10-Q: Quarterly report [Sections 13 or 15(d)]

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

Form 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended June 30, 2001

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________

Commission File Number: 0-11576

HARRIS & HARRIS GROUP, INC.
- -----------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

New York 13-3119827
- -----------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

One Rockefeller Plaza, Rockefeller Center, New York, New York 10020
- -----------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)

(212) 332-3600
- -----------------------------------------------------------------------
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(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 [X] No [ ]

Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date.

Class Outstanding at August 9, 2001
- ------------------------------------------------------------------------
Common Stock, $0.01 par value per share 9,064,231 shares


Harris & Harris Group, Inc.
Form 10-Q, June 30, 2001

TABLE OF CONTENTS

Page Number
PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements. . . . . . . . 1

Consolidated Statements of Assets and Liabilities . . . . 2

Consolidated Statements of Operations . . . . . . . . . . 3

Consolidated Statements of Cash Flows . . . . . . . . . . 4

Consolidated Statements of Changes in Net Assets. . . . . 5

Consolidated Schedule of Investments. . . . . . . . . . . 6

Notes to Consolidated Financial Statements. . . . . . . . 14

Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. . 21

Financial Condition . . . . . . . . . . . . . . . . . . . 21

Results of Operations . . . . . . . . . . . . . . . . . . 23

Liquidity and Capital Resources . . . . . . . . . . . . . 26

Risk Factors. . . . . . . . . . . . . . . . . . . . . . . 27

Item 3. Quantitative and Qualitative Disclosures
About Market Risk. . . . . . . . . . . . . . . . 30

PART II OTHER INFORMATION

Item 1. Legal Proceedings. . . . . . . . . . . . . . . . 32
Item 2. Changes in Securities and Use of Proceeds. . . . 32
Item 3. Defaults Upon Senior Securities. . . . . . . . . 32
Item 4. Submission of Matters to a Vote of
Security Holders . . . . . . . . . . . . . . . . 32
Item 5. Other Information. . . . . . . . . . . . . . . . 32
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . 32

Exhibit Index . . . . . . . . . . . . . . . . . . . . . . 33
Signature . . . . . . . . . . . . . . . . . . . . . . . . 33


Harris & Harris Group, Inc.
Form 10-Q, June 30, 2001


PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

The information furnished in the accompanying consolidated
financial statements reflects all adjustments that are, in the
opinion of management, necessary for a fair presentation of the
results for the interim period presented.

On June 30, 1994, the Company's shareholders approved a
proposal to allow the Company to make an election to become a
Business Development Company ("BDC") under the amended Investment
Company Act of 1940. The Company made such election on July 26,
1995. Certain information and disclosures normally included in
the consolidated financial statements in accordance with
Generally Accepted Accounting Principles have been condensed or
omitted as permitted by Regulation S-X and Regulation S-K. It is
suggested that the accompanying consolidated financial statements
be read in conjunction with the audited consolidated financial
statements and notes thereto for the year ended December 31, 2000
contained in the Company's 2000 Annual Report.

On September 25, 1997, the Company's Board of Directors
approved a proposal to seek qualification of the Company as a
Regulated Investment Company ("RIC") under Sub-Chapter M of the
Internal Revenue Code (the "Code"). At that time, the Company
was taxable under Sub-Chapter C of the Code (a "C Corporation").
In order to qualify as a RIC, the Company must, in general (1)
annually derive at least 90 percent of its gross income from
dividends, interest, gains from the sale of securities and
similar sources; (2) quarterly meet certain investment
diversification requirements; and (3) annually distribute at
least 90 percent of its investment company taxable income as a
dividend. In addition to the requirement that the Company must
annually distribute at least 90 percent of its investment company
taxable income, the Company may either distribute or retain its
taxable net capital gains from investments, but any net capital
gains not distributed could be subject to corporate level tax.
Further, the Company could be subject to a four percent excise
tax if it fails to distribute 98 percent of its annual taxable
income and would be subject to income tax if it fails to
distribute 100 percent of its taxable income.

Because of the specialized nature of its investment
portfolio, the Company could satisfy the diversification
requirements under Sub-Chapter M of the Code only if it received
a certification from the SEC that it is "principally engaged in
the furnishing of capital to other corporations which are
principally engaged in the development or exploitation of
inventions, technological improvements, new processes, or
products not previously generally available."

On March 8, 2001, the Company received SEC certification and
qualified for RIC treatment for 2000 (as it had for 1999).
Although the SEC certification for 2000 was issued, there can be
no assurance that the Company will receive such certification for
subsequent years (to the extent it needs additional certification
as a result of changes in its portfolio) or that it will actually
qualify for Sub-Chapter M treatment in subsequent years. In
addition, under certain circumstances, even if the Company
qualified for Sub-Chapter M treatment in a given year, the
Company might take action in a subsequent year to ensure that it
would be taxed in that subsequent year as a C Corporation, rather
than as a RIC.

1



CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

ASSETS

June 30, 2001 December 31, 2000
(Unaudited) (Audited)
Investments, at value (See
accompanying schedule of
investments and notes). . . $ 32,695,185 $ 42,568,559
Cash and cash equivalents . . 130,069 253,324
Restricted funds (Note 5) . . 373,942 265,183
Interest receivable . . . . . 1,848 30,082
Note receivable . . . . . . . 10,888 10,888
Prepaid expenses. . . . . . . 40,662 82,615
Other assets. . . . . . . . . 122,440 132,772
------------- -----------------
Total assets. . . . . . . . . $ 33,375,034 $ 43,343,423
============= =================

LIABILITIES & NET ASSETS

Accounts payable and
accrued liabilities . . . . $ 856,458 $ 771,763
Payable to broker for
unsettled trade . . . . . . 0 115,005
Accrued profit sharing
(Note 3). . . . . . . . . . 1,257,369 3,483,241
Deferred rent . . . . . . . . 19,276 23,903
Current income tax liability
(Note 6). . . . . . . . . . 16,667 5,751,566
Deferred income tax liability
(Note 6). . . . . . . . . . 1,364,470 1,364,470
------------- -----------------
Total liabilities . . . . . . 3,514,240 11,509,948
------------- -----------------
Commitments and contingencies
(Note 7)

Net assets. . . . . . . . . . $ 29,860,794 $ 31,833,475
============= =================

Net assets are comprised of:
Preferred stock, $0.10 par
value, 2,000,000 shares
authorized; none issued . . $ 0 $ 0
Common stock, $0.01 par
value, 25,000,000 shares
authorized; 10,692,971
issued at 6/30/01 and
12/31/00. . . . . . . . . . 106,930 106,930
Additional paid in capital
(Note 4). . . . . . . . . . 26,724,595 26,724,595
Additional paid in capital --
common stock warrants . . . 109,641 109,641
Accumulated net realized
(loss) gain . . . . . . . . (1,003,290) 642,418
Accumulated unrealized
appreciation of investments,
net of deferred tax liability
of $1,630,506 at 6/30/01 and
$1,630,506 at 12/31/00. . . 6,990,449 7,317,422
Treasury stock at cost
(1,628,740 shares at 6/30/01
and at 12/31/00). . . . . . (3,067,531) (3,067,531)
------------ ----------------
Net assets. . . . . . . . . . $ 29,860,794 $ 31,833,475
============ ================
Shares outstanding. . . . . . 9,064,231 9,064,231
============ ================
Net asset value per
outstanding share . . . . . . $ 3.29 $ 3.51
============ ================

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

2

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

Three Months Ended Six Months Ended
June June June June
30, 30, 30, 30,
2001 2000 2001 2000
Investment income:
Interest from:
Fixed-income
securities. . . . . . . .$ 117,846 $ 60,861 $ 270,376 $ 144,815
Affiliated companies. . . 1,765 12,376 11,382 34,058
Other income. . . . . . . 17,350 19,252 47,162 35,064
--------- ------------ ------------ -----------
Total investment income. 136,961 92,489 328,920 213,937

Expenses:
Profit-sharing accrual
(reversal)(Note 3). . . . 712,982 (2,465,091) (133,308) (4,116,427)
Salaries and benefits. . . 256,212 244,740 555,916 522,286
Administration and
operations. . . . . . . . 123,680 152,525 216,937 245,099
Professional fees. . . . . 32,616 120,707 91,819 206,014
Rent . . . . . . . . . . . 48,393 41,634 90,465 83,109
Directors' fees and
expenses. . . . . . . . . 23,366 34,278 46,356 55,410
Depreciation . . . . . . . 7,500 10,000 15,000 20,000
Bank custody fees. . . . . 2,779 1,064 6,425 4,600
Interest expense (Note 4). 0 0 0 146,141
--------- ----------- ----------- -----------
Total expenses. . . . . .1,207,528 (1,860,143) 889,610 (2,833,768)
--------- ----------- ----------- -----------
Operating (loss) income
before income taxes. . .(1,070,567) 1,952,632 (560,690) 3,047,705
Income tax provision
(Note 6) . . . . . . . . 0 0 0 0
--------- ----------- ----------- -----------
Net operating (loss)
income. . . . . . . . . .(1,070,567) 1,952,632 (560,690) 3,047,705

Net realized gain (loss) on investments:
Realized gain (loss) on
sale of investments. . . 161,909 4,332,410 (1,032,743) 8,095,682
---------- ----------- ----------- -----------
Total realized gain
(loss) . . . . . . . . 161,909 4,332,410 (1,032,743) 8,095,682
Income tax provision
(Note 6) . . . . . . . . (22,641) (1,457,455) (52,275) (2,641,073)
---------- ------------ ----------- -----------
Net realized gain (loss)
on investments . . . . . 139,268 2,874,955 (1,085,018) 5,454,609

Net realized (loss)
income . . . . . . . . . . (931,299) 4,827,587 (1,645,708) 8,502,314

