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 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.
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.
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.
Disadvantages of BDC Investment
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.
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 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.