Business Development Company (BDC)
A business development company (BDC) is a type of closed-end investment fund that provides debt or equity capital to businesses, including small and medium-sized private companies. A publicly traded BDC gives stock-market investors exposure to these investments through listed shares. It is an investment fund, not a bank deposit, and its dividend is not guaranteed.
The SEC explains the structure and its investment focus in its overview of publicly traded business development companies.
How a business development company earns income
A lending-focused BDC receives interest and may earn fees from portfolio companies. It may also hold equity investments. Borrowing costs, management expenses and other operating costs affect how much investment income remains for shareholders.
Consider a simplified, hypothetical quarter. A BDC earns $10 million of investment income and incurs $4 million of expenses. The difference is $6 million before any additional items required by its reporting definitions. With 10 million shares, that is $0.60 per share. Comparing it with a $0.50 dividend provides a starting point, but one quarter does not establish durable support.
Public shares, less-liquid investments
Being able to trade a BDC’s shares does not mean its underlying loans can be sold as easily. Private investments may be difficult to value or dispose of. The share price can also differ from the reported net asset value, or NAV, per share.
Borrowing introduces another consideration. Leverage can increase shareholder gains when investments perform well, but it can also magnify losses. Fees reduce returns, and struggling borrowers can impair income and asset values. The SEC’s BDC investor bulletin discusses these risks.
How income investors review a BDC
Start with what the BDC owns, how borrowers generate cash, the fees it charges and the debt it uses. Then examine the earnings measure supporting distributions and how that measure has changed. A large quoted yield does not answer those questions.
Fly High perspective
Fly High starts with the company-specific earnings measure identified as the source of the dividend. Net investment income is relevant for many BDCs, but the company’s reporting must confirm the appropriate definition. The formal coverage calculation uses two reported actual quarters and two following quarters of independent analyst consensus. Loan quality, NAV and leverage help explain earning power; they are not a separate mandatory Fly High scoring formula.
This article is for education and information, not individualized investment, tax, or legal advice.