following table summarizes the cash to be received over the next five years from portfolio companies based on contractual obligations as of December 31, 2005. These payments represent scheduled principal and interest payments that are contained in the investment documents of each portfolio company.

Disclosure of Contractual Obligations

      The following table shows the Corporation’s contractual obligations at December 31, 2005. The Corporation does not have any capital lease obligations or other long-term liabilities reflected on its balance sheet.

      The Corporation’s investment activities contain elements of risk. The portion of the Corporation’s investment portfolio consisting of equity and debt securities in private companies is subject to valuation risk. Because there is typically no public market for the equity and equity-linked debt securities in which it invests, the valuation of the equity interests in the portfolio is stated at “fair value” as determined in good faith by the Board of Directors in accordance with the Corporation’s investment valuation policy. (The discussion of valuation policy contained in the “Notes to Schedule of Portfolio Investments” in the consolidated financial statements contained in Item 8 of this report is hereby incorporated herein by reference.) In the absence of a readily ascertainable market value, the estimated value of the Corporation’s portfolio may differ significantly from the values that would be placed on the portfolio if a ready market for the investments existed. Any changes in valuation are recorded in the Corporation’s consolidated statement of operations as “Net unrealized depreciation on investments.”

      At times a portion of the Corporation’s portfolio may include marketable securities traded in the over-the-counter market. In addition, there may be a portion of the Corporation’s portfolio for which no regular trading market exists. In order to realize the full value of a security, the market must trade in an orderly fashion or a willing purchaser must be available when a sale is to be made. Should an economic or other event occur that would not allow the markets to trade in an orderly fashion, the Corporation may not be able to realize the fair value of its marketable investments or other investments in a timely manner.

      As of December 31, 2005, the Corporation did not have any off-balance sheet investments or hedging investments.

      The following consolidated financial statements and consolidated supplemental schedule of the Corporation and report of independent auditors thereon are set forth below:

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

December 31,

See accompanying notes.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For The Years Ended December 31, 2005, 2004 and 2003

See accompanying notes.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

For The Years Ended December 31, 2005, 2004 and 2003

See accompanying notes.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For The Years Ended December 31, 2005, 2004 and 2003

See accompanying notes.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF PORTFOLIO INVESTMENTS

December 31, 2005

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF PORTFOLIO INVESTMENTS

December 31, 2005 – (Continued)

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF PORTFOLIO INVESTMENTS

December 31, 2005 – (Continued)

RAND CAPITAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED SCHEDULE OF PORTFOLIO INVESTMENTS

December 31, 2005 – (Continued)

Notes to Consolidated Schedule of Portfolio Investments

RAND CAPITAL CORPORATION AND SUBSIDIARIES

SCHEDULES OF SELECTED PER SHARE DATA AND RATIOS

For the Five Years Ended December 31, 2005, 2004, 2003, 2002 and 2001

      Selected data for each share of capital stock outstanding throughout the five most current years is as follows:

RAND CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1. – Summary of Significant Accounting Policies

      Nature of Business – Rand Capital Corporation (“Rand”) was founded in 1969 and is headquartered in Buffalo, New York. Rand’s investment strategy is to seek capital appreciation through venture capital investments in small, unseasoned, developing companies, primarily in the northeastern United States.

      Rand continues to operate as a publicly-held venture capital company, listed on the NASDAQ Small Cap Market under the symbol “RAND”.

      Effective August 16, 2002, Rand made an election, following an authorized vote of its stockholders to become a Business Development Company, or “BDC”. Generally, a BDC is a specialized type of investment company that is primarily engaged in the business of furnishing capital and managerial expertise to companies that do not have ready access to capital through conventional finance channels. There was no impact on the corporate structure as a result of the change to a BDC. Prior to this election, Rand operated as a diversified closed-end management investment company registered under the Investment Company Act of 1940.

      During the first quarter of 2002, Rand formed a wholly-owned subsidiary, Rand Capital SBIC, L.P., (Rand SBIC) for the purpose of operating it as a small business investment company. Simultaneously with the formation of Rand SBIC, Rand Capital Management, LLC (Rand Management), also a wholly-owned subsidiary, was formed to act as the general partner of Rand SBIC. On January 25, 2002, Rand transferred $5 million in cash to Rand SBIC to serve as “regulatory capital.” On August 16, 2002, Rand received notification that its Small Business Investment Company (SBIC) application had been approved and licensed by the Small Business Administration (SBA). The approval allows Rand SBIC to obtain loans up to two times its initial $5 million of “regulatory capital” from the SBA for purposes of making new investments in portfolio companies. As of December 31, 2005, the Corporation had drawn down $7,200,000 on its leverage commitments (see Note 4).

      Principles of Consolidation – The consolidated financial statements include the accounts of Rand, Rand SBIC and Rand Management, collectively, the “Corporation”. All intercompany accounts and transactions have been eliminated in consolidation.

      Investments – Investments are stated at fair value as determined in good faith by the Board of Directors, as described in the Notes to Consolidated Schedule of Portfolio Investments. Certain investment valuations have been determined by the Board of Directors in the absence of readily ascertainable fair values. The estimated valuations are not necessarily indicative of amounts which may ultimately be realized as a result of future sales or other dispositions of securities, and these favorable or unfavorable differences could be material.

