A Business Development Company is a form of unregistered closed-end investment company in the United States that invests in small and mid-sized businesses. This form of company was created by Congress in 1980 as amendments to the Investment Company Act of 1940. Publicly filing firms may elect regulation as BDCs if they meet certain requirements of the Investment Company Act. BDCs were created 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. While BDCs are allowed to invest anywhere in the capital structure, the vast majority of the investment has been debt because BDCs typically lever their equity with debt, and fixed income investing supports their debt obligations.
Regulation and tax structure
Election means the BDC must subject itself to all relevant provisions of the Investment Company Act, which limits how much debt a BDC may incur, prohibits most affiliated transactions, requires a code of ethics and a comprehensive compliance program, and requires regulation by the Securities and Exchange Commission and subject to regular examination, like all mutual funds and closed-end funds. BDCs are also required to file quarterly reports, annual reports, and proxy statements with the SEC. Some BDCs are publicly traded, while others are not. BDCs are usually taxed as regulated investment companies under the Internal Revenue Code. Like real estate investment trusts, as long as the RIC meets certain income, diversity, and distribution requirements, the company pays little or no corporate income tax. As a pass-through tax structure, RICs must distribute at least 90 percent of taxable income as dividends to investors. Most BDCs distribute 98 percent of their taxable income to avoid all corporate taxation. At least two BDCs have stated that they intend to be taxed as a REIT. Because income is not taxed at the corporate level, distributions to investors are generally taxable for investors based on the type of income earned by the BDC. For example, ordinary income to the BDC is taxable for investors at ordinary income rates, while capital gains income to the BDC is generally taxable for investors at capital gains rates. Historically, BDCs are listed on a national stock exchange like the NYSE or NASDAQ. Recently, as is common for REITs, some BDCs have declined listing on an exchange. Unlisted BDCs are required to follow the same regulatory structure as listed BDCs.
Distinctiveness
BDCs are similar to venture capital or private equity funds since they provide investors with a way to invest in small companies and participate in the sale of those investments. However, VC and PE funds are often closed to all but wealthy investors. BDCs, on the other hand, allow anyone who purchases a share to participate in the open market. This feature often attracts money to newly public BDCs, thereby giving them a faster way to raise capital for investments than VC funds.