Net increase (decrease) in
unrealized appreciation on investments:
Increase (decrease) as
a result of investment
sales. . . . . . . . . . 36,881 (9,247,287) 1,564,963 (12,452,277)
Increase on investments
held . . . . . . . . . . 3,216,789 1,094,989 3,216,789 15,433,562
Decrease on investments
held . . . . . . . . . . (497,712) (7,783,785) (5,108,725)(29,517,624)
---------- ----------- ----------- ------------
Net change in unrealized
appreciation on
investments . . . . . . 2,755,958 (15,936,083) (326,973)(26,536,339)
Income tax benefit
(Note 6). . . . . . . . 0 0 0 153,304
---------- ----------- ---------- ------------
Net increase (decrease) in
unrealized appreciation
on investments . . . . . 2,755,958 (15,936,083) (326,973)(26,383,035)
---------- ------------ ----------- ------------
Net increase (decrease) in
net assets resulting from
operations:
Total . . . . . . . . . . $1,824,659 $(11,108,496) $(1,972,681)$(17,880,721)
========== ============ =========== ============
Per outstanding share . . $ 0.20 $ (1.20) $ (0.22)$ (1.92)
========== ============ =========== ============

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

3

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000

Cash flows from operating activities:
Net decrease in net assets resulting
from operations. . . . . . . . . . . . $ (1,972,681) $ (17,880,721)
Adjustments to reconcile net decrease
in net assets resulting from operations
to net cash used in operating activities:
Net realized and unrealized gain
on investments . . . . . . . . . . . 1,359,716 18,440,657
Deferred income taxes. . . . . . . . . 0 (153,304)
Depreciation . . . . . . . . . . . . . 15,000 20,000
Other. . . . . . . . . . . . . . . . . 0 83,007

Changes in assets and liabilities:
Restricted funds . . . . . . . . . . . (108,759) (147,656)
Interest receivable. . . . . . . . . . 28,234 43,971
Prepaid expenses . . . . . . . . . . . 41,953 38,647
Funds in escrow. . . . . . . . . . . . 0 1,327,748
Other assets . . . . . . . . . . . . . (1,113) 18,489
Accounts payable and accrued
liabilities. . . . . . . . . . . . . 84,695 (107,752)
Payable to broker for unsettled trade. (115,005) 0
Accrued profit sharing . . . . . . . . (2,225,872) (5,141,123)
Current income tax liability . . . . . (5,734,899) 2,672,413
Deferred rent. . . . . . . . . . . . . (4,627) (4,627)
Collection on notes receivable . . . . 0 10,887
---------------- --------------
Net cash used in operating activities. (8,633,358) (779,364)

Cash flows from investing activities:
Net purchase (sale) of short-term
investments and marketable
securities . . . . . . . . . . . . . 7,579,689 (4,277,993)
Proceeds from sale or liquidation
of investments . . . . . . . . . . . 2,112,796 9,580,519
Investment in private placements
and loans. . . . . . . . . . . . . . (1,178,827) (4,417,500)
Purchase of fixed assets . . . . . . . (3,555) (6,974)
---------------- --------------
Net cash provided by investing
activities. . . . . . . . . . . . . . . 8,510,103 878,052

Cash flows from financing activities:
Proceeds from note payable . . . . . . 0 3,000,000
Payment of note payable. . . . . . . . 0 (3,000,000)
---------------- --------------
Net cash used in financing activities. 0 0
---------------- --------------
Net (decrease) increase in cash and cash equivalents:
Cash and cash equivalents at beginning
of the period. . . . . . . . . . . . 253,324 133,256
Cash and cash equivalents at end
of the period. . . . . . . . . . . . 130,069 231,944
---------------- --------------
Net (decrease) increase in cash and
cash equivalents . . . . . . . . . . $ (123,255) $ 98,688
================ ==============
Supplemental disclosures of cash flow information:
Income taxes paid. . . . . . . . . . . $ 5,787,174 $ 600
Interest paid. . . . . . . . . . . . . $ 0 $ 36,500


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

4

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)

Three Months Ended Six Months Ended
June June June June
30, 30, 30, 30,
2001 2000 2001 2000

Changes in net assets from operations:
Net operating (loss)
income. . . . . . . . $(1,070,567) $ 1,952,632 $ (560,690) $ 3,047,705
Net realized gain (loss)
on investments. . . . 139,268 2,874,955 (1,085,018) 5,454,609
Net increase (decrease)
in unrealized
appreciation on
investments as a
result of sales . . . 36,881 (9,247,287) 1,564,963 (12,298,973)
Net increase (decrease)
in unrealized
appreciation on
investments held. . . 2,719,077 (6,688,796) (1,891,936) (14,084,062)
----------- ----------- ---------- -----------
Net increase (decrease)
in net assets
resulting from
operations. . . . . . 1,824,659 (11,108,496) (1,972,681) (17,880,721)


Changes in net assets from capital
stock transactions:

Additional paid in
capital on Common Stock
Warrants issued . . . 0 0 0 109,641
----------- ----------- ---------- -----------
Net increase in net
assets resulting
from capital stock
transactions. . . . . 0 0 0 109,641
----------- ----------- ---------- -----------
Net increase (decrease)
in net assets. . . . . . 1,824,659 (11,108,496) (1,972,681) (17,771,080)

Net assets:

Beginning of the
period . . . . . . . 28,036,135 46,972,221 31,833,475 53,634,805
----------- ----------- ----------- -----------
End of the
period . . . . . . . $29,860,794 $35,863,725 $29,860,794 $35,863,725
=========== =========== =========== ===========

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

5

CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2001
(Unaudited)

Method of Shares/
Valuation (3) Principal Value

Investments in Unaffiliated Companies
(13)(14)(15) -- 14.3% of total investments

Publicly Traded Portfolio (Common stock unless noted otherwise) --
9.6% of total investments

Genomica Corporation (1)(6)(7) --
Develops software that enables the
study of complex genetic diseases --
2.94% of fully diluted equity
Common Stock. . . . . . . . . . . . . . . (C) 731,111 $3,143,777
----------
Total Publicly Traded Portfolio (cost: $1,500,304). . . . . . . . . $3,143,777
----------
Private Placement Portfolio (Illiquid) (13)(14)(15) --
4.7% of total investments

AlphaSimplex Group, LLC (1)(2) --
Investment advisory firm. . . . . . . . . (D) -- $ 641

Essential.com, Inc. (1)(2)(8) --
Online energy and communications
marketplace -- 0.97% of fully diluted
equity
Common stock. . . . . . . . . . . . . . . (D) 253,271 --

Exponential Business Development Company (2)(5) --
Venture capital partnership focused
on early stage companies
Limited partnership interest. . . . . . . (A) -- 25,000

Informio, Inc. (1)(2)(5)(6)(9) --
Developing audio web portal
technology -- 0.80% of fully diluted
equity
Series A Voting Convertible
Preferred Stock . . . . . . . . . . . . . (A) 229,364 504,601

Kriton Medical, Inc. (1)(2)(5)(6) --
Research and development of
medical devices -- 1.86% of fully
diluted equity
Series B Convertible Preferred Stock. . . (A) 476,191 1,000,001

MedLogic Global Corporation (1)(2)(5)(6) --
Medical cyanoacrylate adhesive --
0.23% of fully diluted equity
Series B Convertible Preferred Stock. . . (D) 54,287
Common Stock. . . . . . . . . . . . . . . (D) 25,798 --
----------
Total Private Placement Portfolio (cost: $3,912,910). . . . . . . . $1,530,243
----------
Total Investments in Unaffiliated Companies (cost: $5,413,214). . . $4,674,020
----------

The accompanying notes are an integral part of this
consolidated schedule.

6

CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2001
(Unaudited)

Method of Shares/
Valuation (3) Principal Value

Investments in Non-Controlled Affiliated Companies (13)(15) -- 60.2%
of total investments

Publicly Traded Portfolio -- 23.9% of total investments

Nanophase Technologies Corporation (1)(10) --
Manufactures and markets inorganic
crystals of nanometric dimensions --
4.67% of fully diluted equity. . . . . . (C) 705,916 $7,800,372
----------
Total Publicly Traded Portfolio (cost: $1,500,418). . . . . . . . . $7,800,372
----------
Private Placement Portfolio (Illiquid) (13)(15) -- 36.3% of total
investments

Experion Systems, Inc. (1)(2)(6)(11) --
Provides e-business software selling
platforms based on trust-based
marketing -- 13.42% of fully diluted
equity
Convertible Preferred Stock . . . . . . (D) 197,500 $1,100,000

NeuroMetrix, Inc. (1)(2)(5)(6) --
Medical devices for monitoring
neuromuscular disorders -- 13.51% of
fully diluted equity
Series A Convertible Preferred Stock. . (D) 875,000
Series B Convertible Preferred Stock. . (D) 625,000
Series C-2 Convertible Preferred Stock. (D) 1,148,100
Series E Convertible Preferred Stock. . (D) 266,665 6,708,225

PHZ Capital Partners Limited Partnership (2)(12) --
Organizes and manages investment
partnerships -- 20.0% of fully
diluted equity
Limited partnership interest. . . . . . (D) -- 1,988,791

Questech Corporation (1)(2)(5)(6) --
Manufactures and markets proprietary
decorative tiles and signs -- 9.36% of
fully diluted equity
Common Stock. . . . . . . . . . . . . . (B) 646,954
Warrants at $5.00 expiring 11/15/04 . . (B) 1,965
Warrants at $4.00 expiring 11/28/01 . . (B) 152,422
Warrants at $1.50 expiring 11/16/05 . . (B) 1,250 970,598

Schwoo, Inc. (1)(2)(4) -- Developing
software that automatically manages
e-commerce security infrastructure --
11.9% of fully diluted equity
Series B Convertible Preferred Stock. . (A) 2,306,194
Convertible Bridge Loans. . . . . . . . (A) $ 210,250
Warrants at $0.3853 . . . . . . . . . . (A) 81,851 1,098,827
-----------
Total Private Placement Portfolio (cost: $8,803,890). . . . . . . .$11,866,441
-----------
Total Investments in Non-Controlled Affiliated
Companies (cost: $10,304,308) . . . . . . . . . . . . . . . . . . $19,666,813
-----------

The accompanying notes are an integral part of this
consolidated schedule.

