Its All Good

Introduction to BDCs ( last updated 12/2002 )

History/Background:
• Business development company (BDC) regulation was created in 1980 by Congress
• Goal of BDC regulation was to encourage the flow of public equity capital to private businesses in the United States

BDCs are:
• Regulated by the Investment Company Act of 1940
• Unique because they focus on investing in private companies, rather than publicly traded companies
• Required to report to shareholders like traditional operating companies - file regular quarterly and annual reports with the SEC
• Required to make available significant managerial assistance to their portfolio companies

By investing in a BDC:
• Shareholders enjoy the liquidity of a publicly traded stock, while participating in the private equity industry

Regulation

To be treated as a "regulated investment company" (RIC) under Subchapter M of the Internal Revenue Code a BDC must:
• Qualify as a regulated investment company
• Distribute to stockholders in a timely manner at least 90% of their "investment company taxable income," as defined in the Internal Revenue Code -- this rule similar to that of REITs means BDCs are typically high yielding stocks (click preceeding link for table of stocks VF members have tagged with as BDCs or hybrid/REIT/similar)

A BDC will receive an exempt status on the 4% nondeductible federal excise tax if they distribute to their shareholders:
• 98% of their ordinary income for each calendar year and
• 98% of their capital gain net income for the one-year period ending December 31 in that calendar year and
• Any income not distributed in prior years

In order to qualify as a regulated investment company for federal income tax purposes, the BDC must, among other things:
• Continue to qualify as a business development company under the 1940 Act
• Derive in each taxable year at least 90% of their gross income from dividends, interest, payments with respect to securities loans , gains from the sale of stock or other securities, or other income derived with respect to their business of investing in such stock or securities (the "90% Income Test")
• Diversify their holdings so that at the end of each quarter of the taxable year:
- At least 50% of the value of their assets consists of cash, cash items, U.S. government securities, securities of other regulated investment companies, and other securities if such other securities of any one issuer do not represent more than 5% of their assets or more than 10% of the outstanding voting securities of the issuer
- No more than 25% of the value of their assets is invested in the securities (other than U.S. government securities or securities of other regulated investment companies) of any one issuer or of two or more issuers that are controlled (as determined under applicable Internal Revenue Code rules) by the BDC and are engaged in the same or similar or related trades or businesses (the "Diversification Tests'').