Business Development
Company (BDC)
The Growth of Private Credit and the Role of Business Development Companies (BDCs)
The private credit market has experienced remarkable growth, establishing itself as a key player in the global financial ecosystem. By the end of 2023, the market reached approximately $2 trillion in assets, and the addressable market in the United States alone could surpass $30 trillion in the coming years*. This rapid expansion has drawn increased attention to Business Development Companies (BDCs), which serve as popular vehicles for private credit investments. According to LSEG LPC, in early 2024, BDCs collectively managed over $300 billion in assets.
BDCs were created as a part of the Small Business Investment Incentive Act of 1980, an amendment to the Investment Company Act of 1940. This legislation aimed to address the capital constraints faced by small and medium-sized businesses during the 1970s, a period marked by crises in capital markets. By encouraging investments in this critical segment of the economy, BDCs have played a pivotal role in fostering economic growth while offering investors access to diversified private credit portfolios.
Structure and Benefits of Business Development Companies (BDCs)
Structure
BDCs can be structured in two primary ways: internally managed or externally managed, each offering distinct advantages depending on the management approach.
Internally Managed BDCs: These BDCs differ from externally managed ones in that they do not pay management fees to an outside adviser. This structure directly aligns management’s interests with those of shareholders, as company executives are employed by the BDC and compensated based on company performance rather than assets under management.
The internal management structure typically results in lower fees, which can lead to higher returns for investors. Additionally, the team’s incentive is closely tied to the company’s long-term success, creating a focus on stable performance, careful capital allocation, and shareholder value.
Externally Managed BDCs: These BDCs hire external investment advisers to manage their portfolios. The external manager typically charges both a base management fee and an incentive fee tied to performance, such as net investment income and capital gains. While this structure may lead to higher costs, it provides access to specialized management expertise without the BDC having to hire staff in-house.
Benefits
Access to private investments: BDCs offer investors exclusive access to private companies, a segment of the market that is typically unavailable to most individual investors.
Dividend Income: BDCs are required by law to distribute at least 90% of their taxable income to shareholders as dividends. This pass-through structure, similar to real estate investment trusts (REITs), makes BDCs appealing to income-seeking investors.
Portfolio Diversification: BDC allows investors to gain exposure to a wide variety of private credit investments, including loans, asset-based lending, and mezzanine financing. This diversification can help spread risk across multiple industries and geographies.
Regulated Structure: BDCs are highly regulated, offering transparency and safeguards for investors. BDCs are required to file periodic reports with the SEC (e.g., Forms 10-K, 10-Q, 8-K, and proxy statements), ensuring accountability in their investment practices.