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 September 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 November 9, 2001
- -----------------------------------------------------------------------------
Common Stock, $0.01 par value per share 8,864,231shares



Harris & Harris Group, Inc.
Form 10-Q, September 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. . . . . . . . . . . 13

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . 20

Financial Condition . . . . . . . . . . . . . . . . . . . . . . 20

Results of Operations . . . . . . . . . . . . . . . . . . . . . 22

Liquidity and Capital Resources . . . . . . . . . . . . . . . . 25

Risk Factors. . . . . . . . . . . . . . . . . . . . . . . . . . 26

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

PART II OTHER INFORMATION

Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . 31
Item 2. Changes in Securities and Use of Proceeds. . . . . . . 31
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . 31
Item 4. Submission of Matters to a Vote of Security Holders. . 31
Item 5. Other Information. . . . . . . . . . . . . . . . . . . 31
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 31

Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . 32
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . 32


Harris & Harris Group, Inc.
Form 10-Q, September 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 of 1986 (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

Sept. 30, 2001 December 31, 2000
(Unaudited) (Audited)

Investments, at value (See accompanying
schedule of investments and notes). . . .$ 27,454,804 $ 42,568,559
Cash and cash equivalents . . . . . . . . . 526,060 253,324
Restricted funds (Note 5) . . . . . . . . . 427,820 265,183
Interest receivable . . . . . . . . . . . . 11,283 30,082
Note receivable . . . . . . . . . . . . . . 9,888 10,888
Prepaid expenses. . . . . . . . . . . . . . 19,078 82,615
Other assets. . . . . . . . . . . . . . . . 118,795 132,772
------------ -------------
Total assets. . . . . . . . . . . . . . . .$ 28,567,728 $ 43,343,423
============ =============

LIABILITIES & NET ASSETS

Accounts payable and accrued liabilities. .$ 882,899 $ 771,763
Payable to broker for unsettled trade . . . 0 115,005
Payable for treasury stock purchase . . . . 338,000 0
Accrued profit sharing (Note 3) . . . . . . 0 3,483,241
Deferred rent . . . . . . . . . . . . . . . 16,963 23,903
Current income tax liability (Note 6) . . . 133,241 5,751,566
Deferred income tax liability (Note 6). . . 1,274,005 1,364,470
------------ -------------
Total liabilities . . . . . . . . . . . . . 2,645,108 11,509,948
Commitments and contingencies (Note 7) ------------ -------------

Net assets. . . . . . . . . . . . . . . . .$ 25,922,620 $ 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
9/30/01 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. . . . 1,203,283 642,418
Accumulated unrealized appreciation of
investments, net of deferred tax
liability of $1,540,044 at 9/30/01
and $1,630,506 at 12/31/00. . . . . . . . 1,183,702 7,317,422
Treasury stock at cost (1,828,740 shares
at 9/30/01 and 1,628,740 shares at
12/31/00) . . . . . . . . . . . . . . . . (3,405,531) (3,067,531)
------------ ------------
Net assets. . . . . . . . . . . . . . . . .$ 25,922,620 $ 31,833,475
============ ============
Shares outstanding. . . . . . . . . . . . . 8,864,231 9,064,231
============ ============
Net asset value per outstanding share . . .$ 2.92 $ 3.51
============ ============

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

2

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

Three Months Ended Nine Months Ended
Sept. Sept. Sept. Sept.
30, 2001 30, 2000 30, 2001 30, 2000
Investment income:
Interest from:
Fixed-income
securities. . . . . .$ 100,538 $ 145,748 $ 370,914 $ 290,563
Affiliated companies. . 9,436 15,701 20,818 49,759
Other income. . . . . . 24,519 18,368 71,681 3,432
----------- ---------- ------------- -----------
Total investment
income. . . . . . . 134,493 179,817 463,413 393,754

Expenses:
Profit-sharing accrual
(reversal) (Note 3) . .(1,028,995) 1,928,945 (1,162,303) (2,187,482)
Salaries and benefits. . 228,038 231,671 783,953 753,957
Administration and
operations. . . . . . . 68,885 62,910 285,820 308,009
Professional fees. . . . 48,956 44,251 140,775 250,265
Rent . . . . . . . . . . 44,364 42,827 134,830 125,936
Directors' fees and
expenses. . . . . . . . 22,020 20,180 68,375 76,220
Depreciation . . . . . . 7,500 10,000 22,500 30,000
Custodian fees . . . . . 3,780 4,469 10,205 9,069
Interest expense
(Note 4).. . . . . . . 0 0 0 146,141
--------- ---------- ----------- ----------
Total expenses. . . . (605,452) 2,345,883 284,155 (487,885)
--------- ---------- ----------- ----------
Operating income (loss)
before income taxes . . 739,945 (2,166,066) 179,258 881,639
Income tax provision
(Note 6). . . . . . . . 0 0 0 0
--------- ---------- ----------- ----------
Net operating income
(loss) . . . . . . . . . 739,945 (2,166,066) 179,258 881,639

Net realized gain (loss) on investments:
Realized gain (loss)
on investments. . . . . 1,590,171 6,261,211 557,428 14,356,893
---------- ----------- ------------ -----------
Total realized gain
(loss) . . . . . . . 1,590,171 6,261,211 557,428 14,356,893
Income tax provision
(Note 6). . . . . . . . (123,546) (1,472,905) (175,821) (4,113,978)
---------- ---------- ----------- -----------
Net realized gain (loss)
on investments. . . . . 1,466,625 4,788,306 381,607 10,242,915

Net realized income . . . 2,206,570 2,622,240 560,865 11,124,554

Net increase (decrease) in unrealized appreciation on investments:
Increase as a result of
investment sales. . . . 3,237,775 0 4,802,738 0
Decrease as a result of
investment sales. . . . (854,467) (4,286,250) (854,467) (16,738,527)
Increase on investments
held. . . . . . . . . . 16,130 11,305,318 3,232,919 26,738,880
Decrease on investments
held. . . . . . . . . . (8,296,645) (2,583,958) (13,405,372) (32,101,582)
---------- ----------- ------------ -----------
Net change in unrealized
appreciation on
investments . . . . . (5,897,207) 4,435,110 6,224,182) (22,101,229)
Income tax benefit
(Note 6). . . . . . . . 90,462 0 90,462 153,304
---------- ---------- ----------- -----------
Net (decrease) increase
in unrealized
appreciation on
investments . . . . . . (5,806,745) 4,435,110 (6,133,720) (21,947,925)
----------- ----------- ------------ ------------
Net (decrease) increase in
net assets resulting from operations:
Total. . . . . . . . . $(3,600,175) $7,057,350 $(5,572,855) $(10,823,371)
=========== ========== =========== ============
Per outstanding share. $ (.39) $ 0.76 $ (.63) $ (1.17)
============ =========== =========== ============

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

3

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Nine Months Ended Nine Months Ended
September 30, 2001 September 30, 2000

Cash flows from operating activities:
Net decrease in net
assets resulting from operations. . . $ (5,572,855) $ (10,823,371)
Adjustments to reconcile net
decrease in net assets resulting
from operations to net cash used in operating activities:
Net realized and unrealized loss
on investments. . . . . . . . . . . 5,666,752 7,744,336
Deferred income taxes . . . . . . . . 90,462 0
Depreciation. . . . . . . . . . . . . 22,500 30,000
Other . . . . . . . . . . . . . . . . 0 82,632

Changes in assets and liabilities:
Restricted funds. . . . . . . . . . . (162,637) (202,575)
Funds in escrow . . . . . . . . . . . 0 1,327,748
Interest receivable . . . . . . . . . 18,799 28,645
Notes receivable. . . . . . . . . . . 1,000 10,888
Prepaid expenses. . . . . . . . . . . 63,539 57,969
Other assets. . . . . . . . . . . . . (4,968) 18,452
Accounts payable and accrued
liabilities . . . . . . . . . . . . 111,136 (39,846)
Payable to broker for unsettled
trade . . . . . . . . . . . . . . . (115,005) 472,716
Payable for treasury stock purchase . 338,000 0
Accrued profit sharing. . . . . . . . (3,483,241) (3,326,033)
Current income tax liability. . . . . (5,708,790) 4,109,621
Deferred income tax liability . . . . 0 (153,304)
Deferred rent . . . . . . . . . . . . (6,940) (6,940)
------------ -------------
Net cash used in operating
activities. . . . . . . . . . . . . (8,742,248) (669,062)

Cash flows from investing activities:
Net sale (purchase) of U.S.
Treasury & Governmental Agency
Securities and purchase of
marketable securities . . . . . . . 8,181,247 (12,409,717)
Proceeds from sale or liquidation
of investments. . . . . . . . . . . 2,656,118 17,551,338
Investment in private placements
and loans . . . . . . . . . . . . . (1,818,826) (4,417,500)
Purchase of fixed assets. . . . . . . (3,555) (6,974)
------------ -------------
Net cash provided by investing
activities . . . . . . . . . . . . 9,014,984 717,147

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 . . . . . . . . 526,060 181,341
----------- -------------
Net increase in cash and cash
equivalents . . . . . . . . . . . $ 272,736 $ 48,085
=========== =============

Supplemental disclosures of cash flow information:
Income taxes paid . . . . . . . . . $ 5,794,149 $ 84,728
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 Nine Months Ended
Sept. Sept. Sept. Sept.
30, 2001 30, 2000 30, 2001 30, 2000

Changes in net assets from operations:
Net operating gain (loss)
income. . . . . . . . . . $ 739,945 $(2,166,066) $ 179,258 $ 881,639
Net realized gain on
investments . . . . . . . 1,466,625 4,788,306 381,607 10,242,915
Net increase (decrease) in
unrealized appreciation
on investments as a
result of sales. . . . . 2,473,770 (4,286,250) 4,038,733 (16,585,223)
Net (decrease) increase in
unrealized appreciation on
investments held . . . . (8,280,515) 8,721,360 (10,172,453) (5,362,702)
----------- ---------- ----------- -----------
Net (decrease) increase in
net assets resulting from
operations. . . . . . . (3,600,175) 7,057,350 (5,572,855)(10,823,371)


Changes in net assets from capital
stock transactions:

Additional paid in capital on Common Stock
Warrants issued . . . . 0 0 0 109,641
Purchase of treasury
stock . . . . . . . . . (338,000) 0 (338,000) 0
---------- --------- --------- ----------
Net increase in net assets
resulting from capital
stock transactions . . . (338,000) 0 (338,000) 109,641
---------- --------- --------- ----------
Net (decrease) increase in
net assets. . . . . . . . (3,938,175) 7,057,350 (5,910,855)(10,713,730)

Net assets:

Beginning of the period . . 29,860,795 35,863,725 31,833,475 53,634,805
----------- ----------- ----------- ----------
End of the period . . . . . $25,922,620 $42,921,075 $25,922,620 $42,921,075
=========== =========== =========== ===========


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

5

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

Method of Shares/
Valuation (3) Principal Value

Investments in Unaffiliated Companies (10)(11)(12) -- 4.3% of total
investments

Private Placement Portfolio (Illiquid) (10)(11)(12) -- 4.3% of total
investments

AlphaSimplex Group, LLC (1)(2) --
Investment advisory firm. . . . . . . . .(D) -- $ 712

Exponential Business Development
Company (1)(2)(5) -- Venture
capital partnership focused on
early stage companies
Limited partnership interest. . . . . . .(A) -- 25,000

Informio, Inc. (1)(2)(6)(7) -- Developing
audio web portal technology -- 0.81%
of fully diluted equity
Series A Voting Convertible
Preferred Stock . . . . . . . . . . . . .(D) 229,364 151,380

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
----------
Total Private Placement Portfolio (cost: $1,529,602). . . . . . . . $1,177,093
----------

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

6

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

Method of Shares/
Valuation (3) Principal Value

Investments in Non-Controlled Affiliated Companies (10)(12) -- 46.0% of total
investments

Private Placement Portfolio (Illiquid) (10)(12) -- 46.0% of total investments

Experion Systems, Inc. (1)(2)(5)(6)(8) --
Provides e-business software
selling platforms based on
trust-based marketing -- 14.21%
of fully diluted equity
Convertible Preferred Stock. . . . . . . (D) 197,500 $1,100,000

Nantero, Inc. (1)(2)(4)(6) --
Developing a high density
nonvolatile random access
memory chip using
nanotechnology
Convertible Preferred Stock. . . . . . . (A) 345,000 489,999

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)(9) -- Organizes and
manages investment partnerships --
20.0% of fully diluted equity
Limited partnership interest . . . . . . (D) -- 2,127,859

Questech Corporation (1)(2)(5)(6) --
Manufactures and markets proprietary
decorative tiles -- 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 --
14.53% of fully diluted equity
Series B Convertible Preferred Stock . . (A) 2,306,194
Convertible Bridge Loans . . . . . . . . (A) $ 360,250
Warrants at $0.3853 expiring 5 years
from issue . . . . . . . . . . . . . . . (A) 934,985 1,248,827
-----------
Total Private Placement Portfolio (cost: $9,582,956). . . . . . . .$12,645,508
-----------
Total Investments in Non-Controlled Affiliated Companies
(cost: $11,112,558) . . . . . . . . . . . . . . . . . . . . . . . .$13,822,601
-----------

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

7

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

Method of Shares/
Valuation (3) Principal Value


U.S. Government and Agency Obligations -- 49.7% of total investments

U.S. Treasury Bills -- due date 10/4/01 . .(K) $1,000,000 $ 1,000,000
U.S. Treasury Bills -- due date 10/11/01. .(K) $ 800,000 799,648
U.S. Treasury Bills -- due date 10/18/01. .(K) $ 894,000 893,231
U.S. Treasury Bills -- due date 11/5/01 . .(K) $1,700,000 1,695,614
Federal Home Loan Bank Discount Notes -
due date 11/8/01. . . . . . . . . . . . .(K) $3,300,000 3,290,529
U.S. Treasury Bills -- due date 11/29/01. .(K) $ 700,000 697,613
U.S. Treasury Bills -- due date 12/6/01 . .(K) $1,381,000 1,375,683
U.S. Treasury Bills -- due date 12/20/01. .(K) $1,900,000 1,891,108
Federal Home Loan Bank Discount Notes -
due date 12/20/01 . . . . . . . . . . . .(K) $2,000,000 1,988,776
----------
Total Investments in U.S. Government and Agency Obligations
(cost: $13,618,500). . . . . . . . . . . . . . . . . . . . . . . .$13,632,203
-----------
Total Investments -- 100% (cost: $24,731,058). . . . . . . . . . .$27,454,804
===========

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

8


CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF SEPTEMBER 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 nine
months ended September 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) Previously named iPacer Corporation.

(8) Previously named MyPersonalAdvocate.com, Inc.

(9) 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.

(10) 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.

(11) The aggregate cost for federal income tax purposes of investments in
unaffiliated companies is $1,529,602. The gross unrealized depreciation
based on the tax cost for these securities is $353,221. The gross
unrealized appreciation based on the tax cost for these securities is
$712.

(12) 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.

9

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 development of

10

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.

11

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.

12

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 corporation taxable under Sub-Chapter C of
the Code (a "C Corporation"), rather than as a RIC. As a RIC, the Company
must, among other things, distribute at least 90 percent of its investment
company taxable 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.

13

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 September 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 net operating loss carryforwards
incurred by the Company through December 31, 1998.

The September 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
September 30, 2000 and December 31, 2000 financial statements to conform to
the September 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 September 30, 2001
and December 31, 2000, and the reported amounts of revenues and expenses for
the three months ended September 30, 2001 and September 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.

14

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;
Helene B. Shavin, 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


15

June 30, 2001. The cumulative profit-sharing accrual was reduced to zero as
of September 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 at approximately
$3.00 per share for a total of $530,051. The Company purchased 200,000
additional shares in the third quarter of 2001 at $1.69 per share for a total
of $338,000.

Since 1998, through September 30, 2001, the Company has repurchased a
total of 1,859,047 shares for a total of $3,496,388, including commissions and
expenses, at an average price of $1.88 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


16

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 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 $427,820
as of September 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.

17

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 September 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 included 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 incurring corporate level income tax, depending on whether

18

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 approximately $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 nine months ended September 30, 2001, the Company accrued a
net tax provision of $85,359. 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 nine months ended September 30, 2001 and 2000, the
Company's income tax provision was allocated as follows:

Three Months Ended Nine Months Ended
Sept. Sept. Sept. Sept.
30, 2001 30, 2000 30, 2001 30,2000

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

Net realized gain (loss)
on investments . . . . . . . 123,546 1,472,905 175,821 4,113,978

Net increase (decrease) in
unrealized appreciation
on investments . . . . . . . . (90,462) 0 (90,462) (153,304)
-------- ---------- -------- ----------
Total income tax provision . .$ 33,084 $1,472,905 $ 85,359 $3,960,674
======== ========== ======== ==========

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

Current - Federal, State
& City . . . . . . . . . . . .$123,546 $1,472,905 $175,821 $4,113,978
Deferred --Federal . . . . . . (90,462) 0 (90,462) (153,304)
-------- ---------- -------- ----------
Total income tax provision . .$ 33,084 $1,472,905 $ 85,359 $3,960,674
======== ========== ======== ==========

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

September 30, 2001 December 31, 2000

Tax on unrealized appreciation
on investments. . . . . . . . . . . $1,540,044 $1,630,506

Net operating loss carryforward . . (266,039) (266,036)
---------- ----------
Net deferred income tax liability . $1,274,005 $1,364,470
========== ==========

19

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 $44,365 and $42,827 for the three months
ended September 30, 2001 and September 30, 2000 and $134,830 and $125,936 for
the nine months ended September 30, 2001 and September 30, 2000, respectively.
Future minimum lease payments in each of the following years are: 2002 --
$178,561; 2003 -- $101,946.

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,
$28,567,728 and $25,922,620 at September 30, 2001, compared with $43,343,423
and $31,833,475 at December 31, 2000.

Among the significant changes in the nine month ended September 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 Experion Systems, Inc. of $480,000; (3) decline in the
value of the Company's holdings in Informio, Inc. of $353, 221; (4) the sale
of the Company's holdings in Nanophase Technologies Corporation, Genomica
Corporation, Essential.com and MedLogic Global Corporation; and (5) the
payment of the 2000 realized gain profit sharing awards of $2,320,938.

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.")


Net asset value per share ("NAV") was $2.92 at September 30, 2001,
versus $3.51 at December 31, 2000.

20

The Company's shares outstanding changed during the nine months ended
September 30, 2001 to 8,864,231 from 9,064,231 due to the Company's repurchase
of its shares in the open market.

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 September 30, 2001,
$13,822,601 or 48.4 percent of the Company's total assets consisted of non-
publicly traded securities at fair value, of which net unrealized appreciation
was $2,710,043.

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 decrease in the value of publicly traded securities from $10,240,018
at December 31, 2000 to $0 at September 30, 2001 is primarily owing to the
sale of shares of SciQuest.com, Kana Communications, Nanophase Technologies
Corporation and Genomica Corporation. The value of the Company's investments
may vary significantly on a quarterly basis (see "Risk Factors").

The net decrease in the value of the non-publicly traded securities from
$16,782,438 at December 31, 2000 to $13,822,601 at September 30, 2001 resulted
primarily from the decreases in the Company's valuation of its holdings in
Informio, Experion Systems and Essential.com of $353,221, $480,000 and
2,204,000, respectively. These decreases in value were partially offset by
the Company's new investments in Schwoo, Inc. and Nantero, Inc.

The changes in the values of SciQuest.com, Nanophase Technologies and
Kana Communications took place in the context of the extreme volatility of
publicly traded, small capitalization, high technology stocks in the last few
years.

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

September 30, 2001 December 31, 2000

Investments, at cost. . . . . . . $24,731,058 $33,620,631
Unrealized appreciation . . . . . 2,723,746 8,947,928
----------- -----------
Investments, at fair value. . . . $27,454,804 $42,568,559
=========== ===========

The accumulated unrealized appreciation on investments net of deferred
taxes is $1,183,702 at September 30, 2001, versus $7,317,422 at December 31,
2000.

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


21

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 nine months ended
September 30, 2001:

New Investments: Amount
Schwoo, Inc. $ 888,577
Nantero, Inc. 489,999

Additional Investments:
Experion Systems, Inc. 80,000

Loans:
Schwoo, Inc. 360,250
----------
Total $1,818,826
==========

Results of Operations

Investment Income and Expenses:

The Company realized a net operating gain income of $179,258 and
$881,639 for the nine months ended September 30, 2001 and September 30, 2000,
respectively. The Company's net operating income in the nine months ended
September 30, 2001 and September 30, 2000 reflected decreases in the employee
profit-sharing accrual that resulted in credits to expenses of $1,162,303 and
$2,187,482, 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.

The Company had interest income from fixed-income securities of $370,914
and $290,563 for the nine months ended September 30, 2001 and September 30,
2000, respectively. The increase of $80,351 or 27.7 percent reflects an
increase in the balance of the Company's fixed income portfolio during the
nine months ended September 30, 2001 offset by declining interest rates.

The Company had interest income from affiliated companies of $20,818 and
$49,759 for the nine months ended September 30, 2001 and September 30, 2000,
respectively. The decrease of $28,941 or 58.2 percent is owing to a decrease
in the outstanding loans to investee companies.

22

The Company had other income of $71,681 and $53,432 for the nine months
ended September 30, 2001 and September 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 $284,155 and ($487,885) for the nine months
ended September 30, 2001 and September 30, 2000, respectively. The operating
expenses of the nine months ended September 30, 2001 and 2000 were reduced by
decreases in the employee profit-sharing accrual of $1,162,303 and $2,187,482,
respectively, owing to decreases in unrealized appreciation of investments for
the respective nine month periods. Salaries and benefits increased $29,996 or
4.0 percent. Administration and operations decreased $22,189 or 7.20 percent,
and professional fees decreased $109,489 or 43.7 percent. The remaining
expenses are related to office and rent expenses and director compensation.

The Company had interest income from fixed-income securities of $100,538
and $145,748 for the three months ended September 30, 2001 and September 30,
2000, respectively, reflecting net changes in the Company's investments in
short-term fixed income securities and lower interest rate levels.

The Company had interest income from affiliated companies of $9,436 and
$15,701 for the three months ended September 30, 2001 and September 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 $24,519 and $18,368 for the three months
ended September 30, 2001 and September 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 ($605,452) and $2,345,883 for the three months
ended September 30, 2001 and September 30, 2000, respectively. The operating
expenses of the third quarter of 2000 were reduced by a decrease in the
employee profit-sharing accrual, owing to a decrease in unrealized
appreciation of investments for the three months ended September 30, 2000,
resulting in a credit to expenses of $2,465,091. The operating expenses of
the third quarter of 2001 reflect a decrease in the employee profit-sharing
accrual, of $1,028,995 owing to a decrease in unrealized appreciation of
investments for the three months ended September 30, 2001. Salaries and
benefits decreased by $3,633 or 1.6 percent. Administration and operation
increased by $5,973 or 9.5 percent and professional fees increased by $4,706
or 10.6 percent. The remaining expenses are related to rent and director
compensation.

