The U.S. Securities and Exchange Commission has updated rules on Business Development Company co-investment transactions, relaxing restrictions on BDCs and their affiliates, and allowing them to invest more easily in small and medium-sized businesses. The guidance removes roadblocks to those investments, so different types of BDCs will be able to operate on more even footing.
"BDCs have had restrictions when they have a registered investment adviser, as far as limited partners that are in a private fund that they advise being prohibited from investing in deals that the BDC is doing," says Brett Palmer, president of the Small Business Investor Alliance. The alliance is a group of lower middle-market private equity funds and investors.
The SEC's December guidance update involves the Investment Company Act of 1940, which restricts transactions between investment companies regulated under the act, including BDCs.
"If you were structured as a C corporation, it was allowed. But if you had a general-partner/limited-partner structure, it wasn't allowed," Palmer says. "This clears up a bit of BDC arcana, and makes the rules consistent for all BDCs."
Before the guidance update, for limited partners to co-invest with BDCs when they had the same registered investment adviser, they would need SEC exemptive relief. That process required filing documents with the SEC, which would decide on a case-by-case basis if it would allow a co-investment.
The Act distinguishes between transactions involving "close affiliates" and "remote affiliates." Before the guidance update, private funds structured as a GP/LP partnership were considered a close affiliate of the BDC because of the mutual registered investment adviser, and they were therefore not allowed to co-invest without exemptive relief from the SEC.
Under the new guidance, those LPs will be able to co-invest with the BDC as long as there is board approval the LP has between 5 percent and 25 percent of the private fund's outstanding voting securities.
The news represents a small step forward for the Small Business Investor Alliance, which is trying to achieve regulatory modernization for BDCs.