Business Development Companies (BDCs) and Private Credit

Business Development Companies are often introduced to investors through their yields. That is understandable, but incomplete. BDCs are not equity income instruments. They are publicly traded conduits into private credit markets.

Understanding BDCs requires thinking less like a stockholder and more like a lender.

Why BDCs Exist at All

BDCs occupy a financing gap. Middle-market companies are often too large for community banks and too small, or too opaque, for public bond markets. BDCs provide capital to this segment through senior secured loans, subordinated debt, and, in some cases, equity stakes.

This is not incidental. It is the economic reason BDCs can earn yields that appear disconnected from public market norms.

Income Comes From Interest, Not Operations

Unlike REITs, BDCs do not generate cash flow through operations. Their income comes primarily from interest paid by portfolio companies.

This distinction matters.

Interest income is contractual, but it is only as reliable as the borrower’s ability to pay. When credit quality deteriorates, income can decline quickly.

An Illustrative Credit Example

A large, diversified BDC such as Ares Capital lends across a wide range of industries and capital structures. Its reported income reflects interest collected from dozens or hundreds of private borrowers, not from any single operating asset.

This highlights both the appeal and the risk of BDCs. Income is diversified across borrowers, but exposure to economic slowdowns is direct and unavoidable.

Again, the takeaway is structural. The example exists to clarify how the model works, not to suggest suitability. Let’s explore how to select and monitor a BDC like Ares Capital.

Evaluating BDC Income Sustainability

Because BDCs are lenders, evaluation centers on credit quality and portfolio performance.

Commonly reviewed indicators include:

• Net investment income relative to distributions
• Non-accrual rates, loans no longer paying interest
• Portfolio yield trends
• Exposure to cyclical industries
• Leverage relative to regulatory limits

A high yield does not compensate for weak underwriting. In credit markets, losses tend to be asymmetric.

Incentives and Risk Alignment

Many BDCs are externally managed and operate with incentive fee structures tied to assets or income. This can create misalignment if growth is prioritized over credit discipline.

Investors must understand not only what a BDC owns, but how management is rewarded for owning it.

Tax Treatment and Reporting

Most BDCs issue a Form 1099, not a K-1. Distributions are generally taxed as ordinary income, reflecting their interest-based nature.

This makes BDCs operationally simple, but tax efficiency depends on account placement and investor circumstances.

When BDCs Add Portfolio Value

BDCs provide access to private credit that would otherwise be difficult for individual investors to reach. They can enhance income when credit conditions are stable and underwriting standards are strong.

They are most appropriate when:

• An investor seeks income uncorrelated with public equity earnings
• Credit risk is intentionally accepted
• Position sizing reflects downside asymmetry

Compared with REITs, BDCs trade operating clarity for credit exposure. That tradeoff can be productive, but only when understood. REITs and BDCs pursue income from opposite sides of the balance sheet. One owns assets. The other finances them.

Closed-end funds, option strategies, and municipal structures add still other facets. None are complete on their own.

Taken together, they form a toolkit and a team.