Let's talk about business development companies today. For the record, I love BDC's. They are banks on steroids with a lot less regulation.

BDC’s have been around since an amendment to the 40-act bringing them into being was passed back in 1980. A BDC must invest at least 70% of its assets in nonpublic US companies with a market value of less than $250M. 90% of cash flows have to be paid out to shareholders to avoid taxation at the corporate level.

BDC's can invest in any level of a company's capital structure, but debt has been the most popular strategy. From experience, I can tell you that when raising money from John Q. Public, a fat dividend makes the sales pitch a lot easier.

BDC's allow individual investors to invest in small to midsize private companies, much like private equity and venture capital funds are able to do. Often the loans they make will have some form of equity participation so we can collect fat interest checks and have some exposure to the potential upside of the business.

BDC's came into their own in the aftermath of the Great Financial Crisis of 2008-2009. Banks decided-or in many cases, were forced to -step away from riskier types of corporate lending, especially in the smaller company segment of the market. Banks were out of the buyout, and early-stage lending to growth businesses and BDC's stepped up to fill that void.

2021 should be a strong year for well-managed BDC's. The economy should continue to open, and we should see some of the service businesses begin to open as more of us are vaccinated. Margins should move higher as the fed keeps a lid on short rates and long rates drift higher as the economy recovers.

Already in 2021, we have seen BDCs raise about $2.7 billion at very low rates.

As an example, Golub Capital (GBDC) just issued 6-year bonds at 2.50% and obtained a new senior credit facility at one month LIBOR +1.5% to start. At the moment, that is about 1.61%.

Now lend that cash out at 8% and lever it by 50%, and you begin to see just how vital locking in low rates can be for BDC's.

Let's look at the best BDC's to hold for the long term. Business development companies have a history of working what private equity firms to source deals. Many of the investments look a lot like private equity transactions once you factor in the equity participation that is added into many of the loans.

With that being the case, why don't we just go straight to the BDC's sponsored by or affiliated with private equity firms?

FS/KKR II is a BDC that is co-managed by FS Investments and KKR Credit (KKR). FS Investment is a firm that specializes in bringing alternative strategies usually only available to large institutions to the public. KKR Credit is a division of one of the largest and top-performing private equity firms of all time. KKR has borrowed and lent billions of dollars for its portfolio companies, so I think they know a little something about middle-market lending.

FS/KKR II is merging with FS/KKR I to BDC's to create a single fund with over $14 billion in assets. The increased scale will give the new giant BDC access to capital markets on more favorable terms and create cost-savings. The new fund will also lower the fees t chares investors by a significant amount.

Management has indicated the new dividend yield will be 9.5% on the new BDC's net asset value. Based on the projected NAV of $24.46 when the merger closes, that will be an annual payout of $2.32.

That’s a yield of over 13%.

There is also an upside to NAV of over 30%.

Once the deal is done, a $100 million buyback program will be instituted.

You could buy either BDC here, but FS/KKR II has more firepower available for investment right now and a little less leverage. I doubt there will be any problems closing the merger, but just in case there is, I would prefer to walk away owning FS/KKR II.

The combined entity will be the second-largest Business Development company in these here United States.

You should also own the largest. Ares Capital Corporation (ARCC) is affiliated with Ares Management (ARES), an alternative credit and private equity firm that has achieved enormous success in private markets.

The BDC has also done very well for its investors with double-digit returns over the last decade.Since their IPO in 2004, Ares Capital has invested about $63 billion with a Gross Internal rate of return (IRR) of 14.3$%. You would have beaten the index by about 50% if you had bought the IPO and just hung onto Ares Capital shares.

These guys are very good at making money in private credit, and this BDC gives you a chance to share the wealth they create.

They are even better at not losing money as they have one of the lowest loan loss rates of any leveraged lender. First Lien Loan losses are .10 % of loans, and second lien loans are just .20%. That's about 10% of the industry averages for both classes of loans.

Ares is in outstanding financial shape with in-depth access to capital. They are one of the few business development companies to achieve an investment-grade rating from all three major credit agencies.

Ares Capital trades right around NAV right now and has a yield of 8.87%.

You can buy FS/KKR almost with abandon at current levels. I expect the market to look at the combined BDC's very favorably, and we will see the price slide up towards NAV. In the meantime, you will be paid handsomely to own the shares.

With ARCC, it's probably best to buy a little bit and then, as Henry McVey of KKR advises, look to lean into disruption in equity and credit markets to build a larger position.

That’s BDC’s from the private equity side of the building. Next week, unless something outrageous happens, we will look at BDC’s with more of a venture capital spin to their investing strategy.