BDC Basics by SoberLook

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									                          January 30, 2013




BDC Basics:
What Every New BDC Must Know Before
Launching
    BDC Basics


    • Part I: History and Overview of the BDC Model

    • Part II: Regulatory and Reporting Requirements

    • Part III: Management and Operational Considerations

    • Part IV: BDC Structures




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            Part I:
    History and Overview
     of the BDC Model




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    Overview

    •   Created by Congress in 1980 to promote financing to small, growing
        businesses.
    •   Special type of closed-end fund regulated under the Investment
        Company Act of 1940 (the “1940 Act”):
             Provides small, growing companies access to capital
             Enables private equity funds to access public capital markets
             Enables retail investors to participate in the upside of pre-IPO investing with complete
              liquidity
             Traditional listed BDC may sell to all retail investors
             Non-listed BDC enables accredited retail investors to participate in the upside of pre-
              IPO investing, but with limited liquidity

    •   Typically structured as Regulated Investment Company (“RIC”) for tax
        purposes
    •   Hybrid between an operating company and an investment company


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    Benefits of the BDC Model

    •   Access to public capital markets

    •   Shares may be traded on national exchanges

    •   Flow-through tax treatment as a RIC

    •   Reduced burden under 1940 Act, as compared to registered closed-end funds
             Restrictions on leverage
             Restrictions on affiliated transactions

    •   External model permits management fee and “carried interest” incentive fee
        structure

    •   Publicly available financial information through quarterly reporting

    •   Portfolio is diversified to comply with RIC tax requirements
             Reduces risk typically associated with private equity investments




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    How the BDC Market Developed

         •   Prior to 2003, the largest BDCs were primarily internally managed.
                  Choice reflected the success of the internally managed, income producing BDC
                   model.

         •   In 2004, Apollo Investment Corporation raised $930 million in less than three months
             which ignited the growth in the BDC industry.
                  Shifted the industry focus to the externally managed model


         •   There has been a steady stream of BDC IPOs since that period.
                  10 IPOs completed since the beginning of 2011
                  7 pending registration statements at the SEC for traded BDCs
                  Many others exploring the model

         •   BDCs continue to access the capital markets, and since 2012 have raised:
                  Approximately $3.6 billion in follow-on equity transactions
                  Approximately $1.1 billion in convertible debt offerings
                  Approximately $1.6 billion in retail debt offerings

         •   Today, BDCs have approximately $37 billion in assets as of January 25, 2013


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    Typical BDC Structure




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            Part II:
       Regulatory and
    Reporting Requirements




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    How Does a Company Become a BDC?


    •   Organize the BDC as a Delaware or a Maryland corporation
    •   Register a class of securities under the 1934 Act
    •   Make an election to be a BDC- file a Form N-54A (Notification of
        election to be subject to sections 55 through 65 of the 1940 Act)
    •   Register a class of securities on Form N-2
    •   List securities on the New York Stock Exchange (NYSE), the
        Nasdaq Stock Market, Inc. (Nasdaq), or the NYSE MKT, or the
        BDC can be a non-traded BDC
    •   Comply with the Sarbanes-Oxley Act of 2002 and Dodd-Frank Act
    •   Comply with regulatory requirements of the 1940 Act



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     “Good” vs. “Bad” BDC Assets

     •   A BDC must invest 70% of its assets in “good” BDC assets.

     •   70% basket includes securities issued by an “eligible portfolio company,” as
         defined in Section 2(a)(46), which includes:
              U.S. issuers that are neither an investment company as defined in section 3 (other than
               a wholly-owned SBIC) nor a company which would be an investment company except
               for the exclusion from the definition of investment company in section 3(c) and
                  (i) do not have any class of securities listed on a national securities exchange; or
                  (ii) have a class of securities listed on a national securities exchange, but have an
                     aggregate market value of outstanding voting and non-voting common equity of
                     less than $ 250 million.

