What is a business development company (BDC)?
A business development corporation (BDC) is an organization that invests in small and medium-sized businesses as well as struggling businesses. A BDC helps these businesses grow in the early stages of their development. With companies in difficulty, the BDC helps companies get back on a solid financial footing.
Similar to closed-end investment fund, many BDCs are public companies whose shares are traded on major stock exchanges, such as the American Stock Exchange (AMEX), Nasdaq and others. As investments, they are high risk but offer higher returns.
Key points to remember
- A business development corporation (BDC) is a type of closed-end fund that invests in developing and financially distressed businesses.
- Many BDCs are publicly traded and open to retail investors.
- BDCs offer investors high dividend yields and some potential for capital appreciation.
- BDCs’ extensive use of leverage and targeting of small or struggling businesses makes them relatively high risk investments.
Understanding the Business Development Company
The US Congress created business development corporations in 1980 to fuel job growth and help emerging US companies raise funds. BDCs are closely involved in mentoring and developing the businesses in their portfolios, as it is in a BDC’s interest to help them succeed.
BDCs invest in private companies and small public companies that have low trading volumes or are in financial difficulty. They raise capital through initial public offerings or by issuing corporate bonds and shares or forms of hybrid investment instruments to investors.
The capital raised is then used to provide funds to struggling businesses. BDCs can use different financial instruments to provide capital, but in general, most issue loans or buy shares or convertible securities of companies.
Qualification as a BDC
To qualify as a BDC, a business must be registered in accordance with section 54 of the Investment Companies Act 1940. In addition, it must be a domestic company whose class of securities is registered with the Security and Exchange Commission (SECOND).
BDC must invest at least 70% of its assets in US private or public companies with a market value of less than US$250 million. These companies are often young companies seeking financing or companies in difficulty or emerging from financial difficulties. In addition, the BDC must provide management assistance to companies in its portfolio.
Business development corporations avoid corporation tax by distributing at least 90% of their income to shareholders.
BDC vs venture capital
If the BDCs look like venture capital fund, they are. However, there are some key differences. One is related to the nature of the investors that each seeks. Venture capital funds are primarily accessible to large institutions and high net worth individuals through private placements. By contrast, BDCs allow smaller, unlicensed investors to invest in them and, by extension, in small, growing businesses.
Venture capital funds retain a limited number of investors and must meet specific asset-related tests to avoid being classified as regulated investment companies. On the other hand, BDC shares are generally traded on an exchange and are constantly available as investments for the public.
BDCs that refuse to list on an exchange must follow the same regulations as registered BDCs. However, less stringent provisions regarding the amount of borrowings, related party transactions and equity compensation make BDC an attractive form of incorporation for venture capitalists who were previously unwilling to take on the heavy regulation. of an investment company.
Advantages and disadvantages of BDC Investissement
High dividend yields
Open to retail investors
- High dividend yields: Because BDCs are regulated investment companies (RIC), they must distribute more than 90% of their profits to shareholders. This RIC status means that they do not pay corporation tax on profits before distributing them to shareholders. This results in above-average dividend yields.
- Open to retail investors: BDCs expose investors to debt and equity investments in mostly private companies, typically closed to retail investors.
- Liquid: BDCs trade on public exchanges, which gives them a healthy dose of liquidity and transparency.
- Diversity: BDC’s investments can diversify an investor’s portfolio with securities that may offer significantly different yields than stocks and bonds.
- High risk: Although a BDC itself is liquid, many of its holdings are not. The holdings in the portfolio are mainly private companies or small public companies with low ratings. BDCs invest aggressively in businesses that offer both income now and capital appreciation later; as such, they are a bit high on the risk scale.
- Sensitive to interest rate spikes: A rise in interest rates, which makes borrowing more expensive, can hurt a BDC’s profit margins.
- Illiquid or opaque assets: Since most of BDC’s holdings are generally invested in illiquid securities, a BDC’s portfolio has subjective estimates of fair value and may suffer sudden and rapid losses. In addition, the target companies in which BDC invests generally have no balance sheet or a troubling track record.
- Magnify losses: Losses can be magnified because BDCs often use leverage, that is, they borrow the money they invest or lend to their target companies. Leverage can improve the rate of return on investment (ROI), but it can also cause cash flow problems if the leveraged asset loses value.
- Dividends taxed as income: BDC dividends are taxed as income because they do not meet the qualifying dividend criteria.
How to invest in a BDC
A business development company is a publicly traded company whose shares are traded on public stock exchanges. So you can buy shares through your broker.
Some BDC shares are included in exchange-traded funds and mutual funds. For example, the VanEck BDC Income ETF is offered by many brokers and is available to retail investors.
How does a BDC make money?
Business development companies can make money in different ways. One of the most common is to buy shares of the companies they finance and sell them when they appreciate.
If a BDC buys convertible bonds from a company in which it has invested, it can receive returns from the bonds and later convert them into shares. Once converted, the shares can be held for appreciation or sold for capital gains.
Loans are another way for BDCs to earn money. Like a consumer who borrows from a bank, a BDC charges interest on the loans it makes.
What are the advantages of a BDC?
Business development companies offer investors higher yields and returns.
How does a BDC make money?
BDCs make money by lending capital and buying stocks or bonds to companies in their portfolio.
What are BDC loans?
Business development business loans occur when a BDC lends capital to a business in which it has invested.
Business development companies are companies that exist to help small businesses or businesses in financial difficulty. BDCs use fundraising techniques to raise capital from investors and then use that money to invest in these small businesses.
They were created by Congress in 1980 to help small businesses grow while trying to protect them from the predatory tactics sometimes used to take over struggling businesses.
BDCs generally have higher returns than mutual funds and exchange-traded funds, but with those returns comes an equal increase in risk and volatility. If you’re considering investing in BDCs, it’s worth talking to a professional financial advisor to determine if it meets your investment goals and risk tolerance.