Business Development Companies Research Articles

A Benchmark for Collateralized Loan Obligations

We build a benchmark for AAA-rated tranches of collateralized loan obligations (CLOs) using business development companies (BDCs), which hold a diversified portfolio of loans as CLOs do. BDCs are publicly listed, and their share price, equity volatility, and borrowing cost can be easily obtained. Applying a structural model to BDCs, we extract market-implied correlation in their loan portfolio, compare spreads on CLO tranches and BDC-implied benchmark, and find that observed large credit spreads on CLO senior tranches after the financial crisis are a fair reflection of the systematic risk of correlated loan defaults. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00097 .

Private Credit: Characteristics and Risks

Private credit or private debt investments are debt-like, non-publicly traded instruments provided by non-bank entities, such as private credit funds or business development companies (BDCs), to fund private businesses. Private credit is typically extended to middle-market firms with annual revenues between $10 million and $1 billion, but has grown rapidly in recent years to fund larger companies that were traditionally funded by leveraged loans.

Market-based private equity returns

Using the universe of business development companies (BDCs), a unique publicly traded segment of U.S. Private Equity (PE), for the period 1998–2017, we provide the first in-depth examination of their performance and risk-adjusted characteristics and compare our results to contrasting evidence derived from recently developed time series proxies for unlisted PE returns. BDCs exhibit zero alpha, beta of one, and significant exposure to SMB, HML, and CMA factors of 0.5, 0.7, and -0.3, respectively. BDC performance and market beta are sensitive to fund size and leverage. We provide evidence that BDC returns capture both the asset selection and PE ownership elements of the unlisted PE investment strategy. Finally, an event study analysis shows that NAV disclosures become informative only after the adoption of the Statement of Financial Accounting Standards 157 (SFAS 157). We posit that BDCs provide a readily available market-based PE benchmark for use by regulators, market participants, and academics.

Market Discipline in the Direct Lending Space

Abstract Using the exclusion of business development companies (BDCs) from stock indexes, this paper studies the effectiveness of market discipline in the direct lending space. Amid share sell-offs by institutional investors, a drop in BDCs’ valuations limits their ability to raise new equity capital. Following this funding shock, BDCs do not adjust their capital structure. At the same time, they are reducing the risk exposure of their portfolios. We document a greater reduction in risk for BDCs subject to stronger market discipline from their debtholders. BDCs pass through the capital shock to their portfolio firms by reducing their investment intensity.

Direct Lending Returns

I examine the performance of US business development companies (“BDC”). BDCs have produced returns in line with those of private funds engaged in direct lending. Leveraged loan and small-cap value equity returns explain a significant part of BDC performance, and the alpha of BDCs is zero on a market-value basis but a statistically significant 2.74% per annum based on net asset value (NAV) valuations. I find no evidence of an illiquidity premium, which suggests that the alpha could result from regulatory arbitrage or a peso problem. Cross-sectional BDC returns are widely dispersed and exhibit strong persistence in top- and bottom-quartile manager performance.

A Benchmark for Collateralized Loan Obligations

We build a benchmark for AAA-rated tranches of Collateralized Loan Obligations (CLOs) using Business Development Companies (BDCs), which hold a diversified portfolio of loans as CLOs do. However, BDCs are publicly listed, and their share price, equity volatility and borrowing cost are observable. Furthermore, BDCs' debt is not rated as AAA. Applying a structural model to BDCs, we extract market-implied correlation in their loan portfolio, compare spreads on CLO tranches and BDC-implied benchmark, and find that observed large credit spreads on CLO senior tranches after the financial crisis are a fair reflection of the systematic risk of correlated loan defaults.

