Since its arrival in the 1980s, business development companies (BDC) have developed into a growing, but niche sector of investment. Emerging from the financial crisis a few years ago, BDCs began to shift to make decisions that would avoid such a situation arising once again. However, BDCs are still risk takers at its core. It’s what makes them BDCs to a certain degree. Unfortunately, that may mean that some will go too far with its risk assessment. That doesn’t have to be the case, though, for you and your BDC.
With wise risk management and leadership able to weather most situations, BDCs are generally well-equipped for making educated risks that generate gains for all parties. Whether they be internal, external or a composite risk, the best BDCs are prepared to do what is right after the proper preparation and assessment.
When it comes to risks, these are just some of what the sector faces:
External Risks
When it comes to risks arising outside the BDC, management has little to no control over what can be done. However, these risks can be anticipated to a certain degree–creating a safety net of sorts for the company and its portfolio.
The public sector is certainly a driving force in creating risky scenarios a BDC must evaluate. The vagaries of the market, as well as individual sentiments, can alter the course of a well-thought out plan of action relatively quickly. While possible to anticipate, no one can be certain when a loan extension is requested. On the flip side, companies sometime do so well they want to repay their loans early, which is sometimes the penalty for investing in good companies. Worse for the BDC, a company deciding to restructure can derail any plans that had previously been laid out.
By doing its “homework” of sorts, a BDC understands the type of company it is investing in. Thorough vetting allows the company to truly understand if the risk is too high to get involved with. Each BDC must have a plan in place to meet these concerns while remaining flexible to each individual entity. Additionally, just as investing in a BDC isn’t right for every investor, not all companies are right for a BDC. Even though BDCs often say “maybe” when banks say “no,” we often say no as well.
By properly overseeing the BDC as well as understanding its portfolio, the company puts itself in a position to succeed more often than not on those high-risk investments. In the end, these risks are largely about risk assessment and evaluation. After that, it falls largely on anticipating new circumstances and remaining open to new ideas.
Internal Risks
Obviously, internal risk management is much easier to anticipate and plan for than the external. With a fundamental understanding of the BDC and its portfolio, a proper leader knows what is needed to grow or keep your company thriving. This should be an obvious answer to most people reading this. However, actions by certain BDCs in the past may leave some wondering if these points are as obvious as they may seem.
For those that have veered off the path, there are several aspects to evaluate when seeing where improvements can be made. At its core, people risk and corporate culture are vital to success in every facet. If your BDC lacks in quality staffers, all bets are off when it comes to managing risks. In fact, those less than ideal staffers can cause the internal problems you have been avoiding all this time. Whether it be a fragmented workforce or a lack in core business components, those not operating under company ethos can cause significant risk and harm to the business. With a unified vision and corporate culture in place, this shouldn’t become an issue at your BDC.
Other key internal risks BDCs have to look out for include market assessment, as well as intelligence and portfolio management. These risks can include reading the market’s trends, identifying gaps in the market and maintaining a balanced portfolio. A lack in quality employees often results in these errors coming to light. With quality and unified employees in place, the BDC is set up for proactive success that is more than capable in assessing risks and potential problems that may arise.
Composite Risks
There are three main risks that come to mind when assessing composite risks. The first would be where your BDC stands with commercial relationships. These sorts of risks include understanding what makes an appropriate partner, communication from both parties and what is the level of viable candidates for partnership in a particular sector. Your BDC can only do so much to prepare for these factors, but all that due diligence will certainly leave it in prime position to make the most educated decisions it can–even if the circumstances are far from ideal.
Additionally, investor understanding is vital to managing composite risks. Knowing market trends, individual investment opportunities and an ability to differentiate between companies and sub-sectors are just the tip of the composite risk iceberg. Investor understanding requires having the brightest talent possible on your staff, as I mentioned in the internal risks section. With a capable staff in place, a BDC is once again poised to make the wisest decision for the company and its portfolio.
Lastly, the public’s perception of your company can drive risk like nothing else. Not only can public perception leave your BDC in shambles, it can just as easily promote it to one of the sector’s most revered businesses. That’s why everything from portfolio selection to pricing to investing in a potentially divisive industry could negatively impact your BDC. And of course, even after taking all the appropriate measures to avoid these pitfalls, a long list of circumstances could occur on your investment’s side of the business.
How to Manage the Risks
As I’ve stated above, having a unified team of intelligent business leaders should set you on the right path to avoiding most of these problems. Regardless of the risk type, proper preparation should be your BDC’s first step in combating these problems. Once that is in place, your company should be able to understand the risks to the best possible degree. And while nothing is a guaranteed success or failure, these measures will certainly put you in place to make the best possible decisions on even the riskiest subject.