Business Development Company (BDC)
What Exactly Is a BDC (Business Development Company)?
A business development company (BDC) is an investment firm that focuses on small and medium-sized businesses as well as troubled businesses. A BDC assists small and medium-sized businesses in their early phases of growth. The BDC assists struggling firms in regaining strong financial footing.
Many BDCs are public corporations whose shares trade on major stock exchanges such as the American Stock Exchange (AMEX), Nasdaq, and others, and are structured similarly to closed-end investment funds. They might be high-risk investments, but they can pay out huge dividends.
According to Closed-End Fund Advisors, there are roughly 49 public BDCs as of May 2019.
The Business Development Company: An Overview
In 1980, the United States Congress established business development corporations to promote job creation and aid new enterprises in acquiring capital. BDCs are heavily active in giving operational guidance to their portfolio firms.
Many BDCs invest in private companies, as well as tiny public companies with limited trading volumes. They offer these firms with long-term funding by utilising a number of sources, including stock, debt, and hybrid financial instruments.
TAKEAWAYS IMPORTANT
A business development company (BDC) is a closed-end fund that invests in growing and financially troubled businesses.
Many BDCs are available to ordinary investors and are publicly listed.
BDCs provide investors with substantial dividend rates as well as the possibility of capital appreciation.
Because of their extensive use of debt and focus on tiny or troubled businesses, BDCs are considered high-risk investments.
Becoming a BDC requires a lot of hard work.
A corporation must be registered as a BDC in accordance with Section 54 of the Investment Company Act of 1940. It must be a domestic corporation with a Securities and Exchange Commission-registered security class (SEC).
The BDC must invest at least 70% of its assets in private or public companies in the United States with market capitalizations of less than $250 million. These are frequently new enterprises that are looking for funding or businesses that are experiencing or have just experienced financial troubles. In addition, the BDC must support the firms in its portfolio with management issues.
Venture Capital vs. BDCs
If BDCs sound like venture capital funds, that's because they are. There are, nevertheless, some significant variances. One has to do with the type of investors each is looking for. Through private placements, venture capital funds are mostly available to major organisations and rich people. BDCs, on the other hand, enable non-accredited investors to invest in them, and hence in tiny growing enterprises.
To avoid being classed as regulated investment businesses, venture capital funds retain a small number of investors and must pass specific asset-related standards. BDC shares, on the other hand, are often traded on stock exchanges and are always available to the general public as investments.
BDCs that choose not to list on an exchange must nonetheless adhere to the same rules as listed BDCs. The BDC is an enticing form of incorporation for venture capitalists who were previously hesitant to adopt the cumbersome regulation of an investment company due to less rigorous rules for the amount of borrowing, related-party transactions, and equity-based remuneration.
The Benefits of Investing in a BDC
BDCs give investors access to debt and equity investments in primarily private enterprises that are traditionally closed to outside capital.
BDCs must distribute over 90% of their revenues to shareholders since they are regulated investment firms (RICs). However, because of their RIC classification, companies are exempt from paying corporate income tax on earnings before distributing them to shareholders. As a result, dividend yields are higher than usual. According to "BDCInvestor.com," the ten highest-yielding BDCs had yields ranging from 10.82 percent to 14.04 percent in May 2019.
Dividends are taxed at the standard income tax rate for investors who receive them. BDC investments may also help diversify an investor's portfolio by allowing them to own assets that have significantly different returns than stocks and bonds. Of course, because they trade on public exchanges, they have a good deal of liquidity.transparency.
Pros
Dividend yields that are high
Profits are not subject to corporation taxes.
Retail investors are welcome to participate.
Liquid
Cons
High-risk
Sensitive to changes in interest rates
Holdings that are illiquid or opaque
The Risks of Investing in BDCs
While a BDC is liquid in and of itself, many of its holdings are not. Private enterprises or tiny, thinly traded public corporations make up the majority of the portfolio's assets. A BDC's portfolio has subjective fair-value estimations and may face rapid and swift losses because most BDC assets are often illiquid equities.
Because BDCs frequently utilize leverage—that is, they borrow the money they invest or loan to their target companies—their losses can be amplified. Leverage may boost the rate of return on investment (ROI), but it can also wreak havoc on cash flow if the leveraged asset loses value.
The target firms in which the BDC has invested usually have no or a bad track record. There's always the possibility that they'll go bankrupt or default on a debt. A rise in interest rates, which makes borrowing money more expensive, can also hurt a BDC's profit margins.
In brief, BDCs invest aggressively in firms that provide both current income and future capital appreciation; as a result, they have a somewhat high risk profile.
A BDC in the Real World
CM Finance Inc. is the highest-yielding BDC on BDC Investor's list as of May 2019, with a market and income yield of 14.04 percent (CMFN). CMFN, based in New York City, seeks total returns from current and capital appreciation largely through loans to middle-market firms, but also through equity investments in them. These companies are in the middle market, with revenues of at least $50 million. The entire assets of CMFN in 2018 were approximately $301 million. CM Finance is listed on Nasdaq and has an average daily volume of 60,000 shares. The company's market capitalization is about $97 million.