SEC adopts offering reforms for BDCs and registered closed-end funds and issues a temporary exemptive order

Purpose To analyze and identify the key findings from the April 8, 2020, U.S. Securities and Exchange Commission’s (the “SEC”) recently approved rule amendments (“Adopted Rules”) extended to business development companies (“BDCs”) and registered closed-end funds and an Exemptive Order providing regulatory flexibility to BDCs. Design/methodology/approach Discusses the key takeaways and implications from the Adopted Rules and Exemptive Order. Findings The Adopted Rules provide BDCs and registered closed-end funds some of the more efficient registration, reporting, offering, and communication requirements currently applicable to operating companies. The Exemptive Order provides BDCs additional flexibility with respect to (1) the issuance and sale of senior securities and (2) the participation in certain joint transactions. Practical implications Firms and their representatives should heed the trends in both the substantial restitution FINRA is ordering and the related enforcement issues in the cases FINRA has brought. Originality/value Expert analysis and guidance from experienced asset management lawyers.

Sustainability of Direct Lending: Evidence from Index Exclusion

The 2006 change in the disclosure requirements for Acquired Fund Fees and Expenses (AFFE) led to the exclusion of business development companies (BDCs) from major stock indexes in 2014, constituting a contractionary shock to the flow of equity capital into publicly traded BDCs. In a difference-in-differences setting, we demonstrate that AFFEcted BDCs — those with high pre-shock mutual fund ownership — experience a 10%-14% larger drop in their equity growth and 12%-16% larger decline in investment growth relative to non-AFFEcted BDCs. These findings highlight the importance of access to capital markets for BDCs to sustain their investment activities. Exploiting the geographic dispersion of BDC borrowers, we further document the negative impact of the AFFE regulation on local employment growth.

Business Development Companies-The Basics

Business Development Companies (“BDCs”) are a type of closed end investment company, created when Congress amended the Investment Company Act of 1940 in 1980. BDCs were first created to make it easier to invest in venture capital pools and private equity investments. Over the past decade, interest in BDCs has increased. BDCs provide funding to small and mid-sized businesses. Following the financial crisis, BDCs were able to provide loans to businesses that may not have been able to receive financing from more traditional sources. In 2009, the first non-traded public BDCs were issued, raising almost $100 million that year. The following year, sales more than tripled to $369 million. Non-traded BDCs hit their peak in 2014, raising $5.5 billion. In 2020, broker-dealers sold only $362.3 million of non-traded BDCs, the lowest volume since 2010. This article describes the regulations that govern BDCs: federal, state, and SRO. Next, the article examines recent enforcement actions concerning the sale of BDCs by broker-dealers. Finally, the article discusses concerns raised by the sale of non-traded BDCs to investors.

Fund Management Structure and Conflicts of Interest: Evidence from Business Development Companies

Using the universe of Business Development Companies for the period 2006-17, we analyze the effects of fund management structure on managerial decisions and fund premiums. We show that externally managed funds trade at significantly higher discounts relative to their internally managed counterparts and they are 74% (67%) less likely to announce (execute) value enhancing share repurchase programs. We further find a significantly higher positive market reaction to share repurchase announcements of externally relative to internally managed funds. Overall, we show the benefits of internal management structure in avoiding agency costs associated with the dependence of managerial compensation on total assets.

Innovations in veterinary markets: opinion leaders’ social capital

PurposeThis study aims to identify how the personal social capital of opinion leaders contributes to the market adoption of start-up innovations.Design/methodology/approachA design-oriented case study is undertaken with a start-up company focusing on the development and commercialization of innovations in the veterinary market. Based on a literature review, the authors examine the social capital in value creation and the role of opinion leaders and use qualitative methodology and semi-structured in-depth interviews to collect data.FindingsThe adoption of innovations could start with opinion leaders that will later share their experience with other members of the professional community. In turn, social capital allows for creating a collaboration between start-ups and leaders based on a number of specific parameters.Originality/valueThis paper contributes to marketing literature by providing new insights regarding collaboration between start-ups and opinion leaders. The collaboration between opinion leaders and start-ups could be implemented not only in the veterinary industry but also in other industries with minor adaptations. Authors demonstrate how the social capital of external stakeholders may be used as a resource of the company for business development. The main contribution of this study is to demonstrate that social capital could be used as a parameter for the adoption of innovations. The key parameters that allow creating cooperation between start-up and opinion leader have been identified.