7

CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2001
(Unaudited)

Method of Shares/
Valuation (3) Principal Value


U.S. Government and Agency Obligations -- 25.5% of total investments

Federal Home Loan Bank Discount Notes --
due date 7/11/01. . . . . . . . . . . . . (K) $1,200,000 $1,198,512
Federal Home Loan Bank Discount Notes --
due date 8/6/01 . . . . . . . . . . . . . (K) $1,600,000 1,593,776
Federal Farm Credit Bank Discount Notes --
due date 8/20/01. . . . . . . . . . . . . (K) $1,700,000 1,690,956
Federal Home Loan Bank Discount Notes --
due date 9/5/01 . . . . . . . . . . . . . (K) $2,000,000 1,986,080
Federal Home Loan Bank Discount Notes --
due date 9/14/01. . . . . . . . . . . . . (K) $1,900,000 1,885,028
-----------
Total Investments in U.S. Government and
Agency Obligations (cost: $8,356,708) . . . . . . . . . . . . . . $ 8,354,352
-----------
Total Investments -- 100% (cost: $24,074,230). . . . . . . . . . . $32,695,185
===========

The accompanying notes are an integral part of this
consolidated schedule.

8

CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2001
(Unaudited)

Notes to Consolidated Schedule of Investments

(1) Represents a non-income producing security. Equity investments
that have not paid dividends within the last 12 months are considered
to be non-income producing.

(2) Legal restrictions on sale of investment.

(3) See Footnote to Schedule of Investments for a description of
the Methods of Valuation A to L.

(4) These investments were made during 2001. Accordingly, the
amounts shown on the schedule represent the gross additions
in 2001.

(5) No changes in valuation occurred in these investments during
the six months ended June 30, 2001.

(6) These investments are development stage companies. A
development stage company is defined as a company that is
devoting substantially all of its efforts to establishing a
new business, and either it has not yet commenced its planned
principal operations or it has commenced such operations but
has not realized significant revenue from them.

(7) In 1996, Genomica Corporation was cofounded by the Company,
Cold Spring Harbor Laboratory ("CSHL"), a not-for-profit
institution, and Falcon Technology Partners, LP. Mr. G. Morgan
Browne serves on the Board of Directors of the Company and is
Chief Financial Officer of CSHL. In late 1998, Charles E. Harris,
Chairman and CEO of Harris & Harris Group, became a trustee of
CSHL. On September 29, 2000, Genomica Corporation (National
Market Symbol: GNOM) commenced trading on Nasdaq. During July and
August 2001, the Company sold its position in Genomica
Corporation for total net proceeds of approximately $2,523,274
or $3.45 per share.

(8) On June 29, 2000, Sundial Marketplace Corporation was
acquired in a tax-free merger by Essential.com, Inc.
Essential.com has filed for bankruptcy.

(9) Previously named iPacer Corporation.


The accompanying notes are an integral part of this
consolidated schedule.

9

(10) During July and August 2001, the Company sold its position
in Nanophase Technologies Corporation (National Market
Symbol: NANX) for total net proceeds of approximately
$4,263,242 or $6.04.

(11) Previously named MyPersonalAdvocate.com, Inc.

(12) Harris Partners I L.P. owns a 20 percent limited partnership
interest in PHZ Capital Partners L.P. The partners of Harris
Partners I L.P. are Harris & Harris Enterprises, Inc. (sole
general partner) and Harris & Harris Group, Inc. (sole limited
partner). Harris & Harris Enterprises, Inc. is a 100 percent
owned subsidiary of Harris & Harris Group, Inc.

(13) Investments in unaffiliated companies consist of investments
in which the Company owns less than five percent of the
investee company. Investments in non-controlled affiliated
companies consist of investments in which the Company owns
more than five percent but less than 25 percent of the
investee company. Investments in controlled affiliated
companies consist of investments in which the Company owns
more than 25 percent of the investee company.

(14) The aggregate cost for federal income tax purposes of
investments in unaffiliated companies is $5,413,214. The
gross unrealized appreciation based on the tax cost for these
securities is $2,383,308. The gross unrealized depreciation
based on the tax cost for these securities is $1,644,114.

(15) The percentage ownership of each investee company disclosed
in the Consolidated Schedule of Investments expresses the
potential common equity interest in each such investee. The
calculated percentage represents the amount of the issuer's
common stock the Company owns or can acquire as a percentage
of the issuer's total outstanding common stock plus common
shares reserved for issued and outstanding warrants,
convertible securities and stock options.


The accompanying notes are an integral part of this
consolidated schedule.

10

FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS

ASSET VALUATION POLICY GUIDELINES

The Company's investments can be classified into five broad
categories for valuation purposes:

1) EQUITY-RELATED SECURITIES

2) INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR
RESEARCH AND DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT

3) LONG-TERM FIXED-INCOME SECURITIES
4) SHORT-TERM FIXED-INCOME INVESTMENTS
5) ALL OTHER INVESTMENTS

The Investment Company Act of 1940 (the "1940 Act") requires
periodic valuation of each investment in the Company's portfolio to
determine net asset value. Under the 1940 Act, unrestricted
securities with readily available market quotations are to be valued
at the current market value; all other assets must be valued at
"fair value" as determined in good faith by or under the direction
of the Board of Directors.

The Company's Board of Directors is responsible for (1)
determining overall valuation guidelines and (2) ensuring the
valuation of investments within the prescribed guidelines.

The Company's Investment and Valuation Committee, comprised of
at least three or more Board members, is responsible for reviewing
and approving the valuation of the Company's assets within the
guidelines established by the Board of Directors.

Fair value is generally defined as the amount that an
investment could be sold for in an orderly disposition over a
reasonable time. Generally, to increase objectivity in valuing the
assets of the Company, external measures of value, such as public
markets or third-party transactions, are utilized whenever possible.
Valuation is not based on long-term work-out value, nor immediate
liquidation value, nor incremental value for potential changes that
may take place in the future.

Valuation assumes that, in the ordinary course of its business,
the Company will eventually sell its investment.

The Company's valuation policy with respect to the five broad
investment categories is as follows:

EQUITY-RELATED SECURITIES

Equity-related securities are carried at fair value using
one or more of the following basic methods of valuation:

A. Cost: The cost method is based on the original cost to
the Company. This method is generally used in the early stages
of a company's development until significant positive or negative
events occur subsequent to the date of the original investment
that dictate a change to another valuation method. Some examples
of such events are: (1) a major recapitalization; (2) a major
refinancing; (3) a significant third-party transaction; (4) the

11

development of a meaningful public market for the company's
common stock; and (5) significant positive or negative changes in
the company's business.

B. Private Market: The private market method uses actual
third-party transactions in the company's securities as a basis
for valuation, using actual, executed, historical transactions in
the company's securities by responsible third parties. The
private market method may also use, where applicable,
unconditional firm offers by responsible third parties as a basis
for valuation.

C. Public Market: The public market method is used when
there is an established public market for the class of the
company's securities held by the Company. The Company discounts
market value for securities that are subject to significant legal
and contractual restrictions. Other securities, for which market
quotations are readily available, are carried at market value as
of the time of valuation. In accordance with recently published
SEC guidelines, the Company changed its policy, effective March
31, 2001, and no longer discounts the market value of securities
for liquidity considerations.

Market value for securities traded on securities exchanges
or on the Nasdaq National Market is the last reported sales price
on the day of valuation. For other securities traded in the
over-the-counter market and listed securities for which no sale
was reported on that day, market value is the mean of the closing
bid price and asked price on that day.

This method is the preferred method of valuation when there
is an established public market for a company's securities, as
that market provides the most objective basis for valuation.

D. Analytical Method: The analytical method is generally
used to value an investment position when there is no established
public or private market in the company's securities or when the
factual information available to the Company dictates that an
investment should no longer be valued under either the cost or
private market method. This valuation method is inherently
imprecise and ultimately the result of reconciling the judgments
of the Company's Investment and Valuation Committee members,
based on the data available to them. The resulting valuation,
although stated as a precise number, is necessarily within a
range of values that vary depending upon the significance
attributed to the various factors being considered. Some of the
factors considered may include the financial condition and
operating results of the company, the long-term potential of the
business of the company, the values of similar securities issued
by companies in similar businesses, the proportion of the
company's securities owned by the Company and the nature of any
rights to require the company to register restricted securities
under applicable securities laws.

INVESTMENTS IN INTELLECTUAL PROPERTY OR PATENTS OR RESEARCH AND
DEVELOPMENT IN TECHNOLOGY OR PRODUCT DEVELOPMENT

Such investments are carried at fair value using the
following basic methods of valuation:

E. Cost: The cost method is based on the original cost to
the Company. Such method is generally used in the early stages of
commercializing or developing intellectual property or patents or
research and development in technology or product development
until significant positive or adverse events occur subsequent to
the date of the original investment that dictate a change to
another valuation method.

F. Private Market: The private market method uses actual
third-party investments in intellectual property or patents or
research and development in technology or product development as
a basis for valuation, using actual executed historical
transactions by responsible third parties.

12

The private market method may also use, where applicable,
unconditional firm offers by responsible third parties as a basis
for valuation.

G. Analytical Method: The analytical method is used to
value an investment after analysis of the best available outside
information where the factual information available to the
Company dictates that an investment should no longer be valued
under either the cost or private market method. This valuation
method is inherently imprecise and ultimately the result of
reconciling the judgments of the Company's Investment and
Valuation Committee members. The resulting valuation, although
stated as a precise number, is necessarily within a range of
values that vary depending upon the significance attributed to
the various factors being considered. Some of the factors
considered may include the results of research and development,
product development progress, commercial prospects, term of
patent and projected markets.

LONG-TERM FIXED-INCOME SECURITIES

H. Fixed-Income Securities for which market quotations are
readily available are carried at market value as of the time of
valuation using the most recent bid quotations when available.

Securities for which market quotations are not readily
available are carried at fair value using one or more of the
following basic methods of valuation:

I. Fixed-Income Securities are valued by independent
pricing services that provide market quotations based primarily
on quotations from dealers and brokers, market transactions, and
other sources.

J. Other Fixed-Income Securities that are not readily
marketable are valued at fair value by the Investment and
Valuation Committee.

SHORT-TERM FIXED-INCOME INVESTMENTS

K. Short-Term Fixed-Income Investments are valued at
market value at the time of valuation. Short-term debt with
remaining maturity of 60 days or less is valued at amortized
cost.

ALL OTHER INVESTMENTS

L. All Other Investments are reported at fair value as
determined in good faith by the Investment and Valuation
Committee.

