Middle and Back Office Support Helps Business Development Companies Deal with Risks

In the aftermath of the 2008 financial crisis, banks became the subject of tighter industry regulation, media attention, and public scrutiny, all of which set limitations on their financing opportunities especially for mid-market companies. Rising in their stead are business development companies (BDCs), which are investment vehicles that raise capital particularly to fund small and middle-sized businesses.

But in this endeavor, BDCs face different kinds of risks. Here are three of them:

Leverage risk. To be able to fund businesses, BDCs first raise capital from such sources as corporate bonds, equity offerings, and convertible bonds. These borrowed funds compose majority of their investments, and the goal is for the gains from these investments to exceed the interest that their loans will incur. If the investment does not generate returns, the BDC will have to take losses.

Liquidity risk. BDCs are categorized as publicly traded companies, and are therefore considered liquid. However, the businesses they invest in are private, and are then not liquid. Through strategies like taking the company public through an IPO or facilitating a buyout, BDCs hope to make a profit and be able to settle their debt, distribute cash to their investors, and find more capital to invest. But within their portfolio, BDCs may find it hard to liquidate assets, and the longer the process takes, the more interests they must pay.

Interest rate risk. Finally, as entities that both borrow and lend, the best case scenario for BDCs is to find providers of long-term loans with low fixed rates, and small businesses willing to borrow short-term loans at variable rates. In reality, BDCs are subject to the volatile nature of the interest rates. The risk is that when they borrow to pay off their original loans and acquire more funds to invest, the rates have risen, making the capital now more expensive.

To deal with these risks, business development companies need to invest towards an infrastructure that promotes swift but informed decision-making, superior investor relations, and smooth operations in multiple market cycles.

Central to this infrastructure is a robust middle and back office, consisting of experienced personnel utilizing cutting edge technologies to handle recordkeeping, accounting, treasury, due diligence, and tax reporting cost-efficiently and under exacting standards. With their help, BDCs can easily evaluate and manage the risks that are inherent in their business, and satisfy the investment goals of their investor clients as well as their own.