What Is a Business Development Company
Should You Invest in a Business Development Company (BDC)?
A business development company (BDC) is a type of closed-end investment company that is designed to invest in small- and mid-sized companies. Investors that buy into BDCs are typically looking for high yields from dividends or an alternative investment vehicle to mutual funds and exchange-traded funds (ETFs).
Business development companies can be smart investment vehicles; however, BDCs are not for everyone. As is the case with any investment type, investors considering investing in a BDC should understand how they work and if their unique qualities align with their investment objectives and tolerance for risk.
How Do Business Development Companies Work?
Created by Congress in 1980 as an amendment to the Investment Company act of 1940, BDCs are in the closed-end fund category of investments. In simple terms, BDCs are closed-end investment companies that use their capital to make loans to or buy ownership (equity stakes) in small- and mid-sized companies around the U.S. that are mostly privately owned.
For tax purposes, most BDCs are treated as a regulated investment company (RIC). The tax benefit for the BDC is that they are not taxable entities. In exchange for the favorable tax treatment, the BDC must distribute at least 90 percent of their income to shareholders every year. In this regard, BDCs are similar to Real Estate Investment Trusts (REITs). Therefore, because of their high dividend and interest payouts, BDCs are often used by investors as income vehicles.
How to Invest in a BDC
A business development company (BDC) works similar to mutual funds and exchange-traded funds (ETFs). When investors think of or invest in mutual funds, as in a brokerage account, individual retirement account (IRA), or 401(k), they are using open-end funds.
With mutual funds, investors can buy shares at the fund's net asset value and the funds are not limited to certain number of shares. However, closed-end funds issue a set number of shares through an initial public offering.
If you want to invest in a business development company (BDC), it's done the same as with publicly traded stocks, mutual funds and ETFs. Each BDC has a ticker symbol and investors can buy shares in their brokerage account or IRA.
Top 10 Largest BDCs on the Market
Although Congress created the business development company (BDC) form in 1980, most BDCs on the market today have only been around since the early 2000's. This means that there is not a large amount of information and history to analyze for making informed investment decisions. Therefore, investors thinking of investing in BDCs are wise to consider the largest ones with long track records.
Here are the 10 largest BDCs, as measured by assets under management, according to BDCinvestor:
- Ares Capital Corp (ARCC): $7.10 billion in assets
- Prospect Capital Corporation (PSEC): $3.35 billion in assets
- FS Investment Corp (FSIC): $2.29 billion in assets
- Appolo Investment Corp (AINV): $1.43 billion in assets
- Main Street Capital Corp (MAIN): $1.38 billion in assets
- New Mountain Finance Corp (NMFC): $1.04 billion in assets
- TPG Specialty Lending, Inc (TSLX): $1.03 billion in assets
- Fifth Street Finance Corp (FSC): $1.01 billion in assets
- Golub Capital BDC, Inc (GBDC): $958 million in assets
- Solar Capital Liminted (SLRC): $922 million in assets
The largest BDCs are not by default the best BDCs to buy. However higher assets under management, along with long track records, is generally better when investing in BDCs. To begin your research for buying BDCs, you may get initial information, such as price, earnings, and yield, from an unbiased investment research company like Morningstar, Inc.
Bottom Line of Investing in BDCs
Although BDCs may appear attractive, especially those that have high yields above 10 percent, higher yields can also bring high risk. Since many BDCs invest in small, privately-held businesses, the risk of severe declines in market value exists. For example, in the 2008 credit crisis, BDCs had larger losses than many conventional funds.
As with any investment type, especially with alternative investment vehicles, investors should do their homework before investing in BDCs. After gaining a good understanding of the investment and how it works, the investor will need to determine if the BDC is appropriate for their investment objectives and risk tolerance.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.