One of the more intriguing investments to emerge in the market over the past decades are business development companies, also known as BDCs. These entities are required to distribute 90% of their annual taxable net income every year. For BDCs that are well-managed, this can generate distributions that yield 10% or more annually. These well-managed BDCs are the kind of investment that my forthcoming stock advisory newsletter, The Liberty Portfolio, will seek to own.
So what are BDCs, and who do they serve? BDCs provide specialized debt and equity finance to what is commonly known as the “lower-middle market.” These are usually corporations with revenues ranging from the low eight-digits on up to one hundred million dollars. And they can be in just about any industry. The best BDCs create debt that is secured, often with some form of equity kicker such as warrants, or some form of preferred stock.
BDCs have a specific mandate: Make as much money as possible in the form of total return, usually from high-yielding debt along with an exit strategy from the equity position. Other forms of investment are the creation of convertible securities that can be purchased in one of the BDCs portfolio companies.
The trick, then, are finding BDCs that are smartly invested to the point where their income exceeds their distributions — just as you hope any dividend-paying company will generate enough cash flow or net income to fund the dividend. There are several of these BDCs, and I think these three have the best chance at remaining in that category.