Annual Report 2003

A Publicly Traded Venture Capital Company
Investing in Tiny Technology

Fellow Shareholders:

Since 2001, when we began to focus our investing activity exclusively in tiny technology (microsystems, microelectromechanical systems (MEMS) and, especially, nanotechnology), our Company has been transformed We have grown rapidly in terms of deal flow, investment professionals, co-investing relationships and capital. We now have over 650 tiny technology companies in our data base. To give an idea of the recent tempo of activity in our Company, our deal flow so far in 2004 has brought in more than another 50 tiny technology companies. In 2004 to date, we have made two initial investments and five follow-on investments in deals that included tier one venture and corporate investors, for a total of $7,223,662. In 2004, we have been joined by two additional investment professionals. In March of 2004, along with the other shareholders in NanoGram Devices Corporation, we sold our interest in that maker of batteries for implantable medical devices for $2,750,000, versus our cost 14 months previously and carrying value on our books of $813,210.

On December 24, 2003, we sold 2,300,000 shares of our common stock at $8.00 per share in an oversubscribed, follow-on public offering. We had never previously presented our Company to institutional investors on a formal "road show." According to the underwriters of the issue, Punk, Ziegel & Company, LP, approximately 64 percent of the shares in our offering were purchased by 15 of the 30 institutional investors to which we made presentations during the "road show," which meant that we now had access to capital from institutional investors.

Nothing is more important to a venture capital firm than its people. Our rising identity in the world of tiny technology investing, coupled with our growth, in the context of the lingering doldrums in the venture capital industry, have given us wonderful opportunities to add to our staff. Daniel V. Leff joined us in January, 2004, as Executive Vice President, to open an office for us in Los Angeles. In addition to managing our West Coast office, he has been designated as a Managing Director, as one of our four decision makers with respect to all of our venture capital investments, and he is now involved in our Company's strategic direction, along with our three other senior officers. He joined us from Sevin Rosen Funds, prior to which he worked for Redpoint Ventures, after holding engineering, marketing and strategic investment positions with Intel Corporation. He was graduated with a Ph.D. degree from UCLA's Department of Chemistry and Biochemistry, where his thesis advisor was Professor James R. Heath (recipient of the 2000 Feynman Prize in nanotechnology). Mr. Leff also was graduated with an MBA degree from The Anderson School at UCLA and a B.S. in Chemistry from the University of California, Berkeley. We have also agreed to hire, as a Vice President, Daniel B. Wolfe, upon completion of his Ph.D. work at Harvard University, where he is a member of one of the most prominent research laboratories working in nanotechnology, that of Professor George M. Whitesides. Mr. Wolfe's business experience includes consulting work for one of our portfolio companies, Nanosys, Inc. In late 2003, we were joined by a new board member, Mark A. Parsells, Chairman, President and CEO of Fusura LLC, an AIG company that is an internet-based, direct-to-consumer auto insurance business. He was graduated from Emory University (B.A.), Cornell University (MBA) and Vlerick LeuvenGent Business School (MBA). Previously, he was President and COO of Citibank Online, worked in executive positions for Bank One and American Express and acted as Special Assistant to U.S. Senator John Heinz.

This will be the final year of service of two of our stalwarts, who have played important roles in helping us position our Company as a leader in tiny technology venture capital. Pursuant to our mandatory retirement program for senior executives at the end of the calendar year in which they attain the age of 65, our President, COO and CFO, Mel P. Melsheimer, will be retiring at the end of this year. (Douglas W. Jamison, who currently serves our Company as a Vice President, has been named by our Board of Directors to assume Mr. Melsheimer's responsibilities.) Mr. Melsheimer has been affiliated with our Company since 1994, first as a nearly full-time consultant and then as a senior officer in a variety of capacities, bringing to bear his extensive financial, operating and deal experience on our behalf. Glenn E. Mayer, our longest serving director, has elected not to stand for reelection at this year's Annual Meeting of Shareholders. Mr. Mayer has had an incalculable effect on our Company, as can be appreciated simply by acknowledging one of his many contributions, the people that he has recruited to the Company, which include our Chairman and CEO and two of our directors, G. Morgan Browne and Kelly S. Kirkpatrick, Ph.D.

