Business Development Company

A sponsor of a non-traded business development company runs a magazine advertisement explaining what business development companies are, how they typically invest, and where a reader may obtain further information. The advertisement names no particular company and no security. What is the consequence under the generic advertising rule?

1. A.It is an offer, because the sponsor published it while its own program was being soldWrong. The publisher's motive is not the test that the rule applies.
2. B.It is not deemed an offer, because it refers to no particular company or securityCorrect. Explanatory material about a class of vehicles falls outside the definition of an offer.
3. C.It is a preliminary prospectus and must carry the legend that appears on oneWrong. Nothing in the piece describes a registered offering, so no legend is at issue.
4. D.It is permitted only after the sponsor's registration statement has been declared effectiveWrong. The rule exists precisely to allow such material without regard to an offering timetable.

Why: The generic advertising rule lets a communication that does not refer by name to the securities of any particular company carry explanatory material about a class of investment vehicles without being treated as an offer to sell. Because this piece identifies no company and no security, it is not deemed a prospectus and does not engage the Securities Act machinery that governs offers. Naming a specific program is the one fact that would flip the outcome, because the shelter depends entirely on the absence of an identified security. The sponsor's reason for publishing is irrelevant to the analysis.

A business development company, as defined under the Investment Company Act, wants to invest in a private placement. Its total assets have not been disclosed. Can it be accredited on the basis of its status as a business development company alone?

1. A.No — a business development company must satisfy the same $5,000,000 total-assets test as an ordinary corporation.Wrong. BDC status is its own distinct accredited category, separate from the general entity-size test.
2. B.No — business development companies are excluded from the accredited investor definition because they are themselves investment vehicles for retail investors.Wrong. Business development companies are included, not excluded, from the accredited investor categories.
3. C.Yes, but only if it is also registered as a closed-end investment company under a separate provision.Wrong. No additional closed-end registration condition is imposed beyond BDC status itself.
4. D.Yes — a business development company is its own accredited investor entity category by virtue of that status, without a separate size test.Correct. BDC status alone qualifies the entity.

Why: A business development company is its own accredited investor entity category by virtue of that status, without a separate size test.

Client Anwar Haddad is comparing a publicly traded business development company (BDC) currently yielding 9.5% with a high-yield bond mutual fund yielding 6.8%. He asks his adviser why he should not simply take the higher yield. Which response is most accurate?

1. A.BDC distributions are exempt from federal income tax, which is why the stated yield exceeds that of the taxable mutual fund.Incorrect. BDC distributions are taxable. Only municipal issuers generate federally tax-exempt interest.
2. B.A BDC is a closed-end fund that must redeem shares at net asset value on demand, so its liquidity is comparable to the mutual fund.Incorrect. Redemption at NAV on demand is the defining feature of an OPEN-end fund. Listed BDC shares are sold in the market.
3. C.Because a BDC is regulated under the Investment Company Act of 1940, it is prohibited from borrowing, so the higher yield comes purely from superior security selection.Incorrect. BDCs are expressly permitted to use leverage, and that leverage is a major source of both the yield and the risk.
4. D.A BDC lends to and invests in small private companies, typically employs leverage, and trades at a market price that can differ materially from NAV, so the extra yield compensates for materially greater credit, leverage and price risk.Correct. Private credit exposure, permitted leverage and exchange pricing away from NAV together explain and justify the higher yield.

Why: A business development company is a closed-end investment company that lends to and takes equity stakes in small and mid-sized private U.S. companies. Three features explain the yield gap. Its borrowers are private, unrated and often highly leveraged, so credit risk is greater than in a diversified high-yield bond portfolio. BDCs are permitted to borrow, and that leverage magnifies both income and losses. Finally, because a listed BDC trades on an exchange rather than redeeming at net asset value, its share price can sit at a large premium or discount to NAV, adding price risk the mutual fund does not have.