The reported values of securities for which market
quotations are not readily available and for other assets
reflect the Investment and Valuation Committee's judgment of
fair values as of the valuation date using the outlined basic
methods of valuation. They do not necessarily represent an
amount of money that would be realized if the securities had to
be sold in an immediate liquidation. The Company makes many of
its portfolio investments with the view of holding them for a
number of years, and the reported value of such investments may
be considered in terms of disposition over a period of time.
Thus valuations as of any particular date are not necessarily
indicative of amounts that may ultimately be realized as a
result of future sales or other dispositions of investments
held.

13

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1. THE COMPANY

Harris & Harris Group, Inc. (the "Company") is a venture
capital investment company operating as a business development
company ("BDC") under the Investment Company Act of 1940 ("1940
Act"). A BDC is a specialized type of investment company under
the 1940 Act. The Company operates as an internally managed
investment company whereby its officers and employees, under the
general supervision of its Board of Directors, conduct its
operations.

The Company elected to become a BDC on July 26, 1995, after
receiving the necessary approvals. From September 30, 1992 until
the election of BDC status, the Company operated as a closed-end,
non-diversified, investment company under the 1940 Act. Upon
commencement of operations as an investment company, the Company
revalued all of its assets and liabilities at fair value as
defined in the 1940 Act. Prior to such time, the Company was
registered and filed under the reporting requirements of the
Securities and Exchange Act of 1934 as an operating company and,
while an operating company, operated directly and through
subsidiaries.

Harris & Harris Enterprises, Inc. ("Enterprises") is a 100
percent wholly owned subsidiary of the Company. Enterprises
holds the lease for the office space, which it subleases to the
Company and an unaffiliated party; operates a financial relations
and consulting firm; is a partner in Harris Partners I, L.P. and
is taxed as a C corporation. Harris Partners I L.P. is a limited
partnership and owns a 20 percent limited partnership interest in
PHZ Capital Partners, L.P. The partners of Harris Partners I
L.P. are Enterprises (sole general partner) and the Company (sole
limited partner).

The Company qualified for 2000 as a Regulated Investment
Company ("RIC") under Sub-Chapter M of the Internal Revenue Code
of 1986 (the "Code"). There can be no assurance that the Company
will qualify as a RIC in 2001 or that, if it does qualify, it
will continue to qualify for subsequent years. In addition, even
if the Company were to qualify as a RIC for a given year, the
Company might take action in a subsequent year to ensure that it
would be taxed in that subsequent year as a C Corporation, rather
than a RIC. As a RIC, the Company must, among other things,
distribute at least 90 percent of its taxable net income and may
either distribute or retain its taxable net realized capital
gains on investments.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting
policies followed in the preparation of the consolidated
financial statements:

Principles of Consolidation. The consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States for
investment companies and include the accounts of the Company
and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.

Cash and Cash Equivalents. Cash and cash equivalents
include money market instruments with maturities of less than
three months.

14

Portfolio Investment Valuations. The Investment Company Act
of 1940 (the "1940 Act") requires periodic valuation of each
investment in the Company's portfolio to determine net asset
value. Under the 1940 Act, unrestricted securities with readily
available market quotations are to be valued at the current
market value; all other assets must be valued at "fair value" as
determined in good faith by or under the direction of the Board
of Directors.

Securities Transactions. Securities transactions are
accounted for on the date the securities are purchased or sold
(trade date); dividend income is recorded on the ex-dividend
date; and interest income is accrued as earned. Realized gains
and losses on investment transactions are determined on the
specific identification basis for financial reporting and tax
reporting.

Income Taxes. Prior to January 1, 1999, the Company
recorded income taxes using the liability method in accordance
with the provision of Statement of Financial Accounting Standards
No. 109. Accordingly, deferred tax liabilities had been
established to reflect temporary differences between the
recognition of income and expenses for financial reporting and
tax purposes, the most significant difference of which related to
the Company's unrealized appreciation on investments.

The June 30, 2001 consolidated financial statements include
a liability for deferred taxes on the remaining net built-in
gains as of December 31, 1998, net of the unutilized operating
and capital loss carryforwards incurred by the Company through
December 31, 1998.

The June 30, 2000 and December 31, 2000 consolidated
financial statements also reflect a tax provision on net realized
long-term capital gains which the Company retained for liquidity
and to fund investment opportunities, rather than distribute to
shareholders as a cash distribution. Accordingly, the Company
declared a designated undistributed capital gain dividend for the
year. (See "Note 6. Income Taxes" and Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of
Operation -- Sub-Chapter M Status -- Recent Developments.")

The Company pays federal, state and local income taxes on
behalf of its wholly owned subsidiary, Harris & Harris
Enterprises, which is a C corporation. (See Note 6. Income
Taxes.)

Reclassifications. Certain reclassifications have been made
to the June 30, 2000 financial statements to conform to the June
30, 2001 presentation.

Estimates by Management. The preparation of the
consolidated financial statements in conformity with accounting
principles generally accepted in the United States requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of June 30, 2001
and December 31, 2000, and the reported amounts of revenues and
expenses for the three months ended June 30, 2001 and June 30,
2000. Actual results could differ from these estimates.

NOTE 3. EMPLOYEE PROFIT-SHARING PLAN

On August 3, 1989, the shareholders of the Company approved
the 1988 Long Term Incentive Compensation Plan (the "1988 Plan").
The Company's 1988 Plan was cancelled as of December 31, 1997,
canceling all outstanding stock options and eliminating all
potential stock option grants. As a substitution for the 1988
Plan, the Company adopted an employee profit-sharing plan.

15

As of January 1, 1998, the Company began implementing the
Harris & Harris Group, Inc. Employee Profit Sharing Plan (the
"1998 Plan") that provides for profit sharing equal to 20 percent
of the net realized income of the Company as reflected on the
Consolidated Statement of Operations for such year, less the
nonqualifying gain, if any. The 1998 Plan was terminated by the
Company as of December 31, 1999. All the amounts owed on the
1999 realized gains were paid during 2000. In March 2000, the
Company paid out 90 percent of the profit sharing in the amount
of $1,024,696 on the 1999 realized gains; the remaining 10
percent or $113,855 was paid out in September 2000, upon the
completion and filing of the Company's 1999 federal tax return.

As of January 1, 2000, the Company implemented the Harris &
Harris Group, Inc. Employee Profit Sharing Plan (the "Plan") that
provides for profit sharing equal to 20 percent of the net
realized income of the Company as reflected on the Consolidated
Statement of Operations of the Company for such year, less the
nonqualifying gain, if any.

Under the Plan, net realized income of the Company includes
investment income, realized gains and losses, and operating
expenses (including taxes paid or payable by the Company), but is
calculated without regard to dividends paid or distributions made
to shareholders, payments under the Plan, unrealized gains and
losses, and loss carryovers from other years ("Qualifying
Income"). The portion of net after-tax realized gains
attributable to asset values as of September 30, 1997 is
considered nonqualifying gain, which reduces Qualifying Income.

As soon as practicable following the year-end audit, the
Board of Directors will determine whether, and if so how much,
Qualifying Income exists for a plan year, and 90 percent of the
Qualifying Income will be paid out to Plan participants pursuant
to the distribution percentages set forth in the Plan. The
remaining 10 percent will be paid out after the Company has filed
its federal tax return for that year in which Qualifying Income
exists. Currently, the distribution amounts for each officer and
employee are as follows: Charles E. Harris, 13.790 percent; Mel
P. Melsheimer, 4.233 percent; Rachel M. Pernia, 1.524 percent;
and Jacqueline M. Matthews, 0.453 percent. If a participant
leaves the Company for other than cause, the amount earned will
be accrued and may subsequently be paid to such participant.

Notwithstanding any provisions of the Plan, in no event may
the aggregate amount of all awards payable for any Plan year
during which the Company remains a "business development company"
within the meaning of 1940 Act be greater than 20 percent of the
Company's "net income after taxes" within the meaning of Section
57(n)(1)(B) of the 1940 Act. In the event the awards exceed such
amount, the awards will be reduced pro rata.

The Plan may be modified, amended or terminated by the
Company's Board of Directors at any time with the stipulation
that no such modification, amendment or termination may adversely
affect any participant that has not consented to such
modification, amendment or termination. Nothing in this Plan
shall preclude the Board of Directors from, for any Plan Year
subsequent to the current Plan Year, naming additional
Participants in the Plan or changing the Award Percentage of any
Full Participant or New Participant (subject to the overall
percentage limitations contained herein).

The Company calculates the Plan accrual at each quarter end
based on the realized and unrealized gains at that date, net of
operating expenses for the year. Any adjustments to the Plan
accrual are then reflected in the Consolidated Statements of
Operations for the quarter. The Plan accrual is not paid out
until the gains are realized. During the first six months of
2001, the Company paid out 90 percent of the 2000 profit sharing
in the amount of $2,092,565 and reduced the profit-sharing
accrual by $133,308 as a result of the realized losses and a
decrease in the net unrealized appreciation. Accordingly, the
cumulative accrual under the Plan decreased to $1,257,369 at June

16

30, 2001. The remaining 10 percent of the 2000 profit sharing,
approximately $228,374, was paid out in July 2001 upon the
completion and filing of the Company's 2000 federal tax return.

NOTE 4. CAPITAL TRANSACTIONS

In 1998, the Board of Directors voted that, effective
January 1, 1998, 50 percent of all directors' fees be used to
purchase Company common stock from the Company. Subsequently,
the directors approved purchases of the Company's common stock in
the market, rather than from the Company, effective March 1,
1999.

On April 15, 1998, the Company announced that the Board of
Directors had approved the purchase of up to 700,000 shares of
Company stock in the open market. The Company purchased a total
of 401,878 shares in the open market for a total of $795,506. On
July 14, 1999, the Board of Directors announced a tender offer to
purchase up to 1,100,000 shares of its common stock for cash at a
price equal to $1.63 per share. A total of 1,080,569 shares were
tendered for a total cost, including related expenses of
approximately $71,500, of $1,832,831. Of these shares, 1,075,269
were tendered by one shareholder, which tendered all of its
holdings.

