This is the third in the investing for monthly income series: get paid by business development companies.
A business development company (BDC) is a publicly traded company that lends money to private companies. BDCs must pay out 90% of their income to avoid paying taxes. Therefore, BDCs pay out nearly all of their income to investors.
BDCs invest in companies that are private and do not have access to capital from the public stock exchanges. Generally, BDCs make a loan to a private company that carries a significant interest rates i.e., 10-15% and an option to own shares of the company. The BDCs are borrowing money at a fixed-rate of 3-4%. This is a great business model to borrow at 3-4% and loan at 10-15%. The difference minus expenses being income paid to the BDCs investors.
BDCs operate like a bank making loans to private companies. To protect themselves, many BDC loans have a floating rate that will adjust if interest rates rise. BDCs also are very adapt at managing the risk of each company they loan money to by judging the financial health of each prospective partner. This decreases the risk of loan default by the private company. Many BDCs make first lien loans that are similar to a mortgage. If something goes wrong with the loan, the BDC gets the house.
The BDC model is so stable that many private equity firms will loan money to the BDCs to make returns for their high net worth clients. Let’s look at a small-cap BDC.
Main Street Capital (MAIN) is a small BDC with a market cap of $370 million. Main Street’s lower middle market investments are made to support management buyouts, recapitalizations, growth financings and acquisitions of companies that operate in diverse industry sectors and generally have annual revenues ranging from $10 million to $100 million. Main Street seeks to partner with entrepreneurs, business owners and management teams and generally provides “one stop” financing alternatives within its lower middle market portfolio. Main Street also maintains a portfolio of privately placed secured, interest-bearing debt investments in middle market businesses that are generally larger in size than its lower middle market portfolio companies.
MAIN had a net profit margin of 91% and income of $30 million in 2010. MAIN continues to grow new investments in new private companies. The share price has increased from $14 in January 2010 to above $19 today. The yield was 11.14% in January 2010 but has decreased to 7.7% due to the share price increase. Main pays a monthly dividend of $0.13 per share. MAIN will continue to grow investment income as more private equity firms invest their capital in MAIN.
The next part of this series will discuss royalty trusts.