This practice note covers recent market trends affecting business development companies (BDCs), particularly focusing on various types of securities offerings undertaken by public and private BDCs. BDCs are closed-end investment management companies that are specially regulated by the Investment Company Act of 1940, as amended (the 1940 Act). BDCs provide capital to, and invest in, small and middle-market companies in the United States. As a result of this investment purpose, BDCs are exempt from certain regulatory constraints imposed by the 1940 Act on traditional investment companies and generally benefit from pass-through tax treatment (i.e., the entity is not taxed at the entity level and tax obligations pass to the owners of the entity). For additional information on BDCs, see Business Development Company Guide for Capital Markets, Business Development Companies, and Top 10 Practice Tips: Business Development Companies.

To be regulated as a BDC, a company must elect to be subject to the provisions of Sections 55–65 of the 1940 Act. Given the limited access to, and availability of, financing from traditional bank lenders for small- and medium-sized enterprises, BDCs have played an increasingly important role since the onset of the financial crisis as a source of capital to small- and mid-sized enterprises.

In addition to being subject to the 1940 Act, the securities issued by BDCs are typically also registered under the Securities Act of 1933, as amended (the Securities Act), and the Securities Exchange Act of 1934, as amended (the Exchange Act), and BDCs are subject to the registration and reporting requirements under those two regulatio

Notable Transactions

In July 2019, Owl Rock Capital Corporation (NYSE: ORCC), a BDC externally managed by an indirect subsidiary of Owl Rock Capital Partners LP, consummated an initial public offering (IPO). The IPO priced at $15.30 per share, raising approximately $153.0 million in gross proceeds for the BDC. Goldman Sachs & Co. LLC; BofA Securities, Inc.; RBC Capital Markets, LLC; SunTrust Robinson Humphrey, Inc.; and Wells Fargo Securities, LLC acted as joint book-running managers for the IPO. The BDC primarily invests in senior secured or unsecured loans, subordinated loans, and mezzanine loans. In connection with the IPO, the BDC's board of directors approved a stock repurchase plan to acquire up to $150 million of the BDC's common stock pursuant to a Rule 10b5- 1 plan. For further information on 10b5-1 plans, see Rule 10b5-1 Plans and 10b5-1 Plans Best Practices Checklist.

Deal Structure and Process

Initial Public Offerings

Recently, the number of BDC IPOs has stagnated and the private BDC has emerged as a popular alternative for sponsors seeking to access the BDC structure.

To undergo an IPO, a BDC must register its securities on Form N-2. The Form N-2 registration statement should describe the terms of the IPO (including the amount of shares being offered, underwriting arrangements, and price); intended use of proceeds, any risk factors associated with investing in a BDC; details about management of the BDC; and investment policies and objectives. In addition, the registration statement must include financial statements pursuant to the requirements in Regulation S-X.

In advance of its IPO, if a BDC has identified potential portfolio companies, but has not yet purchased such portfolio companies, the Form N-2 must still describe the BDCs general criteria for identifying portfolio companies and must also describe the identified portfolio companies generally. If a BDC owns securities of a particular portfolio company at the time of the IPO, then the registration statement must identify the portfolio company and also provide the following details:

  • The nature of the portfolio company's business.
  • The general terms as well as the amount of all loans given to the portfolio company.
  • The relationship of the portfolio company to the BDC. –and–
  • The class, title, and percentage of class and value of any securities of the portfolio company in possession of the BDC.

Shelf Offerings

The use of the Shelf Registration statement process has proven useful for publicly listed BDCs that trade at a premium to net asset value (NAV) for only a short, and typically unpredictable, period of time. An effective shelf registration statement enables a BDC to access the capital markets when needed or when market conditions are optimal. The shelf registration statement can be filed with the SEC and reviewed while the BDC is trading at a discount to its NAV and then can be used to conduct an offering of the BDC's shares when market conditions permit or following receipt of approval from its stockholders for below-NAV issuances. The typical SEC review process for an initial shelf registration statement takes approximately 30 to 45 days from the filing date. Takedowns from an effective shelf registration statement can then be consummated without SEC staff review or delay. For further information on shelf registration, see Shelf Registration and Top 10 Practice Tips: Shelf Registration Statements and Takedowns. For information on the SEC review process, see SEC Review Process and Top 10 Practice Tips: Responding to SEC Comment Letters.

The SEC generally limits the cumulative dilution to a BDC's current NAV per share that a BDC may incur while using a shelf registration statement to sell shares of common stock at a price below NAV. A BDC can complete multiple offerings pursuant to an effective shelf registration statement only to the extent that the cumulative dilution to the BDC's NAV per share does not exceed 15%. Once the cumulative dilution exceeds 15%, the BDC must file a post-effective amendment to the shelf registration statement or file a new shelf registration statement.

BDCs typically use shelf registration statements to issue debt and equity securities. Debt securities are issued by BDCs from time to time either in stand-alone offerings or as takedowns from a medium-term note program. For additional information on follow-on offerings and mediumterm note programs, see Follow-On Offerings Resource Kit, Top 10 Practice Tips: Follow-on Offerings, and MediumTerm Note (MTN) Programs. BDCs also frequently list their debt securities on a national securities exchange (such debt securities, which are aimed at retail investors, are referred to as baby bonds due to their small face amount). Equity securities are issued by BDCs from time to time either in follow-on offerings or in at-the-market (ATM) offerings as described in more detail below.

In October 2019, New Mountain Finance Corporation (NYSE: NMFC) completed an underwritten shelf offering of 9,200,000 shares of its common stock at a public offering price of $13.25 per share. The total included an aggregate 400,000 shares purchased by certain interested NMFC directors and officers. NMFCs investment adviser, New Mountain Finance Advisers BDC, L.L.C., paid a sales load of $0.41 per share to the underwriters in the offering. NMFC used the net proceeds from the offering for new investments in portfolio companies in accordance with its investment objective and strategies.

In January 2020, TriplePoint Venture Growth BDC Corp. (NYSE: TPVG) completed an underwritten shelf offering of 5,000,000 shares of its common stock at a public offering price of $14.08 per share. TPVG used the net proceeds from the offering to repay outstanding debt borrowed under its credit facility

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Originally published by Lexis Practice Advisor

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