     •   A BDC can generally invest with flexibility in “bad” assets that do not fall within the
         “70% basket”.
              The SEC Staff has never been called upon to consider whether utilizing a specific
               strategy for the entire “30% basket,” e.g., investing solely in foreign companies, might
               run afoul of the intent of Section 55(a)




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     What are BDCs Investing In?

      • Entire spectrum of securities issued by public and private
        companies, including:
          • Debt

          • Equity

      • Typically:
          • Small to middle-market U.S. companies

          • Carry a rating below investment grade “BBB-” by Standard &
            Poor’s Corporation

      • Note: This asset class is not typically available to retail investors




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     Investing Across the Capital Structure




            Higher
              Balance Sheet        Senior Secured Debt

                                Second Lien Secured Debt

                              Mezzanine Debt & Equity Warrants

                                     Preferred Equity
            Lower
                                     Common Equity




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     Limitations on Borrowings

     •   BDCs must have 200% asset coverage (Total Assets/Total Debt).
              For example, a BDC with $50 in equity can borrow up to $50
              A BDC would be able to invest $100 in growing businesses

                                                 $50
                             $50                 Debt
                            Equity                $50
                                                 Equity



     •   Other investment companies are restricted to a 300% asset coverage requirement
         with respect to issuing debt.

                                                 $25
                             $50                 Debt
                            Equity                $50
                                                 Equity


     •   BDCs may exclude leverage at the SBIC level if the SEC grants exemptive relief,
         which many have received.
     •   Legislation currently pending in Congress that would increase the amount of funds
         BDCs may borrow by reducing the asset-to-debt coverage requirement from 2:1 to
         1.5:1
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     Limitations on Transactions with Affiliates

     •   Section 57 addresses the ability of BDCs to engage in certain types of
         transactions with affiliates:
              Section 57 is less onerous than its counterpart for registered investment companies
               (Section 17).


     •   Depending on the nature of the affiliation with the BDC, transactions involving a
         BDC and one or more of its affiliates require either:
              Authorization by the required majority of the board of directors, which consists of a
               majority of the board, including a majority of disinterested board members; or
              An order of the Commission.


     •   Co-investment between a BDC and an affiliated fund generally requires SEC
         exemptive relief
              Mass Mutual exception (i.e., no terms negotiated other than price)




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     1940 Act Requirements

     •   BDC must have a majority of independent directors - persons who are not
         “interested persons” as defined in Section 2(a)(19) of the 1940 Act.

     •   Custodian Agreement
              A BDC generally must place and maintain its securities and similar investments in
               the custody of a bank qualified under Section 26(a)(1) of the 1940 Act or a broker
               dealer, or be subject to additional audit and operational procedures related to
               securities held in safekeeping.


     •   Fidelity Bond
              A BDC must maintain a bond issued by a reputable fidelity insurance company, in
               an amount prescribed by the 1940 Act, to protect the BDC against larceny and
               embezzlement. The bond must cover each officer and employee with access to
               securities and funds of the BDC.


     •   Requirement to maintain and enforce a Code of Ethics for officers of the
         BDC
              Includes reporting of all securities holdings and transactions.



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     1940 Act Requirements (cont.)

     •   Restrictions on investing in other investment companies. May not invest:
              In more than 3% of the outstanding voting stock of a registered investment company or
               BDC; or
              More than 5% of the value of its total assets in a registered investment company or
               BDC; or
              More than an aggregate of 10% of its total assets in registered investment companies
               or BDCs.

     •   Restrictions on investment funds investing in a BDC.
              Neither a public (i.e. registered) or private investment fund may own more than 3% of
               the outstanding voting stock of a BDC

     •   Limitations on indemnification.
              A BDC is prohibited from protecting any director or officer against any liability to the
               company, or its security holders, arising from willful misfeasance, bad faith, gross
               negligence or reckless disregard of the duties involved in the conduct of such person’s
               office.

     •   Bookkeeping and records requirements.
              A BDC must maintain and make available for inspection prescribed books and records.

     •   BDCs must make available significant managerial assistance to their portfolio
         companies.

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     1940 Act Requirements (cont.)

     •   Must appoint a chief compliance officer.

