Annual Report 2002

A Publicly Traded Venture Capital Company
Investing in Tiny Technology

Fellow Shareholders:

Early in 2002, for the first time, we committed the Company to make all of our initial private-equity investments in a single area: tiny technology, including nanotechnology, microsystems and microelectromechanical systems (MEMS). We chose this focus because we believe that important new technological developments for years to come will increasingly be enabled by tiny technology. We also chose this focus because tiny technology is not a single industry, but rather sets of enabling technologies underlying a wide variety of products for a wide variety of end users. Thus, we can retain our traditional insistence on maintaining a reasonable degree of diversification -- an insistence that heretofore had precluded our concentrating our investment activity in a single area -- while focusing our new investments exclusively in tiny technology.

Currently, there are worldwide celebrations to commemorate the fiftieth anniversary of the momentous discovery by Nobel Laureates James Watson and Francis Crick of the double helix structure of DNA. In various interviews, Dr. Watson has commented to the effect that in some respects he and his colleague were lucky to have made the historic discovery, but in other important respects they deserved to have made it. They deserved the discovery because they had chosen the right problem on which to work -- a problem that was extremely important, with significant potential rewards for success. Moreover, while there were highly respected competitors, the field was not yet overcrowded with competitors. They were persistent in their quest. Finally, Dr. Watson stresses that they were aided by their openness to working with others on the problem they had chosen. In fact, he recommends that when one is working on a difficult problem, one should take care not to be the smartest person in the room.

We believe that Dr. Watson's principles for pioneering work are an excellent guide for an early-stage venture capital firm like Harris & Harris Group. We believe that commercialization of tiny technology is an extremely important problem. We think that the potential rewards for venture capitalists working in this space are great -- that important companies will be built on the sets of enabling technologies that fall under the tiny-technology rubric. There are highly respected venture capital firms investing in the space, either because they are interested in the enabling technologies or because they are interested in the end-user markets, or both. But the competition is not yet nearly as intense as it is in the more traditionally defined areas for venture capital, such as information technology or biotechnology. We must be persistent in our quest. Although we have tiny-technology companies in our portfolio that are on the cusp of introducing commercial products, it will take a long time for most of the companies being built on tiny technologies to achieve significant profitability. In traditional venture capital fashion, we collaborate with other professional venture capital firms in financing and helping to build the companies in which we invest, as well as with the scientists and managers who are the most important people of all in these ventures. And as we interact with these people, we have no difficulty ascertaining that we are not the smartest people in the room!

But we have been adding some very smart people to our team as we orient the Company to our new mission. Early in 2002, two independent consultants who consult regularly for the Company joined our board as interested directors. Lori D. Pressman trained as a physicist, worked in industry and spent some 12 years with the Technology Licensing Office at MIT, most recently as one of its two Assistant Directors. Kelly S. Kirkpatrick, Ph.D., trained as a materials scientist, worked in academic and national research laboratories, was co-author of the National Nanotechnology Initiative report while in the White House Office of Science and Technology Policy and most recently served at Columbia University in the Office of the Executive Vice Provost as Director, Columbia Nanotechnology Initiative and Director for Research and Technology Initiatives. Ms. Pressman conducts her business from Cambridge, Massachusetts, and Dr. Kirkpatrick conducts hers from Oakland, California -- two of the key locations for tiny-technology research and new company formation. After the close of the third quarter, we also elected Charles E. Ramsey to the Board of Directors as a non-interested director. An active private equity investor, Mr. Ramsey is a retired founder and principal of Ramsey/Beirne Associates Inc., an executive search firm that specialized in recruiting top officers for high-technology companies (many of which were backed by venture capital, including companies in which we invested). We have spent a great deal of time interviewing candidates for our professional staff, and we extended an offer to one, Douglas W. Jamison. Doug joined us on September 9, 2002 as a Vice President, from his previous position with the University of Utah Technology Transfer Office. If all of our future hires are as productive and creative for the Company as Doug has been so far, we have little doubt that Harris & Harris Group will become a great company.

Altogether, since August of 2001, we have invested in nine tiny-technology enabled companies -- seven in 2002 alone and one in early 2003. (We had invested in our first such company, Nanophase Technologies Corporation, in 1994. Nanophase went public in 1997, and we sold our interest in the open market in 2001.) To fund the new investments that we made in 2002, plus make follow-on investments in two of our non-tiny technology companies, Experion Systems, Inc. and NeuroMetrix, Inc., while maintaining our cash reserves, we raised capital externally and generated it internally. Specifically, we completed a transferable rights offering of shares for net proceeds of $5,665,970 and liquidated our interest in a non-tiny technology investment, PHZ Capital Partners L.P., for proceeds of $6,486,492. (We had invested $720,000 in equity as the seed venture capital investor in PHZ in 1995, which returned a cumulative total of $8,560,118 to us over the years.) Thus, we were able to increase our liquidity in 2002, while actively building our private equity portfolio.

By our calculations, over the years, we have sold 35 private equity investments for a total of $105,659,158 in cash, versus their cost to us of $37,366,522. Economic and capital markets conditions were much more conducive to good returns on private equity investments during most of those years than they have been since early 2000. But the quality of our deal flow was not nearly as good as it is today, as a result of our specializing for the first time in a single, defined space. And, given our small size, we do not believe that we could have hoped to achieve in better times the competitive position that we seem to have attained in our chosen field of tiny-technology investing. One tangible indication of this position is that both of the last two tiny-technology deals in which we have been fortunate enough to invest, Optiva, Inc. and NanoGram Devices Corp., have been oversubscribed.

We were honored on November 11, 2002 to be informed by Small Times Media that Harris & Harris Group had been named one of five finalists for the 2002 Small Times Magazine Best of Small Tech Company Award. Small Times® magazine created the Best of Small Tech Awards to recognize the best people, products and companies in nanotechnology, MEMS and microsystems. A complete list of winners and finalists can be found in the November/December issue of Small Times® magazine and online at

In summary, we believe that the Company has a great opportunity to build shareholder wealth through private equity investing in tiny-technology enabled companies. But we are ever mindful that persistence will indeed be required. Our overall financial returns from our private equity investments have been good. But, according to our calculations, only 16 of our 35 closed-out private equity investments have been profitable. So we will inevitably experience setbacks that will manifest themselves as portfolio company write-downs and write-offs. And we are particularly mindful of the support that the Company needs and enjoys from our fellow shareholders. When the stock market was collapsing in July of 2002, very few other equity offerings were completed, let alone a rights offering in which no broker/dealer or other agent was paid to sell it. We thank you!

Charles E. Harris
Chairman and Chief Executive Officer

Mel P. Melsheimer
President and Chief Operating Officer

March 24, 2003

This letter may contain statements of a forward-looking nature relating to future events. 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 and recent Prospectus 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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