Business Development Companies (BDCs) are a type of closed-end investment company aimed at investing in small and medium-sized enterprises, as well as distressed companies. BDCs provide small businesses access to the capital they need to grow, which they may not be able to obtain elsewhere. Regarding distressed companies, they help restore business stability financially.
Definition and Example of a Business Development Company
Investors who invest in BDCs often seek high returns from dividends or an alternative investment vehicle to mutual funds and exchange-traded funds (ETFs). Investing in BDCs can be effective, but it is not suitable for everyone. As with any type of investment, those considering BDCs should research how they work and whether their unique characteristics align with their investment goals and risk tolerance.
Benefits of BDCs
With small companies, BDCs provide them access to the capital they need to grow, which they may not be able to obtain elsewhere. BDCs can also assist distressed companies in improving their financial stability.
The U.S. Congress originally established BDCs in 1980 to provide another source for stimulating the economy. BDCs are designed to create jobs by providing investment and management support to small and medium-sized businesses. According to the BDC Council, BDCs invest more than 70% of their assets in companies valued at less than $250 million.
Example of a BDC
Oaktree Specialty Lending Corporation (OCSL) provides financing solutions or loans to companies that lack access to capital markets, such as issuing bonds or debt securities to raise funds. They emphasize a long-term commitment to their clients by providing loans across various stages of the economic cycle. With over $2.5 billion invested, Oaktree generates income that it returns to investors through its dividend yield of 8.6% as of April 2021.
How Do Business Development Companies Work?
BDCs use their capital to provide loans or purchase equity stakes in small and medium-sized enterprises throughout the United States. They are primarily owned by individuals.
Dividend Distribution
Most BDCs are treated as regulated investment companies (RICs) for tax purposes and are not taxable entities. In exchange for favorable tax treatment, a BDC must distribute at least 90% of its income to shareholders each year. The structure of dividend distribution in BDCs resembles that of real estate investment trusts (REITs). Due to their high distributions of income and interest, BDCs are often used as an income tool.
Investor Accessibility
BDCs are similar to venture capital funds in that they invest in companies but are more accessible to investors. Venture capital funds are typically available only to accredited investors, large institutions, and wealthy individuals. They must also limit the number of investors and impose specific criteria not to be classified as RICs. On the other hand, BDCs are available to anyone with access to the stock exchange.
How Can You Invest in a BDC?
You can invest in BDCs the same way you invest in stocks, mutual funds, and exchange-traded funds (ETFs). Each BDC has a ticker symbol, and investors can purchase shares through their brokerage account or individual retirement account (IRA). Like mutual funds, investors can buy shares at the net asset value of the fund, and the funds are not limited to a specific number of shares. However, closed-end funds like BDCs issue a fixed number of shares through an initial public offering.
Warning
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Because BDCs are not considered low-risk investments, it is important to assess your risk tolerance and seek help from a financial advisor before investing.
What are the largest BDCs?
Congress established the BDC structure in 1980, but today, most of the BDCs available in the market have only been around since the early 2000s. As a result, there is not a lot of information and history to research before investing. Below are the ten largest BDCs by assets under management (AUM) as of December 31, 2021:
- Ares Capital Corp (ARCC): $9.27 billion
- FS KKR Capital Corp (FSK): $7.72 billion
- Owl Rock Capital (ORCC): $5.96 billion
- Prospect Capital Corporation (PSEC): $4.15 billion
- Golub Capital BDC, Inc (GBDC): $2.61 billion
- Main Street Capital Corp (MAIN): $1.81 billion
- Goldman Sachs BDC Inc (GSBD): $1.62 billion
- Hercules Capital (HTGC): $1.34 billion
- Oaktree Specialty Lending Corp. (OCSL): $1.32 billion
- New Mountain Finance Corp (NMFC): $1.31 billion
There is no guarantee that the largest BDCs are the best BDCs to buy, but higher assets and long performance records may be good indicators of stability. When conducting your research, you should consider gathering information that includes price, earnings, and yield from an unbiased source such as Morningstar.
Source: https://www.thebalancemoney.com/business-development-company-bdc-investing-definition-4163397
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