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), Hercules Technology Growth Capital (HTGC), Main Street Capital (MAIN), Triangle Capital (TCAP) and MCG Capital (MCGP). TICC Capital (NASDAQ:TICC), which has a market cap of about $300 million, has traded publicly since 2003:
The company filed its annual proxy statement on April 29th. Like most of its larger peers, where management is provided by an affiliated company, TICC is managed by its investment adviser, TICC Management. BDC Partners, in turn, manages TICC Management. Jonathan Cohen (46) has served as CEO of both TICC and its adviser and is the managing member of BDC Partners. He also serves as the CEO of T2 Advisers. His COO and his CFO have both served in their roles since 2003. Cohen and his two executives also work with Oxford Lane Capital.
Total ownership of directors and officers is listed at 2.4%, which puts it a little below average for the BDCs. Cohen's ownership stake represented about 40% of the beneficial ownership at 310K shares. The second largest holder is Charles Royce, a director. Royce & Company is an investor in TICC Management. Royce bought about 78K shares on the open market in August.
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 MAIN is structured with outside management, it still discloses this information, but most don't. TICC doesn't disclose pay information either. As the 10-K describes, there are many potential conflicts of interest.
While there are two more BDCs to evaluate regarding management's alignment with shareholders, MCG Capital appears below average given skimpy insider ownership levels and an external management structure with no compensation disclosure. Main Street looks superior to all of the previously reviewed BDCs, especially Apollo Investment. With the exception of MCG Capital and 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, Triangle Capital and Fifth Street Finance stand out from the crowd as well.
While many factors ultimately influence the level of future dividends, it is unclear if the ownership of TICC's management team and outside directors creates enough of an incentive for its executives to steer it in a direction that sustains or even grows the payment without taking excessive risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.