Business Development Companies
A business development company, or BDC, is a specialized investment vehicle structured as a type of closed-end fund. Created and authorized by the U.S. Congress in 1980, BDCs are intended to provide a source of capital for smaller, middle-market businesses. A BDC—essentially a hybrid between an operating company and an investment company—is required to invest at least 70 percent of its assets in “eligible portfolio companies” defined as U.S. companies with a market capitalization (or total worth) of no greater than $250 million.
By providing various credit solutions such as debt and mezzanine financing to smaller, less-established companies, BDCs seek to collect higher-than-average interest income. In turn, some income earned on the BDC’s portfolio is paid to investors in the form of dividends. While BDCs may offer investors an attractive yield, their business model presents considerable risk, including the material credit risk arising from the BDC investing in smaller, unproven companies which may be unrated or below investment grade, as well as the risk associated with the use of leverage, as discussed further below.
In addition to their credit risk, investors in non-traded BDCs will encounter other complexities and risks. The primary concern with non-traded BDCs is their lack of liquidity, as shares cannot readily be resold on a liquid, national securities exchange. Investors in non-traded BDCs may be surprised to learn that their investment capital could be locked up for an extended period of time, in some instances for up to 7-10 years, until such time as a liquidity event transpires (such as the listing of shares on a public exchange). Another concern with non-traded BDCs has to do with their typically high up-front fees and expenses, which can total as much as 15% of the initial investment, in some cases. Such high fees act as an immediate drag on investment performance, and together with their illiquid nature, means that non-traded BDCs typically must be held for a long period of time to achieve liquidity and profitability.
Another point of consideration for investors in non-traded BDCs is the potential for their “blind pool” offering structure. In a blind-pool investment vehicle—where specific investments are not initially identified—investors will not have the opportunity to evaluate historical data or assess the risk/reward on any underlying portfolio investment prior to making an investment. In addition to credit risk stemming from a BDC’s portfolio company investments, as well as the potential for a blind pool offering structure, both traded and non-traded BDCs typically employ internal leverage, or the risky borrowing of investor capital to potentially enhance investment returns. Together, these many risks make BDCs—and in particular non-traded BDCs—very complex and risky financial products.
Stockbrokers and financial advisors may recommend non-traded BDCs to retail investors as a means of participating in private equity-type investing in smaller, less-established companies. However, investors in non-traded BDCs may not be fully informed of the complex and risky nature of these investment products. A brokerage firm has an affirmative duty to conduct adequate due diligence on investment products, including illiquid products such as non-traded BDCs, before permitting its brokers to recommend such investments to their customers. Further, broker-dealers must ensure that their financial advisors conduct an appropriate customer-specific suitability determination before recommending an investment in a non-traded BDC.
The attorneys at Giarrusso Law Group LLC have significant experience in successfully representing investors in non-traded BDCs and similar illiquid and costly financial products, who have suffered losses due to financial fraud or related misconduct. In many instances, investors may pursue a claim to recover monies through securities arbitration before the Financial Industry Regulatory Authority (FINRA). Investors who wish to discuss a possible claim are invited to contact us by telephone at (201) 771-1115 or by email at info@gialawgroup.com for a no-cost, confidential consultation.