Direct Lending in the U.S. Middle Market

The reduction in credit supply from traditional lenders following the 2007--2008 Financial Crisis contributed to a surge of direct lenders and, in particular, business development companies (BDCs). Using a novel hand-collected dataset, we provide the first systematic analysis of the BDC sector. In a difference-in-differences setting, we exploit three exogenous shocks to credit supply, including new banking regulations and a major finance company collapse, to establish that BDC capital acts as a substitute for traditional financing. Using an instrumental variable approach, we further document that access to BDC funding and, more broadly, private debt capital has stimulated economic growth.

Business Development Companies: Private Equity for Individual Investors

Using the universe of Business Development Companies (BDCs), a unique publicly traded segment of U.S. Private Equity (PE), for the period 1998-2017 we provide the first in depth examination of their performance and risk adjusted characteristics and compare our results to contrasting evidence derived from recently developed time series proxies for unlisted PE returns. BDCs exhibit zero alpha, beta of one and significant exposure to SMB, HML, and CMA factors of 0.5, 0.7, and -0.3, respectively. BDC performance and market beta are sensitive to fund size and leverage. We provide evidence that BDC returns capture both the asset selection and PE ownership elements of the unlisted PE investment strategy. Finally, an event study analysis shows that NAV disclosures become informative only after the adoption of the Statement of Financial Accounting Standards 157 (SFAS 157). We posit that BDCs provide a readily available market-based PE benchmark for use by regulators, market participants, and academics.

ПЕРСПЕКТИВИ РОЗВИТКУ ДЕЯКИХ ВИДІВ ІННОВАЦІЙНОГО МАРКЕТИНГУ

In this article the essence of innovative marketing inbound marketing and Internet marketing have been identified. Total expenditure on advertising and internet advertising costs according to the company «eMarketer» marketing have been analyzed. Ratio of spending on Internet advertising in the total advertising spend have been investigated. The importance of improving innovative marketing policy of the company for sustainable business development has been emphasized. The effectiveness of the introduction of innovative marketing in the conduct of business has been considered.

SEC proposes sweeping changes to the use of derivatives and financial commitment transactions by registered funds and BDCs

Purpose To describe and analyze a proposed rule recently issued by the US Securities and Exchange Commission (“SEC”) that would overhaul the use of derivatives and financial commitment transactions by registered investment companies and business development companies. Design/methodology/approach This article summarizes the various aspects of the proposed rule, discusses the elements of the proposed rule in greater detail, explains the effect of the proposed rule on existing guidance from the SEC and its staff, and notes the potential transition period for any final rule. Findings While the proposed rule is subject to public comment and subsequent consideration by the SEC and its staff, if the proposed rule is adopted in its current form it would result in sweeping changes for registered investments companies and business development companies. Originality/value This article contains a detailed overview of a recent SEC rule proposal regarding the use of derivatives by registered investment companies and business development companies and practical guidance from experienced asset management lawyers.

Business Development Companies: Cashing In on Private Equity?

Business Development Companies: Cashing In on Private Equity?

Trends in Private Equity

The author starts with the observation that there has been a distinct change in the private equity market. What was previously thought to be a segmented, inefficient marketplace has turned into an efficient, auction driven asset class. Defining private equity as comprising the market for leveraged buyouts and corporate restructuring and excluding other segments such as venture capital, mezzanine debt, and distressed debt, the author reviews the current state of the private equity market, observing trends such as the increasing prevalence of auctions, the growing role of secondary purchases, and even the internationalization of the marketplace, and draws implications on return expectations. He considers a few interesting new trends such as a focus on middle market deals, business development companies, and the cross-over between private equity and hedge fund offerings. He concludes with the view that the competitive environment for private equity firms has changed significantly, forcing private equity firms to seek new sources of revenues and businesses, but one should be careful to note that the skill sets needed to extract value from a privately run operating company versus the skill sets needed to extract trading/arbitrage opportunities from publicly traded securities are very different.

