What is a business development company?
A business development company (“BDC”) is a type of closed-end fund that was created by an amendment to the Investment Company Act of 1940 called the Small Business Investment Incentive Act of 1980. As the name suggests, the structure was created to promote investment in an important part of the U.S. economy, small and middle market businesses. Comprised of more than 200,000 companies generating over $10 trillion in annual revenue1, the middle market is a driving force of the U.S. economy.
Most BDCs are organized as Regulated Investment Companies (“RICs”), which means they must derive a minimum of 90% of income from capital gains, interest, or dividends earned on investments. BDCs are also required to invest no less than 70% of total assets in private U.S. companies or public U.S. companies with market capitalizations of less than $250 million. Companies that fit this profile typically have fewer options to raise capital to facilitate growth and support daily operations when compared to their larger, public counterparts.
Most BDCs provide financing solutions to middle market businesses by raising money from individual and institutional investors and deploying it in the form of senior secured, floating rate loans. Interest payments on these loans are paid to the fund, which is then required to distribute at least 90% of its taxable income back to its investors.
As RICs, BDC dividend payments are not subject to entity-level tax on distributed income. This flow through treatment creates tax efficiency by avoiding the possibility of double taxation of shareholders, provided the fund meets periodic asset, income, and distribution requirements.
What are the different types of business development companies?
BDCs typically fall under one of three categories: Private Placement, Non-traded, and Public. BDCs can be offered in different ways and their investment strategies can vary significantly.
| Private placement BDC | Non-traded BDC | Public BDC | |
| Offering type | Private placement | Continuous offering, up to a stated limit | Traditional IPO |
|
Can offer multiple share classes |
No | Yes | No |
| Liquidity | Typically, none while private; Liquidity event when portfolio is listed or wound down | Typically, periodic share repurchases | Exchange-traded |
How can BDCs benefit investors?
BDCs present several potential benefits for investors, including:
- Access: BDCs provide individual investors with access to private assets and investment strategies more commonly associated with the institutional investment space. Non-traded BDCs may also offer multiple share classes, providing further flexibility.
- Income & return potential: BDC portfolios have the potential to generate attractive returns due to the yield premium associated with private, less-liquid assets. Net investment income is distributed to shareholders in the form of regular distributions.
- Downside management: BDC managers typically structure investments as senior-secured loans. Senior-secured loans are collateralized by a borrowing company’s assets and have the highest payment priority in the event of a default.
- Liquidity: The BDC structure typically offers investors periodic liquidity opportunities while taking advantage of the potential benefits of investing in less-liquid asset classes.
- Diversification: The underlying assets that BDCs invest in are usually not traded on public exchanges which may reduce exposure of an investor’s portfolio to publicly traded markets.
- Transparency & simplicity: Public filings disclose the makeup of BDC portfolios and their valuations at regular intervals, providing shareholders a level of transparency not commonly associated with private investment opportunities. The pass-through nature of BDC income means shareholders receive more efficient tax treatment, receiving form 1099s instead of schedule K-1s.
What are the risks of BDCs?
As with any investment, there are certain risks and trade-offs associated with BDCs and the underlying assets they contain.
Publicly traded BDCs, for example, have exposure to the volatility risk of public markets but offer daily liquidity; while non-traded BDCs are considered less liquid but can offer illiquidity premiums. BDCs may contain equity or debt investments but are usually associated with the latter in the form of leveraged loans. Credit risk is the risk of nonpayment of scheduled interest or principal payments on a debt investment. Should a borrower fail to make a payment, or default, this may affect the overall return to the portfolio. Although fees vary from one BDC to the next, they may involve substantial costs. Anyone considering an investment in BDCs should thoroughly review the corresponding offering documents for information regarding risks, fees and expenses.
Past performance is not a guarantee of future results. The views and opinions expressed herein are those of Blue Owl and are subject to change as markets and other conditions fluctuate. Blue Owl is under no obligation to update or keep current the information presented.
Please see endnotes and important information at the end of this page.
