Business development companies (BDCs) offer several benefits to investors, including high dividend yields, low barriers to entry, and a focus on specific markets. Unlike traditional investment companies, BDCs are regulated investment companies.
High dividend yields
Business Development Companies, or BDCs, are a type of closed end investment company that invests in small and medium-sized businesses. They are similar to REITs (real estate investment trusts) in that they have a special tax status. Unlike ordinary corporations, BDCs do not pay corporate taxes, and they do not have to pay out profits to shareholders.
Although these types of investments have higher dividend yields than other asset classes, it is important to remember that they come with risks. Often, debt securities in a BDC portfolio have high credit risk, meaning that you are more likely to experience large price declines than in other types of assets.
If you choose to invest in business development companies, you will need to make sure that you are choosing a company that has a solid financial track record and can pay out a stable dividend. In addition, check for any equity stakes that you might want to take in the company.
Focus on certain markets
Identifying the best market for your product or service requires a bit of research. In this case, the best approach is to identify the niche markets that have proven demand for your offerings. For example, if your product or service primarily targets a specific age group, you will be able to garner an edge over the competition. If you are trying to enter the Australian market, your sales department can do the legwork for you. Once you’ve scoured the horizon for profitable prospects, your business development team can slap on some marketing savvy to make sure you don’t miss out on a lucrative deal.
As you would expect, identifying the right markets for your products or services takes time and money. To minimize those costs, you may want to consider one of two strategies.
Low barriers to entry
In business, barriers to entry can come in many forms. They can be structural or policy-based. But, they can also be innocent or intentional.
These barriers come in all shapes and sizes, from simple pricing practices to patents. And they can be caused by the very nature of the industry. A new entrant can have a huge advantage if it can produce a product or service that customers can’t get anywhere else.
However, a low barrier to entry isn’t always good. For instance, an oligopoly, which is a group of related large companies that produce similar products or services, can be difficult for a new entrant to break into.
Other strategic barriers to entry include a firm’s high spending on advertising. Also, the age and size of the dominant players in a market can be a barrier to entry.
Regulated Investment Companies (RICs)
Regulated Investment Companies (RICs) are a type of business development company. They have a portfolio of investments that meet mandated diversification requirements. They are not grantor trusts, and their income is passed through to shareholders. In most cases, RICs don’t pay federal income taxes on distributions, and they can avoid double taxation by deducting dividends paid out to shareholders. However, the Internal Revenue Service may impose an excise tax on regulated investment companies.
RICs can pass through many tax-exempt interest and capital gain items. For example, RICs can distribute dividends that qualify for long-term capital gains rates. Likewise, they can pass through tax-credit bonds to shareholders. Additionally, RICs can pass through exclusions from the taxation of interest income, and foreign tax credits.
A regulated investment company must make a timely election to be treated as a RIC. It must also satisfy the minimum distribution rules. Regulations require a RIC to distribute 90% of its net investment income. It must also distribute net short-term capital gains.
Middle-market financing is the metaphorical bread and butter of a BDC
The middle-market financing sector is one of the most lucrative areas for BDCs to participate in. Companies that fall under the category can enjoy significant returns, but they do come with a few risks.
In recent years, new BDCs have stepped up to fill the lending gap left by the financial crisis. These companies are tasked with raising capital to invest in and finance middle-market growth companies.
There are three main sources of capital. These include equity offerings, management buyouts and borrowed funds. Each of these is a different animal, and investors must understand which one is right for them. For example, BDCs commonly take a long-term loan at a low fixed rate, a feature that reduces the risk for the company and its investors. But these companies are also at risk for interest rate volatility. If rates rise, the company could be less profitable and the revenue generated by debt service payments could be reduced.