UNDERSTANDING STOCKS

Business Development Company (BDC)

Get a better understanding of what BDCs are and considerations for incorporating them into your investing or trading strategy.

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What is a BDC?

A BDC is a special type of investment that combines attributes of publicly traded companies and closed-end (private) investment vehicles.

BDCs can provide exposure to investments similar to those associated with private equity or venture capital firms, including the potential for high yields but with added risk.

BDCs are considered specialty finance companies that invest primarily in different types of debt and/or equity of small- to mid-size U.S. companies:

  • Debt investment types: Senior secured, subordinated, unsecured
  • Equity investment types: Preferred stock, common stock

Some companies may offer two (or more) BDCs, one for investing in their debt and another for investing in their equity. BDC managers will offer significant managerial assistance to the companies held in the portfolio.

BDCs may be registered as Regulated Investment Companies (RICs), which are not typically taxed at the entity level. 90% of the RIC's annual income must also be paid in dividends which, when combined with a structure that avoids double taxation, allows RIC-registered BDCs to typically pay out a higher dividend rate than common stock investments. Keep in mind that dividends received from BDC investments are taxed as regular income.

Benefits and drawbacks of BDCs

Benefits of BDCs

Potential for higher yield 
BDCs generally offer higher dividend yields than other common stocks due to their favorable tax structure.


Accessibility 
BDCs are typically listed on national exchanges. These firms invest in private instruments not typically available to retail investors. BDCs allow investors to gain exposure to private equity-like investments without lockups or minimum investments.

Drawbacks of BDCs

Portfolio and liquidity risk
While many BDCs are exchange-traded and considered liquid, BDCs hold illiquid investments in non-publicly traded companies. These loans and investments may not be investment grade and are often illiquid and lack transparency.


Credit and interest rate fluctuations
BDC investments can be highly sensitive to interest rate fluctuations. BDCs must borrow money to lend to companies at higher rates. They use a mix of fixed-rate and floating-rate loans. Interest rate policy changes can significantly affect borrowing-lending cost margins and BDC distribution capacity.


Management fees
Costs associated with BDC investments can be quite high and challenging to calculate. The BDC may charge management, incentive, loan-servicing, and other fees that may not be clearly disclosed and reduce the investment's total return.


Key personnel risk
BDC investment decisions rely on a small management team. If part of the team leaves, it can adversely impact the company, causing potential management expertise loss. The board can vote to replace the external manager if needed.


Diversification risk
BDCs often concentrate assets in small to mid-size developing and distressed companies. Such companies may share risks in loan repayment and economic resilience. Each BDC invests across various companies but cannot hold more than 25% of its assets in one company.

Schwab's perspective on BDCs

We encourage investors interested in BDCs to consider their risk tolerance and to view these products as higher-yield, higher-risk investments that warrant careful evaluation and may not be appropriate for all investors. BDCs generally invest in illiquid debt securities with high credit risk, which can lead to increased volatility and potential large price drops during market downturns. BDCs are better suited as part of your equity allocation, not as a substitute for fixed income.

Common BDC investments

BDCs invest in several different types of non-public securities including tiered investment structures.

Common stock

  • Bottom tier of corporate equity shares
     
  • Earnings on dividends vary and are subordinate to preferred stockholders
     
  • Last in line for asset distribution during liquidation

Preferred stock

Senior secured debt

  • Top-priority debt repayment secured by collateral
     
  • Settled first in the event of company liquidation
     
  • Collateral assets can be sold to cover the debt

Subordinated or unsecured debt

  • Collected after higher priority debt has been paid
     
  • Not backed by any collateral
     
  • Presents a higher level of risk to investors

How do I invest in BDCs?

You can buy and sell BDCs on your own with a Schwab One® Brokerage Account or call 877-566-0054 to talk to an experienced specialist about BDCs.

Common questions about BDCs

The main difference between BDCs and traditional private equity firms is that BDCs are publicly traded, meaning individual investors can buy and sell shares on a stock exchange, while private equity funds are typically only accessible to institutional investors and high-net-worth individuals. BDCs also tend to focus on providing debt financing to small- and mid-market companies, whereas private equity firms tend to serve larger companies and play a more active management role where operational improvements can provide significant value.

Shares of BDC stocks can be purchased by investors using a brokerage account, just like any other publicly traded stock. Search for BDC companies by their ticker symbols and place an order to buy shares in your account. You can also invest in BDCs using exchange-traded funds (ETFs) that track a basket of BDC stocks.

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