      Certain investment agreements require the portfolio companies to meet certain financial and non-financial covenants. At December 31, 2005 a few of Rand’s portfolio investments were in violation of its loan covenants. Management of the Corporation is pursuing compliance and has considered this in determining the appropriateness of the carrying value of the investment.

      Amounts reported as realized gains and losses are measured by the difference between the proceeds from the sale or exchange and the cost basis of the investment without regard to unrealized gains or losses reported in prior periods. The cost of securities that have, in the Board of Directors’ judgment, become worthless, are written off and reported as realized losses.

      Cash and Cash Equivalents – Temporary cash investments having a maturity of three months or less when purchased are considered to be cash equivalents.

      Revenue Recognition – Interest Income – Interest income generally is recognized on the accrual basis except where the investment is in default or otherwise presumed to be in doubt. In such cases, interest is recognized at the time of receipt. A reserve for possible losses on interest receivable is maintained when appropriate.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

      Deferred Debenture Costs – SBA debenture origination and commitment costs, which are included in other assets, will be amortized ratably over the terms of the SBA debentures. Amortization expense during the year ended December 31, 2005 was $17,272 ($7,852 in 2004). Annual amortization expense for the next five years is estimated to average $26,000 per year.

      Deferred Revenue – The Corporation charges application and closing fees in connection with its investments. These fees are deferred and amortized into income over the life of the debt or equity investment. Deferred fees amortized into income for the years ended December 31, 2005, 2004 and 2003 amounted to $37,916, $42,094 and $9,584, respectively. Deferred revenue amortization income is estimated to average $29,000 per year in 2006 and 2007, and less than $10,000 annually thereafter, based on the deferred revenue balance at December 31, 2005.

      Net Assets Per Share – Net assets per share are based on the number of shares of common stock outstanding. There are no common stock equivalents.

      Supplemental Cash Flow Information – Income taxes paid during the years ended December 31, 2005, 2004 and 2003 amounted to $27,517, $42,273, and $22,913, respectively. Interest paid during the years ended December 31, 2005 and 2004 amounted to $216,068 and $44,564, respectively. No interest was paid during the year ended December 31, 2003. During 2005 and 2004, the Corporation converted $30,852 and $138,319, respectively, of interest receivable into equity investments.

      Concentration of Credit and Market Risk – Financial instruments that potentially subject the Corporation to concentrations of credit risk consisted of cash and cash equivalents. Cash is invested with banks in amounts, which, at times, exceed insurable limits. Management does not anticipate non-performance by the banks.

      As of December 31, 2005, 52% of the Corporation’s total investment value was held in seven notes and equity securities. As of December 31, 2004, 51% of the Corporation’s total investment value was held in six notes and equity securities.

      Accounting Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 2. – Promissory Notes Receivable

      In January 2001, the Corporation received promissory notes from certain principals of its former portfolio companies. Principal payments commenced in January 2001. Amounts were paid in full during the year ended December 31, 2005.

Note 3. – Income Taxes

      Deferred tax assets and liabilities are recorded for temporary differences between the financial statement and tax bases of assets and liabilities using the currently enacted tax rate expected to be in effect when the taxes are actually paid or recovered.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

      The tax effect of the major temporary difference and carryforwards that give rise to the Corporation’s net deferred tax assets at December 31, 2005 and 2004 are approximately as follows:

      The Company assesses annually the recoverability of its deferred tax asset to determine if a valuation allowance is necessary. In performing this assessment, it considers estimated future taxable income and ongoing tax planning strategies. At December 31, 2005 and 2004 it was determined that a valuation allowance was not required.

      The components of income tax (benefit) expense reported in the statements of operations are as follows for the years ended December 31,:

      A reconciliation of the expense (benefit) for income taxes at the federal statutory rate to the expense reported is as follows:

      At December 31, 2005 and 2004, the Corporation had federal net operating loss carryforwards of approximately $1,257,000 and $894,000, respectively, which expire commencing in 2015. For state tax purposes the Corporation had net operating loss carryforwards of approximately $1,238,000 and $877,000, respectively, which expire commencing 2014. The Corporation had a capital loss carryforward at December 31, 2005 of approximately $382,000 which expires in 2010.

RAND CAPITAL CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Note 4. – SBA Debenture Obligations

      Rand SBIC paid a non-refundable commitment fee of $100,000 to the SBA to reserve $10,000,000 of its approved SBA Guaranteed Debenture leverage. This fee was paid in two installments of $50,000 each in July 2003 and August 2004. The fee represents 1% of the face amount of the leverage reserved under the commitment and is a partial prepayment of the SBA’s nonrefundable 3% leverage draw fees. As of December 31, 2005, Rand SBIC has debentures payable to and guaranteed by the SBA totaling $7,200,000 ($3,500,000 at December 31, 2004) against this commitment. The debenture terms require semiannual payments of interest at annual interest rates ranging from 4.12% to 5.01%, plus an annual charge that ranged from .855% to .887% during the year ended December 31, 2005. The debentures outstanding at December 31, 2005 mature in 2014 and 2015.

Note 5. – Stockholders’ Equity (Net Assets)

      At December 31, 2005 and 2004, there were 500,000 shares of $10.00 par value preferred stock authorized and unissued.

      The Board of Directors has authorized the repurchase of up to 5% of the Corporation’s outstanding stock on the open market through October 27, 2006.

      Summary of change in equity accounts: