Annual Report 2001

A Publicly Traded Venture Capital Company
Investing in Small Technology

Fellow Shareholders:

Harris & Harris Group, Inc. has traditionally functioned as a classical venture capital firm, investing in early-stage, high technology companies based on proprietary intellectual property. We have always tried to maintain some diversification in the Company's portfolio. Although diversification has served us well, the tradeoff of this policy is that, unlike many venture capital firms, the Company has never specialized in one or two investment categories. There are many advantages to industry specialization. Indeed, it is more difficult to build a substantial venture capital organization without specialization.

As we will discuss in this Letter to Shareholders, we have now for the first time committed the Company to making all of its new private equity investments in one investment category, small technology. Accordingly, on March 27, 2002, we changed our stock symbol on the Nasdaq National Market to TINY. And at the 2002 Shareholders' Meeting, shareholders will be asked for approval to change the name of the Company to Small-Technology Venture Capital, Inc.

Harris & Harris Group and Small Tech

In 1994, the Company made an investment in one of the first nanotechnology companies to attract professional venture capital funding, Nanophase Technologies Corporation. A spinoff from Argonne National Laboratory, seeded by Arch Venture Partners, Nanophase subsequently completed an initial public offering in 1997. The due diligence that we conducted prior to making our initial investment and follow-on investments in Nanophase awakened us to the commercial potential of nanotechnology and other small tech, including microsystems and microelectromechanical systems (MEMS). But we also learned that it would be some time before scientific research into small tech, especially at the nanoscale, would mature to the stages of technology transfer and commercialization that venture capital firms such as ourselves require. Meanwhile, the emerging field of nanotechnology was leading to unprecedented understanding and control over the fundamental building blocks of all physical things. But even today, researchers are just beginning to understand the phenomena and material properties at the nanoscale.

By mid 2001, some seven years after initially investing in Nanophase, we began to find small-tech startups that were ready for commercialization and funding by professional venture capital organizations. Often, these startups are based on years of work that has been conducted in research universities and national laboratories. Universities are making large investments to poise their institutions and researchers for the demands that research in nanotechnology requires and to transfer more efficiently discoveries made in the labs to applicable technologies and devices. Gradually, we became convinced that the number of worthwhile small-tech startups will keep expanding and that the science, technology and commercialization of small tech will continue to develop for decades to come.

We concluded that, for the first time, we had the opportunity to concentrate all of our new business activities in a single focus, small tech, while maintaining a modicum of diversification in our portfolio. Small tech is enabling technology, not a field of use. Some observers believe that it is difficult to identify any commercial product in future years and decades that will not incorporate, be enhanced by, or made possible by small tech. Nevertheless, our practical view as venture capitalists is that small tech will become commercial in some fields long before others, which may cause us to have industry clusters in our portfolio at any point in time.

What is Small Tech and Why Does it Matter?

Small tech is the world of small objects and devices. The largest of these objects and devices, microsystems and microelectromechanical systems (MEMS), are at the microscale, with dimensions that are measured in microns, which are one-millionth (10-6) of a meter. The smallest of these objects and devices are at the nanoscale. A nanometer represents one-billionth (10-9) of a meter, and nanotechnology is considered to be the creation and use of objects in the range of one to 100 nanometers.

From a commercial point of view, nanotechnology, microsystems, MEMS and macro technology can be viewed as a continuum. Macro technology may integrate microsystems that integrate MEMS that integrate nanotechnology. While the exact pathway of impact is unknown, nanotechnology will eventually impact broadly many sectors. According to the plan of the National Nanotechnology Initiative (published in July 2000 and co-authored by Dr. Kelly S. Kirkpatrick, who recently joined Harris & Harris Group's Board of Directors), "long-term nanoscale research and development … [will lead] to potential breakthrough in areas such as materials and manufacturing, nanoelectronics, medicine and healthcare, environment, energy, chemicals, biotechnology, agriculture, information technology and national security. The effect of nanotechnology on the health, wealth and lives of people could be at least as significant as the combined influences of microelectronics, medical imaging, computer aided engineering, and man-made polymers…."

Small tech catalyzes the miniaturization of objects and devices that use less material and energy, are eventually cheaper to manufacture, or have superior characteristics to existing materials and components that they will replace. Breakthroughs in small tech will also lead to revolutionary technologies capable of performances never achievable with existing, larger scale technologies. At the microscale, MEMS devices are already common in automobiles, used as accelerometers to deploy airbags and devices to monitor air pressure in tires. At the nanoscale, Nanophase Technologies produces zinc oxide particles for use in sunscreen to provide a physical, instead of a chemical, sunblock. Because these particles are smaller than the visible wavelength of light, this sunblock is transparent, yet it provides the same protection that lifeguards achieve by coating their noses with traditional opaque zinc oxide.

The first five small tech companies in which we have invested reflect the diversity of technology and applications within small tech. Nanophase Technologies Corporation, a spinoff from Argonne National Laboratory, produces nanoxide powders (Harris & Harris Group sold its shares of Nanophase in mid-2001). Nantero, Inc. a spinoff of Harvard University, is developing a high density nonvolatile random access memory chip using nanotechnology. Nanopharma Corp., a spinoff of Massachusetts General Hospital, is developing fully biodegradable nanoscopic drug delivery vehicles based on proprietary molecular constructs and "biological stealth" materials. NeoPhotonics Corporation develops and manufactures advanced planar optical devices by monolithically integrating active and passive optical materials using the company's proprietary nanomaterials-based process solutions. And NanoOpto Corporation, a spinoff of Princeton University, fabricates subwavelength optical elements using proprietary nano-imprint lithography methods to form optical nanostructures.

Grand Opportunities -- and Challenges

We believe that Harris & Harris Group has a significant corporate opportunity to create wealth for our shareholders by investing in small tech. The investments that we have made in small tech to date were made possible by the expertise, relationships and capital that we have built up through years of making venture capital investments in a wide variety of early stage companies, typically spun out of research universities and national laboratories with proprietary intellectual property. But the risks in small tech will include all of the traditional risks in early stage, high technology venture capital investments, which is to say that the risks are serious and should be fully appreciated by anyone investing in Harris & Harris Group. It will be hard for any venture capital firm to identify the eventual winners in small tech at the early stages at which the Company invests: we think that it makes sense to take a portfolio approach to investing in small tech.

An academic researcher might be interested primarily in conducting experiments designed to advance knowledge of the unique properties that emerge in materials at the nanoscale. But as a professional venture capital firm interested in helping to build significant new companies, we are interested in commercial products. We are focusing on small tech as enabling technology, broadly defined. We will have to be careful in our selection of small-tech investments to avoid the tempting trap of funding fundamental research instead of commercial enterprises.

To even begin to capitalize on the open-ended potential of small tech, we will have to grow the Company's capacity significantly. We have recently added two members to our board of directors, Dr. Kelly S. Kirkpatrick and Lori D. Pressman, who are active consultants for us in assessing small-tech opportunities and who are particularly qualified to help guide us in our specialization in small tech. We are going to have to add very high-grade professionals to our internal staff with training and experience appropriate to our new mission. And we will have to grow our capital base to act on the opportunities that we select from the small-tech deal flow that we are fortunate enough to be receiving. Over the years, the Company has remained small, paying out capital to shareholders through cash dividends and share repurchases (indeed, as a result of stock buybacks, the Company's shares outstanding have declined in each of the last four years). Now it is time for the Company to retain and attract capital as we endeavor to build a high-quality franchise in small-tech venture capital.

Our mission is straightforward and simple: 1) to create wealth for our shareholders by making the best venture capital investments that we can make in small technology; and, 2) as a natural byproduct of that work, to give our shareholders an increasingly pure play on a reasonably diversified portfolio of small-technology venture capital investments. But while the mission is straightforward and simple, we recognize that successful investing in small technology will not be easy. It will require excellence of personnel and execution on our part to fulfill our mission.

Although we are not restricting our small-tech investing to nanotechnology per se, we are inspired by the National Nanotechnology Initiative's plan, which envisions nanotechnology as "a revolution in the making…leading to the next industrial revolution," promising "to be a dominant force in our society in coming decades." We concluded earlier this year that if we wanted to specialize in small technology, we either had to take the risk of being too early or too late. We decided to take the risk of being too early. We decided that for us, as the President's Committee of Advisors on Science and Technology has stated, "now is the time to act."

Additional information about Harris & Harris Group and its holdings can be found on its website on the internet at

Charles E. Harris
Chairman and Chief Executive Officer

Mel P. Melsheimer
President and Chief Operating Officer

April 23, 2002

This letter may contain statements of a forward-looking nature relating to future events. Statements contained in this letter that are forward looking statements are intended to be made pursuant to the Safe Harbor Provisions for the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. These statements reflect the Company's current beliefs, and a number of important factors could cause actual results to differ materially from those expressed in this letter. Please see the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission for a more detailed discussion of the risks and uncertainties associated with the Company's business, including but not limited to the risks and uncertainties associated with venture capital investing and other significant factors that could affect the Company's actual results. Except as otherwise required by Federal securities laws, Harris & Harris Group, Inc. undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

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