Business development companies are ripe for retail

Many venture debt lenders choose to structure themselves as a business development company because the model fits the strategy like a glove.

BDCs are required to invest 70 percent of their portfolio into U.S.-based companies that have a market value of less than $250 million, which makes them ideal lenders to early-stage startups. Regulations also require BDCs to play an active role in the companies they invest in to help facilitate their growth.

U.S.-based venture debt companies fall easily into this structure, which makes it seem like an obvious choice for them. Many lenders said they are also drawn to the strategy because it gives them access to the coveted retail investor base while enjoying the model’s tax efficiencies.

BDCs do not pay corporate taxes and are required to distribute 90 percent of their profits to their shareholders.

Woodside, California-based Runway Growth Capital uses a private BDC for its venture lending strategy. Chairman, CIO and CEO David Spreng said that the BDC model made sense for Runway because of its tax efficient construction. “As we become more institutional, the tax benefits are a huge driver for why we chose the BDC,” Spreng said.

Another benefit to lenders is that a BDC is permanent capital, which is appealing because it gives them more investment and exit flexibility. “That’s the reason BDCs became popular with the platforms from the side of the issuer, it was permanent capital,” Spreng said.

Hercules Capital, a Palo Alto, California-based BDC that trades on the New York Stock Exchange, has found that offering a permanent capital product is just as appealing to their investors as well, said Michael Hara, the head of corporate communications and investor relations.

“Customers need the confidence that you have the permanent capital to lend,” Hara said. “This is why private shops may have a harder time. They have no guarantee that the equity behind them is permanent.”

Hara added that market volatility is a factor: “Permanent capital and having public access to the equity and debt markets is especially important when you are potentially heading into the end of a credit cycle,” Hara said. “Access to capital is key.”

The access to capital extends to shareholders as well. BDCs are open to more than just accredited investors, which opens the floodgates to a much wider investor base, including those who don’t usually have access to private markets because of their high barriers to entry.

Spreng said he remembers the BDC structure gaining popularity about 15 years ago as high net-worth individuals were looking for a way to invest in the private credit market.

BDCs offer liquidity for its investors, an uncommon perk throughout private markets, while still delivering private market equivalent returns.

“We are very well liked by retail investors,” Hara said. “That group is looking for yield. It’s hard to compete with a BDC that yields 8 to 10 percent versus other options that yield far below that.”

Horizon Technology Finance, a Farmington, Connecticut-based venture debt BDC that trades on the NASDAQ, has also garnered a large investor base from retail investors.

“They love the dividend and the yield that we provide,” said Rob Pomeroy, the CEO of Horizon.

The one downside of the BDC model is that it’s less accessible for institutional investors because of an SEC rule that prevents investors from taking a larger than 3 percent stake in a BDC. However, multiple managers have noticed that there is a growing appetite from institutions to invest in these vehicles.

“The institutional interest is there, but less so for some of the smaller funds,” Pomeroy said. “The asset class, when we are out talking to investors about it, is very intriguing to them.”

Other venture debt BDCs include Western Technology Investment (WTI) and TriplePoint Venture Growth.