     •   Must maintain a compliance program compliant with Rule 38a-1 of the 1940
         Act, which requires:
              Adoption and implementation of policies and procedures designed to prevent
               violation of the federal securities laws.
              Review of these policies and procedures annually for their adequacy and the
               effectiveness of their implementation.


     •   Compliance polices and procedures for the registered investment adviser under
         Rule 206(4)-7 of the Investment Advisers Act of 1940.
              Requires an investment adviser of a BDC to adopt and implement policies and
               procedures.
              Requires maintenance and enforcement of a code of ethics for advisor’s employees.


     •   Subject to regular examinations by the SEC.




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     Other Important Limitations

     •   BDCs are not permitted to sell shares below net asset value without shareholder
         approval
              Approval must be obtained annually
              Markets have imposed limitations on how much an BDC can sell below NAV


     •   BDCs may seek to receive an SEC order granting exemptive relief permitting,
         among other things:
              Co-investment among affiliates
              Ownership of a registered investment adviser
              Exclusion of leverage from the asset coverage calculation for debt held by an SBIC
               subsidiary
              Issuance of restricted stock to officers / employees
              Issuance of stock options to independent directors


     •   Exemptive relief process may take from 6 – 18 months depending on complexity
              Typically based on precedents




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     SEC Reporting Requirements for BDCs

     •   Form 10-K (Annual Report)

     •   Form 10-Q (Quarterly Report)

     •   Form 8-K (Current Report)

     •   Proxy Statements

     •   Sections 13 and 16 Filings
              Forms 3, 4 or 5 for reporting beneficial ownership by insiders
              Schedules 13D and 13G for reporting beneficial ownership by others

     •   Regulation G and Regulation FD

     •   Comply with the Sarbanes-Oxley Act of 2002

     •   Disclosure Controls and Procedures

     •   Internal Control over Financial Reporting/Attestation



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     Financial Statement Disclosures

     •   Consolidation of subsidiaries vs. portfolio companies

     •   Valuation policy, including description of valuation process and methodologies

     •   Control investments, investments in affiliates, and investment in non-affiliates

     •   Schedule of investments
              Disclose non-income producing investments
              Disclose assets held in securitized vehicles
              Interest rate and maturity date on debt investments


     •   Fair value and Level 3 reconciliation tables

     •   Concentration – Geography and industry sectors




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     Exchange Listing Standards

     •   BDCs that have their securities listed or traded on NASDAQ or NYSE must
         comply with the corporate governance listing standards, including, among other
         things:
              A listed BDC must have an audit committee composed solely of “independent
               directors” (as defined by the applicable exchange or association).


              Director nominees of a listed BDC must be selected or recommended for the Board’s
               selection by a nominating committee or the vote of a majority of the BDC’s
               independent directors (depending on the exchange).


              The non-management, or “independent directors”, of the BDC must hold regularly
               scheduled executive sessions.


              The BDC must adopt a code of business conduct and ethics, various committee
               charters and, in the case of NYSE-listed BDCs, corporate governance guidelines.
                  All such documents must be posted on the company’s website.




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              Part III:
         Management and
     Operational Considerations




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         Internally Managed Structure

     •    BDC is managed internally by executive officers (i.e., no external adviser)
               9 of the 39 actively traded BDCs are internally managed

     •    Must comply with SEC executive compensation disclosure requirements

     •    Certain performance-based compensation is permitted, including:
               Issuance of at-the market options, warrant, or rights pursuant to an executive
                compensation plan; or
               Maintenance of a profit sharing plan

     •    Otherwise, the BDC must use cash assets as compensation

     •    Exemptive orders permitting the issuance of restricted stock have been issued in a
          number of circumstances including:
               Hercules Technology Growth Capital
               MCG Capital Corporation
               Main Street Capital Corporation




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     Externally Managed Structure

     •   Portfolio managed by external investment adviser
             30 of the 39 actively traded BDCs are externally managed


