What is a Business Development Company (BDC)


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What is a Business Development Company (BDC) and how does it work.

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What is a Business Development Company (BDC)

  1. 1. ABC Corporation, Inc. Becoming a Business Development Company (BDC) To Fund Future Growth1 Confidential © SBD Investment Partners, Inc.
  2. 2. Discussion Topics Attributes of a BDC BDC Industry Review and Market Receptivity Funding Options Engagement Relationship with SBDConfidential © SBD Investment Partners, Inc. 2
  3. 3. History of the Business Development Company (BDC)1. Investment Company Act 1940 (the “1940 Act”), which is the same regulatory framework of mutual funds.2. BDC was created as part of the Small Business Investment Incentive Act of 1980 (the “1980 Amendments”) as a result of a perceived crisis in the capital markets in the 1970s. (much like happening now)3. Regulated Investment Company (RIC) Status in 1990.Confidential © SBD Investment Partners, Inc. 3
  4. 4. What is a BDC? Hybrid between an operating company and an investment company. Invest primarily in private companies. Typically a closed-end fund regulated as a 1940 Act company. Structured as Regulated Investment Company (RIC) for tax purposes.Confidential © SBD Investment Partners, Inc. 4
  5. 5. Attributes of the BDC to the Investor and Portfolio Companies? Public company which has: Access to public capital markets Shares are publicly traded - liquidity Publicly available audited financial information Flow-through tax treatment. Reduced regulatory burden as compared to a 1940 Act Company Restrictions on leverage/affiliated transactions Hybrid between an operating company and an investment company. No audit requirements for portfolio companies. Portfolio is typically diversified which reduces risk to investors compared to a single private equity investment.Confidential © SBD Investment Partners, Inc. 5
  6. 6. How and what do BDC’s invest? Typically - small to middle-market private companies Entire spectrum of financial instruments: Equities (preferred stock, common stock, debentures, PIPE’s) Commercial style debt Services subsidiary originates financial services for the BDC that will be in the form of: Commercial debt Due diligence Merger and acquisitions (buy and sell side) Management consultingConfidential © SBD Investment Partners, Inc. 6
  7. 7. How BDC’s Invest in the Portfolio Senior Secured Debt Higher Second Lien Secured Debt Mezzanine Debt & Warrants Preferred Equity Lower Common EquityConfidential © SBD Investment Partners, Inc. 7
  8. 8. Becoming a BDC? Be publically listed on one of the exchanges: New York Stock Exchange (NYSE) Nasdaq Stock Market, Inc. (Nasdaq) NYSE AMEX Register a class of securities on Form N-2 Make an election to be a BDC- file a Form N-54A Comply with the exchange reporting requirementsConfidential © SBD Investment Partners, Inc. 8
  9. 9. BDC Investing Rules? A BDC must invest at least 70% of its assets in eligible portfolio companies. Generally: Organized and principally operating in the United States Private, or very thinly traded public company Can’t invest in other BDC’s or insurance companies Affiliated transactions (highly regulated) Certain transactions may be prohibited, or require approval of a majority of the Board, or an order from the SECConfidential © SBD Investment Partners, Inc. 9
  10. 10. Borrowing Limitations? BDC’s can have and equal amount of debt to equity to invest . $50 For example: $50 Debt A BDC with $50 in equity Equity $50 would be able to invest $100 Equity in growing businesses. Other investment companies are restricted to 50% debt to equity. $25 $50 Debt Equity $50 EquityConfidential © SBD Investment Partners, Inc. 10
  11. 11. BDC’s Operational Requirements Must have a majority of independent directors - persons who are not “interested persons.” Must make available significant managerial assistance to these companies. Must appoint a Chief Compliance Officer and maintain a comprehensive compliance program. Custodian Agreement - Must place and maintain its securities and similar investments in the custody of a bank. Fidelity Bond - A BDC must provide and maintain a bond issued by a reputable fidelity insurance company to protect the company against larceny and embezzlement. The bond must cover each officer and employee with access to securities and funds of the company.Confidential © SBD Investment Partners, Inc. 11
  12. 12. SEC Reporting Requirements? Form 10-K (Annual Report) Form 10-Q (Quarterly Report) Form 8-K (Current Report) Proxy Statements Comply with the Sarbanes-Oxley Act of 2002 Must comply with the corporate governance of the exchange you are listed.Confidential © SBD Investment Partners, Inc. 12
  13. 13. How Are BDC Assets Valued? Each asset must be valued on a quarterly basis (i.e., “mark-to-market”) Market value is used for those assets for which market quotations are readily available “Fair value,” as determined by the board of directors, is used for other securities and assets Portfolio assets of intellectual property and patents which can not be recognize by the portfolio companies can be recognized on the BDC’s balance sheet There is no single standard for determining fair value Determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process.Confidential © SBD Investment Partners, Inc. 13
  14. 14. How are BDC’s Managed? Internally managed or, Externally managedConfidential © SBD Investment Partners, Inc. 14
