I recently suggested that business development companies merit further investigation for income-oriented investors. Given the complexity of some of the management structures, as well as the risky nature of the underlying investments made, investors interested in this niche should pay careful attention to the alignment of interests between management and shareholders.
I had indicated that I would follow up with a review of this dynamic if readers were interested, and that was overwhelmingly the case. Therefore, I am reviewing each of the 14 dividend-paying BDCs I had highlighted in order to assess the amount of "skin in the game."
After recently reviewing Ares Capital (ARCC), the largest of the group, Apollo Investment (AINV), and Prospect Capital (PSEC), I am following with Solar Capital (SLRC), which has a market cap of about $800 million. SLRC is one of the newer BDCs, trading publicly since 2010 (after its 2007 formation):
The company filed its annual proxy on April 26, 2011. Like its three larger peers, management is provided by an affiliated company, in this case Solar Capital Partners.
Total insider ownership is listed as 5.8%, almost all of which is held by Solar Capital Investors and Solar Capital Investors II, which are owned at least partially by CEO Michael Gross and COO Bruce Spohler. Like many other insiders in the industry, Gross purchased shares in August, boosting his own personal holdings by 10,000 shares to 52,000 (more than $1 million). Compared to the three larger BDCs, the alignment in terms of share ownership is significantly better at SLRC.
Due to the structure of outside management, investors are unable to clearly weigh the alignment of interests, as there is no disclosure regarding salary and incentive pay levels (or metrics) for the individuals involved in running the firm. As the 10-K describes in detail, there are many potential conflicts of interest. I would also point out that CEO Gross has several outside demands on his time beyond his duties as CEO of Solar Senior Capital (SUNS) and leading Solar Capital Partners, including serving as the chairman of the board of Global Ship Lease (GSL) and as a director at Saks (SKS) and Jarden (JAH).
While there are several other BDCs to evaluate regarding management's alignment with shareholder's, SLRC compares favorably to the previously reviewed ARCC, PSEC and, especially, AINV, which, interestingly, was where CEO Gross worked previously as CEO from the IPO in 2004 through 2006 before leaving to form Solar. While many factors ultimately influence the level of future dividends, it is likely that Gross and Spohler, who have substantial equity exposure, are incentivized to steer the firm in a direction that sustains or even grows the payment.