     •   Investment adviser of a BDC must be registered under the Advisers Act

     •   May utilize an external administrator for expense reimbursement purposes

     •   Adviser is permitted to charge a base management fee, as well as an incentive
         fee on both:
             Investment income
             Realized capital gains


     •   Contrasts with most registered closed-end funds, which are typically prohibited
         from taking an incentive fee on capital gains

     •   Incentive fees are often subject to hurdle/catch-up features



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     Portfolio Considerations

     •   Composition of the portfolio will impact trading characteristics

     •   Debt securities – senior, mezzanine, or unitranche (a blended-rate security
         representing both senior and mezz debt)
              May generate current income
              May reflect unrealized depreciation if asset becomes non-performing
              May generate “paid in kind” (PIK) or other non-cash income that must be distributed


     •   Equity securities – preferred, common, warrants, or rights
              May generate capital gains or losses
              May reflect unrealized appreciation or depreciation


     •   Industry focus
              Technology
              Energy




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     Calculation of Adviser’s Incentive Fee

     •   SEC Staff has taken no formal position on the calculation of the fee but requires
         BDCs to include extensive disclosure in registration statements regarding the
         manner in which the fee will be calculated in varying scenarios.

     •   Section 205(b)(3) of the Advisers Act permits external investment advisers to
         BDCs to receive incentive fees, provided that the BDCs do not have outstanding
         any equity-based compensation arrangement or profit-sharing plan.
              Section 205(b)(3) provides an exception from the general prohibition on an investment
               adviser charging an incentive fee based on a share of capital gains.
              May assess an incentive performance fee of up to 20% on a BDC’s realized capital
               gains net of all realized capital losses and unrealized capital depreciation over a
               specified period.


     •   Section 205(b)(3) of the Advisers Act makes no reference to whether the
         unrealized capital depreciation by which the fee must be reduced includes:
              Only depreciation below the original cost of the security in question, or
              Whether it includes a decrease in value in a security above the original cost but below
               the point of a previous unrealized capital appreciation.



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     Portfolio Valuation Process

     •   Investments are reported at fair value, as determined in good faith by the board
         of directors.

     •   ASC 820 – Fair Value Measurements and Disclosures (formerly FAS 157).

     •   “Fair value” – Price that would be received to sell an asset or paid to transfer a
         liability in an orderly transaction between market participants at measurement
         date.

     •   Key Controls in the Valuation Process:
             Documented approval of trades
             Controls over inputs in valuation write-ups
             Segregation between preparation and review of valuations
             Identified and monitored problem loans
             High level analytical reviews
             Completeness of disclosures
             All controls evidence Sarbanes-Oxley 404 readiness




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     General Principles of Valuation

     •   Investments classified into three levels:
              Level 1: Inputs are unadjusted, quoted prices in active markets for identical financial
               instruments at the measurement date.
              Level 2: Inputs include quoted prices for similar financial instruments in active
               markets and inputs that are observable for the financial instruments, either directly or
               indirectly, for substantially the full term of the financial instrument.
              Level 3: Inputs include significant unobservable inputs for the financial instruments
               and include situations where there is little, if any, market activity for the investment.
               The inputs into the determination of fair value are based upon the best information
               available and may require significant management judgment or estimation.


     •   Majority of BDCs classify debt and equity investments as Level 3 instruments.

     •   Debt investments with broker quotes may be considered a Level 2 instrument
         (broadly syndicated loans).




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     Factors That Impact Valuation

     •   General Economic Factors
              Changes in interest rates and credit spreads and return on equity.
              Changes in aggregate demand level.
              Changes in economic outlook.

     •   Industry Factors
              Change in supply or demand for product.
              Change in competition.
              Barriers to entry.

     •   Company Specific Factors
              Current and expected life cycle of company – Achievement of milestones, company
               performance relative to projections.
              Experience and competence of the top management team and board of directors.
              Existence of intellectual capital and intangible assets.
                  Proprietary technology, products, or services.
                  Quality of work force.
                  Strategic relationships with major suppliers or customers.
              Cost structure and financial condition.


