Tax-advantaged, non-traded business development companies (BDCs) are alternative investment funds designed to boost the economy while generating a steady stream of income for both retail and accredited investors in the fund.
Background and Outlook
BDCs are closed-end investment funds that help finance small, developing, and financially troubled U.S. firms. BDCs pool money from multiple investors and invest that money in business debt and equity. They are also required to provide subject matter expertise to the companies they invest in.
BDCs must invest at least 70% of their total assets in so-called “eligible portfolio companies,” which are valued at less than $250 million and typically lack conventional means of raising money or inviting analyst interest to boost their profiles.
Created by Congress in 1980 as part of amendments to the Investment Company Act of 1940, BDCs can be publicly or privately traded. Those that file publicly may elect to come under the auspices of the Act, meaning, among other things, that they agree to Securities and Exchange Commission (SEC) regulation. Election also means BDCs must develop compliance programs and file regular reports with the SEC.
In April 2020, the SEC adopted rule amendments aimed at making it easier for BDCs to respond to market opportunities by streamlining BDC registration processes. The reforms also included disclosure and structured data requirements designed to help investors better analyze fund data.
As of July 2022, there are currently 49 publicly traded BDCs with combined assets of more than $121 billion, according to CEFdata.com which monitors listed and non-listed BDCs. The universe of non-traded BDCs is smaller with $95.6 billion in assets across 58 funds. Assets or gross assets are total investments including leverage and doesn't take any discount into account.
2021 was a big year for publicly registered, non-traded BDCs, which raised more than $15.7 billion that year, according to The Stanger Market Pulse. This year looks to be even bigger, with the same category of BDCs having already raised more than $13.8 billion through May, according to Stanger.
Sizing Up BDCs and their Investments
The universe of BDCs may be swiftly expanding, but the funds themselves — and the businesses they invest in — are down to earth, and certainly not as lofty in investing in the Amazons of the world, CEFdata.com’s John Cole Scott tells Altigo:
“These aren’t large corporate deals, they’re small- to middle-market investments. The average BDC loan size is around $11 million, with the average BDC portfolio containing roughly 100 such investments,” says Scott. Interest rates for about a third of BDC loans come in under 6.5%, with the rest averaging around 7.31%, he notes.
“BDC companies are both geographically and industry sub-sector diverse and are often operating in your own back yard. They really are impacting communities everywhere, not just in New York or California,” Scott adds.
BDC Risks and Benefits
A continuous offering over time, BDCs have the potential to provide both retail and accredited investors with a steady stream of distributions stemming from interest income, dividends, and/or capital gains when the investments are sold.
Without factoring for inflation or commissions and fees, BDC yields can range anywhere from 5-10% depending on market conditions. However, BDC fee structures are often far more steep than other types of alternative investments.
As with real estate investment trusts (REITs), if 90% or more of a BDC’s taxable income is annually distributed to investors, BDCs may enjoy pass-through tax treatment. This is only allowed if BDCs are registered and regulated as a registered investment company, and most are. BDCs are only taxed once at the stakeholder level, thus, as with REITs, investors must pay ordinary taxes on their investment earnings.
BDC’s low liquidity profile and sometimes lengthy investment commitments make them unsuitable for some investors, and because BDC target businesses are generally small businesses, these types of alternative investments are typically considered high-risk. Therefore, it’s good to collect as much information as you can on any individual fund before making any commitments.
Streamlining the Investment Process
As with other offering types, the investment process for BDCs is time consuming and paper laden. Subscription processing technology like Altigo can reduce investment time from weeks to minutes and virtually eliminate errors associated with paper subscription documents.
With over 200 alternative investment offerings currently available on Altigo, our platform supports a range of alternative investment products such as non-listed BDCs, non-listed REITs, qualified opportunity zone funds, non-listed preferreds, interval funds, direct private placements, DSTs, and private equity funds.
For more information about how Altigo can streamline the investment process for BDCs and other alternative investments, contact us for a brief demo.
Disclaimer: Altigo provides this information for educational purposes only. It should not be construed or relied upon as legal or tax advice.