Updated on August 10th, 2023 by Bob Ciura
Business Development Companies, otherwise known as BDCs, are highly popular among income investors. BDCs widely have high dividend yields of 5% or higher.
This makes BDCs very appealing for income investors such as retirees. With this in mind, we’ve created a list of BDCs.
You can download your free copy of our BDC list, along with relevant financial metrics such as P/E ratios and dividend payout ratios, by clicking on the link below:
Of course, before investing in BDCs, investors should understand the unique characteristics of the sector.
This article will provide an overview of BDCs. It will also list our top 5 BDCs right now as ranked by expected total returns in The Sure Analysis Research Database.
Table Of Contents
The table of contents below provides for easy navigation of the article:
Overview of BDCs
Business Development Companies are closed-end investment firms. Their business model involves making debt and/or equity investments in other companies, typically small or mid-size businesses.
These target companies may not have access to traditional means of raising capital, which makes them suitable partners for a BDC. BDCs invest in a variety of companies, including turnarounds, developing, or distressed companies.
BDCs are registered under the Investment Company Act of 1940. As they are publicly-traded, BDCs must also be registered with the Securities and Exchange Commission.
To qualify as a BDC, the firm must invest at least 70% of its assets in private or publicly-held companies with market capitalizations of $250 million or below.
BDCs make money by investing with the goal of generating income, as well as capital gains on their investments if and when they are sold.
In this way, BDCs operate similar business models as a private equity firm or venture capital firm.
The major difference is that private equity and venture capital investment is typically restricted to accredited investors, while anyone can invest in publicly-traded BDCs.
Why Invest In BDCs?
The obvious appeal for BDCs is their high dividend yields. It is not uncommon to find BDCs with dividend yields above 5%. In some cases, certain BDCs provide 10%+ yields.
Of course, investors should conduct a thorough amount of due diligence, to make sure the underlying fundamentals support the dividend.
As always, investors should avoid dividend cuts whenever possible. Any stock that has an abnormally high yield is a potential danger.
Indeed, there are multiple risk factors that investors should know before they invest in BDCs. First and foremost, BDCs are often heavily indebted. This is commonplace across BDCs, as their business model involves borrowing to make investments in other companies. The end result is that BDCs are often significantly leveraged companies.
When the economy is strong and markets are rising, leverage can help amplify positive returns. However, the flip side is that leverage can accelerate losses as well, which can happen in bear markets or recessions.
Another risk to be aware of is interest rates. Since the BDC business model heavily utilizes debt, investors should understand the interest rate environment before investing. For example, rising interest rates can negatively affect BDCs if it causes a spike in borrowing costs.
That said, BDCs may benefit from falling interest rates. In the current climate of low interest rates, many BDCs could see a tailwind.
Lastly, credit risk is an additional consideration for investors. As previously mentioned, BDCs make investments in small to mid-size businesses.
Therefore, the quality of the BDC’s portfolio must be assessed, to make sure the BDC will not experience a high level of defaults within its investment portfolio. This would cause adverse results for the BDC itself, which could negatively impact its ability to maintain distributions to shareholders.
Another unique characteristic of BDCs that investors should know before buying is taxation. BDC dividends are typically not “qualified dividends” for tax purposes, which is generally a more favorable tax rate. Instead, BDC distributions are taxable at the investor’s ordinary income rates, while the BDC’s capital gains and qualified dividend income is taxed at capital gains rates.
After taking all of this into account, investors might decide that BDCs are a good fit for their portfolios. If that is the case, income investors might consider one of the following BDCs.
Tax Considerations Of BDCs
As always, investors should understand the tax implications of various securities before purchasing. Business Development Companies must pay out 90%+ of their income as distributions. In this way, BDCs are very similar to Real Estate Investment Trusts.
Another factor to keep in mind is that approximately 70% to 80% of BDC dividend income is typically derived from ordinary income. As a result, BDCs are widely considered to be good candidates for a tax-advantaged retirement account such as an IRA or 401k.
BDCs pay their distributions as a mix of ordinary income and non-qualified dividends, qualified dividends, return of capital, and capital gains.
Returns of capital reduce your tax basis. Qualified dividends and long-term capital gains are taxed at lower rates, while ordinary income and non-qualified dividends are taxed at your personal income tax bracket rate.
The Top 5 BDCs Today
With all this in mind, here are our top 5 BDCs today, ranked according to their expected annual returns over the next five years.
BDC #5: Prospect Capital (PSEC)
- 5-year expected annual return: 12.0%
Prospect Capital Corporation provides private debt and private equity to middle–market companies in the U.S. The company focuses on direct lending to owner–operated companies, as well as sponsor–backed transactions.
Prospect invests primarily in first and second lien senior loans and mezzanine debt, with occasional equity investments.
Source: Investor Presentation
Prospect posted third quarter earnings on May 9th, 2023, and results were worse than expected on both the top and bottom lines. Net investment income was 21 cents per share, which was two cents light against estimates, and down from 23 cents in the prior quarter. Total investment income was up 19% year-over-year to $215 million, but missed expectations by $5.8 million.