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     Compliance Considerations

     •   BDCs are regulated by the SEC’s Division of Investment Management

     •   Rule 38a-1 of the 1940 Act requires the BDC to have a comprehensive
         compliance program
            Oversight of compliance with all federal securities laws
            Quarterly testing and documentation intended to ensure program
             effectiveness
            Chief Compliance Officer reports directly to the board of directors
            Management expected to set tone at the top

     •   Rule 206(4)-7 of the Advisers Act requires the investment adviser to have a
         comprehensive compliance program

     •   SEC’s Office of Compliance, Inspections and Examinations have examination
         authority
            Risk-based exams may occur at any time – be prepared


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     Taxation as a RIC

     •   A BDC may elect to be taxed as a “regulated investment company,” or RIC, under
         the Internal Revenue Code.
              Allows “pass through” tax treatment for income and capital gains that are distributed to
               shareholders – no taxation at BDC.
              Must distribute at least 90% of its investment income to shareholders annually.
                May retain, distribute or “deem distribute” capital gains.
     •   Annually, at least 90% of gross income must be generated from investment
         company taxable income (generally interest, dividends and capital gains)
     •   Quarterly, at least 50% of assets (at fair value) must be:
              Cash, cash equivalents, or government securities
              Securities of other RICs
              Securities that, with respect to any one issuer, both (1) represents an amount 5% or
               less of the RIC’s total assets and (2) is not more than 10% of the outstanding voting
               securities of the issuer
     •   Quarterly, not more than 25% of the RIC’s total assets can be invested in:
              Securities of any one issuer (excluding other RICs or government securities)
              Securities of two or more issuers controlled by the RIC and engaged in the same trade
               or business
              Securities of qualified publicly traded partnerships

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        Part IV:
     BDC Structures




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     Types of BDC Structures

     •   Publicly-traded BDCs
              Listed on NASDAQ/NYSE
              Formed either as a blind-pool vehicle, or through the acquisition of an existing portfolio
               or conversion of SBIC funds
              IPO through traditional firm commitment underwritten offering


     •   Non-Traded BDCs
              Shares are not listed on any exchange
              IPO through continuous offering of shares up to preset maximum amount
              Liquidity offering through periodic repurchase offers
              Typically have fixed 5-7 year period before exchange listing or traditional IPO


     •   Private BDCs
              Shares are not listed on any exchange
              Shares are sold through private placement offering
              Intention to conduct IPO in near term
              Funding may be effected through a capital call model
              Generally no liquidity prior to a qualifying IPO

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     Publicly Traded BDCs




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     IPO Process Overview

     •   Typically 6 – 8 months to complete IPO depending on:
              Market Conditions
              SEC review process


     •   Consider formation / structuring issues
              Portfolio acquisition / manage any built-in gain
              Form of consideration

     •   Consider any necessary exemptive relief
              Co-investment with sister funds

     •   Prepare registration of investment adviser (if externally-managed)

     •   Develop compliance / corporate governance programs

     •   Establish independent Board of Directors

     •   Select service providers
              Public accountants, valuation assistance, custodian, etc.

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     IPO Process Overview (cont.)

     •   Organize the entity - typically as a Delaware or a Maryland corporation
     •   File an IPO registration statement on Form N-2 under the Securities Act
     •   Register a class of securities under the Exchange Act
     •   Apply to list securities on the NASDAQ or NYSE
     •   Make an election to be regulated as a BDC by filing a Form N-54A
     •   Have N-2 registration statement declared effective by the SEC
     •   Comply with regulatory requirements of the 1940 Act
     •   Comply with reporting requirements including the Exchange Act, Sarbanes-Oxley
         Act, etc.




