Retail investors can get liquid, exchange-traded exposure to private credit and private equity through business development companies (BDCs). These are a unique type of stock that doesn’t quite operate like a regular public company.
Like real estate investment trusts (REITs) and master limited partnerships (MLPs), BDCs are pass-through vehicles. That means they avoid paying corporate income tax as long as they distribute at least 90% of their taxable income to shareholders, resulting in high dividend yields.
But despite their appeal, the BDC space is both narrow and complex. These firms have different mandates, risk levels, and portfolio exposures, and they often use leverage.
That’s why due diligence is especially important before investing in a BDC. In this article, we’ll walk through how BDCs work, what to watch out for, and how to compare your options.
What is a Business Development Company (BDC)?
BDCs can trace their roots back to the Investment Company Act of 1940, but the modern BDC structure didn’t emerge until a 1980 amendment to that act.
The goal was to bridge Wall Street and Main Street by allowing ordinary investors to access private-market opportunities -- namely, lending to and investing in small and mid-sized U.S. businesses that typically don’t have access to public capital markets.
Most BDCs are structured as Regulated Investment Companies (RICs), which means they’re not taxed at the entity level as long as they distribute at least 90% of their taxable income each year to shareholders. This pass-through setup is what allows BDCs to offer such high dividend yields.
There are many different types of BDCs, depending on their market segment focus. Some specialize in the middle market, generally companies with $10 million to $1 billion in annual revenue. Others may lean more toward venture capital-style equity investments in earlier-stage firms.
Regardless of strategy, all BDCs share one common feature: They use a combination of private credit and private equity to build their portfolios.
The credit side often consists of senior secured loans, mezzanine debt, or subordinated debt. On the equity side, BDCs may take direct stakes in companies or hold preferred equity.
Hybrid instruments like convertible debt and warrants are also common, offering upside participation along with some downside protection.
It’s also worth noting that although BDCs invest in private companies, the BDCs themselves are publicly traded, fully audited, and regulated by the Securities and Exchange Commission (SEC).
That gives investors many of the same safeguards and disclosures as traditional listed stocks.
Business Development Company (BDC)
Advantages of investing in BDC stocks
The main advantage of investing in BDC stocks is the potential for higher-than-average income.
BDCs are known for offering yields that often exceed those of REITs and MLPs, and sometimes rival the income generated from high-yield bonds or covered-call exchange-traded funds (ETFs). This income is made possible by the legal requirement that most BDCs distribute at least 90% of their taxable income to shareholders.
Another key benefit is liquidity. Unlike traditional private equity or private credit funds, which typically involve multiyear lockups or limited redemption windows, many BDCs (especially the larger names) trade on major stock exchanges with high volume and tight bid-ask spreads.
Finally, adding BDCs can enhance portfolio diversification. Because they invest in private loans and equity positions that behave differently from public equities or bonds, BDCs may offer low correlation to traditional asset classes. This could help smooth overall portfolio volatility across market cycles.
Risks and considerations when investing in BDCs
One important consideration every BDC investor needs to monitor is the fund’s NAV.
NAV represents the fair market value of the BDC’s assets, mainly its loans and equity stakes in private companies, minus any liabilities, divided by the number of shares outstanding. It’s typically reported quarterly.
However, that figure is not the same as the market price you pay for the stock, which may trade at a discount or premium to NAV. In most asset classes, buying above NAV would be a red flag.
But in the BDC space, a premium can signal perceived quality and strong investor demand. Conversely, a persistent discount to NAV may suggest governance concerns or deteriorating asset quality.
BDC investors must also understand and accept several risks. Interest rate risk is one of the biggest. Since BDCs borrow money to lend at higher rates, their profits rely on the spread between borrowing costs and lending returns. When interest rates change, especially quickly, it can squeeze margins and hurt earnings.
Another key issue is management alignment. Some BDCs, like MAIN, are internally managed, meaning executives are on payroll and generally more aligned with shareholders. Many others, however, are externally managed and charge fees based on assets, which can incentivize growth over performance.
Lastly, because BDCs trade as stocks, they carry market risk. Even if the underlying loan portfolios are sound, a broad market sell-off or recession can still drag down BDC share prices, sometimes well below NAV.
Steps to invest in BDCs
- Open your brokerage app: Log in to your brokerage account where you handle your investments.
- Search for the stock: Enter the ticker or company name into the search bar to bring up the stock's trading page.
- Decide how many shares to buy: Consider your investment goals and how much of your portfolio you want to allocate to this stock.
- Select order type: Choose between a market order to buy at the current price or a limit order to specify the maximum price you're willing to pay.
- Submit your order: Confirm the details and submit your buy order.
- Review your purchase: Check your portfolio to ensure your order was filled as expected and adjust your investment strategy accordingly.
Related investing topics
Investing in BDC stocks
Investing in BDC stocks gives everyday investors rare access to the private credit and private equity markets, two areas typically reserved for institutions.
These unique vehicles are designed to pass through the majority of their income to shareholders, which often results in significantly higher yields than traditional stocks or bonds.
On top of that, most BDCs are listed on major exchanges and trade with strong liquidity, making them easy to buy and sell just like any other stock.
However, BDCs are not without risks. Investors need to monitor premiums or discounts to NAV, understand how interest rate changes can affect profit margins, and evaluate how aligned management is with shareholder interests.
While the income potential is strong, the space is narrow, complex, and can be volatile during economic downturns. With proper due diligence, however, BDCs can be a valuable addition to an income-focused portfolio.
