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New BDC Opportunities

The impact of the Small Business Credit Availability Act

TECHNICAL

After years of intense regulatory and legislative efforts, the business development company (“BDC”) industry earned a potentially significant win in the form of the Small Business Credit Availability Act (“SBCAA”), which was included as part of the Consolidated Appropriations Act, 2018 (“Omnibus Spending Bill”) passed by Congress on March 23, 2018. The SBCAA enacts a number of meaningful legislative reforms with respect to BDCs — closed-end investment companies regulated under the Investment Company Act of 1940 (“1940 Act”), that generally invest in the debt, and to a lesser extent equity, of primarily U.S.-based, nonpublic middle-market issuers.

Specifically, the SBCAA impacts BDCs in two fundamental ways. First, it significantly increases the ability of BDCs to utilize leverage to acquire investments by modifying the asset coverage requirements applicable to BDCs under the 1940 Act (“Leverage Reform Provisions”). Second, it directs the SEC to implement regulations enabling BDCs to follow the more lenient reporting requirements and communications restrictions under the Securities Act of 1933, as amended (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) applicable to traditional public operating companies, including with respect to incorporation by reference and the use of free writing prospectuses (collectively, “Securities Offering Reform Provisions”).

These changes will likely have a significant impact on BDCs going forward, though the impact may differ materially between existing publicly traded BDCs and newly formed non-traded BDC structures, including the increasingly popular “private” BDC structure, which mimics a traditional private credit fund capital call model but utilizes a 1940 Actregulated BDC vehicle. In particular, as a result of certain conditions that must be met under the Leverage Reform Provisions, existing BDCs — particularly publicly traded ones — will likely face some headwinds in taking advantage of the looser leverage limits under the 1940 Act. However, newly formed BDCs, as well as private BDCs that may only have a relatively small number of stockholders, may more easily meet the requirements to permit a reduction in the required asset coverage ratio under the 1940 Act. In contrast, many of the most useful sections of the Securities Offering Reform Provisions, including with respect to incorporation by reference and automatic effectiveness of shelf registration statements, will only apply to publicly traded BDCs.

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