The History of Business Development Companies (BDCs)

Quick Definition: A Business Development Company (BDC) is a type of investment company that provides capital to small and mid-sized businesses while offering retail investors access to private market investments with high dividend yields.

When I first looked into BDCs, I'll admit I was skeptical. They sounded too good to be true - high yields, access to private companies, and monthly or quarterly payouts. What I found was a fascinating piece of financial engineering that's been quietly powering American business for over four decades.

BDCs are like the Swiss Army knife of high-yield income investing. They give everyday investors a chance to own pieces of private companies without needing millions of dollars or special connections.

Think of it as democratizing private equity - instead of being locked out because an investor doesn't have $1 million minimum, they can buy shares for the price of a nice dinner.

The Birth of BDCs: Solving a 1970s Problem

The story of BDCs starts in the 1970s when America faced a capital crisis. Small and growing businesses couldn't get funding from banks, which were busy chasing bigger deals. Meanwhile, private equity firms hit a wall - they could only have 100 investors due to old regulations from 1940.

An example scenario: A promising tech startup needed $5 million to expand, but banks wouldn't lend to "risky" ventures, and private equity funds were maxed out on investor limits. Businesses were stuck in no-man's land - too big for traditional bank loans but too small for public markets.

Congress stepped in with the Small Business Investment Incentive Act of 1980. This created BDCs as a new type of investment company designed to bridge that gap. The idea was brilliant in its simplicity: let regular investors pool their money to fund America's growing businesses.

BDCs had to invest at least 70% of their assets in private companies or small public companies (under $250 million market cap). They also had to provide "significant managerial assistance" - essentially acting as business advisors, not just lenders.

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The Tax Advantage That Changed Everything

Here's where BDCs get interesting from an income investor perspective. Congress structured them as Regulated Investment Companies (RICs), similar to REITs. This means BDCs avoid corporate taxes by paying out at least 90% of their taxable income as dividends and distributions.

Like a bypass on a freeway - money flows from portfolio companies to the BDC, then directly to investors without getting taxed twice. This structure creates the high yields that make BDCs attractive to income investors like myself.

As someone who's analyzed countless financial systems, I appreciate this elegant solution. It aligns the BDC's interests with investors while ensuring capital flows to businesses that need it most.

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Early Days: Slow Start (1980s-1990s)

Despite the solid framework, BDCs took time to catch on. By 2000, only three notable BDCs existed: American Capital, Allied Capital, and Medallion Financial.

Why the slow adoption? Several reasons...

Most early BDCs were internally managed, operating like traditional companies with employees on payroll. They focused primarily on debt investments - essentially becoming specialized lenders to small businesses.

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The 2000s Breakthrough

Everything changed in 2004 when Apollo Investment Corporation raised $930 million in three months through its IPO. This success proved BDCs could attract serious capital and sparked a wave of new formations.

The shift to externally managed structures was crucial. Instead of hiring employees, BDCs contracted with investment advisers to manage their portfolios. This model, similar to mutual funds, proved more efficient and scalable.

Then came the 2008 financial crisis - which, paradoxically, became BDCs' golden opportunity. Banks tightened lending standards and pulled back from small business loans. BDCs filled this gap, providing much-needed capital when traditional sources dried up.

By 2013, nearly 50 BDCs existed with over $200 billion in assets under management. That's explosive growth by any measure.

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Real-World Investor Scenarios

A breakdown of how different investors might approach BDCs…

Please keep in mind that I’m not a professional or licensed financial advisor and this is not financial advice. I create all of my articles based on my personal experience and research. Check out our full disclaimer(s).

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The Modern BDC Landscape (2010s-Present)

Today's BDC sector is vastly different from its humble beginnings. As of 2024, 156 BDCs manage over $434 billion in assets. That includes 50 publicly traded BDCs with $159 billion and 47 non-traded BDCs with $205 billion.

The 2018 Small Business Credit Availability Act was a game-changer. It allowed BDCs to increase their leverage from 1:1 to 2:1 debt-to-equity ratios.

Key Players in Today's Market...

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How BDCs Work

BDCs function like specialized banks for middle-market companies. They collect money from investors, then lend it to or invest in businesses typically earning $10-150 million annually.

Here's the process, broken down like a software workflow...

1. Capital Collection

   
   Investors buy BDC shares, providing the asset with capital to deploy.