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     Initial Portfolio Acquisitions

     •   Can start with or without an initial portfolio
              Market has generally favored vehicles with existing portfolios
              Some blind-pool vehicles have completed IPOs recently, though

     •   Initial portfolio can be acquired from an affiliated fund on a pre-IPO basis

     •   Considerations in connection with the acquisition of an initial portfolio:
              Consider required approvals at the private fund level
              Consider funding issues on a pre-BDC basis
                 Use of a bridge facility or notes
                 Equity may be issued, provided that no fund will hold greater than 3% of the BDC
                   post-transaction
              Consider tax implications
                 Timing and recognition of accrued but unrealized appreciation/depreciation in
                   initial portfolio

     •   Disclosure requirements for initial portfolio
              Typically an audited schedule of investments is required
              More fulsome financial statements may also be acquired in certain cases




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     Non-Traded BDCs




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     Development of Non-Traded BDCs

     •   REITs have successfully used the non-traded model for years.
     •   In January 2009, FS Investment Corporation launched the first non-traded BDC
              IPO of $1.5 billion and follow-on offering of $1.0 billion fully subscribed

     •   Eleven non-listed BDCs have launched public offerings (nearly $15.5 billion target
         fund size) and approximately four non-listed BDCs are in registration.
     •   Non-listed BDCs have collectively raised nearly $4.3 billion since 2008.
     •   Most of the non-traded BDCs combine an investment platform with an existing
         distribution network. For example,
              FS Investment Corporation, FS Energy and Power Fund and FS Investment
               Corporation II combines the distribution network of FS2 Capital Partners with
               investment personnel of GSO/Blackstone
              KKR Asset Management is the investment sub-adviser for Corporate Capital Trust,
               while CNL Fund Advisors serves as the dealer manager
              CION Investment Corp. combines the distribution network of ICON with the investment
               personnel of Apollo
              HMS Income Fund combines the distribution network of Hines with the investment
               personnel of Main Street
              Sierra Income Corp. combines the distribution network of SC Distributors with the
               investment personnel of Medley



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     Non-Traded BDC Structures

     •   A Non-Traded BDC enables retail investors to receive stable income and
         potentially receive capital appreciation in the event of a liquidity event, such as a
         listing, liquidation or merger.
              Shares not listed on any exchange
              Raise capital through continuous private offerings
              Eliminates price volatility through the ability to adjust net offering price so that it remains
               at or below NAV
              Limited liquidity
                  Most Non-Traded BDCs have a mechanism that provides liquidity after a certain
                     holding period (such as periodic repurchase offers to their shareholders)
              Subject to the individual state registration requirements for public offerings

     •   All the non-traded BDCs that are currently offering and in registration are
         externally managed




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     Additional Characteristics of
     Non-Traded BDCs
     •   Suitability requirements
              May only be sold to investors that meet certain state suitability requirements

     •   FINRA review

     •   State blue sky review
              Must be approved to sell securities in each state where solicitations will occur, requiring
               compliance with the “Omnibus Guidelines” published by the National Association of
               State Securities Administrators (“NASAA”)
              Completing blue sky process can take up to a year

     •   Continuous offering over a period of time
              497 is filed periodically to report sales, update portfolio and keep prospectus current

     •   Liquidity Event
              Typically complete liquidity event within five to seven years following completion of
               offering
              Liquidity event could include: (1) sale of all or substantially all of company’s assets
               either on a complete portfolio basis or individually followed by a liquidation, (2) listing of
               company’s common shares on a national exchange, or (3) merger or another
               transaction approved by company’s board of directors in which shareholders receive
               cash or shares of a publicly traded company


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     Additional Characteristics of
     Non-Traded BDCs (Con’t)

     •   Redemptions/Repurchases
              Non-listed issuers typically offer to redeem or repurchase portion of outstanding
               shares on quarterly basis
              Periodic tender offers by closed-end funds, including BDCs, excepted from Regulation
               M under the Securities Exchange Act of 1934 if made at net asset value or if the
               comply with Rule 23c-3 of the Investment Company Act of 1940
              REITs received class exemption from Regulation M from the SEC for certain
               redemption plans
                  BDCs may receive similar relief




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     NASAA Omnibus Guidelines:
     Compliance with “Blue Sky Laws”
      •   Sponsor Requirements
               Sponsor must have adequate experience and net worth
               Limited indemnification of Sponsor, which may affect bylaws and/or charter of an issuer


