Making Sense of Business Development Companies (BDCs)
With a background that hits a wide range of finance and business management, I came to Saratoga excited to take on the challenges unique to business development companies, or BDCs. I soon discovered that Saratoga – and, by extension, BDCs in general – was unlike any company I had previously worked for. By and large, BDCs require new CFOs to adopt a less-familiar set of public company practices that encourage a flexible and sometimes improvisatory approach toward funding. It’s basically yoga for the underwriting process: the more dynamic your exercise, the better you’ll know how to obtain funding for a broad diversity of situations. Moreover, the better funding you’ll receive. Here’s a brief primer for any fellow CFO who may work with a BDC in the future (you still have to keep up your practice):
- When traditional banks say “no”, BDCs say “maybe”. It’s important to remember that BDCs exist to serve a particular segment of the market economy, namely those businesses that have trouble getting funded by traditional lenders. This doesn’t mean they’re bad bets; it just means they’re either considered sizable credit risks or deemed unworthy due to relatively small funding needs. For BDCs, these criteria describe an underserved segment of the business economy: the middle market. Indeed, BDCs offer funding opportunities to portfolio companies that rival the speed at which private equity and venture capital firms obtain funding for their own portfolio companies. The difference is, BDCs are usually traded on the open market, which enables them to collect capital from the public (often in exchange for regular dividends), as well as a plethora of private lenders more likely to consider a regulated BDC over a middle market company.
- Do your homework (and show your work, please). Any investment from a BDC in a potential portfolio company requires a comprehensive review by the CFO and investment team. (Brace yourself; it’s due diligence on another level entirely.) In addition to a traditional executive summary and top-to-bottom business review, you’ll want a quality of earnings (QOE) review, reasons to invest, a proven record of stability and profitability, risk assessments, evaluation of the market, and realistic projections of future performance. Rule of thumb: if you think it might be worth a closer look, it always deserves one.
- It’s a partnership, not a battle for supremacy. BDCs invest in companies that private equity firms and banks often overlook. Always remember that a company with proven, consistent, and stable cash flow in a sustainable niche market must have done something right to be where they are today. Therefore, their goals are worth paying close attention to. No reason that their goals can’t be yours as well.
That’s just for starters. We’ll plunge deeper into the responsibilities of CFOs at BDCs next time.