Publicly Traded Business Development Companies (BDCs)
BDCs are a type of closed-end investment fund. They are a way for retail investors to invest money in small and medium-sized private companies and, to a lesser extent, other investments, including public companies. BDCs are complex and have certain unique risks. This Investor Bulletin discusses BDCs whose shares can be bought and sold on national securities exchanges, or “publicly traded” BDCs.
Read more about publicly traded closed-end funds at Investor Bulletin: Closed-End Funds.
How are publicly traded BDCs similar to other SEC-regulated investment funds?
In some ways, BDCs are similar to other investment funds – like mutual funds, other closed-end funds, and exchange-traded funds (ETFs):
- BDCs pool money from many investors and invest that money.
- All types of investors, including retail investors, can own shares.
- Investors own shares representing a pro rata or proportional part of the BDC.
- BDCs’ offerings of shares are registered with the SEC, and BDCs are regulated by the SEC.
- BDCs’ investment managers may be investment advisers that are registered with the SEC.
In some ways, publicly traded BDCs are also similar to other closed-end funds and ETFs: their shares are typically bought and sold on national securities exchanges at market prices.
How are BDCs different from other SEC-regulated investment funds?
As a technical matter, BDCs are not registered investment companies but elect to be subject to many of the regulations applicable to registered investment companies. The main difference between BDCs and other SEC-regulated investment funds is the type of companies they invest in. BDCs invest in debt and equity of small and medium-sized private, or some small public, companies. The companies BDCs invest in are typically in their early stages of development, or are distressed companies that may not be able to obtain bank loans or raise money from other investors. Sometimes BDCs may help manage the companies they invest in. BDCs are sometimes compared to venture capital funds or private equity funds, which provide exposure to private, often illiquid, investments and may provide assistance to the companies they invest in. However, BDCs are open to all investors, including retail investors.
In addition, BDCs are structured differently from other closed-end funds, mutual funds, or ETFs. BDCs also have more leeway to invest using debt and other leverage.
These differences create potential benefits and risks unique to BDCs.
What are some potential risks and benefits of investing in BDCs?
As with any investment, you could lose money investing in a BDC.
Investment Risks. BDCs invest in small and medium-sized companies that are developing and/or financially distressed. Many are private companies that don’t make public disclosures, and the shares of the companies do not regularly trade on a national securities exchange.
- What this means for you: BDCs’ equity investments have potential for growth and their debt investments may earn higher interest rates than those of other debt investments, so BDCs may seek to achieve a higher return than other types of funds. But such equity or debt investments could also increase BDCs’ risks. There are risks in owning shares or loaning money to the small- and medium-sized companies that are different from, and in some ways more significant than, investments in larger public companies. These smaller companies may be more likely to go out of business or default on their debts. Also, it can be difficult to find information about the companies BDCs invest in and to know for sure what they are worth.
Different Investing Opportunities. At least 70% of a BDC’s total assets must be invested in certain types of investments, including certain privately issued securities, distressed debt, and government securities.
- What this means for you: BDCs can offer a different investing opportunity for retail investors than is offered by typical mutual funds, ETFs, or other closed-end funds. Investing in a wider range of assets can be a good tool for portfolio diversification and may mean that a BDC follows movements of the stock market less closely. But these investments can expose you to certain risks, as described in this Investor Bulletin.
Exposure to Leverage or Debt. BDCs can and often do use more leverage or debt than other types of funds to purchase their investments.
- What this means for you: BDCs’ use of leverage can increase your return but can also increase your losses. It can also increase risk and can make the price of BDC shares more volatile. In addition, it can be more expensive for BDCs to borrow to invest if interest rates go up. Higher interest rates can also reduce BDCs’ profits.
Paying a Premium or Discount. The market price for BDC shares may be greater or less than the shares’ net asset value (NAV). Shares that sell at a price higher than the NAV are said to be sold at a premium, and shares that sell at a price lower than the NAV are said to be sold at a discount. BDC shares may sometimes trade at a discount, but may sometimes sell at a premium.
- What this means for you: Trading at market price means you may pay more or less for BDC shares than the current value of the fund’s underlying investments. This pricing creates an additional layer of risk and opportunity when owning BDC shares. If you purchase shares at a premium, you are paying more than the current value of the underlying investments. If you purchase shares at a discount, you are paying less than the current value of the underlying investments, but you may not be able to sell the shares other than at a discount.
Potentially large distributions. BDCs’ distributions can include income generated by the fund – interest income, dividends, and/or capital gains – but can also include a return of capital. Because of their tax structure, most BDCs (that have elected a certain tax status) must distribute 90% of their taxable income to their investors each year.
