An Alternative for Private Equity: BDCs

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As we all know, the credit crisis has shut off classic sources of funding for many small businesses. However we know that for every action there is an equal and opposite reaction. One reaction to the shrinking supply of credit has been the emergence (actually the re-emergence) of business development companies (“BDC”s) as an alternative form of small business finance. Investors are reconsidering BDCs because of the current opportunities to extract more favorable terms from portfolio companies and the resulting attractive risk-adjusted yields.

A BDC is a special investment vehicle designed to facilitate capital formation for small companies. BDCs are exempt from many of the regulatory constraints imposed by the Investment Company Act of 1940 (the “1940 Act”) and the rules thereunder. Section 2(a)(48) of the 1940 Act defines “business development company” to mean a domestic closed-end company that (i) operates for the purpose of making investments in certain securities specified in Section 55(a) of the 1940 Act and, with limited exceptions, makes available “significant managerial assistance” with respect to the issuers of such securities; and (ii) has elected business development company status.1 A BDC must, as a general matter, maintain at least 70% of its investments in eligible assets before investing in non-eligible assets, and must provide or make available “significant managerial assistance.”

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