Small businesses often face more stringent loan requirements. They usually have non-investment grade ratings and therefore may find it difficult to obtain debt financing from banks. As a result, these higher risk companies seek alternative sources of funding. There are a variety of alternative financing methods that help finance small businesses. The Business Development Corporation (BDC) is one of those alternatives.
Once an emerging industry, BDCs have become a rapidly growing industry in recent years. They allow small, medium and distressed businesses to access capital by lending them directly. Direct loans from BDCs became a strong growth area after the 2008 financial crisis.
A brief history of BDC
Congress created the concept of the BDC in 1980 with the goal of stimulating economic growth. BDCs offer ordinary investors the opportunity to buy stocks that help grow mid-market companies. In turn, mid-market firms are able to deploy BDC capital. They use this capital to develop their businesses, finance capital projects and create jobs.
Congress has established the conditions required to obtain BDC status and the rules that govern it. The 1940 amendments to the Investment Companies Act included these elements. This law is often simply referred to as the 1940 Law. The 1940 Law regulates investment funds or companies primarily engaged in investing and dealing in securities. CAEs fall under the regulatory authority of the 1940 Act. Therefore, there are a number of restrictions on CAEs. For example, the board of directors of a BDC must be composed of a majority of independent directors. However, CAEs are also exempt from many of the regulatory constraints of the 1940 Act.
the BDC Council oversees the industry. They attempt to create reforms that strike a balance between facilitating the growth of the BDC industry and providing adequate protections for investors.
The spending bill passed by President Trump in 2018 raised the maximum debt limit of BDCs to a 2: 1 ratio of total debt to equity. Before Congress passed the Small Business Credit Availability Act of 2018 and the $ 1.3 trillion spending bill, the law capped the 1: 1 ratio of total debt to debt. equity. As a result, BDCs can now provide even larger amounts of debt financing to mid-market companies.
Attractive features of BDCs
A BDC is a closed-end investment company, which means that it only raises capital once during an initial public offering (IPO). After the IPO, they are âclosedâ or prohibited from issuing additional shares. A closed-end fund trades on a stock exchange similar to an individual stock. This contrasts with open-ended funds, which issue new shares and can initiate share buybacks. Another difference is that open funds do not trade directly on the stock exchange. Rather, a fund company trades them. He then sells the shares to investors.
A BDC can provide management expertise to the mid-market companies it supports. The middle market lending market includes around 200,000 private companies. Today, BDCs have over $ 80 billion in loans outstanding to small and medium-sized businesses.
In addition to the benefits to the direct lender and society, BDCs allow individual investors to invest in small-cap companies with relative ease. This has opened up a highly regulated investment opportunity for ordinary investors once accessible only to institutional investors and high net worth individuals.
Roughly speaking, CAEs fall into one of three categories: Listed, Private, and Unlisted CAEs. The most common category, publicly traded BDCs, typically trade on national stock exchanges and sell shares to individual investors. In contrast, only accredited investors who meet certain financial standards determined by state regulations can purchase private and non-traded PPAs.
The largest BDCs
Today there are 99 BDCs and the industry is booming. There are more than 50 listed BDCs. Some of the largest BDCs in terms of total market capitalization include Ares Capital Corp, Owl Rock Capital, Prospect Capital Corporation, FS KKR Capital Corp, Golub Capital BDC, Goldman Sachs BDC, Main Street Capital Corp, and New Mountain Finance Corp. the majority of CAEs.
Owl Rock, one of BDC’s main platforms, announced at the end of December 2020 that it had signed a merger agreement with Dyal Capital Partners. “Blue Owl” will be the name of the newly named company. Blue Owl aims to be a giant asset management company with particular strength in directing loans to small and medium businesses.
The IRS treats BDCs as regulated investment companies (RICs). RICs are defined in Regulation M of the Internal Revenue Code. A key characteristic of RICs is that they do not pay taxes on their income. These non-taxable entities have passive or flow-through income. In addition to BDCs, other types of investment entities can also be structured as RICs. These include mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and unit-linked investment trusts (UITs).
Through the pass-through tax treatment, an RIC avoids paying corporation tax and passes capital gains taxes on to individual shareholders. In return for this benefit, an RIC must earn and distribute a minimum of 90% of its net investment income in the form of interest, dividends or capital gains to its shareholders.