Business Development Companies

Through Business Development Companies (BDCs), large, well-known private equity firms have rushed to the market to raise billions of dollars in an extension of the private equity markets to the public equity markets. Large amounts of capital can be raised from the public equity markets more quickly than the typical 12 to 18 months to close a private equity fund. In this article, we trace the origins of BDCs, review their structure and provide a summary of recent deals. We also review the pros and cons of BDCs both from an investor9s point of view as well as the private equity firm establishing the BDC. Last, we consider some of the risks associated with BDCs that are different from traditional private equity partnerships.

Publicly traded venture capital funds: implications for institutional “fund of funds” investors

Institutional investors supply the bulk of the funds which are used by venture capital investment firms in financing emerging growth companies. These investors typically place their funds in a number of venture capital firms, thus achieving diversification across a range of investment philosophy, geography, management, industry, investment life cycle stage and type of security. Essentially, each institutional investor manages a “fund of funds,” attempting through the principles of portfolio theory to reduce the risk of participating in the venture capital business while retaining the up-side potential which was the original source of attraction to the business. Because most venture capital investment firms are privately held limited partnerships, it is very difficult to measure risk adjusted rates of return on these funds on a continuous basis. In this paper, we use the set of twelve publicly traded venture capital firms as a proxy to develop insight regarding the risk reduction effect of investment in a portfolio of venture capital funds, i.e., a fund of funds. Measurements of weekly total returns for the shares of these funds are compared with similar returns on a set of comparably sized “maximum capital gain” mutual funds and the daily return of the S&P 500 Index. A comparison of returns on an individual fund basis, as well as a correlation of daily returns of these individual funds, were made. In order to adjust for any systematic bias resulting from the “thin market” characteristic of the securities of the firms being observed, the Scholes-Williams beta estimation technique was used to reduce the effects of nonsynchronous trading. The results indicate that superior returns are realized on such portfolios when compared with portfolios of growth-oriented mutual funds and with the S&P 500 Index. This is the case whether the portfolios are equally weighted (i.e., “naive”) or constructed to be mean-variant efficient, ex ante, according to the capital asset pricing model. When compared individually, more of the venture funds dominated the S&P Market Index than did the mutual funds and by much larger margins. When combined in portfolios, the venture capital funds demonstrated very low beta coefficients and very low covariance of returns among portfolio components when compared with portfolios of mutual funds. To aid in interpreting these results, we analyzed the discounts and premia from net asset value on the funds involved and compared them to Thompson's findings regarding the contribution of such differences to abnormal returns. We found that observed excess returns greatly exceed the level which would be explained by these differences. The implications of these results for the practitioner are significant. They essentially tell us that, while investment in individual venture capital deals is considered to have high risk relative to potential return, combinations of deals (i.e., venture capital portfolios) were shown to produce superior risk adjusted returns in the market place. Further, these results show that further combining these portfolios into larger portfolios (i.e., “funds of funds”) provides even greater excess returns over the market index, thus plausibly explaining the “fund of funds” approach to venture capital investment taken by many institutional investors. While the funds studied are relatively small and are either small business investment companies or business development companies, they serve as a useful proxy for the organized venture capital industry, despite the fact that the bulk of the funds in the industry are institutionally funded, private, closely held limited partnerships which do not trade continuously in an open market. These results demonstrate to investors the magnitude of the differences in risk adjusted total return between publicly traded venture capital funds and growth oriented mutual funds on an individual fund basis. They also demonstrate to investors the power of the “fund of funds” approach to institutional involvement in the venture capital business. Because such an approach produces better risk adjusted investment results for the institutional investor, it seems to justify a greater flow of capital into the business from more risk averse institutional investment sources. This may mean greater access to institutional funds for those seeking to form new venture capital funds. For entrepreneurs seeking venture capital funds for their young companies, it may also mean a lower potential cost of capital for the financing of business venturing. From the viewpoint of public policy makers interested in facilitating the funding of business venturing, it may provide insight regarding regulatory issues surrounding taxation and the barriers and incentives which affect venture capital investment.