      •   Suitability of Investors
               Default minimum suitability standards of either $70,000 gross income and $70,000 net
                worth or $250,000 net worth
               Enhanced suitability standards may be imposed by various states
               Minimum investment amounts

      •   Fees, Compensation and Expenses
               Sponsor’s compensation must be “reasonable”
                   For BDCs, compensation presumptively reasonable if limited to “participation in
                     net gains” of the issuer
                   For Sponsor providing services to the issuer, fees must be competitive as
                     compared to independent third-parties
               Offering document must estimate and itemize fees and expenses




43                                                                                 ©2013 Sutherland Asbill & Brennan LLP
     NASAA Omnibus Guidelines:
     Compliance with “Blue Sky Laws” (cont.)

     •   Conflicts of Interest
              Issuer may only invest in joint ventures or general partnerships with non-affiliates so long
               has “controlling interest”
              Issuer may only invest in joint ventures or general partnerships with affiliated entities
               provided there are no duplication of fees and each investor has right of first refusal to
               buy the affiliates’ interests in the venture
              Limited ability to invest in joint ventures or general partnerships with non publicly
               registered affiliates
              Multi-tiered arrangements permissible so long not designed to circumvent the
               Guidelines, there are no duplication of fees, no decrease in the voting rights of
               stockholders and the fiduciary obligations of the various parties are adjusted




44                                                                                      ©2013 Sutherland Asbill & Brennan LLP
     NASAA Omnibus Guidelines:
     Compliance with “Blue Sky Laws” (cont.)
     •   Rights and Obligations of Participants (i.e. Stockholders)
              10% holders have right to call stockholders meetings
              Majority approval of stockholders required to amend entity charter, dissolve the
               company, remove the Sponsor, elect a new Sponsor or approve the sale of substantially
               all of the assets of the company
              Stockholder right to inspect and copy the company’s records, including stockholder list
              Reports to stockholders (e.g.,10-Qs and 10-Ks)
              Distribution Reinvestment Plans (“DRPs”) may not charge sales commissions for shares
               issued under the DRP
                  Stockholders must be able to elect or revoke participation in the DRP
                  Stockholders participating in the DRP must receive “current” copy of the
                   prospectus each time shares under the DRP are issued
                  Broker-dealers responsible for ensuring participants in the DRP remain “suitable” to
                   invest in the issuer




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     Private BDCs




46                  ©2013 Sutherland Asbill & Brennan LLP
What is a Private BDC?

Capital Raise
•   Typically sponsored by large private equity firms with an existing investor base
          TPG Specialty Lending, Inc. registered on Form 10 and has raised approximately $360 million
           through private offerings.

•   Typically draws down capital via a capital call model, similar to a private fund
    structure
Private Offering
•   Shares are offered through a private placement offering to the sponsor’s
    existing investor base, rather than via a continuous public offering
•   Private placement structure eliminates need to be declared effective by each
    state in which offering shares
Regulatory Structure
•   BDC/RIC structure helps mitigate need for offshore feeder fund structure for
    foreign/tax exempt investors
Exit
•   Generally target an initial public offering and exchange listing, similar to the non-
    traded BDC structure
                                                  47                                   ©2013 Sutherland Asbill & Brennan LLP
     Private BDC Process

     •   Organize the entity - typically as a Delaware or a Maryland corporation
     •   Prepare a private placement memorandum and subscription agreement for the
         private offering
     •   File a registration statement on Form 10 to register a class of securities under
         the Exchange Act
             No registration statement on Form N-2 needs to be filed under the Securities Act

     •   Make an election to be regulated as a BDC by filing a Form N-54A
     •   Comply with regulatory requirements of the 1940 Act
     •   Comply with reporting requirements including the Exchange Act, Sarbanes-
         Oxley Act, etc.




