What is a Business Development Company (BDC)?

Quick Definition: A Business Development Company (BDC) is a publicly traded investment fund that provides capital to small and mid-sized businesses while paying high dividends and distributions to investors from the interest and profits earned on these business loans and investments.

When I first stumbled across BDCs in my early dividend hunting days, I was blown away by their yields.

"Pays high dividends and distributions to investors from the interest and profits earned on business loans and investments."

Uhm. Sounds like a bank. I want to be like a bank. I hear they make pretty good money.

We're talking 8-12% dividends and distributions in many cases. But of course, like any system I encounter, I had to understand how every piece worked before putting my money at risk.

Think of BDCs like being a bank for smaller businesses that can't get traditional loans. Through a BDC, an investor can own shares in a company that lends money to growing businesses, collects interest, and passes most of that income back as dividends and distributions.

It's a way to tap into private lending without needing millions to start a lending business.

How BDCs Work

BDCs operate as closed-end funds, meaning they issue a fixed number of shares that trade on exchanges like regular stocks. The magic happens when they pool investor money and lend it to companies that banks won't touch.

Here's the process - think of it like a well-designed software system with clear inputs and outputs…

1. Investors Buy Shares

   
   An investor purchases BDC shares on exchanges like NYSE or NASDAQ

2. BDCs Lend Money

   
   They provide loans or equity investments to small and mid-sized businesses

3. Companies Pay Interest

   
   Portfolio companies pay back loans with interest, often at high rates due to risk

4. Dividends Flow Back

   
   BDCs must distribute at least 90% of their income as dividends and distributions to shareholders (heavily regulated, so yeah, pay up Mr. and Ms. BDC)

The companies receiving funding are usually too small for big banks or too risky for traditional lenders. We're talking tech startups, manufacturing companies, healthcare businesses - companies with real potential but limited access to capital.

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Types of BDC Investments

During my years analyzing different systems, I learned that understanding the components is crucial. BDCs typically make three types of investments…

Most BDCs focus heavily on debt investments because they generate the consistent income needed to pay those attractive dividends and distributions. Like being the bank instead of the borrower - you collect interest instead of paying it.

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Why BDCs Appeal to Income Investors

BDCs caught my attention for several compelling reasons. I've come to appreciate what they offer dividend-focused portfolios…

Think of it like this: instead of lending money directly to businesses and dealing with collections, an investor can own shares in a company that handles all the hard work while sharing the profits. It's similar to how REITs work for real estate - professional management with shared returns without worrying about a 2AM call because the neighbor’s dogs are barking at your rental property.

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Real-World Investor Scenarios

Here's how different investors might approach BDC assets…

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 Risks Every Investor Should Know

Like any high-yield investment, BDCs come with risks that can bite unwary investors. I learned this lesson during my trading days - high rewards usually mean high risks.

It's like lending money to your neighbor's startup versus lending to Apple. The potential returns are higher, but so is the chance of losing money. This is why I never put more than 10-15% of my portfolio into any one basket.

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How BDCs Compare to Other Assets

BDCs share similarities with other investment vehicles but have distinct characteristics that set them apart…

Think of BDCs as sitting between regular stocks and private lending - more accessible than private investments but riskier than traditional dividend stocks.

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Getting Started with BDC Assets

Here's a practical approach…

1. Research First

   
   Study different BDC assets and their historical performance - treat it like debugging code, understand every component

2. Choose Your Platform

   
   Use a brokerage like those on Everdend’s Top Brokerage Picks that offer commission-free BDC trading

3. Start Small

   
   Invest what fits an investor's budget and risk tolerance - these aren't starter investments for everyone

4. Monitor Regularly

   
   Track dividends and distributions, portfolio quality, and management decisions

5. Diversify

   
   Never put all eggs in one BDC basket (fundamental investment common sense for everything) - spread risk across multiple assets

From my software development background, I know that the best systems are built incrementally. The same applies to BDC investing - start small, learn how they work, and gradually increase positions as knowledge grows.

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Examples of Established BDCs

Several prominent BDCs have track records worth checking out for educational purposes…

These provide starting points for research, but thorough due diligence is essential before investing in any BDC asset.

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Tax Considerations for BDC Investors

BDC taxation can be complex since they're pass-through entities. Dividends and distributions may be classified as…

Tax situations vary significantly and wildly, so investors should consult with tax professionals for their specific circumstances. If you’ve read any of my other articles, you’ll know I stay far away from tax topics. No one knows anyone’s potential tax implications based on some random internet search.

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The BDC “Backdoor” and "Duh" Moment

Picture this: So as I mentioned, Congress cooked up the Business Development Company (BDC) structure back in 1980, aiming to pump cash into small businesses struggling to get loans. The plan was REALLY focused on letting professional money managers and big institutions funnel capital to these underdog companies.

Retail investors like you and me? Not really the main characters in this story. But here’s where it gets awesome - a clever tax rule tied to the Investment Company Act of 1940 lets BDCs play by the same playbook as REITs. By paying out 90% of their profits as dividends, BDCs could skip corporate income taxes (a pass-through structure). Sweet deal, right?

Fast forward to the 1990s, and some sharp finance folks started paying attention to something extremely obvious: this BDC setup wasn’t just for the Wall Street elite (the "Duh" part - the way I read this during my research, it really sounds like one of those).

Because BDCs could be traded on public stock markets, regular investors could jump in, snagging a piece of the high-yield private credit world - stuff usually locked away for private equity hotshots and hedge fund tycoons.

So yeah, thanks to a tax rule baked into a decades-old law, you can kick back on your couch, invest in BDCs, and rake in dividends - sometimes 10% or more - from loans to small businesses. It’s not quite a secret cheat code, but it’s definitely a slick move in the U.S. financial game, and Wall Street AND Main Street has been cashing in on it ever since.

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Common FAQs About BDCs

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The Roundup

BDCs can be valuable additions to any portfolio focused on income, offering exposure to private lending markets and attractive dividend and distribution yields. Like any investment strategy, they work best as part of a diversified approach rather than a concentrated bet.

Remember, as usual in my closing statements, there's no perfect passive income scheme. But dividend and distribution-paying BDCs, combined with other solid income investments, can build meaningful passive income streams. That's the real way to accessing alternative investments while generating income.

The key is to start with what an investor can afford to lose, learning along the way , and staying disciplined about position sizing. Whether someone is building their first income portfolio or looking to diversify an existing one, BDCs deserve consideration as part of a wealth-building strategy.

But always remember – higher yields usually mean higher risks. Do the research, understand the risks, and never invest more than you can afford to lose in any single asset or asset class.