During the third quarter 2001, the Company (1) sold its position in
Nanophase Technologies Corporation (Nasdaq: NANX) for total net proceeds of
approximately $4,263,242 or $6.04 per NANX share; (2) sold its position in
Genomica Corporation (Nasdaq: GNOM) for total net proceeds of approximately
$2,523,274 or $3.45 per GNOM share; (3) sold its position in MedLogic for a
net loss of $1,033,765; (4) sold its position in Essential.com for a net loss
of $1,349,523; (5) invested an additional $150,000 in Schwoo, Inc.; and (6)
invested $489,999 in Nantero, Inc.

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.

23

Realized Gains and Losses on Sales of Portfolio Securities:

During the nine months ended September 30, 2001 and 2000, the Company
realized net (losses) gains of $557,428 and $14,356,893, respectively. The
2001 net gains of $557,428 consist primarily of gains (losses) from sales of
350,000 shares of SciQuest.com common stock, ($1,528,082), Essential.com,
($1,349,523), shares of Genomica, $1,022,970, shares of Nanophase, $2,762,696,
MedLogic, ($1,033,765). The Company also recorded a gain of $473,586 from its
partnership interest in PHZ Capital Partners L.P.

The net gains realized during the nine months ended September 30, 2000
included $5,865,521 on the sale of 500,000 shares of Alliance Pharmaceutical
Corp., $7,407,377 on the sale of shares of SciQuest.com, $241,025 on the sale
of 85,100 shares of Nanophase Technologies, $725,661 from PHZ Capital Partners
LP and $147,528 on the realization of the reserve on the NBX/3Com escrow (the
Company received in full the escrowed funds on March 6, 2000).

During the three months ended September 30, 2001 and September 30, 2000,
the Company realized net gains of $1,590,171 and $6,261,211, respectively.
The net gain of $1,590,171 in 2001 consisted primarily of a gain of $196,409
from the Company's partnership interest in PHZ Capital Partners L.P. and a net
gain of $1,402,496 on the sale of its positions in Nanophase Technologies,
Genomica Corporation, Essential.com and MedLogic Global Corporation.

During the three months ended September 30, 2000, the Company realized a
net gain of $6,261,211, consisting primarily of a gain of $5,865,521 on the
sale of 500,000 shares of Alliance Pharmaceutical Corp. As a result of the
gains and losses realized in the three months ended September 30, 2000,
unrealized appreciation decreased by $4,286,250.

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 $6,224,182 or
69.6 percent during the nine months ended September 30, 2001, from $8,947,928
to $2,723,746, primarily as a result of the decline in the value of the
Company's holdings of Nanophase, Genomica, Essential.com and Experion Systems,
Inc. of $5,499,664, $1,540,375, $854,467 and $480,000, respectively. This
decrease was offset by an increase in unrealized appreciation of $1,528,082
and $1,033,775 as a result of the realization of the loss on the sale of the
Company's positions in SciQuest.com and MedLogic.

Net unrealized appreciation on investments decreased by $22,101,229 or
47.2 percent during the nine months ended September 30, 2000, from $46,882,521
to $24,781,292, primarily as a result of declines in the values of the
Company's holdings in SciQuest.com, Kana Communications and Questech of
$24,736,593 (net of the gain realized on sale), $4,040,855 and $1,165,879,
respectively, offset by increases in the values of the Company's holdings in
Nanophase Technologies, Genomica and Essential.com of $5,223,510, $9,463,645
and $854,467, respectively. The changes in the values of SciQuest.com, Kana
Communications, Nanophase Technologies and Alliance Pharmaceutical occurred
during a period of extreme volatility of publicly traded, small
capitalization, high technology stocks. (See "Risk Factors.")

