Starting A Business Development Company-What You Need To Know!
Introduction
History shows that we live in a low interest rate environment today. To this end, investors are encountering great difficulty discovering current income for their investment portfolios. In order to solve this problem, business development companies come into view. Business development companies exist as a potential solution for diversification and complementary income. Well, if you are looking to start a business development company, there are some things you need to know.
Such as, getting an idea of how business development companies began. Then, it makes sense to know what a business development company is primarily about. Afterwards, understand how they work and the regulations requirements behind them, etc. These knowledge are all important steps towards learning what it takes to start a business development company.
Table Of Contents
- A Brief History on Business Development Company
- Business Development Company-The Rise to Prominence
- What is a Business Development Company?
- How Business Development Companies Work
- Some More Ways By Which BDCs Work
- Regulations Requirements- How to Qualify to be a BDC
- Business Development Companies vs Venture Capital
- Examples Of The Largest Business Development Companies
A Brief History on Business Development Company
The story of Business Development Companies goes far back as the early twentieth century. The companies began with the creation of an investment company.
An investment company is a company with a primary aim of investing money in the stead of its clients, who in return, share both in the profits and losses. The Investment Company Act was created(the ’40 Act) in 1940. With an aim to govern BDCs and protect the interest of investors.
However, in the 1970s, large businesses started growing rapidly into sizes that challenged the once great spirit of American entrepreneurialism. As a result of this, lawmakers saw the need to stimulate private and small growing companies.
In order to address these issues, Congress signed an amendment to the ’40 Act; This law amendment was named aptly as, “Small Business Investment Incentive Act of 1980.” The amendment ensured a new type of registered investment company was instituted. Which is now referred to Business Development Company.
Business Development Company- The Rise to Prominence
Even though the regulation that brought Business Development Company into existence was passed in 1980, the early adopters were internally managed and private. Internally managed Business Development Companies employ and compensate their staffs like a typical operating companies. They rely on stock option plans and cash to incentisize management personnel. In 2004 Business Development Companies(BDCs) came to limelight with the listing of the first publicly traded BDC. As a result of this success, the main attention of the industry shifted to externally managed BDCs. So that, a steady stream of BDC IPOs hit the market seeking to follow suit.
Externally managed BDCs have no personnel. They are managed by administrators and third-party investment advisers. Such as mutual funds and traditional closed end funds.
Going further, the world financial crisis of 2007 in combination with subsequent regulatory changes represented a fresh opportunity for BDCs. As banks were compelled to reduce the liabilities on their balance sheets, small and average market companies had to search for other sources of financing.
As a result, BDCs surged forward to fill the lending void – Non-traded BDCs first appeared in 2009. Then five years later, this non-traded market raised over 5.8 billion dollars.
What is a Business Development Company?
A business development company has the acronym ‘BDC’. It is a type of closed-end investment company, with a design to invest in both small and middle sized businesses, as well as damaged or distressed companies. The duty of Business Development Companies to smaller companies, was to give them access to capital needed for their growth. A capital which they’ll unlikely be able to access elsewhere. For distressed companies, BDCs had the mandate of bringing their distressed businesses back to full operation. Afterwards, enabling them to be financially stable.
Business development companies serve as a source of stimulation to the economy. They make jobs available through provisions for investment and management support to both small and middle size companies. According to the Business Development Council, BDCs invest more than 70% of their assets in companies that value less than $250 million. There are 93 BDCs in operation today, with 53 traded, 20 private, and 20 non-traded companies.
How Business Development Companies Work
Business Development Companies employ their capital to make loans to or buy ownership in small and mid-sized companies around the United States. Companies that are mostly owned privately. For tax purposes, most BDCs are not a taxable entity. But are instead treated as regulated investment companies (RICs).
In exchange for the auspicious tax treatment, Business Development Companies have a duty to distribute at least 90% of its income to shareholders every year. An act similar to Real Estate Investment Trusts (REITs). BDCs have high dividend and interest payouts. So is used often by investors as income vehicles.
In comparison with venture capital funds, they are similar. This is because they both invest in businesses. However, they are not exactly the same.
Some More Ways By Which BDCs Work
BDCs may assist in providing investors a complementary stream of income from the traditional suite of corporate, municipal and government bonds. Most BDC portfolios concentrates on senior secured bonds and loans, with repayment priority in the event of a default. This is to counter subordinate debt and equity holders. Private companies below investment-grade can receive loan. Meaning that they may be more illiquid, cumbersome to value and experience higher default rates. This is in comparison with investment-grade companies. Hence Business Development Companies seek these investments due to the increased yield connected with illiquid securities. This yield is weighed against the height of risk assumed with such investments.
Regulations Requirements- How to Qualify to be a BDC
Business Development Companies designates as Registered Investment Companies (RICs) under the ’40 Act. This means they must meet specified and regulated requirements regarding their diversification of assets and source of income. RICs must obtain a minimum of 90% of their income from capital gains, dividends or interest earned on investments. Registered Investment Companies must also distribute a minimum of 90% of net investment income in the form of interest, capital gains or dividends to their shareholders.
All BDCs must also satisfy the requirements listed below:
Presence of majority-independent board of directors.
Asset Valuation value at least quarterly.
They must file periodic reports with the SEC (e.g., Forms 8-K, 10-K, 10-Q and proxy statements).
Appointment of a chief compliance officer (who reports directly to the board) and maintain compliance procedures. Procedures designed to prevent violations of federal securities laws.
Fidelity bond maintenance for insurance against embezzlement.
Business Development Companies vs. Venture Capital
Business Development Companies may seem similar to venture capital funds, but they are not the same. There are some very significant differences between them.
Venture capital funds are available mainly to wealthy individuals and large institutions through private placements. BDCs on the other hand, allow smaller, non-accredited investors to invest in them. Therefore, they are investing in small growth companies by extension.
Venture capital funds maintain a limited number of investors. They must meet certain asset related test. This is what categorize them as regulated investment companies. In contrast, BDC typically trades it’s shares on stock exchanges and are regularly available as investments for the public.
Business Development Companies that refuse to list on an exchange are still required to follow the same regulations-as listed BDCs. Restrictions for the amount of borrowing, equity-based compensation and related-party transactions are less on BDCs. This makes BDC an appealing form of incorporation to venture capitalists, who were previously reluctant to assume the burdensome regulation of an investment company.
Examples Of The Largest Business Development Companies
BDCs did not just start now. Though instituted in 1980, yet most BDCs on the market today haven’t been around for long. In fact, majority of them have only been on ground since the early 2000s. Hence, there is not a large amount of history and information to analyze for making informed investment decisions.
Here are the 10 largest Business Development Companies, 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 billion
Note though, being the largest BDCs doesn’t make them by default, the best to buy from. However, long track records and higher assets under management are generally good indicators. Therefore do research to get information yield, earnings and price, from an unbiased investment research company. An example of such company is Morningstar.
A Final Note
The end goal of starting any company, even a business development company is towards growth and profitability. However, desired growth will not happen by mistakes. Knowledge is what makes it work.
Knowledge they say is powerful. Adequate knowledge will thoroughly equip you to take the right steps. This will make your every effort justified with a commensurate result.
Grabbing an idea of the history and rise to prominence of BDCs, understanding what BDCs is about, how they work, how to satisfy the regulations requirements, knowing BDCs difference with visual capital, etc are all vital steps to take. As these steps will help you accomplish your desire of starting a business development company. To sum up, firstly, don’t rush. Secondly, take your time to do more research. Afterwards start your business development company.