On January 27, 2000, the Company placed privately, with an
unaffiliated investor, for $3 million in cash, a one-year 12
percent note with one-year warrants to purchase 25,263 shares of
the Company's common stock at $11.8750 per share. During March
2000, with part of the proceeds from the sale of SciQuest.com
stock, the Company prepaid the Note. The Company incurred total
interest costs of $146,141; $36,500 in cash interest paid on the
note and $109,641 in non-cash interest attributed to the
warrants, which expired unexercised on January 26, 2001.

On October 12, 2000, the Company announced that the Board of
Directors had authorized a repurchase program in the open market
of up to $2 million of the Company's stock, at the discretion of
management. As of December 31, 2000, the Company had repurchased
a total of 176,600 shares in the open market at approximately
$3.00 per share for a total of $530,051. The Company did not
purchase any additional shares in the first quarter of 2001.

Since 1998, Company has repurchased a total of 1,659,047
shares for a total of $3,158,388, including commissions and
expenses, at an average price of $1.90 per share. These treasury
shares were reduced by the purchases made by the Directors.

On December 14, 2000, the Company declared a deemed dividend
of $1.78 per share for a total of $16,253,987 and in 2001 paid
federal income taxes on behalf of shareholders of $0.62 per share
for a total of $5,688,896. The Company paid the tax at the
corporate rate on the distribution, and the shareholders received
a tax credit equal to their proportionate share of the tax paid.
The net of the total deemed dividend declared ($16,253,987) and
the taxes paid on behalf of shareholders ($5,688,896) is
considered to be reinvested by the shareholders; therefore,
during 2000 additional paid in capital increased by $10,565,091.

NOTE 5. EMPLOYEE BENEFITS

On October 19, 1999, Charles E. Harris signed an
Employment Agreement with the Company (disclosed in a Form 8-K
filed on October 27, 1999) (the "Employment Agreement"), which
superseded an employment agreement that was about to expire on
December 31, 1999. The Employment Agreement would terminate on
December 31, 2004 ("Term") absent to either an earlier
termination or an extension in accordance with the terms; on
January 1, 2000 and on each

17

day thereafter, the Term extends automatically by one day
unless at any time the Company or Mr. Harris, by written
notice, decides not to extend the Term, in which case the Term
will expire five years from the date of the written notice.

During the period of employment, Mr. Harris shall serve as
the Chairman and Chief Executive Officer of the Company. He
shall be responsible for the general management of the affairs
of the Company and all its subsidiaries, reporting directly to
the Board of Directors of the Company. He shall serve as a
member of the Board for the period of which he is elected and
shall from time to time be reelected. If elected, he shall
serve as President of the Company and as an officer and
director of any subsidiary or affiliate of the Company.

Mr. Harris is to receive compensation under his Employment
Agreement in the form of base salary of $215,508 for 2001, with
automatic yearly adjustments to reflect inflation. In addition,
the Board may increase such salary, and consequently decrease
it, but not below the level provided for by the automatic
adjustments described above. Mr. Harris is also entitled to
participate in the Company's Profit-Sharing Plan as well as in
all compensation or employee benefit plans or programs, and to
receive all benefits, perquisites, and emoluments for which
salaried employees are eligible. Under the Employment
Agreement, the Company is to furnish Mr. Harris with certain
perquisites which include a company car, membership in certain
clubs and up to a $5,000 annual reimbursement for personal,
financial or tax advice.

The Employment Agreement provides Mr. Harris with life
insurance for the benefit of his designated beneficiaries in
the amount of $2,000,000; provides reimbursement for uninsured
medical expenses (not to exceed $10,000 per annum, adjusted for
inflation, over the period of the contract); disability
insurance in the amount of 100 percent of his base salary; and
provides Mr. Harris and his spouse with long-term care
insurance. These benefits are for the term of the Employment
Agreement.

The Employment Agreement provides for the Company to adopt
a supplemental executive retirement plan (the "SERP") for the
benefit of Mr. Harris. Under the SERP, the Company will cause
an amount equal to one-twelfth of the Mr. Harris's current base
salary to be credited each month (a "Monthly Credit") to a
special account maintained for this purpose on the books of the
Company for the benefit of Mr. Harris (the "SERP Account").
The amounts credited to the SERP Account will be deemed
invested or reinvested in such mutual funds or U.S. Government
securities as determined by Mr. Harris. The SERP Account will
be credited and debited to reflect the deemed investment
returns, losses and expenses attributed to such deemed
investments and reinvestments. Mr. Harris' benefit under the
SERP will equal the balance in the SERP Account and such
benefit will always be 100 percent vested (i.e., not
forfeitable). Mr. Harris will determine the form and timing of
the distribution of the balance in the SERP Account; provided,
however, in the event of the termination, the balance in the
SERP Account will be distributed to Mr. Harris or his
beneficiary, as the case may be, in a lump-sum payment within
30 days of such termination. The Company established a rabbi
trust for the purpose of accumulating funds to satisfy the
obligations incurred by the Company under the SERP. The
restricted funds for the SERP Plan total $373,942 as of June
30, 2001. Mr. Harris' rights to benefits pursuant to this SERP
will be no greater than those of a general creditor of the
Company.

The Employment Agreement provides severance pay in the event
of termination without cause or by constructive discharge and
also provides for certain death benefits payable to the surviving
spouse equal to the executive's base salary for a period of two
years.
18

In addition, Mr. Harris is entitled to receive severance pay
pursuant to the severance compensation agreement that he entered
into with the Company, effective August 15, 1990. The severance
compensation agreement provides that if, following a change in
control of the Company, as defined in the agreement, such
individual's employment is terminated by the Company without cause
or by the executive within one year of such change in control, the
individual shall be entitled to receive compensation in a lump sum
payment equal to 2.99 times the individual's average annualized
compensation and payment of other welfare benefits. If Mr.
Harris's termination is without cause or is a constructive
discharge, the amount payable under the Employment Agreement will
be reduced by the amounts paid pursuant to the severance
compensation agreement.

As of January 1, 1989, the Company adopted an employee
benefits program covering substantially all employees of the
Company under a 401(k) Plan and Trust Agreement. As of January 1,
1999, the Company adopted the Harris & Harris Pension Plan and
Trust, a money purchase plan which would allow the Company to stay
compliant with the 401(k) top-heavy regulations and deduction
limitation regulations. Contributions to the plan are at the
discretion of the Company.

On June 30, 1994, the Company adopted a plan to provide
medical and health insurance for retirees, their spouses and
dependents who, at the time of their retirement, have ten years of
service with the Company and have attained 50 years of age or have
attained 45 years of age and have 15 years of service with the
Company. On February 10, 1997, the Company amended this plan to
include employees who "have seven full years of service and have
attained 58 years of age." The coverage is secondary to any
government provided or subsequent employer provided health
insurance plans. Based upon actuarial estimates, as of June 30,
2001, the Company had a reserve of $354,840 for the plan.

NOTE 6. INCOME TAXES

On September 25, 1997, the Company's Board of Directors
approved a proposal to seek qualification as a RIC under Sub-
Chapter M of the Code. As a RIC, the Company annually must
distribute at least 90 percent of its investment company taxable
income as a dividend and may either distribute or retain its
taxable net capital gains from investments. The Company qualified
as a RIC under Sub-Chapter M of the Code for the year ended
December 31, 2000.

As a RIC, to the extent that the Company retains capital
gains, and declares a deemed dividend of those gains to
shareholders, the dividend is taxable to the shareholders as
capital gains. The Company would pay tax, at the corporate rate,
on the distribution, and the shareholders would receive a tax
credit equal to their proportionate share of the tax paid. The
Company took advantage of this rule for 2000. During the six
months ended June 30, 2000, the Company accrued a net tax
provision of $2,487,769. The Company's December 31, 2000 financial
statements include a tax liability of $5,709,884. The taxes paid
by the Company as a result of its deemed dividend declaration
($5,688,896) are reflected as a deduction to the additional paid
in capital in the Company's Consolidated Statement of Assets and
Liabilities rather than as an expense in the Consolidated
Statement of Operations.

A corporation that qualifies and elects treatment as a RIC
continues to be taxable as a C Corporation on any gains realized
within 10 years of its election from sales of assets that were
held by the corporation on the effective date of the election ("C
Corporation Assets") to the extent of any gain built into the
assets on such date ("Built-In Gain"). In 1999, the Company
received a ruling from the IRS concluding that the Company can
carry forward its C Corporation losses to offset any Built-In
Gains resulting from sales of its C Corporation Assets. That
ruling may enable the Company to retain some or all of the
proceeds from such sales without disqualifying itself as a RIC or

19

incurring corporate level income tax, depending on whether the
Company's sale of C Corporation Assets with Built-In Gains will
generate C Corporation E&P. In general, a RIC is not permitted
to have, as of the close of any RIC taxable year, E&P accumulated
during any C Corporation taxable year. However, because the
realization of Built-In Gains will occur while the Company is a
RIC, the Company believes that, under current law and IRS
pronouncements, the sale of C Corporation Assets with Built-In
Gains during RIC taxable years will not generate C Corporation
E&P. The Company had accumulated net ordinary and capital losses
of approximately $7.0 million (resulting in a potential tax credit
of approximately $2.5 million) during its C Corporation taxable
years, of which $0.8 million still remains available for use.
The Company intends to use the remaining $0.8 million loss
carryforward (resulting in a potential tax credit of
approximately $0.3 million) to reduce its taxes that are the
result of Built-In Gains.

Continued qualification as a RIC requires that the Company
continue to satisfy certain portfolio diversification
requirements. The Company's ability to satisfy those
requirements may not be controllable by the Company. There can
be no assurance that the Company will qualify, or will not take
action to disqualify itself, as a RIC for 2001 or subsequent
years.

During the six months ended June 30, 2001, the Company
accrued a net tax provision of $52,275. The Company pays
federal, state and local taxes on behalf of its wholly owned
subsidiary, Harris & Harris Enterprises, Inc., which is taxed
as a C Corporation.