Click here to download our most recent Sure Analysis report on PSEC (preview of page 1 of 3 shown below):
BDC #4: Goldman Sachs BDC Inc. (GSBD)
- 5-year expected annual return: 12.6%
Goldman Sachs BDC provides specialty finance lending to U.S.-based middle-market companies, which generate EBITDA in the range of $5-$200 million annually, primarily through “unitranche” first-lien loans. The company will usually make investments that have a maturity between three and ten years and in size between $10 million and $75 million.
On August 3rd, 2023, GSBD announced its Q2 results for the period ending June 30th, 2023. For the three-month period, the company achieved a total investment income of $112.1 million, compared to $107.4 million in the previous quarter. The increase in investment income was primarily driven by an increase in interest rates.
Net investment income (NII) also rose from $48.0 million in Q1 to $64.5 million. On a per-share basis, NII came in at $0.59, up from $0.45 in the previous quarter.
Click here to download our most recent Sure Analysis report on GSBD (preview of page 1 of 3 shown below):
BDC #3: Horizon Technology Finance (HRZN)
- 5-year expected annual return: 13.3%
Horizon Technology Finance Corp. provides venture capital to small and medium–sized companies in the technology, life sciences, and healthcare–IT sectors.
The company has generated attractive risk–adjusted returns through directly originated senior secured loans and additional capital appreciation through warrants, featuring a last–nine–month annualized portfolio yield of 14.7%.
On August 1st, 2023, Horizon released its Q2 results for the period ending June 30th, 2023. For the quarter, total investment income grew 51.3% year-over-year to $28.1 million, primarily due to growth in interest income on investments resulting from an increase in the average size of the debt investment portfolio and an increase in the base rate for most of the company’s variable rate debt investments. The latter was driven by rising interest rates.
Net investment income per share (IIS) rose to $0.54, roughly 54% higher compared to Q2-2022. Net asset value (NAV) per share landed at $11.07, 2.4% lower sequentially or 5.3% lower year-over-year.
Click here to download our most recent Sure Analysis report on HRZN (preview of page 1 of 3 shown below):
BDC #2: TriplePoint Venture Growth BDC (TPVG)
- 5-year expected annual return: 15.5%
TriplePoint Venture Growth BDC Corp specializes in providing capital and guiding companies during their private growth stage, before they eventually IPO to the public markets.
TPVG offers debt financing to venture growth companies, proposing a less dilutive way to raise capital than raising additional equity while also helping with the businesses’ acceleration and expansion.
Source: Investor Presentation
On August 2nd, 2023, the company posted its Q2 results for the period ending June 30th, 2023. For the quarter, the company achieved a total investment income of $35.2 million compared to $27.4 million in Q2-2021. The increase in total investment was primarily due to a greater weighted average principal amount outstanding on its income-bearing debt investment portfolio and higher investment yields, partially offset by reduced loan prepayment activity.
The company’s weighted average annualized portfolio yield during the period came in at 14.7%. Further, the company kept expanding its portfolio in Q2 by funding $30.6 million in debt investments to eight companies with a 16.4% weighted average annualized portfolio yield at origination.
Click here to download our most recent Sure Analysis report on TPVG (preview of page 1 of 3 shown below):
BDC #1: Oaktree Specialty Lending Corp. (OCSL)
- 5-year expected annual return: 21.4%
Oaktree Specialty Lending Corp. is a specialty finance company, or BDC. It provides lending services and invests in small and mid-sized companies. As of March 31, 2023, the investment portfolio accounted for $3.2 billion at fair value diversified across 165 portfolio companies, with a focus on software (18.2%) and Pharmaceuticals (5.2%).
On May 4th, 2023, Oaktree Specialty Lending Corp. released its second quarter fiscal 2023 results for the period ending March 31st, 2023. For the quarter the company reported adjusted net investment income (NII) of $45.4 million or $0.62 per share, up from $37.1 million or $0.61 per share in the first quarter and $0.53 for the same quarter last year.
Click here to download our most recent Sure Analysis report on OCSL (preview of page 1 of 3 shown below):
Final Thoughts
Business Development Companies allow everyday retail investors the opportunity to invest indirectly in small and mid-size businesses. Previously, investment in early-stage or developing companies was restricted to accredited investors, through venture capital.
And, BDCs have obvious appeal for income investors. BDCs widely have high dividend yields above 5%, and many BDCs pay dividends every month instead of the more typical quarterly payment schedule.
Of course, investors should consider all of the unique characteristics, including but not limited to the tax implications of BDCs. Investors should also be aware of the risk factors associated with investing in BDCs, such as the use of leverage, interest rate risk, and default risk.
If investors understand the various implications and make the decision to invest in BDCs, the 5 individual stocks on this list could provide attractive total returns and dividends over the next several years.
At Sure Dividend, we often advocate for investing in companies with a high probability of increasing their dividends each and every year.
If that strategy appeals to you, it may be useful to browse through the following databases of dividend growth stocks:
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