Risks of a Business Development Company (BDC)
1. Credit Risk: BDCs finance mostly small and mid-cap firms, meaning that their credit risk might be significantly higher than that of large and more established companies. Such companies may be in high-risk industries prone to the ill effects of recession, industry dips, or any other conditions that compromise their capacity to service debt.
2. Market Risk: Secondly, BDCs finance private companies whose stocks may be more illiquid and sensitive to changes in market conditions than publicly traded securities. The opportunity to invest in a target portfolio may arise and change due to shifts in market conditions, investor sentiment, or trends in the industry. BDC’s investment portfolio and its share price may be affected.
3. Interest Rate Risk: Leveraging investments is common among BDCs; hence, they use debt financing to undertake operations. The interest rate also has an influence on the interest expense incurred by BDCs in their borrowings or on the interest income received from their investments, which may affect the earnings or the dividends to be paid.
4. Liquidity Risk: Lack of liquidity may hold for private companies; it may be difficult to sell investments in these companies or do it with an acceptable value from the market. BDCs might experience a form of self-imposed liquidity constraint following either the desire to meet redemption demands by shareholders in the BDCs or the need to fund new investments for the BDCs.
5. Regulatory Risk: The United States of America’s statutes require BDCs to be regulated by the Securities and Exchange Commission (SEC) and adhere to some specific standards. New rules or regulations, or even the alteration of some of the compliance factors, could affect the operations of the BDC, its profitability, or even the payments that can be made to the shareholders.