Business development company

A Business Development Company (BDC) is a company designed to help grow small and mid size companies (mostly privately owned companies). These companies are similar to venture capital funds, but are public stocks listed on the New York and NASDAQ stock exchanges. BDCs were created by Congress in the Small Business Incentive Act of 1980. To qualify as a regulated BDC, companies must be registered in compliance with Section 54 of the Investment Company Act of 1940. They are similar in structure to closed-end funds.

Overview
A BDC usually invests in privately held companies in three ways:
 * 1) By offering debt financing to the company.
 * 2) By offering equity financing to the company by taking an equity stake in the company.
 * 3) By taking an active consultancy roll in the management of a company.

BDCs roughly fall into three types:


 * Growth focused: These BDCs resemble venture capital funds. They invest mostly equity capital in early development stage companies which usually have limited operating histories.
 * Value focused : These BDCs invest in companies with more established operating histories than do growth focused BDCs.
 * Income focused: An income focused BDC primarily makes loans to later stage companies. The loans often are accompanied with warrants.

BDCs are similar to REITS in that they must distribute 90% of investment income. Distributed income and capital gains are not taxed at the corporate level but are assessed to the individual shareholder when distributed. BDC's usually have high dividend yields. These dividends (primarily representing interest on loans) are considered ordinary income and are not qualified dividend, which under current tax law are taxed at lower rates. However, any dividends that a BDC receives from a stock investment and distributes to shareholders can be a qualified dividend.

A BDC is limited to 1:1 leverage. This means that a BDC with $100 of equity can borrow a maximum $100 dollars and invest $200 in businesses

Mutual funds and BDCs
A BDC can be either internally managed by its staff or externally managed by hiring an investment advisor. An internally managed BDC does not pay advisory fees. It pays the operating costs of the business.

An externally managed BDC has an investment advisor and pays advisory fees. Approximately half of all DBCs are now externally managed. The advisory fee of externally managed DBCs typically runs between 1.75% to 2.50% per annum. In addition to a base fee, the advisor is permitted by law to receive an incentive performance fee up to s maximum 20% of a BDC’s realized capital gains net of all realized capital losses and unrealized capital depreciation over a specified period.

The SEC mandates that a mutual fund must account for the expenses of a BDC as an "acquired expense". Here is a list of Vanguard fund expenses adjusted for BDC costs.

"'SEC rules nevertheless require that any expenses incurred by a BDC be included in a fund’s expense ratio as 'Acquired Fund Fees and Expenses.' The expense ratio of a fund that holds a BDC will need to overstate what the fund actually spends on portfolio management, administrative services, and other shareholder services by an amount equal to these Acquired Fund Fees and Expenses. The Acquired Fund Fees and Expenses do not impact a fund’s total return or index tracking error and are not included in a fund’s financial statements, which provide a clearer picture of a fund's actual operating expenses.'"

Recent activity
On February 24, 2011, Wells Fargo & Company created the Wells Fargo Business Development Company Index, comprising 24 BDCs at launch. The index currently consists of 26 stocks.

In April 2011, UBS launched an exchange traded note (ETN) tracking the index.

Also in April 2011, Van Eck, parent company of Market Vectors, has filed plans with the SEC to introduce an ETF tracking business development companies. The Market Vectors Business Development Company/Specialty Finance ETF will track the the Market Vectors Business Development Company/Specialty Finance Index.

Index returns
Wells Fargo has calculated the return of the Wells Fargo Business Development Company Index from 2005 forward. The following table provides the returns data of the index along with the returns of the MSCI Broad Market Index.

BDC Index and index tracking investment options

 * E-TRACS Linked to the Wells Fargo Business Development Company Index
 * Reviewing the New Wells Fargo Business Development Company Index
 * UBS Debuts ETN Tracking Business Development Companies