The Income Engine You’re Probably Ignoring: Why Business Development Companies Deserve a Spot in Your Portfolio

As an income investor, you have very few choices to find safe, consistent income in today’s market. Treasury yields barely cover inflation. Dividend aristocrats are overpriced. And bond funds? They bleed when rates rise.

But there’s a corner of the market quietly throwing off 8%–12% annual yields—backed by real businesses.

If you’ve never looked into Business Development Companies (BDCs), now’s the time. In this article, you’ll learn how they work, how they fit into a sophisticated investor’s strategy, and which pitfalls to avoid.

What Are Business Development Companies—and Why Do They Exist?

Before you invest a dime, it’s crucial to understand what a BDC actually is.

BDCs were created by Congress in 1980 to provide capital to small and mid-sized U.S. businesses. These companies were struggling to get funding after the recession in 1970s. Business Development Companies are structured like closed-end investment funds but are regulated under the Investment Company Act of 1940.

Business Development Companies lend capital to fund small and mid market companies. BDCs in turn are funded with equity and debt. They are required to distribute 90% of taxable income to the shareholders, just like REITs. In turn, the investment income is not taxed at the corporate level.

How BDCs Deliver Outsized Dividends

The high yields aren’t magic—they’re built into the business model of the Business Development Companies.

BDCs act as middlemen. They borrow at low rates and then turn around and lend it to the funded companies at high rates. Most BDCs use leverage and floating-rate debt to enhance returns.

As a funding source, Business Development Companies can issue loans that earn interest, derive income from fees and at times they take equity in the funded companies. Most BDCs payout to the shareholders in the range from 8-12%. The distribution is made either on a monthly or on quarterly schedule.

You can compare BDCs to Venture Capital – your returns will only be as good as the management that is managing the portfolio of businesses. It is important to review the pedigree of the BDC you want to invest in.

The Tax and Regulation Edge: Why the IRS Works in Your Favor

High income usually means high taxes—unless the IRS wrote the rules in your favor. Business Development Companies tend to be tax efficient in that the income is only taxed once – at the investor’s rate. The company itself avoids corporate income tax by distributing 90% of the profits.

Distributions are taxed as ordinary income. To minimize your personal tax liability, you may want to invest in BDCs in your IRA or tax-deferred accounts. Please note that some distributions may include return of capital, or capital gains, depending on the structure of the company. BDCs issue the form 1099 to the investors unlike MLPs who issue K-1s.

Risks Lurking Beneath the Surface (and How to Manage Them)

No investment is perfect. And if you chase yield blindly, you’ll get burned.

• External vs internal management: how incentives affect performance. Internally managed BDCs hire their own management team, have employees and overhead. As a result, there will be operational expenses to cover. Externally managed BDCs pay a fee to experienced investment managers to manage the portfolio. Generally, the expense ratios are higher for the externally managed BDCs. However, if the internally managed BDCs offer stock based compensation to its executives, there is a possibility to dilute the shareholders.
• NAV erosion from poor underwriting or excessive dilution. Most BDCs make secondary equity offerings on a regular basis to raise funds for new investments. These offerings dilute existing shareholders. Poor underwriting dilute shareholders unnecessarily without a commensurate return to show for it.
• Sector and borrower concentration risk. Business Development Companies may specialize in a sector or may end up overweight a few companies. This creates a concentration risk. Investors should be aware of this possibility so they can take steps to mitigate this risk.
• Use of leverage amplifies both gains and losses. Business Development Companies can and do lose money on investments. With leverage, these losses can become significant.
• Rate sensitivity—floating-rate loans help in rising rate environments, but watch refinancing risk.

Just like any other investment, it is important to understand how these entities work so you will be prepared and avoid any surprises.

How BDCs Fit in a Modern Income Strategy

Business Development Companies generate high yield. If you invest for income, this is an important asset class for you to consider. You don’t need to go all-in to benefit. Here’s how to slot them into a smart portfolio.

You can pair them with CEFs, covered call ETFs, and dividend stocks in an Income Factory framework. Alternatively, certain dividend income portfolios include BDCs due to many of them being monthly payers. This allows for a predictable income stream and more frequent reinvestment and compounding.

When you invest in BDCs, carefully consider your allocation, diversify across different BDCs and consider using limit orders if liquidity is low. Also keep an eye out on the yield changes. Often the BDCs like to maintain a stable distribution, but their own income can be very variable. There are times when a BDC may need to cut their dividend.

Top Business Development Companies to Put on Your Radar

You don’t have to sift through the entire sector. Here are some of the better regarded BDCs in the market.

• Ares Capital (ARCC): internally managed, diversified, strong track record.
• Main Street Capital (MAIN): monthly payer, conservative underwriting. I like MAIN and it has been an integral part of my income factory portfolio.
• Owl Rock Capital (OBDC): high yield, large asset base.

Before you invest in any BDC, review its NAV and distribution history, management team and insider ownership. Also review the types of investments the company makes and how sensitive it is to the interest rates. Alternatively, if you want an exposure to Business Development Companies, but do not wish to spend time and effort researching individual names, you can purchase an ETF like BIZD. It will keep things simple and give you instant diversification. On the other hand, it will contain weaker names that may not do well, and may be more expensive as there are additional fees to consider.

Conclusion: It’s Time to Give BDCs a Closer Look

You don’t need to overhaul your portfolio to benefit from BDCs. A small, well-researched allocation can significantly boost your income, particularly in accounts where tax-efficiency matters. If you’re serious about building a reliable income stream—and want more control than bonds or high-yield ETFs offer—this overlooked asset class might be the secret weapon your portfolio’s been missing.