On October 17, 2019, the staff of the Division of Investment Management (the “Staff”) of the US Securities and Exchange Commission issued guidance regarding an unlisted business development company’s (BDC) repurchase obligations in connection with its determination to reduce its asset coverage ratio. Under section 61(a) of the Investment Company Act of 1940 (the “1940 Act”), a BDC may lower its asset coverage ratio from 200% to 150% when certain conditions are met. To lower the asset coverage ratio, the BDC must obtain approval from a “required majority"1 of the company’s board of directors or the company’s shareholders. Additionally, section 61(a)(2)(D)(ii) of the 1940 Act requires unlisted BDCs (i.e., BDCs whose common stock is not listed on a national securities exchange) to offer its shareholders an opportunity to sell their shares back to the BDC upon approval of the lower asset coverage threshold, and requires the BDC to repurchase 25% of those securities on a quarterly basis for each of the four quarters following the approval date. Due to uncertainty surrounding the procedural requirements of section 61(a)(2)(D)(ii), few unlisted BDCs have taken advantage of the lower asset coverage ratio since the passage of the Small Business Credit Availability Act in March 2018, and as a result, the Staff issued this clarifying guidance.
First, the Staff discussed the permissibility of an unlisted BDC extending a single offer to repurchase versus four separate offers to do so. In the Staff’s view, an unlisted BDC may make: (1) a single offer to repurchase all of the securities held by all shareholders on the date of approval, with the repurchase of 25% of the securities of shareholders that accept the offer to be effected quarterly; or (2) four separate quarterly offers to repurchase 25% of the securities held by all shareholders on the date of approval, with the repurchase from shareholders that accept each offer to be effectuated in the same quarter as the offer. In either case, the price at which the repurchase is effectuated must be based on the BDC’s current net asset value at the time of repurchase rather than the net asset value at the time of the offer.
Next, the Staff indicated that an unlisted BDC could effectuate a repurchase of shares earlier than required under section 61(a)(2)(D)(ii). Because the purpose of section 61(a)(2)(D)(ii) is to protect shareholders who do not wish to remain invested in an unlisted BDC with a lower required asset coverage ratio, allowing a BDC that has sufficient funds to effectuate the repurchase more quickly is consistent with the purpose of that section because it would allow shareholders to dispose of their shares more quickly. However, an unlisted BDC that intends to effectuate the repurchase more quickly should: (1) consider the consequences of the offer on the remaining shareholders (e.g., shareholder dilution and potential effects on portfolio management), and (2) disclose its anticipated schedule for effectuating the repurchase, since the timing of liquidity may affect a shareholder’s decision to accept the offer.
The Staff also confirmed that unlisted BDCs may, but are not required to, conduct offers to repurchase under section 61(a)(2)(D)(ii) in accordance with section 23(c) of the 1940 Act and sections 13(e) and 14(e) of the Securities and Exchange Act of 1934 (the “1934 Act”). Nonetheless, the Staff encouraged unlisted BDCs to follow the filing and disclosure requirements under section 13(e) of the 1934 Act in connection with any tender offers.
Finally, the Staff made clear that, even if an unlisted BDC lists its common stock on a national securities exchange after receiving section 61(a) approval, it is still required to offer to repurchase all the shares held by shareholders as of the date of approval and repurchase the shares from the shareholders who accept the offer. However, the offer under section 61(a)(2)(D)(ii) would not attach to shares transferred after the listing or shares purchased after the section 61(a) approval date.
For more information, the full SEC release is available at https://www.sec.gov/investment/staff-responses-regarding-business-development-companies.
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1 Section 57(o) of the 1940 Act defines “required majority,” when used with respect to the approval of a proposed transaction, plan, or arrangement, as both a majority of a BDC’s directors or general partners who have no financial interest in such a transaction, plan, or arrangement and a majority of such directors or general partners who are not interested persons of the BDC.
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