90 Second Lesson: What are BDCs? A Look at the Business Development Company Model

A Primer to BDC Investing

A Business Development Company, also known as a BDC, is an investment vehicle that invests in small and medium-sized businesses. BDC investing is similar to venture capital and private equity because it provides investors with a way to invest in small companies. Unlike venture capital and private equity funds, however, investments in a BDC are open to non-accredited investors; shares are bought and sold on the open market (many are NASDAQ-traded).

What are BDCs? A Historical Overview

BDCs were created by the Small Business Investment Act of 1980 to help small businesses raise capital. Capital formation is still an issue for small businesses, even though 138 BDCs currently invest over $247 billion in small  and mid-sized businesses across the country. (This is one of the reasons the JOBS Act was signed into law).

Investment capital raised by BDCs remains under heavy scrutiny by the SEC.  However, recent reforms and emergency relief legislation have increased flexibility during the COVID-19 pandemic.

Benefits of a Business Development Company

BDC investing is popular among individuals and public retail investors because:

• It has the liquidity of other publicly traded investments.
• It can produce high-yield returns.
• Investors are not obligated to meet any income, net worth or other criteria that private equity investments require.
• Leverage and other transaction types allow more investment flexibility
• BDCs feature a diversity of investment types (as required by law).
• Managers receive performance-based fees, cash, or profit-sharing, rather than a percentage of returns.
• Governance and oversight include a strictly held code of ethics.

Still, it’s important to remember that these securities are a relatively new type of investment vehicle, and risk can vary depending on the maturity of the companies in their portfolios — smaller, less mature companies may have more potential, but they also come with greater risk.

Legal Requirements of a BDC

BDCs are subject to many of the regulations applicable to registered investment companies. According to the SEC, BDCs also must abide by rules specifying applicable investment opportunities. By law, 70% of the investments a BDC makes must be in:

• Privately issued securities
• Securities of other BDC companies
• Distressed debt
• Government securities
• Cash or cash items
• Rapidly maturing debt securities
• Interests in real estate or business assets
• Favorable tax advantages

BDCs Can Help Companies Build Capital

In short, BDCs are an important vehicle to fund small and medium-sized businesses and businesses in financial distress.

Anyone with a brokerage account can invest in a BDC, allowing the non-accredited investor to participate. There are several reasons for their popularity, but remember, because BDCs invest in developing or distressed companies, they can have a greater volatility risk.

Interested investors can find more resources and news related to BDCs at the BDC Reporter.

We think you’ll also like:

1. An Introduction to the World of Angel Investing 
2. Beginner’s Guide to Venture Capital Investment and Returns 
3. 5 Alternative Lending Solutions for Small Business Financing

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Raising Capital: Negotiating With Potential Investors 
2. What Every Founder/Entrepreneur Must Know 
3. Capital Raising: PE, VC and Hedge Funds De-Mystified

This is an updated version of an article originally published on March 26, 2014, and previously updated on April 21, 2020.]

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