- What this means for you: BDCs may pay large distributions. If the distributions include a return of capital, BDCs may not be as tax-efficient as other investments. In addition, a return of capital means you are getting back some of your principal, which is the money you originally invested. A distribution that includes a return of capital reduces the BDC’s asset base (the money the BDC has available to invest) and may make it harder for the BDC to make money in the future. It also means that the value of your remaining investment in the BDC may decline. When a distribution includes a return of capital, the BDC will send you a written notice.
Higher Fees. BDCs often have higher fees than other investment funds, like mutual funds or ETFs. Typically BDCs that are managed by an investment adviser have an advisory fee, which is generally equal to 1.5% – 2% of the fund’s gross assets annually, plus certain incentive fees generally up to 20% of any profits earned. Because management fees are typically calculated on gross assets, which would include leverage, the actual management fee charged to investors may be higher depending on the amount borrowed by a particular BDC. Also, BDCs’ operating expenses may be higher than those of other types of funds. In addition, if an investor buys BDC shares in the initial offering, the investor will pay a sales charge or commission that will be a certain percent of the purchase price. If an investor purchases BDC shares on a securities market, the only transaction fees the investor pays are typical brokerage commissions.
- What this means for you: These fees reduce the value of your investment. If you buy BDC shares in the initial offering, you will likely pay higher fees than if you were to buy the shares of the same fund later on a securities exchange. In addition, typically the price of BDC shares immediately decreases after an initial offering, and the shares sell at a discount. If you buy or sell BDC shares on a securities exchange, you will pay a typical brokerage commission, but not any sales loads or purchase or redemption fees.
- Regardless of whether you purchase your shares in an initial offering or on a securities exchange, you will pay for the BDC’s operating expenses. These expenses – management fees, distribution fees and shareholder services fees – are paid indirectly by shareholders out of the BDC’s assets. For a list and explanation of fees associated with a BDC investment, you should review the fee table, which is available in the fund’s prospectus, or other relevant fund documents, or ask your financial professional.
Before you invest in a BDC
- Carefully read all of the fund’s available information, including its registration statement, prospectus, and any recent 10-Ks, 10-Qs, and 8-Ks. You can get this information by looking at the fund’s filings on the SEC’s EDGAR database, from your investment professional, or directly from the fund.
- Understand the fees and expenses you will pay for the fund, and compare them to other investment options.
- Be sure that the fund’s investment strategy is consistent with your goals.
- Ask Questions:
- What kind of companies does the BDC invest in?
- What kind of loans does the BDC make? Are they higher quality loans or lower-rated loans?
- How much debt has the BDC taken on to make its investments?
- Has the BDC consistently paid distributions to its investors? A long and stable distribution history can show that the BDC has paid its loans and has money available to return to investors.
- What fees and expenses are my investment dollars subject to?
Non-Publicly Traded Business Development Companies (BDCs): Investor Bulletin
The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to provide investors with information about business development companies, or BDCs, whose shares are not traded on national securities exchanges. It is important to understand them before investing. Learn more about BDCs whose shares are traded on national securities exchanges at Publicly Traded Business Development Companies (BDCs): Investor Bulletin.
What are BDCs?
BDCs are a type of closed-end investment fund. They are a way for retail investors to invest money in small and medium-sized private companies and, to a lesser extent, other investments, including public companies. BDCs typically invest in companies that are in the early stages of development or are financially distressed. BDCs are sometimes compared to venture capital funds or private equity funds, which provide exposure to private, often illiquid, investments and may provide assistance to the companies they invest in. Some BDCs are focused on investing in private credit loans, which generally means they lend money directly to businesses or purchase syndicated loans. Syndicated loans are loans to businesses generally originated by a bank and sold in several pieces to other investors.
BDCs are complex and have certain unique risks. BDCs also may be structured in different ways. One way that BDCs can differ is in whether their shares are traded on national securities exchanges. This Investor Bulletin focuses on BDCs whose shares are not traded on national securities exchanges, or “non-publicly traded” BDCs. Because these BDCs’ shares are not traded on a national securities exchange, an investor cannot sell their shares on an exchange and has fewer options to liquidate their investment in the BDC.
BDCs are not registered with the SEC as investment companies. However, BDCs are subject to many protective provisions of the Investment Company Act, such as governance requirements, compliance and recordkeeping provisions, and prohibitions on certain conflicts of interest.
What are non-publicly traded BDCs?
Shares of non-publicly traded BDCs are not bought and sold on national securities exchanges. Instead, investors purchase shares through SEC-registered or private placement offerings. In addition, investors are limited in when they can sell their shares.
Non-publicly traded BDCs fall into two main categories:
- Retail-offered BDCs, and
- Privately-offered BDCs.
Retail-offered and privately-offered BDCs have significant differences from each other, and from publicly traded BDCs. It is important to understand these differences and which type of BDC you are being offered. Retail-offered BDCs are commonly called “non-traded” BDCs. Privately-offered BDCs are commonly called “private” BDCs.
