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."
So far, I have reviewed Ares Capital (ARCC), the largest of the group, Apollo Investment (AINV), the worst in terms of alignment, Prospect Capital (PSEC), Fifth Street Finance (FSC), BlackRock Kelso (BKCC), PennantPark (PNNT), Solar Capital (SLRC) and Hercules Technology Growth Capital (HTGC). Main Street Capital (MAIN), which has a market cap of about $500 million has traded publicly since 2007.
Typically in this series, I would include a chart of the stock along with the dividend and the yield, but my data source has an error. In the case of MAIN, which has held up very well (trading near its all-time high), the dividend was $1.50 in 2009 and 2010 and was recently increased to an annual rate of $1.62 after a smaller hike earlier in the year. Sustaining the dividend through the downturn stands out among its peers.
The company filed its annual proxy statement on April 14th. Similar to most of its peers, where management is provided by an affiliated company, MAIN is managed by Main Street Capital Partners LLC. CEO Vincent Foster (54) has headed the firm since it was formed in 2007.
Total ownership of directors and officers is listed at 15.2%, the best of the BDCs I have reviewed. At the time of the proxy, Foster owned 1.2mm shares (6.4%), while President Todd Reppert owned 3.7%. The balance included three independent directors holding in excess of 1%. After a recent offering of 3mm shares, the ownership levels may have been diluted but are still quite substantial.
Due to the common structure of outside management, BDC investors are often 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 company. While the executives are paid by Main Street Capital Partners, the company discloses compensation. CEO Foster's salary in 2010 was $419K, with other top execs earnings $232K base (except Reppert, whose salary was $325K). Cash bonuses are subjective. The company also regularly grants restricted stock. Foster's total compensation of $1.182mm included $454K of equity. The payment structure seems reasonable, especially in light of Foster's holdings being so much higher than his annual compensation (about 18X).
While there are several other BDCs to evaluate regarding management's alignment with shareholders, Main Street looks superior to all of the previously reviewed BDCs, especially Apollo Investment. With the exception of Fifth Street Finance, all of the BDCs I have reviewed are permitted to sell stock below the NAV, which I find to be a negative. The best alignment so far beyond MAIN has been Hercules Technology Growth Capital. I think that Solar Capital and Fifth Street Finance stand out from the crowd as well. While many factors ultimately influence the level of future dividends, it is very likely that the ownership of Foster and his team and outside directors creates an incentive for its management team to steer it in a direction that sustains or even grows the payment without taking excessive risk. Quite simply, Foster has more than ample "skin in the game."