The Death of the Stretch IRA: Surviving the SECURE Act’s 10-Year Rule
Business Development Companies (BDCs): How to Earn 10% Yields from Private American Business
COACHING POINTS
- The Mechanism: Just as REITs allow you to own real estate without buying a building, BDCs allow you to act as a “Commercial Bank” without opening a branch. They lend money to private middle-market companies ($10M-$100M EBITDA) and pass the interest income directly to you.
- The Tax Loophole: BDCs are Regulated Investment Companies (RICs). As long as they distribute 90% of their taxable income to shareholders, they pay zero corporate income tax. This avoids “double taxation,” resulting in massive dividend yields (often 8-12%).
- The Rate Hedge: Unlike regular bonds that crash when interest rates rise, BDC loans are typically “Floating Rate” (Senior Secured). When the Fed raises rates, the interest payments from borrowers increase, boosting your dividend.
After the 2008 Financial Crisis, big banks (JPMorgan, BofA) stopped lending to smaller companies due to regulations.
Business Development Companies (BDCs) stepped in to fill the void.
By investing in a BDC, you are essentially becoming a “Shadow Banker,” collecting high interest rates from the backbone of the American economy.
Source: Small Business Investment Incentive Act of 1980
Why BDCs yield so much more than regular corporations.
- Standard Corp (C-Corp): Earns $1.00 profit. Pays $0.21 tax. Net $0.79. Distributes 30%.
Dividend to You: $0.24. - BDC (RIC Structure): Earns $1.00 profit. Pays $0.00 tax (if 90% distributed).
Dividend to You: $0.90+. - The Alpha: By removing the IRS from the corporate level, the distributable cash flow nearly quadruples compared to a standard dividend stock.
What-If Scenario: Interest Rate Spike (0% to 5%)
Comparison: Standard Bond ETF (AGG) vs. Top-Tier BDC (e.g., ARCC).
| Asset Class | Asset Structure | Impact of Rates Rising |
|---|---|---|
| Aggregate Bond ETF | Fixed Rate Loans | Price Crashes (Duration Risk). Yield stays fixed. |
| Business Dev. Co (BDC) | Floating Rate Loans | Income Rises. Borrowers pay more interest. Special dividends often declared. |
Result: In the 2022 rate hike cycle, bonds collapsed (-13%), while many BDCs generated record net investment income because their loan books re-priced upwards.
Visualizing the Yield Spread
| Asset Class | Average Annual Yield (%) |
|---|---|
| S&P 500 | 1.5 |
| REITs (Real Estate) | 4.5 |
| High Yield Bonds (Junk) | 6.5 |
| BDCs (Private Credit) | 10.5 |
*BDCs offer the highest yields in the public markets because they lend to private companies at high rates (SOFR + 6~7%) and pass that income directly to shareholders.
Execution Protocol
The dividend must be sustainable. Ensure the BDC’s NII (operating profit from loans) is > 100% of the dividend payout. If NII coverage is 80%, a dividend cut is imminent.
Not all BDCs are safe. Some invest in risky equity or “Mezzanine” debt. Stick to “Blue Chip” BDCs (like Ares, Blue Owl, Blackstone) where 80-90% of the portfolio is “First Lien Senior Secured” debt. This means if a borrower goes bust, you get paid first.
Since BDC dividends are taxed as Ordinary Income (not qualified dividends), they are highly inefficient in a taxable account. Always hold BDCs in an IRA or 401(k) to shelter the massive yield from taxes.
COACHING DIRECTIVE
- Do This: If you are an income-focused investor (retiree) looking for double-digit yields to beat inflation.
- Avoid This: If we are entering a deep recession (Hard Landing). Middle-market companies are more vulnerable to bankruptcy than Apple or Microsoft. In a severe crash, BDC prices can drop 30-40%.
Frequently Asked Questions
What is a BDC?
A Business Development Company (BDC) is a type of closed-end investment company that invests in small and medium-sized businesses. They are publicly traded on stock exchanges (like NYSE/Nasdaq), offering liquidity to retail investors.
How is it different from a Bank?
Banks take deposits and make low-risk, low-yield loans (mortgages). BDCs raise investor capital to make higher-risk, higher-yield loans to private companies. BDCs are legally required to distribute profits, whereas banks retain them.
Why is the yield so high?
Two reasons: 1) The ‘Illiquidity Premium‘ of lending to private companies, and 2) The ‘Pass-Through’ tax structure that avoids corporate taxes. However, high yield implies higher credit risk.