How do non-publicly traded BDCs compare to publicly traded BDCs?
All BDCs are similar in that they are regulated by the SEC and invest in the same types of companies. However, there are substantial differences among the types of BDCs. Below is a chart highlighting some key differences.
Publicly traded BDCs
Non-publicly traded BDCs
Who can invest?
Only investors who meet state-level suitability requirements, which generally means income and/or net worth minimums.
Generally sold to accredited investors, which means investors who meet income or net worth minimums higher than those of state-level suitability requirements, or who hold certain financial professional licenses.
How can I buy shares?
Any investor can buy shares of the BDC on a national securities exchange at the market price.
Investors purchase shares from the BDC through a continuous offering.
Investors invest in the BDC through private placement transactions with the BDC.
When can I sell shares?
Any investor can sell shares of the BDC on a national securities exchange at the market price at any time.
Investors can generally only sell their shares when the BDC offers to repurchase them. Typically, a retail-offered BDC will offer to repurchase investors’ shares quarterly or monthly.
Absent a share repurchase program, investors generally cannot sell their shares until the BDC chooses to go public, sells its portfolio, winds down, or pursues another event or transaction in which investors have an opportunity to sell their shares for cash. Such an event or transaction may be several years (e.g., 5-7) after initial investment.
Does the BDC file a registration statement with the SEC?
The BDC publicly files a Form N-2 registration statement, which includes comprehensive strategy and risk information about the BDC.
The BDC publicly files a Form 10 registration statement, which is not as detailed as a Form N-2.
Will the BDC provide a prospectus?
No, but you may receive a private placement memorandum.
Does the BDC file periodic reports about itself?
The BDC must publicly file periodic reports, including Forms 10-K, 10-Q, and 8-K. These forms contain information about the BDC’s business and financial condition, financial statements, and information about certain material corporate events.
What additional risks do non-publicly traded BDCs have?
All BDCs share certain risks, such as risks of the underlying investments, exposure to leverage or debt, and potentially higher fees than other types of funds. Read more about these generally applicable risks at Publicly Traded Business Development Companies (BDCs): Investor Bulletin. Many of the risks discussed in that Bulletin apply to both publicly traded and non-publicly traded BDCs. As with any investment, you could lose money investing in a BDC.
Non-publicly traded BDCs, which include retail-offered and privately-offered BDCs, present some additional risks to consider before investing.
- Lack of liquidity. Investments in retail-offered and privately-offered BDCs are illiquid, which means they cannot be sold readily in the market. Instead, investors can only sell their shares at certain times determined by the BDC. Investors may only have the opportunity to sell their shares sporadically or several years after initial purchase. As a result, investors in a retail-offered or privately-offered BDC may not be able to sell their shares when they want or need to.
- Limited public information about privately-offered BDCs. While all BDCs must publicly file the same periodic reports, there are significant differences in other important disclosures made by BDCs.
Retail-offered and publicly traded BDCs are required to provide extensive information to investors about the investment and the issuer through a publicly filed Form N-2 registration statement. They must also provide a prospectus as part of their registration statement, and periodically update that prospectus.
Privately-offered BDCs are not required to publicly file as much information about themselves as other types of BDCs. Privately-offered BDCs use the Form 10 registration statement, which is not as detailed as Form N-2. In addition, privately-offered BDCs are not required to provide a prospectus.
If you receive little or no information about a privately-offered BDC, that may be a red flag.
Because non-publicly traded BDCs may come with additional risk, it is important to understand what type of BDC you are investing in and to be sure it matches your investment time horizon.
Before you invest in a BDC
- Carefully read all of the BDC’s available information, including its registration statement, prospectus or private placement memorandum, as applicable, and any recent 10-Ks, 10-Qs, and 8-Ks. You can get this information by looking at the BDC’s filings in the SEC’s EDGAR database, from your investment professional, or directly from the BDC.
- Understand the fees and expenses you will pay for the BDC, including up-front fees to purchase shares of the BDC along with longer term management fees and performance fees, and compare them to other investment options. A fund with high costs must perform better than a lower cost fund to generate the same returns for you.
- Be sure that the BDC’s investment strategy is consistent with your goals.
- Ask questions:
- What kind of companies does the BDC invest in?
- What kind of loans does the BDC make? Are they higher quality loans or lower-rated loans?
- What are the most significant risks of an investment in the BDC?
- How much debt has the BDC taken on to make its investments?
- Has the BDC consistently paid distributions to its investors?
- What ongoing fees and expenses are my investment dollars subject to? Do the fees change depending on the investment performance of the BDC?
- Will my initial investment be reduced by an up-front fee to invest in the BDC?
Additional Information
This Investor Bulletin represents the views of the staff of the Office of Investor Education and Advocacy. It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”). The Commission has neither approved nor disapproved its content. This Bulletin, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
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