Our raison d'etre is to endeavor to earn a high return on our shareholders' investment in our Company by making profitable investments in tiny technology. Our Company is a publicly traded venture capital firm and, as such, we are regulated as a business development company (BDC). Most venture capital firms are organized as private limited partnerships. Because there are very few BDCs, it is understandable that relatively few investors are familiar with their structure, and many wonder how to measure a BDC's performance and how to think about valuing a BDC.

The accounting conventions used for BDCs are different from those used for operating companies. BDCs do not report "net income"; instead, the measure of a BDC's operating performance is called "net increase in net assets resulting from operations." This figure is the sum of: "net operating income" (which is the difference between "total investment income" and "total expenses") plus "net realized income from investments" plus "net increase in unrealized appreciation on investments." Similarly, BDCs do not report "shareholders' equity" (book value); instead, they report "net assets." An operating company seeks to grow by earning high levels of "net income" relative to its "shareholders' equity" (book value); if successful, it increases book value and/or dividends rapidly. If an operating company is expected by investors to be successful in rapidly increasing book value and/or dividends, its common stock may sell at premiums to "shareholders' equity" per share (book value per share). Similarly, a BDC seeks to grow by generating high rates of positive change in "net increase in net assets resulting from operations." If a BDC is expected by investors to be successful in rapidly increasing "net asset value per outstanding share" (often abbreviated as "NAV"), and/or dividends, its common stock may sell at premiums to NAV. And of course, if investors expect a BDC's NAV to be stagnant or to decline, they can be expected to value the shares of common stock at a discount to NAV. Indeed, our Company's common stock has often traded at discounts to NAV, and may do so again in the future, especially during periods of adverse economic and capital markets conditions, when there are in general very few initial public offerings or acquisitions of privately held, technology-based companies.

We believe that tiny technology in general and nanotechnology in particular are advancing rapidly on all fronts -- education, science, technology and commercialization -- and that venture capital has a vital role to play in the commercialization of tiny technology. We believe that nanotechnology in particular may one day become one of the most capital intensive areas of investment in the world. As small a firm as we are today, we believe that we may have some competitive advantages. We have the perspective of one of the first venture capital firms to invest in and focus on nanotechnology. Having reorganized and staffed our whole company around one business, venture capital for tiny technology, we have the advantage of a team approach -- all eyes on all deals all the time -- to an inherently difficult-to-organize, multi-disciplinary activity. If we are right in our expectation that nanotechnology is going to continue and even accelerate its growth, we are going to need every possible advantage if we are to keep pace. In short, to avoid falling behind, we believe that we need to do that which is consistent with being prepared to grow rapidly.

Recognition for a leadership role in this emerging field of tiny technology brings with it deal flow, co-investment opportunities, ability to attract highly talented, qualified people to our professional team and board of directors and enhanced ability to assist our portfolio companies to make the connections critical to their achieving their potential. Thus, we were pleased to be named in the inaugural issue of Nanotechnology Law & Business, Volume I, Issue One, 2004, a journal for attorneys, entrepreneurs and investors, in an article entitled, "Top Ten Nanotech VCs," as one of the top 10 nanotech venture capital firms that are most active in nanotechnology. Similarly, we appreciated that our CEO was voted one of the "top 10 power brokers of nanotechnology" in a 2004 poll conducted by the leading investment-oriented newsletter in nanotechnology, the Forbes/Wolfe Nanotech Report; and that our CEO was given an award as one of the five finalists for the 2003 Small Times Magazine Best of Small Tech Business Leader Award, sponsored by Small Times Media LLC, the leading source of business news about the small tech industry, which includes nanotechnology, MEMS and microsystems. Previously, in 2002, our Company had received an award as one of five finalists for the Small Times Magazine Best of Small Tech Company Award.

With the continued support of you, our 12,550 shareholders, we are determined to make the most of the great opportunity for potential wealth creation for our shareholders that our Company's position in venture capital for tiny technology makes possible. But as always, we hope that our shareholders will remain prudent: ever mindful that early stage venture capital, particularly as practiced in a field as new as tiny technology in general and nanotechnology in particular, is one of the most cyclical, highest risk forms of business.

Charles E. Harris
Chairman, Chief Executive Officer/
Managing Director

Mel P. Melsheimer
President and Chief Operating Officer/
Managing Director

Daniel V. Leff
Executive Vice President/
Managing Director

Douglas W. Jamison
Vice President/
Managing Director

March 31, 2004

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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