Solid 8% Yield Investing In American Small Businesses: Gladstone

Solid 8% Yield Investing In American Small Businesses: Gladstone

ronniechua/iStock via Getty Images Quick Introduction to Business Development Companies (“BDCs”)

Business development companies (“BDCs”) invest shareholder capital in privately owned, small- and medium-sized companies most of which are American/U.S. (as a requirement of the BDC/RIC structure). BDCs aim to generate income and capital gains when the companies they invest in are sold, much like venture capital or private equity funds. Anyone can invest in BDCs as they are public companies, traded on major stock exchanges.

Similar to Real Estate Investment Trusts (“REITs”), Business Development Companies are regulated investment companies (“RICs”) required to pay at least 90% of their annual taxable income to shareholders, avoiding corporate income taxes before distributing to shareholders. This structure prioritizes income to shareholders (over capital appreciation), driving higher annual dividend yields that mostly range from around 6% to 11%. I firmly believe that higher-yield investments will become even more attractive in an inflationary and rising interest rate environment (as shown below) especially as investors are seeking additional income from invested capital.

This article compares two BDCs that I currently own, Gladstone Investment ( GAIN ) and Gladstone Capital ( GLAD ), both of which are managed by Gladstone Management Corporation. GAIN is a private equity fund focused on acquiring mature, lower middle market companies with attractive fundamentals and strong management teams. As a publicly-traded business development company, GAIN provides both equity and debt capital, which greatly increases certainty and speed of closing as well as provides GAIN’s shareholders with both current yield in the form of monthly dividends and potential capital gains upside. In addition to providing most, if not all, of the equity and debt capital required to close a transaction, GAIN has no partnership end-of-life deadlines and can structure investments in line with the long-term needs of the businesses we invest in. By providing truly patient, long-term capital, GAIN is a value-added partner to the companies we invest in. GAIN GAIN Dividend Coverage Update

Author’s Note: The following information was provided to subscribers along with three quarters of financial projections using base, best, and worst-case assumptions to test the sustainability of the current dividends for GAIN .

For calendar Q4 2021, GAIN beat my best-case projections only due to adviser fee credits and higher-than-expected success fee income (mostly from SOG Specialty Knives & Tools ) partially offset by lower portfolio yield and no dividend income. Also, there was a decline in the overall portfolio resulting in lower leverage which is now the lowest in the sector with a debt-to-equity ratio of 0.54 (net of cash) and plenty of growth capital available to improve dividend coverage. More importantly and as predicted in the previous report, there were additional realized gains of $0.66 per share mostly due to exiting its investment in Pioneer Square Brands to support additional supplement dividends in 2022 which will be discussed in the updated GAIN Deep Dive Projections report. ‘Core NII’ takes into account incentive fees related to capital gains: BDC Buzz GLAD Dividend Coverage Update

Author’s Note: The following information was provided to subscribers along with three quarters of financial projections using base, best, and worst-case assumptions to test the sustainability of the current dividends for GLAD .

For calendar Q4 2021, GLAD easily beat my best-case projections due to higher-than-expected dividend and fee income combined with higher fee credits covering its monthly dividends by 137%. As discussed in the previous report, GLAD sold its investment in Lignetics, Inc. resulting in success fee income of $1.6 million and $13.4 million or $0.39 per share of realized gains during Q4 2021. GLAD’s net asset value (“NAV”) per share increased by another 1.7% during the quarter due to overearning its dividends and improved valuations from its ‘watch list’ as discussed later.

As of December 31, 2021, the company has over $100 million of available liquidity under its credit facility for additional portfolio growth. As shown in the following table, GLAD would have covered its dividends by 108% without the benefit of fee credits. BDC Buzz GLAD’s dividend coverage continues to improve including the reduced reliance on incentive fee credits by management to cover the dividend.

GLAD’s advisor credits have historically included the following three components: Credits for closing deal fees paid directly to the manager of which there should always be some and this eliminates any conflicts in pushing fees over yield on investments.

Credits to reduce the management fee on syndicated credits to 0.50% which is declining as a percentage of the overall portfolio and will become immaterial soon.

Incentive fee credits […]

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