No one ever accused business development companies (BDCs) of being easy to understand. Listen as Industry Focus analysts Kristine Harjes and Gaby Lapera try to demystify BDCs with pizza and mutual funds.
A full transcript follows the video.
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This podcast was recorded on Nov. 16, 2016.
Kristine Harjes: Turning to the financials world, I feel like it gets a lot hairier.
Gaby Lapera: It can, definitely. You have a ton of regular type companies in the financials world, like banks and insurance companies and stuff like that, that do this what I like to call "the normal way," the way that Kristine just described. But then there's other companies. We've discussed these companies before. A great example of them is a BDC, which is a business development company. When you think about a BDC, think of them as a venture capitalist that you can buy shares of. Instead of you personally going out and saying, "I would like to invest in your pizza delivery company," you would invest in the BDC, who would then give money to the pizza delivery company. Obviously, you can't buy shares of private equity firms, because they're private equity firms. BDCs are really interesting because they're closed-end funds, which means they can't accept new investments all the time.
Harjes: What do you mean by that?
Lapera: Imagine you have a mutual fund, and you give the mutual fund $1,000 of your money. You can go to the mutual fund any time and say, "I want my $1,000 back," or, "I want to give you an extra $1,000," and the mutual fund says, "Great, totally fine, here's your $1,000 back." You can't do that with BDCs. The only way to get your money in and out of the BDC is just to buy or sell the shares that are on the exchange. That's because BDCs typically invest in the debt or equity of really small private companies -- back to this single pizza store in Washington, D.C., or a jewelry store in Idaho, or a mattress company. I don't know why, but BDCs love mattress companies.
The problem with that is that if you have the debt of a very small company, it's really difficult to buy or sell those companies or the debt on those companies, because not a lot of people want it. So if an investor were able to just come up to the BDC and say, "Hey, I want my $1,000 back," or, in this case, maybe "I want my $100,000 back," the BDC might not have the cash on hand to give it back to them, which is why they issue shares instead. That's why BDCs have shares to begin with, as opposed to a mutual fund.