Updated on April 26th, 2022 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: Monroe Capital Corp. (MRCC)
- 5-year expected annual return: 9.6%
Monroe Capital Corporation is a specialty finance company focused on providing financing solutions primarily to lower middle–market companies in the United States and Canada.
The company primarily invests in senior and “unitranche” secured loans ranging between $2.0 million and $25.0 million each. It generates nearly $60 million annually in total investment income.
Source: Investor Presentation
On March 2nd, 2022, Monroe Capital Corporation reported its Q4 and full-year results for the period ending December 31st, 2021. Total investment income for the year came in at $53.8 million, compared to $61.6 million in FY2020.
The $7.8 million decline during the year was primarily the result of the inclusion of $7.4 million of previously unrecorded interest and fee income associated with the company’s investment in Rockdale Blackhawk, LLC last year.
Consequently, net investment income per share declined from $1.45 to $1.03 year-over-year. Net asset value (NAV) per share increased 4.6% to $11.51 during the year, primarily driven by net realized and unrealized gains and net investment income in excess of dividends paid during the year.
Click here to download our most recent Sure Analysis report on MRCC (preview of page 1 of 3 shown below):
BDC #4: Horizon Technology Finance (HRZN)
- 5-year expected annual return: 10.4%
Horizon Technology Finance provides venture capital to small and medium-sized companies in the technology, life sciences, and healthcare-IT sectors, which account for around 53%, 43%, and 4% of its portfolio, respectively.
The company has been able to generate attractive risk-adjusted returns through directly originated senior secured loans and additional capital appreciation through warrants, featuring a last-12-month annualized portfolio yield of 15.7%.
Source: Investor Presentation
Horizon has exceeded the typical industry average IRR of around 10% from its loan coupons by engaging in commitment fees, guidance fees, and potential equity rights, maximizing its total yield.
Click here to download our most recent Sure Analysis report on HRZN (preview of page 1 of 3 shown below):
BDC #3: Capital Southwest Corp. (CSWC)
- 5-year expected annual return: 10.9%
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 January 31st, 2022, Capital Southwest reported its Q3-2022 results for the quarter ending December 31st, 2021. For the quarter, the company achieved a total investment income of $223 million, 9.8% higher than the previous quarter. The increase in investment income was primarily attributable to an increase in average debt investments outstanding and an increase in prepayment fees received from portfolio companies.
Pre-tax net investment income (NII) came in at $11.8 million, 19.1% higher versus Q2-2022. However, due to a higher share count, pre-tax EPS came in at $0.51, a cent lower quarter-over-quarter. Amid robust results, the company raised its dividend by 2.1% to $0.48, which rises to $0.58 when adding the usual $0.10 supplemental dividend.
Click here to download our most recent Sure Analysis report on CSWC (preview of page 1 of 3 shown below):
BDC #2: Newtek Business Services (NEWT)
- 5-year expected annual return: 10.9%
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.
Click here to download our most recent Sure Analysis report on NEWT (preview of page 1 of 3 shown below):
BDC #1: Great Elm Capital Corp. (GECC)
- 5-year expected annual return: 14.5%
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 fourth quarter and FY 2021 results on March 2nd, 2022. Net investment income increased to $7.1 million quarter-over-quarter primarily due to the positive impact of approximately $5.2 million reversal of previously accrued incentive fees associated with the company’s investments in the secured debt of Avanti that have been deemed unlikely to be collected.
For the full year 2021 , total investment increased 10.3% to $25.25 million while GAAP earnings per share stood at -$2.52. Moreover, FY net investment income decreased to $3.02 from $3.22 in the year-ago period. Meanwhile, Q4 net assets stood at $74.6 million, up from $79.6 million in the year-ago period. The company’s asset coverage ratio as of December 31, 2021, was approximately 151.1%. Finally, NAV per share stood at $16.63.
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 38 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.