Understanding business development companies.

Business development companies (BDCs) are a unique type of alternative investment designed to fuel economic growth while generating steady income for investors. These tax-advantaged funds provide capital to small and midsized U.S. businesses—often underserved by traditional financing channels—offering both retail and accredited investors access to a diversified pool of private credit and equity investments.

What are BDCs? 

At their core, BDCs are closed-end investment funds that raise capital from investors and deploy it into private U.S. businesses, typically those that are too small or too early-stage to access traditional capital markets. They provide capital in the form of debt, equity, or hybrid instruments and are often actively involved in advising or supporting the businesses in their portfolios.

Created by Congress in 1980 through an amendment to the Investment Company Act of 1940, BDCs were designed to increase capital access for small and developing businesses. To qualify as a BDC, at least 70% of a fund’s assets must be invested in U.S.-based “eligible portfolio companies” valued at less than $250 million. BDCs can be publicly traded, privately offered, or non-traded but publicly registered, each with distinct characteristics in terms of liquidity, transparency, and accessibility. For clients seeking income and diversification, BDCs may offer an attractive value proposition:

• Income potential: BDCs typically invest in debt instruments that pay regular interest, which can support consistent investor distributions. Yields may range from 5-10% depending on market conditions and fund structure.
• Tax efficiency: Like real estate investment trusts (REITs), most BDCs avoid entity-level taxation by distributing at least 90% of their taxable income to shareholders, resulting in pass-through treatment. However, distributions are generally taxed as ordinary income.
• Portfolio diversification: BDCs offer exposure to private credit and equity markets that are otherwise difficult to access for most retail clients.

Advisor considerations.

When evaluating BDCs for clients, consider the following:

• Liquidity constraints: Publicly traded BDCs are accessible via major exchanges, but non-traded BDCs are illiquid and may impose restrictions on redemptions. Advisors should ensure that client goals and time horizons align with the fund’s structure.
• Credit risk: BDC portfolios are largely comprised of small or midsized companies, many of which carry higher credit risk than larger, publicly traded firms. Economic downturns can disproportionately impact these businesses.
• Fee structure: Management and incentive fees for BDCs can be relatively high, especially in the non-traded space. It is important to evaluate whether a fund’s net return justifies its cost and compare fee terms across offerings.
• Transparency and reporting: Public BDCs must file regular disclosures with the Securities and Exchange Commission (SEC). Non-traded BDCs may be less transparent, although those that are publicly registered will still be subject to SEC reporting standards.

Balance opportunity and risk.

Incorporating BDCs into a diversified investment strategy can provide clients with exposure to private credit markets and potential income streams. However, it’s important to balance these opportunities with a comprehensive understanding of the associated risks and structural considerations.

Important Information

Information provided by SEI through its affiliates and subsidiaries. This information is for educational purposes only and should not be considered investment advice. The strategies discussed herein are complex and are not suitable for all investors.

Neither SEI nor its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.