BDCs make mostly short-term, unsecured loans from $20 million to $50 million to these clients. Such loans, when made to corporations, are often termed “mezzanine” loans.
To qualify for the corporate tax exemption, a BDC must loan at least 70% of its assets to private or thinly traded, public U.S. corporations, and must distribute at least 90% of its taxable income to shareholders in the form of dividends.
Further, a BDC must make significant managerial assistance available to its client companies. In fact, BDCs often take equity interests in their client companies, which creates the opportunity for the BDC to rack up capital gains when it liquidates those positions. BDCs can qualify for additional tax breaks (lower federal excise taxes) when they distribute at least 98% of ordinary income, plus 98% of any realized capital gains, to shareholders as dividends.
My comments: BCD’s don’t usually fare well during severe market stress like a financial melt down or during outsized business failure rates. They do offer juicy cash flow and dividends when the cycle is favorable.