For the three and six months ended June 30, 2001 and 2000,
the Company's income tax provision was allocated as follows:

Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30,2000

Net operating
(loss) income. . . .$ 0 $ 0 $ 0 $ 0

Net realized
gain (loss)
on investments . . . 22,641 1,457,455 52,275 2,641,073

Net increase
(decrease) in
unrealized appreciation
on investments . . . 0 0 0 (153,304)
--------- ---------- --------- ----------
Total income tax
provision. . . . . .$ 22,641 $1,457,455 $ 52,275 $2,487,769
========= ========== ========= ==========

The above tax provision (benefit) consists of the following:

Current. . . . . . .$ 22,641 $1,457,455 $ 52,275 $2,641,073

Deferred --Federal . 0 0 0 (153,304)
--------- ---------- --------- ----------
Total income tax
provision. . . . . .$ 22,641 $1,457,455 $ 52,275 $2,487,769
========= ========== ========= ==========

The Company's net deferred tax liability at June 30, 2001
and December 31, 2000 consists of the following:

June 30, 2001 December 31, 2000

Tax on unrealized appreciation
on investments . . . . . . . . . . . . . $ 1,630,506 $ 1,630,506

Net operating loss and capital
carryforward . . . . . . . . . . . . . . (266,036) (266,036)
----------- -----------
Net deferred income tax liability. . . . $ 1,364,470 $ 1,364,470
=========== ===========

20

NOTE 7. COMMITMENTS AND CONTINGENCIES

During 1993, the Company signed a ten-year lease with sublet
provisions for office space. In 1995, this lease was amended to
include additional office space. During 1999, the Company sublet
this space to an unaffiliated party. Rent expense under this
lease was $48,393 and $41,634 for the three months ended June 30,
2001 and June 30, 2000 and $90,465 and $83,109 for the six months
ended June 30, 2001 and June 30, 2000, respectively. Future
minimum lease payments in each of the following years are: 2002
- -- $178,561; 2003 -- $101,946.

NOTE 8. SUBSEQUENT EVENTS

During July and August 2001, the Company (1) sold its
position in Nanophase Technologies Corporation for total net
proceeds of approximately $4,263,242 or $6.04 per share; (2) sold
its position in Genomica Corporation for total net proceeds of
approximately $2,523,274 or $3.45 per share; and (3) invested an
additional $62,500 in Schwoo, Inc.

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations

The Company accounts for its operations utilizing accounting
principles generally accepted in the United States for investment
companies. On this basis, the principal measure of its financial
performance is captioned "Net increase (decrease) in net assets
resulting from operations," which is the sum of three elements.
The first element is "Net operating income (loss)," which is the
difference between the Company's income from interest, dividends,
and fees and its operating expenses. The second element is "Net
realized (loss) gain on investments," which is the difference
between the proceeds received from dispositions of portfolio
securities and their stated cost, net of applicable income tax
provisions (benefits). These two elements are combined in the
Company's financial statements and reported as "Net realized
(loss) income." The third element, "Net increase (decrease) in
unrealized appreciation on investments," is the net change in the
fair value of the Company's investment portfolio.

"Net realized (loss) gain on investments" and "Net increase
(decrease) in unrealized appreciation on investments" are
directly related. When a security is sold to realize a (loss)
gain, net unrealized appreciation (increases) decreases and net
realized (loss) gain increases (decreases).

Financial Condition

The Company's total assets and net assets were,
respectively, $33,375,034 and $29,860,794 at June 30, 2001,
compared with $43,343,423 and $31,833,475 at December 31, 2000.

Among the significant changes in the six month ended June
30, 2001 were: (1) the payment of $5,709,884 in federal income
taxes as a result of the Company's deemed dividend distribution;
(2) decline in the value of the Company's holdings in
Essential.com and Experion Systems, Inc. of $2,204,000 and
$480,000, respectively; (3) the increase in the valuation of the
Company's holdings in Nanophase Technologies Corporation of
800,290; and (4) the payment of the 2000 realized gain profit
sharing of $2,092,565.

In accordance with recently published SEC guidelines as of
March 31, 2001, the Company changed its valuation policy by no
longer discounting publicly held securities for liquidity
considerations. (See "Asset Valuation Policy Guidelines" in the
"Footnote to Consolidated Schedule of Investments" contained in
"Item 1. Consolidated Financial Statements.")

21

Net asset value per share ("NAV") was $3.29 at June 30,
2001, versus $3.51 at December 31, 2000.

The Company's shares outstanding remained unchanged during
the six months ended June 30, 2001.

The Company's financial condition is dependent on the
success of its investments. The Company has invested a
substantial portion of its assets in private development stage or
start-up companies. These private businesses tend to be thinly
capitalized, unproven, small companies that lack management depth
and have little or no history of operations. At June 30, 2001,
$10,944,149 or 32.8 percent of the Company's total assets
consisted of investments in publicly traded securities (these
investments were private equities at the time the Company made
the investments), of which net unrealized appreciation was
$7,943,427; $13,396,684 or 40.1 percent of the Company's total
assets consisted of non-publicly traded securities at fair value
in private businesses, of which net unrealized depreciation was
$679,884.

At December 31, 2000, $10,240,018 or 23.6 percent of the
Company's total assets consisted of investments in four publicly
traded securities (three of which were private businesses at the
time the Company made the investments), of which net unrealized
appreciation was $5,539,997; $16,782,438 or 38.7 percent of the
Company's total assets consisted of non-publicly traded
securities at fair value in private businesses, of which net
unrealized appreciation was $3,406,915.

The increase in the value of publicly traded securities from
$10,240,018 at December 31, 2000 to $10,944,149 at June 30, 2001
is primarily owing to the increase in the value of Nanophase
Technologies Corporation offset by the sale of shares of
SciQuest.com. The value of the Company's investments may vary
significantly on a quarterly basis (see "Risk Factors").

The decrease in the value of the non-publicly traded
securities from $16,782,438 at December 31, 2000 to $13,396,685
at June 30, 2001 resulted primarily from the decreases in the
Company's valuation of its holdings in Essential.com and Experion
Systems of $2,204,000 and $480,000, respectively, as well as the
dissolution and liquidation of Harris Newco for approximately
$2,000,000 at no material gain or loss. This decrease was
partially offset by the Company's new investment in Schwoo, Inc.

The changes in the values of SciQuest.com, Nanophase
Technologies and Essential.com reflect the extreme volatility of
private and publicly traded, small capitalization, high
technology stocks in the past 24 month period.

A summary of the Company's investment portfolio is as
follows:

June 30, 2001 December 31, 2000

Investments, at cost. . . . . . $ 24,074,230 $ 33,620,631
Unrealized appreciation . . . . 8,620,955 8,947,928
------------- ----------------
Investments, at fair value. . . $ 32,695,185 $ 42,568,559
============= ================

The accumulated unrealized appreciation on investments net
of deferred taxes is $6,990,449 at June 30, 2001, versus
$7,317,422 at December 31, 2000.

22

Following an initial investment in a private company, the
Company may make additional investments in such investee in order
to: (1) increase its ownership percentage; (2) exercise warrants,
options or convertible securities that were acquired in the
original or subsequent financing; (3) preserve the Company's
proportionate ownership in a subsequent financing; or (4) attempt
to preserve or enhance the value of the Company's investment.
There can be no assurance that the Company will make follow-on
investments or have sufficient funds to make additional
investments. The Company has the discretion to make follow-on
investments as it determines, subject to the availability of
capital resources. The failure to make such follow-on
investments may, in certain circumstances, jeopardize the
continued viability of the investee company and the Company's
initial investment or may result in a missed opportunity for the
Company to increase its participation in a successful operation.
Even if the Company has sufficient capital to make a desired
follow-on investment, it may elect not to make a follow-on
investment either because it does not want to increase its
concentration of risk, because it prefers other opportunities, or
because it is inhibited by compliance with BDC or RIC
requirements, even though the follow-on investment opportunity
appears attractive.

The following table is a summary of the cash investments
made by the Company in its private placement portfolio during the
six months ended June 30, 2001:

Amount
New Investments:
Schwoo, Inc.. . . . . . . . . . . . . $ 750,000

Additional Investments:
Experion Systems, Inc.. . . . . . . . 80,000

Exercise of Warrants Held:
Schwoo, Inc.. . . . . . . . . . . . . 138,577

Loans:
Schwoo, Inc.. . . . . . . . . . . . . 210,250
----------
Total . . . . . . . . . . . . . . . . $1,178,827
==========

Results of Operations

Investment Income and Expenses:

The Company realized a net operating (loss) income of
($560,690) and $3,047,705 for the six months ended June 30, 2001
and June 30, 2000, respectively. The Company's net operating
income in the six months ended June 30, 2001 and June 30, 2000
reflected decreases in the employee profit-sharing accrual that
resulted in credits to expenses of $133,308 and $4,116,427,
respectively. When unrealized appreciation as of a certain date
subsequently decreases the profit-sharing accrual will be
decreased accordingly, resulting in a credit to expenses.

The Company'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 provides little or no current yield in the form
of dividends or interest. The Company does earn interest income
from fixed-income securities, including U.S. Government and
Agency Obligations. The amount of interest income earned varies
with the average balance of the Company's fixed-income portfolio
and the average yield on this portfolio.

23

The Company had interest income from fixed-income
securities of $270,376 and $144,815 for the six months ended June
30, 2001 and June 30, 2000, respectively. The increase of
$125,561 or 86.7 percent reflects an increase in the balance of
the Company's fixed income portfolio during the six months ended
June 30, 2001 versus the six months ended June 30, 2000.

The Company had interest income from affiliated companies of
$11,382 and $34,058 for the six months ended June 30, 2001 and
June 30, 2000, respectively. The decrease of $22,676 or 66.6
percent is owing to a decrease in the outstanding loans to
investee companies. Therefore, the amount of outstanding loans
to investee companies varies on a quarterly basis.

The Company had other income of $47,162 and $35,064 for the
six months ended June 30, 2001 and June 30, 2000, respectively.
Other income represents rental income from subletting office
space to an unaffiliated party and, in 2001, a gain on the sale
of Company property.

Operating expenses were $889,610 and ($2,833,768) for the
six months ended June 30, 2001 and June 30, 2000, respectively.
The operating expenses of the six months ended June 30, 2001 and
2000 reflect decreases in the employee profit-sharing accrual of
$133,308 and $4,116,427, respectively, owing to decreases in
unrealized appreciation of investments for the respective six
month periods. Salaries and benefits increased $33,630 or 6.4
percent. Administration and operations decreased $28,162 or
11.49 percent and professional fees decreased $114,195 or 55.4
percent. The remaining expenses are related to office and rent
expenses and director compensation.

