Business development companies invest in or develop businesses. Business development companies or BDCs are often themselves publicly traded companies, with stock shares available for purchase on the major exchanges. Learn how a BDC works and the advantages and disadvantages of this approach.
What Is a BDC (Business Development Company)?
BDCs were created by Congress under the Investment Company Act of 1980. Their purpose is to spur US businesses and act as a vehicle for jobs. As stated above, BDCs exist to develop and nurture companies so they enjoy success. The more successful the companies they develop are, the more successful the BDC. Typically, BDCs invest in US-based small to mid-sized firms and trade publicly, offering private-equity exposure to retail investors. As of June 2021, the BDC market represented approximately $156 billion in assets.
In order to qualify as a BDC, a company must keep 70% of its assets in US firms with a market value below $250 million. The company must provide managerial assistance or developmental help to the companies in which it invests. Lastly, a company must register securities with the SEC and comply with the Investment Company Act's Section 54.
How Does a BDC Work? What Does a BDC Invest In?
Typically, BDCs invest in smaller public companies or private companies in need of assistance. These companies may have low trading volume and look like a good value pick, or they may be underwater financially and in need of assistance. Either way, the BDC will infuse these companies with capital in the form of bonds, equities or by conducting an initial public offering.
BDCs sound similar to venture capital. There are areas of overlap. The main distinction to keep in mind is that BDCs are publicly traded companies that everyday investors can purchase shares in, whereas venture capital is money that belongs to private individuals and equity firms.
Typically, BDCs target their investments into smaller firms of less than $250 million. About 70% of their assets are invested into these companies, with financing provided through equity, bonds, or IPOs. The structure of these investment vehicles allows for retail access to private-credit-like returns, and they commonly use debt leverage of up to twice equity value. Their tax pass-through status means they must distribute at least 90% of their taxable income.
Benefits of BDC Investment
Investor benefits include:
- Greater-than-average yields: BDCs come with above-average yields as high as 14%.
- Access to private companies: BDCs provide exposure to private investments for average investors.
- Enhanced liquidity: If you invest in a BDC, you can pull your money out easily.
- Greater transparency: BDCs must abide by transparency laws when it comes to investments.
Drawbacks and Risks for BDC Investments
BDCs have disadvantages to consider, which include:
- Short records: The oldest BDCs are forty-plus years old. Many were formed in the early 2000s.
- Steep debt exposure: BDCs themselves have low liquidity and significant debt loads. In an economic crisis, the BDC could default on a loan or shutter outright due to the combination of low liquidity and high debt.
- Higher tax rates: BDC dividends are taxed at ordinary income rates. Other dividends are taxed at a lower capital gains rate.
- Illiquidity: The underlying assets of BDCs, unlike public trading, are illiquid.
- Leverage risks: Investors may be exposed to risks including margin compression and defaults during downturns.
- Volatility: Spikes may occur due to forced selling during times of market stress.
Tax Considerations for BDC Investing
How are BDC dividends taxed? It bears special mention. To avoid tax hits, consider keeping BDCs in tax-advantaged retirement accounts. This way, you can enjoy the income appreciation and defer tax payment. BDCs are structured similarly to REITs and RICs, in the sense that they must distribute between 90% and 98% of their income, which avoids corporate tax. Like RICs, their distributions are mostly taxable as ordinary income. Although this may change in the near future, BDCs also are excluded from QBI pass-through deductions.
Frequently Asked Questions about Business Development Companies
Can BDCs fail?
There is a risk of a BDC failing, due mainly to the credit risks and high leverage associated with them. Investors should proceed with caution.
How is yield generated?
BDCs generate their yields primarily due to interest income on leveraged loans.
What are the differences between public and perpetual non-traded BDCs?
Some of the key differences between these two types of BDCs are their liquidity, redemption models and valuations.
Are tax-advantaged accounts recommended?
In many cases, yes, due to their ordinary income tax rates.
What is the market share of BDCs?
According to the most recent figures from the Loan Syndications and Trading Association, BDC AUM has grown roughly 38% year-over-year to approximately $475 billion in the first quarter of 2025. There are currently more than 150 BDCs in operation, with private and perpetual types dominating asset share.
BDCs help grow companies and offer investors better-than-average returns. When it comes to the financial reporting side, BDCs must tick boxes regarding financial reporting. DFIN's software can help with regulatory reporting requirements and so much more.
