Definition and Example of a Business Development Company
Investors who buy into BDCs often look for high yields from dividends or an alternative investment vehicle to mutual funds and exchange-traded funds (ETFs). Investing in BDCs can be effective, but it's not for everyone. As is the case with any investment type, those looking into BDCs should research how they work and whether their unique qualities align with your investment objectives and risk tolerance.
Benefits of BDCs
With smaller companies, BDCs provide them with access to the capital they need for growth that they might not be able to get elsewhere. BDCs can also help distressed companies improve their financial stability.
The U.S. Congress originally created BDCs in 1980 in order to add another source of stimulation to the economy. BDCs were designed to create jobs by providing investment and management support to small- and mid-size companies. According to the BDC Council, BDCs invest more than 70% of their assets in firms valued at under $250 million.
- Acronym: BDC
According to the BDC Council, 77 BDCs exist today, of which 48 are traded and 29 are private and non-traded companies.
Example of a BDC
Oaktree Specialty Lending Corporation (OCSL) provides financing solutions or lending to companies that don't have access to the capital markets, such as issuing a bond or debt instrument to raise money. They stress a long-term commitment to their customers lending through the various ups and downs of the economic cycles. With more than $2.5 billion in investments, Oaktree generates income, which it returns to investors through its 8.6% dividend yield as of April 2021.
How Do Business Development Companies Work?
BDCs use their capital to make loans to or buy ownership in small- and mid-sized companies around the U.S. They are mostly privately owned.
Most BDCs are treated as regulated investment companies (RICs) for tax purposes and not taxable entities. In exchange for the favorable tax treatment, the BDC must distribute at least 90% of its income to shareholders every year. The payout structure of BDCs is similar to Real Estate Investment Trusts (REITs). Because of their high dividend and interest payouts, BDCs are often used as income vehicles.
BDCs are similar to venture capital funds in that they both invest in businesses but are more accessible to investors. Typically, venture capital funds are only available to accredited investors, large institutions, and wealthy individuals. They also must limit their number of investors and enforce specific criteria not to be labeled as RICs. On the other hand, BDCs are open to anyone with access to a stock exchange.
How Can You Invest in a BDC?
You can invest in BDCs the same way as stocks, mutual funds, and ETFs. Each BDC has a ticker symbol, and investors can buy shares in their brokerage account or individual retirement account (IRA). With mutual funds, investors can buy shares at the fund's net asset value, and the funds are not limited to a certain number of shares. However, closed-end funds such as BDCs issue a set number of shares through an initial public offering.
Since BDCs are not considered low-risk investments, it's important to assess your risk tolerance and seek the help of a financial advisor before investing.
What Are the Largest BDCs?
Congress created the BDC form in 1980, but today, most BDCs on the market have only been around since the early 2000s. As a result, there's not a large amount of information and history available to research before investing. Below are the ten largest BDCs, as measured 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's no guarantee that the largest BDCs are the best BDCs to buy, but higher AUM and long track records might be good indicators of stability. When conducting your research, consider gathering information that includes price, earnings, and yield from an unbiased company like Morningstar.
- Business development companies are a type of closed-end investment company meant to fund small-, mid-sized, and distressed companies.
- Many BDCs have high yields, but the returns come with greater risk.
- Since many BDCs invest in small, privately held businesses, there's a risk of severe declines in market value.
- Before investing, please research and consult a financial advisor to see whether BDCs align with your financial goals and risk tolerance.