A business development company (BDC) is a type of investment fund, created by US law in 1980, that lends to or invests in small and mid-sized private companies. BDCs are the main vehicle through which ordinary investors access private credit: loans made outside the banking system to businesses too small or too leveraged for public bond markets. They are required to distribute at least 90 per cent of taxable income to shareholders, which is why they typically offer high dividend yields, often 8 to 12 per cent.
How BDCs work
A BDC raises capital from investors, adds leverage (regulations cap debt at two times equity), and lends the money to private companies, usually as senior secured floating-rate loans. Interest collected, minus funding and management costs, flows out as dividends. Some BDCs trade on exchanges like shares. Others, called non-traded or perpetual BDCs, sell shares directly to investors and offer to buy them back quarterly, typically capped at around 5 per cent of net assets per quarter.
The liquidity mismatch
That repurchase structure is the fault line. The loans a BDC holds cannot be sold quickly at fair value, but investors in non-traded BDCs expect quarterly liquidity. In normal times redemption requests sit well below the cap and the mismatch is invisible. When sentiment turns, requests exceed the cap, funds impose gates, and investors who cannot exit this quarter queue for the next one, making the following quarter’s requests larger. The gate designed to protect the fund can advertise distress and amplify it.
What to watch
Key indicators for BDC health: the share price discount or premium to net asset value for listed BDCs, quarterly redemption requests against the repurchase cap for non-traded vehicles, non-accrual rates (loans no longer paying), and the spread between dividend yields and underlying portfolio yields. Payment-in-kind (PIK) income rising as a share of total income is an early warning that borrowers are struggling to pay cash interest.