Business Development Companies: A Primer With 2 Warnings

Summary

• BDCs can serve as attractive vehicles to access private credit and, to a much lesser extent, private equity.
• The reported valuations of a BDC's assets determine the management fees and may not always be accurate.
• Investors in BDCs should very carefully consider governance issues.
• Some BDCs are "fee traps" that are unattractive even at large discounts.
• Investors should be aware of very high fees, especially bifurcated incentive fees.

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Business Development Companies: A Primer with Two Warnings

By Don Chambers, September 2020

This article starts with a primer and ends with two warnings about BDCs (Business Development Companies) that may shock even seasoned investors. Investors considering the addition of a BDC to their investment portfolios should read all of this article and do extensive research on corporate governance before buying their first BDC share.

A PRIMER ON BDCs:

The first half of this article reviews the basics on BDCs in order to lay a foundation for better understanding the warnings that are laid out in the second half of the article.

Overview of BDCs: Legislation enabling Business Development Companies ((BDCs)) was passed in 1980 to spur creation of small businesses and the growth of those businesses. Although BDCs can be private entities (i.e., not listed on any exchanges), this article focuses on BDCs that are listed on the NYSE or NASDAQ. While most private BDCs have limited lifetimes (liquidating in perhaps 7 years or so), listed BDCs usually are designed to live on in perpetuity.

BDCs are very similar to "middle-market private equity firms." BDCs invest in “portfolio companies." The BDC investment can be of three possible types. The first type of BDC investment is in the equity of a portfolio company. The second type of investment is in the debt of a portfolio company. The third type of investment is in a hybrid security, a security that has some equity-like features and some debt-like features. One example of a hybrid security is convertible debt. There are many different ways that a

Analyst’s Disclosure: I am/we are long SVVC MCC PTMN GARS FDUS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.