By Harry Prabandham · Updated September 28, 2026
Investing & Markets
Business Development Companies (BDCs): How They Work and Their Risks
BDCs are closed-end funds that lend to and invest in private U.S. businesses, paying high, mostly ordinary-income distributions with real credit risk.
Business Development Companies (BDCs): How They Work and Their Risks
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What is a business development company?
- A BDC is a closed-end fund that elects special status under the Investment Company Act of 1940 to invest mainly in small and mid-sized U.S. businesses.
- At least 70% of a BDC's assets must be qualifying assets, largely securities of eligible private or small public U.S. companies.
- BDCs can be exchange-traded or non-traded; non-traded BDCs usually offer only limited, periodic share repurchases.
- Most elect to be taxed as regulated investment companies, which requires distributing at least 90% of taxable income.
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Full Guide
What is a business development company?
- A BDC is a closed-end fund that elects special status under the Investment Company Act of 1940 to invest mainly in small and mid-sized U.S. businesses.
- At least 70% of a BDC's assets must be qualifying assets, largely securities of eligible private or small public U.S. companies.
- BDCs can be exchange-traded or non-traded; non-traded BDCs usually offer only limited, periodic share repurchases.
- Most elect to be taxed as regulated investment companies, which requires distributing at least 90% of taxable income.
How BDCs earn income
- Most income is interest on loans to middle-market companies, much of it at floating rates.
- Some BDCs also hold equity or warrants, which can add gains or losses.
- Origination and structuring fees supplement interest income.
- Total return combines distributions with changes in net asset value or share price, and either can fall.
How much leverage can a BDC use?
- Since the Small Business Credit Availability Act of 2018, a BDC may reduce its asset coverage requirement from 200% to 150% with board or shareholder approval.
- At 150% coverage, debt can reach about twice equity, which magnifies both gains and losses in NAV.
- Floating-rate borrowings mean rising rates raise a BDC's funding costs along with its loan income.
- In a downturn, falling loan values can push a BDC toward its coverage limit and force deleveraging.
Management structure and fees
- Externally managed BDCs pay an outside adviser a base management fee plus an incentive fee tied to income and gains.
- Internally managed BDCs employ their own team, so costs appear as operating expenses instead.
- Fees and expenses are disclosed in the prospectus fee table and can meaningfully reduce net returns.
- Non-traded BDCs may add upfront sales charges and ongoing distribution fees.
How are BDC distributions taxed?
- Most BDC distributions are ordinary dividends rather than qualified dividends, taxed at rates up to 37% federally in 2026.
- The 3.8% net investment income tax can apply above $200,000 of modified AGI for single filers or $250,000 for joint filers.
- Some distributions may be capital gain dividends or return of capital, which lowers your cost basis.
- Because of the ordinary-income character, where a BDC is held (taxable versus tax-deferred account) affects its after-tax result.
Main risks
- Borrowers are typically below investment grade, and defaults tend to rise in recessions.
- Private loans are valued using models rather than market prices, so reported NAV can lag real conditions.
- Traded BDC shares can sit at a discount to NAV and fall further in stress.
- Credit losses can lead to distribution cuts, and non-traded BDCs may limit or suspend repurchases.
Key takeaways
- BDCs give public-market investors access to private credit, with the credit risk that comes with it.
- Leverage of up to about 2:1 debt to equity magnifies results in both directions.
- Distributions are mostly taxed as ordinary income, and fees can be significant.
- Liquidity differs sharply between exchange-traded and non-traded BDCs.
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Sources
- Investor.gov — Publicly Traded Business Development Companies (BDCs): Investor Bulletin
- Investor.gov — Non-Publicly Traded BDCs: Investor Bulletin
- 15 U.S.C. § 80a-54 — BDC qualifying assets
- 15 U.S.C. § 80a-60 — BDC capital structure and asset coverage
- 26 U.S.C. § 852 — Taxation of regulated investment companies