Business Development Companies (BDCs)

Business development companies (BDCs) were enacted by a Congressional Act in 1980 to stimulate the U.S. economy to encourage investments in American companies.  BDCs are registered with the U.S. Securities and Exchange Commission (SEC) and regulated under the Investment Company Act of 1940, as closed end funds that invest primarily in debt through loans to small to medium-sized private companies with annual revenues from $25 million to $25 billion.  BDCs role as a provider of “middle market” debt financing for U.S. corporations has exploded for BDCs since the credit crisis in 2008.  Commercial banks no longer play this role since the Dodd-Frank banking reform rules created disincentives for banks to provide capital to this sector of the loan demand marketplace.

Business Development Company investments offer individual investors access to private debt, an asset class that typically was available only to high-net-worth and institutional investors.  Business Development Companies are available to investors as either traded or non-traded securities.  BDCs must distribute at least 90 percent of their taxable income to qualify as a BDC (for BDCs structured as a registered investment company) and avoid corporate income tax.

To evaluate traded BDC investments, the Wells Fargo Business Development Index which is a float adjusted, capitalization-weighted Index is intended to measure the performance of all Business Development Companies that are listed on the NYSE or NASDAQ and satisfy specified market capitalization and eligibility requirements.  To evaluate a non-traded BDC, investors have less information to rely upon to determine performance and valuation.

Non-traded BDCs give individuals the ability to purchase shares in a managed portfolio of loans made to private American companies. To evaluate the suitability of a non-traded BDC, consider the following before investing:

• How does a BDC investment interact with existing portfolio holdings;
• Investment track record of portfolio manager;
• Portfolio protections from rising interest rates;
• Financial reporting transparency, and;
• BDC Capital Structure.

Investors must examine more closely upon fees, costs and risks disclosed in a prospectus before investing in a non-traded BDC. Some risk considerations include:

• Limited liquidity and share repurchase/redemption plan subject to suspension and/or modification;
• Distributions that are not guaranteed in frequency or amount;
• Effects on valuation from distributions made from loans and return of capital instead of earnings;
• Limited operating history of portfolio manager, and;
• Undue reliance upon the financial advisor with conflicts of interest due to high compensation paid.

According to Financial Regulatory Industry Authority (FINRA), non-traded BDCs are not suitable for all investors. Suitability standards generally require an investor to have either a net worth of at least $250,000, or an annual gross income of at least US $70,000.  To improve investor ability to better evaluate non-traded BDCs, FINRA Notice to Members 15-02, provides greater transparency and suitability standards including updated account statement valuations.   A financial advisor who fails to limit the amount invested in BDCs subjects a client to the risks of securities concentration.  Securities concentration risk occurs when a portfolio is over-weighted in a particular asset class or investment product.

It is important to determine what portion of your investment portfolio should be invested in Business Development Companies based on your investment objectives, risk tolerances and investment time horizon.

Investors are advised to seek competent financial, tax and legal advice concerning the decisions they make with their investments. KlaymanToskes can provide you with a free consultation concerning any securities industry violations related to the handling of your investments accounts by a full-service brokerage firm or registered investment advisor.

Information contained on this webpage is for educational purposes only and should not be considered legal advice.
No Information contained on this website creates an attorney-client relationship.