Ned Sherwood Discloses 6.6% Stake in Capital Southwest (CSWC), Wants Company Liquidated

In a 13D filing on Capital Southwest Corporation (Nasdaq: CSWC), Ned Sherwood disclosed a 6.6% stake and disclosed a letter delivered a letter to the Board of Directors expressing its belief that the shares trade at an excessive discount to the market value of its assets and highlighting several concerns it has about certain aspects of the strategy and direction of the Issuer. Sherwood recommends the company completely liquidation distribute the proceeds to investors.

From the letter, "it is our belief that the Company's stock price continues to trade at an excessive discount to the market value of its assets, which we estimate to range between $175 and $200 per share."

The firm also said, "Given our discussions with management and our review of publicly available information, however, we have little faith that the Board and the Company's new CEO are prepared to make the necessary changes. Absent such changes, we believe that a complete liquidation of the Company is the best way to realize the Company's full value for stockholders."

A Copy of the Letter:

We appreciate the time management took to speak with us earlier this week. Based on our discussions with Capital Southwest Corporation ("CSWC" or the"Company") management and our in-depth review of publicly available information, it is our belief that the Company's stock price continues to trade at an excessive discount to the market value of its assets, which we estimate to range between $175 and $200 per share. This market value is 58% to 81% greater than yesterday's closing price of CSWC of $110.66 per share. We believe that the Company is trading at a significant discount to its intrinsic value because of,among other things, certain policies and practices that the Company has historically adopted and has indicated it will continue to apply for the foreseeable future.

We also have serious issues with certain judgments of CSWC's Board of Directors (the "Board"). Unlike most Business Development Companies ("BDCs"),CSWC has generally chosen to retain its realized gains rather than distribute the proceeds to its shareholders. CSWC has also chosen not to exercise its registration rights on its four most significant holdings in public companies so such shares can be freely traded as market conditions warrant. Based on CSWC's Quarterly Report on Form 10-Q for the period ended June 30, 2007 (the "Form10-Q"), these two policies resulted in a reduction of the Company's stated net asset value ("NAV") by nearly $100 per share. In other words, as of June 30,2007, CSWC's NAV would have been $233.95 per share as opposed to the $135.61 per share that was reported.

It is clear to us that the Board and senior management have adopted policies or utilized accounting presentation practices which result in a significant understatement of CSWC's NAV, and that these policies and practices should be changed immediately.

The rationale for this belief is as follows:

o CSWC owns significant equity positions in four publicly traded companies(Alamo Group Inc., Encore Wire Corporation, Palm Harbor Homes, Inc., and Heelys,Inc.). Although CSWC has held these stakes for many years, it has chosen not to exercise its registration rights with respect to these securities and,therefore, it values these stakes at significant discounts (generally 30% or more) to their end-of-quarter market prices. Further, as a result of its affiliate's status, the failure to register the shares does not permit CSWC to sell a significant portion of its position when market conditions warrant.

o CSWC has historically adopted a policy of electing to "retain all gains realized with one exception during the past 39 years" (quote from the Form10-Q), and its stated intention is to continue to do so in the future. This policy is the most damaging with regard to value obfuscation because it the justification for the accrual of the deferred tax liability which totaled $219.6million, or $56.47 per share, as of June 30, 2007.

CSWC is structured as a BDC and, therefore, all income and tax liabilities are the responsibility of the shareholders, and not of the Company. Nonetheless,CSWC, by choosing to retain all gains, has obligated the Company to pay on behalf of its shareholders a 35% tax to the IRS. If gains were distributed to the shareholders rather than retained, CSWC would owe no tax, and the shareholders would owe long-term capital gains taxes at either a 15% rate (for individuals) or 0% (for tax-exempt entities). In either case, the 35% rate is well in excess of what actually is owed. This practice is unwarranted and totally inconsistent with good business practice.

The Company has indicated that this policy permits it the flexibility to make new investments without having to raise new equity in the capital markets;however, the Form 10-Q showed that CSWC had approximately $94.6 million of cash and unrestricted marketable securities plus $41.4 million of available credit lines or a total of $136.0 million of liquidity. The Company could also increase its credit lines very significantly if it so decided.

During the past five years, CSWC has made new venture capital investments at the rate of approximately $8.5 million per year. Therefore, the maintenance of a policy that requires the booking of a $219.4 million deferred tax liability when the Company has enough liquidity to make 16 years of investments at its recent pace is unwarranted and totally inconsistent with good business practice.By just changing CSWC's distribution policy, this liability would no longer have to be accrued and CSWC's NAV would increase by $56.47 per share from $135.21 to$191.68 per share (as of June 30, 2007). This figure does not include the discount attributable to CSWC's failure to register its shares in its four major public company holdings.

We also believe that CSWC has created value historically by being a successful growth capital investor in private companies. Your policy of retaining virtually all of your securities holdings even after the companies have matured (i.e., earnings have leveled off and/or the company has gone public) has significantly impaired shareholders' returns.

For example, in the case of Alamo, its compound annual return since its1993 IPO has been approximately 5.4% versus the S&P 500's compound return of10.2% over the same period. Similarly, since Palm Harbor's IPO in 1995, is stock price has increased by approximately 6.9% per year versus the S&P 500'scompound annual return of 9.7% over the same period. Heely's went public in December 2006 at a price of $21.00, and it closed yesterday at $8.76. Given thatCSWC does not have a track record of creating value in its publicly traded securities, the Company should have sold such securities as soon as was possible and/or distributed them to its shareholders who could then have made their own investment decisions.

In summary, it is clear that the Board and senior management are not working to narrow the gap between CSWC's intrinsic value and its stock price but, instead, have adopted policies and practices which result in the significant and continued understatement of CSWC's intrinsic value. These practices are clearly not in the best interest of CSWC's stockholders.

We would expect the Board and the Company's new CEO to immediately change these policies and practices, including:

- the method of valuing its portfolio securities;

- the policy of retaining realized gains; and

- the holding on to investments after they are public and have matured.

Given our discussions with management and our review of publicly available information, however, we have little faith that the Board and the Company's new CEO are prepared to make the necessary changes. Absent such changes, we believe that a complete liquidation of the Company is the best way to realize the Company's full value for stockholders.

Accordingly, we believe that management should make the necessary changes we recommend or that the Board should adopt a formal plan of complete liquidation for CSWC under which all of its assets would be sold and the proceeds distributed to stockholders. We would be happy to meet with the Board and management to discuss our views on maximizing shareholder value for CSWC's stockholders; however, we can no longer tolerate inaction. We therefore must reserve all rights to take any and all actions we deem appropriate if the Board and new CEO are unwilling to do what is necessary and proper for its stockholders. We look forward to a positive response and hope further actions on our part will be unnecessary.

Sincerely,

Ned L. Sherwood