24

Net unrealized appreciation decreased by $5,897,209 or 68.4 percent
during the three months ended September 30, 2001, from $8,620,955 to
$2,723,746, owing primarily to the sale of Genomica Corporation and Nanophase
Technologies Corporation, and to a decline in the value of the Company's
investments in Experion Systems of $480,000 and in Informio of $353,221.

Net unrealized appreciation on investments increased by $4,435,110 or
21.8 percent during the three months ended September 30, 2000, from
$20,346,182 to $24,781,292 owing primarily to increases in the value of the
Company's holdings in Genomica Corporation and Nanophase Technologies
Corporation of $8,133,125 and $1,854,724, offset by a decrease in the value of
the Company's holdings in Kana Communications of $2,418,828 and a net decrease
in unrealized appreciation in the value of Alliance Pharmaceutical of
$2,968,781 owing to the sale and realization of the appreciation.

The changes in the values of SciQuest.com, Kana Communications,
Nanophase Technologies and Alliance Pharmaceutical reflected the extreme
volatility of publicly traded, small capitalization, high technology stocks in
the past few years.

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
September 30, 2001 and December 31, 2000, respectively, the Company's total
primary liquidity was $14,179,434 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 nine months ended September 30, 2001 of $62,500.

The decrease in the Company's primary source of liquidity from December
31, 2000 to September 30, 2001 is primarily owing to the (1) payment of income
taxes, primarily federal, of $5,794,149; (2) payment of the 2000 employee
profit sharing of approximately $2,320,939; (3) investment of $1,248,827 in
Schwoo, Inc., $80,000 in Experion Systems, Inc. and $489,999 in Nantero, 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) the receipt of funds from the sales
of Nanophase Technologies Corporation and Genomica Corporation of $4,263,242
and $2,523,274, respectively.

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

From December 31, 2000 to September 30, 2001, the Company's liabilities
for accrued employee profit sharing and deferred income tax liability
decreased significantly. Accrued profit sharing decreased by $3,483,241 or
100 percent to $0. The Company's total income tax liability decreased by
$5,708,790 or 80.2 percent to $1,407,246 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. 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

25

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.

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, nanotechnology material sciences and other high technology
industries, will also affect the Company's stock price. The recent
decimalization of the stock exchanges, particularly Nasdaq, may decrease
liquidity of smaller capitalization issues such as the Company's own common
stock and that of its publicly traded holdings.

Economic Recessions or Downturns Could Impair Portfolio Companies and Harm the
Company's Operating Results

Many of the companies in which the Company has made or will make
investments may be susceptible to economic slowdowns or recessions. An
economic slowdown may impact the ability of a company to engage in a liquidity
event. These conditions could lead to financial losses in the Company's
portfolio. Unfavorable economic conditions also could increase the Company's
cost of capital.

On September 11, 2001, the World Trade Center in New York City and the
Pentagon near Washington, DC were targets of terrorist attacks. As a result
of these events and other general economic conditions, the United States
equity markets experienced declines. For the quarter ended September 30,
2001, the Nasdaq Composite Index declined 31%.

The Company's business of making private equity investments and
positioning them for liquidity events also may be impacted by current and
future market and economic conditions. Significant changes in the public
equity markets could have an effect on the valuations of private companies and
on the potential for liquidity events involving such companies. This could
affect the amount and timing of gains that may be realized on the Company's
investments. There can be no assurance that the events of September 11, 2001
and the reaction to them may not have other material and adverse implications
for the Company and for the equity markets in general.

26

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.

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

27

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.

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.")

28

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 or 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 investment company taxable income 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, 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.

29

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 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."

30

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 nine
months ended September 30, 2001.

31

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: November 12, 2001

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