  15. 15. How Can an Internally Managed BDC Compensate Management? Certain performance-based compensation permitted, including: Issuance of at-the-market options, warrants, or rights pursuant to an executive compensation plan Maintenance of a profit sharing plan. Otherwise, BDC must use cash assets as compensation Restricted stock – some exceptionsConfidential © SBD Investment Partners, Inc. 15
  16. 16. How Can an Externally Managed BDC Compensate the Advisor? The investment advisor must be registered under the Investment Advisors Act of 1940 The Advisors Act contains no prohibition against an advisor taking an incentive fee against income, although the market has effectively capped these fees at 20%, usually subject to a hurdle.Confidential © SBD Investment Partners, Inc. 16
  17. 17. How are BDC’s Taxed? Allows “pass through” tax treatment for income and capital gains that are distributed to shareholders. Must distribute at least 90% of its investment income to shareholders annually May retain, distribute or “deem distribute” capital gains. Gains in asset appreciation is recognized when the asset is sold.Confidential © SBD Investment Partners, Inc. 17
  18. 18. BDC Industry Review and Market ReceptivityConfidential © SBD Investment Partners, Inc. 18
  19. 19. BDC Market Activity Wells Fargo created a BDC Index of “27” BDC’s in April 2011 Market Cap $15 Billion Average stock price = $9.78 Average dividend = 5.78% Registrations in 2010 = $5.1B 6 IPO’s in 2010 = $513M In 2010 8 BDC’s did $1.2B in secondarys There are ~ 63 BDC’s 0f which 39 are “active”Confidential © SBD Investment Partners, Inc. 19
  20. 20. Recent Industry Trends Stock is valued against NAV or Book Value plus a premium for dividends The BDC model has proven to be resilient - 2010 and 2011 have been years of recovery: Resumption of dividend payments; Increase in repurchase programs; Lower asset coverage ratios. Of the top 27 actively traded BDC’s 10 are currently trading above NAV/Share 3 are trading between 90% - 99% of NAV/ShareConfidential © SBD Investment Partners, Inc. 20
  21. 21. Options to Finance GrowthConfidential © SBD Investment Partners, Inc. 21
  22. 22. Financing Assumptions ABC needs interim funding (mezzanine) of $15,000,000 to carry out the current operational plans to be used as follows: $5,500,000 for Phase II to retrofit a production facility; $4,500,000 for working capital and $5,000,000 for new projects. Shareholders would like to see a liquidity event or have the ability to be liquid in 18 to 24 months. Additional capital to expand the growth of the company. Capital available to fund a technology incubator to remain at the forefront of the technology.Confidential © SBD Investment Partners, Inc. 22
  23. 23. Two Options Option Time to Capital Acquire a Public Company 9-18 Months File an S-1 (IPO) 18-24 Months Preferable option is to acquire a public companyConfidential © SBD Investment Partners, Inc. 23
  24. 24. ABC Entity Chart ABC Inc Incubator IP Bank ABC Operating Logistics & Construction Advisor Services Company Transportation Services Refinery I Terminal I Refinery II Terminal IIConfidential © SBD Investment Partners, Inc. 24
  25. 25. Advisor Services This subsidiary will be responsible for providing support services to portfolio companies as well as to commercial clients that are not part of the BDC. It originates business in the form of: Merger and Acquisition Buy Side Sell Side Due Diligence Management Consulting Commercial FinanceConfidential © SBD Investment Partners, Inc. 25
  26. 26. Pro-forma Capital Table ABC Shares 10,000,000 Acquisition Share 541,125 Total Shares Outstanding 10,541,125 IP and other Values $30,000,000 Core operations $20,000,000 Pro Forma market capitalization $50,000,000 Pro Forma Share Price Range $4.74 Use of proceeds of a $100M offering Acquisition creditors $500,000 Placement costs $4,500,000 Debt Reduction (mezzanine) $17,500,000 Investment Capital $77,500,000 Total $100,000,000Confidential © SBD Investment Partners, Inc. 26
  27. 27. Time Line Value IP & Secure Public Secure BDC Election IPO Assets Company Mezzanine •Month 6 •Month 18 •Month 2 •Month 3 •Month 4Confidential © SBD Investment Partners, Inc. 27
  28. 28. Post Offering Ownership IPO Share Price $10.00/share Post IPO share price Book Value/Asset Value $192,500,000 Shares in the market 20,541,125 Post IPO Share Price $9.37/share Entity Shares % Market Value ABC Shareholders 10,000,000 49% $93,700,000 Acquisition Shareholders 541,125 2% $5,100,000 IPO Shareholders 10,000,000 49% $93,700,000 Total 20,541,125 100% $192,500,000Confidential © SBD Investment Partners, Inc. 28
  29. 29. Future 2012 2013 2014 2015 ABC Revenue $85,000,000 $177,000,000 $345,000,000 $531,000,000 Net Income $2,000,000 $11,000,000 $18,000,000 $26,000,000 BDC Book Value $50,000,000 $145,000,000 $245,000,000 $325,000,000 Shares Out 10,500,000 10,500,000 20,500,000 20,500,000 Share Price $4.80 $13.80 $12.00 $13.50 Dividends Paid $1,800,000 $5,200,000 $17,000,000 $22,100,000Confidential © SBD Investment Partners, Inc. 29
  30. 30. SBD Investment Partners, Inc. 5815 Guenevere Ct. Saint Cloud, FL 34772 www.sbdip.com Roy Salisbury 207.553.0086 rsalisbury@ sbdip.com Doug Calaway 907.227.5633 dcalaway@sbdip.comConfidential © SBD Investment Partners, Inc. 30
  31. 31. Sources Seeking Alpha Sutherlin, Ashbill Yahoo Finance John Dresher “Stock Strategies” REISA Conference McGladreyConfidential © SBD Investment Partners, Inc. 31