How Do BDCs Work?

By Markets Fool.com

No one ever accused business development companies (BDCs) of being easy to understand. Listen as Industry Focusanalysts Kristine Harjes and Gaby Lapera try to demystify BDCs with pizza and mutual funds.

Continue Reading Below

A full transcript follows the video.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early-in-the-know investors! To be one of them, just click here.

This podcast was recorded on Nov. 16, 2016.

Kristine Harjes: Turning to the financials world, I feel like it gets a lot hairier.

Continue Reading Below

Gaby Lapera:It can, definitely. You have a ton of regular type companies in the financials world, like banks and insurance companies and stuff like that, that do this what I like to call "the normal way," the way that Kristine just described. But then there's other companies. We'vediscussed these companies before. A great example of them is a BDC, which is a business development company. When you think about a BDC, think of them as a venture capitalist that you can buy shares of. Instead of youpersonally going out and saying, "Iwould like to investin your pizza delivery company," you would invest in the BDC, who would then give money to the pizza delivery company. Obviously, you can't buy shares of private equity firms, because they'reprivateequity firms.BDCs are really interesting because they're closed-end funds, which means they can't accept new investments all the time.

Harjes:What do you mean by that?

Lapera:Imagine you have a mutual fund, and you give the mutual fund $1,000 of your money. You can go to the mutual fund any time and say, "I want my $1,000 back," or, "I want to give you an extra $1,000," and the mutual fund says, "Great, totally fine, here's your $1,000 back." You can't do that with BDCs. The only way to get your money in and out of the BDC is just to buy or sell the shares that are on the exchange. That's because BDCs typically invest in the debt or equity of really small private companies -- back to this single pizza store in Washington, D.C., or ajewelry store in Idaho, or a mattress company. I don't know why, but BDCs lovemattress companies.

Theproblem with that is that if you have the debtof a very small company,it's really difficult to buy or sell those companiesor the debt on thosecompanies, because not a lot of people want it. So if an investor were able to just come up to the BDC and say, "Hey,I want my $1,000 back," or, in this case, maybe "I want my $100,000 back," the BDC might not have the cash on hand to give it back to them, which is why they issue shares instead. That's why BDCs have shares to begin with,as opposed to a mutual fund.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.