BUSINESS DEVELOPMENT COMPANY(BDC): How Does It Work?

What is a Business Development Company?

A business development company (BDC) is an organization that invests in small and medium-sized businesses, as well as companies in difficulty. A BDC helps small and medium-sized businesses grow in the early stages of their development. In distressed businesses, BDC helps businesses find a solid financial foundation again.

How Business Development Companies Work

CDBs use their capital to make loans or to buy ownership of small and medium-sized businesses in the US, most of which are privately owned. For tax purposes, most BDCs are treated as regulated investment companies (RICs) rather than taxable companies. In return for favorable tax treatment, the BDC must distribute at least 90% of its income to shareholders every year, similar to real estate investment trusts (REITs). Due to their high dividend and interest payments, investors often use CDBs as income instruments.

BDCs are similar to venture capital funds in that they both invest in companies, but the main difference between them is access. Venture capital funds are generally only available to accredited investors, large institutions and high net worth individuals. You have to limit the number of your investors and enforce certain criteria in order not to be marked as a RIC. However, BDCs are open to anyone with access to an exchange.

WHat are the Types of BDC?

There are two types of BDC , they are:

• Call Transaction Method
• Classical Batch Method

How To Qualify as a BDC?

To qualify as a Business Development Company (BDC), a company must meet several requirements. First, the purpose of CDBs is to provide funding opportunities for small, medium, and distressed businesses. To ensure that CDBs do their job, the government requires them to invest at least 70% of their money in qualifying assets (the term used for the companies they are supposed to help).

Next, the BDCs must be based in the United States. CDBs are under the supervision of the Securities and Exchange Commission (SEC). BDCs must register with the SEC and comply with reporting requirements, including a quarterly summary of the investments they hold.

How Does a BDC Make Money?

A BDC generally makes money in two ways.

First, some BDCs make money by investing in stocks, which means they buy preferred or common stocks in their portfolio companies (i.e., the companies they invest in).

Most CDBs, however, make money by investing in debt. In this case, the company invests in secured and unsecured debt (secured debt is secured by collateral, a type of asset, whereas unsecured debt is not). Debt BDCs also invest in senior debt, that is, debt that borrowers must pay off first before they can meet other obligations.

CDBs that invest in debt rather than stocks tend to be less risky. Because the company you invested in has a contractual obligation to repay its debtors, there is less risk of losing your main investment.

What is BDC Lending?

When a business development company (BDC) lends money to one of the businesses it has already invested in, this is known as business development company lending.

How to Invest in a Business Development Company

You can invest in BDCs as well as stocks, mutual funds and ETFs. Each BDC has a ticker symbol and investors can buy shares in their brokerage or IRA account. In mutual funds, investors can buy shares at the net asset value of the fund and the funds are not limited to a specific number of shares. However, closed-end funds like BDCs issue a certain number of shares as part of an IPO

CDBs are not considered a low-risk investment. You should assess your risk tolerance and discuss options with a financial advisor before buying stocks.

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Largest Business Development Company

Although Congress created the BDC Form in 1980, most BDCs have only existed in the market today since the early 2000s. As a result, there isn’t an abundance of information and history that needs to be analyzed in order to make informed investment decisions. If you’re looking to invest in BDCs, consider the larger ones with a long history. These are the 10 largest BDCs as measured by assets under management:

• Ares Capital Corp (ARCC): $ 6.96 billion
• Owl Rock Capital (ORCC): $ 5.70 billion
• Prospect Capital Corporation (PSEC): $ 3.20 billion
• FS KKR Capital Corp (FSK): $ 3.03 billion
• Golub Capital BDC, Inc (GBDC): $ 2.35 billion
• Goldman Sachs BDC Inc (GSBD): $ 1.57 billion
• Main Street Capital Corp (MAIN): $ 1.43 billion
• New Mountain Finance Corp (NMFC): $ 1.19 billion
• Hercules Capital (HTGC): $ 1.18 billion
• TPG Specialty Lending Inc. (TSLX): $ 1.14 billion6

Business Development Company (BDC)- Regulatory Requirements

Designation of BDCs as Registered Investment Companies (RIC) under the 40 Act means that they must meet certain requirements regarding their source of income and asset diversification. RICs must derive at least 90% of their income from capital gains, interest, or dividends from investments. RICs must also distribute at least 90% of net investment income to their shareholders in the form of interest, dividends, or capital gains.

All BDCs must also meet the following requirements:

• Must have a largely independent board of directors
• You must value assets at least quarterly
• You will need to file regular reports with the SEC (such as Forms 10-K, 10-Q, and 8-K, and proxy instructions).
• Must appoint a chief compliance officer (report to the board) and follow compliance procedures to prevent violations of federal securities laws.
• You must maintain a declaration of loyalty to ensure the BDC against theft and misappropriation.

What are Pros and Cons of Investing in BDC?

Let’s talk about some of the benefits of investing in a Business Development Company (BDC). First, CDBs are an affordable investment. Unlike similar venture capital firms, getting their hands on stocks in a BDC is easy for the average investor.

Another benefit of investing in BDCs is that they often generate above-average dividends. One of the main reasons for this benefit is that BDCs have a more affordable tax structure than many companies, where they don’t have to pay corporate tax on the profits they distribute to shareholders.

Despite their advantages, CDBs are not without risk. Initially, BDCs mainly focus on small or medium-sized businesses or companies with financial difficulties. In other words, they’re investing in companies that haven’t had a chance to prove themselves, or companies that may not have properly managed the money they already had.

As a result, there is always a risk that these companies will not perform as expected by the BDC. Because BDCs tend to invest in companies with similar characteristics, they are also less diversified than other mutual funds.

It’s also important to remember that every time you invest your money in the stock market, you are putting your money at risk. There is no investment opportunity associated with a return guarantee. If you don’t invest in government-backed security, there is an inherent risk.

Besides the risk, there are other disadvantages. BDCs typically come with high fees that reduce returns. CDBs may charge loan processing fees when trading debt instruments. They also often charge incentive and management fees.

READ ALSO: Wise Investment Tips For Young Business Newbies

What are the Tax Implications of Investing in BDC?

To ensure that you are able to make an educated choice regarding any investment, it is critical to conduct adequate research.Because of the potential for long-term gains,  that business development companies (BDCs) should be taken into consideration for tax-advantaged accounts such as individual retirement plans (IRAs).

Investors can profit from the compounding returns on aggressive income-producing

,” and “BDCs” are examples of such instruments. You won’t have to pay annual taxes on any of the money they generate as long as you maintain it in a tax-advantaged account, so long as that is the case. “What this means is that these gains have the potential to compound and build your portfolio more quickly, if you chose your investments intelligently.”

However, BDCs aren’t the right choice for everyone. Investors with a lower risk tolerance may not be able to swallow the opportunities. But for income-focused investors who are willing to do their homework and acknowledge that the risks are a trade-off for greater dividend yields, business development companies (BDCs) may be an attractive addition to a portfolio that is already well-diversified.

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