The Company had interest income from fixed-income securities
of $117,846 and $60,861 for the three months ended June 30, 2001
and June 30, 2000, respectively, reflecting net changes in the
Company's investments in short-term fixed income securities and
prevailing interest rate levels.

The Company had interest income from affiliated companies of
$1,765 and $12,376 for the three months ended June 30, 2001 and
June 30, 2000, respectively. The amount of outstanding loans to
investee companies varies; typically, loans made to investee
companies are bridge loans and are converted into equity at the
next round of equity financing.

The Company had other income of $17,350 and $19,252 for the
three months ended June 30, 2001 and June 30, 2000, respectively.
This other income represents rental income; in December of 1999,
the Company started subleasing office space to an unaffiliated
party.

Operating expenses were $1,207,528 and ($1,860,143) for the
three months ended June 30, 2001 and June 30, 2000, respectively.
The operating expenses of the second quarter of 2000 reflect a
decrease in the employee profit-sharing accrual, owing to a
decrease in unrealized appreciation of investments for the three
months ended June 30, 2000, resulting in a credit to expenses of
$2,465,091. The operating expenses of the second quarter of 2001
reflect an increase in the employee profit-sharing accrual, of
$712,982 owing to an increase in unrealized appreciation of
investments for the three months ended June 30, 2001. Salaries
and benefits increased $11,472 or 4.7 percent. Administration
and operation decreased $28,845 or 18.91 percent and professional
fees decreased $88,091 or 73 percent. The remaining expenses are
related to rent expenses and director compensation.

24

The Company has in the past relied, and continues to rely to
a large extent, upon proceeds from sales of investments, rather
than investment income, to defray a significant portion of its
operating expenses. Because such sales cannot be predicted, the
Company attempts to maintain adequate working capital to provide
for fiscal periods when there are no such sales.

Realized Gains and Losses on Sales of Portfolio Securities:

During the six months ended June 30, 2001 and 2000, the
Company realized (losses) gains of ($1,032,743) and $8,095,682,
respectively. The 2001 losses of $1,032,743 consist primarily of
a loss on the sale of 350,000 shares of SciQuest.com common stock
offset by a gain of $277,177 from the Company's partnership
interest in PHZ Capital Partners L.P.

During the six months ended June 30, 2000, the Company
realized a total gain of $8,095,682 consisting primarily of a
gain of $7,407,377 on the sale of its position in SciQuest.com;
$241,025 on the sale of Nanophase Technologies shares and
$147,528 on the realization of a reserve for an escrow for part
of the Company's share of the proceeds of the NBX/3Com
transaction (the Company received in full the escrowed funds on
March 31, 2000).

During the three months ended June 30, 2001 and June 30,
2000, the Company realized gains of $161,909 and $4,332,410,
respectively. During the three months ended June 30, 2001, the
Company realized a net gain of $161,909 consisting primarily of a
gain of $204,744 from its partnership interest in PHZ Capital
Partners L.P. and a loss of $38,890 on the sale of its position
in Kana Communications. During the three months ended June 30,
2000, the Company realized a total gain of $4,332,410, consisting
primarily of a net gain of $4,142,388 on the sale of 417,639
shares of SciQuest.com.

Unrealized Appreciation and Depreciation of Portfolio
Securities:

The Board of Directors values the portfolio securities on a
quarterly basis pursuant to the Company's Asset Valuation
guidelines in accordance with the 1940 Act. (See "Footnote to
Consolidated Schedule of Investments" contained in "Item 1.
Consolidated Financial Statements.")

Net unrealized appreciation on investments decreased by
$326,973 or 3.6 percent during the six months ended June 30,
2001, from $8,947,928 to $8,620,955, primarily as a result of the
decline in the value of the Company's holdings of Essential.com
and Experion Systems, Inc. of $2,204,000 and $480,000,
respectively. This decrease was offset by an increase in the
value of Nanophase Technologies Corporation of $800,290 and an
increase in unrealized appreciation of $1,528,082 as a result of
the realization of the loss on the sale of the Company's position
in SciQuest.com.

Net unrealized appreciation on investments decreased by
$26,536,339 or 56.6 percent during the six months ended June 30,
2000, from $46,882,521 to $20,346,182, primarily as a result of
declines in the value of SciQuest.com, Kana Communications and
Questech of $31,981,750, $1,622,027 and $1,165,879, respectively,
offset by increases in the value of Nanophase Technologies,
Alliance Pharmaceutical, Genomica and Essential.com of
$3,368,786, $3,019,000, $1,330,520 and $854,467, respectively.

Net unrealized appreciation increased by $2,755,958 or 47.0
percent during the three months ended June 30, 2001, from
$5,864,997 to $8,620,955, owing primarily to the increase in the
value of the Company's position in Nanophase Technologies
Corporation of $3,088,204, offset by a decline in the value of
the Company's investment in Experion Systems, Inc. of $480,000.

25

Net unrealized appreciation on investments decreased by
$15,936,083 or 43.9 percent during the three months ended June
30, 2000, from $36,282,265 to $20,346,182, owing primarily to
declines in the value of SciQuest.com, Nanophase Technologies,
Alliance Pharmaceutical and Questech of $9,247,287, $3,823,004,
$2,794,900 and $1,165,879, respectively, offset by an increase in
Essential.com and Kana Communications of $854,467 and $239,472,
respectively.

The changes in the values of SciQuest.com, Silknet
Software, Nanophase Technologies, Essential.com and Alliance
Pharmaceutical reflected the extreme volatility of private and
publicly traded, small capitalization, high technology stocks in
the past 18 month period.

Liquidity and Capital Resources

The Company's primary sources of liquidity are cash,
receivables and freely tradable marketable securities. The
Company's secondary sources of liquidity are restricted
securities of companies that are publicly traded. At June 30,
2001 and December 31, 2000, respectively, the Company's total
primary liquidity was $19,441,306 and $23,039,736. On the
corresponding dates, the Company's total secondary liquidity was
$0 and $3,040,679, respectively. The Company's tertiary source
of liquidity is its holding of PHZ Capital Partners, L.P., from
which the Company received net after-tax distributions in the six
months ended June 30, 2001 of $62,500.

The decrease in the Company's primary source of liquidity
from December 31, 2000 to June 30, 2001 is primarily owing to the
(1) payment of income taxes, primarily federal, of $5,787,174;
(2) payment of the 2000 employee profit sharing of approximately
$2,092,565; (3) investment of $1,098,827 in Schwoo, Inc. and
$80,000 in Experion Systems, Inc.; and (4) the use of funds for
operating expenses. These decreases were offset by (1) the
receipt of approximately $2,000,000 of the funds from the
liquidation of Harris Newco, Inc. and (2) an increase in value
in the Company's investment in Nanophase Technologies Corporation
of $800,290.

The decrease in the Company's secondary source of liquidity
from December 31, 2000 to June 30, 2001 is owing to the
expiration of the lock-up period on Genomica Corporation, which
increased the Company's primary liquidity corresponding.

From December 31, 2000 to June 30, 2001, the Company's
liabilities for accrued employee profit sharing and deferred
income tax liability decreased significantly. Accrued profit
sharing decreased by $2,225,872 or 63.9 percent to $1,257,369 as
a result of payment of $2,092,565 of the 2000 profit sharing.
The remaining 2000 profit sharing accrual, approximately
$228,374, was paid in July 2001 upon the completion and filing of
the Company's 2000 federal tax return.

The Company's total income tax liability decreased by
$5,734,899 or 80.6 percent to $1,381,137 primarily as a result of
the payment of taxes in connection with the deemed dividend
distribution.

Sub-Chapter M Status -- Recent Developments

On March 8, 2001, the Company received SEC certification and
qualified for RIC treatment for 2000 (as it had for 1999).
Although the SEC certification for 2000 was issued, there can be
no assurance that the Company will receive such certification for
subsequent years (to the extent it needs additional certification
as a result of changes in its portfolio) or that it will actually
qualify as a RIC for subsequent years. In addition, under certain
circumstances, even if the Company qualified for Sub-Chapter M
treatment in a given year, the Company might take action in a
subsequent year to ensure that it would be taxed in that
subsequent year as a C Corporation, rather than as a RIC.

26

On December 14, 2000, the Company announced that its Board of
Directors, in accordance with rules governing a RIC under Sub-
Chapter M of the Code, declared a designated undistributed capital
gain dividend (also known as a deemed dividend) of $1.78 per
share, for a total of $16,253,987 and paid corporate taxes on
behalf of shareholders of $0.62 per share, for a total of
$5,688,896.

Risk Factors

Investing in the Company's Stock is Highly Speculative and the
Investor Could Lose Some or All of the Amount Invested

The value of the Company's common stock may decline and may
be affected by numerous market conditions, which could result in
the loss of some or all of the amount invested in the Company's
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. Because of the Company's
focus on the technology and very small capitalization sectors,
its stock price is likely to be impacted by these market
conditions. 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 Company's stock price. The recent decimalization of
the stock exchanges, particularly Nasdaq, is a new risk factor
that may decrease liquidity of smaller capitalization issues such
as the Company's own common stock and that of its publicly traded
holdings.

Investing in the Company's Shares May be Inappropriate for the
Investor's Risk Tolerance

The Company's investments, in accordance with its investment
objective and principal strategies, result in a far above average
amount of risk and volatility and may well result in loss of
principal. The Company's 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 Market for Venture Capital Investments is Highly Competitive.
In Some Cases, the Company's Status as a Regulated Business
Development Company May Hinder its Ability to Participate in
Investment Opportunities.

The Company faces substantial competition in its investing
activities from private venture capital funds, investment
affiliates of large industrial, technology, service and financial
companies, small business investment companies, wealthy
individuals and foreign investors. As a regulated business
development company, the Company is required to disclose
quarterly the name and business description of portfolio
companies and value of any portfolio securities. Most of the
Company's competitors are not subject to this disclosure
requirement. The Company'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 Company less attractive as a potential
investor to a given portfolio company than a private venture
capital fund not subject to the same regulations.

