Financial Poise
BDC investing for small business

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 in 1980 by an act of Congress to help small businesses raise capital. Capital formation for small businesses, however, is still an issue, even though BDCs currently invest in roughly 3,000 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 remain under heavy scrutiny by the SEC, although there have been some recent reforms to laws pertaining to them, as well as emergency relief legislation that increased flexibility during the COVID-19 pandemic. 

A Business Development Company is Often Popular with the Populace

Nonetheless, BDC investing is popular, 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.
  • The use of leverage and other types of transactions make BDC funds more flexible with investments.
  • BDCs feature a diversity of investment types (as required by law).
  • BDCs pay their managers in performance-based fees, cash or through a profit-sharing plan, rather than with a percentage of returns.
  • Governance and oversight includes 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

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
  • BDCs also have favorable tax advantages which add to their appeal. In short, BDCs are an important vehicle to fund small and medium-sized businesses while also allowing the non-accredited investor to participate in the investment.

For interested investors, you can find more resources and news related to BDCs at the BDC Reporter.

 

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Due Diligence Before Investing and Alpha, Beta & Other Key Concepts. This is an updated version of an article originally published on March 26, 2014.]

 

©All Rights Reserved. August, 2020.  DailyDACTM, LLC d/b/a/ Financial PoiseTM

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