2. Investment Deployment

   
   BDCs lend money or buy equity stakes in portfolio companies.

3. Income Generation

   
   Portfolio companies pay interest on loans or dividends and distributions on equity investments.

4. Dividend Distribution

   
   BDCs pass most income to shareholders as dividends and distributions.

The beauty is in the diversification. Instead of lending $1 million to one company, a BDC might lend $50,000 each to 20 different businesses. This spreads risk while maintaining high yields.

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Understanding the Risks

Like any high-yield investment, BDCs carry significant risks. I learned this lesson during my early trading days in the '90s - high returns always come with high risks.

Think of BDC investing like playing in a band on tour. The potential rewards are high, but an investor needs to budget carefully and understand the risks. One bad gig (or portfolio company default) can impact the entire tour (portfolio performance).

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Types of BDC Assets

Modern BDCs offer two main structures...

Both types must follow the same fundamental rules: 70% investment in qualifying companies, 90% income distribution, and significant managerial assistance requirements.

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The Economic Impact

BDCs have become crucial to America's economic ecosystem. By 2014, they served approximately 65,000 businesses, providing capital for expansion, equipment purchases, and operational improvements.

This isn't just about investment returns - it's about job creation and economic growth. When a BDC funds a manufacturing company's expansion, that creates jobs in the local community. The ripple effects spread throughout the economy.

As someone who's seen how small businesses struggle for capital, I appreciate BDCs' role in filling this gap. They're like the reliable rhythm section in a band - not flashy, but essential for keeping everything together.

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Not So Fun Fact: BDCs Once Owned a Taxi Medallion Empire

A taxi medallion is a city-issued license or permit that grants a vehicle the legal right to operate as a street-hail taxi in designated urban areas. These permits are transferable and are typically regulated by local authorities - such as the Taxi and Limousine Commission in New York City - and they authorize drivers to pick up passengers directly from the street without prearranged bookings.

One of the earliest and strangest BDC success stories involved Medallion Financial Corp. that I mentioned earlier: a BDC that built its fortune not from tech startups or industrial loans—but from New York City taxi medallions.

In the early 2000s, each medallion could sell for over $1 million, making them some of the most expensive licenses on the planet. Medallion Financial specialized in financing these purchases, turning the humble cab into a lucrative investment.

But like any quirky script, the plot twisted: the rise of Uber and Lyft decimated the medallion market almost overnight. Prices collapsed, loan defaults soared, and Medallion's once-prized niche turned into a cautionary tale. It’s a wild example of how even BDCs, with their diversification and due diligence, can be blindsided by innovation.

Let that be a reminder - past performance, no matter how solid, can be completely upended by future disruption.

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FAQs About BDCs

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Getting Started with BDCs

Here's a systematic approach…

1. Research First

   
   Study different BDCs' portfolios, management teams, and track records. Look for consistent dividend coverage and reasonable fee structures.

2. Start Small

   
   Begin with established, publicly traded BDCs from reputable managers. Platforms like those on Everdend’s Top Brokerage Picks offer commission-free BDC trading.

3. Diversify

   
   Don't put all funds into one BDC. Consider spreading investments across different managers and strategies.

4. Monitor Performance

   
   Track dividend coverage ratios, net asset values, and portfolio quality. But don't obsess over daily price movements.

From my software background, I know the best systems are built incrementally. The same applies to BDC investing - start small, learn the mechanics, and gradually build positions as comfort and knowledge grow.

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Putting it all Together

BDCs represent a unique intersection of public markets and private company investing. They've evolved from a 1980s policy experiment into a $434 billion industry that's crucial for American business financing.

Like any investment, BDCs work best as part of a diversified portfolio. Their high yields make them attractive for income investors, but the risks require careful consideration. They're not suitable for everyone, but for investors seeking higher yields and willing to accept additional risk, BDCs offer compelling opportunities.

BDCs aren't just high-yield stocks - they're specialized financial companies lending to and investing in America's growing businesses. When those businesses succeed, BDC investors share in the profits through consistent dividends and distributions.

Dividend and distribution paying BDCs, combined with other solid income investments, can build meaningful passive income streams. That's the real way to preserve capital and generate income.

Whether someone is just beginning their investment journey or looking to diversify an existing portfolio, BDCs deserve consideration as part of a long-term wealth-building strategy. Just make sure to do the homework first - these assets reward informed investors and punish those who chase yields without understanding the underlying risks.