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     SBICs




49           ©2013 Sutherland Asbill & Brennan LLP
     BDC SBIC Trends

     •   SBIC Subsidiaries
           Twelve BDCs have SBIC subsidiaries.
           Provides access to low-cost debt (a fully funded SBIC with $75
            million in regulatory capital can access up to $150 million in
            leverage from the SBA with an option for a second license for an
            additional $75 million).
               SBICs under common control can access up to $225 million in
                leverage, which Congress may increase to $350 million.
     •   Fund Formation
           Some BDCs are using BDCs as asset managers. The benefit of
            this structure is the fee income received.
     •   Fund Platforms
           Some BDCs are building a platform of funds that complement the
            BDC’s business.


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     Are There BDCs That Have SBIC
     Subsidiaries?

     •   Three (3) SBICs elected to become BDCs and conducted successful
         IPOs
                Main Street Capital Corporation / $64,500,000
                Triangle Capital Corporation / $71,550,000
                Fidus Investment Corporation / $70,050,000

     •   BDCs that have received an SBIC license for a wholly-owned
         subsidiary:
                Fifth Street Finance Corp.
                Hercules Technology Growth Capital, Inc.
                Medallion Financial Corp.
                MCG Capital Corporation
                PennantPark Investment Corporation
                Rand Capital Corporation
                Saratoga Investment Corporation
                OFS Capital Corporation
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                Golub Capital BDC, Inc.                         ©2013 Sutherland Asbill & Brennan LLP
     How Does an SBIC Convert to a BDC?


     •   Conversion Transaction
           Approval of LPs in advance of valuation and merger
           Merger of SBIC into subsidiary of BDC
           Amend limited partnership agreement
           SBA approval


     •   SEC Review
           Affiliate transaction issues
           Compensation issues
           Disclosure issues




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     BDC/SBIC Structure

     •   Exemptive Relief
     •   Relief to get SBIC leverage treatment at BDC level
     •   Section 18(a):
           Question of whether BDC with an SBIC subsidiary must comply
            with the asset coverage requirements of Section 18(a) (as modified
            by Section 61(a) for BDCs) on a consolidated basis.
           The senior securities issued by the SBIC Subsidiary would be
            excluded from the SBIC Subsidiary’s individual asset coverage
            ratio by Section 18(k) if the SBIC Subsidiary were a BDC.
           Exemption requested- senior securities representing indebtedness
            issued by the SBIC Subsidiary may be excluded from the BDC’s
            consolidated asset coverage ratio.
                The SEC regularly provides this exemptive relief, which
                 generally does not take as long as other forms of relief.


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     What are the Incentives for an SBIC to
     Convert to a BDC?

      •   Why Are BDCs Attractive to SBICs?
            Ability to access public market
            Flexibility in funding portfolio investments
            Permanent capital base
            Additional compensation incentives

      •   Why Are SBICs Attractive to the BDC Market?
            Existing portfolio – not blind pool
            Existing management team with track record
            Market niche – lower middle market
            Additional leverage capacity



54                                                          ©2013 Sutherland Asbill & Brennan LLP
Contact Information



            Steve B. Boehm                           Cynthia M. Krus
            Partner                                  Partner
            202.383.0176                             202.383.0218
            steven.boehm@sutherland.com              cynthia.krus@sutherland.com




            John J. Mahon                           Harry S. Pangas
            Partner                                 Partner
            202.383.0515                            202.383.0805
            john.mahon@sutherland.com               harry.pangas@sutherland.com



            For more information, please visit our practice site at
         www.publiclytradedprivateequity.com and our corporate site at
                            www.sutherland.com.


 55                                                              ©2013 Sutherland Asbill & Brennan LLP
     Disclaimer

        All Rights Reserved. This communication is for general informational purposes
        only and is not intended to constitute legal advice or a recommended course of
        action in any given situation. This communication is not intended to be, and
        should not be, relied upon by the recipient in making decisions of a legal nature
        with respect to the issues discussed herein. The recipient is encouraged to
        consult independent counsel before making any decisions or taking any action
        concerning the matters in this communication. This communication does not
        create an attorney-client relationship between Sutherland and the recipient.




56                                                                          ©2013 Sutherland Asbill & Brennan LLP

								
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