The Why Behind BDC Investments
Investors who don’t meet income and net worth criteria for some investments can invest in business development companies (BDCs). What's the future of BDCs?
30 July 2014
By Isabel Munson and Michelle Wu
Investors who don’t meet income and net worth criteria for certain investments can invest in business development corporations (BDCs). From a structural standpoint, BDCs closely resemble other special investment vehicles, such as the real estate investment trust (REIT) or the master limited partnership (MLP). These structures all function as tax pass-through entities to prevent double taxation on dividends, and are often publicly traded.
By purchasing a BDC, investors are able to “own” a small part of a large portfolio of companies or properties. To qualify for tax-exempt status, these investment vehicles must distribute at least 90 percent of income to investors. Most BDCs distribute 98 percent of their income to investors, usually in the form of dividends at seven percent to eight percent or more.
The Future of BDCs
Positive and negative changes loom ahead for BDCs. On a negative note, BDCs may face a temporary sell-off after being dropped from Russell Indexes. This was due to the way their fee reporting is structured. Likewise, S&P Dow Jones Indices also removed BDCs because of accounting and reporting requirements, as well as expenses.
Despite these setbacks in trading, BDCs still remain a strong investment opportunity — one that may get even stronger. There are proposed reform bills on the horizon (H.R. 31, H.R. 1800, and H.R. 1973) that aim to raise debt-to-equity restrictions from 1-1 to 2-1, allowing BDCs to further leverage their debt and create significantly higher returns.
Larger BDC Returns Possible
Additionally, the proposed reforms include an expansion of “eligible portfolio companies,” which will enable BDCs to invest in a wider range of companies and securities, offering them more flexibility and, hopefully, larger returns.
All of these positive changes could reduce the costs of creating or maintaining a BDC, provide greater investment opportunities, and increase returns to investors. But even if the bill doesn’t pass, BDCs should continue to remain an equalizing vehicle for all investors.