What is a BDC?
A Business Development Company (BDC) is a type of US investment company that invests in small and mid-sized businesses that are not traded publicly. BDCs were created, by a 1980 act of Congress, to provide small and growing companies access to capital and to enable private equity funds to access public capital markets. Under the legislation, a BDC must invest at least 70% of its assets in nonpublic US companies with market value less than $250M. Moreover, like REITs, as long as 90% or more of the BDC’s income is distributed to investors, a BDC is not taxed at the corporate level.
Gladstone Investment as an Example
Gladstone Investment (Nasdaq: GAIN) is a BDC. It invests in companies that you and I cannot own, because they are not traded on a stock market. For example, GAIN has investments in manufacturing, consumer products, and business/consumer services. Most of the time we won’t recognize the companies, because they are often small and sometimes regional. Some companies in GAIN’s portfolio include Educators Resource, CCE Golf Cars, The Maids, Brunswick, Old World Christmas, Funk, and Utah Pacific Bridge and Steel. The beauty of this is the different sectors represented throughout the entire United States with a focus on mature businesses with strong management teams. Furthermore, GAIN has a goal to have minimal market risk or technology risk.
“Founded in 2005, Gladstone Investment Corporation is a private equity fund focused on acquiring mature, lower middle market companies with attractive fundamentals and strong management teams. As a publicly-traded business development company, GAIN provides both equity and debt capital, which greatly increases certainty and speed of closing as well as provides GAIN’s shareholders with both current yield in the form of monthly dividends and potential capital gains upside.” – From GAIN’s website
Retirement Gain Versus Bonds
One way to think about a BDC is to do a comparison with bond investing. Bond investing can provide an investor with monthly and somewhat predictable income. Unfortunately, bond investing has very little opportunity for real growth. Furthermore, bonds rarely can keep up with inflation. A wise investor usually considers 5-year and 10-year results when buying shares in a company, an ETF, or a mutual fund.
Good BDC’s like ARCC, GAIN, and MAIN offer better yields than bonds, and much better ten-year returns. Of course, you have to be willing to be patient during market volatility and when the market plummets like it did in 2008 and 2019-2020. The following images from Seeking Alpha a very instructive. Notice both the dividend yield and the performance of BDCs when compared to bonds.
Why to Avoid BDCs
Not every investor should have a similar allocation to BDCs in their portfolio. For example, if your current IRA or 401(k) balance is less than $100K, you might want to go slowly when investing in BDCs. You are probably better served to focus on dividend growth ETFs like VYM. In fact, you should notice in the Quicken Top Ten illustration, that our top holding is VYM with 8.08% of our total investment dollars in this dividend growth ETF. However, the total of the top three BDC’s is 9.4%. As you can see, I am more interested in dividend income than growth investing at this stage of our lives.
Income is the Primary Benefit
Bear in mind that we don’t have to spend all of the dividends. We can reinvestment the dividends in other non-BDC investments. Every month, GAIN provides us with $354 in dividends and MAIN produces $666.50 in dividends. ARCC pays quarterly. Our quarterly dividend from ARCC is also sizable. For March 31, 2022, we received $2,025, or effectively $675 per month. This is more than half of what I receive in monthly Social Security benefits!
Although ARCC, GAIN, and MAIN are the top three BDCs in our investment portfolio, we also own shares of other BDC’s as well that also pay a quarterly dividend.