Updated on January 13th, 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: Goldman Sachs BDC, Inc. (GSBD)
- 5-year expected annual return: 12.1%
Goldman Sachs BDC is a closed-end management investment company. In 2020, the company merged with Goldman Sachs Middle Market Lending Corp.
Post-merger GSBD 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. Its investment advisor is Goldman Sachs’ very own Asset Management Team, “GSAM”. Goldman Sachs BDC generates over $300 million in annual total investment income and is based in New York, New York.
On November 3rd, 2022, GSBD announced its Q3 results for the period ending September 30th, 2022. For the threemonth period, the company achieved a total investment income of $95.2 million, compared to $77.5 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 $49.6 million in Q2 to $61.2 million as a result. Excluding purchase discount amortization per share of $0.04 from the GSBD merger, adjusted NII per share came in at $0.56, up from $0.45 in Q2.
As of September 30th, GSBD’s portfolio comprised 133 companies with a fair value of around $4.05 billion. The investment portfolio was comprised of 97.7% senior secured debt, including 91.7% in first lien investments, whose amortized yield at cost comes in at 10.4%. GSBD’s investments are well-diversified, with Software, Healthcare Providers, and Diversified Financial Services accounting for 15.3%, 11.4%, and 10.9% of its total portfolio, respectively. Net asset value per share declined 3.28% to $15.02 from $15.53 sequentially.
Click here to download our most recent Sure Analysis report on GSBD (preview of page 1 of 3 shown below):
BDC #4: Capital Southwest Corp. (CSWC)
- 5-year expected annual return: 13.6%
Capital Southwest Corporation is an internally managed BDC. The company specializes in providing customized debt and equity financing to lower middle market (LMM) companies and debt capital to upper-middle market (UMM) companies located primarily in the United States. Capital Southwest generates around $68 million in annual revenues.
The company has a long history of paying out regular and supplemental dividends.
Source: Investor Presentation
On October 31st, 2022, Capital Southwest reported its Q2 results for the period ending September 30th, 2022. It’s
important to note that the company’s fiscal year ends on March 31st. This applies to the figures shown in our tables. For the quarter, the company achieved a total investment income of $26.8 million, 3.9% higher than the previous quarter.
The increase in investment income was primarily attributable to an increase in average debt investments outstanding, an increase in the weighted average yield on investments, and higher dividend income. Pre-tax net investment income (NII) came in at $15.0 million, 19% higher than in Q1-2023. On a per-share basis, pre-tax net investment income came in at $0.54 compared to $0.45 in the previous quarter. For fiscal 2023, our estimates point toward a pre-tax NII/share of $2.06.
Click here to download our most recent Sure Analysis report on CSWC (preview of page 1 of 3 shown below):
BDC #3: Newtek Business Services (NEWT)
- 5-year expected annual return: 14.3%
Newtek Business Services Corp. specializes in providing financial and business services to the small and medium–sized business market in the United States. What makes NewTek a unique BDC is that a good portion of its income is derived from subsidiaries that provide a wide array of business services to its large client base.
The company also gets a significant amount of its income from being an issuer of SBA (Small Business Administration loans), which very few BDCs are licensed to do. This is not your typical BDC that only generates income from interest rate spreads, but also from a much wider range of small business services.
Source: Investor Presentation
On November 7th, 2022, Newtek reported its Q3-2022 results for the period ending September 30th, 2022. The company produced an adjusted net investment income of $15.0 million or $0.62 per share compared to $12.6 million or $0.56 per share in the prior-year period.
Click here to download our most recent Sure Analysis report on NEWT (preview of page 1 of 3 shown below):
BDC #2: TriplePoint Venture Growth BDC (TPVG)
- 5-year expected annual return: 16.3%
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
Its investment portfolio consists of debt provision in 48 companies (86.3%), warrants in 86 companies (3.2%), and equity in just 42 companies (7.1%). It is well-diversified amongst 20+ industries, with its highest exposure of 14.9% in e-commerce clothing & accessories. The majority of its funds are allocated in the tech sector.
On October 28th, 2022, TriplePoint increased its base dividend by one cent to a quarterly rate of $0.37. On November 2nd, 2022, TriplePoint released its Q3 results for the period ending September 30th, 2022. The company achieved a total investment income of $29.7 million during the quarter compared to $21.2 million in Q3-2021. The increase in total investment was primarily due to a greater weighted average principal amount outstanding on TriplePoint’s income-bearing debt investment portfolio and higher investment yields.
Specifically, the company’s weighted average annualized portfolio yield during the period was 13.8%, compared to 12.3% last year. Further, the company funded $101.7 million in debt investments to 14 portfolio companies with a 14.5% weighted average annualized portfolio yield at origination during the quarter. Net investment income (NII) per share was $0.51, compared to $0.32 in Q3-2021.
Click here to download our most recent Sure Analysis report on TPVG (preview of page 1 of 3 shown below):
BDC #1: Great Elm Capital Corp. (GECC)
- 5-year expected annual return: 18.3%
Great Elm Capital Corporation is a business development company that specializes in loan and mezzanine, middle market investments. It seeks to create long–term shareholder value by building its business across three verticals: Operating Companies, Investment Management, and Real Estate.
The company favors investing in media, healthcare, telecommunication services, communications equipment, commercial services and supplies.
Great Elm Capital Corporation released its third quarter results on November 3rd, 2022.
Source: Investor Presentation
Q3 GAAP EPS of $0.18 missed analyst consensus estimates by $0.05. Revenue of $6.03M (-18.2% Y/Y) missed analyst consensus estimates by $0.27M.
Net investment income for the quarter was $1.1M, or $0.14 per share. NAV per share was $12.56 as of September 30, 2022, as compared to $12.84 as of June 30, 2022, and $22.17 as of September 30, 2021. GECC’s asset coverage ratio was approximately 165.5% as of September 30, 2022, as compared to 166.9% as of June 30, 2022.
Click here to download our most recent Sure Analysis report on GECC (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:
- The Dividend Aristocrats List: S&P 500 stocks with 25+ years of dividend increases.
- The High Yield Dividend Aristocrats List is comprised of the 20 Dividend Aristocrats with the highest current yields.
- The Dividend Achievers List is comprised of ~350 stocks with 10+ years of consecutive dividend increases.
- The Dividend Kings List is even more exclusive than the Dividend Aristocrats. It is comprised of 48 stocks with 50+ years of consecutive dividend increases.
- The High Yield Dividend Kings List is comprised of the 20 Dividend Kings with the highest current yields.
- The Blue Chip Stocks List: stocks that qualify as Dividend Achievers, Dividend Aristocrats, and/or Dividend Kings
- The High Dividend Stocks List: stocks that appeal to investors interested in the highest yields of 5% or more.
- The Monthly Dividend Stocks List: stocks that pay dividends every month, for 12 dividend payments per year.
- The Dividend Champions List: stocks that have increased their dividends for 25+ consecutive years.
Note: Not all Dividend Champions are Dividend Aristocrats because Dividend Aristocrats have additional requirements like being in The S&P 500. - The Dividend Contenders List: 10-24 consecutive years of dividend increases.
- The Dividend Challengers List: 5-9 consecutive years of dividend increases.