The Company Operates in a Regulated Environment

The Company is subject to substantive SEC regulations as a
BDC. Securities and tax laws and regulations governing the
Company's activities may change in ways adverse to the Company's
and its shareholders' interests and interpretations of such laws
and regulations may change with unpredictable consequences. Any
change in the laws or regulations that govern the Company's
business could have an adverse impact on the Company or its
operations.

27

The Company is Dependent Upon Key Management Personnel for
Future Success

The Company is dependent for the selection, structuring,
closing and monitoring of its investments on the diligence and
skill of its senior management and other management members. The
future success of the Company depends to a significant extent on
the continued service and coordination of its senior management
team, and particularly on the Chairman and Chief Executive
Officer. The departure of any of the executive officers or key
employees could materially adversely affect the Company's ability
to implement its business strategy. The Company does not
maintain key man life insurance on any of its officers or
employees.

Investment in Small, Private Companies

There are significant risks inherent in the Company's
venture capital business. The Company has invested a substantial
portion of its assets in private development stage or start-up
companies. These private businesses tend to be thinly
capitalized, unproven, small companies with risky technologies
that lack management depth and have not attained profitability or
have no history of operations. 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 Company 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 Company
has been risk seeking rather than risk averse in its approach to
venture capital and other investments. Neither the Company's
investments nor an investment in the Company is intended to
constitute a balanced investment program. The Company has in the
past relied, and continues to rely to a large extent, upon
proceeds from sales of investments rather than investment income
to defray a significant portion of its operating expenses. Such
sales are unpredictable and may not occur.

Illiquidity of Portfolio Investments

Most of the investments of the Company are or will be equity
securities acquired directly from small companies. The Company's
portfolio of equity securities are and will usually be subject to
restrictions on resale or otherwise have no established trading
market. The illiquidity of most of the Company's portfolio of
equity securities may adversely affect the ability of the Company
to dispose of such securities at times when it may be
advantageous for the Company to liquidate such investments. In
addition, the imposition of decimalization on the stock
exchanges, particularly Nasdaq, may reduce liquidity and increase
volatility and riskiness of small, thinly traded public companies
because it may create a disincentive for dealers to market
smaller issues.

Volatility and Illiquidity of Publicly Traded Holdings

When companies in which the Company has invested as private
entities complete initial public offerings, they are by
definition unseasoned issues. Typically, they have relatively
small capitalizations. Thus, they can be expected to be highly
volatile and of uncertain liquidity. If they are perceived as
suffering from adverse news or developments and/or the capital
markets are in a negative phase, not only their market prices,
but also their liquidity can be expected to be impacted
negatively. Historically, the Company has also invested in
unseasoned publicly traded companies with similar characteristics
and thus with similar exposure to potential negative volatility
and illiquidity. The decimalization of the stock markets,
particularly Nasdaq, may decrease liquidity of stocks in general
and smaller capitalization issues in particular.

28

The Inability of the Company's Portfolio Companies to
Successfully Market Their Products Would Have a Negative Impact
on its Investment Returns

Even if the Company'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 Company's portfolio companies may not be
successful.

Valuation of Portfolio Investments

There is typically no public market of equity securities of
the small privately held companies in which the Company invests.
As a result, the valuation of the equity securities in the
Company's portfolio is subject to the good faith estimate of the
Company's Board of Directors. (See "Asset Valuation Policy
Guidelines" in "Footnote to Consolidated Schedule of
Investments.") In the absence of a readily ascertainable market
value, the estimated value of the Company's portfolio of equity
securities may differ significantly 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 Company's statement of operations as "Change in
unrealized appreciation on investments." (See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations.")

Fluctuations of Quarterly Results

The Company'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 the
Company encounters competition in its markets and general
economic conditions. As a result of these factors, results for
any one quarter should not be relied upon as being indicative of
performance in future quarters. (See "Management's Discussion
and Analysis of Financial Condition and Results of Operations.")

Risk of Loss of Pass Through Tax Treatment

If the Company meets certain diversification and
distribution requirements under the Code, it may qualify as a RIC
under the Code for pass-through tax treatment. The Company would
cease to qualify for pass-through tax treatment if it were unable
to comply with these requirements, or if it ceased to qualify as
a BDC under the 1940 Act. The Company also could be subject to a
four percent excise tax (and, in certain cases, corporate level
income tax) if it failed to make certain gain on income
distributions. The lack of Sub-Chapter M tax treatment could
have a material adverse effect on the total return, if any,
obtainable from an investment in the Company. If the Company
fails to qualify as a RIC, the Company would become subject to
federal income tax as if it were an ordinary C Corporation, which
tax would result in a corresponding reduction in the Company's
net assets and the amount of income available for distribution to
the Company's stockholders.

Because the Company Must Distribute Income, the Company Will
Continue to Need Additional Capital

The Company will continue to need capital to fund
investments and to pay for operating expenses. The Company must
distribute at least 90 percent of its net operating income other
than net realized long-term capital gains to its stockholders to
maintain its RIC status. As a result, such earnings will not be
available to fund investments. If the Company fails to generate
net realized long-term capital gains or to obtain funds from
outside sources, it could have a material adverse effect on the
Company's financial condition and results. The Company does not
normally establish reserves for taxes on unrealized capital
gains. To the extent that the Company retains capital gains,

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either as a C corporation or as a Sub-Chapter M corporation, it
will have to make provisions for federal taxes and possibly state
and local taxes. In addition, as a BDC, the Company is generally
required to maintain a ratio of at least 200 percent of total
assets to total borrowings, which may restrict its ability to
borrow in certain circumstances.

Reserves for Taxes

As a Sub-Chapter M corporation, the Company does not have to
pay federal income taxes on realized capital gains to the extent
that such gains are distributed to shareholders. Accordingly, it
does not establish reserves for taxes on its unrealized capital
gains. If the Company were not to qualify for Sub- Chapter M tax
status, it would have to establish such reserves for taxes, which
would reduce its net asset value, net of a reduction in the
reserve for employee profit sharing, accordingly. To the extent
that the Company as a Sub-Chapter M corporation were to decide to
make a deemed distribution of net realized capital gains and were
to retain such net realized capital gains, it would have to
establish appropriate reserves for taxes upon making such a
decision.

Forward-Looking Statements

The information contained herein contains certain forward-
looking statements. These statements include the plans and
objectives of management for future operations and financial
objectives, portfolio growth and availability of funds. These
forward-looking statements are subject to the inherent
uncertainties in predicting future results and conditions.
Certain factors that could cause actual results and conditions to
differ materially from those projected in these forward-looking
statements are set forth herein. Other factors that could cause
actual results to differ materially include the uncertainties of
economic, competitive and market conditions, and future business
decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions
underlying the forward-looking statements included herein are
reasonable, any of the assumptions could be inaccurate and
therefore there can be no assurance that the forward-looking
statements included or incorporated by reference herein will
prove to be accurate. Therefore, the inclusion of such
information should not be regarded as a representation by the
Company or any other person that the objectives and plans of the
Company will be achieved.

Item 3. Quantitative and Qualitative Disclosures About Market
Risk

The Investment Company Act of 1940 (the "1940 Act") requires
periodic valuation of each investment in the Company's portfolio
to determine net asset value. Under the 1940 Act, unrestricted
securities with readily available market quotations are to be
valued at the current market value; all other assets must be
valued at "fair value" as determined in good faith by or under
the direction of the Board of Directors.

Neither the Company's investments nor an investment in the
Company is intended to constitute a balanced investment program.
The Company has exposure to public-market price fluctuations to
the extent of its publicly traded portfolio, which portfolio may
be composed primarily or entirely of highly risky, volatile
securities.

The Company has invested a substantial portion of its
assets in private development stage or start-up companies. These
private businesses tend to be thinly capitalized, unproven, small
companies that lack management depth and have not attained
profitability or have no history of operations. Because of the
speculative nature and the lack of a public market for these

30

investments, there is significantly greater risk of loss than is
the case with traditional investment securities. The Company 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.

Because there is typically no public market for the equity
interests of the small privately held companies in which the
Company invests, the valuation of the equity interests in the
Company's portfolio is subject to the estimate of the Company's
Board of Directors in accordance with the Company's Asset
Valuation Policy Guidelines. In the absence of a readily
ascertainable market value, the estimated value of the Company's
portfolio of equity interests may differ significantly from the
values that would be placed on the portfolio if a ready market
for the equity interests existed. Any changes in valuation are
recorded in the Company's consolidated statements of operations
as "Net increase (decrease) in unrealized appreciation on
investments."

31

PART II. OTHER INFORMATION

Item 1. Legal Proceedings
Not Applicable

Item 2. Changes in Securities and Use of Proceeds
Not Applicable

Item 3. Defaults Upon Senior Securities
Not Applicable

Item 4. Submission of Matters to a Vote of Security Holders
None.

Item 5. Other Information
Recent Sales of Unregistered Securities
None

Item 6. Exhibits and Reports on Form 8-K

3.1(a) Restated Certificate of Incorporation of the
Company, as amended, incorporated by reference to
Exhibit 3.1(a) to the Company's Form 10-K for the
year ended December 31, 1995.

3.1(b) Restated By-laws of the Company, incorporated by
reference to Exhibit 3.1(b) to the Company's Form
10K for the year ended December 31, 1995.

4.1 Specimen Certificate of Common Stock, incorporated by
reference to Exhibit 4 to Company's Registration Statement
on Form N-2 filed October 29, 1992.

10.22 Harris & Harris Group, Inc. Employee Profit-Sharing Plan,
incorporated by reference as Exhibit 10.22 to the Company's
Form 10K for the year ended December 31, 1999.

11.0* Computation of per share earnings. See Consolidated
Statements of Operations.

(b) The Company did not file any reports on Form 8-K during the six
months ended June 30, 2001.

32

EXHIBIT INDEX

Item Number (of Item 601 of Regulation S-K)

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


Harris & Harris Group, Inc.

/s/ Mel P. Melsheimer
---------------------------
By: Mel P. Melsheimer, President,
Chief Operating Officer, Chief
Financial Officer and Chief
Compliance Officer


Date: August 9, 2001

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