BDCs

What Is a Business Development Company (BDC)?

A business development company (BDC) is an organization that invests in small- and medium-sized companies as well as distressed companies. A BDC helps these firms grow in the initial stages of their development. With distressed businesses, the BDC helps the companies regain sound financial footing.

Advantages Explained

High dividend yields: Because BDCs are regulated investment companies (RICs), they must distribute over 90% of their profits to shareholders. That RIC status means they don't pay corporate income tax on profits before distributing them to shareholders. The result is above-average dividend yields.
Open to retail investors: BDCs expose investors to debt and equity investments in predominantly private companies—typically closed to retail investors.
Liquid: BDCs trade on public exchanges, giving them a fair amount of liquidity and transparency.
Diversity: BDC investments may diversify an investor's portfolio with securities that can display substantially different returns from stocks and bonds.

Disadvantages Explained

High risk: Although a BDC itself is liquid, many of its holdings are not. The portfolio holdings are primarily private firms or small, thinly-traded public companies. BDCs invest aggressively in companies that offer both income now and capital appreciation later; as such, they register somewhat high on the risk scale.
Sensitive to interest rate spikes: A rise in interest rates—making it more expensive to borrow funds—can impede a BDC's profit margins.
Illiquid or opaque holdings: Because most BDC holdings are typically invested in illiquid securities, a BDC's portfolio has subjective fair-value estimates and may experience sudden and quick losses. In addition, the BDC-invested target companies typically have no track records or troubling ones.
Magnify losses: Losses can be magnified because BDCs often employ leverage—that is, they borrow the money they invest or loan to their target companies. Leverage can improve the rate of return on investment (ROI), but it can also cause cash-flow problems if the leveraged asset declines in value.
Dividends taxed as income: Dividends from BDCs are taxed as income because they don't meet the criteria for qualified dividends.