Playbook #055: Business Development Companies (BDCs)

🖼️ The Big Picture

Business Development Companies (BDC’s) invest in “middle market businesses” and can be both private (not traded on exchanges and requiring higher initial investments and illiquidity) or public (trading on public stock exchanges, with many under $10 per share).

These “middle market” companies have revenues between $10 million - $1 billion and less stable credit profiles, so large banks aren’t as willing to lend to them.

Similar to the structure of a REIT, a BDC must invest at least 70% of its assets in public or private firms with market values of less than $250 million. They must also provide assistance to the companies in their portfolio.

Unlike VC (venture capital) funds, public BDCs are available to individual, non-accredited investors. All BDCs have to pay at least 90% of their taxable income out to shareholders each year.

They don’t pay corporate income tax on profits before they distribute them, so they’re able to pay dividends in the 6% - 17% range. In order to yield these kinds of returns, however, they’re exposed to a great deal of credit risk and leverage.

As an investor, BDCs can be quite attractive: they get you some of the benefits of investing in middle-market businesses without the need to tie up capital for long periods of time (as long as you buy publicly traded BDCs) or the hassle of buying and managing a business.

There are some serious traps (like greedy external management companies) that you need to watch out for (so read this issue in full) and in general, economic downturns aren’t good for BDCs. But while there’s risk here, wise investors can earn a strong yield by using BDCs as a part of their portfolio.

🔢 By The Numbers